This article is a non-technical summary of the paper written by Julien Acalin (BSI Economics) and Olivier Blanchard, available here.
News: Foreign direct investment (FDI) flows are generally perceived as relatively stable capital flows, resulting from decisions based on long-term factors. In contrast, other capital flows, particularly portfolio flows, are often considered more volatile, even destabilizing. Thus, when it comes to capital controls, the traditional message from researchers and policymakers is to encourage FDI inflows into their countries and restrict portfolio flows.
In a recent study, however, Olivier Blanchard and Julien Acalin (2016) highlight three findings that suggest that FDI flows measured in balance of payments actually paint a different picture from the one described above.
1) First , for several countries, there is a strong positive correlation between inward and outward FDI flows during the same quarter, whereas one would expect this correlation to be zero or even negative. Indeed, if a country appears attractive to foreign investors, it would be surprising if domestic investors found it more profitable to invest abroad at the same time. This strong positive correlation, which is robust to various statistical adjustments, suggests that part of the FDI measured corresponds to flows that transit through, rather than to, the country concerned, with another country as the final destination.
2) Secondly , FDI inflows into many emerging countries increase following a decline in the US Federal Reserve’s key interest rate during the same quarter. Furthermore, in line with the previous point, FDI outflows from these emerging countries also show negative elasticity with respect to the US policy rate (in other words, these flows increase/decrease when the US rate falls/rises). Unlike other capital flows, particularly portfolio flows, FDI flows would be expected to be relatively insensitive to the Fed’s interest rate, at least in the short term. Nevertheless, FDI flows appear to react more strongly than portfolio flows to changes in US policy rates. These two observations reinforce the conclusion reached in the previous point: some of the capital flows recorded as FDI are in fact similar to portfolio flows.
3) Third , the average corporate tax rate and restrictions on capital inflows (excluding FDI) into the country appear to explain the correlations between FDI inflows and outflows from the country during the same quarter mentioned above. A lower corporate tax rate and greater restrictions on capital inflows (excluding FDI) lead to a higher correlation between a country’s FDI inflows and outflows. These results suggest that part of the measured FDI flows correspond to portfolio flows passing through the country to take advantage of more favorable taxation, with a completely different country as their final destination.
In conclusion, quarterly FDI inflows and outflows from an emerging country respond to changes in the US policy rate during the same quarter, are strongly correlated with each other, and this correlation is even stronger when the average corporate tax rate is low or when restrictions on capital inflows into the country are high. These findings, which do not call into question the positive impact of « real » FDI, should serve as a warning to researchers and policymakers: some measured FDI flows are not « real » FDI flows.
