《国际政治经济学》文献资料（Political Economy of Foreign Investment）International Investment and International Trade in the Product Cycle

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INTERNATIONAL INVESTMENT AND INTERNATIONAL TRADE IN THE PRODUCT CYCLE RAYMOND VERNON Location of new products,191.-The maturing product,196.-The standardized product,202. Anyone who has sought to understand the shifts in internation- al trade and international investment over the past twenty years has chafed from time to time under an acute sense of the inadequacy of the available analytical tools.While the comparative cost con- cept and other basic concepts have rarely failed to provide some help,they have usually carried the analyst only a very little way toward adequate understanding.For the most part,it has been necessary to formulate new concepts in order to explore issues such as the strengths and limitations of import substitution in the de- velopment process,the implications of common market arrange- ments for trade and investment,the underlying reasons for the Leontief paradox,and other critical issues of the day. As theorists have groped for some more efficient tools,there has been a flowering in international trade and capital theory.But the very proliferation of theory has increased the urgency of the search for unifying concepts.It is doubtful that we shall find many prop- ositions that can match the simplicity,power,and universality of application of the theory of comparative advantage and the inter- national equilibrating mechanism;but unless the search for better tools goes on,the usefulness of economic theory for the solution of problems in international trade and capital movements will probably decline. The present paper deals with one promising line of generaliza- tion and synthesis which seems to me to have been somewhat neg- lected by the main stream of trade theory.It puts less emphasis upon comparative cost doctrine and more upon the timing of in- novation,the effects of scale economies,and the roles of ignorance and uncertainty in influencing trade patterns.It is an approach The preparation of this article was financed in part by a grant from the Ford Foundation to the Harvard Business School to support a study of the implications of United States foreign direct investment.This paper is a by- product of the hypothesis-building stage of the study

INTERNATIONAL INVESTMENT AND INTERNATIONAL TRADE IN THE PRODUCT CYCLE * Location of new products, 191.-The maturing product, 196.-The standardized product, 202. Anyone who has sought to understand the shifts in international trade and international investment over the past twenty years has chafed from time to time under an acute sense of the inadequacy of the available analytical tools. While the comparative cost concept and other basic concepts have rarely failed to provide some help, they have usually carried the analyst only a very little way toward adequate understanding. For the most part, it has been necessary to formulate new concepts in order to explore issues such as the strengths and limitations of import substitution in the development process, the implications of common market arrangements for trade and investment, the underlying reasons for the Leontief paradox, and other critical issues of the day. As theorists have groped for some more efficient tools, there has been a flowering in international trade and capital theory. But the very proliferation of theory has increased the urgency of the search for unifying concepts. It is doubtful that we shall find many propositions that can match the simplicity, power, and universality of application of the theory of comparative advantage and the international equilibrating mechanism; but unless the search for better tools goes on, the usefulness of economic theory for the solution of problems in international trade and capital movements will probably decline. The present paper deals with one promising line of generalization and synthesis which seems to me to have been somewhat neglected by the main stream of trade theory. It puts less emphasis upon comparative cost doctrine and more upon the timing of innovation, the effects of scale economies, and the roles of ignorance and uncertainty in influencing trade patterns. It is an approach * The preparation of this article was financed in part by a grant from the Ford Foundation to the Harvard Business School to support a study of the implications of United States foreign direct investment. This paper is a by- product of the hypothesis-building stage of the study

INVESTMENT AND TRADE 191 with respectable sponsorship,deriving bits and pieces of its inspira- tion from the writings of such persons as Williams,Kindleberger, MacDougall,Hoffmeyer,and Burenstam-Linder.1 Emphases of this sort seem first to have appeared when econ- omists were searching for an explanation of what looked like a persistent,structural shortage of dollars in the world.When the shortage proved ephemeral in the late 1950's,many of the ideas which the shortage had stimulated were tossed overboard as prima facie wrong.?Nevertheless,one cannot be exposed to the main cur- rents of international trade for very long without feeling that any theory which neglected the roles of innovation,scale,ignorance and uncertainty would be incomplete. LOCATION OF NEW PRODUCTS We begin with the assumption that the enterprises in any one of the advanced countries of the world are not distinguishably dif- ferent from those in any other advanced country,in terms of their access to scientific knowledge and their capacity to comprehend scientific principles.3 All of them,we may safely assume,can secure access to the knowledge that exists in the physical,chemical and biological sciences.These sciences at times may be difficult,but they are rarely occult. It is a mistake to assume,however,that equal access to scien- tific principles in all the advanced countries means equal probabil- ity of the application of these principles in the generation of new products.There is ordinarily a large gap between the knowledge of a scientific principle and the embodiment of the principle in 1.J.H.Williams,"The Theory of International Trade Reconsidered," reprinted as Chap.2 in his Postwar Monetary Plans and Other Essays (Oxford: Basil Blackwell,1947);C.P.Kindleberger,The Dollar Shortage (New York: Wiley,1950);Erik Hoffmeyer,Dollar Shortage (Amsterdam:North-Holland, 1958);Sir Donald MacDougall,The World Dollar Problem (London:Mac- millan,1957);Staffan Burenstam-Linder,An Essay on Trade and Transforma- tion (Uppsala:Almqvist Wicksells,1961). 2.The best summary of the state of trade theory that has come to my attention in recent years is J.Bhagwati,"The Pure Theory of International Trade,"Economic Journal,LXXIV (Mar.1964),1-84.Bhagwati refers ob- liquely to some of the theories which concern us here;but they receive much less attention than I think they deserve. 3.Some of the account that follows will be found in greatly truncated form in my "The Trade Expansion Act in Perspective,"in Emerging Concepts in Marketing,Proceedings of the American Marketing Association,December 1962,pp.384-89.The elaboration here owes a good deal to the perceptive work of Se'ev Hirsch, summarized in his unpublished doctoral thesis,"Loca- tion of Industry and International Competitiveness,"Harvard Business School, 1965

