12/02/2009
Lecture 24: International Dimensions III: Capital Flows

Before we looked at flow of goods (globalization).  Now we'll talk about flow
  of money/investments.

Capital flows into/out of a country are measured in capital accounts
  -> tracks financial flows between countries
  -> capital is an asset that you wouldn't want to consume, but can generate
     consumption.
Flow of goods (instead of assets) is tracked in current accounts

Flow of assets take two main forms
  -> Foreign direct investment: acquiring ownership w/ control (usually minimum
     10% stake in voting shares).  Can be done by setting up a subsidiary/company,
     pursuing join venture, merger, acquisition.  e.g., if someone in brazil bought
     15% of google, that would be outflow from brazil into usa.
  -> Portfolio/other investments: purchase of stocks, bonds, or other financial
     instruments without acquiring legal control.

How can this be tracked?  Usually by combination of customs and foreign exchange
  (need dollars to buy US firm, etc.)

From perspective of a developing country, is net inward FDI different from
  net inward portfolio investment?
  -> maybe dev. country wants capital investments, but want to maintain
     control so that their interests are aligned with country.
  -> FDI might be harder to reverse, i.e., you've thought your decision through
     a lot, and might be in it for the longer haul, so that might be better.
  -> sometimes (like china in africa), FDI investors bring their own workers into
     the country, so wages/jobs get diverted to foreigners.

Tariffs are for barring trading of goods.  WTO regulates these.  An analogous
  thing happening w/ capital is barring foreign ownership, or taxing foreign
  investment.  India in 80's, switzerland homeownership today, etc.
  There's also a subsidy on FDIs: china gives explicit subsidies on FDIs
  and implicit ones by setting up economic develpment zones that are nice to
  live in, have nice schools, etc.

Symbols:
  Income = Consumption + Investments + Government expenditures + Exports - Imports
  Y = C + I + G + X - M
  
  Income spent by individuals = Consumption + Savings + Taxes
  Y = C + S + T
  
  Exports - Imports = Current account = Capital Account
  X - M = KA
  Note: Current account = Capital account -> for every money coming in, there are
    goods traded out, and vice versa
  
  From these, you can derive this equation:
  borrowing/lending + government budget/deficit = capital account
  (S - I) + (T - G) = KA
  that's kind of profound: if the government is balanced (T-G = 0), and 
    the economy is closed (KA = 0), then we have to save as much as we invest.
  this accounting identity is touched upon in at least one business article
    in nytimes every day

Benefits of international _portfolio_ capital mobility
  - improved consumption smoothing over the years
  - break S=I requirement temporarily
  - more competition in banking sector to own different stocks keeps companies
    honest, thrifty.

Costs of international _portfolio_ capital mobility
  - hightened volatility---it's easy to reverse investment decisions since it's
    not a large stake in stock, so things jump fast
  - since things can move fast, changes in perception of fundamentals lead to
    immediate inflows/outflows that result in herding/contagion (multiplier of
    perception), which is exaggerated further by leverage.
  - once you're talking international, sudden withdrawls can lead to liquidity runs,
    and sudden inflows can lead to inflationary pressure
  - these pressures can hurt outside of the original sector they were noticed in,
    especially in developing nations w/ weak financial systems.

1997 south asian financial crisis
  - various underlying financial crises rapidly depreciated the Indonesian Rupiah
  - chart shows that entire income distribution earned less per capital income (PCY).
    all of them dropped their per capita expenditure (PCE) by less, meaning they
    did consumption smoothing---they saved less to make up for money.
  - note: PCE dropped 15-20%, PCY dropped 20-30%, and Wages dropped ~40%
  - other than savings, people also responded by havng more members of household
    work, poor went to live with richer relatives/friends, and people worked
    longer hours.

Benefits of inward _FDI_ capital mobility
  - more efficient use of world's resources (both capital and management)
  - transfer of knowledge/technology to other domestic firms (licensing
    patents in other countries, consulting on open source, [chinese] get spillover
    of technological ideas into country, etc.)
  - more competition in domestic market (competition from foreign entities)
  - exploit intra-firm capital markets---large multinational can take profits
    from one branch to invest in another branch.
  - overcome trade frictions---even if there's no tariffs, there's overhead
    to trade.  e.g., almost half of current US trade occurs within firms.
(note: there is little evidence for the first two bullet points.  tha doesn't
 mean it doesn't exist---it's just hard to measure, since you need randomization
 or something like that)

Costs of inward _FDI_ capital mobility
  - even though it's more stable, there is more volatility in developing nations.
  - sweatshop labor
    - not clear---multinationals pay higher wages
    - but they do seem to underpay, since they pay more when pressured by poor
      media coverage.