Putting it to Work in Developing Countries - Nathan Associates

esources, including Internet addresses; and
Appendix C is a glossary of terms related to
FDI.
FOREIGN DIRECT
INVESTMENT AND THE
DEVELOPMENT MODEL
Economists agree that economic growth drives
development. They do not fully agree on what
drives growth. Some—the “capital fundamentalists”—assert
that capital accumulation, through
investment in plant, equipment, and worker
training and general education, is most important
in raising total output and output per
worker. Others emphasize the role of “total factor
productivity,” a difficult-to-measure bundle
of positive variables including technology, organizational
methods, and institutions that affects
how well firms and societies can respond to economic
opportunities and incentives. 2
Regardless of their positions within this debate,
most parties would probably still agree on the
importance of FDI, for two reasons. First, FDI
has become the dominant and most reliable
external source of investment capital for the
developing world. And second, FDI delivers this
investment capital in a way that enhances total
factor productivity.
EXTERNAL CAPITAL FLOWS
One of the most striking changes in international
finance over the last 15 years is the vigorous
expansion of external private capital flows to the
developing world. In 1990, all net external capital
supplied to developing countries totaled
about $110 billion, made up equally of net private
flows and net official flows (loans and
grants). By 2005, net flows had more than
quadrupled to $472 billion, but share distribution
had shifted radically: private capital ($491
billion) accounted for all external flows to the
developing world, while official capital had actually
turned negative ($-19 billion) as developing
country payments to official creditors outstripped
bilateral aid grants received (Table 1-1).
Ireland’s Growth Fueled by FDI
After a decade of sustained economic
growth, Ireland employed more people
in 2004 than at any time since its
inception as a State, and enjoys living
standards, as measured by gross domestic
product (GDP), that exceed the
European Union average. Its government
indebtedness is now the second
lowest in the euro-zone. Flows of FDI
into Ireland fueled this growth. FDI
increased from an annual average of
about $140 million in the 1980s to a
peak of more than $29 billion by 2002.
As a result, Ireland’s total inward stock
of FDI reached $211 billion in 2005,
second only to Hong Kong in per capita
terms. Throughout this period, the foreign-owned
sector contributed significantly
to growth in output, exports, and
employment. And through a multiplier
effect, its prosperity benefited the
indigenous sector by creating jobs,
developing skills, and improving quality
in general.
Net external private capital flows consist of FDI,
portfolio equity, and private commercial debt. 3
Between 1990 and 2005, all three grew significantly
in absolute terms. In 1990, net external
private capital flows to the developing world
totaled about $55 billion, made up of FDI ($24
billion, or 43 percent), portfolio equity ($3 billion,
or 5 percent), and private debt, both longand
short-term loans (more than $28 billion, or
51 percent). In 2005, according to World Bank
statistics, FDI had increased tenfold to $238 billion,
or nearly half of all net private external
capital, and continued to represent the largest
single flow. Portfolio equity had risen even more
sharply to $61 billion (13 percent of total),
while private debt increased to $192 billion (39
percent). The growth paths of these three flows,
2