Following the money: The globalization of capital flows and private equity

Introduct ion

G lobal capital flows and private equity deals havelong been the domain of the developed nations.For decades, various forms of cross-border deal

making—whether foreign direct investment, global merg-ers and acquisitions (M&As), or private equity deals—have been largely driven by well-capitalized firms fromthe United States and Europe. Global capital flows, inother words, were a misnomer since flows were not at all“global.” Rather, global deal making was largely confined

to the United States and Europe, or the transatlanticeconomy, and to a handful of other players, like Japan.The emerging markets, at best, were nominal players,with most cross-border flows taking the shape of foreigndirect investment inflows.

Today, the tables have begun to turn, albeit slowly.The past is not likely to be prologue. Cross-border dealmaking is truly becoming more “global” in scope. Capitalflows and private equity are no longer the exclusive pre-serve of the developed nations, or capital flows that arenorth-north in nature. The developing nations—rich

343

Global capital flows have long been the domain of the developed nations. The emerging markets, at

best, have been nominal players. Today, the tables have begun to turn. The developing nations have be-

come bigger players as global growth increasingly shifts toward the Middle East, Asia, Central Europe,

and Latin America. Accordingly, global capital flows are slowly being reconfigured; in the future, flows will

increasingly take the form of north-south movements, or flows between the developed and developing

nations. They will also become south-south in nature, as well as south-north. Private equity, long driven

by U.S. players, will become less U.S.-centric in the future. © 2008 Wiley Periodicals, Inc.

Following the Money: The Globalization ofCapital Flows andPrivate Equity

Correspondence to: Joseph Quinlan, Managing Director and Chief Marketing Strategist, U.S. Trust-Bank of America Private Wealth Management, 40 W. 57thSt., New York, NY 10019, Phone: 646.313.8791, Fax: 646.313.8717, [email protected].

FEATURE ARTICLE

By

Joseph Quinlan

Published online in Wiley InterScience (www.interscience.wiley.com). © 2008 Wiley Periodicals, Inc. • DOI: 10.1002/tie.20221

with capital and brimming with confidence—have be-come bigger and more important players.

Looking forward, as the gravity of global economicgrowth shifts toward the developing nations, global capi-tal flows will be increasingly dictated and determined bynew players in the Middle East, Asia, and Latin America,challenging more traditional global investors. As a conse-quence, global capital flows are slowly being reconfig-ured; north-north flows are expected to remain quite im-portant in the future. However, global flows willincreasingly take the form of north-south movements, orflows between the developed and developing nations.They will also become south-south in nature, as well assouth-north. Against this backdrop, private equity, longdriven by U.S. players, will increasingly be determinedand shaped by non-U.S. factors.

The following pages examine the sweep of global cap-ital flows since globalization’s return in the late 1980s andearly 1990s. As already highlighted, capital flows have tra-ditionally been controlled by and confined to the devel-oped nations. In the past few years, however, the role ofthe developing nations has increased sharply; nearly un-heard of just a few years ago, sovereign wealth funds arerapidly emerging as the new masters of the financial uni-verse. China, meanwhile, has more excess savings than anyother nation on earth—where it decides to invest its excesssavings will help shape global capital flows. In the end,nearly two decades after globalization’s return, capitalflows are set to become more global in nature. One keyrisk, however, pivots around the spread of investment pro-tectionism, an insidious force gaining strength not only inthe developed nations, but also the developing nations.

Looking Back: North-North Flowsand the Pr imacy of the Transat lant icEconomyThe present era of globalization commenced in 1990 andwas triggered by the collapse of the Soviet Union and thefall of the Berlin Wall. Both events signaled the demiseand bankruptcy of communism and helped usher in anew era of global openness. Consistent with the initial pe-riod of globalization in the second half of the nineteenthcentury, the 1990s were a time of robust and relatively un-fettered global capital flows and buoyant global trade.The latter expanded by an average annual rate of 6.1%(in volume) over the 1990s, roughly double the rate ofworld GDP growth.

Global foreign direct investment (FDI) flows ex-panded at an even faster pace over the 1990s. The level ofglobal inward FDI stock rose from $1.9 trillion in 1990 to

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Thunderbird International Business Review Vol. 50, No. 6 November/December 2008 DOI: 10.1002/tie

$6.3 trillion in 2000. Helping to fuel this trend were ex-panding capital flows between the developed and devel-oping nations.

