The Foreign Direct Investment Queue theory
A new theory on how poor nations become rich, and why they cannot do it all at once.
Make someone’s day: Gift a subscription to your friends and family!
Progress Studies involve a delicate theoretical balancing act, because we must explain a number of apparently conflicting trends:
Throughout virtually all of history, human societies were mired in absolute poverty. This state persisted for so long that this level of poverty must be considered the normal state of the human condition.
Yet, over the last few centuries (Progress Studies researchers disagree on how many centuries), there has been a dramatic increase in the material standard of living for the masses.
This trend started in a few very unusual Commercial societies in Northwest Europe and then slowly and unevenly spread through much of the world.
The result is that today, a level of wealth far beyond what any previous generation could imagine is now the norm in many societies.
Yet, vast inequalities within nations still exist (and may always exist).
And vast inequalities between nations still exist.
Immigrants from some types of societies are far more successful in their new nation than immigrants from other types of societies.
So Progress Studies researchers must answer some very complex questions:
Why did humanity persist in poverty for hundreds of millennia?
Why did humanity “suddenly” transition to a state of long-term material progress after millennia of stagnation?
Why did this transition happen where and when it did?
Why did the transition not happen earlier, later, or in a different location?
Why did the material progress flow to some societies and not others?
Why has there been such a significant time delay between the first societies to experience long-term material progress for the masses and other societies?
When a society experiences long-term material progress, why don’t all citizens enjoy the benefits of that progress?
In addition, there are several key policy questions that need answering:
What can governments in wealthy nations do to keep their material progress going?
What can governments in wealthy nations do to ensure that the maximum number of citizens enjoy the benefits of that progress?
What can individuals who live in wealthy nations do to experience the benefits of the progress that surrounds them?
How can developing nations create this transition in their homeland?
How can wealthy nations help developing nations to make this transition?
Regular readers of my Substack column and my From Poverty to Progress book series know that I believe that I have a compelling theory that goes a long way towards answering these questions. My theory is most concisely expressed in the following articles:
The Five Keys to Progress (and the linked articles on each of the five keys in the numbered list)
How Progress Works (and the linked articles about each of the six human behaviors in the numbered list)
Experts are not answering the key questions
One thing is clear, no one outside of Progress Studies has presented a theory that can answer these questions in compelling ways.
One of my key complaints about how economists, political leaders, and development experts view the world is that they focus almost exclusively on recent causes of economic growth and poverty instead of considering deeper historical causes. This Substack column and my From Poverty to Progress book series focus heavily on those deeper causes of global inequality and national industrialization.
I can understand why economists, political leaders, and development experts focus on more immediate causes. Among the most important are global market conditions, economic policy, regulations, tariffs, corruption, property rights, flows of foreign direct investment, and political stability.
Economists, political leaders, and development experts should focus on those factors because leaders in developing nations have some control over those factors. A key principle to achieving success is to focus on what you have control over and adapt to what you cannot change.
But Progress Studies researchers also have to be careful of going too far in the other direction. Deep historical factors have a very real impact on global inequality and make it far easier for some nations to get rich sooner than others. Understanding deep historical factors also matters for politics, as many political leaders and ideologues falsely claim that global inequalities are caused by racism, colonialism, capitalism, slavery, and other forms of oppression.
Worse, these leaders and ideologues claim that some form of socialism is the only answer for developing nations. This “solution” destroys nations, as we have seen in Venezuela, Cuba, North Korea, and other developing nations. As long as we lack credible theories to explain current global inequalities and how to escape them, Leftist ideologues will convince many voters that bad policies are actually their only means to achieving a better world.
So in this article, I will sketch out how “deep historical causes” can be meshed with more recent causes that are under the control of political and economic leaders in developing nations today. I do not claim that this is a fully developed theory, but I do claim that no one else that I know of has linked all these factors together.
