In the short run, foreign capital invested in the United States raises U.S. gross domestic product (GDP). This means that U.S. residents are better off than they would be without foreign capital. Still, long-run scenarios of foreign ownership trouble many critics: What payment will foreigners exact for our use of their capital? Will sustained inflows of foreign capital give foreigners control of the U.S. capital stock, reduce job quality, or distort U.S. investment and research? Fortunately, these concerns can be dispelled by reviewing the extent of foreign investment in the U.S. economy vs. U.S. investment abroad, considering the motivations for foreign investment, and computing the negligible potential for foreign control.
Foreign Investment in the United States—How Much? Of What? By Whom?
Between 1982 and 1990 U.S. current account deficits—the amount by which imports of goods and services plus foreign aid exceeded U.S. exports of goods and services—totaled over $900 billion. The deficits were financed by net capital inflows—foreign investment in the United States less U.S. investment abroad. Although U.S. holdings of foreign assets rose, foreign holdings of U.S. assets rose by $900 billion more. U.S. assets abroad minus foreign assets in the United States went negative in 1985 for the first time since 1914.
These data, however, are based on historic cost, the cost at the time the investment was made. The proper measure of any investment is its current market value, not its historic cost. Recognizing this, the U.S. Commerce Department switched to market valuation in its June 1991 report. Measured by market values, the net foreign investment position of the United States remained positive until 1987, and reached minus $360.6 billion in 1990, about 40 percent smaller than the number computed on an historic cost basis.
At the end of 1990, about 16 percent of foreign assets in the United States were owned by foreign governments, while 84 percent were privately owned. (Similarly, 14 percent of foreign assets owned by the United States were official, and 86 percent were private.)
In contrast, as a share of total investment, U.S. direct investment abroad (comprising equity holdings of 10 percent or more of any firm) is substantially larger than foreign direct investment in the United States. U.S. direct investment abroad still exceeded foreign direct investment in the United States in 1990, and by a wider margin than in 1985—$184 billion versus $152 billion.
Despite the notoriety of Japanese investors, the British have the largest U.S. direct investment holding—with the Dutch not far behind—as has been the case since colonial times. In 1990 the United Kingdom held about 27 percent of foreign direct investment in the United States, significantly greater than Japan's 21 percent. The European Economic Community (EC) collectively holds about 57 percent. Moreover, according to research by Eric Rosengren, between 1978 and 1987, Japanese investors acquired only 94 U.S. companies, putting them fifth behind the British (640), Canadians (435), Germans (150), and French (113).
Why Do Foreigners Invest in the United States?
With no restrictions on movements of labor or capital, each tends to flow to any host country where wages or returns are higher than at home. During the eighties laborers migrated to western Europe from eastern Europe, southern Europe, and Turkey, and to the Arab Gulf states from Africa and southern Asia because of higher wages. Capital migrated to the United States because of higher returns. The U.S. stock market's annual appreciation of over 15 percent (not counting dividends) was exceeded among the major Western industrial countries only by the Japanese stock market's rise of nearly 20 percent. In comparison, average stock market increases were 5 percent in Canada, about 11 percent in France, 12 percent in Germany, 14 percent in Italy, and 12 percent in the United Kingdom.
Tax differences also influence international capital flows. Both defenders and critics of the Reagan administration's 1981 tax cuts agree that they caused increased capital inflows during the eighties. Defenders argue that U.S. investments became more profitable after tax than non-U.S. investments, both to U.S. investors and to foreign investors, while critics argue that large federal deficits drew the capital inflows.
Consistent with the defenders' view, U.S. investors were selling off foreign assets in the early eighties to finance domestic investment. U.S. direct investment abroad, valued at historic cost, declined from 1981 to 1984; in market value it declined during 1983 and 1984. Correspondingly, U.S. nonresidential fixed investment rose substantially in 1983 and 1984 and peaked in 1985, following publication of the U.S. Treasury's tax reform proposals in the fall of 1984. In 1985 U.S. direct investment abroad began to rise again. Meanwhile, foreign investment in the United States grew somewhat faster in the early eighties than in the late eighties. Higher tax rates on capital gains became effective in 1986, and, from the end of 1985, the rise in U.S. foreign direct investment has exceeded that of foreign direct investment in the United States. Moreover, the pattern of the rise and fall of the U.S. dollar—appreciating between 1980 and 1985 and depreciating from 1985 to 1987—is also consistent with the defenders' view.
