Capital Flows and Investment Returns

money and arrows going left and right

Capital is synonymous with wealth, both real (land, buildings, and other material goods) and representational (money, stocks, and bonds). All of these items have economic value that represents the invested savings of individuals, corporations, governments, and other organizations.

Characteristics of Capital

It is important to note that capital has 3 very important characteristics: mobility, sensitivity to its environment, and scarcity. These characteristics allow capital to be selective about where it settles, which is usually countries or locations where favourable conditions exist. Favourable conditions for capital are made up of stable governments, economic growth with minimal government intervention, and profitable investment opportunities. Therefore, it is easy to see that the majority of capital is drawn towards democratic and developed nations.
For example, Canadians face a daily battle with the decision to invest in Canada, the United States (U.S.), or both. When people invest into stock markets they need to know which market will be more profitable and grow their investments. There are times when Canada’s stock market will be more attractive but most often the U.S. stock market will prove to be more advantageous. The country with the more favourable conditions for capital will attract more money to its stock markets which will in turn accelerate the growth of one’s investments.

Country Specific Factors that Affect Capital Flows

When evaluating the various components of country risk, it’s important to consider the following factors:
  • The Political Environment (Are there internal or external conflicts?)
  • Economic Trends (Is there growth in GDP, employment, inflation, and economic activity?)
  • Fiscal Policy (How high are taxes on individuals, businesses, and goods and services?)
  • Monetary Policy (How does the country manage its money supply? And is there FX stability?)
  • Investment Opportunities (What options for investment exist? And how are the returns?)
  • The Labour Force (What percentage of the labour force is skilled and productive?)
These 6 factors will dominate the movement of capital from country to country. Capital is scarce, mobile, and sensitive which means it will move in anticipation of changes to monetary and fiscal policy. These factors should be used to compare countries when deciding where to put money to work.
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