Internalization theory

Internalization occurs only when firms perceive the benefits to exceed the costs. When internalization leads to foreign investment the firm may incur political and commercial risks due to unfamiliarity with the foreign environment. These are known as ‘costs of doing business abroad’,Hymer, Stephen H. (1976) [http://hdl.handle.net/1721.1/27375 The International Operations of National Firms: A Study of Direct Foreign Investment], [MIT PhD dissertation, 1960] Cambridge, MA: MIT Press, xxii + 253pp.; Stephen H. arising from the ‘liability of foreignness’.{{Cite journal | jstor = 256683| title = Overcoming the Liability of Foreignness| journal = Academy of Management Journal| volume = 38| issue = 2| pages = 341–363| year = 1995| last1 = Zaheer | first1 = S.| citeseerx = 10.1.1.477.3477}} When such costs are high a firm may license or outsource production to an independent firm; or it may produce at home and export to the country instead.

Firms without special knowledge may become multinational to internalise supplies of components or raw materials in order to guarantee quality or continuity of supply, or for tax advantages from transfer pricing.

Buckley and Casson (1976)Buckley, Peter J. and Mark C. Casson (1976) The Future of the Multinational Enterprise, London: Macmillan [Basingstoke, Hants: Palgrave Macmillan, 25th Anniversary ed. 2001], 112pp. was a seminal work. Two Canadian economists, Stephen HymerHymer, Stephen H. (1990) The large multinational corporation: An analysis of some motives for the international integration of business, (trans. N. Vacherot, intro. M.C. Casson), in Mark Casson (ed.) Multinational Corporations, Aldershot: Edward Elgar, 1990, 3-31 [originally published in French in Revue Economique, 19 (6), 1968, 949-73]. and John McManus,

{{cite book|editor-first=Gilles| editor-last=Paquet|work=The Multinational firm and the nation state|url={{google books |plainurl=y |id=v64SAQAAMAAJ |p=32-59}}|year=1972|publisher=Collier-Macmillan Canada |last=McManus |first=John |title=The theory of the international firm |pages=32–59}} independently noted the relevance of internalization, and their contribution is the subject of debate. Alan M. Rugman{{Cite journal | doi = 10.1111/j.1467-8586.1986.tb00208.x| title = New Theories of the Multxnational Enterprise: An Assessment of Internalization Theory| journal = Bulletin of Economic Research| volume = 38| issue = 2| pages = 101–118| year = 1986| last1 = Rugman | first1 = A. M. }} linked internalization theory to his earlier work on market imperfections, applying it empirically in a North American context. Jean-Francois Hennart {{cite book|first=Jean François |last=Hennart|title=A Theory of Multinational Enterprise|url={{google books |plainurl=y |id=-yy7AAAAIAAJ}}|year=1982|publisher=University of Michigan Press|isbn=978-0-472-10017-0}} subsequently developed a variant of the theory that emphasised the interplay of headquarters authority and local autonomy within the firm. Internalization theory is also closely related to Stephen Magee's appropriability theory.Magee, Stephen P. (1977) [http://www.kluwerlawonline.com/abstract.php?id=TRAD1977033&PHPSESSID=cbd6lk3krq0nsan51ht7fm66b5 Multinational corporation, industry technology cycle and development], Journal of World Trade Law, 11, 297-321.

Internalization theory was used by John Harry Dunning as one of the components of his eclectic paradigm or OLI model.{{cite book|editor-first1=Bertil Gotthard|editor-last1=Ohlin|editor-first2=Per Ove|editor-last2=Hesselborn|editor-first3=Per Magnus|editor-last3=Wijkman|title=The International Allocation of Economic Activity: Proceedings of a Nobel Symposium Held at Stockholm|chapter-url={{google books |plainurl=y |id=JlvAQgAACAAJ |p=395}}|year=1977|publisher=Palgrave Macmillan Limited|isbn=978-0-333-21423-7|last=Dunning|first=John H.|chapter=Trade, location of economic activity and the multinational enterprise: a search for an eclectic approach|pages=[https://archive.org/details/internationalall0000nobe/page/395 395–418]|url=https://archive.org/details/internationalall0000nobe/page/395}} Dunning referred to knowledge as an ‘ownership advantage’ and claimed that ownership advantage was necessary for a firm to become a multinational. This was disputed by internalization theorists on the grounds that if quality control and transfer pricing are sufficient, then ownership advantage cannot be necessary. Dunning argued that the firm's ability to internalise could also be described as an ownership advantage, which led internalization theorists to suggest that his concept of ownership advantage had become tautological.{{Cite journal | doi = 10.1111/1467-6419.00024| title = Positive Theories of Multinational Banking: Eclectic Theory Versus Internalisation Theory| journal = Journal of Economic Surveys| volume = 11| pages = 71–100| year = 1997| last1 = Williams | first1 = B. }}

