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Abstract
This article analyses the role of foreign direct investment (FDI) in neoclassical theory of trade with a focus on the relocation of production into low wage countries. The conceptual analysis shows that FDI not only constitutes a weak spot in comparative advantage theory, but also that the latter is incompatible with efficiency-seeking FDI—with significant implications for policy. In Ricardian and Heckscher-Ohlin models of trade, FDI is ruled out via the assumption of factor immobility. In models in which factor immobility is relaxed, the closest FDI comes to is a generic reference to capital imports and exports, which affect factor endowments and, therefore, comparative advantage. Due to the assumption that input factors are determined by wage-rental ratios, this leads to the condition that firms operating in advanced economies must produce more labor-intensively, if investing in facilities in low-wage countries. Efficiency and market-seeking FDI, which combines productive, capital-intensive modes of production with cheap labor to exploit unit labor cost differentials, is a theoretical and mathematical impossibility in this framework. This conceptual weakness questions the validity of conventional approaches to development policy, which largely rely on market liberalization and free capital mobility.
Acknowledgments
I thank Heiner Flassbeck and Richard Kozul-Wright on early versions of this draft. I also thank two anonymous reviewers for their generous and helpful comments. All errors remain my own.
Correction Statement
This article has been corrected with minor changes. These changes do not impact the academic content of the article.
Additional information
Notes on contributors
Patrick Kaczmarczyk
Dr. Patrick Kaczmarczyk is a policy consultant at the Economic Forum of the SPD. Previously, he worked as a consultant at the United Nations Conference on Trade and Development (UNCTAD) in the Debt and Development Finance Branch (DDFB) within the Globalization and Development Strategies Division (GDS). The views expressed in this paper are solely those of the author.