INVESTMENT AND TRADE 191 with respectable sponsorship, deriving bits and pieces of its inspiration from the writings of such persons as Williams, Kindleberger, MacDougall, Hoffmeyer, and Burenstam-Linder.l Emphases of this sort seem first to have appeared when economists were searching for an explanation of what looked like a persistent, structural shortage of dollars in the world. When the shortage proved ephemeral in the late 19501s, many of the ideas which the shortage had stimulated were tossed overboard as prima facie wrong.2 Nevertheless, one cannot be exposed to the main currents of international trade for very long without feeling that any theory which neglected the roles of innovation, scale, ignorance and uncertainty would be incomplete. We begin with the assumption that the enterprises in any one of the advanced countries of the world are not distinguishably different from those in any other advanced country, in terms of their access to scientific knowledge and their capacity to comprehend scientific principle^.^ All of them, we may safely assume, can secure access to the knowledge that exists in the physical, chemical and biological sciences. These sciences at times may be difficult, but they are rarely occult. It is a mistake to assume, however, that equal access to scientific principles in all the advanced countries means equal probability of the application of these principles in the generation of new products. There is ordinarily a large gap between the knowledge of a scientific principle and the embodiment of the principle in 1. J. H. Williams, "The Theory of International Trade Reconsidered," reprinted as Chap. 2 in his Postwar Monetary Plans and Other Essays (Oxford: Basil Blackwell, 1947) ; C. P. Kindleberger, The Dollar Shortage (New York: Wiley, 1950) ; Erik Hoffmeyer, Dollar Shortage (Amsterdam: North-Holland, 1958); Sir Donald MacDougall, The World Dollar Problem (London: Macmillan, 1957) ; Staffan Burenstam-Linder, An Essay on Trade and Transformation (Uppsala: Almqvist & Wicksells, 1961). 2. The best summary of the state of trade theory that has come to my attention in recent years is J. Bhagwati, "The Pure Theory of International Trade," Economic Journal, LXXIV (Mar. 19641, 1-84. Bhagwati refers obliquely to some of the theories which concern us here; but they receive much less attention than I think they deserve. 3. Some of the account that follows will be found in greatly truncated form in my "The Trade Expansion Act in Perspective," in Emerging Concepts in Marketing, Proceedings of the American Marketing Association, December 1962, pp. 384-89. The elaboration here owes a good deal to the perceptive work of Se'ev Hirsch, summarized in his unpublished doctoral thesis, "Location of Industry and International Competitiveness," Harvard Business School, 1965