Globalization’s return meant that new and untappedmarkets in Central Europe, Latin America, and the In-dian subcontinent were open for business. Free-marketreforms became the mantra of Poland, Hungary, andeven Russia, in addition to Brazil, India, Mexico, andChina. At the heart of these reforms were initiatives topromote trade and investment that opened new marketslong out of reach to multinationals and financiers in theWest. In conjunction with these measures, fallingtelecommunication and transportation costs and othertechnological advances gave global firms the capabilitiesand confidence to venture further afield. The prolifera-tion of regional trading blocs had a similar effect. Besidesthese structural changes, cyclical variables like low inter-est rates and surging equity prices created excellent liq-uidity conditions and copious amounts of cash for globalmergers and acquisitions and overseas expansion. For theworld’s financiers, the world was their oyster.

Yet despite all the hype about globalization, andnotwithstanding all the excitement revolving around theemerging markets, globalization has remained tremen-dously uneven. Over the 1990s, the pace and level ofglobal integration varied by country and region. In partic-ular, one defining feature of the global economic land-scape since the early 1990s has been the increasing inte-gration and cohesion of the transatlantic economy. Thelatter remains one of the most powerful global economicentities in the world thanks in large part to the transat-lantic convergence in such key areas as industry deregula-tion, technology usage, and financial market liberaliza-tion. These factors, among others, have helped to alignthe macro and micro policies and practices of the UnitedStates and Europe, setting the stage for a massive transat-lantic cross-border investment wave beginning in theearly 1990s.

American companies invested more capital overseasin the 1990s—in excess of $750 billion—than in the priorfour decades combined. But the surge in U.S. foreign in-vestment did not flow to the new and untapped marketsof the developing nations, as many assumed. Rather, themajority of U.S. foreign direct investment in the 1990s,and the better part of this decade, has been directed atthe Old World—or Europe, in particular, and the devel-oped nations in general.

Reflecting this preference, the developed nations ac-counted for roughly 70% of total U.S. FDI outflows in the1990s and for a similar percentage this decade, or be-tween 2000 and 2007.

of political power within the European Union. In con-trast, securing an investment stake in India and China,while attractive on paper, is a much more laboriousprocess, requiring more time, due diligence, and invest-ment capital on account of the many deficiencies stillplaguing both nations.

Against this backdrop, U.S. global capital flows—whether in the form of FDI or mergers and acquisitions—have remained predominantly directed at the developednations. The same dynamic is evident in Europe.

Europe’s Investment Bias Toward theUnited States

The collapse of the Berlin Wall and the demise of com-munism opened new markets right in the backyard ofWestern Europe, and not unexpectedly, European firmsjumped at the opportunity. Europe’s leading firmsplowed billions into Hungary, Poland, and the Czech Re-public over the 1990s, drawn by the region’s cheap labor,raw materials, and new market opportunities. Late in thedecade, the prospects of EU enlargement sustainedhealthy investment inflows to central Europe.

Yet, despite Western Europe’s investment push intocentral Europe over the 1990s, the amount of capitalsunk in such places as Hungary, Poland, and others palesin comparison to the amount of capital sent across the At-lantic over the same period. After averaging $22.2 billion

In the 1990s, the most popular foreign destination ofU.S. firms was the United Kingdom, which accounted fornearly 22% of total U.S. FDI outflows (on a cumulativebasis). To put that number into perspective, the amount ofU.S. investment in the United Kingdom in the 1990–99 pe-riod ($175 billion) was nearly 50% larger than the total in-vested in the entire Asia Pacific region. Additionally, despiteall the talk about U.S. investment flows to Mexico courtesyof the North American Free Trade Agreement (NAFTA),U.S. firms plowed nearly twice as much capital in theNetherlands in the 1990s as they sank in Mexico. Of the topten destinations of U.S. investments in the 1990s, five coun-tries were in Europe—the United Kingdom (ranked No. 1),the Netherlands (3), Switzerland (6), Germany (7), andFrance (8). Rounding out the top ten were Canada (2),Brazil (4), Mexico (5), Australia (9), and Japan (10).

In the first eight years of this decade (2000–07), sixcountries in Europe were among the top ten destinationsof U.S. foreign investment. The United Kingdom rankedfirst again, followed by Canada (2), the Netherlands (3),Mexico (4), Ireland (5), Japan (6), Germany (7), Switzer-land (8), Australia (9), and Belgium (10). Reflecting thebias toward Europe, for every one dollar invested overseasby U.S. corporations this decade, half, or 50 cents, hasgone to develop Europe. This bias toward Europe runscounter to the hype and angst associated with U.S. out-sourcing to such low-cost locales like China and India, andthe common belief that it is the low-cost destinations ofEast Asia that have attracted the bulk of U.S. investment.

