In this project I will analyze the effects of foreign direct investment (FDI) and licensing on the process of innovation and growth of an economy. Both FDI and licensing involve risks and costs due to the public nature of the technology transferred abroad and incentive and information asymmetries caused by principle-agent problems, which eventually influence the innovation's activities of a firm. The associated internalization issues are well known from the static models on multinationals, but hardly discussed in a dynamic context. It is the objective of this project to explicitly include the internalization issues related to FDI in a dynamic framework to examine the effects on innovation, on the trade pattern, the trade volume, and welfare and to see to what extent trade and industrial policy is useful to support innovation. The theoretical analysis is supplemented by an empirical study, which deals explicitly with FDI in services.