192 QUARTERLY JOURNAL OF ECONOMICS a marketable product.An entrepreneur usually has to intervene to accept the risks involved in testing whether the gap can be bridged. If all entrepreneurs,wherever located,could be presumed to be equally conscious of and equally responsive to all entrepreneurial opportunities,wherever they arose,the classical view of the dom- inant role of price in resource allocation might be highly relevant. There is good reason to believe,however,that the entrepreneur's consciousness of and responsiveness to opportunity are a function of ease of communication;and further,that ease of communication is a function of geographical proximity.Accordingly,we abandon the powerful simplifying notion that knowledge is a universal free good,and introduce it as an independent variable in the decision to trade or to invest. The fact that the search for knowledge is an inseparable part of the decision-making process and that relative ease of access to knowledge can profoundly affect the outcome are now reasonably well established through empirical research.5 One implication of that fact is that producers in any market are more likely to be aware of the possibility of introducing new products in that market than producers located elsewhere would be. The United States market offers certain unique kinds of op- portunities to those who are in a position to be aware of them. First,the United States market consists of consumers with an average income which is higher (except for a few anomalies like Kuwait)than that in any other national market-twice as high as that of Western Europe,for instance.Wherever there was a chance to offer a new product responsive to wants at high levels of income,this chance would presumably first be apparent to someone in a position to observe the United States market. Second,the United States market is characterized by high unit labor costs and relatively unrationed capital compared with prac- tically all other markets.This is a fact which conditions the demand for both consumer goods and industrial products.In the case of consumer goods,for instance,the high cost of laundresses contributes to the origins of the drip-dry shirt and the home washing machine. In the case of industrial goods,high labor cost leads to the early 4.Note C.P.Kindleberger's reference to the "horizon"of the decision- maker,and the view that he can only be rational within that horizon;see his Foreign Trade and The National Economy (New Haven:Yale University Press,1962),p.15 passim. 5.See,for instance,Richard M.Cyert and James G.March,A Behavioral Theory of the Firm (Englewood Cliffs,N.J.:Prentice-Hall,1963),esp.Chap. 6;and Yair Aharoni,The Foreign Investment Decision Process,to be pub- lished by the Division of Research of the Harvard Business School,1966

192 QUARTERLY JOURNAL OF ECONOMICS a marketable product. An entrepreneur usually has to intervene to accept the risks involved in testing whether the gap can be bridged. If all entrepreneurs, wherever located, could be presumed to be equally conscious of and equally responsive to all entrepreneurial opportunities, wherever they arose, the classical view of the dominant role of price in resource allocation might be highly relevant. There is good reason to believe, however, that the entrepreneur's consciousness of and responsiveness to opportunity are a function of ease of communication; and further, that ease of communication is a function of geographical pr~ximity.~ Accordingly, we abandon the powerful simplifying notion that knowledge is a universal free good, and introduce it as an independent variable in the decision to trade or to invest. The fact that the search for knowledge is an inseparable part of the decision-making process and that relative ease of access to knowledge can profoundly affect the outcome are now reasonably well established through empirical re~earch.~ One implication of that fact is that producers in any market are more likely to be aware of the possibility of introducing new products in that market than producers located elsewhere would be. The United States market offers certain unique kinds of opportunities to those who are in a position to be aware of them. First, the United States market consists of consumers with an average income which is higher (except for a few anomalies like Kuwait) than that in any other national market -twice as high as that of Western Europe, for instance. Wherever there was a chance to offer a new product responsive to wants at high levels of income, this chance would presumably first be apparent to someone in a position to observe the United States market. Second, the United States market is characterized by high unit labor costs and relatively unrationed capital compared with practically all other markets. This is a fact which conditions the demand for both consumer goods and industrial products. In the case of consumer goods, for instance, the high cost of laundresses contributes to the origins of the drip-dry shirt and the home washing machine. In the case of industrial goods, high labor cost leads to the early 4. Note C. P. Kindleberger's reference to tlie "horizon" of the decisionmaker, and the view that he can only be rational within that horizon; see liis Foreign Trade and The National Economy (New Haven: Yale University Press, 19621, p. 15 passim. 5. See, for instance, Richard M. Cyert and James G. March, A Behavioral Theory of the Firm (Englewood Cliffs, N.J.: Prentice-Hall, 19631, esp. Chap. 6; and Yair Aharoni, The Foreign Investment Deczsion Process, to be published by the Division of Research of the Harvard Business School, 1966

INVESTMENT AND TRADE 193 development and use of the conveyor belt,the fork-lift truck and the automatic control system.It seems to follow that wherever there was a chance successfully to sell a new product responsive to the need to conserve labor,this chance would be apparent first to those in a position to observe the United States market. Assume,then,that entrepreneurs in the United States are first aware of opportunities to satisfy new wants associated with high income levels or high unit labor costs.Assume further that the evidence of an unfilled need and the hope of some kind of monopoly windfall for the early starter both are sufficiently strong to justify the initial investment that is usually involved in converting an ab- stract idea into a marketable product.Here we have a reason for expecting a consistently higher rate of expenditure on product development to be undertaken by United States producers than by producers in other countries,at least in lines which promise to sub- stitute capital for labor or which promise to satisfy high-income wants.Therefore,if United States firms spend more than their foreign counterparts on new product development (often mislead- ingly labeled "research"),this may be due not to some obscure sociological drive for innovation but to more effective communication between the potential market and the potential supplier of the mar- ket.This sort of explanation is consistent with the pioneer appear- ance in the United States (conflicting claims of the Soviet Union notwithstanding)of the sewing machine,the typewriter,the tractor, etc. At this point in the exposition,it is important once more to emphasize that the discussion so far relates only to innovation in certain kinds of products,namely to those associated with high income and those which substitute capital for labor.Our hypothesis says nothing about industrial innovation in general;this is a larger subject than we have tackled here.There are very few countries that have failed to introduce at least a few products;and there are some,such as Germany and Japan,which have been responsible for a considerable number of such introductions.Germany's outstand- ing successes in the development and use of plastics may have been due,for instance,to a traditional concern with her lack of a raw materials base,and a recognition that a market might exist in Germany for synthetic substitutes. 6.See two excellent studies:C.Freeman,"The Plastics Industry:A Comparative Study of Research and Innovation,"in National Institute Eco- momic Review,No.26 (Nov.1963),p.22 et seg.;G.C.Hufbauer,Sunthetic Materials and the Theory of International Trade (London:Gerald Duckworth, 1965).A number of links in the Hufbauer arguments are remarkably similar to