U.S. foreign direct investment to China and India hasjumped dramatically this decade, notably to China. TotalU.S. investment to China, for instance, surged to nearly$21 billion (on a cumulative basis) in the first eight yearsof this decade, roughly triple U.S. investment flows toChina of $7.8 billion over the entire 1990s. That repre-sents a dramatic rise, although on a comparative basis,U.S. investment in Ireland this decade has been roughlythree times greater.

By the same token, while U.S. foreign investment toIndia has soared this decade—to $9 billion over the2000–07 period—U.S. firms have plowed more capital intosmaller European economies such as Italy and Belgium.

The discrepancy in U.S. investment flows to Euro-pean nations on the one hand, versus U.S. investment inChina and India on the other, reflects many variables.The attraction of Ireland, for instance, lies with its low-cost, English-speaking labor force, first-class infrastruc-ture, and access to the larger European Union market.U.S. firms have been drawn to Belgium for a variety ofreasons, including its world-class infrastructure, accessto the EU market, and Brussels’s position as the center

The Globalization of Capital Flows and Private Equity 345

DOI: 10.1002/tie Thunderbird International Business Review Vol. 50, No. 6 November/December 2008

U.S. global capital flows—

whether in the form of

FDI or mergers and

acquisitions—have

remained predominantly

directed at the developed

nations. The same dynamic

is evident in Europe.

While a significant source

of global FDI, Japan’s

share of inward foreign

investment flows has long

lagged behind the United

States and Europe.

over the first half of the 1990s, foreign direct investmentinflows to the United States from Europe soared to an an-nual average of nearly $110 billion in the second half ofthe decade, marking one of the most explosive periods ofinward foreign investment in U.S. history. For the entiredecade, European firms sank nearly $660 billion into theUnited States, accounting for roughly three-quarters oftotal U.S. investment inflows over the 1990s. European in-vestors have accounted for a similar percentage again thisdecade, with the United Kingdom, Switzerland, andFrance ranked as the top three foreign investors in theUnited States over the 2000–07 period.

Many variables lie behind the large and expandingEuropean investment stakes in the United States. As thelargest and wealthiest market in the world, the UnitedStates is considered to be too important to neglect. In ad-dition to market access, many European firms have en-tered the United States to obtain U.S. technological capa-bilities, or so-called “created assets.” Other firms havecrossed the Atlantic to gain greater market access in U.S.services sectors like utilities, financial services, andtelecommunications. Indeed, greater service linkages be-tween the United States and Europe have been at theheart of greater transatlantic linkages.

The Preference for the DevelopedNations

Given all of the above, global foreign direct investmentflows, and other types of related activities like private eq-uity, have long been biased toward the developed nations,

notably the United States and Europe. Over the 1990s, forinstance, two-thirds of total foreign investment inflowswere directed at the developed nations in general, withthe United States and the European Union, in particular,accounting for the bulk of the global total.

Japan, meanwhile, has been an outlier in terms of at-tracting foreign direct investment and participating invarious private equity deals. While a significant source ofglobal FDI, Japan’s share of inward foreign investmentflows has long lagged behind the United States and Eu-rope. In 2006, for instance, Japan’s share of inward for-eign direct investment stock as a percentage of the globaltotal was less than 1%. Inward stock was only 2.5% ofgross domestic product versus an average of nearly 25%among the developed nations. Finally, in terms of globalM&A sales and purchases in 2006, Japan accounted for0.3% of global sales and 1.6% of global purchases. M&Apurchases from Brazilian and Chinese firms were larger.

The extraordinary low figures from Japan reflectboth cyclical and structural variables, including Japan’sprolonged economic slump of the 1990s, which dimin-ished investor interest in Japan. Structural and culturalbarriers have also made it difficult and burdensome forforeign multinationals and foreign capital to penetratethe Japanese market. Recently, a rebound in economicgrowth, combined with market liberalization efforts inJapan, have made the world’s second-largest economymore attractive to foreign investors, although Asia’slargest economy continues to lag behind the UnitedStates and Europe in terms of attracting foreign direct in-vestment and interest among private equity investors.

