Foreign Direct Investment in Neoclassical Theory of International Trade: A Conceptual Weak Spot

Patrick Kaczmarczyk

International Journal of Political Economy, 2023, vol. 52, issue 1, 70-87

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.

Date: 2023
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Persistent link: https://EconPapers.repec.org/RePEc:mes:ijpoec:v:52:y:2023:i:1:p:70-87

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DOI: 10.1080/08911916.2023.2186054

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