I n t h I s c h a p t e r y o u w I l L

T h e W o r l d ’s N e w F i n a n c i e r I s Yo u
B
Y
E
DWARD
W
YATT
Investors flocked to Eastern Europe after
the Berlin Wall fell in 1989, eager to
scoop up bargains in what they were
sure would be a quick economic revival.
A year later, the technology boom drew
their money to the Far East. Then Latin
America heated up—that is, until the
Mexican peso went bust, which sent
investors scurrying back to the Pacific
Rim. Russia got sexy as an investment
early [in 1997], and more recently South
America has had allure.
Billions of dollars are sloshing back
and forth over the globe with seemingly
little rhyme or reason, chasing invest-
ments in once-obscure markets from
Santiago to Kuala Lumpur. But there is at
least some method to the madness—de-
spite occasional debacles like the recent
Bre-X gold mining fraud, in which mutual
fund managers poured scads of money
into what amounted to little more than
holes in the ground in Borneo.
To begin with, foreign stock and
bond markets are growing much faster
than those in America, providing much
higher returns to investors. In 1970, for-
eign markets accounted for only a third
of the value of the world’s stock and
bond markets, with the United States
alone accounting for the other two-
thirds. But by last year, they had grown
to nearly 60 percent of the total.
Stock markets in newly emerging
economies like those of Turkey, Ar-
gentina, and South Africa now account
for 14 percent of the world’s total stock
market value, up from 4 percent 10
years ago.
Investors have flocked to them as
global economic trends have shifted
since the end of the cold war. Central-
ized, state-planned economies have
been scuttled for ones favoring private
ownership of industry. With the trans-
formation, the resulting vibrant new
economies no longer need to rely on
international development agencies or
giant New York banks for foreign invest-
ment, as they did in the 1970s and
1980s; instead, much of their seed capi-
tal since 1990 has come from a sur-
prising source: millions of average
Americans who invest in mutual funds.
“This is a trend that has been led by
America, which pushed the international
lending agencies to encourage the de-
velopment of private enterprise, to open
up these markets and get the hands of
government out of industrial ownership,”
said J. Mark Mobius, who oversees sev-
eral Templeton mutual funds that invest
in emerging markets. “That led to the
development of capital markets—bond
markets and stock markets—in many of
these countries, and now to people like
me trying to invest all the money that is
flowing into our mutual funds.” . . .
And these days, when the finance
minister of a developing country wants
to encourage foreigners to invest in his
country, he is less likely to court the
World Bank or the Agency for Interna-
tional Development than someone like
Mr. Mobius.
S
OURCE
:
The New York Times,
May 25, 1997, Week
in Review, p. 3.
I N T H E N E W S
It’s the 21st Century,
Do You Know Where
Your Capital Is?

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C H A P T E R 2 9
O P E N - E C O N O M Y M A C R O E C O N O M I C S : B A S I C C O N C E P T S
6 6 3
Mexican government has imposed, or might impose in the future, on foreign
investors in Mexico.
T H E E Q U A L I T Y O F N E T E X P O R T S
A N D N E T F O R E I G N I N V E S T M E N T
We have seen that an open economy interacts with the rest of the world in two
ways—in world markets for goods and services and in world financial markets.
Net exports and net foreign investment each measure a type of imbalance in these
markets. Net exports measure an imbalance between a country’s exports and its
imports. Net foreign investment measures an imbalance between the amount of
foreign assets bought by domestic residents and the amount of domestic assets
bought by foreigners.
An important but subtle fact of accounting states that, for an economy as a
whole, these two imbalances must offset each other. That is, net foreign investment
(
NFI
) always equals net exports (
NX
):
NFI
NX.
This equation holds because every transaction that affects one side of this equation
must also affect the other side by exactly the same amount. This equation is an
identity
—an equation that must hold because of the way the variables in the equa-
tion are defined and measured.
To see why this accounting identity is true, consider an example. Suppose that
Boeing, the U.S. aircraft maker, sells some planes to a Japanese airline. In this sale,
a U.S. company gives planes to a Japanese company, and a Japanese company
gives yen to a U.S. company. Notice that two things have occurred simultaneously.
The United States has sold to a foreigner some of its output (the planes), and this
sale increases U.S. net exports. In addition, the United States has acquired some
foreign assets (the yen), and this acquisition increases U.S. net foreign investment.
Although Boeing most likely will not hold on to the yen it has acquired in this
sale, any subsequent transaction will preserve the equality of net exports and net
foreign investment. For example, Boeing may exchange its yen for dollars with a
U.S. mutual fund that wants the yen to buy stock in Sony Corporation, the Japan-
ese maker of consumer electronics. In this case, Boeing’s net export of planes
equals the mutual fund’s net foreign investment in Sony stock. Hence, 
NX
and 
NFI
rise by an equal amount.
Alternatively, Boeing may exchange its yen for dollars with another U.S. com-
pany that wants to buy computers from Toshiba, the Japanese computer maker. In
this case, U.S. imports (of computers) exactly offset U.S. exports (of planes). The
sales by Boeing and Toshiba together affect neither U.S. net exports nor U.S. net
foreign investment. That is, 
NX
and 
NFI
are the same as they were before these
transactions took place.
The equality of net exports and net foreign investment follows from the fact
that every international transaction is an exchange. When a seller country transfers
a good or service to a buyer country, the buyer country gives up some asset to pay
for this good or service. The value of that asset equals the value of the good or ser-
vice sold. When we add everything up, the net value of goods and services sold by
a country (
NX
) must equal the net value of assets acquired (
NFI
). The international

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6 6 4
PA R T E L E V E N
T H E M A C R O E C O N O M I C S O F O P E N E C O N O M I E S
flow of goods and services and the international flow of capital are two sides of
the same coin.
S AV I N G , I N V E S T M E N T, A N D T H E I R R E L AT I O N S H I P
T O T H E I N T E R N AT I O N A L F L O W S
A nation’s saving and investment are, as we have seen in Chapters 24 and 25, cru-
cial to its long-run economic growth. Let’s therefore consider how these variables
are related to the international flows of goods and capital, as measured by net
exports and net foreign investment. We can do this most easily with the help of
some simple mathematics.
As you may recall, the term 
net exports
first appeared earlier in the book when
we discussed the components of gross domestic product. The economy’s gross
domestic product (
Y
) is divided among four components: consumption (
C
),
investment (
I
), government purchases (
G
), and net exports (
NX
). We write 
this as
Y
C
I
G
NX.
W
ILL THE WORLD
’
SDEVELOPING COUN
-
tries, such as those in Latin America,
flood the world’s industrial countries
with cheap exports while refusing to
import goods from the industrial coun-
tries? Will the developing countries use
the world’s saving to finance invest-
ment and growth, leaving the indus-
trial countries with insufficient funds
for their own capital accumulation?
Some people fear that both of these out-
comes might occur. But an accounting
identity, and economist Paul Krugman,
tell us not to worry.