Internalization theory

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Internalization theory is a branch of economics that is used to analyse international business behaviour. [1]

Contents

Outline

Internalization theory focuses on imperfections in intermediate product markets. [2] Two main kinds of intermediate product are distinguished: knowledge flows linking research and development (R&D) to production, and flows of components and raw materials from an upstream production facility to a downstream one. Most applications of the theory focus on knowledge flow. [3] Proprietary knowledge is easier to appropriate when intellectual property rights such as patents and trademarks are weak. Even with strong protections firms protect their knowledge through secrecy. Instead of licensing their knowledge to independent local producers, firms exploit it themselves in their own production facilities. In effect, they internalise the market in knowledge within the firm. The theory claims the internalization leads to larger, more multinational enterprises, because knowledge is a public good. [4] Development of a new technology is concentrated within the firm and the knowledge then transferred to other facilities.

Refinements

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’, [5] arising from the ‘liability of foreignness’. [6] 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.

Variants

Buckley and Casson (1976) [7] was a seminal work. Two Canadian economists, Stephen Hymer [8] and John McManus, [9] independently noted the relevance of internalization, and their contribution is the subject of debate. Alan M. Rugman [10] linked internalization theory to his earlier work on market imperfections, applying it empirically in a North American context. Jean-Francois Hennart [11] 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. [12]

Controversies

Internalization theory was used by John Harry Dunning as one of the components of his eclectic paradigm or OLI model. [13] 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. [14] Internalization theory is related to transaction cost theory through common dependence on the seminal work of Ronald Coase. [15] 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. [16] 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. [17]

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. [18]

Policy implications

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. [19] 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. [20]

Related Research Articles

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Mark Casson is a British economist and academic. He is a professor of economics at the University of Reading in England. He was Head of Department (1987–94) and is the institution's current Director of the Centre for Institutional Performance.

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John Harry Dunning was a British economist and is widely recognised as the father of the field of international business. He researched the economics of international direct investment and the multinational enterprise from the 1950s until his death. In the 1980s, he published the eclectic paradigm or OLI-Model/Framework as further development on Internalization theory. OLI remains the predominant theoretical perspective to study international business activities, notably foreign direct investment and multinational enterprises. His first book, American Investment in British Manufacturing Industry (1958), is the first seminal work in the international business field.

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Rajneesh Narula, is an economist and academic. He is Professor of International Business Regulation and Director of the John H. Dunning Center for International Business at Henley Business School, University of Reading in Reading, UK.

Alan M. Rugman (1945-2014) was a leading scholar in the field of international business. In his last academic role, he served as Head of International Business and Strategy at Henley Business School, University of Reading in Reading, UK.

The Reading School of International Business is widely understood in the field of international business (IB), management and economics to embody a stream of conceptual, and theoretically-driven empirical research, and consists of a group ofpoxkkdkforovhhlfl

a common approach to analyzing multinational enterprise and foreign direct investment. Some are based in the Department of Economics and in Henley Business School at the University of Reading, England, but membership is international. The Reading School builds upon the pathbreaking theoretical work of Peter Buckley and Mark Casson on internalization theory. This was complemented by simultaneous work by John Dunning as he developed the eclectic paradigm of international business as an envelope explanation containing three principal drivers of foreign direct investment, comprising ownership (O); location (L); and internalization (I). The Reading School approach continues through the work of its academic disciples around the world, as well as through The John Dunning Centre at Henley Business School, University of Reading, under the directorship of Rajneesh Narula.

Geoffrey G. Jones is a British-born business historian. He became a US citizen in 2010. He is currently Isidor Straus Professor of Business History at the Harvard Business School. The previous holders of this Chair, which was the first in the world in business history being founded in 1927, included Alfred D. Chandler, Jr. and Thomas K. McCraw.

Raymond Vernon was an American economist. He was a member of the group that developed the Marshall Plan after World War II and later played a role in the development of the International Monetary Fund and the General Agreement on Tariffs and Trade. He was the Clarence Dillon Professor of International Affairs at Harvard Kennedy School, becoming emeritus on his retirement. His formulation of the Product life-cycle theory of US exports, first published in 1966, in turn influenced the behavior of companies.

