In recent years outward foreign direct investment (FDI) by US corporations to other countries has been increasing rapidly, while inward FDI by foreign corporations into the US has been trending down. Since investment in the US is critical for future economic prosperity, these patterns are troubling and provide evidence of how globalization and flawed policy are encouraging corporations to abandon America.
Inward FDI is usually good for countries, though there can be legitimate national security and strategic industry caveats. Such investment has foreign investors either building new facilities or taking large ownership stakes in existing businesses. Their willingness to build new facilities expands productive capacity and creates jobs, while making large investments in existing businesses usually signifies an intention to grow them. The net result is that inward FDI benefits countries, especially since foreign investors bear the cost of financing these investments.
The benefits of outward FDI are less clear-cut. On one hand, it can expand the global reach of companies, thereby potentially increasing exports, and it can also give companies access to profitable foreign market opportunities. On the other hand, outward FDI may simply displace domestic investment and employment, as when corporations create offshore production platforms whose only purpose is to export back to home markets. In this case, outward FDI can be problematic.
These characteristics suggest that policy should aim to encourage inward FDI and discourage outward FDI that hollows the domestic economy. Yet, the US appears set on the exact opposite course, with inward FDI trending down while outward FDI has trended up.
Having peaked at 321 billion dollars in 2000, inward FDI fell to 64 billion dollars in 2003 and then recovered somewhat to 110 billion dollars in 2005. Meanwhile, US outward FDI rose from 159 billion dollars in 2000 to 252 billion dollars in 2004.Whereas in 2000 the US had net FDI inflow of 162 billion dollars, by 2004 this had transformed into net FDI outflow of 145 billion dollars.
The volume and pattern of FDI can be viewed as indicating the degree of confidence business feels about US economic prospects. Part of the decline of inward FDI between 2000 and 2003 can be attributed to the impact of recession. However, the subsequent weak recovery of inward FDI accompanied by the acceleration of outward FDI suggests deeper problems.
One policy problem is the over-valued dollar that raises the relative cost of producing in America, thereby discouraging investment. A second is policies that give incentives to corporations to offshore production. The net effect is to undermine the relative competitiveness of the US economy, thereby making it a less attractive place to invest, especially in manufacturing.
With regard to outward FDI, part of the increase is attributable to affirmative improvements in emerging market economy prospects, but part is due to bad policy. The over-valued dollar has encouraged US business to shift productive investments from the US to both developing and other developed economies, while the lack of global labor and environmental standards encourages shifts to developing economies where standards are lower or even absent.
Another factor is the preferential tax treatment of foreign profits of US corporations, which encourages outward FDI that displaces domestic investment. This speaks to repealing that provision.
Inward FDI is discouraged by the over-valued dollar and the extent to which US corporation tax is higher than foreign country corporation tax. This connects to the problem of tax competition between economic jurisdictions. Such competition distorts investment decisions, strips the public purse of revenues, and contributes to shifting the tax burden from capital on to worker incomes. This is a global problem, to which the US is also contributing, albeit through tax competition between the fifty states. That suggests need for stricter multilateral agreements on tax competition and the US should also act unilaterally to prevent tax competition between the states.
Given the decline in inward FDI the US Commerce Department recently launched an initiative to promote such investment, promising to actively court foreign companies. The initiative is welcome since inward FDI is generally beneficial, but it is also incomplete and inadequate. Cheerleading cannot substitute for fundamental policy change, while the exclusive focus on inward FDI is like one-hand clapping and completely misses the problem of investment off-shoring by US corporations.
Copyright Thomas I. Palley
A slightly more recent picture of those FDI inflows according to this (table near bottom):
http://www.unctad.org/Templates/Webflyer.asp?docID=7993&intItemID=1528&lang=1 which shows those efforts by the Commerce Dept might have been successful in 2006, but as you point out, a fraction of the inflows (and likely largely US outflows) to developing countries and Europe.
This remark there
“Increased corporate profits (and resulting higher stock prices) have boosted the value of the cross-border mergers and acquisitions (M&As) that constitute a large share of FDI flows.”
is not often noted by the press. Not only are those imports the work of transnationals and not foreign companies acting independently, but also there is a physical dimension to the M&As and LBOs that make them lucrative financial plums.
That other larger ‘one hand clapping’ is Paulson’s. Those in the financial community find their national interests an impediment to their real interests. QED.
We read your article in the St. Louis Post-Dispatch. It alerted us to the concern we’ve felt for a long time. Corporate greed is undermining our country. We’re just hardworking Americans who feel the “duty” card to citizenship is before us. Suggestions for making a difference in SEC decisions weakening the Sarbanes-Oxley Act, of which we never heard of till reading your article, would be helpful.
I agree with the basic theses in this well written and timely work. I would add that the massive surge- globally and in the US- in specialization and spatial diffusion of production should be factored into this discussion. Manufacturing has become increasingly specialized and worked-up inputs are a rising portion of final value in most product classes. This gives nations with “over-valued” currencies advantages that can be captured as well as adding risk to nations with “under-valued” currency.
The US and China would be cases in point here. Recent work suggests the above outlined processes are distorting output and productivity numbers that dont factor worked-up inputs. The presence of insufficient global final demand is also distroting production and direct investment flows toward higher yields.
Finally future economic and demand growth should play a shaping role in directing capital flows. Thus, realignments of direction- of sufficient size and duration- become self fulfilling prophecy of future growth and gain momentum. That might be a cause for concern in the US?
This is interesting. I admit I haven’t been keeping track of the actual numbers, but I was getting the impression that foreign organizations were buying US organizations outright. For example Chrysler and Lucent. Are these purchases of US organizations included in the inflow numbers that you cited?
Another factor contributing to the inward/outward FDI shift is Sarbanes-Oxley Section 404. It is sufficiently burdensome for corporations that many are choosing to go public oversees rather than in the US. The impact is dramatic. Last year, just 5% of the value of global initial public offerings was raised in the US. That number was 50% in 2000. I can’t say it was all due to Section 404, but I know much of it was.