Internalization theory is a branch of
economics
Economics () is the social science that studies the Production (economics), production, distribution (economics), distribution, and Consumption (economics), consumption of goods and services.
Economics focuses on the behaviour and intera ...
that is used to analyse
international business
International business refers to the trade of goods, services, technology, capital and/or knowledge across national borders and at a global or transnational scale.
It involves cross-border transactions of goods and services between two or more ...
behaviour.
Outline
Internalization theory focuses on imperfections in intermediate product markets.
Two main kinds of
intermediate product
Intermediate goods, producer goods or semi-finished products are goods, such as partly finished goods, used as inputs in the production of other goods including final goods. A firm may make and then use intermediate goods, or make and then sell, o ...
are distinguished: knowledge flows linking
research and development
Research and development (R&D or R+D), known in Europe as research and technological development (RTD), is the set of innovative activities undertaken by corporations or governments in developing new services or products, and improving existi ...
(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. Proprietary knowledge is easier to appropriate when
intellectual property rights
Intellectual property (IP) is a category of property that includes intangible creations of the human intellect. There are many types of intellectual property, and some countries recognize more than others. The best-known types are patents, cop ...
such as
patent
A patent is a type of intellectual property that gives its owner the legal right to exclude others from making, using, or selling an invention for a limited period of time in exchange for publishing an enabling disclosure of the invention."A p ...
s and
trademark
A trademark (also written trade mark or trade-mark) is a type of intellectual property consisting of a recognizable sign, design, or expression that identifies products or services from a particular source and distinguishes them from others ...
s 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. 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’, arising from the ‘liability of foreignness’. When such costs are high a firm may license or
outsource
Outsourcing is an agreement in which one company hires another company to be responsible for a planned or existing activity which otherwise is or could be carried out internally, i.e. in-house, and sometimes involves transferring employees and ...
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
In taxation and accounting, transfer pricing refers to the rules and methods for pricing transactions within and between enterprises under common ownership or control. Because of the potential for cross-border controlled transactions to distort ...
.
Variants
Buckley and Casson (1976) was a seminal work. Two Canadian economists, Stephen Hymer and John McManus,
independently noted the relevance of internalization, and their contribution is the subject of debate.
Alan M. Rugman
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."Alan M. ...
linked internalization theory to his earlier work on market imperfections, applying it empirically in a North American context. Jean-Francois Hennart
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.
Controversies
Internalization theory was used by
John Harry Dunning
John Harry Dunning (26 June 1927 – 29 January 2009) 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 e ...
as one of the components of his
eclectic paradigm The eclectic paradigm, also known as the OLI Model or OLI Framework (''OLI'' stands for ''Ownership'', ''Location'', and ''Internalization''), is a theory in economics. It is a further development of the internalization theory and published by Joh ...
or OLI model.
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.
Internalization theory is related to
transaction cost
In economics and related disciplines, a transaction cost is a cost in making any economic trade when participating in a market. Oliver E. Williamson defines transaction costs as the costs of running an economic system of companies, and unlike produ ...
theory through common dependence on the seminal work of
Ronald Coase
Ronald Harry Coase (; 29 December 1910 – 2 September 2013) was a British economist and author. Coase received a bachelor of commerce degree (1932) and a PhD from the London School of Economics, where he was a member of the faculty until 1951. ...
. They are not the same however. Internalization theory focuses on links between R&D and production whereas
transaction cost
In economics and related disciplines, a transaction cost is a cost in making any economic trade when participating in a market. Oliver E. Williamson defines transaction costs as the costs of running an economic system of companies, and unlike produ ...
theory focuses on links between one production facility and another.
Transaction cost
In economics and related disciplines, a transaction cost is a cost in making any economic trade when participating in a market. Oliver E. Williamson defines transaction costs as the costs of running an economic system of companies, and unlike produ ...
theory typically attributes market imperfections to
bounded rationality
Bounded rationality is the idea that rationality is limited when individuals make decisions, and under these limitations, rational individuals will select a decision that is satisfactory rather than optimal.
Limitations include the difficulty of ...
and ‘lock in’, whilst internalization theory emphasises
asymmetric information and weaknesses in property rights.
Transaction cost
In economics and related disciplines, a transaction cost is a cost in making any economic trade when participating in a market. Oliver E. Williamson defines transaction costs as the costs of running an economic system of companies, and unlike produ ...
theory is typically applied in a domestic context, whereas internalization theory was developed specifically for an international context.
Links to international business theory
Prior to internalization theory, the study of
international business
International business refers to the trade of goods, services, technology, capital and/or knowledge across national borders and at a global or transnational scale.
It involves cross-border transactions of goods and services between two or more ...
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.
Policy implications
The view that multinationals transfer technology and not capital provided a major boost to the process of
globalisation
Globalization, or globalisation (Commonwealth English; see spelling differences), is the process of interaction and integration among people, companies, and governments worldwide. The term ''globalization'' first appeared in the early 20t ...
. The
United Nations Conference on Trade and Development
The United Nations Conference on Trade and Development (UNCTAD) is an intergovernmental organization within the United Nations Secretariat that promotes the interests of developing countries in world trade. It was established in 1964 by the ...
(UNCTAD) was strongly influenced by internalization theory and the
eclectic paradigm The eclectic paradigm, also known as the OLI Model or OLI Framework (''OLI'' stands for ''Ownership'', ''Location'', and ''Internalization''), is a theory in economics. It is a further development of the internalization theory and published by Joh ...
.
[UNCTAD World Investment Report, Geneva: United Nations nnual, various issues/ref> It persuaded political leaders to encourage inward investment as a source of the new technologies required for ]economic development
In the economics study of the public sector, economic and social development is the process by which the economic well-being and quality of life of a nation, region, local community, or an individual are improved according to targeted goals and o ...
, 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.
References
{{Reflist, 2
Macroeconomic theories