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Capital Flows and Foreign
Investment
MBAW6
Dermot McAleese
FROM TRADE TO CAPITAL MOBILITY
Trade
Traders need to hold or
borrow foreign
exchange; trade
imbalances need to be
financed
Better access to
credit spurs trade
International finance
Domestic
financial firms
are forced to
compete
Range of
financial products
expands
Innovation
Access to
foreign
capital
markets
Domestic institutions
demand relief form
rules; regulation ever
harder to enforce
Deregulation
OUTLINE
 Trends in capital flows
 Analysis of capital flows
 Basic model
 Capital mobility and taxes
 Extensions
 FDI and multinationals
 Trends in FDI
 Why invest abroad?
 Effects of foreign investment
Table. 1 Savings, investments and lending,
1993-2000 (% GDP)
Investment
Developed Countries
US
EU
Japan
Developing Countries
of which:
Africa
Asia
Middle East & Europe
Latin America
Net borrowing
from rest of
world
Savings
18.0
19.7
28.0
16.4
20.5
30.1
1.6
-0.8
-2.1
27.8
26.2
1.6
20.1
32.7
22.0
21.5
16.3
32.8
20.6
18.4
3.8
-0.1
1.4
3.1
Source: IMF, World Economic Report (October 1999)
Table. 2 Inward and outward stock of foreign-owned capital (US$bn)
1980
1990
1998
European Union
Inward
Outward
143
153
406
477
1303
1175
United States
Inward
Outward
83
202
395
435
811
1022
Japan
Inward
Outward
3
20
10
201
36
310
Latin America and the Caribbean
Inward
Outward
48
3
116
13
431
45
32
2
146
38
610
329
n/a
n/a
14
3
262
23
1
0
2
0.03
14
0.7
East, south and South-East Asia
Inward
Outward
of which
China
Inward
Outward
India
Inward
Outward
Source: United Nations, World Investment Report, 1991, 1999 (1999 figures are author’s own estimates)
TRENDS IN CAPITAL FLOWS
 1990s – ‘the decade of equity finance’
 Increased level of integration
International bank lending has risen to ½ of GDP in industrial
countries
Increasing share of government bonds held by foreigners
Increasing orientation of the foreign private sector issuers of bonds
and securities to the international markets
 Proliferation of different types of mobile investment funds
 Demand and supply factors of increasing capital mobility
BASIC MODEL
Gains form capital mobility
Rate of
interest
(R)
A
Rs
E
C
R*
R*
Rn
D
B
MPn
MPs
On
Rate of
interest
(R)
K* K
World capital stock (K)
On
TAXING CAPITAL IN THE CAPITAL-MOBILE
WORLD
Rate of
interest
(R)
R
tax
T
Sk
E
T
G
Ko
Capital stock (K)
D
tax
E
R
Dk
O
Sk
Rate of
interest
(R)
World rate
of return
F
O
Dk
K1
K0
Capital stock (K)
EXTENSIONS
Positive effects:
capital inflows represent critical part in development of some
countries
capital inflows create spill-over effect – macro management
capital mobility allows risk spreading through portfolio diversification
Adverse effects:
international capital flows can be very volatile
capital inflows can cause unsustainable inflationary pressures
capital flows can lead to short term misalignment of the exchange rate
capital mobility can weaken country’s tax base by forcing
governments to offer excessive enticement to investors
FOREIGN DIRECT
INVESTMENT
Table. 3 Stocks of FDI (% GDP)
US
UK
Japan
Germany
Netherlands
Developing countries
Outward
1973
1996
Inward
1973
1996
7.7
9.1
2.5
3.4
25.8
10.4
30.7
5.6
12.4
49.1
1.6
13.9
0.4
3.8
n/a
8.3
20.5
0.7
5.9
30.4
0.6
4.9
5.4
15.6
Source: Computed form J.H. Dunning, The Globalisation of Business
(London: Routledge, 1993) and World Investment Report (United
Nations, various years)
Table. 4 Regional distribution of FDI inflows and outflows
(%)
Inflows
1995
1998
Outflows
1995
1998
Developed countries
of which:
US
Japan
EU
Other
63.4
71.5
85.3
91.6
17.9
~
35.1
10.4
30.0
0.5
35.7
5.3
25.7
6.3
44.7
8.6
20.5
3.7
59.5
7.9
Developing countries
of which:
Asia
Latin America
Developing Europe
Other
32.3
25.8
14.5
8.1
20.7
10.0
0.1
1.5
13.2
11.1
0.2
1.3
12.3
2.1
~
0.1
5.6
2.4
~
0.1
4.3
2.7
0.2
0.3
100
100
100
100
Rest of world
Total
Source: UNCTAD, World Investment Report (1999).
WHY INVEST ABROAD? - OLI PARADIGM
Ownership advantages
Intangible assets
Economies of size
Location advantages
Labour costs and other inputs
Availability of skilled labour
Market size, growth of market
Government
Other costs
Internalisation advantages
’Failure’ in markets for final goods and inputs
Monopoly power
Product differentiation
EFFECTS OF FOREIGN
INVESTMENT
 Multinationals generate externalities
 Multinationals create more jobs
 Foreign investment generates tax revenues
 Foreign investment generates foreign
exchange
TO MAXIMISE SPILLOVERS HOST
COUNTRY NEEDS TO DEVELOP:
 An integrated policy approach
 Targeted incentives
 After-care policies
 Support for indigenous industry