How foreign money funds capital investments

By capital investment (also known as fixed capital formation) we mean the purchase of machines, land, real estate, and other production items by firms. Capital investment is important as it expands the capacity of firms to produce and grow over time. Greater investment also leads to higher employment as firms hire people to work with the new machinery. Looking across many countries over time, investment is about 10-15 percent of GDP but it can exceed 20 percent in some of the rapidly growing emerging markets.

The capital investment is funded by savings. People and firms save part of their income in bank deposits or the stock market from where the savings go to firms that want to buy machines and equipment. The amount of available savings determines how much firms can invest.

How can then investment be greater than the national savings as in Australia?

Here is an important point: the savings could come from domestic or international sources. It the first case, firms use the savings of domestic firms and households. In the second case, foreign banks and investment companies provide financing to the domestic firms using the savings of households and firms from other countries. In that way, if the country is able to attract foreign capital, investment can exceed significantly the amount that can be funded by domestic savings.

In other words, countries are not limited by their own income and savings when funding investment and economic growth. In fact, all rapidly growing emerging markets rely heavily on international savings to fuel their economic development.


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