Sunday, December 13, 2009

US FDI, growth, and the capital stock abroad

The precipitous drop in world trade is well documented (see one of my previous posts for a look at nose-diving exports in Asia); but the adverse effects on FDI is overlooked, in my view.

Foreign direct investment (FDI) is an important conduit to economic growth in the US and abroad. As an example, let's look at what's going on in Alabama, according the local paper (bold font by yours truly):
BAY MINETTE, Ala. -- Things are quiet at a 3,000-acre industrial megasite northeast of town, but events in China are moving an eco-friendly auto plant closer to reality, a company executive and local economic recruiter said last week.

Charles Huang, vice chairman of Hybrid Kinetic Motors, said company leaders including Chairman Yung "Benjamin" Yeung, are finishing several agreements for design and production of components for the Alabama-built autos.

HK Motors announced in September that th
e $4.3 billion plant would employ about 5,800 at full capacity, producing 1 million vehicles annually by 2018.
If and when the HK Motors plant opens up, with the onset of production comes jobs, new income, and a growing capital stock (i.e., the machines and buildings). In the developing world, the effects are magnified since incomes and capital stocks start at a relatively low levels.

But this recession has dropped FDI markedly. According to the Q3 2009 Flow of Funds Accounts of the United States, outward FDI (US firms building plants in non-US economies) rebounded to a 3.8% annual pace, while inward FDI (foreign firms building plants in the US) slowed to a meager 1.7% rate.

In spite of the rebound in outward FDI, the growth rate of the stock of capital stemming from FDI is suffering.

The chart above illustrates the growth of the stock of capital resulting from FDI in and out of the US. The stock of capital is constructed using a simple dynamic equation, which includes investment each period (from the Flow of Funds Accounts, Table L.229) and the non-depreciated existing capital stock.

Since their peaks, capital formation stemming from outward FDI has slowed 40% to an 8.1% annual growth rate, while that stemming from inward FDI slowed 32% to a 9.2% annual rate. The global problem here is: even though US outward FDI rebounded in Q3, the production-generating FDI stock of capital growth is falling to its slowest annual pace since since 1995.

Going forward, the stock will depreciate further; and it will take new FDI to bring it back. This is critical for emerging markets that depend on FDI to foster economic growth.

Rebecca Wilder

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