Trillions of dollars in capital now cross borders each year in search of profit. And since more is flowing out of developing countries than coming in, the return must be higher in the rich industrialized economies.
Wait; that can't be right. The low-hanging fruit in the United States, Western Europe, and Japan was presumably picked long ago. Shouldn't capital now be sucked into places where labor's cheap and opportunities abound? Indeed, isn't that what global economic integration is about?
It's more complicated than that. (Bet that caught you by surprise.) But there's an important truth underlying this paradox: In a world in which financial market integration lags far behind the integration of trade and technology, flows of financial capital are playing a surprisingly limited role in driving growth in developing economies. In fact, there seems to be a negative correlation between growth and imports of financial capital: The fastest growing emerging-market economies typically save more than they invest at home, with the difference spilling into foreign securities.
To understand what's been happening, look closely at capital flows between the U.S. and China -- the iconic example of the aforementioned paradox. Each year, hundreds of billions of dollars more flow from China (where the productivity of capital is very high) to the United States (where the potential return is lower) than vice-versa. One reason is that Beijing is eager to support job-creating, politically wired exporters, and is thus willing to accept foreigners' IOUs in order to induce them to buy all those laptops and dining sets and designer jeans. To put it another way, if the China's central bank didn't buy humongous quantities of dollars (mostly in the form of U.S. Treasury securities) as a means for holding down the value of China's currency, Walmart and friends might well find it cheaper to buy goods in, say, Thailand or Mexico.
That's not the only reason, though, that Beijing pushes international capital "uphill." It fears currency exchange volatility if it lets private interests determine financial flows in and out of China. This fear, moreover, hardly springs from thin air. Back in 1997-98, surges of "hot" money (short-term liquid investments) from abroad shattered the stability of currencies from Thailand to Indonesia to Korea -- and then went on to wreak havoc in Russia and Brazil. Even Hong Kong, arguably the best-run economy on the planet, was badly shaken in the tumult.
China, by contrast, escaped relatively unscathed because capital controls kept its currency, the renminbi, out of global play. That is, for the most part, Beijing limited foreigners' holdings of renminbi to the amounts needed to do business in China.
Oh, you say: We've learned from the mistakes of the Asian currency crisis; now it's safe to go back in the water of global financial capitalism. Dream on. After all, it was the integration of international capital markets that meant that the American mortgage-backed securities collapse quickly spread to Europe and beyond. Why should China risk infection from global financial viruses?