Why Has Foreign Investment Increased So Dramatically in Recent Decades
Why Has Foreign Investment Increased So Dramatically in Recent Decades

As stated earlier in this Issue in Depth, international investment levels have exploded in recent decades. These increases in the flows of foreign investment have themselves marked a new and distinct phenomenon in the era of globalization. Several factors have helped drive this growth:

1) Technology: Telecommunications and transportation advances have simply made it easier to do business across large distances. As former American President William Jefferson Clinton once pointed out, in the 1960s, transatlantic telephone lines could only accommodate 80 simultaneous calls between Europe and the United States. Today, satellites and other telecommunications infrastructure can handle one million calls at one time.

Fax machines, email and the drop in the cost of air travel have also contributed significantly to the growth of FDI. As you can imagine, a business owner might think twice about trying to run an affiliate in a foreign country if communication with that office were not both easy and cheap. Changes in practices tend to be driven by changes in capabilities, and these new methods to communicate have unquestionably helped drive much of the subsequent desire to promote economic integration.

2)The lure of higher profits: In the 1980s and early 1990s, a number of countries in East Asia (Hong Kong, Indonesia, Japan, South Korea, Malaysia, Singapore, Taiwan, and Thailand) began to experience enormous economic growth rates, in some cases piling up double-digit expansions in their GDP per capita year after year. These countries had built their phenomenal growth on a foundation based on greater integration into the international economy. In particular, they began emphasizing export-led growth. Investors from around the world realized that access to East Asian markets and their trading partners might help them attain much higher returns on their investments than they could obtain at home.

3) The fall of the Berlin Wall: The end of the Cold War had an important impact on international financial liberalization. First, many developing countries that had previously been committed to socialist models of economic planning began to turn toward market economies. The resulting efforts to privatize state-owned enterprises and changes in economic policies that were more favorable to capital investment made these economies much more attractive to potential investors.

In addition, the demise of the Soviet Union also gave many investors much more confidence in the political stability of developing countries in general. Fears that a government might be overthrown or voted out in favor of one that might expropriate foreign assets declined.

4) Financial liberalization: Prior to the 1970s, many countries, including the United States, imposed strict limits on the rights of companies and individuals to invest overseas, to purchase foreign stocks and bonds, or even to hold foreign currencies. Many of these restrictions were put in place following the Great Depression of the 1930s, which had produced volatile movements of capital, triggering financial panics in some cases.

However, in the early 1970s, the United States went off the gold standard and the previous system of fixed exchange rates between foreign currencies was abandoned. In addition, many restrictions were lifted on the flows of international capital, making it much easier for investors to purchase foreign securities. Since that time, the United States has been in the forefront of efforts to remove remaining controls on the movement of international capital. The Reagan, Clinton, and George W. Bush Administrations in particular made de-regulation of capital movement a high priority on their international economic policy agendas.

Financial liberalization has been the most direct, and probably the single biggest, factor accounting for the growth of international investment flows over the past several decades.


Next: Where does Foreign Investment Take Place