What have international capital flows brought us?

Brad DeLong writes:

It is not possible for a card-carrying neoliberal like me to wish for any but the most minor of controls to curb the most speculative of capital flows. Capital markets can get the allocation of investment badly wrong, but governments are likely to get it even worse, and the incentives to corrupt bureaucrats do need to be kept as low as possible. But the hope for a repetition of the late nineteenth-century experience, in which core investors’ money gave peripheral economies the priceless gift of cutting decades off the time needed for successful economic development, has–so far–proved vain.

The full post — worth reading — is a very thoughtful and indeed moving elegy to the nineteenth century. DeLong points out that today a good deal of international capital flows today to the United States, rather than to the poorer countries.

Nonetheless I am more optimistic about the contemporary potential for international capital movements to spur growth. Singapore moved from a run-down port to a wealthy country in a few decades, and the transition was driven largely by foreign investment. Malaysia has faced a rockier road but by historical standards must be judged a success. Most of Africa has stood still or regressed, but clearly domestic policies are the major culprit. The more serious counterexamples have been in the Latin countries, many of which have received significant foreign direct investment, yet without coming close to eliminating poverty.

When it comes to China, we can see the glass as either half empty or half full:

China’s scorecard for attracting foreign investment reads like this: Trying hard, doing well, but could do even better. That is the assessment of a just-published OECD report, Investment Policy Review of China — Progress and Reform Challenges. In 2002, China became the world’s largest recipient of total foreign direct investment (FDI), attracting nearly $53 billion. That performance comes thanks to China’s progress on structural reforms, its accession to the World Trade Organization, and efforts to bring regulations in line with international standards.

So is China a counterexample to Brad’s claim? It depends how we count. It is only one country but of course over a billion people.

It also depends how we understand China. Liberalization has brought foreign investment, which has made its “low-wage-but-much-higher-than-before-wage” factories possible. My post immediately below cites research that finds much of the Chinese progress as coming from the shift of labor out of agriculture. This does not mean that capital flows had no role, since they helped make such a shift possible. We also should distinguish between total foreign investment and the per capita measure: “At $30 per capita, China receives less FDI than other major developing countries, such as Brazil with $195 per capita.” But of course foreign capital flows, and Chinese progress, have been concentrated in just a few regions of China.

What is the lesson? Foreign direct investment needs good domestic policies to translate into significantly higher living standards. When such policies are in place, it is amazing how far foreign direct investment can go. Even small per capita amounts of FDI can have a large and positive impact on individuals’ lives. Foreign capital flows have not lost their magic, but they will not lift all boats either.


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