INVESTMENT AND TRADE 193 development and use of the conveyor belt, the fork-lift truck and the automatic control system. It seems to follow that wherever there was a chance successfully to sell a new product responsive to the need to conserve labor, this chance would be apparent first to those in a position to observe the United States market. Assume, then, that entrepreneurs in the United States are first aware of opportunities to satisfy new wants associated with high income levels or high unit labor costs. Assume further that the evidence of an unfilled need and the hope of some kind of monopoly windfall for the early starter both are sufficiently strong to justify the initial investment that is usually involved in converting an abstract idea into a marketable product. Here we have a reason for expecting a consistently higher rate of expenditure on product development to be undertaken by United States producers than by producers in other countries, at least in lines which promise to substitute capital for labor or which promise to satisfy high-income wants. Therefore, if United States firms spend more than their foreign counterparts on new product development (often misleadingly labeled "research"), this may be due not to some obscure sociological drive for innovation but to more effective communication between the potential market and the potential supplier of the market. This sort of explanation is consistent with the pioneer appearance in the United States (conflicting claims of the Soviet Union notwithstanding) of the sewing machine, the typewriter, the tractor, etc. At this point in the exposition, it is important once more to emphasize that the discussion so far relates only to innovation in certain kinds of products, namely to those associated with high income and those which substitute capital for labor. Our hypothesis says nothing about industrial innovation in general; this is a larger subject than we have tackled here. There are very few countries that have failed to introduce at least a few products; and there are some, such as Germany and Japan, which have been responsible for a considerable number of such introductions. Germany's outstanding successes in the development and use of plastics may have been due, for instance, to a traditional concern with her lack of a raw materials base, and a recognition that a market might exist in Germany for synthetic substitute^.^ 6. See two excellent studies: C. Freeman, "The Plastics Industry: A Comparative Study of Research and Innovation," in National Institute Economic Review, No. 26 (Nov. 1963), p. 22 et seq.; G. C. Hufbauer, Synthetic Materials and the Theory of International Trade (London: Gerald Duckworth, 1965). A number of links in the Hufbauer arguments are remarkably similar to

194 QUARTERLY JOURNAL OF ECONOMICS Our hypothesis asserts that United States producers are likely to be the first to spy an opportunity for high-income or labor-saving new products.7 But it goes on to assert that the first producing facilities for such products will be located in the United States.This is not a self-evident proposition.Under the calculus of least cost, production need not automatically take place at a location close to the market,unless the product can be produced and delivered from that location at lowest cost.Besides,now that most major United States companies control facilities situated in one or more locations outside of the United States,the possibility of considering a non- United States location is even more plausible than it might once have been. Of course,if prospective producers were to make their loca- tional choices on the basis of least-cost considerations,the United States would not always be ruled out.The costs of international transport and United States import duties,for instance,might be so high as to argue for such a location.My guess is,however,that the early producers of a new product intended for the United States market are attracted to a United States location by forces which are far stronger than relative factor-cost and transport considera- tions.For the reasoning on this point,one has to take a long detour away from comparative cost analysis into areas which fall under the rubrics of communication and external economies. By now,a considerable amount of empirical work has been done on the factors affecting the location of industry.8 Many of these studies try to explain observed locational patterns in conven- tional cost-minimizing terms,by implicit or explicit reference to labor cost and transportation cost.But some explicitly introduce problems of communication and external economies as powerful locational forces.These factors were given special emphasis in the analyses which were a part of the New York Metropolitan Region Study of the 1950's.At the risk of oversimplifying,I shall try to summarize what these studies suggested. some in this paper;but he was not aware of my writings nor I of his until after both had been completed. 7.There is a kind of first-cousin relationship between this simple notion and the "entrained want"concept defined by H.G.Barnett in Innovation: The Basis of Cultural Change (New York:McGraw-Hill,1953)p.148.Albert O.Hirschman,The Strategy of Economic Development (New Haven:Yale University Press,1958),p.68,also finds the concept helpful in his effort to explain certain aspects of economic development. 8.For a summary of such work,together with a useful bibliography,see John Meyer, "Regional Economics:A Survey,"in the American Economic Review,LIII (Mar.1963),19-54. 9.The points that follow are dealt with at length in the following pub- lications:Raymond Vernon,Metropolis,1986 (Cambridge:Harvard Uni-