As for the developing nations, this cohort has not at-tracted as much foreign capital as media headlines wouldsuggest. The developing nations, for instance, attracted34% of global foreign direct investment inflows on aver-age over the 1990–99 period; however, when China is ex-cluded from the figures, the developing nations’ share ofglobal investment inflows represented just one-quarter ofthe total. Meanwhile, over the 2000–07 time frame, thedeveloping nations attracted 31% of total FDI inflows: ex-cluding China, the percentage drops to 25%.

That said, global capital flows have maintained anorth-north bias for most of this decade. To this point,the developed nations accounted for over 86% of totalglobal FDI outflows over the 2000–07 period, while com-prising two-thirds of aggregate total FDI inflows.

Other metrics—notably global M&A deals—highlighta similar trend. In 2006, for instance, the developing na-tions accounted for roughly 15% of total M&A sales and14% of global M&A purchases. That said, over the pastcouple of years there has been a discernible change in the

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stance, Chinese banks have bought large stakes in Britishbanks. Russian energy companies have snapped strategicassets in Europe and Australia, while firms from the Mid-dle East have taken control of companies in the UnitedKingdom and the United States. Indian companies,among the most acquisition-minded among the develop-ing nations, have also been on a global shopping spree.

Add it all up and global deal making has taken a newand interesting turn. Indeed, since the beginning of2008, the developing nations have acquired more assetsin the developed nations than vice versa—a trend thatcould signal a seismic shift in global M&A activity. Fromthe beginning of the year to early May, the value of devel-oping-to-developed M&As ($70 billion) was nearly 21%greater than the amount from developed-to-developing($58 billion).

The trends of 2008 have been building over the pastfew years, as more and more firms from the developingnations spread their global wings. For instance, develop-ing-to-developed M&A deals soared to a record high of$174 billion last year. That was roughly 16 times greaterthan comparable deals in 2003 and underscores the on-going shift between the hunters and the hunted. The lat-ter, including sovereign wealth funds and state-ownedcompanies, are flush with cash, hunger for world-class as-sets, and on the prowl for wounded prey in the UnitedStates and Europe—think U.S. and European banks, aswell as struggling U.S. automobile manufacturers.

All of the above has resulted in a shift in preferenceamong corporations in the developing nations. Wherecross-border M&A deals initiated by the developing na-tions have traditionally been directed at other developingnations, it is firms from the developed nations that are in-creasingly in the crosshairs of corporate entities fromSouth Korea, Mexico, China, and others. Evident of thistrend, developing M&A flows to the developing nationsrose roughly 5% on a year-over-year basis from the start of2008 to early May, but soared some 27% to the developednations. The latter accounted for nearly one-third of totalM&A deals done by the developing nations over the pe-riod, up sharply from prior years.

Finally, it is the developing nations that have movedto the forefront of global M&A this year, and helped, inturn, cushion the downturn in global deal making. Totalglobal M&A deals were down roughly 40% in the year toearly May thanks to the global credit crunch and the U.S.financial crisis. This toxic combination, not surprisingly,has caused many firms in the developed nations to re-treat, with total M&A deals of the developed nationsplunging nearly 50% through early May. Over the sameperiod, in contrast, M&A deals from the developing na-

composition of global M&A deals. In particular, firmsfrom the developing nations have become more acquisi-tion-minded, attracted to assets not only in other emerg-ing markets but also in the developed nations.

Global Mergers and Acquisi t ions:The Hunters Are Now the Hunted

Since the rough-and-tumble days of the East India TradingCompany, global mergers and acquisitions have been thedomain of multinationals from the developed nations.Well endowed with capital and possessing superior brandsand extensive logistics networks, Western multinationalshave long been the global hunters, or the commercial en-tities with the wherewithal to pick off foreign assets/com-panies via cross-border mergers and acquisitions.

One favorite hunting ground has been the develop-ing nations, with popular targets including countries inpossession of copious amounts of natural resources or alarge, inexpensive labor force. For decades, the hunted(firms from the developing nations) have been no matchfor the hunters since they lacked the capital, the manage-ment expertise, the brands, and other core competenciesto effectively compete beyond their home market.

Given this dynamic, global M&A flows have tradition-ally been a developed-to-developed story, or a developed-to-developing story. Times, however, are changing.

A new world order, perhaps, may be in the makingwhen it comes to global deal making. Notably, aspiringmultinationals in the developing nations have not onlybecome more aggressive bidders for assets in otheremerging markets. They have also stepped up their ac-quisitions in the developed nations. Reflecting this dy-namic, total global M&A from the developing nationssoared to a record $665 billion in 2007; that marks a near21% increase from the prior year and was more thanthree and a half times larger than M&A deals in 2000, to-taling $182 billion.

