The product cycle

The product cycle hypothesis (Kuznetz, 1953; Posner, 1961; Vernon, 1966) postulates that an innovation may emerge as a developed country export, extend its life cycle by being produced in more favourable foreign locations during its maturing phase and ultimately, once standardized, become a developing country export (developed country import). FDI, therefore, occurs when, as the product matures and competition becomes fierce, the innovator decides to shift production in developing countries because lower factor costs make this advantageous. Vernon’s (1966) model of the product cycle was primarily intended to explain the expansion of US MNEs in Europe after the Second World War and, at the time of its inception, could account for the high concentration of innovations in, and technological superiority of, the USA.

Although during the late 1960s and early 1970s a number of empirical studies provided results consistent with the hypothesis’ insightful description of the dynamic process of product development, the model is now regarded by many as largely anachronistic. First, as acknowledged by Vernon (1979) himself, the technological gap between the USA and other regions of the world (most notably Europe and Japan) has been eroded. Second, the product life extension which characterizes the maturity phase is difficult to reconcile with MNEs’ tendency to produce the new product where factor costs are at their lowest from the start, and opt for a simultaneous introduction phase of the product worldwide. Most importantly, the hypothesis appears to be at odds with the fact that most FDI flows have been, and continue to be, between developed countries. Indeed, rather than moving toward truly global production relations, available evidence suggests a tendency toward a regionalization of international production primarily concentrated within the three major regional blocks of the ‘Triad’ (the USA, the EU and Japan).

If these trends of intra-regional growth in FDI persist, we are likely to witness a further consolidation of the Triad members. The extent to which similar regional dynamics will emerge in the developing world largely depends upon the ability of developing countries to both close the gap on more advanced industrial economies (Kozul-Wright and Rowthorn, 1998), and cement regional cooperation with neighbouring countries.