194 QUARTERLY JOURNAL OF ECONOMICS Our hypothesis asserts that United States producers are likely to be the first to spy an opportunity for high-income or labor-saving new products.* But it goes on to assert that the first producing facilities for such products will be located in the United States. This is not a self-evident proposition. Under the calculus of least cost, production need not automatically take place at a location close to the market, unless the product can be produced and delivered from that location at lowest cost. Besides, now that most major United States companies control facilities situated in one or more locations outside of the United States, the possibility of considering a nonUnited States location is even more plausible than it might once have been. Of course, if prospective producers were to make their locational choices on the basis of least-cost considerations, the United States would not always be ruled out. The costs of international transport and United States import duties, for instance, might be so high as to argue for such a location. My guess is, however, that the early producers of a new product intended for the United States market are attracted to a United States location by forces which are far stronger than relative factor-cost and transport considerations. For the reasoning on this point, one has to take a long detour away from comparative cost analysis into areas which fall under the rubrics of communication and external economies. By now, a considerable amount of empirical work has been done on the factors affecting the location of ind~stry.~Many of these studies try to explain observed locational patterns in conventional cost-minimizing terms, by implicit or explicit reference to labor cost and transportation cost. But some explicitly introduce problems of communication and external economies as powerful locational forces. These factors were given special emphasis in the analyses which were a part of the New York Metropolitan Region Study of the 1950's. At the risk of oversimplifying, I shall try to summarize what these studies suggested? some in this paper; but he was not aware of my writings nor I of his until after both had been completed. 7. There is a kind of first-cousin relationship between this simple notion and the "entrained want" concept defined by H. G. Barnett in Innovation: The Basis of Cultural Change (New York: McGraw-Hill, 1953) p. 148. Albert 0.Hirschman, The Strategy of Economic Development (New Haven: Yale University Press, 1958), p. 68, also finds the concept helpful in his effort to explain certain aspects of economic development. 8. For a summary of such work, together with a useful bibliography, see John Meyer, "Regional Economics: A Survey," in the American Economic Review, LIII (Mar. 1963), 19-54. 9. The points that follow are dealt with at length in the following publications: Raymond Vernon, Metropolis, 1986 (Cambridge: Harvard Uni-

INVESTMENT AND TRADE 195 In the early stages of introduction of a new product,producers were usually confronted with a number of critical,albeit transitory, conditions.For one thing,the product itself may be quite unstand- ardized for a time;its inputs,its processing,and its final specifica- tions may cover a wide range.Contrast the great variety of auto- mobiles produced and marketed before 1910 with the thoroughly standardized product of the 1930's,or the variegated radio designs of the 1920's with the uniform models of the 1930's.The unstand- ardized nature of the design at this early stage carries with it a number of locational implications. First,producers at this stage are particularly concerned with the degree of freedom they have in changing their inputs.Of course, the cost of the inputs is also relevant.But as long as the nature of these inputs cannot be fixed in advance with assurance,the calcula- tion of cost must take into account the general need for flexibility in any locational choice.1 Second,the price elasticity of demand for the output of individ- ual firms is comparatively low.This follows from the high degree of production differentiation,or the existence of monopoly in the early stages.2 One result is,of course,that small cost differences count less in the calculations of the entrepreneur than they are likely to count later on. Third,the need for swift and effective communication on the part of the producer with customers,suppliers,and even competi- tors is especially high at this stage.This is a corollary of the fact that a considerable amount of uncertainty remains regarding the ultimate dimensions of the market,the efforts of rivals to preempt that market,the specifications of the inputs needed for production, and the specifications of the products likely to be most successful in the effort. All of these considerations tend to argue for a location in which communication between the market and the executives directly con- cerned with the new product is swift and easy,and in which a wide versity Press,1960),pp.38-85;Max Hall (ed.),Made in New York (Cam- bridge:Harvard University Press,1959),pp.3-18,19 passim;Robert M. Lichtenberg,One-Tenth of a Nation (Cambridge:Harvard University Press, 1960),pp.31-70. 1.This is,of course,a familiar point elaborated in George F.Stigler, "Production and Distribution in the Short Run,"Journal of Polilical Econ- omy,XLVII (June 1939),305,et seq. 2.Hufbauer,op.cit.,suggests that the low price elasticity of demand in the first gtage may be due simply to the fact that the first market may be a "captive market"unresponsive to price changes;but that later,in order to expand the use of the new product,other markets may be brought in which are more price responsive

