3 min read

Money, Cash, Flows

Capital is flowing to the US and out of China.

The United States was the top destination for foreign direct investment (FDI) — up 11 percent compared to global rates around 2% — in 2021.

To again demonstrate the power of cooperation, long-term economic allies — Canada, the Netherlands, and the United Kingdom — were top destinations for inward and outward FDI.


Xi's no good, very bad outlook

Xi's consolidation of power, and the CCP's nightmarish approach to Covid, triggered a significant response among the global investing class. Specifically, foreign investors reallocated capital outside China at scale.

The reallocation was so substantial that China (population 1.4 billion) ended up with significantly less inbound FDI than the Netherlands (population 17 million) and only slightly more than mighty Luxembourg (population 640,000). Humiliating.

Where is Chinese capital going?

A distinct pattern emerges from Chinese outward investment data. In what I read as a leading indicator of dissent against Xi's authoritarianism, outward flows did not invest in emerging markets or productive economies. Rather, as seen below, Chinese capital flooded notorious tax shelters in the Cayman Islands and BVI.

If Chinese investors are moving investable assets beyond Xi's reach, you can expect the CCP to further expand its control over economic and financial resources.


Tiny markets get a bag

One upshot is that smaller economies punched well above their weight relative to inbound capital flows in 2021. Surpassing major economic powers like Germany, the Netherlands, Luxembourg, Hong Kong SAR, Singapore, Ireland, and Switzerland were top destinations for inward FDI.


Making sense of FDI data

When analyzing economic data, it's critical to recognize your constraints. IMF offers helpful context for parsing what factors may be causing the divergence between productivity and capital flows.

The apparent disconnect between FDI data and the real economy comes down to the fact that these numbers are fundamentally a set of financial statistics. They show cross-border financial flows and positions between entities tied to each other by a direct or indirect ownership share of at least 10 percent. Such flows can end up as investments into productive activities within a country, like funds going into new factories and machinery, but they can also be purely financial investments with little to no link to the real economy.

For instance, many multinational companies set up special purpose entities in offshore financial centers where funds just flow through the economy, as an intermediate step towards their final destination. These entities are often established to obtain tax or regulatory benefits and can inflate FDI data considerably even though they have relatively little tangible impact on the host economy.

Research by Damgaard, Elkjaer, and Johannesen and Lane and Milesi-Ferretti shows how offshore financial centers play an outsized role in global FDI statistics, which increased even further in the years following the 2008 global financial crisis. The latest data from the CDIS shows that offshore financial centers still account for a disproportionately high share of global FDI. However, their share has gradually declined since 2017, while that of the largest economies such as the United States and China has increased.

The exact drivers of this development are hard to disentangle, but are likely linked to several policy initiatives. For example, the fall in the offshore financial centers’ share of global FDI comes after the US Tax Cuts and Jobs Act took effect in 2018.