Policymakers pay a heck of a lot of attention to foreign direct investments when it comes to economic development. Almost no one mentions another driver of growth: domestic savings. That’s strange because even for major economies there’s no question what’s more important:
Both savings and direct investment enter capital that then gets mixed up with labor to produce stuff, but savings are 22 times larger than FDI (2005, 187 countries). And no research shows impact of FDI on productivity of the magnitude that would compensate this difference. This is how it looks with growth:
Most developing countries outside of this sample don’t have to choose between foreign capital and domestic savings because they have no foreign capital at all. Their savings rates also hit the bottom (see, for example, “Are We Consuming Too Much?” by Arrow and coauthors). Countries seem to need more knowledge about accumulating domestic capital than about attracting money from abroad.
What do development agencies and business media respond to this? The World Bank published 7 papers on savings and 58 papers on FDI. Google News finds 3,000 news on “domestic savings” and 58,000 results on “foreign direct investment.” Well, all attention to capital inflow.
But then where does this FDI fixation come from?
As for economics, savings have been considered an exogenous variable for a long time. Sort of, if a nation likes spending, then it saves. An exogenous saving rate is implausible. Faster economic growth implies higher return to capital and labor, so households save more knowing that their deposits and investments yield high returns. Insofar as technology backs this growth, decreasing marginal returns to capital are of less importance. Whatever discount rate households have, growth pays. In the sample above, China, India, and Korea reduced their consumption during the growth times:
But policymakers can’t control growth expectations much. It makes domestic savings less interesting to them. On the other hand, foreign direct investments are institutional and opportunistic. A national leader gives a talk, assures corporate executives that their investments are safe, shows opportunities to invest in—and FDI flow into the country. Well, actually, they don’t. But it still looks easier than convincing millions of people to bring their wages to banks.
The emphasis on foreign capital is hard to justify with numbers, anyway. People’s saving rates respond to their long-term confidence in the economy. If they don’t invest, FDI have little to add.