In the wake of the Asian financial crisis, policymakers, governments, and academics around the world are busy devising ways to reform the global financial architecture. The plethora of articles, speeches, and essays on this topic, however, has failed to produce a consensus on the path that reforms should take, largely because the issue is highly complex.
On the one hand, foreign investment brings clear benefits. International investors provide an extra pool of lenders for borrowing nations, particularly developing countries, for increasing liquidity, lowering the costs of borrowing, and raising output.
With foreign direct investment the host country may also derive benefit from positive spillover effects such as new technologies, ideas, and skills. Even the often-criticized speculative capital flows enable investors to hedge against risk such as exchange rate fluctuations. Not all of the above capital flows constitute investment. Economists define investment as expenditure on productive, as opposed to expenditure on consumption. Hence, foreign investment is defined as the purchase of assets in Country A by residents of Country B. It is usually divided into two categories: Foreign Direct Investment (FDI). This refers to investment where the foreign investor (from Country A) owns or controls the assets (in Country B). Foreign Portfolio Investment refers to investment where a foreign resident provides the capital, but the activity is owned and operated by domestic residents.