I tentatively call this theory the “Foreign Direct Investment Queue theory”
You can read other articles on developing nations, including:
Why developing nations are still poor:
What wealthy nations can do to help developing nations:
What developing nations can do to help themselves:
How developing nations can create competitive export industries
Why Developing nations need to create thriving export industries
You might also be interested in reading my “From Poverty to Progress” book series:
The Foreign Direct Investment Queue theory is a combination of deep historical factors and economics. The theory consists of two parts:
Deep historical factors that account for the relative level of economic development until very recently, and
Contemporary economic factors that determine which nations receive the most Foreign Direct Investment.
The Deep Historical Factors
The deep historical factors that account for the relative level of economic development until very recently go something like this:
Throughout virtually all of history, humans, like all other biological organisms, have been highly constrained by geographical factors.
To innovate, humans need to eat first. For almost all human history, the vast majority of people focused the majority of their waking hours on getting enough food to eat.
Geography constrains the types of food available for humans to eat in any given local environment.
Humans innovate new subsistence (food acquisition) technologies and techniques to acquire the most food calories via the least amount of human labor in their local environment.
In a few geographies, humans can create a large enough food surplus so that some individuals can focus on solving problems other than getting enough food to eat.
In those geographies, societies evolve into more complex society types. In most geographies, unfortunately, these society types are impossible.
Within those new and more complex society types, technological innovations accelerate. This puts pressure on genes, technologies, skills, and organizations to evolve.
So geographical variations constrain historical development and the possibility of the masses experiencing an increased material standard of living.
Certain geographical conditions enabled the evolution of Agrarian societies, which dominated the recorded history of Europe and Asia for millennia.
The majority of societies, however, have been trapped in simpler societies without any chance of development. This makes material progress for the masses in those regions impossible (until now). This is particularly true outside the Eurasian continent. This explains why racism, colonialism, capitalism, slavery, and other forms of oppression are not the causes of global inequality. The cause is variations in geography. Oppression has been a constant until modern times, so it cannot account for variations in outcomes.
Where very unusual geographical and political conditions are present, Commercial societies evolve. Examples include medieval city/states of Northern Italy, Flanders, the Dutch Republic, and pre-industrial England. These Commercial societies invented four of the Five Keys to Progress and material progress for the masses.
One of those Commercial societies, England, invented the fifth and final Key to Progress and applied the awesome energy density of fossil fuels to agriculture, transportation, communication, urban, and military technologies.
We call this the “Industrial Revolution.” For the first time in history, these industrial technologies made it possible for the rest of the world to partially overcome geographical constraints that had held them back for millennia.After victory in World War II, the United States used its economic and military dominance to impose a global free trade system. This is in contrast to previous hegemons who imposed centralized political empires. This system made it far easier for poor developing nations to establish the Five Keys to Progress by purchasing them from other nations. Now, geographical constraints were lower than they had been in world history.
Since 1991, when the only real rival to the global free trade system, the Soviet Union, collapsed, every nation now has the opportunity to transform from poverty to progress in one generation. Previously, this was only possible for a few geographically-gifted nations, and it would take generations to achieve.
A key strategy for developing nations to escape the geographical poverty trap is to create high-value added export industries. These industries inject wealth into the region and accelerate economic growth. Other than expanding energy usage, I believe this is by far the most effective strategy that developing nations can implement to initiate progress and keep it going.
This can be done by:Copying the technologies, skills, and organizations that it took the West centuries to innovate and deploy at scale.
So, by 1990, the world had huge variations in economic development. Western nations and a sprinkling of East Asian nations had industrialized, but the vast majority of nations had not yet done so. Because of their history, these developing nations were not identical. There were actually significant variations in their propensity to develop. This created an effective rank-order for nations based on how effectively they could transform foreign direct investment into profit.
I will discuss the rank-order below, but first let’s look at how that order influences investors.
Contemporary economic factors
Now, let’s get on to the contemporary economic factors that determine which nations receive the most Foreign Direct Investment in any given year.
The key means for developing nations to transform from poverty to progress is being able to create domestic high-value-added export industries that can compete in the global marketplace. These industries inject wealth into the region and accelerate economic growth. This wealth can then be spent locally by its employees, generating demand for a gaggle of smaller local businesses. They also create a revenue stream for governments to invest in education, health, transportation, sanitation, and energy infrastructure.