INVESTMENT AND TRADE 195 In the early stages of introduction of a new product, producers were usually confronted with a number of critical, albeit transitory, conditions. For one thing, the product itself may be quite unstandardized for a time; its inputs, its processing, and its final specifications may cover a wide range. Contrast the great variety of automobiles produced and marketed before 1910 with the thoroughly standardized product of the 1930's, or the variegated radio designs of the 1920's with the uniform models of the 1930's. The unstandardized nature of the design at this early stage carries with it a number of locational implications. First, producers at this stage are particularly concerned with the degree of freedom they have in changing their inputs. Of course, the cost of the inputs is also relevant. But as long as the nature of these inputs cannot be fixed in advance with assurance, the calculation of cost must take into account the general need for flexibility in any locational ch0ice.l Second, the price elasticity of demand for the output of individual firms is comparatively low. This follows from the high degree of production differentiation, or the existence of monopoly in the early stage^.^ One result is, of course, that small cost differences count less in the calculations of the entrepreneur than they are likely to count later on. Third, the need for swift and effective communication on the part of the producer with customers, suppliers, and even competitors is especially high at this stage. This is a corollary of the fact that a considerable amount of uncertainty remains regarding the ultimate dimensions of the market, the efforts of rivals to preempt that market, the specifications of the inputs needed for production, and the specifications of the products likely to be most successful in the effort. All of these considerations tend to argue for a location in which communication between the market and the executives directly concerned with the new product is swift and easy, and in which a wide venity Press, lW), pp. 38-85; Max Hall (ed.), Made in New York (Cam- bridge: Harvard University Press, 1959), p?. 3-18, 19 passim; Robert M. Lichtenberg, One-Tenth of a Nation (Cambridge: Harvard University Press, lW), pp. 31-70. 1. This is, of course, a familiar point elaborated in George F. Stigler, "Production and Distribution in the Short Run," Jouml of Political Economy, XLVII (June 1939), 305, et seq. 2. Hufbauer, op. cit., suggests that the low price elasticity of demand in the first stage may be due simply to the fact that the first market may be a "captive market" unresponsive to price changes; but that later, in order to expand the yse of the-new product, other marketa may be brought in which are more pnce responmve

196 QUARTERLY JOURNAL OF ECONOMICS variety of potential types of input that might be needed by the production unit are easily come by.In brief,the producer who sees a market for some new product in the United States may be led to select a United States location for production on the basis of national locational considerations which extend well beyond simple factor cost analysis plus transport considerations. THE MATURING PRODUCT 3 As the demand for a product expands,a certain degree of stand- ardization usually takes place.This is not to say that efforts at product differentiation come to an end.On the contrary;such ef- forts may even intensify,as competitors try to avoid the full brunt of price competition.Moreover,variety may appear as a result of specialization.Radios,for instance,ultimately acquired such specialized forms as clock radios,automobile radios,portable radios, and so on.Nevertheless,though the subcategories may multiply and the efforts at product differentiation increase,a growing ac- ceptance of certain general standards seems to be typical. Once again,the change has locational implications.First of all, the need for flexibility declines.A commitment to some set of prod- uct standards opens up technical possibilities for achieving econ- omies of scale through mass output,and encourages long-term com- mitments to some given process and some fixed set of facilities. Second,concern about production cost begins to take the place of concern about product characteristics.Even if increased price com- petition is not yet present,the reduction of the uncertainties sur- rounding the operation enhances the usefulness of cost projections and increases the attention devoted to cost. The empirical studies to which I referred earlier suggest that, at this stage in an industry's development,there is likely to be con- siderable shift in the location of production facilities at least as far as internal United States locations are concerned.The empirical materials on international locational shifts simply have not yet been analyzed sufficiently to tell us very much.A little speculation, however,indicates some hypotheses worth testing. Picture an industry engaged in the manufacture of the high- income or labor-saving products that are the focus of our discussion. Assume that the industry has begun to settle down in the United States to some degree of large-scale production.Although the first 3.Both Hirsch,op.cit.,and Freeman,op.cit.,make use of a three-stage product classification of the sort used here

