Capital Flows and Foreign Investment

1
Capital Flows and Foreign Investment

• MBAW6
• Dermot McAleese

2
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 institutions demand relief form rules
regulation ever harder to enforce
Domestic financial firms are forced to compete
Range of financial products expands
Access to foreign capital markets
Deregulation
Innovation
3
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

4
Table. 1 Savings, investments and lending,
1993-2000 ( GDP)
Source IMF, World Economic Report (October 1999)
5
Table. 2 Inward and outward stock of
foreign-owned capital (USbn)
Source United Nations, World Investment Report,
1991, 1999 (1999 figures are authors own
estimates)
6
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

7
BASIC MODEL Gains form capital mobility

Rate of interest (R)
Rate of interest (R)
A
Rs
E
C
R
R
Rn
D
B
MPn
MPs
On
On
K
K
World capital stock (K)
8
TAXING CAPITAL IN THE CAPITAL-MOBILE WORLD
Sk
Sk
Rate of interest (R)
Rate of interest (R)
D
E
R
T
World rate of return
tax
tax
G
E
T
R
Dk
F
Dk
O
Ko
O
K1
K0
Capital stock (K)
Capital stock (K)
9
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 countrys tax base
  by forcing governments to offer excessive
  enticement to investors

10
FOREIGN DIRECT INVESTMENT
11
Table. 3 Stocks of FDI ( GDP)

• Source Computed form J.H. Dunning, The
  Globalisation of Business (London Routledge,
  1993) and World Investment Report (United
  Nations, various years)

12
Table. 4 Regional distribution of FDI inflows and
outflows ()

• Source UNCTAD, World Investment Report (1999).

13
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

14
EFFECTS OF FOREIGN INVESTMENT

• ? Multinationals generate externalities
• ? Multinationals create more jobs
• ? Foreign investment generates tax revenues
• ? Foreign investment generates foreign exchange

15
TO MAXIMISE SPILLOVERS HOST COUNTRY NEEDS TO
DEVELOP

• ? An integrated policy approach
• ? Targeted incentives
• ? After-care policies
• ? Support for indigenous industry