Unlike Europe and North America, developing nations today do not have to innovate. Instead, developing nations can create high-value-added export industries by:
Leveraging the global trade system established and protected by the United States.
Copying Western technologies, skills, and organizations that it took the West centuries to innovate and deploy at scale.
Taking advantage of their cheaper labor costs to outcompete industries in wealthier nations.
Typically, nations start by creating simple, low-labor-cost export industries, such as textiles, and then leverage those technologies, skills, and organizations to move into similar industries with higher profit margins.
As more and more developing nations industrialize, global demand for products increases, so the process tends to feed on itself. This development pricess causes increased global demand which enables more development.
The same is true for investment capital. As more nations industrialize, more foreign investment capital becomes available as former receivers of investments eventually become investors themselves.The one thing developing nations are missing and cannot copy is capital. Developing nations are by definition poor, so they do not have the excess capital to invest in new export industries. And many of their leaders are authoritarian or corrupt, who would rather use the scarce capital to bribe their political cronies and pay for a lavish lifestyle.
Most investors prefer safe investments in wealthy and politically stable nations, but some are willing to make riskier bets. This has been particularly true since 1990. Foreign investors want to take advantage of investment opportunities in emerging markets, but they have a profit incentive to focus on nations that show the most promise.
There is far more demand for Foreign Direct Investment in developing nations than foreign investors can possibly supply, plus foreign investors want to maximize their returns and avoid the biggest risks.
All the above create what I call a “Foreign Direct Investment Queue” (sorry to take so long to get to the main point, but that is how deep historical causes work). Without realizing it, foreign investors look to invest in nations that have been relatively blessed by long-run geographical factors that enabled the evolution of more complex society types. Nations that lack good geographical factors are seen as risky investments. So, even without understanding deep historical factors, foreign investors behave as if they do.
The order of developing nations in the Foreign Direct Investment Queue is roughly established by the complexity of the society type of their ancestors in the year 1500. I will explain this in more detail below.
Developing nations can skip a few places in the Foreign Direct Investment Queue with political and economic reforms, but this alone will not lead to a sudden rush of foreign investment or economic growth.
There are simply too many other developing nations who crave foreign investment. Only the nations at the front of the queue receive enough foreign investment to make a difference.
So the domestic reforms that development economists, the World Bank, IMF, etc recommend only matter on the margins. It is the long-run geographical factors that enabled the development of complex society types that matter the most, and developing nations cannot change those historical factors.For the last 30 years, China has been the 800-pound gorilla sucking up foreign direct investment. This makes it difficult for other developing nations to get the investment capital they desperately need.
Worse, Chinese manufacturing dominates the global manufacturing supply chain. This means that developing nations not only have to outcompete both wealthy Western manufacturers but also hyper-competitive Chinese manufacturers.
Some experts believe that this means the end of developing nations industrializing via manufacturing exports. They believe that it is now simply too difficult for developing nations. I will discuss whether this is true in future articles.
Keep in mind that I am not saying that developing nations must receive large amounts of Foreign Direct Investment. Some nations are able to leverage their own domestic capital to perform the same service, but domestic or foreign investment capital does appear to be an important part of any modern development strategy.
It is possible for the governments to debt-finance these investments, as China does. Regardless of the source of the investment capital, it is only possible for nations that are already at the front of the queue for deep historical reasons.
And developing nations also need to copy all the technologies, skills, and organizations required to create world-class export industries.
Is the Foreign Direct Investment Queue good?
Yes, but…
There is no doubt that the FDI queue makes it difficult for developing nations to receive the necessary capital, but queue also makes it possible. Throughout virtually all of human history, it was simply not possible for societies to receive substantial investments from abroad. And the technological base was simply not developed enough for those investments to be transformative.
Queues are simply a means for people to deal with scarce resources. While it may seem unfair that available investment capital is far less than demand, and that capital tends to go to nations that have been blessed by long-run geographical factors, it is far better than in the past.