A decade ago, total M&A value from the developingnations stood at just $80 million, accounting for less than4% of the global total. Last year, the developing nationsaccounted for over 16% of the total; more impressivestill, the developing nations represented nearly one-quarter of total M&A in the first four months of this year,a trend driven in large part by rising purchases in the de-veloped nations.

While firms from the developing nations have main-tained their bias toward other emerging markets, moreand more companies from Asia, Latin America, and otherregions are stepping up purchases in the United States,Europe, Canada, and Australia. In the past year, for in-



tions soared by over 20%, lifting their M&A share as a per-centage of the global total to roughly one-quarter, arecord level.

As part of this trend, global private equity deals, aftersoaring over the past few years, have declined sharply thisyear. Slower economic growth in the United States andtighter global liquidity conditions have severely reducedthe wherewithal and appetite for private equity deals.

The upshot: barring the deal making of the develop-ing nations this year, the current recession in global M&Aand private equity would be far deeper and uglier than itactually is. In a significant change from the past, however,the hunters are now the hunted, and the hunted increas-ingly the hunters. Put another way, in the future, every-one is fair game when it comes to global M&A. Direction-ally, cross-border M&A is expected to become moresouth-south and south-north in the future. Fueling thisprocess is the speed of global capital flows and the stun-ning emergence of sovereign wealth funds.

The Veloci ty of Global Capital andthe Rise of Sovereign Wealth Funds

Global capital flows are determined and affected by manydifferent variables—including the global business cycle,the cost of capital, and various government regulationsand nontariff barriers. The ebb and flow of these vari-ables bear directly on the climate for cross-border deals.In addition, two other variables have come to the fore toplay a significant role in influencing global capital flows.

The first relates to the daily movement of global cap-ital—or the velocity of money. In 1900, private capitalflows from the developed to developing nations couldbe measured in the hundreds of millions of dollars, andrelatively few countries were involved. In the 1950s and1960s, there was not much in terms of global capitalflows since many nations imposed capital controls re-stricting the cross-border movement of capital. Fixed ex-change rates did not help matters. Gradually, as variousnations removed capital controls, the velocity of moneygradually increased.

Today, global capital flows are measured in the hun-dreds of billions of dollars, and with more countries in-volved than ever before. Presently, money is tradedaround the clock; deal making is a 24/7 process, withmore and more of the world’s financial markets electron-ically connected and linked.

Daily turnover in the foreign exchange markets to-taled $3.2 trillion in early 2007, an increase of over 70%at current exchange rates from the levels of 2004. Sincethe early 1990s, the daily turnover in the foreign ex-

change markets has nearly quadrupled. The euro, surpris-ingly, has been at the cutting edge of this trend. Europe’ssingle currency accounts for 37% of daily global turnover,second only to the U.S. dollar.

Thanks to the rising velocity of money, the world’sexcess savings have been more effectively mobilized overthe past decade, with the excess capital of Russia andMiddle East oil producers, for instance, more accessibleto investors on Wall Street or London. The lubricant ofmany cross-border deals comes courtesy of developingnations. The velocity of money has also spawned more ofglobal equity culture, evident by the fact that at the endof 2006, the world’s stock market capitalization repre-sented 99.2% of world output, up from a 36.2% share in1990. The evolution of this equity culture has helpedspur cross-border deals in the Middle East, South Amer-ica, and many other parts of the world long hostile to for-eign capital and their owners.

Critically, capital is increasingly under the domain ofthe developing nations. While Europe and Japan accountfor roughly one-quarter of global savings, the bulk of theworld’s excess savings now resides with the oil-rich nationsof the Middle East, Africa, and Russia, as well as with thetrading powers of Asia. In the aggregate, the developingnations accounted for nearly 75% of total global interna-tional reserves in mid-2007, giving this group extraordi-nary clout when it comes to global capital flows andglobal purchasing power. In particular, the rise of sover-eign wealth funds (SWFs) has been of notable concern.

Indeed, nothing has engendered more anxiety inmany parts of Europe and the United States than the riseof state-controlled wealth funds. These entities now con-trol roughly $3 trillion in assets. That figure equates toonly 2% of the world’s traded securities but is largeenough to make many policymakers worried, and forgood reason. Assets under management are expected tocontinue rising in the years ahead; according to someWall Street estimates, sovereign wealth funds are ex-pected to expand to $15 trillion in the next few years,swamping the size of hedge funds and private equity play-ers. Meanwhile, many of these funds have become moreaggressive in making high-profile investments in publiclytraded companies in the West. It is the size of SWFs, theirlack of transparency, and the potential for funds to seekcontrol of strategic assets in the United States and Europethat have led many to conclude that sovereign wealthfunds pose a significant national security risk.

