The Dynamic Impact of Internalization Advantage

Abstract:     
Internalization advantage determines whether firms use foreign direct investment (FDI) or licensing to serve markets abroad. We determine how innovation affects the incentives for internalization and how internalization in turn affects the incentives for innovation. Bigger innovations are kept within the firm through establishing a local production subsidiary, while smaller innovations are licensed. Additionally, multinational firms choose larger innovations than licensors. Subsidizing multinational production increases the extent of FDI, the aggregate rate of innovation and the average magnitude of innovation. The increase in the average innovation magnitude occurs despite a reduction in the average innovation magnitude chosen by multinational firms due to the shift from licensing to FDI.

Number of Pages in PDF File: 29

JEL Classification: F21, F43, O31, O34

working papers series