GLOBAL INVESTMENT : Private Money Gaining as Chief Economic Fuel
If East Asia (population: 1.8 billion) continues its extraordinarily high rate of growth through the 1990s and beyond; if South Asia (population: 1.2 billion) ratchets up its recent growth toward that of East Asia; if Latin America (population: 450 million) resumes its high growth of the early 1990s, and if Eastern Europe, Russia, Ukraine and the Central Asian republics (combined population: 400 million) succeed at liberalizing their economies--where will all the needed long-term capital come from?
What’s clear is that the next decade will be marked by an intensely competitive international market for long-term money. And where the relatively scarce international savings from wealthier countries end up will chiefly depend on three factors:
* Past capital flows. Precedents and experience lower the transaction costs of future investment, thereby facilitating the flow of money. From 1985 through the start of 1994, net global long-term capital flows totaled $1.3 trillion. Of this, 60% went to the Asia-Pacific region, which reflects the region’s impressive growth as well as contributing to it. Another 15% was destined for Latin America, 10% to South Asia, with smaller amounts going to the Middle East, Eastern Europe and Central Asia and Sub-Saharan Africa.
* Expectations of economic growth . Regions where economies remain strong and business is expected to expand will continue to attract foreign investors looking for profits. Conversely, areas where growth rates are flat are unlikely to attract investment. For the 1995-2004 decade, the World Bank estimates that annual growth in the Asia-Pacific region will be greatest (7.7%), followed by South Asia (6.9%) and Latin America (6%), with lower rates forecast for Eastern Europe, Russia, the former Soviet Union, the Middle East and Sub-Saharan Africa. Within these regions, China’s annual growth is estimated to be the highest (8.1%), followed by India’s (7.1%). (RAND’s independent estimates place China’s and India’s growth rates about one-third lower than the World Bank’s, at 4.9% and 5.5%, respectively.)
* The economic, political and legal envi - ronments of host countries . This factor will probably become increasingly decisive, because the types of capital most sensitive to it have become an increasing proportion of total capital flows.
Long-term capital is composed of five principal types: foreign direct investment; portfolio equity investment; private commercial debt; public and publicly guaranteed debt, and government grants. The first three are “voluntary”--they flow from business decisions and are motivated by market and profit considerations. Voluntary capital is heavily dependent upon the policies and politics of host governments, including their overall prospects for political stability. By contrast, public and publicly guaranteed debt, as well as grants, depend on the policies, priorities and preferences of donor governments and international agencies.
Between 1985 and 1993, when long-term capital flows increased at an annual rate of 8%, the three voluntary sources each increased between 19% and 25% annually; publicly provided money showed no change. Voluntary capital, taken together, increased from $32 billion in 1985 to $173 billion by 1994, about two-thirds of total annual flows.
The increasing importance of voluntary capital in financing global economic growth adds significance to such factors as a host country’s property rights, the character and predictability of its tax and regulatory policies, its currency convertibility and the enforceability of contractual obligations by its local and central governments.
Countries hoping to attract foreign capital to finance their economic growth face international markets in which the supply of capital from the wealthier nations will likely be constrained by their own capital demands, as well as by their continued high levels of public spending on social programs. Consequently, these developing countries will have to rely predominantly on domestic savings to finance their economies.
In the future competition for scarce capital, winners will not only be those successful in sustaining high levels of economic growth, but also those whose economic, legal and regulatory policies are geared to easing the concerns of foreign investors and engaging the “animal spirits” that often motivate them.*