Not surprisingly, the topic of how to respond to sov-ereign wealth funds has become all the rage in Washing-ton and many capitals of Europe. Proposals range fromestablishing a Code of Conduct for SWFs to formalizing

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wealth funds could become a catalyst for closer global tiesbetween the developed and developing nations and aforce that helps drive more south-north capital flows.Meanwhile, there is a very good chance that China will useits excess savings to strengthen more south-south flows.

Where Wil l China Invest I ts Bounty?Think “Bamboo Network”

China is on course to become a major source of globalcapital. The Middle Kingdom’s decision to create a new in-vestment corporation to manage its massive savings hastriggered a great deal of speculation about where Beijingmight actually put its capital to work. For investors, gettingahead of this massive liquidity wave could reap handsomedividends since the amount slated to be invested overseasby China is $200 billion. That figure is roughly equivalentto the total market capitalization of Thailand’s equity mar-ket and in excess of the market cap of such countries asIreland, Portugal, the Philippines, and New Zealand.

Where the mainland decides to invest its capital is any-one’s guess. Australian mines, U.S. equities, African oil de-posits, and European real estate top the list, although in-vestors hoping to ride the China investment wave should

standards that would result in greater transparency, bettercorporate governance, and clearer accounting rules.Some have even broached the idea of establishing behav-ioral guidelines for SWFs.

To a large degree, the rising influence of sovereignwealth funds reflects the energy shortcomings/failures ofthe developed nations in general, and the United Statesin particular. Since roughly two-thirds of the total assets ofthese funds are derived from oil and gas revenue, thehigher the price of energy, the more that capital is redis-tributed from the transatlantic economy to the world’senergy providers. By extension, the more capital thatflows to SWFs, the greater their global purchasing power.

With world oil prices currently hovering around $125per barrel, reserves of the Gulf Cooperation Council(GCC) are expected to top $150 billion this year, up nearlyfivefold from a decade ago. Finally, at current price levels,the proven reserves of the GCC are worth over $50 trillion,a staggering sum, one in excess of the total output of theglobal economy. The upshot: the financial clout of theworld’s major oil producers and their sovereign funds isexpected to remain quite formidable in the decade ahead.

While many in the United States and Europe cannotagree on the role of SWFs—white knights rushing to the aidof battered Western banks, or the equivalent of a financialTrojan Horse, bent on impairing the market-based systemof the global economy—sovereign wealth funds represent anew source of global liquidity and a new dynamic shapingglobal capital flows. By purchasing stakes in Western banks,U.S. retailers, and other sectors of the transatlantic econ-omy, Middle East money flows have already exerted a pro-found influence on global capital flows. Many Middle Eastnations are becoming greater stakeholders in the Westerncapitalist system—a positive development given the cash-strapped, debt-laden nature of the U.S. economy.

Looking ahead, rising capital outflows from the Mid-dle East could result in deeper and stronger commercialties between the region and the rest of the world. By recy-cling more of their savings into American/Europeancompanies rather than U.S. securities, Middle East in-vestors are signaling their long-term confidence in theUnited States and Europe. That said, Washington andBrussels, rather than placing onerous conditions on sov-ereign wealth funds, should be pressing the governmentsof the Middle East for reciprocal access to their local mar-kets. Trade and investment barriers in the region remainrelatively high, yet lowering such barriers would help pro-mote more cross-border trade and investment and assistin further globalizing the Middle East.

In the end, with the right conditions in place in theUnited States, Europe, and the Middle East, sovereign



In the end, with the right

conditions in place in the

United States, Europe, and

the Middle East, sovereign

wealth funds could become a

catalyst for closer global ties

between the developed and

developing nations and a

force that helps drive more

south-north capital flows.

Rising capital outflows from

China will help grease the

wheels for more trade and

investment deals between

China and its neighbors,

thereby boosting the

economic integration of

the region, with the

mainland at the helm.

think regionally. There is a very good chance that Chinawill direct a significant share of its reserves toward Asia’smost powerful yet invisible force—the “Bamboo Network.”

