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FDI Levels In Global Economy During The Period 1870-1914
- 1. FDI Levels in the Period 1870-1914: Why England Was Lending So Much The 19th century marked a period of unprecedented change in favor of a world economy, especially during the second half of the century. These changes were due in no small part to the actions taken by Britain, such as the free trade policy it took circa 1846, as well as unsurpassed levels of foreign investment after 1870. To fully appreciate the importance of the high level of foreign direct investment (FDI) during the period 1870-1914, as well as Britain's critical involvement in this phenomenon, involves a deeper understanding of the dynamic changes occurring at this time and its lead-in to the growth of an international economy. There is a strong link between the rise in foreign investment and increased technological innovation, migration, trade, and capital accumulation. The questions concerning FDI also feed into other important areas of research and debate within an economic historical context; namely, accounting for Britain's loss of economic superiority after 1870. There are many different models in trade theory that attempt to explain the flow of trade between countries. An important assumption that is made is the concept of costless trade, or equivalently, no transport costs. In reality, trade will only be beneficial when goods are produced cheaper abroad after taking transport costs into consideration, as well as any other frictional costs. This is an important concept because significant developments occurred across the world during the mid- to late-1800s with the help of vital contributions from FDI. Such innovations as railway and steamships, harbor improvements, and buildings of docks and warehouses contributed greatly to the expansion of trade and efficient handling of cargo. Between 1870 and 1910, world railway expanded from approximately 130,000 miles to 640,000 miles. North American, alone, experienced 40% of this growth in railway production. Communications also improved vastly during this period. By 1870, there were nine intercontinental telegraph networks between North America and Europe. Within one generation, the invention of the telephone by Alexander Graham Bell facilitated communications even further. These were not static changes, however, but were vital to the movement of capital (human and stock) and population. From 1800 to 1900, world population grew dramatically from around 900 million people to 1,600 million. In Europe, death rates were decreasing while birth rates remained steady - the inflows of immigrants into North America were primarily responsible for their population growth. Another important fact is that by the end of 1913, 45- to 46-million Europeans moved overseas. These factors played an important role in the growth of FDI and can be partially explained borrowing ideas from Classical economics. Thomas Malthus, author of An Essay on the Principle of the Population of 1803, feared that unchecked population growth would make a nation poor and miserable. Evidence, in fact, reveals that the ratio of land-to- labor in Europe, indeed, was unfavorable following the huge spike in population growth. This triggered increased agricultural prices, as well as increased urbanization and migration. International trade and investment followed this trend as movements of capital and population were transferred from places where they were abundant (i.e., Europe) to areas in which they were scares (i.e., Oceania and the U.S.). In fact, nearly $20 million from Europe was invested abroad in the century ending 1913. Improved transport and communications assisted in cheaper movements of goods and people. This also led to an expansion of primary-producing markets and the rise of productivity through specialization due to spillovers from comparative advantage - an idea trumpeted by David Ricardo in The Principles of Political Economy and Taxation. 1
- 2. Britain was the primary player in these developments. Approximately 37% of total migration outflows from Europe before 1914 were from the British Isles, of which over 85% headed for the U.S. Additionally, Britain was the unsurpassed foreign lender after 1870. Nearly 4% of national income was utilized as foreign investment outflow before 1914, peaking at 9% in 1913. What accounts for these significant economic developments? There are disagreements in literature between 'push' and 'pull' factors relating to migration. Suffice it to say that farmers were at a competitive disadvantage in Britain as a result of its free trade policies and many flocked to labor markets abroad. Many other British citizens moved throughout the British empire, which still consisted of nearly 25% of the world's land mass at the time. The most critical element, nonetheless, was Britain's foreign lending. Britain was factor abundant in high skilled labor, while primarily producing countries, especially the U.S. and Australasia, were abundant in land and natural resources. Therefore, Britain became the most important exporter of manufactured goods to these countries, while importing raw materials and foodstuffs. This specialization led to growth in real incomes due to the increased labor productivity, resulting in a rise of the middle class with an accumulation of savings. With the rise of commercial and investment banks and the aforementioned benefits of improved transportation and communication systems, savings were channeled abroad where better returns on investment could be made. Between 1865 and 1914, 70% of Britain's investment abroad went into social overhead capital, such as railways, docks, telegraphs, and electric works. In other words, Britain played a predominant role in supporting the very technological advancements that were critical to the integration of the international economy. Another major contribution of Britain was its commitment to the gold standard. Although only implemented by most major countries for a period lasting no longer than 30 years, integration to the international monetary system significantly facilitated the movement of goods, services, capital, and income payments. This system established fixed exchange rates for participating nations in which money was valued in terms of gold. The multilateral payment system, although only accounting for 20-25% of trade by WWI, helped stabilize the gold standard by increasing the world gold supply. In essence, the multilateral payment system was a complex system that allowed for reduced movement of gold to balance economic transactions between countries because a nation's export surpluses with some countries was counterbalanced with import deficits with others. Britain used gold as the primary unit of account since 1717 and the British pound sterling was stable since 1821. In many respects, this was a sterling standard. London was the financial center of the world by the late 1800s and the sterling was the international accepted currency. By recycling its surplus through reinvested capital gains on foreign investments, Britain eased the transition for countries moving onto the gold standard and their need to make harsh domestic adjustments when faced with trade deficits. Why is the discussion of the gold standard and the multilateral payments system important to understanding the rise in FDI during this period? The most important concept is that this was another substantial step toward an integrated international economy. These were two institutional factors that complemented this phenomenon and also encouraged investment in peripheral countries due to decreased risks. Inclusion in the gold standard gave countries such as Greece, Argentina, and Brazil credibility and opened them up to an international network of investment and trade. There were many forces simultaneously at play in the 19th century that led to the high level of FDI in the period 1870-1914. Technological innovations in transport and communication made the world a smaller place, facilitating the movement of human capital (i.e., migration) and opening up trade and physical capital accumulation abroad. Facilitating the economic integration of the international economy was the development 2
- 3. of an international monetary system that gave participating countries requisite credibility by participating players in order to join. Not to be overlooked is the fact that this was mainly a time of peace throughout the international community, which supported these economic developments. Britain was the largest foreign lender at the time and invested more abroad than at any other time in history. The recycling of Britain's trade surpluses made many contributions to the technological innovations occurring abroad, such as railway building throughout the U.S., Latin America, and Oceania. A serious long-term commitment with the gold standard and stance on free trade was also a testament to Britain's support of the growing international economy in the 19th century. The most interesting questions that are subsequently raised when considering this phenomenon include: Did Britain develop a policy that was too external-oriented during this period, resulting in a decline in its industry and position as the de facto economic leader in the world? Other unsettled questions are also raised concerning the migration phenomenon and why the gold standard did not last after WWI. The topic of FDI investment and Britain's important role is, therefore, an important springboard for much further research. 3