Global competition for long-term capital: who will win?

Business Economics, July, 1996 by Charles Wolf, Jr.

If East Asia, with a population of about 1.8 billion, continues its extraordinarily high rate of growth through the 1990s and beyond; if South Asia, with a population of 1.2 billion, ratchets up its recent growth toward that of East Asia; if Latin America, with a population of 450 million, resumes its high growth of the late 1980s and early 1990s; and if Eastern Europe, Russia, Ukraine, and the Central Asian Republics, with a combined population of about 400 million, succeed in economic liberalization that moves them to a path of sustained economic growth, their combined demand for long-term capital investment will be enormous. Clearly, the bulk of these demands will have to be met from internal sources. Yet, there will be a large residual constituting an increasing demand for long-term capital from the international capital market.

So, the question arises where will the long-term capital come from, and who will be the winners and the losers in the competition for it?

The answer to the first question is that, in general, the OECD developed countries, in Western Europe, the United States, Japan, Australia, and New Zealand, with a combined population of about 650 million, will be the principal sources of global savings and of long-term capital. Yet, their supply of capital will be limited by their own domestic demands for new investment in their private sectors, by their public infrastructure demands, and by their commitments to the social welfare programs their political structures maintain. As a consequence, the bulk of the long-term capital demands of the developing regions will have to be provided from their own sources of domestic savings. This has been an abiding characteristic of all prior development experience and will continue to be the case in the future.

However, there will be a residual representing the difference between long-term capital demands in the previously mentioned developing regions, and their domestic savings, and this residual will be reflected by demands in the global capital market. Consequently, competition for long-term capital flows in that market will be intense in the years ahead.

Before considering the determinants of future capital flows, the next section of this paper briefly describes the different types of long-term capital flows and the record of prior flows in the period from 1985 to 1993.

TYPES OF LONG-TERM CAPITAL FLOWS AND PRIOR FLOWS, 1985-1993

Long-term capital flows are composed of five principal types shown in Table 1:

Table 1

Types of Long-Term Capital Flows

* Foreign Direct Investment }

* Portfolio Equity } "Voluntary"

* LT Private nonguaranteed debt }

* LT public and publicly guaranteed debt

* Grants

As indicated in Table 1, the first three types are "voluntary," i.e., they flow as a result of business, rather than government, decisions and are motivated principally by market and profit considerations. Foreign direct investment is defined as acquisition of 10 percent or more of the assets of a business entity abroad, and typically takes the form of tangible, real-property "bricks and mortar" investment. Portfolio equity investment represents asset acquisitions that are less than the 10 percent equity threshold. Long-term private nonguaranteed debt consists of commercial loans of more than one-year's maturity.

Voluntary capital, i.e., the first three types shown in Table 1, is heavily dependent upon the policy and politics of host governments, including their overall prospects for political stability, which, of course, affect the reliability of market and profit calculations. By contrast, public and publicly guaranteed debt, as well as grants, depend on the policies, priorities and preferences of donor governments and international agencies. Lending by the Export-Import Bank, debt guaranteed by the Overseas Private Investment Corporation, and grants from the Agency for International Development, as well as its counterpart agencies in the other OECD countries, are principally motivated by policy considerations that differ from those of the three voluntary types of capital flows.

Table 2 shows the distribution of long-term capital inflows across the five principal types shown in Table 1, from 1985 through 1993, in billions of current dollars.

As Table 2 indicates, in the last part of the 1980s net long-term capital flows were dominated by public debt, publicly guaranteed debt and grants, amounting to over $500 billion during the 1985-89 period, while the "voluntary" forms of capital flows amounted to less [TABULAR DATA FOR TABLE 2 OMITTED] than $100 billion (after allowance for the net repayment of previously accumulated private, nonguaranteed debt by the capital importing countries). In the first four years of the 1990s, by contrast with the earlier period, the voluntary sources of capital, especially foreign direct investment, substantially increased. The combination of foreign direct investment, portfolio equity, and long-term private nonguaranteed debt slightly exceeded the volume of publicly provided capital ($340 billion for the voluntary types of capital flows versus $336 billion for the publicly provided debts and grants).