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Physical Capital, Knowledge Capital and the Choice Between FDI and Outsourcing

  • Yongmin Chen
  • Ignatius J. Horstmann
  • James R. Markusen

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).

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 14515.

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Date of creation: Dec 2008
Date of revision:
Publication status: published as Yongmin Chen & Ignatius J. Horstmann & James R. Markusen, 2012. "Physical capital, knowledge capital, and the choice between FDI and outsourcing," Canadian Journal of Economics, Canadian Economics Association, vol. 45(1), pages 1-15, February.
Handle: RePEc:nbr:nberwo:14515
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  1. Pol Antràs, 2003. "Firms, Contracts, and Trade Structure," NBER Working Papers 9740, National Bureau of Economic Research, Inc.
  2. Caves,Richard E., 2007. "Multinational Enterprise and Economic Analysis," Cambridge Books, Cambridge University Press, number 9780521860130, September.
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  4. Edwin Mansfield & Anthony Romeo, 1980. "Technology Transfer to Overseas Subsidiaries by U. S.-Based Firms," The Quarterly Journal of Economics, Oxford University Press, vol. 95(4), pages 737-750.
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  9. Robert C. Feenstra & Gordon H. Hanson, 2005. "Ownership and Control in Outsourcing to China: Estimating the Property-Rights Theory of the Firm," The Quarterly Journal of Economics, Oxford University Press, vol. 120(2), pages 729-761.
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  15. repec:fth:michin:282 is not listed on IDEAS
  16. James R. Markusen, 2004. "Multinational Firms and the Theory of International Trade," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262633078, March.
  17. Ignatius Horstmann & James R. Markusen, 1987. "Licensing versus Direct Investment: A Model of Internalization by the Multinational Enterprise," Canadian Journal of Economics, Canadian Economics Association, vol. 20(3), pages 464-81, August.
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