Essay Example on How the International Flow of Capital Is Measured by Net Foreign Investment

2021-07-09 07:27:54
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University of Richmond
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Foreign investment comprises the flow of capital from one nation to a different one, allowing large and extensive ownership stakes in domestic businesses and assets. Foreign investment symbolizes that foreign investors have an active part in managing a business as a portion of their investment (Mankiw, 2007). There is a contemporary trend that has leaned towards globalization, where international companies have investments in different nations. In some cases, foreign investments are made by individuals, but these endeavors are mostly pursued by firms and businesses with considerable assets with an aim to expand their reach. Due to increase in globalization, more and more companies have opened up branches in countries around the globe. Some companies prefer opening new industrial and production plants in other countries because of the opportunities for inexpensive production, cheap labor and lower or fewer taxes. Foreign investment can take numerous forms in actual practice but it usually takes two forms; vertical and horizontal investment (Madura, 2015).

In vertical investment, the investor includes foreign events to a current business, for example an American manufacturer of auto spares launching and acquiring the spare parts supply business in an overseas nation. Horizontal investment exists when a firm that already exists in a country simply launches the same type of business procedures in another country (Mizen & Pentecost 1996). A good example is when a fast food firm founded in the US opens a restaurant in overseas. The conglomerate investment, is when a company in one nation launches anther distinct business operation in another state.

A country experiences an account deficit when its imports exceed its exports. Its foreign partners with net monetary entitlements can keep holding their privileges as monetary deposits, or they can use the cash to purchase other financial assets or stocks in the trade-deficit state. The capital flows consist the financial claims. The capital flow shifts in the different direction to that of goods and services trade claims that give rise to them. Therefore, a nation with a deficit definitely has an extra capital account. The current balance of globally traded goods and services, is the entire balance of claims that local investors and overseas investors have attained in new investments. International investment movements can sustain long-run development but they come with short-term risks. The gains originate from a competent allotment of saving and investment amongst surplus and deficit countries.


How the purchasing-power parity theory influences exchange rates and their implications

The Purchasing Power Parity is a theory in economics that gives a comparison between different nations' money through a market approach. According to this theory, the two currencies are in symmetry when a market commodity is valued equally in both states (MacDonald & Ricci, 2002). In making this evaluation of prices across nations that embrace any import, a variety of goods and services should get considered. The complexity of making these comparisons drags the process making it hard to achieve. Such actions frequently affect financial markets in the end. The use of this theory is a substitute for using market exchange rates. The buying power of any currency is the measure of that money that is needed to purchase a stated unit of goods or services. The theory gets determined in each nation founded on its comparative cost of living and the inflation rates. It eventually means that equalizing the purchasing control of two different currencies by accounting for variances in inflation rates and the cost of living.

Adam Smith argued that possessing money gives one the capability to command others' labor, thus buying control to some extent in which they get willing to exchange their labor for money or currency is power over other people (Wood, 1983). He used one hour's work as the purchasing power unit, so that price would be assessed in hours of labor expected to make a given quantity or to make some other commodity which is worth an amount adequate to buy the same.


Effect of a decline in consumer confidence in the economy

Consumer confidence is the attitude that customers possess towards the economy and their money situation (Danthine, Donaldson & Johnsen, 1998). The attitude can be high consumer confidence or low consumer confidence. The degree of consumer trust is a crucial factor that regulates the readiness of consumers to buy, borrow and save (Adolfson, 2007).


Quantity of loanable funds LF

If there is a high level of consumer confidence, then the result will be an advanced marginal inclination to the consumer. A drop-in degree of consumer confidence frequently indicates an economic recession. A decline in consumer confidence causes a reduction of the aggregate demand curve. Other distinguished aggregate demand elements are interest rates, the federal deficit, and money supply. The domestic sector is therefore motivated to spend a smaller amount of money to reduce expenditures on durable goods, like cars, furniture, and home appliances. Instead of spending as much, they save a bit more. The outcome of this decline in consumer confidence is a reduction in consumption expenditures and afterward a decrease aggregate demand. If clients have a feeling that they might make less revenue in the future and perhaps might hold a low-paying job, it means consumer confidence has decreased. When consumer confidence drops, clients, cynical about the days ahead, will begin consuming less now and be saving more. They will start preparing for that future by saving more and cutting back on present consumption.

The Foreign investment refers to the variance between the purchase of foreign possessions by domestic residents and the gaining of domestic assets by foreigners. Hence, it is involved with savings and investment which are also called loanable funds, and foreign currency exchange. The association between capital outflows and currency can be effortlessly evaluated using a model that analyzes the market for loanable funds, also the market for foreign money exchange, in the framework of an open economy (Feldstein, 2007). The connection amid these markets will be the net capital outflows. In the first market is a modified interpretation of the monetary system for loanable funds. All those who wish to do a saving come to the market for loanable funds. In this market, they get to deposit their savings. Also, the individuals that want a loan for any purpose come to this market. Savings is all of that an economy saves starting from its income, both in the private sector and government accounts. Savings thus represents the national economies. On the other side, we have capital outflows and domestic investing. It means that while on the one hand, we have savings supplied to the market, we have money demanded net capital flows on the other. As seen in the figure, steadiness gets reached when the quantity of savings equals investment and net capital outflows.



Adolfson, M. (2007). Evaluating an estimated new Keynesian small open economy model. London: Centre for Economic Policy Research.

Danthine, J., Donaldson, J. and Johnsen, T. (1998). Productivity growth, consumer confidence and the business cycle. London: Centre for Economic Policy Research.

Feldstein, M. (2007). International Capital Flows. Chicago: The University of Chicago Press.

MacDonald, R. and Ricci, L. (2002). Purchasing Power Parity and New Trade Theory. [Washington, DC]: International monetary fund (IMF).

Madura, J. (2015). Financial markets and institutions. Stamford, CT: Cengage Learning.

Mankiw, N. (2007). Principles of macroeconomics. Mason, OH: Thomson South-Western.

Mizen, P. and Pentecost, E. (1996). The macroeconomics of international currencies. Cheltenham, UK: Edward Elgar.

Wood, J. C., & Wood, J. C. (1983). Adam Smith: Critical assessments. London: Croom Helm.


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