Because the capital market favors non-aligned countries. Economist Report
Studies, research and scenarios on the capital market between finance, states and geopolitics. The in-depth analysis of the weekly The Economist
Listening to American officials describe the trade and investment barriers they are erecting against China, you might think they are doing what they can to limit the ripple economic effects. “These measures have nothing to do with protectionism, nor an intent to hold anyone back,” Jake Sullivan, a national security adviser, said recently at the Council on Foreign Relations, a New York think tank. Officials talk about “small yards and high fences” when describing restrictions on doing business with China — measures aimed at protecting national security but difficult to circumvent. When Gina Raimondo, the Commerce secretary, warns that some Chinese companies have become “uninvestable” for their American counterparts, she uses an almost mournful tone, urging China to allow such partnerships to flourish again.
The new movements of capital on the market
But the talk of limiting disturbances is a fantasy. The prioritization of national security over free investment is reshaping the movement of capital across borders. Global capital flows – especially foreign direct investment (FDI) – have collapsed and are now directed along geopolitical lines. This has advantages for non-aligned countries that can play both sides and, if it limits the volatility of capital flows, it can be positive for the financial stability of emerging markets. But the further distancing of geopolitical blocs risks making the world poorer than it would otherwise be – writes The Economist .
Cross-border capital flows come from investors' portfolio positions, banks' loan portfolios and corporate investments. All of these types of flows declined after the 2007-2009 financial crisis and have not recovered since. But the decline in FDI worsened after the start of the trade war between America and China during Donald Trump's presidency. A study by IMF economists published in April 2023 found that, as a share of world GDP, global gross FDI fell from an average of 3.3% in the 2000s to just 1.3% between 2018 and 2022. Following Russia's invasion of Ukraine in 2022, cross-border bank lending and portfolio debt flows to countries that supported Russia in the votes fell by 20% and 60%, respectively.
At the end of the day
To assess whether FDI has also been redirected over time, IMF researchers analyzed data relating to 300,000 new cross-border (or “greenfield”) investments made between 2003 and 2022. They found a rapid decline in flows towards China after trade tensions escalated in 2018. Between then and the end of 2022, direct investment into China in sectors deemed “strategic” by policymakers fell by more than 50%. Strategic FDI flows to Europe and the rest of Asia also declined, but to a much lesser extent; those to America remained relatively stable. FDI to China's chip sector has plummeted fourfold, even as FDI to chip businesses has risen sharply in the rest of Asia and America.
IMF researchers then compared investments in different regions completed between 2015 and 2020 with those completed between 2020 and 2022. From one period to the next, average FDI flows fell by 20%. But the decline was extremely uneven across different regions. America and European countries, especially the emerging economies, emerged relatively winners. FDI to China and the rest of Asia fell much more than the aggregate decline.
The list of relative winners – wealthy America and its closest allies – suggests that geopolitical alignment has played a role in diverting capital flows. Certainly, it has become more important than ever. By measuring this alignment through voting models, IMF researchers calculated the share of FDI flowing between pairs of geopolitically close countries. They found that this share has increased significantly over the past decade and that geopolitical proximity is more important than geographic proximity. The same correlation with geopolitical alignment is present for cross-border bank lending and portfolio flows, albeit to a lesser extent.
The fact that all this does not seem to arouse much concern or interest from politicians might seem surprising. Like free trade, the free flow of capital should in theory offer more opportunities for businesses and investors, giving everyone a better chance of getting rich. Long-term investments by large companies also provide innovation, management expertise and business networks. For poor countries it is particularly important. Foreign capital promotes growth where domestic savings may be lacking. And if global capital is free to move, its cost is expected to be lower.
Slow down, you're moving too fast
However, despite the far-reaching scope of financial globalization over the past three decades, with gross cross-border positions rising from 115% of global GDP in 1990 to 374% in 2022, the gains have proven difficult to measure. That doesn't mean there were no gains. But at the same time there is clear evidence that sudden inflows of foreign capital can cause financial crises.
A paper published in 2016 by Atish Ghosh, Jonathan Ostry and Mahvash Qureshi, then all of the IMF, identified 152 episodes of unusually large capital inflow “surges” in 53 emerging market countries between 1980 and 2014. About 20% resulted in banking crises within two years of the end of the wave, including 6% that resulted in a double banking and currency crisis (a much higher number than the reference one). Crises tended to be synchronized, clustering around global financial convulsions. But the link between sudden foreign capital inflows and resulting credit growth, currency overvaluation and economic overheating is difficult to rule out.
This constitutes a ballast for Asian policymakers who have methodically reduced their dependence on foreign capital since the 1998 disaster. Indeed, the resistance of emerging countries in recent years, while the Federal Reserve has tightened monetary policy at the fastest pace since the 1980s, it has been remarkable. Then the Fed's tightening triggered a Latin American debt crisis; this time most of the large middle-income countries managed to insulate themselves and weather the storm.
The problem is that even countries with less risky capital flows are losing FDI. Ghosh and his coauthors found that FDI-dominated surge episodes were less likely to end in crisis; it is the sudden floods of bank loans that are destabilizing. What evidence exists on the benefits of unhindered capital also suggests that FDI flows are best suited to stimulating growth and spreading risk among businesses and investors.
The 2023 IMF study modeled the impact of fragmenting the world into separate FDI blocs centered on America and China, while India, Indonesia and Latin America would remain non-aligned (and therefore open to flows from both sides). The impact on global GDP was estimated to be around 1% after five years and 2% in the long term. The growth loss was concentrated in the two blocks; non-aligned regions stood the chance of benefiting. But lower global growth and the possibility that they will be forced to join a bloc could turn that into a loss.
The real losers are the low-income economies that have to deal with the worst of the old and new worlds. Lacking the domestic savings rates, capital markets and foreign currency reserves of middle-income countries, they are simultaneously dependent on foreign capital flows for investment and are less insulated from their sudden reversals. Lacking economic clout, they are more vulnerable to being forced to choose a geopolitical side, limiting their access to finance. The dilemma has become familiar to these countries, and not just in the next arena of change in the global financial system: payments.
(Extract from the eprcomunicazione press review)
This is a machine translation from Italian language of a post published on Start Magazine at the URL https://www.startmag.it/economia/mercato-capitali-paesi-non-allineati/ on Sun, 12 May 2024 07:25:02 +0000.