Physical Capital, Knowledge Capital and the Choice between FDI and Outsourcing
University of Colorado at Boulder - Department of Economics
Ignatius J. Horstmann
University of Toronto - Rotman School of Management; University of Toronto - Institute for Policy Analysis
James R. Markusen
University of Colorado at Boulder - Department of Economics; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)
CEPR Discussion Paper No. DP7073
There exist two approaches in the literature concerning the multinational firm's mode choice for foreign production between an owned subsidiary and a licensing contract. One approach considers environments where the firm is transferring primarily knowledge-based assets. An important assumption there is that the relevant knowledge is absorbed by the local manager or licensee over the course of time: knowledge is non-excludable. More recently, a number of influential papers have adopted a property-right view of the firm, assuming the application abroad of physical capital, the owner of which retains full and exclusive rights to the capital should a relationship break down. In this paper we combine both forms of capital assets in a single model. The model predicts that foreign direct investment (owned subsidiaries) is more likely than licensing when the ratio of knowledge capital to physical capital is high, or when market value is high relative to the book value of capital (high Tobin's-Q).
Number of Pages in PDF File: 30
Keywords: FDI, hold-up, knowledge capital, outsourcing, physical capital
JEL Classification: F2, F23, L2, L22, L23
Date posted: December 18, 2008
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