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Risks of Foreign Investment

I read an article in the WSJ (Merger, Indian Style: Buy a Brand, Leave it Alone) a while back about how Tata Motors was going to buy Jaguar and Land Rover from Ford. The main focus of the story was how Tata was looking to learn from the US companies:
Rather than seeking to wring profits out of two luxury automotive brands that frequently have lost money, Tata is looking to learn from them to help launch its own global expansion in autos, using the brands' own management team and a full roster of employees.
I thought that was an interesting trend. I later came across an opinion piece by Matthew Slaughter, an associate dean and professor at Tuck, about what the Tata deal tells us about the benefits of foreign direct investment. He pointed out how these multinationals undertake their "insourcing" deals:
It is well known that new FDI can come via "greenfield" investments that build new businesses from scratch. Think photo opportunities of business executives and government officials turning fresh dirt with shiny shovels.

But foreign multinationals can also merge with, or acquire part or all of, an existing U.S. company. Greenfield investments can protect proprietary technologies. Acquisitions can yield quicker presence, and can build on target-firm assets such as customer connections and managerial talent.

The second thing he points out is who has been making these investments. Traditionally, FDI has flowed from high-income or "developed" nations. But there has been a significant rise in FDI from developing countries such as China and India.

There was a more recent article on the topic (Capital Flow from Emerging Nations to U.S. Poses Some Risks) from the WSJ that put in perspective the total flows of currency and the risks they pose. Here's where the money's coming from:

The U.S. has to import, on net, almost $2 billion in capital a day to cover its enormous trade gap. Of the $920 billion that foreigners pumped into U.S. stocks, bonds and government securities last year, $361 billion -- a stunning 39% -- came from emerging-market nations, according to calculations by Bank of America, using Treasury Department data.

China alone accounted for 21 percentage points of the total, with Brazil at 8.4 points, Russia at 2.8 points, and Mexico, Singapore, Malaysia, South Korea and others in the mix.

Here's a chart that summarizes things:



So, what's the problem with this? Well, these countries aren't just investing in the U.S. because they get better returns, indeed "from 2002 to 2006, as the dollar slid, foreigners earned an average annual return of 4.3% on their U.S. investments, while Americans earned 11.2% on their investments overseas." The article concludes "that it's not the profits that attract foreign money to the U.S., it's the sophistication of U.S. capital markets." That's where the real risk comes in. If you lose the transparency in the U.S. markets, you may just lose that investment. Subprime mortgage problems, speculation, etc. aren't helping things.

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