NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Foreign Direct Investors in Three Financial Crises

"Much of the direct investment is bound up in enterprises that, in times of instability, can redirect sales from a country's local markets to export markets."

In Foreign Direct Investors in Three Financial Crises (NBER Working Paper No. 8084), Research Associate Robert Lipsey finds that direct investors, chiefly those who operate manufacturing facilities in foreign countries, are much more likely to ride out economic squalls than those involved in foreign bonds, equities, bank loans, and other forms of investment. This was true, Lipsey reports, in the Latin America crisis of 1982, the Mexico crisis of 1994, and most recently the East Asia meltdown of 1998.

In Latin America, for example, while dropping at one time to 40 percent of 1982 levels, flows of direct investment remained positive even as flows of other forms of investment turned negative (that is more money rushing out than coming in). Similarly, in the aftermath of the 1994 Mexico crisis, direct investment dipped by about 15 percent in two years, but by 1997 and 1998, was at or above its 1994 peak. Contrast that to other investment flows, which quickly plummeted into negative territory. While they eventually came back into positive territory, they remained a pale shadow of their former selves through 1998. The story appears to have been the same during the Asian crisis of 1998--although those data are still coming in--with direct investment dipping only slightly and then coming back to previous levels by 1999. Meanwhile, other types of investment, in contrast, quickly beat a rapid retreat to net outflows.

The key reason for these circumstances appears to be that much of the direct investment is bound up in enterprises that, in times of instability, can redirect sales from a country's local markets to export markets. Lipsey finds this to be particularly true for U.S. firms operating abroad. "The most consistent feature of the responses to the crises by U.S. manufacturing affiliates was the rapid growth in their export sales," Lipsey states. "The shifts were in response to both the host country devaluations and the stagnation in host country markets." The crises dampened local consumption of the U.S. firms' products, but the drop in currency values made those same products much cheaper for foreign buyers and, hence, much easier to export.

Lipsey notes that direct investors, unlike other investors, may not have the luxury of simply pulling up stakes in the face of a crisis. It's much harder to dispose of a manufacturing plant than to sell off stocks and bonds. So in that sense it could be argued that it isn't so much grit and tenacity as it is a lack of better options that prompts direct investors to stay put.

But Lipsey also credits the direct investors with being more willing to hang tough in the midst of seeming chaos. For instance, Lipsey finds foreign direct investors operating in the developing countries of Asia "to be much less skittish than other investors in responding to the crisis." Similarly, he notes that during Mexico's turmoil, U.S. direct investors "seemed able to look past the crisis, without waiting for it to end."

-- Matthew Davis


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