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Global Capital, 1914 to the present

In the Victorian era, most of the world’s surplus savings flowed from Western Europe to the developing countries of the time, which included some rapidly industrialising ones like the United States. So American railroads and canals were financed, at least in part, by European capital. At the same time, European portfolios also included the raw materials and agricultural output of what today is called the Third World. These would be extracted, processed and exported to the European market.

Of course when I say “Europe”, I mean mostly the United Kingdom, for it was the premier global investor par excellence, by far the largest shareholder in the global stock of foreign investments in 1870-1914. The UK had accumulated huge savings surpluses from its early industrialisation and these were exported around the world. Sometimes, historians talk of Britain’s “informal empire” which might have been more important and influential than the formal empire of the red bits on the map. I agree with that view.

But all that was essentially brought to a dramatic end by a conspiracy amongst the First World War, the Great Depression, the Second World War, Decolonisation and Third World socialism. The scanty historical data are presented by one of the best sources on this subject 

A chart of Mexico fr Twomey:

After 1945, global FDI flows did recover from depression and war, but the geographical pattern of foreign investment was completely transformed. In the postwar economic boom of 1945-80, most of the investment flows took place within and between developed countries in a phenomenon which has been labelled the Lucas Paradox Here is a comparison of the foreign investment stocks between 1914 and 2001 from Schularick:

Basically, most — over 90% in 2001 — of the world’s foreign investment positions represent rich countries owning one another’s productive assets. The chart below (source) uses cruder data, but it still illustrates the within-rich pattern of FDI flows had been well under way for the United States as early as 1960 :

An even more illuminating way of looking at FDI data, from the second besdt source on the subject :


 

I cannot improve on the implications of the above by Obstfeld and Taylor themselves :

Figure 10 both illustrates the periphery’s need to draw on industrial country savings, as well as an important dimension in which the globalization of capital markets remains behind the level attained under the classical gold standard. In the last great era of globalization, the most striking characteristic is that foreign capital was distributed bimodally; it moved to both rich and poor countries, with relatively little in the middle. Receiving regions included both colonies and independent regions. The rich countries were the settler economies where capital was attracted by abundant land, and the poor countries were places where capital was attracted by abundant labor.

Globalized capital markets are back, but with a difference: capital transactions seem to be mostly a rich-rich affair, a process of “diversification finance” rather than “development finance.” The creditor-debtor country pairs involved are more rich-rich than rich-poor, and today’s foreign investment in the poorest developing countries lags far behind the levels attained at the start of the last century. In other words, we see again the paradox noted by Lucas (1990), of capital failing to flow to capital-poor countries, places where we would presume the marginal product of capital to be very high. And the figure may understate the failure in some ways: a century ago world income and productivity levels were far less divergent than they are today, so it is all the more remarkable that so much capital was directed to countries at or below the 20 percent and 40 percent income levels (relative to the U.S.). Today, a much larger fraction of the world’s output and population is located in such low productivity regions, but a much smaller share of global foreign investment reaches them. [emphasis mine]

Personally I’ve never found the Lucas Paradox terribly paradoxical — it’s one of those “paradoxes” that arise only from ahistorical models of the world. Basically, in the 19th century, raw materials had high value relative to the manufacturing process that converted them into stuff. But with the exponential rise in technological sophistication, the manufacturing process became relatively more valuable (=added much more value than previously), and the materials intensity of output (the amount of raw material input per unit of output) declined. Put simply, more was being made with less.

But such a process requires technological mastery, and that mainly exists in the rich countries. So whereas Victorian investors were concerned with acquiring high-value raw materials for use in production (and consumption) at home, mid-20th century foreign investment was more about owning the high-value-adding manufacturing operations that produced stuff for the internal markets of the rich countries themselves.

It’s not that resources were not flowing to the Third World in the post-war period. They were, but mostly in the form of foreign aid and bank loans (source) :

Ironically, most of the resource transfers from the rich to developing countries in the form of loans were just reshuffling of ledger entries in Western and Japanese banks. In the 1970s the prices of all commodities skyrocketed — oil, copper, gold, tin, coffee, everything. So developing countries were awash in money. Yet, lacking strong financial institutions they (including many of the Arab oil producers) deposited the commodity revenue in western banks. Thus the dollars, francs, yen, marks & pounds exchanged for Chilean copper, Iranian oil and Ethiopian coffee were re-lent to a different mix of developing countries. What later followed is one of history’s great financial catastrophes.

As the chart above intimates, the late 1980s and early 1990s did see an upswing in FDI flows into the Third World. And that’s related to the debt crisis. In exchange for a combination of debt relief and financial assistance, the international financial community demanded that the debtor countries restructure their economies in fundamental ways, including privatisation of state-owned assets, statutory protection of foreign investment, and the lifting of controls on the mobility of international capital. Thus started, in fitful steps, the return of investment in “emerging markets” :

The pattern of rich countries primarily investing in other rich countries has not gone away. That’s still the predominant case, right now, in 2014. But the absolute level of foreign investment flows has burgeoned in the last 15 years for every country open to them. We are nowhere near back to 1914 levels in most countries, but 25 years of neoliberal prescriptions have definitely had a conspicuous effect on foreign direct investment in the Third World.