1Financial FDI and Host Countries: New and Old Lessons

In the 1990s, foreign direct investment became the largest single source of external finance for many developing countries. For the most part, research into the causes and effects of FDI has mainly focussed on manufacturing and real production activity. This research, interestingly, has been conducted orthogonally to the recent spate of research efforts and methods used for addressing financial FDI. Cross-citation of these literatures is seldom observed. This orthogonality is surprising: financial FDI shares many of the features of more general FDI in productive services. Conceptually, in each case a foreign producer of goods or services makes a two-fold decision. First, he decides whether to service a particular market; second, he determines whether this market be served through exports or through setting up local production. While manufacturers use the language of exports or production by multinationals, there is a direct financial services (and in particular banking) analogue to this two-step decision: first, whether to provide lending, deposit-taking and other services to a market; and if so, second, whether to use cross-border activities (arms-length transactions) or foreign direct investment in the form of setting up branches or subsidiaries followed by local lendin