How to Save Attention Misdirected to Foreign Direct Investments

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:

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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:

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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:

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All countries (GDP per capita artefacts removed)

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.

Real Limits to Growth

 

The Limits to Growth predicted the demise of economic growth back in 1972. Though the book received much criticism since then, Graham Turner recently confirmed that current development follows the patterns predicted by the book.

But there’s one problem, which is well-known to economists in growth economics. The resource ceiling ignores technology as the capacity to switch between limited resources. The confirmatory evidences Turner found belong to the upcoming trend. Indeed, the world economy consumes more oil and food. It’s okay. Bad things are supposed to happen when the economy per capita will be unable to consume more goods and services.

And the model hasn’t yet confirmed these bad expectations. It’s unlikely to. When some resource becomes scarcer, its price increases, and humans demand more efficient technologies, like energy-saving appliances and fuel-efficient cars. The world had an oil price shock already in the 1970s. It made better air conditioning and small cars popular even in the US.

The limit of growth comes not from too little oil, but from too much oil. Everyone invests in oil technologies for more than a century because no one sees a cheaper and more abundant resource. These investments made fossil fuels very efficient and attractive. Alternative energy can hardly compete with them.

Fossil fuels impose indirect costs, affect the environment, and crowd out investments into alternative energy. They are difficult to deal with. And their prices go down, thanks to fracking and other extraction methods.

Technologies may save the world from running out of oil, but they’re themselves powerful enough to slow down development. Nuclear weapon is making troubles around for more than 60 years. Hitler nearly obtained the atomic bomb. And Germany would get it not by surprise, like a terrorist organization, but because it was one of the most developed societies in the world before the 30s. Technologies aren’t safe in the hands of most advanced and democratic countries.

So, the limits to growth are trickier than the finiteness of certain resources. And these limits are less predictable.