196 QUARTERLY JOURNAL OF ECONOMICS variety of potential types of input that might be needed by the production unit are easily come by. In brief, the producer who sees a market for some new product in the United States may be led to select a United States location for production on the basis of national locational considerations which extend well beyond simple factor cost analysis plus transport considerations. As the demand for a product expands, a certain degree of standardization usually takes place. This is not to say that efforts at product differentiation come to an end. On the contrary; such efforts may even intensify, as competitors try to avoid the full brunt of price competition. Moreover, variety may appear as a result of specialization. Radios, for instance, ultimately acquired such specialized forms as clock radios, automobile radios, portable radios, and so on. Nevertheless, though the subcategories may multiply and the efforts at product differentiation increase, a growing acceptance of certain general standards seems to be typical. Once again, the change has locational implications. First of all, the need for flexibility declines. A commitment to some set of product standards opens up technical possibilities for achieving economies of scale through mass output, and encourages long-term commitments to some given process and some fixed set of facilities. Second, concern about production cost begins to take the place of concern about product characteristics. Even if increased price competition is not yet present, the reduction of the uncertainties surrounding the operation enhances the usefulness of cost projections and increases the attention devoted to cost. The empirical studies to which I referred earlier suggest that, at this stage in an industry's development, there is likely to be considerable shift in the location of production facilities at least as far as internal United States locations are concerned. The empirical materials on international locational shifts simply have not yet been analyzed sufficiently to tell us very much. A little speculation, however, indicates some hypotheses worth testing. Picture an industry engaged in the manufacture of the highincome or labor-saving products that are the focus of our discussion. Assume that the industry has begun to settle down in the United States to some degree of large-scale production. Although the first 3. Both Kirsch, op. cit., and Freeman, op. cit., make use of a three-stage product classification of the sort used here

INVESTMENT AND TRADE 197 mass market may be located in the United States,some demand for the product begins almost at once to appear elsewhere.For instance, although heavy fork-lift trucks in general may have a comparative- ly small market in Spain because of the relative cheapness of un- skilled labor in that country,some limited demand for the product will appear there almost as soon as the existence of the product is known. If the product has a high income elasticity of demand or if it is a satisfactory substitute for high-cost labor,the demand in time will begin to grow quite rapidly in relatively advanced countries such as those of Western Europe.Once the market expands in such an advanced country,entrepreneurs will begin to ask themselves whether the time has come to take the risk of setting up a local producing facility. How long does it take to reach this stage?An adequate answer must surely be a complex one.Producers located in the United States,weighing the wisdom of setting up a new production facility in the importing country,will feel obliged to balance a number of complex considerations.As long as the marginal production cost plus the transport cost of the goods exported from the United States is lower than the average cost of prospective production in the market of import,United States producers will presumably prefer to avoid an investment.But that calculation depends on the producer's ability to project the cost of production in a market in which factor costs and the appropriate technology differ from those at home. Now and again,the locational force which determined some particular overseas investment is so simple and so powerful that one has little difficulty in identifying it.Otis Elevator's early pro- liferation of production facilities abroad was quite patently a func- tion of the high cost of shipping assembled elevator cabins to distant locations and the limited scale advantages involved in manufactur- ing elevator cabins at a single location.5 Singer's decision to invest in Scotland as early as 1867 was also based on considerations of a sort sympathetic with our hypothesis.It is not unlikely that the 4.M.V.Posner,"International Trade and Technical Change,"Ozford Economic Papers,Vol.13 (Oct.1961),p.323,et seq.presents a stimulating model purporting to explain such familiar trade phenomena as the exchange of machine tools between the United Kingdom and Germany.In the process he offers some particularly helpful notions concerning the size of the "imita- tion lag"in the responses of competing nations. 5.Dudley M.Phelps,Migration of Industry to South America (New York:MeGraw-Hill,1963),p.4. 6.John H.Dunning,American Investment in British Manufacturing Industry (London:George Allen Unwin,1958),p.18.The Dunning book

INVESTMENT AND TRADE 197 mass market may be located in the United States, some demand for the product begins almost at once to appear elsewhere. For instance, although heavy fork-lift trucks in general may have a comparatively small market in Spain because of the relative cheapness of unskilled labor in that country, some limited demand for the product will appear there almost as soon as the existence of the product is known. If the product has a high income elasticity of demand or if it is a satisfactory substitute for high-cost labor, the demand in time will begin to grow quite rapidly in relatively advanced countries such as those of Western Europe. Once the market expands in such an advanced country, entrepreneurs will begin to ask themselves whether the time has come to take the risk of setting up a local producing facility .4 How long does it take to reach this stage? An adequate answer must surely be a complex one. Producers located in the United States, weighing the wisdom of setting up a new production facility in the importing country, will feel obliged to balance a number of complex considerations. As long as the marginal production cost plus the transport cost of the goods exported from the United States is lower than the average cost of prospective production in the market of import, United States producers will presumably prefer to avoid an investment. But that calculation depends on the producer's ability to project the cost of production in a market in which factor costs and the appropriate technology differ from those at home. Now and again, the locational force which determined some particular overseas investment is so simple and so powerful that one has little difficulty in identifying it. Otis Elevator's early proliferation of production facilities abroad was quite patently a function of the high cost of shipping assembled elevator cabins to distant locations and the limited scale advantages involved in manufacturing elevator cabins at a single locati~n.~ Singer's decision to invest in Scotland as early as 1867 was also based on considerations of a sort sympathetic with our hypothe~is.~ It is not unlikely that the 4. M. V. Posner, "International Trade and Technical Change," Oxford Economic Papers, Vol. 13 (Oct. 19611, p. 323, et seq. presents a stimulating model purporting to explain such familiar trade phenomena as the exchange of machine tools between the United Kingdom and Germany. In the process he offers some particularly helpful notions concerning the size of the "imitation lag" in the responses of competing nations. 5. Dudley M. Phelps, Migration of Industry to South America (New York: McGraw-Hill, 1963), p. 4. 6. John H. Dunning, American Investment in British Manufacturing Industry (London: George Allen & Unwin, 19581, p. 18. The Dunning book

