Chapter 3
Domestic and Foreign Direct
Investment
We can all agree that investment is a good thing. Or can we? It is certainly
true that exhaustive testing by Levine and Renelt (1992) showed that no
other variable had such a close association with economic growth. Many
commentators equate more investment with good economics. For them
investment is the forgoing of present consumption in order to create an asset
that will generate an expected future return. An important part of this defini-
tion is ‘create’. Economists use the term ‘investment’ much more specifi-
cally than is commonly understood. Investment to an economist does not
mean the buying of shares or other assets. This is more properly referred to
as ‘portfolio investment’ and represents the transfer of ownership, or part
ownership, of existing assets. Investment in this sense is not discussed here.
Investment necessarily requires a reduction in resources available for
current consumption, and the creation of productive assets to (hopefully)
generate higher consumption in the future. So investment proper is all about
being virtuous, reducing current consumption to create something for the
future, about thinking long term and contributing to sustainable economic
growth.
However, this is not always true. A household may cut down on frivolous
consumption of alcohol in order to invest in a child’s schooling. Or the choice
could be made by a dictator. In the late 1920s and early 1930s Stalin, the Soviet
dictator, forcibly requisitioned grain from peasants to facilitate the expansion
of output and employment in urban heavy industry. Industrial growth was
rapid but millions of peasants starved. Current consumption in North Korea
over recent years has been reduced to the extent that many observers believe
there has been a substantial famine. Investment was increased, not as under
Stalin to boost industrialization but rather to build a nuclear bomb. A market or
capitalist economy may stimulate investment as firms struggle to gain a
competitive edge over their rivals, to reduce costs or introduce new products
and processes. Investment by one firm may then drive others out of business.
The history of capitalism is littered with examples of firms, industries or entire
economies making huge investments that are simply mistaken. Not all invest-
ment projects will generate a future return. A firm may invest in expanding
capacity, but find there is no market for the extra output and so realize no gain.
Some projects labelled as ‘investment’ were never about creating future
returns, but had a completely different motivation. In 1983 President
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