Resources are always limited, and societies have always struggled to acquire those scarce resources. In the past, this was accomplished by elite extraction of the food surplus and war. Non-violent economic competition is far superior from a moral standpoint. And the global free trade system established by the United States after World War II incentivizes political elites to choose the path of peaceful economic development over the path of war (which dominated for millennia).
The Foreign Direct Investment Queue enables a lucky few nations to transform from poverty to progress within one generation, and then the next few nations can step to the front of the queue. Absent other factors, the Foreign Direct Investment Queue makes it inevitable that most nations will eventually transform from poverty to progress. It just needs to be given enough time. This had previously been impossible.
Why does genetic ancestry in 1500 matter?
As I have explained in other articles, I believe that the society type of their genetic ancestors in 1500 explains many important development outcomes. In addition to explaining the order of developing nations waiting in the Foreign Direct Investment Queue, it also explains:
Current standard of living of a nation, including ethnic minorities within nations, as measured by per capita GDP.
The relative ranking of a nation on dozens of development metrics (see below for list).
The relative success of immigrants within wealthy nations (in other words, migrants can carry most of their advantages with them and benefit from them in their new location).
Those simple facts tell us a great deal about their current standard of living, the timing of their transition into Industrial societies, and their relative outcome on the development metrics such as economic growth, human development, freedom, slavery, poverty, agricultural production, literacy, diet, famines, sanitation, drinking water, life expectancy, neonatal mortality, disease, education, access to electricity, housing, and violence (to name just a few). And there are plenty more in my book.
As I mentioned in an earlier post, if we looked back at society 2000 years ago, much of the ranking would remain largely the same. So these differences cannot be attributed to modern factors, such as institutions, political leaders, government policies, trade, colonialism, exploitation, and racism. These differences go much further back in history. They go back thousands of years.
I choose the year 1500 because that precedes the vast majority of the European and American impact on the rest of the world. Since most regions in the year 1500 had been in developmental stable states, this is the likely final destination of local development absent outside help.
Let me be clear about what I mean by “genetic ancestors in 1500” by giving a few examples:
The Dutch people today are the genetic descendants of people who lived in a Commercial society in 1500 (what later became the Dutch Republic). American settlers who established American culture and institutions in what is now the Northeast of the United States were the genetic descendants of people who lived in Commercial societies in 1500, in this case southeast England.
The Japanese people today are the genetic descendants of people who lived in Agrarian societies in 1500. The Sub-Saharan African people today are the genetic descendants of people who lived in Horticultural and Herding societies in 1500.
Why have other researcher not figured this out?
So why do development economists and social science researchers so often neglect this variable in their studies or do studies that “prove” its insignificance?
There are several reasons:
Social scientists, economists, and historians do not use the critical concept of society type in their analysis. Even experts in the field do not understand the basics of the concept. Those who do fail to realize the intellectual significance of the concept. This concept of society type was widely used in the 19th Century and early 20th Century social science, but it has since fallen out of favor. Modern researchers tend to view the concept as “simplistic,” largely because they do not understand it or have not thought about the concept deeply
Social scientists, economists, and historians do not factor in the enormous impact that geography has in the evolution of those society types. In particular, geography constrains the availability of food, which then constrains the type of society that can evolve.
Social scientists, economists, and historians do not include the massive migration that has taken place since 1500, particularly the Anglo settlement of North America, Australia, and New Zealand. So it is not the current geographical location that matters, but the geography that their ancestors in 1500.
Social scientists, economists, and historians who apply geography to their statistical analysis typically try to use it to explain rates of economic growth in modern times. Geography explains the starting point for a society in 1500. Geography explains relatively little of the variation in economic growth since 1990.
This causes researchers to mistakenly conclude that geography does not matter very much. It is as if researchers are trying to explain the order of finish in a race while neglecting that the racers had different starting points. Geography causes those different starting points.Social scientists, economists, and historians who apply geography to their statistical analysis typically use less important variables, such as latitude or average temperature because the data are easily available. Using biome would be lead to better results. Most of these researchers are not familiar with the term or understand why it matters so much to society types.
