Global Opportunity Index: Capital Seeks Partners

July 06, 2015

Access to capital is essential for sustained national development, growth, and economic stability, and foreign direct investment (FDI) has become an important funding source in both emerging and frontier regions. Since 2012, FDI to developing economies has surpassed that of advanced economies after making steady gains since 2008—comprising 55 percent of global flows in 2014. Indeed, overall investment flows continued to increase while FDI to advanced economies dropped by 28 percent, influenced mainly by global economic fragility, investor uncertainty, and geopolitical risks.

GOI thumbThe question that is top of mind for many countries is how long this trend will continue. With the waning of quantitative easing in the United States and the prospect of rising interest rates, flows to developing countries may be redirected. An additional concern is that a potential “Grexit” could trigger contagion and financial dislocation, raising the threat of wider financial distress in Europe that could diminish investors’ appetite for risk.

Even if Greece’s problems are contained, countries and investors will have to deal with the likelihood that capital flows will reverse as the Federal Reserve prepares to raise borrowing costs. With this in mind, developing countries must make themselves as desirable as possible to compete for these flows. Recent research by the Milken Institute, published in the second edition of the Global Opportunity Index, has shown that countries with stronger institutional environments, along with healthy economic fundamentals, receive more FDI per capita and foreign portfolio flows than those with weaker conditions. Ease of doing business, quality of regulations, and rule of law are among these key elements of good governance. The logic is simple: Poor institutions can impose additional costs on investment, as is clear in economies marked by corruption, inadequate or deteriorating infrastructure, and risk of expropriation.

To brave the waves of volatile capital flows, countries need to prioritize institutional reforms that are conducive to FDI, such as minimizing the time and monetary cost required to open a business, curbing foreign ownership restrictions where appropriate, and reinforcing robust legal standards that uphold property rights and eliminate expropriation risk.