Geography Reference
In-Depth Information
model of Raymond Vernon (1966). Adopting a microeconomic perspec-
tive, Vernon extends the traditional trade theory into one of international
production, while acknowledging market imperfections. His focus is, on
the one hand, on the sources of nation-specific ownership advantages
afforded by factor endowments and market structures and, on the other
hand, on the strategic behaviour arising from oligopolistic markets.
Influenced by the emerging trade theories of that time which focussed
on technology gaps (Posner 1961; Hufbauer 1966) and the life cycle of
products (Kutznets 1953; Hirsch 1965), Vernon links innovation-based
ownership advantages to features such as market size, income elasticities
of demand and wage levels. Vernon's approach therefore departs from the
prevailing neoclassical tradition in that he treats innovation as an endog-
enous phenomenon conditioned on structural issues, rather than as an
exogenous phenomenon dependent on the efficiency of market clearing.
In the first stage of the PLC the innovating firm produces and sells
its product in the home market. New products hinge on applications of
scientific advances. Innovations are thus seen as country-specific, as they
depend on the existence of a large local market to bear the high cost and
risk involved in R&D. The new product starts to be exported abroad
to countries with similar income and demand conditions as the home
economy. In the second stage production gradually shifts to foreign coun-
tries with the largest domestic markets to supply the local demand directly
through FDI. As innovations in Vernon's scheme are demand-driven, the
catching up of demand through technology diffusion allows foreign com-
petitors to gain the potential to develop their own similar technological
capabilities, eventually eroding the innovating country firms' technologi-
cal leadership. With rival firms continuing to enter the market, competi-
tion increases and drives down both price and profits. The cycle progresses
in the third stage, with the standardization of production processes hin-
dering further reductions in production costs. Firms gain a competitive
edge by establishing production facilities in those countries where labour
costs are least expensive, and the home country market is now predomi-
nantly supplied by imports of the product from foreign plants.
In Vernon's product life cycle analysis, and also to some extent as in
Hymer's, the geographical location of international production follows a
hierarchical pattern which is strictly linked to the ownership advantages
that characterize each stage of the oligopolistic structure (Ietto-Gillies
2005). In the innovation-based oligopoly, the location of production is
naturally placed in the economy where the innovation process firstly initi-
ated. In this early stage, when technology is unstable, the demand for the
new product is uncertain and technological capacity is vital. Location
occurs in the metropolitan centres of advanced countries, especially the