Because competing researchers have not developed a sophisticated theory for how long-run factors (such as geography, biome, and society type) interact with short-term factors (such as economic reform, tariffs, foreign direct investments, and corruption) there did not appear to be much need for development economists to focus on long-term factors that leaders in developing nations could not control.
The main competing development theories that use geography as a main causal variable are:“Guns, Germs, and Steel” by Jared Diamond (summary here) and
“Tropical Underdevelopment” by Jeffrey Sachs (summary here).
While both theories are of some use in explaining the starting points of societies in 1500, they cannot explain change over time or how developing nations can overcome geographical constraints. That is why those two theories are not more widely used.
Other studies that show the interaction between geography and more recent causes have received far less attention and still do not explain what developing nations can do to escape geographical traps:
The order of nations with the Foreign Direct Investment Queue
Earlier in this article, I claimed that there is a Foreign Direct Investment Queue, but I did not go into detail about the order of nations within that queue. As I briefly mentioned, the order of developing nations in the Foreign Direct Investment Queue is roughly established by the complexity of the society type of their ancestors in the year 1500.
The domestic reforms that development economists, the World Bank, IMF, etc recommend only matter on the margins. It is the long-run geographical factors that enabled the development of complex society types that matter the most, and developing nations cannot change that.
This is the rough pecking order for nations in the Foreign Direct Investment Queue:
Descendants from Commercial societies in 1500: England, Belgium, Netherlands, Northern Italy, and western Germany plus the nations that were settled by those people - the United States, Canada, Australia, and New Zealand.
These people industrialized early, have some of the highest standards of living in the world, and score very high on development metrics. Minority groups within these nations who descend from less complex society types are less successful.Descendants from Free Peasant societies: Switzerland, Denmark, Norway, Sweden, Iceland, and perhaps Finland.
These nations industrialized slightly later and have some of the highest standards of living in the world. They also score very high on development metrics. Minority groups within these nations who descend from less complex society types are less successful.Descendants from Agrarian societies that were culturally and geographically proximate to the first two groups: Germany, France, and the rest of Europe (with a gradual gradient as one moves away from Northwest Europe to Southeast Europe).
These nations lagged behind the previous groups in industrialization and have somewhat lower standards of living and development metrics. Minority groups within these nations who descend from less complex society types are less successful.Descendants from Agrarian societies that were culturally and geographically distant from Northwest Europe: Japan, South Korea, China, India, Indonesia, Thailand, and Vietnam.
These nations lagged behind most European nations in their industrialization, and have somewhat lower standards-of-living and development metrics. Communist governments in Eastern Europe, China, and Vietnam seem to have hurt the transition, although the fall of the Soviet Union and the adoption of capitalism in China and Vietnam have enabled them to catch up rapidly.
Immigrants from these countries to nations dominated by the above groups have been very successful.Descendants from Horticultural and Herding societies: Latin America, Sub-Saharan Africa, Central Asia, mountainous regions of Southeast Asia, and New Guinea.
None of these societies have made the transition to Industrial societies so far, and they lag behind Europe, North America, and East Asia in their standard of living and in most development metrics.
Many of these societies have ethnic minorities descendants from Commercial and Agrarian societies who have been far more successful economically (Chinese, British, Germans, Spanish, Russians, Lebanese, and Indians). Fortunately, most of these nations have recently experienced significant improvements in development metrics, so there is hope for the future.Descendants from Hunter-Gatherer societies: restricted to very scattered and impoverished regions across the world.
These societies have been the real losers of history. While they once dominated the planet, they are now severely restricted in scope. In most cases, the descendants of Hunter-Gather societies have intermarried with the descendants of more complex societies, so their uniqueness is fading away. Where they can preserve their ways of life, they do so at the cost of poverty and isolation.
Who is at the front of the queue now?
The nations at the front of the Foreign Direct Investment Queue have changed over time. The relative order within the queue has not changed. Just imagine it as an extremely slow queue where nations take decades to move up to the front. Eventually, the nations at the front of the queue get served and everyone moves up a few slots, but the service is really slow.