The United States attracts capital not only because of lower taxes, but also because of greater U.S. consumer wealth and labor productivity. At purchasing power parity—GDP adjusted for differences in exchange rates and prices—U.S. wealth (per capita GDP) was one-fourth greater than Japan's in 1990 and one-third greater than Germany's. Moreover, except for Japan the other main industrial countries did not narrow this margin between 1980 and 1990. On a production-per-employee basis, the message is the same: U.S. labor is the most productive in the world.
Is Foreign Investment Good or Bad?
Foreign investment increases the amount of capital—equipment, buildings, land, patents, copyrights, trademarks, and goodwill—in the host economy. The increase in the quantity and quality of tools for labor's use in converting one set of goods (labor and other inputs) into another (finished output) raises labor productivity and GDP. Because about two-thirds of GDP goes to labor as wages, salaries, and fringe benefits, rising output means higher wages or more employment. Thus, foreign investment raises labor productivity, income, and employment. Workers are better off with more capital than with less and are usually indifferent to the nationality of the investor.
Politicians generally overlook labor's benign attitude toward foreign capital, sometimes at their peril. In the 1988 presidential campaign the Democratic candidate, Michael Dukakis, told a group of workers at a St. Louis automotive parts plant: "Maybe the Republican ticket wants our children to work for foreign owners... but that's not the kind of a future Lloyd Bentsen and I and Dick Gephardt and you want for America." Dukakis's advance staff failed to tell him that the workers Dukakis was addressing had been employed by an Italian corporation for eleven years.
What Are the Long-Term Consequences of Foreign Investment in the United States?
The availability of foreign capital lowers the cost of capital to corporations. This makes additions to plant and equipment cheaper, permits some investment projects that otherwise would not be profitable, and raises the value of firms. Thus, even though most foreign capital inflows do not substantively alter the ownership of U.S. firms, they benefit asset owners as well as labor by lowering interest rates and the cost of capital.
Yet some critics, such as Martin and Susan Tolchin, warn of desperate long-run consequences from foreign capital even while conceding its short-run benefits. They worry about loss of skilled employment opportunities, loss of technological advantage, slower growth, and a declining standard of living. All of these worries are based on two implicit assumptions. First, they assume that foreigners will obtain control of the U.S. economy. Second, they assume that, unlike U.S. investors abroad, foreigners will use this control to systematically reduce the efficiency of the host economy. Both assumptions are false.
The probability of foreign investors obtaining control of the U.S. economy is negligible. Between 1982 and 1989, according to estimates by the U.S. Commerce Department, the U.S. stock of nonresidential capital rose from $5.9 trillion to $8.4 trillion. At the end of 1989, the U.S. net international investment position was estimated to be -$267.7 billion, or only 3.2 percent of this capital stock.
Even sustained net capital inflows of $100 billion per year, as happened during the mideighties, would not shift control of the U.S. capital stock to foreigners. At that rate foreign investors' share of the fixed U.S. capital stock would rise to about 8.4 percent in the year 2000, but decline to 7.8 percent in 2010 and to 2.8 percent in 2020.
The second concern is finessed by competitive forces in a market-based capitalist economy. If foreign owners of a U.S. firm reduced its efficiency by not using employees in the most advantageous way, the owners would lose wealth. They also would lose employees and, eventually, the firm. Labor, management, and technology would be hired away by other existing firms or by new firms eager to use them in the most profitable way feasible. The firm's decline in market value—due to the inefficiency of its incumbent management—also would make it an attractive takeover target, as its price would be lower than its value under efficient resource utilization. Either way, foreign owners could not subjugate an industry through perverse management, even if they were willing to sacrifice profits to do so.
Mack Ott is an economist with the Barents' Applied Economics Group. He was previously a research economist with the Federal Reserve Bank of St. Louis.
"Dukakis-Bensten-Gephardt." The Wall Street Journal, October 11, 1988, 22.
Ott, Mack. "Is America Being Sold Out?" Federal Reserve Bank of St. Louis Review, 71, no. 2 (March/April 1989): 47-63.
Rosengren, Eric S. "Is the United States for Sale?" Federal Reserve Bank of Boston, New England Economic Review, November/December 1988, 47-56.
Sinn, Hans-Werner. "U.S. Tax Reform 1981 and 1986: Impact on International Capital Markets and Capital Flows." National Tax Journal 41, no. 3 (1988): 327-40.
Tolchin, Martin, and Susan Tolchin. Buying into America—How Foreign Money Is Changing the Face of Our Nation. 1988.