Democratic Institutions and Investment Inflows 179 including those based on the industrial organization approach,transaction cost economics,7 and trade and location theory.8 Dunning explains that international production is motivated by three sets of ad- vantages perceived by firms.9 The first set is a firm's ownership-specific advan- tages.These include its ownership of intangible assets and common governance of cross-border production.Some examples of intangible assets are product inno- vations,management practices,marketing techniques,and brand names.Diversi- fication across borders allows a firm to exploit economies of scale and to develop monopoly power based on its size and established position.The foreign investor's ownership-specific advantages are sensitive to property rights protection in the host country.In other words,an MNE's success is tied to the security of its intel- lectual and physical property in multiple countries. The second set of advantages concerns the firm's internalization advantages deriving from its hierarchical control of cross-border production.Internalization refers to a firm's direct control over its value-added activities in multiple coun- tries,as opposed to outsourcing,trade,or licensing.The size of a firm's internal- ization advantages correlates with the degree of transnational market failure.For example,where the risks of opportunism by foreign buyers and sellers are high, such as disrupting supplies and violating property rights in primary product and high technology industries,the firm has an incentive to claim hierarchical control of cross-border production.20 Where economic rents from exploiting oligopolistic or monopolistic market structures or large-scale production are high,the firm is also likely to exert hierarchical control of transnational production.The greater the internalization advantages,the more likely a firm is to pursue international production-hierarchical control of its assets,instead of trading or leasing.The exploitation of these advantages is affected by the antitrust or competition- oriented regulation in the host country. The third set of advantages refers to the location-specific advantages per- ceived by firms or the characteristics of host countries in terms of their economic environment or government policies.They may include scarce natural resources, abundant labor,high economic development,or favorable macroeconomic,mi- croeconomic,and FDI-specific government policies.For instance,oil companies have to produce overseas where required resources are available.Export-processing firms typically shift production based on labor cost.Firms also consider govern- ment policies on tariffs,domestic corporate taxation,investment or tax regula- tion of foreign firms,profit repatriation or transfer pricing,royalties on extracted 16.For example,Hymer 1976;and Caves 1971. 17.For example,Rugman 1981;and Teece 1981. 18.Vernon 1966.See also Dunning 1988 and 1993;and Caves 1996 for reviews of the literature on international production. 19.Dunning 1988 and 1993. 20.For example,metals firms are often MNEs.They centralize the management of different steps of production(mining,smelting,and milling)to avoid the risk of being held hostage by a supplier to whom they have outsourced an aspect of production.Democratic Institutions and Investment Inflows 179 including those based on the industrial organization approach,16 transaction cost economics," and trade and location theory." Dunning explains that international production is motivated by three sets of ad￾vantages perceived by firms." The first set is a firm's ownership-specific advan￾tages. These include its ownership of intangible assets and common governance of cross-border production. Some examples of intangible assets are product inno￾vations, management practices, marketing techniques, and brand names. Diversi￾fication across borders allows a firm to exploit economies of scale and to develop monopoly power based on its size and established position. The foreign investor's ownership-specific advantages are sensitive to property rights protection in the host country. In other words, an MNE's success is tied to the security of its intel￾lectual and physical property in multiple countries. The second set of advantages concerns the firm's internalization advantages deriving from its hierarchical control of cross-border production. Internalization refers to a firm's direct control over its value-added activities in multiple coun￾tries, as opposed to outsourcing, trade, or licensing. The size of a firm's internal￾ization advantages correlates with the degree of transnational market failure. For example, where the risks of opportunism by foreign buyers and sellers are high, such as disrupting supplies and violating property rights in primary product and high technology industries, the firm has an incentive to claim hierarchical control of cross-border production.20 Where economic rents from exploiting oligopolictic or monopolistic market structures or large-scale production are high, the firm is also likely to exert hierarchical control of transnational production. The greater the internalization advantages, the more likely a firm is to pursue international production-hierarchical control of its assets, instead of trading or leasing. The exploitation of these advantages is affected by the antitrust or competition￾oriented regulation in the host country. The third set of advantages refers to the location-specific advantages per￾ceived by firms or the characteristics of host countries in terms of their economic environment or government policies. They may include scarce natural resources, abundant labor, high economic development, or favorable macroeconomic, mi￾croeconomic, and FDI-specific government policies. For instance, oil companies have to produce overseas where required resources are available. Export-processing firms typically shift production based on labor cost. Firms also consider govern￾ment policies on tariffs, domestic corporate taxation, investment or tax regula￾tion of foreign firms, profit repatriation or transfer pricing, royalties on extracted 16. For example, Hymer 1976; and Caves 197 1. 17. For example, Rugman 1981; and Teece 1981. 18. Vernon 1966. See also Dunning 1988 and 1993; and Caves 1996 for reviews of the literature on international production. 19. Dunning 1988 and 1993. 20. For example, metals firms are often MNEs. They centralize the management of different steps of production (mining, smelting, and milling) to avoid the risk of being held hostage by a supplier to whom they have outsourced an aspect of production