The queue before 1990
Before 1990, Japan and the Asian Tigers were at the front of the Foreign Direct Investment Queue. This does not mean that they could not use domestic investment, just that they also had access to foreign capital, and they used it wisely. Now, those nations are considered to be not very different from wealthy Western nations. They offer stable returns with little risk. So those foreign investors who were interested in higher returns and were willing to accept higher risks turned to China after 1990. And Japan is now a key foreign investor in Southeast Asia.
Then China and a few other nations got the front of the queue
After 1990, China was the 800-pound gorilla at the front of the line. Fortunately, there was enough foreign capital that smaller nations in Asia could pick up the scraps left over. But those nations also had to compete against Chinese exports, so they had to have very competitive export industries to do so.
Now China is leaving the queue. This transition has many causes:
Increased labor costs (the most important factor)
A shift of Chinese political leadership from rule by consensus within the CCP to the desires of one man: Xi Jinping
The increasingly volatile economic and foreign policy decisions made by that one man
Supply chain disruptions due to Covid and the Russian invasion of Ukraine
Worries about the increasing dependence of the West on Chinese-dominated supply chains
Fear that future events will cause similar supply chain disruptions
Increasing understanding of the theft of intellectual property
Fear of Chinese invasion of Taiwan
Increasing US tariffs from the Trump and Biden administration
Now, its South and Southeast Asia’s turn at the front
All of the above means that we are entering a new era. Predicting the future is very hard, but if my theory is correct, South Asian and Southeast Asian nations that descend from Agrarian societies in 1500 will step to the front of the queue. Geopolitical opposition to China will likely mean that Western governments will encourage this trend.
Given that South Asian nations have 2 billion people and Southeast Asian nations have 700 million people, they will soak up even more capital than China did from 1990 to 2020. Keep in mind that these nations will be competing against each other to get to the front of the line. The nations that fail to compete may have to wait 20-30 years to get to the front of the queue.
This does not mean that no other nations will be able to experience transformative economic growth, but that such growth will be concentrated in South and Southeast Asia for the next generation. And assuming that the Chinese economy continues to perform (which is a big if), China will continue to be a significant foreign investor.
What about the rest of the world?
If my theory is correct, South Asia and Southeast Asia will experience transformative economic growth in the coming decades, and then afterward, Latin America, the Middle East, and Sub-Saharan Africa will need to compete to get to the front of the queue. A few may be able to get to the front of the queue earlier, but the massive capital needs of 2.7 billion people in South and Southeast Asia will make this difficult.
Most likely, the bulk of nations in Latin America, the Middle East, and Sub-Saharan Africa will have to get by for another 20-30 years. Keep in mind that major geopolitical shifts, civil wars, interstate wars, tariff wars, or cosmic events, such as gamma-ray bursts or asteroids, could disrupt the entire global free trade system.
In particular, the following two factors are critical to the spread of material progress throughout the world:
The economic and political health of the United States. In particular, the US must avoid having its politics ruining its social and economic foundations.
The continuation of the global free trade system under American protection, and
Even if China collapses economically or experiences civil war, this would not disrupt the general trend, as this is one lesser competitor for the rest of the world. The United States, however, is the one indispensable nation to world progress.
.
"The Japanese people today are the genetic descendants of people who lived in Agrarian societies in 1500. The Sub-Saharan African people today are the genetic descendants of people who lived in Horticultural and Herding societies in 1500."
Just out of curiosity, why can't they be cultural descendants rather than genetic descendants?
Maybe I missed it in this discussion, but there's an obvious issue here that a large surplus of FDI-like capital exists in the form of foreign aid. The rich world has been trying to help speed along economic growth in the poor world by subsidizing capital investments for many decades now, to little avail. This was well-documented in William Easterly's work, which I read in undergrad (he's written a book or two since then that I haven't read).
I'm open to the argument that aid by its nature (applied by NGOs and bureaucrats) is necessarily much worse than FDI (applied by rational investors). Maybe this can be fixed, or maybe it simply can't and there can be no alternative to unsubsidized FDI. But it needs to be addressed.