In India last September protesters took to the streets of Bangalore, Calcutta, Delhi, and other cities, shutting down public transportation and halting productivity. The cause of such heated resistance? Reforms intended to open India’s retail sector to foreign direct investment (FDI), allowing corporations like Tesco and Wal-Mart to purchase up to a 51% stake in local enterprises.
The inflow of outside capital certainly creates challenges. It exerts competitive pressure on local businesses and can cause exchange rates to appreciate, slowing export growth. But the health of the global economy depends on continued FDI and its power to drive development. Overseas financiers offer more than money: They bring in new technology and managerial know-how that allow companies — and countries — to leap ahead in innovation. A fine line separates regulation from restriction, and policymakers must walk that line carefully. Otherwise, we risk a return to the days when the norm in the developing world was vilification of foreign capital and, as a result, many lost opportunities for growth.
In the 1970s fear of foreign domination led governments in developing countries to keep out multinational corporations. Resistance to foreign investment, however, made scarce resources even scarcer, leading to an overreliance on loans. That culminated in the Third World debt crisis that began in 1982 and eventually forced developing countries to sell stock in domestic companies to — ironically enough — foreign buyers.
Those inflows ultimately reduced the cost of capital in liberalizing economies. With increased incentive to expand, companies operating in the emerging world ramped up investment, which in turn drove up productivity and wages, delivering greater prosperity for millions of people in the developing world.
But mature economies threaten to undermine progress because of their surprising reluctance to heed their own good counsel. Consider the 2006 firestorm over the proposed sale of U.S. ports to Dubai Ports World, a global company based in the United Arab Emirates. In a backlash against such a move, American lawmakers introduced bills aimed at preventing foreign ownership of strategic assets, culminating in the Foreign Investment and National Security Act of 2007. (DP World, meanwhile, abandoned its acquisition plans.) While national security is important, such restrictions on outside investment send a message of “Do as I say, not as I do.”
It is little wonder, then, that citizens in emerging markets take to the streets in protest. But fear and resentment have no place in a disciplined approach to economic policy. Foreign direct investment in companies increases the standard of living for international and domestic residents. We need leaders in the developed world to uphold the wisdom of cross-border capital flows. Practicing the same medicine we’ve been prescribing is essential for continued growth in the emerging world — and for restoring our own economic health as well.
Peter Blair Henry, dean of New York University’s Stern School of Business, is the author of Turnaround: Third World Lessons for First World Growth.
This story is from the April 08, 2013 issue of Fortune.