International Trade and Foreign Investment: Substitutes or Complements

Recently, there has been some discussion on whether foreign investment "substitutes" for or "complements" mternatronal trade First as will be briefly reviewed in Section II, Robert Mundelll showed that both are complete substitutes for each other under the assumption of identical production functions for two countries within the framework of ordinary Heckscher-Ohlin-Samuelson theory of trade. Second, Andrew Schmitz and Peter Helmberger2 and especially Douglas D. Purvis3 demonstrated that foreign investment may work complementarily to international trade if production functions vary in the two countries (Section 111). However, these people seem not to be able to show definite conditions for substitute or complementary cases. Mundell and Purvis dealt with international movements of capital as one of the homogeneous factors of production, referring to it as a real, or physical capital.4 1 would like in this paper to call it "money capital" for it is to be a general, homogeneous factor of production which is allocable and reallocable to any sector of the economy. It is money capital before allocated while it becomes real capital after allocated.5 Schmitz and Helmberger had in mind foreign direct investment but dealt with it as if there were no difference from money capital movement. But, there is a critical difference, among others, in the sense that the foreign direct investment affects the activities of specific sectors of investing and host economies, whereas international money capital movement is absorbed by and results in the reallocation of factors of production (capital and labor) so as to attain a general equilibrium of both countries. Keeping in mind this characteristic of foreign direct investment, we may be able to differentiate succinctly two cases in which foreign direct investment works as a complement to international trade (trade-creating type) or as a substitute for it (trade-destroying type). This is the main purpose of the present paper (Section IV).