06 Apr 2006

Foreign Investment in the US (II):Being taken to the cleaners?

Daniel Gros

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The income account of the US balance of payments has so far remained in surplus because of a very large differential in reported earnings on direct investment – US firms seem to enjoy a much higher rate of return than foreign firms in the US. There is little difference in terms of the rate of dividend payments; the difference is due to what is called ‘reinvested earnings’ (earnings minus dividends). Foreign firms report almost no reinvested earnings on their direct investment in the US whereas US firms report substantial reinvested earnings from their direct investment abroad, on average over $100 billion more p.a. than foreign firms report on their US investment. This anomaly is probably due to the desire of foreign firms to minimise their US taxes, whereas US firms do not face tax liabilities if they report high foreign profits to the US authorities. The procedure used to generate the data for reinvested earnings thus has a built-in bias to improve the US current account and – over time – its international investment position. The true picture is likely to be much worse.
Reinvested earnings appear in the balance of payments because returns from FDI are measured in a different way than returns from portfolio investment. Returns from FDI are calculated from a mix of firm-level accounting data and broad stock market indices to infer an average capital gain. This procedure will be misleading if, because of the different tax treatment they face, foreign controlled firm in the US report earnings on a different base than other US-owned firms.
A more accurate method of measuring the returns from foreign direct investment in the US, by using the same procedure as for portfolio investment (i.e. using only stock market prices), leads to the result that the deficit of the US current account increases by over $100 billion per annum and the US net international debtor position worsens by over a trillion dollars. The latter amount is the sum that, if one believes the official statistics, foreign investors have been willing to forego compared to the alternative of investing in their home country.