198 QUARTERLY JOURNAL OF ECONOMICS overseas demand for its highly standardized product was already sufficiently large at that time to exhaust the obvious scale advan- tages of manufacturing in a single location,especially if that location was one of high labor cost. In an area as complex and "imperfect"as international trade and investment,however,one ought not anticipate that any hypoth- esis will have more than a limited explanatory power.United States airplane manufacturers surely respond to many "noneco- nomic"locational forces,such as the desire to play safe in problems of military security.Producers in the United States who have a protected patent position overseas presumably take that fact into account in deciding whether or when to produce abroad.And other producers often are motivated by considerations too complex to reconstruct readily,such as the fortuitous timing of a threat of new competition in the country of import,the level of tariff protection anticipated for the future,the political situation in the country of prospective investment and so on. We arrive,then,at the stage at which United States producers have come around to the establishment of production units in the advanced countries.Now a new group of forces are set in train. In an idealized form,Figure I suggests what may be anticipated next. As far as individual United States producers are concerned,the local markets thenceforth will be filled from local production units set up abroad.Once these facilities are in operation,however,more ambitious possibilities for their use may be suggested.When com- paring a United States producing facility and a facility in another advanced country,the obvious production-cost differences between the rival producing areas are usually differences due to scale and differences due to labor costs.If the producer is an international firm with producing locations in several countries,its costs of financ- ing capital at the different locations may not be sufficiently different to matter very much.If economies of scale are being fully exploited, the principal differences between any two locations are likely to be labor costs.7 Accordingly,it may prove wise for the international firm to begin servicing third-country markets from the new location. And if labor cost differences are large enough to offset transport is filled with observations that lend casual support to the main hypotheses of this paper. 7.Note the interesting finding of Mordecai Kreinin in his "The Leontief Scarce-Factor Paradox,"The American Economic Review,LV (Mar.1965), 131-39.Kreinin finds that the higher cost of labor in the United States is not explained by a higher rate of labor productivity in this country

198 QUARTERLY JOURNAL OF ECONOMICS overseas demand for its highly standardized product was already sufficiently large at that time to exhaust the obvious scale advantages of manufacturing in a single location, especially if that location was one of high labor cost. In an area as complex and "imperfect" as international trade and investment, however, one ought not anticipate that any hypothesis will have more than a limited explanatory power. United States airplane manufacturers surely respond to many "noneconomic" locational forces, such as the desire to play safe in problems of military security. Producers in the United States who have a protected patent position overseas presumably take that fact into account in deciding whether or when to produce abroad. And other producers often are motivated by considerations too complex to reconstruct readily, such as the fortuitous timing of a threat of new competition in the country of import, the level of tariff protection anticipated for the future, the political situation in the country of prospective investment and so on. We arrive, then, at the stage at which United States producers have come around to the establishment of production units in the advanced countries. Now a new group of forces are set in train. In an idealized form, Figure I suggests what may be anticipated next. As far as individual United States producers are concerned, the local markets thenceforth will be filled from local production units set up abroad. Once these facilities are in operation, however, more ambitious possibilities for their use may be suggested. When comparing a United States producing facility and a facility in another advanced country, the obvious production-cost differences between the rival producing areas are usually differences due to scale and differences due to labor costs. If the producer is an international firm with producing locations in several countries, its costs of financing capital at the different locations may not be sufficiently different to matter very much. If economies of scale are being fully exploited, the principal differences between any two locations are likely to be labor costs.7 Accordingly, it may prove wise for the international firm to begin servicing third-country markets from the new location. And if labor cost differences are large enough to offset transport is filled with observations that lend casual support to the main hypotheses of this paper. 7. Note the interesting finding of Mordecai Kreinin in his "The Leontief Scarce-Factor Paradox," The American Economic Review, LV (Mar. 1965), 13139. Kreinin finds that the higher cost of labor in the United States is not explained by a higher rate of labor productivity in this country

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