Economics and politics - comment and analysis
24. April 2023 I Heiner Flassbeck I Economic Policy, Economic Theory

How does economic development happen with direct investment – and how does science happen?

Patrick Kaczmarczyk and I have published an article in an international scientific journal (Global Policy) on the importance of direct investment, which can be found and read here. On the one hand, it is interesting that the publication of this article was flatly rejected by several journals. Even more interesting, however, are the reasons given by various referees (the experts who review newly submitted articles for scientific journals) for rejecting such a paper.

The paper says in its present form (and said it even more clearly in earlier versions rejected by the various referees) that the theory of comparative cost advantages, on which the whole theory of trade has been based in a decisive way for 200 years, cannot be upheld. At the latest with the massive expansion of Western direct investment in China, it should have been recognised that it is not comparative cost advantages on which developing countries can and must rely, but absolute cost advantages, i.e. absolutely lower costs in the production of goods suitable for the world market.

Such absolute advantages are always achieved by producers (Western or domestic) in developing countries precisely by importing more productive Western technology directly (physically) (bringing it to the low-wage countries) and combining this modern technology with the low wages in the developing countries. That this is indeed happening on a large scale cannot be disputed and is not disputed. The rest of the argument is pure logic.

If huge absolute advantages can be gained in low-wage countries by importing Western technology, the idea of comparative advantage is completely beside the point. The assumption is that developing countries have absolute disadvantages, but that for some reason they are not used by Western companies because, for example, they are already overemployed, have no capacity left and cannot build new capacity. That in itself is completely unrealistic, but it is downright absurd in a world where the physical relocation of highly productive production facilities to low-wage countries is not a problem.

Also beside the point then, and much worse for the prevailing doctrine in economics, is neoclassical employment theory, i.e. the idea of a functioning “labour market”. When Western companies use technology in low-wage countries that they have developed in high-wage countries, the idea that companies would generally be guided by the relative prices of labour and capital in deciding for or against a new technology is simply absurd.

As you can see, in a truly scientific approach, the referees in the various journals could have effectively denied that there are direct investments where high absolute benefits are achieved. However, not a single one has done so. But if one does not deny it, it is again indisputable that large parts of the prevailing doctrine are obsolete – and this completely irrespective of whether the word direct investment and a description of it appear in some publications over the last forty years.

The referees could have said that they did not want to question the prevailing doctrine. But then their unscientific approach would have been obvious. So they said almost in unison that we had not done enough literature research, because if we had, we would certainly have found a representative of the prevailing doctrine who would have said what we claim before. In the eyes of the “normal” scientist, there is simply nothing that cannot already be found in a comprehensive literature search, in other words, there is nothing new. So in economics, everything that can be said theoretically has already been said. The new empirical developments that emerge every day can be illuminated under the given theory or not at all. And if one finds that the known theory does not provide an explanation of the observable facts or even stands in blatant contradiction to it, one simply ignores new developments.

But let us assume for a moment that thirty years ago someone had already recognised what we recognise today, then this would again be fatal for the prevailing doctrine. This would mean that the prevailing doctrine, despite correct factual observations, is not able or not willing to draw logical conclusions from these facts and to correct its world view accordingly. In that case, too, it would be unscientific.

Today, scientific careers in economics are almost entirely dependent on publication in the so-called peer-reviewed journals. I can easily make fun of the judgements of such referees, but young researchers who seriously want to advance and make a difference are completely dependent on their judgements. This is a real step backwards in science, because insisting on the correctness of the prevailing doctrine (the standard model, as it is often pompously called in reference to physics) is part of good manners even in seemingly progressive journals. It is not originality and criticism that are called for, but rather the confirmation of the standard model by allowing oneself at the very most to turn a very small screw.

Those who question the model itself have no chance of publishing the papers that are indispensable for a scientific career. So young intelligent people waste the most productive (and potentially original) years of their lives showing that they are actually already tremendously old and wise. Narrowing the possibility of a scientific career to the path of publication in peer-reviewed journals is an outrageous blockage to scientific progress in economics.

P. S.: Patrick Kaczmarczyk has meanwhile published another essay in which he shows that the “new trade theory” with which Paul Krugman, among others, has distinguished himself also fails to recognise the significance and implications of FDI.