When the short term gets bumpy it helps to focus on the long term. So, in a week when the news came through that there had been a sharp fall in investment in the US, it seemed a good time to take a longer-term look at what has been happening to international investment flows, as chronicled by the new World Investment Report from the United Nations Conference on Trade and Development (UNCTAD).
To summarise, the story this week has two legs. One is that there was this outflow in August of foreign investment funds in long-term securities of $69bn (£34bn), reversing a monthly inflow running at more than $100 billion and the first significant such outflow since 1995. The US needs this monthly inflow to cover its current account deficit, so though the outflow was associated with the events of the wicked month of August, it raises all sorts of questions about the US ability to attract inward investment, the limits on the ability of the Federal Reserve to cut interest rates and the weakness of the dollar.
The other leg was the evident growing resistance to the so-called Sovereign Funds, the funds that countries such as China and Russia have established to invest their country's surpluses in a wider range of assets. This concern is going to be raised at the Group of Seven finance ministers meeting in Washington this coming weekend. The American authorities don't mind China buying their Treasury bills and government bonds and thus helping finance the fiscal deficit as well as the current account one. But they are less than thrilled at the prospect of Johnny Foreigner buying up Uncle Sam's companies on the cheap. So there will be calls for restrictions on the investments that these country funds are allowed to make.
The threat is obvious. The global imbalances that some of us have been banging on about for what seems like years are at last starting to matter. If countries that have a surplus with the US are restricted from using their balances in such a way as to give them a decent return, then maybe it might be better to invest the balances elsewhere. There is a real possibility that the present gradual decline of the dollar might become a rout. The present decline of the dollar is already enough to start correcting the current account deficit but that might carry little weight with international investors if they were to lose confidence in the US more generally. A falling dollar would push up US import prices and hence inflation and that in turn would make it impossible for the Fed to cut rates enough to stave off recession. It is all a bit scary.
Now, to calm things down, take a look at the longer-term global investment scene. Every year UNCTAD does this report on global flows, and this is really the best source on the subject. Here some messages stand out.
This first point is that foreign direct investment – that is investment by international companies in factories, other plants, offices and so on in other countries – is not portfolio investment. The latter is investment in securities be they issued by companies or by government agencies.
There are two views about the relative value of the different types of investment. One that that direct investment brings greater qualitative benefits than portfolio investment because it results in new physical investments and also transfers knowledge of production, marketing and so on.
The other, which I incline to myself, is that it does not matter much what form investment takes as long as it is in commercial activities, i.e. the crucial distinction is not between direct and portfolio but rather whether the investment is in productive output rather than funding government deficits. After all, if a hedge fund buys a company it can only make a success of that purchase if it puts in good management and improves the business: it cannot sell it on for a profit if it does not add value in some way. Of course, there are examples of bad portfolio investment but there are also plenty of examples of bad direct investment.
But at least commercial investment, if it is to be successful, must bring some management knowledge, even if it is just picking winning managements. Investment in another country's government bonds does not transfer any management skill. So on that basis, arguably the rise of the Sovereign Funds noted above and the switch of investments towards higher-yielding assets will contribute more to the economies of the deficit countries. Maybe the US ought not to be reluctant to accept the switch after all.
The next point to make is the obvious one that FDI has recovered from the trauma of the dot-com bust. There was a real collapse of such investment after 2000 after a steady rise through the 1980s and 1990s. We are not quite back to the previous peak in money terms, let alone real terms, but we are not far off. Within the total, and I find this particularly encouraging, the developing country component has risen and actually is now past its previous peak. So insofar as FDI transfers know-how as well as money, the benefit to the developing world is larger than ever.
What I found completely new was that both reproduced from the first chapter of the report. They are both derived by UNCTAD from the Dun & Bradstreet Who Owns Whom Database. One shows the top locations for the foreign affiliates of financial transnational companies, the other the top locations for the foreign affiliates of the largest 100 transnational companies from developing countries.
Well, the figures speak for themselves. The UK dominates both tables, with more than double the score of the US in each case. Together the UK and US are way out in front of everyone else. You might expect, given the strength of London as a financial centre, for it to be at the top of the finance league but to be top of the developing country league too is quite remarkable. It says that insofar as there is any single place that choreographs globalisation, it is the UK and not the US.
What conclusions should follow from this? The first thing surely is that we should celebrate the fact that global FDI has indeed recovered and particularly that the developing country element has recovered most strongly. That must be good news and a helpful counterweight to set alongside the present concerns about global imbalances. Now it may be that the ructions of the summer will discourage FDI and these figures are of course for last year, not this one. But that experience does carry a concern. We saw how the bursting of the dot-com bubble damaged all international investment, including investment in developing countries and there must be a worry that the incipient slowdown will do the same again.
But the other thing that seems to be to be very important is that it is not just in the UK's national interest to retain the dominance exemplified in this report. It is actually in the world's interest to do so. We must be doing something useful and I would like to see much more analysis of what it is and how we might do even better.Reuse content