Foreign direct investments and the dynamics of trade and capital flows: Schumpeterian insights for sustained development

Abstract

This article analyses the role of foreign direct investment (FDI) in trade and development theory and outlines the resulting implications for economic policy. We propose an alternative model of international trade and development based on absolute, not comparative advantages of firms, which are nested in countries but compete internationally. Applying a Schumpeterian theory of dynamic development, we consider how firms can either increase their competitiveness through productivity gains at a given wage level, or by combining the existing high level of productivity with lower wages in low-income countries. We argue that the aim of competition policy must be to improve the quality of economic competition in international markets, limit monopoly rents and disincentivise rent-seeking activities through the mere outsourcing of production. To that end, we propose that economic policy must reinstate rigorous wage bargaining regimes and make FDI subject to wage conditionality, obliging foreign companies to increase their wages in the host economy in line with average national productivity growth and the national inflation target.