Other things equal, an increase in a country’s residents’ investment in foreign countries means an equal increase in foreigners’ investment in their country. In effect, residents exchange assets within their country for assets outside their country.
Because investors will shift assets between countries in anticipation of any changes in rate of return, we will tend to see no particular correlation between asset flows and rates of return among countries. Instead, countries with attractive investment opportunities will show up as countries attracting investment of physical capital.
In the absence of special information advantages, all investors should own a piece of the same world portfolio. In reality, investors tend to concentrate their holdings in domestic assets because they are familiar. This effect is probably stronger than it should be. Because trading of domestic investors will cause stock prices to reflect all available information, foreign investors can safely buy domestic shares even if they don’t have much information about them.
Foreign investment and changes in foreign investment can have a big effect on a country’s trade balance. A rich country that consumes its return on large outward foreign investment will tend to show a trade deficit. Conversely, a poor country with large inward foreign investment may show a trade surplus. If a country raises its taxes on capital, driving capital goods out of the country, it will tend to show a surplus in its balance of trade.
The balance of payments is an even more mysterious concept. We do not even know how to define it meaningfully, let alone measure it. For every proposed definition it is uncertain whether we would rather have a surplus, a deficit, or neither.