Think of the “Bamboo Network” as an extension ofChina. The “network” consists of hundreds of companiesacross Asia owned and managed by overseas Chinese en-trepreneurs with extensive ties with their ancestral home-land. Many of these companies dominate the private sec-tors and equity markets of such nations as Singapore,Thailand, Malaysia, Indonesia, Taiwan, Hong Kong, thePhilippines, and Vietnam. In these countries, largeswathes of industry (transportation, banking, retail, con-struction, and manufacturing) are under the control ofthe overseas Chinese. Many of these firms started out assmall family-owned enterprises but have subsequentlymorphed into enormous, publicly traded conglomerates.

Exact figures are not available, but many large-capstocks in developing Asia are in the hands of the overseasChinese, with a number of these firms having controllingstakes in a host of smaller and medium-sized, privatelyheld companies.

These same firms have extensive ties with mainlandChina. Indeed, it has been the overseas Chinese them-selves that have emerged as the largest foreign investors inChina over the past quarter-century, helping to transform

the mainland into the powerhouse it is today. China’s risehas not been financed by Western capital; rather, themainland’s emergence has been largely underwritten bythe “Bamboo Network” or overseas Chinese who share thesame culture, language, and business norms of the main-land. For the better part of two decades, the flow of capi-tal between the overseas Chinese and the mainland wasone way—into China. But that’s about to change.

There is a very strong probability that China’s invest-ment agency will exhibit a regional bias toward large-capcompanies run and managed by overseas Chinese execu-tives. This entails more Chinese funds directed at the“Network”—or Hong Kong firms in particular, as well asmore Chinese capital flowing to Singapore, Malaysia,Thailand, and large-cap, Chinese-owned firms in thePhilippines and Indonesia.

Watch for more intra-Asia M&A deals, which havesoared over the past few years. The pace is expected toquicken in the next few years.

The ultimate objective of China’s new investmentstrategy is to achieve higher returns and to diversify awayfrom low-yielding U.S. Treasuries. But there is anotherangle to this story. Investing regionally, funneling moneyinto Southeast Asia serves China’s broader strategic goalof creating a pan-Asian economy with the mainland at itscore. Rising capital outflows from China will help greasethe wheels for more trade and investment deals betweenChina and its neighbors, thereby boosting the economicintegration of the region, with the mainland at the helm.

The bottom line is that the “Bamboo Network” willlikely be one of the primary recipients and beneficiariesof China’s overseas investment push. The big winners arelikely to be large-cap companies run by overseas Chineseentrepreneurs and, by extension, the equity markets ofSoutheast Asia.

The Way Forward: Global Par i ty andthe Coming Shif t in Global CapitalFlowsThe world of tomorrow will not pivot around the UnitedStates and Europe in particular or the developed nationsin general. The tripolar world of the past—loosely config-ured around the United States, Europe, and Japan—isbeing reshaped and redefined. A multipolar world is inthe making, owing to the emergence of powerful new play-ers like China, Russia, and Brazil. Led by these nations, theemerging markets represent a potent new force in theglobal economy. The next phase of globalization will beless about the United States and the transatlantic econ-omy, and the primacy of the United States and Europe in

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the world’s labor force and future consumer base.Roughly nine out of every ten people in the world residein the developing nations. In many cases, these peoplerepresent both a blessing and a curse—an economicinput and economic drag. That said, there is no denyingthe fact that the world’s labor force and consumptionbase is increasingly shifting to the developing nations, be-stowing even more economic clout on this cohort.

Given all of the above, a new world order is in themaking. The future will look different from the past.

Led by the United States, the developed nations, withtheir superior economic and technological capabilitiesand military might, have been the main architects of theglobal economy for the past six decades. They have beenthe standard bearers of the world economy—the rule-makers, regulators, and enforcers, controlling the globalinstitutions (including the World Bank, the World TradeOrganization, and the International Monetary Fund) thatcontrolled the global economic agenda. It has been thedeveloped nations that have led the world in terms ofconsumption, innovation, and competition, and ac-counted for a disproportionate share of global produc-tion, trade, and investment. Skilled labor, excess savings,foreign direct investment flows, technological advances—these and other factors of growth and prosperity havelong been staples of the United States, Europe, andJapan. The developing nations, meanwhile, have largelyexisted on the periphery, barring a few notable excep-tions like the newly industrialized nations of Asia (SouthKorea, Taiwan, Hong Kong, and Singapore).

