Direct Investment is a Steady Source of Foreign Capital

In crisis-beset developing areas such as Latin America and developing Asia, in contrast, direct investment clearly has been the most dependable, steady source of foreign investment, with an upward trend and no reversals of direction over five-year periods.

In recent years, direct investment - which occurs when a company in one country obtains a "lasting interest" in an enterprise in another country -- has acquired a reputation as the tortoise of international finance: a reliable standby in a world of hot money and recurrent financial crises. This popular perception, it turns out, is pretty much on the mark. In The Role of Foreign Direct Investment in International Capital Flows (NBER Working Paper No. 7094), NBER Research Associate Robert Lipsey examines data from 1969 through the 1990s and finds that direct investment flows to and from major world areas have been markedly less volatile than portfolio investment, bank loans, or other investment flows. There is one glaring exception to this rule: the United States, where net direct investment flows have actually been more volatile than portfolio or short-term investment flows.

That high U.S. volatility reflects the events of the 1980s when the United States switched from its traditional role as the world's dominant supplier of direct investment to become the world's largest recipient of direct investment. It returned to its supplier role in the 1990s, but no longer in a dominant way. In crisis-beset developing areas such as Latin America and developing Asia, in contrast, direct investment clearly has been the most dependable, steady source of foreign investment, with an upward trend and no reversals of direction over five-year periods.

Lipsey finds that, relative to other forms of international investment, direct investment grew from 1970 to1994, when it reached 31 percent of world investment flows. Then direct investment declined for a few years relative to other forms of international investment, but it still remained well above its 1970s levels.

While the United States was the main source of direct investment outflows through the 1970s, first Europe and then Japan became major sources of gross direct investment outflows in the 1980s. As of 1996 Europe was by far the leading source of gross direct investment outflows, trailed by the United States, Japan, and the Asian tigers of Hong Kong, Taiwan, and Southeast Asia.

Much of Europe's total, however, consists of intra-European investment, and much of the U.S. gross outflow is matched by a corresponding inflow. Since there is little inflow into Japan, that country is much more important as a net supplier of direct investment than as a gross supplier. Latin America has been the region with the largest net inflows from outside, although developing Asia has at times received larger gross inflows, particularly in the 1990s. Much of the Asian inflow is from Asian countries, while little of the Latin American investment comes from within the region.

-- Justin Fox