Question

Compare and contrast these explanations of FDI: internalization theory and Knickerbocker’s theory of FDI. Which theory do you think offers the best explanation of the historical pattern of FDI? Why?

Answer 1

Internalization theory explains FDI as a firm's strategy to minimize transaction costs and protect proprietary knowledge, while Knickerbocker's theory sees FDI as a response to competitive behavior in oligopolistic markets. The best theory depends on industry context and historical periods.

Step-by-step explanation:

When comparing and contrasting the internalization theory and Knickerbocker's theory of FDI, we see that internalization theory focuses on why firms prefer to control their foreign operations directly, asserting that by doing so, they can minimize the costs of transacting in imperfect markets and protect their proprietary knowledge or technology. Knickerbocker's theory, on the other hand, posits that firms engage in FDI in response to the actions of their competitors within an oligopolistic market structure, leading to an imitation behavior known as 'follow-the-leader'. The preference for either theory to explain the historical pattern of FDI largely depends on the context of the specific industries and time periods considered.

Analyzing the historical patterns of FDI, some might argue that internalization theory could offer a better explanation for FDI in industries where proprietary technology and knowledge are key competitive assets, as firms in such industries would have greater incentive to control their operations abroad. Conversely, Knickerbocker's theory might be more suitable in explaining FDI in markets where competition is tight and strategic behavior among a few large firms dictates international expansion. Both theories have limitations in explaining all aspects of FDI, as the global economy encompasses a diverse range of sectors and strategic behaviors.

Answer 2

The main contrast between the two theories can be summarized as follows:

The internalization theory of multinational firms proposes that direct international investment occurs when a firm has information-related intangible assets with public good properties.

The Knickerbocker theory assumes that markets are monopolistic and firms are oligopolistic and firms try to match each other's moves to keep each other in check so as not to allow a rival gain a competitive advantage over others.

Step-by-step explanation:

After 1945, global Federal Direct Investment (FDI) flows did recover from depression and war, but the geographical pattern of foreign investment was completely transformed. In the postwar economic boom of 1945-80, most of the investment flows took place within and between developed countries

These increases in the flows of foreign investment have themselves marked a new and distinct phenomenon in the era of globalization. Several factors have helped drive this growth such as technological strides in the world of business.

The Knickerbocker theory offers the best explanation and emphasizes interdependence of major players in the same industry.