The world of tomorrow will be different, however.The rise of the developing nations represents a seminaland seismic shift in the global economic hierarchy. WithChina and India at the forefront, a new economic orderis in the making that will challenge the primacy of thetransatlantic economy or the United States’ and Europe’sability to long define and dictate the global economicagenda. The postwar global architecture, whereby the de-veloped nations lead and the developing nations follow, isless prevalent today. The United States, Europe, andJapan have less sway over the developing nations, whilethe latter have more leverage at their disposal (excess sav-ings, abundant labor, natural resources) to resist de-mands from the United States and Europe.

The shifting contours of the global economy willusher in a new era in global capital flows—assuming, ofcourse, investment protectionism in the United Statesand Europe, as well as many developing nations, does notrear its ugly head and impede the mobility of capital.Over the next decade, global capital flows will becomemore dispersed and less centered on the developed na-

setting and promoting the global economic agenda. In amultipolar world, the rules of global engagement will be-come dispersed and shaped by other nations determinedto have a greater say and weight in the world economy.

As part of the above, the world economy is undergo-ing another profound period of integration—or an unset-tling transition whereby a new, large economic entity en-ters the universe, upsetting the existing economic order.We have been here before—between 1870 and 1913, theworld economy was forced to adjust to the emergence ofGermany and the United States; in the quarter-centuryafter 1950, Japan emerged as a new powerful global en-tity. Early in the twenty-first century, it is China, India, andthe emerging markets in total that are now at the fore-front of shaping a new economic order and reconfiguringglobal capital flows.

If economic power is determined by the possessionand availability of critical resources, then the developingnations have emerged as a formidable economic force tobe reckoned.

To this point, in a fossil-fuel-driven global economy,with a premium associated with crude oil and proven oilreserves, the developing nations are clearly in the driver’sseat. While oil production in the developed nations fell bynearly 10% between 2000 and 2006, production in the de-veloping nations rose nearly 16% over the same period.Owing in part to new production coming on line in suchplaces like Russia and West Africa, oil production in thedeveloping nations rose from over 57 billion barrels in2000 to 66.1 billion barrels in 2006. Owing to thesetrends, world oil production is now even more concen-trated in the developing nations: the latter accounted forover 77% of global oil production last year, up from ashare of 72.7% in 2000. In terms of proven oil reserves,the developing nation’s global share is even more concen-trated. Presently, the developing nations sit atop of nearly95% of proven oil reserves—a powerful position givenever-rising demand for world energy.

Capital is another key input increasingly under thedomain of the developing nations. While Europe andJapan do account for some proportion of global savings,the bulk of the world’s excess savings resides with the oil-rich nations of the Middle East, Africa, and Russia, as wellas with the trading powers of Asia. In the aggregate, thedeveloping nations accounted for 70% of total global in-ternational reserves in mid-2007, giving this group ex-traordinary influence when it comes to global capitalflows and purchasing power.

Finally, it is not just natural resources and capital thatis under the control of the developing nations. The latteralso possess another critical input—people, or the bulk of



tions—notably, the United States and Europe. As more ofthe world’s production shifts to the developing nations, asconsumption and investment levels rise in Latin America,China, and other parts of the developing world, globalcapital flows will increasingly reflect and be determinedby the world economy’s new sources of growth.

Just as the 1950s and 1960s ushered in a new age ofglobal capital movement, with money from the UnitedStates flowing to Europe and Asia, so the world standson the cusp of another great turn of capital flows early

in the twenty-first century. Global capital flows arepoised to become less north-north in nature; future cap-ital flows will increasingly pivot around the emergingmarkets—notably China, Singapore, the money centersof the Middle East, and scattered parties in Latin Amer-ica and Central Europe.

In time, cross-border capital flows should becomebetter balanced and truly global in nature. The globaleconomy and all associated parties will benefit from thisdynamic.

352 FEATURE ARTICLE


Joseph Quinlan is a managing director and the chief market strategist of Bank of America, Global Wealth andInvestment Management. He is charged with the development and implementation of domestic and global invest-ment strategies. He is the author, coauthor, editor, or contributor to eight books, the most recent being Deep In-tegration: How Transatlantic Markets Are Leading Globalization (Johns Hopkins University, 2005), coauthored withDaniel Hamilton. He has published more than 125 articles on international economics and trade, with articles ap-pearing in such publications as Foreign Affairs, the Financial Times, the Wall Street Journal, and Barron’s.

Quinlan earned a master’s degree in international political economics and development from Fordham Universityin 1984. He attended Niagara University, graduating in 1980 with a bachelor’s degree in political science. He sitson the board of the Graduate School of Arts and Sciences at Fordham University and is a member of the Presi-dent’s Council at Fordham University.

Following the money: The globalization of capital flows and private equity

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