Capital from Industrialized Nations to less Leveloped and Emerging Markets – Case Study Example

 WHETHER CAPITAL GENERATED IN THE INDSTRIALIZED CONTRIES IS FINDING ITS WAY TO LESS DEVELOPED AND EMERGING MARKETS Abstract This report examines the debatable issue of whether capital flows from rich to poor nations or not. The trends show that this is not happening. On the contrary, the capital flows from poor to rich industrialized nations, which is quite disturbing. Thus, the report shows that poor nations are financing rich nations contrary to economic predictions. Though a clear-cut, distinction is not possible between emerging and less developed nations, the trend shows emerging markets financing industrialized nations. Whether Capital Generated in the Industrialized Countries is Finding its Way to Less Developed and Emerging Markets? 1. Introduction The question of whether capital generated in the industrialized countries is finding its way to less developed and emerging markets has been a highly debated issue among economists. According to standard economic models, capital should flow from rich industrialized nations to poor developing nations because of financial globalization, assuming a neo-classical production function with diminishing returns due to the higher returns of capital in developing countries (Krugman, 1993). At the same time, many economists like Lucas (1990) have shown that in reality, capital flows from rich to poor countries contrary to the economic theory predictions. This report discusses this issue in detail based on the reports collected from World Bank, OECD, EBRD, IMF and UNCTAD. 2. Relative Movements and Magnitude of Global Capital Investments According to the reports by World Bank (2009), the net private capital inflows have shown tremendous decline in 2008 to $707 billion from $1.2 trillion in 2007 .At the same time net capital outflows increased to$244 billion in 2008 from$190 billion in 1997. Among the private capital components, net FDI, Portfolio and remittance capital outflows have shown significant rise while the net inflows of these components show declining trend. The reports by World Bank (2009) and OECD (2009) show that among the developing nations, emerging nations1 had the most significant decline in net private capital inflows. At the same time, the net official inflows to developing nations have increased in 2008(World Bank, 2009; OECD, 2009). The largest recipients of these have been Africa while the largest donors have been the United States, Germany, the United Kingdom, France and Japan. The relative share of industrialized and developing nations based on IMF data shows that contrary to the predictions of economic theory, on average industrialized nations are both the major donors and the major recipients of net private capital flows from 1990 to 2008(88 percent and 84 percent respectively). For the components of private capital flows like FDI, Portfolio flows also, the trend remains the same (IMF, 2009a; UNCTAD, 2009). In the case of FDI, which is a major component of private capital flows, UNCTAD(2009) statistics shows that USA remain the major recipient while the major sources of the inward FDI to USA has been the emerging markets like China(EBRD,2009). Among the developing nations, the emerging nations and the less developed nations have almost the same share of inward FDI, the emerging nations have high share of outward FDI compared to the less developed nations and is even equivalent to the world total outward FDI(UNCTAD, 2009). 3. Conclusion The discussion here shows that capital generated by the industrialized nations are not finding its way to less developed and emerging markets. On the contrary, the reverse trend is seen i.e. the capital flows from developing nations to industrialized nations. Among the developing nations, emerging nations are the major source of outward FDI. However, the distinction between the emerging markets and less developed nations is not very clear-cut. This is because many of the emerging markets are also characterized by features like political instability, strong currency turbulence and high foreign debt, which are the characteristics of less developed nations. Hence they are sometimes called less developed nations also(Fuss ,2002) Thus, a trend of poor nations financing the rich is seen which is against the standard economic theories and favouring Lucas (1990) predictions, which is quite disturbing. References European Bank for Reconstruction and Development (2009): “Transition Report 2009” (online), 7816.8KB, Accessed October 2009. Fuss R (2002): “The Financial Characteristics between Emerging and Developed Equity Markets”(online),, Accessed December2002. International Monetary Fund (2009a). “International Financial Statistics”. Washington, 2009. International Monetary Fund (2009b). “Glossary of Selected FinancialTerms”(online),, Accessed October 2009. Krugman, P (1993). “What do we need to know about the International Monetary System?” Princeton Studies in International Economics 190, International Economics Section, Department of Economics, Princeton, New Jersey, U.S.A: Princeton University. Lucas, R. (1990). "Why Doesn't Capital Flow from Rich to Poor Countries?" American Economic Review 80: 93-96. OECD (2009): “Investment News 2009”, June 2009, issue 10, Paris: OECD. World Bank (2009): “Global Development Finance”. Washington, World Bank. United Nations Conference on Trade and Development (2009): “World Investment Report”, New York and Geneva: United Nations