Domestic market power, the transnational industry cycle, and the merits of free versus fair trade

SPECTIVE The cyclical behavior of the transnational corporation as a major force in both the process and distribution of global trade and investment was initially implied in Vernon" s analysis of the firm' s product life cycle. As a firm's firm specific innovations proceed from new product to maturing product and then to the final stage of product standardization, the firm' s competitive advantage is *Spelman College.
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INTERNATIONAL ADVANCES IN ECONOMIC RESEARCH
progressively eroded as first new domestic competition and then foreign competition compel the firm to export and then to direct invest abroad in an effort to preserve its initial competitive advantage [Vernon, 1966]. Although Vernon does not directly address the market structure implications of the product life cycle, one can infer that during the new product stage the firm enjoys a near monopoly position in both the domestic and international markets. The prospects for technological diffusion to other markets is, therefore, limited. As such, in a world dominated by transnationals, the monopoly stage of the product life cycle is unlikely to move the global economy toward the free trade optimum. With 'the maturing product stage the firm's monopoly at home has been transformed into that of an oligopolist who may or may not exercise sufficient market power to retain a monopoly return on its prior investment in either the home or foreign market. The resort to direct investment during the mature product and standardization stage transforms the original innovator" s position into one of monopolistic competitor as duplication at home and abroad further erode the innovator' s ability to reap monopoly returns on its investment. However, direct investment initiatives designed to service both foreign and domestic markets accelerates the pace of technological diffusion. 2 Hence, the prospects for the realization of the free trade optimum improve. With respect to profitability, the monopoly stage of the product life cycle is likely to be one where the firm's domestic and foreign profitability are positively related such that the firm's decision to export and to invest abroad enhances its domestic market power. 3 However, during the product standardization phase when monopolistic competition is operative in the domestic market, there is an inverse relationship between domestic and foreign profitability. As such, foreign profitably is no longer utilized to enhance a transnational' s domestic market but to offset its decline in the domestic market. The rate and scope of technological diffusion from transnationals to external markets and hence the possibilities for transforming the transnational ' s monopolistic advantage into a monopolistically competitive advantage is influenced by whether such diffusion is influenced by the transnational's need to exploit a knowledge-based advantage or by the need to acquire new knowledge. During the monopoly and oligopoly stage the transnational's need to exploit a knowledge-based advantage outweighs its need to acquire knowledge hence the rate of technological diffusion by transnationals is rather limited and motivated by defensive responses to new entry from either domestic or foreign competitors. However, during the phase of monopolistic competition the rate of technological diffusion by transnationals is accelerated as the need to acquire knowledge about existing and potential markets outweighs consideration pertaining to the exploitation of knowledge-based advantages. 4,5 In sum, when the need to acquire knowledge about existing and/or potential foreign markets outweigh concerns about exploiting knowledge-based advantages, the transnationals behavior will improve the globe's prospects for achieving the free trade optimum. Magee [1977] generates an economic model which explicitly incorporates market structure and market power into the transnational industry cycle. Magee borrowing from Johnson [Johnson, 1971] indicates that the firm's firm-specific advantages in information-intensive production yield economic rents which the firm seeks to exploit and preserve by way of product innovation. According to Magee and others [Horst 1972], large firm size and high market concentration provide a conducive economic environment for forging intrafirm transactions which facilitate the exploitation of monopoly rents inherent in knowledge-intensive production. The transnational's market power under such conditions enhances its ability to lower appropriability costs associated with knowledge-intensive investment and to preserve the price-cost differential which yields the margin of monopoly rent. 6 In this respect, the transnational industry cycle is a profit cycle [Markusen, 1985]. Appropriability barriers to entry prevail during Magee's product innovation stage and are considered natural barriers to entry. Magee borrowing again from Johnson [1971], contends that