Dan Drezner writes:
Given the fact that foreigners currently have a net claim on $2.5 trillion in U.S. assets, one would expect the U.S. to be paying out a lot more in interest, dividends, and profits to foreigners than Americans would receive from their investments.
The weird thing is that, so far, this hasn't been true. Last year the U.S. earned $36 billion more on their foreign investments than foreigners earned in the United States. The question is, why?
It turns out Americans both (seem to) make riskier investments and earn a higher return on investment. One extreme view (not Dan's) suggests the following:
Once assets are valued accordingly, the US appears to be a net creditor, not a net debtor and its net foreign asset position appears to have been fairly stable over the last 20 years.
For months this debate has been making my head spin.
1. I think of FDI as often taking ten or more years to pay off. Yes, we should account for the "dark matter" of superior investment performance but a country with older FDI will appear to have a stronger net asset position than is the case. If we think of the U.S. as the more established foreign investor, the apparent superiority of our investments may be an accounting convention and simply a matter of their vintage.
2. If Americans are earning higher risk-adjusted rates of return by investing abroad, why don't foreigners buy U.S. multinationals until this difference goes away?
3. I also get dizzy pondering the difference between value productivity and real productivity. We, and the world, should be happy if we can produce more widgets. But should we be equally happy if we earn more money simply by buying widget inputs at lower prices? Isn't this just a transfer from abroad? Citing this as a true global benefit seems to invoke precisely the kind of mercantilist reasoning that we reject in other contexts. Even more strongly, should we be so happy that the Japanese sometimes buy U.S. assets at such inflated prices?
Yes, you might welcome wealth transfers, especially if you feel your economy or currency is about to collapse. But what if these transfers are a one-time stock inherited from the past? That means we have mismeasured the height of our perch but we would (if you buy the whole dollar pessimism argument) still collapse. Do we have good reason to believe that an ongoing flow of these wealth transfers will continue in the future?
My bottom line, for now: The U.S. enjoys many intangible competitive advantages, ranging from demographics, a more entrepreneurial climate, and better TV shows. These all affect the value of the dollar, and as you probably know, I have never bought into the dollar pessimism argument. Even if we should consider superior FDI performance as another factor, it is unlikely to stand at the top of the list.
Continuing...as the now-to-be-tenured Dr. Drezner would say...Comments are open...Brad Setser commented on Dan's blog, and I have reproduced his remarks beneath the fold...Addendum: Brad Setser has much more at his blog.
Dan — As erg noted, I argue that the anecdotal evidence points to
corporate tax arbitrage as a key explanation. But if you come across
the definative b-school explanation, do let me know. So ask Bill Gates,
or the big pharma CEOs with big profits in Ireland for the answer, not
old George Soros.I’ll set aside my argument that investing in US dollar denominated
assets is actually very risky for a foreign investors looking to
maintain their real wealth in local currencies terms. The big current
account deficit and all. Not everyone agrees with it.But I don’t think the US just is good at borrowing at low cost to
buy high yielding assets argument works that well. For a couple of
reasons. First, US returns abroad really aren’t that good. The shocking
thing is that reported foreign returns on their FDI are really bad –
less than they would have gotten holding long-term Treasuries
generally. It isn’t US skill, at least not skill at anything other than
taking foreign direct investors for a ride that shows up in the data
(now if FDI in the US doesn’t want to show profits in the US for tax
reasons, the story changes … ). Second, most US FDI is just not in
risky markets, nor are most US debt securities claims on risky places.
Most US FDI is in the UK. lots more is in Switzerland. Throw in Japan,
Canada and the Eurozone and you have a decent mental image of US assets
abroad. Read the CBO report on this topic. Or look at the data the IMF
has assembled on the sources of FDI in China (hint — it ain’t mostly
coming from the US). US investors also own foreign bonds — but they
are mostly the securities issued in well developed markets that are
almost as liquid as our own. UK, Japan, Canada, eurozone and the like.We have lent tons of money to the Caymans too; I bet the Caymans
also invests a lot in the US …. hhmmm? Maybe some b-school prof can
help us out there. Or tax attorney.
Much of foreigners’ investment in the US is by foreign central banks
(like the Bank of China) in US treasury debt, which has a relatively
lower yield than private sector investments.
Americans don’t invest in foreign governments’ debt, prefering higher
yielding investments in both private equity and publicly held
firms.
This has been discussed in “Where Dat Dark Matter?” over
on Maxspeak at length.
One point to keep in mind is that much of the investment
here is by central banks who are not profit maximizers.
Their investment decisions are based on internal
macro policy goals, such as keeping up employment in
Japan and China.
A couple of points.
Dumb Chinese real estate might work, but I wonder how big it is.
Those kinds of flows are also even bigger into europe. Think African, middle eastern
and Russian oligarchs …
I don’t think central bank buying is the whole story. Here is why. You can
match US FDI abroad against foreign FDI here, US portfolio investment abroad v.
foreign porfolio investment here, and so on. They don’t match perfectly, but they
sort of match. Central bank and other buying can explain why the US doesn’t pay more
on its (net) debt position. But it cannot explain why the US makes so much on its(
(net) equity position. that position is generally speaking, offset not by debt claims, but
foreign equity claims on the US (it is maybe 1/4 debt, 3/4 equity — and it asl
all equity til the valuation changes associated with the dollar’s post 02 fall)(
the difference here comes from low returns on foreign direct investment in the US,
and average returns on us direct investment abroad.
the “its old money” argment sort of works, but it implies that say ford/ GM
make a lot in europe, while BMW/ Toyota make less in the US. And new US FDI –
microsoft and pfizer in Ireland — shouldn’t be very profitable. judging from the data,
tho, some of the new FDI is very profitable. And, given how little new FDI is
coming to the US these days, pretty soon the existing stock will be sort of old.
the big equity flows stopped in 01.
cheers
brad makes a reasonable point. Although the
recent flows have been much more heavily weighted
towards central banks, the aggregate fdi balances are
such that one can only surmise that somehow US fdi abroad
is earning higher returns than fdi here. Difficult to
say what is going on with that, although it may be that
US investors are pickier and more risk averse, only going
for the surest and safest bets on high returns.
This of course turns a widespread argument on its head.
We hear from the “dark matter” advocates that the US is
earning all these higher returns because it is so much
more willing to bear risk, to make all these high risk/
high return investments while all those wimpy foreigners
are just buying up our low-yielding Treasury bills and
poorly performing stock market. However, given the risk
of a dollar crash, these assets all look rather dicey.
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