Foreign direct investment

It comprises investing directly in production in another country, either by buying a company there or establishing new operations of an existing business. This is done mostly by companies as opposed to financial institutions, which prefer indirect investment abroad such as buying small parcels of a country’s supply of shares or bonds. Foreign direct investment (FDI) grew rapidly during the 1990s before slowing a bit, along with the global economy, in the early years of the 21^st century. Most of this investment went from one country to another, but the share going to developing countries, especially in Asia, increased steadily.

There was a time when economists considered FDI as a substitute for trade. Building factories in foreign countries was one way of jumping tariff barriers. Now economists typically regard FDI and trade as complementary. For example, a firm can use a factory in one country to supply neighbouring markets. Some investments, especially in services industries, are essential for selling to foreigners. Who would buy a Big Mac in London if it had to be sent from New York?

Governments used to be highly suspicious of FDI, often regarding it as corporate imperialism. Nowadays they are more likely to court it. They hope that investors will create jobs, and bring expertise and technology that will be passed on to local firms and workers, helping to sharpen up their whole economy. Furthermore, unlike financial investors, multinationals generally invest directly in plant and equipment. Since it is hard to uproot a chemicals factory, these investments, once made, are far more enduring than the flows of hot money that whisk in and out of emerging markets.

Mergers and acquisitions are a significant form of FDI. For instance, in 1997, more than 90% of FDI into the United States took the form of mergers rather than of setting up new subsidiaries and opening factories.

Free trade

Free trade means the ability of people to undertake economic transactions with people in other countries free from any restraints imposed by governments or other regulators. Measured by the volume of imports and exports, world trade has become increasingly free in the years since the Second World War. A fall in barriers to trade, as a result of the general agreement on tariffs and trade and its successor, the world trade organisation, has helped stimulate this growth. The volume of world merchandise trade at the start of the 21st century was about 17 times what it was in 1950, and the world's total output was not even six times as big. The ratio of world exports to GDP had more than doubled since 1950. Of this, trade in manufactured goods was worth three times the value of trade in services, although the share of services trade was growing fast.

For economists, the benefits of free trade are explained by the theory of comparative advantage, with each country doing those things in which it is comparatively more efficient. As long as each country specializes in products in which it has a comparative advantage, trade will be mutually beneficial. Some critics of free trade argue that trade in developing countries, where wages are usually lower and working hours longer than in developed countries, is unfair and will wipe out jobs in high-wage countries. They want autarky or fair trade.

Real-world trade patterns sometimes seem to challenge the theory of comparative advantage. Most trade occurs between countries that do not have huge cost differences. The biggest trading partner of the United States, for instance, is Canada. Well over half the exports from France, Germany and Italy go to other European union countries. Moreover, these countries sell similar things to each other: cars made in France are exported to Germany, and German cars go to France. The main reason seems to be cross-border differences in consumer tastes. But the agricultural exports of Australia, say, or Saudi Arabia's reliance on oil, do clearly stem from their particular stock of natural resources. Also poorer countries often have more unskilled labour, so they export simple manufactures such as clothing.