The springboard theory or springboard perspective is an international business theory that elucidates the unique motives, processes and behaviors of international expansion of emerging market multinational enterprises. Springboard theory was developed by Luo and Tung (2007), and has since been used to examine EM MNEs. At the core of this theory is the argument that EM MNEs systematically and recursively use international expansion as a springboard to acquire critical resources needed to compete more effectively against their global rivals at home and abroad and to reduce their vulnerability to institutional and market constraints at home. These efforts are systematic in the sense that “springboard” steps are deliberately designed as a grand plan to facilitate firm growth and as a long-range strategy to establish more solidly their competitive positions in the global marketplace. They are also recursive because such “springboard” activities are recurrent and revolving.

References

  1. ↑ Rugman, Alan M.; Collinson, Simon (2012). International Business. Pearson. ISBN   978-0-273-76097-9.
  2. ↑ M. Rugman, Alan (1981). Inside the Multinationals: The Economics of Internal Markets. Columbia University Press. ISBN   978-0-231-05384-6.
  3. ↑ Markusen, J. R. (1995). "The Boundaries of Multinational Enterprises and the Theory of International Trade". Journal of Economic Perspectives. 9 (2): 169–189. doi: 10.1257/jep.9.2.169 .
  4. ↑ Buckley, Peter J (2009). "The internalisation theory of the multinational enterprise: A review of the progress of a research agenda after 30 years". Journal of International Business Studies. 40 (9): 1563–1580. doi:10.1057/jibs.2009.49.
  5. ↑ Hymer, Stephen H. (1976) The International Operations of National Firms: A Study of Direct Foreign Investment, [MIT PhD dissertation, 1960] Cambridge, MA: MIT Press, xxii + 253pp.; Stephen H.
  6. ↑ Zaheer, S. (1995). "Overcoming the Liability of Foreignness". Academy of Management Journal. 38 (2): 341–363. CiteSeerX   10.1.1.477.3477 . doi:10.2307/256683. JSTOR   256683.
  7. ↑ 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.
  8. ↑ Hymer, 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].
  9. ↑ McManus, John (1972). Paquet, Gilles (ed.). The theory of the international firm. pp. 32–59.{{cite book}}: |work= ignored (help)
  10. ↑ Rugman, A. M. (1986). "New Theories of the Multxnational Enterprise: An Assessment of Internalization Theory". Bulletin of Economic Research. 38 (2): 101–118. doi:10.1111/j.1467-8586.1986.tb00208.x.
  11. ↑ Hennart, Jean François (1982). A Theory of Multinational Enterprise. University of Michigan Press. ISBN   978-0-472-10017-0.
  12. ↑ Magee, Stephen P. (1977) Multinational corporation, industry technology cycle and development, Journal of World Trade Law, 11, 297-321.
  13. ↑ Dunning, John H. (1977). "Trade, location of economic activity and the multinational enterprise: a search for an eclectic approach". In Ohlin, Bertil Gotthard; Hesselborn, Per Ove; Wijkman, Per Magnus (eds.). The International Allocation of Economic Activity: Proceedings of a Nobel Symposium Held at Stockholm. Palgrave Macmillan Limited. pp.  395–418. ISBN   978-0-333-21423-7.
  14. ↑ Williams, B. (1997). "Positive Theories of Multinational Banking: Eclectic Theory Versus Internalisation Theory". Journal of Economic Surveys. 11: 71–100. doi:10.1111/1467-6419.00024.
  15. ↑ Coase, Ronald H. (1937) The nature of the firm, Economica (New series), 4, 387–405
  16. ↑ The Economic Institutions of Capitalism. Simon and Schuster. 1985. ISBN   978-0-684-86374-0.
  17. ↑ Buckley, Peter J.; Casson, Mark (15 January 2010). The Multinational Enterprise Revisited: The Essential Buckley and Casson. Palgrave Macmillan. ISBN   978-0-230-51599-4.
  18. ↑ Rugman, A. M.; Verbeke, A. (1992). "A Note on the Transnational Solution and the Transaction Cost Theory of Multinational Strategic Management". Journal of International Business Studies. 23 (4): 761. doi:10.1057/palgrave.jibs.8490287.Rugman, Alan M (2003). "Extending the theory of the multinational enterprise: internalization and strategic management perspectives". Journal of International Business Studies. 34 (2): 125–137. doi:10.1057/palgrave.jibs.8400012.Rugman, Alan M. (2011). "Fifty Years of International Business Theory and Beyond". Management International Review. 51 (6): 755–786. doi:10.1007/s11575-011-0102-3.
  19. ↑ UNCTAD World Investment Report, Geneva: United Nations [annual, various issues]
  20. ↑ Dicken, Peter (January 2011). Global Shift: Mapping the Changing Contours of the World Economy. Guilford Press. ISBN   978-1-60918-006-5.
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