Economic sanctions’ ‘blind spot’: the power of internalized markets of MNEs

Abstract Governments increasingly use economic sanctions to enforce foreign policy goals. While such measures are intended to weaken the target country’s economy by restricting cross-border market transactions, sanctions have only a limited effect on the divestment of foreign subsidiaries in target countries. In this study, we argue that MNEs gain strategic flexibility through internalizing markets for goods and capital and can use this flexibility to cope with sanctions against host countries. Internalized markets allow them to reroute commercial and financial transactions with subsidiaries in sanctioned countries through their global subsidiary network in a legal way and, thus, maintain FDI activities in sanctioned countries. Using data on subsidiaries of Austrian MNEs in countries of the former Warsaw Pact, we find that sanctions do increase the likelihood of subsidiary divestment. However, for MNEs that maintain subsidiaries in countries that are commercial allies of the sanctioned country or that serve as offshore financial centers, this likelihood is significantly reduced. We discuss policy implications of MNEs’ use of internalized markets for rerouting cross-border transactions through third countries.