Investment From Abroad

So far we have discussed how policies aimed at increasing a country's saving rate can increase investment and, thereby, long-term economic growth. Yet saving by domestic residents is not the only way for a country to invest in new capital. The other way is investment by foreigners.

Investment from abroad takes several forms. Ford Motor Company might build a car factory in Mexico. A capital investment that is owned and operated by a foreign entity is called foreign direct investment. Alternatively, an American might buy stock in a Mexican corporation (that is, buy a share in the ownership of the corporation); the Mexican corporation can use the proceeds from the stock sale to build a new factory. An investment that is financed with foreign money but operated by domestic residents is called foreign portfolio investment. In both cases, Americans provide the resources necessary to increase the stock of capital in Mexico. That is, American saving is being used to finance Mexican investment.

When foreigners invest in a country, they do so because they expect to earn a return on their investment. Ford's car factory increases the Mexican capital stock and, therefore, increases Mexican productivity and Mexican GDP. Yet Ford takes some of this additional income back to the United States in the form of profit. Similarly, when an American investor buys Mexican stock, the investor has a right to a portion of the profit that the Mexican corporation earns.

Investment from abroad, therefore, does not have the same effect on all measures of economic prosperity. Recall that gross domestic product (GDP) is the income earned within a country by both residents and nonresidents, whereas gross national product (GNP) is the income earned by residents of a country both at home and abroad. When Ford opens its car factory in Mexico, some of the income the factory generates accrues to people who do not live in Mexico. As a result, foreign investment in Mexico raises the income of Mexicans (measured by GNP) by less than it raises the production in Mexico (measured by GDP).

Nonetheless, investment from abroad is one way for a country to grow. Even though some of the benefits from this investment flow back to the foreign owners, this investment does increase the economy's stock of capital, leading to higher productivity and higher wages. Moreover, investment from abroad is one way for poor countries to learn the state-of-the-art technologies developed and used in richer countries. For these reasons, many economists who advise governments in less developed economies advocate policies that encourage investment from abroad. Often this means removing restrictions that governments have imposed on foreign ownership of domestic capital.

An organization that tries to encourage the flow of investment to poor countries is the World Bank. This international organization obtains funds from the world's advanced countries, such as the United States, and uses these resources to make loans to less developed countries so that they can invest in roads, sewer systems, schools, and other types of capital. It also offers the countries advice about how the funds might best be used. The World Bank, together with its sister organization, the International Monetary Fund, was set up after World War II. One lesson from the war was that economic distress often leads to political turmoil, international tensions, and military conflict. Thus, every country has an interest in promoting economic prosperity around the world. The World Bank and the International Monetary Fund are aimed at achieving that common goal.

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