The industrial organization theory was pioneered by Stephen Hymer (1960) who emphasised the competition for market shares among oligopolies. The industrial organization theory has come a long way since Hymer postulated that internal operations of national firms was the reason for the foreign direct investment instead of the international exchange of capital, which had been assumed prior to this time. With this idea in mind Hymer proceeded to establish the theoretical foundations of foreign direct investment in industrial organization theory.
Traditional industrial research however theory hardly discusses the relationships between an industry and a market.
While the theory itself has made many theoretical strides, it is confronted by a serious methodological problem that although many models of corporate behaviour applicable to specific industries have been developed, there have been no general model or overarching theory of industrial organization. This theory attempts to explain the Industrial market processes through the economic output of a firm within an industry, taking into account sector and firm specific determinants.
According to the theory, the market structure or the environment determines the market conduct i. e. the behaviour of economic agents within the environment and thereby sets the level of market performance, for instance how close the industry comes to meeting the norm or standard of reference of social welfare (Prasad, Ghauri, 2004, pp. 48). The standard industrial organization theory of FDI suggests that the foreign firms are able to invest overseas only when they posses specific ownership advantages.
In the industrial organization theory of direct investment, a necessary condition for the investment is having distinct rent-yielding advantages (Scott, 1995, pp.
219). The eclectic industrial organization theory of FDI suggests that foreign firms are able to invest in advanced economies such as United States are likely to be efficient. Industrial organization theory posits that a causal flow exists between market structures, conduct and performance.
The theory can be tested using indicators that determine the existence and extent of deviations from the perfectly competitive model. However, even the neoclassical theory of industrial organization is not concerned with the study of real markets, but rather with the markets under the assumption of full information and unlimited rationality. The theory can applied either in its positive i. e. absolute sense or some predictions can be allowed to be made at the time of analysis (Scott, 1995, pp. 219).
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