module 41 Capital Flows and the Balance of Payments 419
The Golden Age of Capital Flows
Technology, it’s often said, shrinks the world. Jet
planes have put most of the world’s cities within
a few hours of one another; modern telecommu-
nications transmit information instantly around
the globe. So you might think that international
capital flows must now be larger than ever.
But if capital flows are measured as a share
of world savings and investment, that belief
turns out not to be true. The golden age of capi-
tal flows actually preceded World War I—it
lasted from 1870 to 1914.
These capital flows went mainly from Euro-
pean countries, especially Britain, to what were
then known as “zones of recent settlement,”
countries that were attracting large numbers of
European immigrants. Among the big recipients
of capital inflows were Australia, Argentina,
Canada, and the United States.
The large capital flows reflected differences
in investment opportunities. Britain, a matureindustrial economy with limited natural re-
sources and a slowly growing population, of-
fered relatively limited opportunities for new
investment. The zones of recent settlement,
with rapidly growing populations and abundant
natural resources, offered investors a higher re-
turn and attracted capital inflows. Estimates
suggest that over this period Britain sent about
40% of its savings abroad, largely to finance
railroads and other large projects. No country
has matched that record in modern times.
Why can’t we match the capital flows of our
great -great -grandfathers? Economists aren’t
completely sure, but they have pointed to two
causes: migration restrictions and political risks.
During the golden age of capital flows, capital
movements were complementary to population
movements: the big recipients of capital from
Europe were also places to which large numbers
of Europeans were moving. These large -scalepopulation movements were possible before
World War I because there were few legal re-
strictions on immigration. In today’s world, by
contrast, migration is limited by extensive legal
barriers, as anyone considering a move to the
United States or Europe can tell you.
The other factor that has changed is political
risk. Modern governments often limit foreign in-
vestment because they fear it will diminish their
national autonomy. And due to political or secu-
rity concerns, governments sometimes seize
foreign property, a risk that deters investors
from sending more than a relatively modest
share of their wealth abroad. In the nineteenth
century such actions were rare, partly because
some major destinations of investment were
still European colonies and partly because in
those days governments had a habit of sending
troops and gunboats to enforce the claims of
their investors.fyi
Module 41 AP Review
Check Your Understanding
- Which of the balance of payments accounts do the following
events affect?
a. Boeing, a U.S.-based company, sells a newly built airplane
to China.
b. Chinese investors buy stock in Boeing from Americans.
c. A Chinese company buys a used airplane from American
Airlines and ships it to China.
d. A Chinese investor who owns property in the United
States buys a corporate jet, which he will keep in the
United States so he can travel around America.Solutions appear at the back of the book.
Tackle the Test: Multiple-Choice Questions
- The current account includes which of the following?
I. payments for goods and services
II. transfer payments
III. factor income
a. I only
b. II only
c. III only
d. I and II only
e. I, II, and III - The balance of payments on the current account plus the
balance of payments on the financial account is equal to
a. zero.
b. one.
c. the trade balance.
d. net capital flows.
e. the size of the trade deficit.