The FDI chickens come home to roost

18 April 2011


Steinhowel's Aesop: Illustrations  (Steinhowel 1479) 140. De ansere et domino suo.

In the heady days following the end of the Cold War — and I remember them well — when people began to thrown around the term “globalization” and before that term acquired some of its present significance, smaller developing countries previously closed to Western business interests suddenly found themselves on the receiving end of Foreign Direct Investment (FDI). Some of these economies blossomed; some of the ballooned. After the balloons burst — especially after the 1997 Asian currency crisis, widely attributed to Soros’ shorting of the Thai Bhat (which I wrote about in Humbug at Davos) — hard questions began to be asked. Many nation-states sought some degree of control over the FDI passing over their borders. Some imposed restrictions on money coming in; some imposed restrictions on money going out; some imposed restrictions on the length of time money could stay.

I spilled a bit of ink on the question myself in my Political Economy of Globalization, in which I attempted to elucidate the conditions under which an economy could assimilate capital, and how globally liquid capital might be allocated to those economies most capable of putting it to good use, and, just as importantly, not putting it where its consequences would be counter-productive to global economic growth. It is important to recognize that smaller economies wrecked (even if only temporarily) by too much money, too fast, represent a lost opportunity, since a catastrophic business cycle exacerbated by excess FDI is likely to result in a longer and deeper downtown. On the other hand, a carefully managed business cycle — for no capitalist economy can be without a business cycle — is likely to be shorter and to do less damage, and therefore will remain a better place overall for both investors and residents.

In the twenty years since the end of the Cold War the world has changed in some expected ways, and one of these ways in which the world has changed is that globalization, which was kicked into high gear by the investments of developed economies into developing economies, is beginning to turn the tide in the opposite direction, and growing developing economies are rapidly producing a class of very wealthy individuals who want to invest their money in a safe place. Overwhelmingly, they prefer to invest their money in the developed economies, where they have be confident that their investment will be there when they come back for it. Also, the growth of sovereign wealth funds has transformed entire nation-states into investors. These nation-state investors have deep pockets and patient capital. They too want stability and return on investment. In a pinch, I think they would err on the side of stability.

The advanced industrialized economies have stability, and they also have capital needs. It would seem to be a match made in heaven, except for the political obstacles to be overcome. We all remember the Dubai Ports World controversy, when Dubai Ports World, a state-owned-enterprise of the UAE, attempted to take over the management of several major US seaports. These ports had been managed by offshore companies previously, but September 11th was still in the minds of many and it was relatively easy to mobilize popular sentiment against the deal.

Before this, in the 1980s, when the Japanese economy seemed unstoppable (and when Herman Kahn, AKA Dr. Strangelove of nuclear war fame, wrote a book about The Emerging Japanese Superstate), there was considerable controversy surrounding Japanese purchase of US assets.

Most of the US electorate viscerally feels these apparent infringements of sovereignty, but, like most peoples, they are pretty much oblivious to the appearance of the actions of those who represent the US around the world. Money flows in both directions, and people love it when they can pick up a cheap deal in another country, but they aren’t so enthusiastic when someone else comes looking for a cheap deal here in the US. And although money has flowed in both directions in the past, money will increasing flow into the US, both because it will be increasingly available outside the US, looking for a safe place to park, and because of the voracious demand for capital in the US, which will suck in capital like a vacuum.

The cover story of the most recent issue of Oregon Business magazine was particularly interesting in this respect. The article Asian investors eye Oregon properties, green cards by Ben Jacklet featured the local financial services firm American Pacific International Capital (APIC), which specializes in funneling Chinese investment capital into Oregon (and apparently elsewhere in the US as well).

In a relatively poor and underpopulated state like Oregon, serious money coming in from outside could make a real difference in the development of the economy, yet the economy is sufficiently small here that many of the cautions and caveats that were not heeded in regard to the “tiger” economies that boomed in the 1990s before they went bust in the Asian currency crisis are lessons that need to be learned. I can’t imagine a more politically disastrous scenario than a major financial debacle caused (even indirectly) by a large influx of Chinese capital into an economically backward region of the US.

It is important to point out that this would be as disastrous to Chinese investors as it would be to US investments. Killing the goose that lays the Golden Egg is bad for both the goose and the farmer. Thus it is worth our while to learn the lessons of FDI and to apply them scrupulously as the tide of money comes flowing into the US, looking for a good return, but just as ready to be pulled out again if things turn sour.

There are already mechanisms in place that will deter overly rapid movement of capital (e.g., the incentive of a Green Card from federal EB-5 program comes with significant strings attached), and small states like Oregon can benefit from a robust federal system of regulation. Moreover, as I pointed out in my book, advanced industrialized economies can inherently integrate far more capital inflows than less advanced and industrialized regions of the world. But these factors in favor of growing Chinese FDI in the US may not be enough, and it will be interests of all concerned to go the extra mile in due diligence to assure that matters don’t go awry.

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