Internalization theory is related to transaction cost theory through common dependence on the seminal work of Ronald Coase.Coase, Ronald H. (1937) The nature of the firm, Economica (New series), 4, 387–405 They are not the same however. Internalization theory focuses on links between R&D and production whereas transaction cost theory focuses on links between one production facility and another.{{cite book|title=The Economic Institutions of Capitalism|url={{google books |plainurl=y |id=MUPVLuiy9uQC}}|year=1985|publisher=Simon and Schuster|isbn=978-0-684-86374-0}} Transaction cost theory typically attributes market imperfections to bounded rationality and ‘lock in’, whilst internalization theory emphasises asymmetric information and weaknesses in property rights. Transaction cost theory is typically applied in a domestic context, whereas internalization theory was developed specifically for an international context.{{cite book|first1=Peter J. |last1=Buckley|first2=Mark |last2=Casson|title=The Multinational Enterprise Revisited: The Essential Buckley and Casson|url={{google books |plainurl=y |id=x3gnAQAAMAAJ}}|date=15 January 2010|publisher=Palgrave Macmillan|isbn=978-0-230-51599-4}}

Prior to internalization theory, the study of international business was largely focused on the environment, and in particular the economic, financial, political and cultural dimensions of doing business abroad. Internalization theory provided a theory of the international firm and thus augmented the international business field by demonstrating the interaction between the external environmental and the internal knowledge flows between MNE parent firm and subsidiaries. This interaction between external country-specific advantages (CSAs) and internal MNE firm-specific advantages (FSAs) is the nexus for strategic managerial international business decisions.{{Cite journal | doi = 10.1057/palgrave.jibs.8490287| title = A Note on the Transnational Solution and the Transaction Cost Theory of Multinational Strategic Management| journal = Journal of International Business Studies| volume = 23| issue = 4| pages = 761| year = 1992| last1 = Rugman | first1 = A. M. | last2 = Verbeke | first2 = A. }} {{cite journal | doi = 10.1057/palgrave.jibs.8400012 | title=Extending the theory of the multinational enterprise: internalization and strategic management perspectives | journal=Journal of International Business Studies | date=2003 | volume=34 | issue=2 | pages=125–137 | first=Alan M | last=Rugman}} {{cite journal | doi = 10.1007/s11575-011-0102-3 | title=Fifty Years of International Business Theory and Beyond | journal=Management International Review | date=2011 | volume=51 | issue=6 | pages=755–786 | first=Alan M. | last=Rugman}}

The view that multinationals transfer technology and not capital provided a major boost to the process of globalisation. The United Nations Conference on Trade and Development (UNCTAD) was strongly influenced by internalization theory and the eclectic paradigm.UNCTAD World Investment Report, Geneva: United Nations [annual, various issues] It persuaded political leaders to encourage inward investment as a source of the new technologies required for economic development, thereby reversing their previous attitudes. Multinational profits were increasingly viewed as payments for knowledge and technology rather than as interest paid on capital, and foreign ownership became accepted, in certain cases, as a necessary safeguard for foreign investors’ intellectual property.{{cite book|first=Peter|last=Dicken|title=Global Shift: Mapping the Changing Contours of the World Economy|url={{google books |plainurl=y |id=PCLdyhx_a4QC}}|date=January 2011|publisher=Guilford Press|isbn=978-1-60918-006-5}}

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Category:Macroeconomic theories