Coming and Going, the U.S. Wins from Foreign Direct Investment

Think of it as strength through diversification

Foreign direct investment (FDI) is a vehicle for gaining entry into growth markets. Companies might decide the best approach is to acquire products and technologies already in the target market, or to secure distribution and retail channels for their existing products, or they might decide to launch greenfield production to serve the local or regional markets, or some combination. Whatever their approach, their goal is to generate additional sales. Investors reward companies that diversify their sales and income. Multinational companies typically look to grow global market share, not just shift market presence.

For the host economy, FDI often brings new well-paying jobs, an expanded tax base (if they don’t offset with too generous a tax holiday), stronger productive capacity, transfer of technological expertise, improvements in infrastructure, and stronger economic growth. In theory and in general, it’s a win-win. In practice and locally, it will depend on each deal.

Companies are not multinational, they are “multi-local”

A.T. Kearney produces an annual Foreign Direct Investment Confidence Index that surveys investor intentions. More than 75 percent of companies say they invest to be close to market, putting them in a better position to cater to local culture and customs, navigate the idiosyncrasies of the local business environment, and embed themselves in the community as a local partner with deeper roots beyond their core business.

Large cities and megacities are the most popular destinations for FDI – nearly two-thirds of the companies surveyed have more than half their FDI in cities, attracted by the concentration of talent, clusters of R&D or related activities, and availability of infrastructure. Fifty-nine percent of respondents said their companies begin their FDI assessments at the regional or city level, rather than take into account national considerations.

Many large cities have built their economic reputations on particular sectors. For example, an information technology investor looking at Asia would identify Hyderabad or Bangalore in India as among their top targets. Companies looking to locate an overseas headquarters in cities with strength in business services might look to Singapore, Hong Kong or Dubai first.

States and cities compete for foreign direct investment – why?

Countries, states and localities compete for capital by offering streamlined administrative procedures, incentives like tax breaks and grants, and by establishing special economic and free trade zones. Many U.S. states have permanent investment promotion offices overseas. South Carolina has offices in Shanghai, Tokyo and Munich. Florida maintains offices in 13 countries.

U.S. states and cities work hard to attract foreign investors because of the benefits they bring to local economies. The U.S. affiliates of majority-foreign owned firms employed more than seven million American workers in 2016, invested $60.1 billion in U.S.-based research and development, and contributed $370 billion to U.S. exports.

According to OFII, the trade association that represents foreign investors in the United States, international companies employ 20 percent of America’s manufacturing workforce and 62 percent of the manufacturing jobs created in the past five years can be attributed to international companies investing in the United States.

What goes out also comes in – how the U.S. wins with overseas FDI

There are two sides to the FDI coin, and the U.S. economy is positioned to win whether the FDI is coming or going.

A common perception exists that American companies who invest overseas are sell-outs, moving jobs in search of lower wages, and that the host country is the only beneficiary.

Politicians stoke this fear. The rhetoric will only heat up in the run up to the 2020 presidential election, but the data tell a surprising and different story.

In fact, economists Oldenski and Moran, who are leaders in studying FDI, have found that increased offshoring of manufacturing by U.S. multinationals is actually associated with increases in the size and strength of the manufacturing sector in the United States.

More specifically, they found that when a U.S. firm increases employment at its foreign affiliate by 10 percent, employment by that same firm in the United States goes up by an average of four percent, capital expenditures and exports from the United States by that firm also increase by about four percent, and R&D spending increases by 5.4 percent.

The idea that outward FDI is associated with expansion of economic activity at home feels counterintuitive, and critics would rightly point out that the overall result for the U.S. economy doesn’t mean there isn’t labor dislocation of some kind.

Demand for certain types of production occupations might increase (e.g., engineering or sales) at the expense of workers with skills that are less or no longer in demand. Or, some local labor markets might be adversely affected despite overall gains, or some manufacturing subsectors may wane as others rise.

But on balance, across the U.S. economy, Oldenski and Moran conclude that the foreign operations of multinational firms tend to be complements, not substitutes for domestic U.S. operations.

Global FDI flows are waning

Globally, companies are engaging in less FDI. For the third year in a row, global FDI flows have fallen. In 2018, FDI flows dropped 19 percent from to $1.47 trillion to $1.2 trillion.

Developed country recipients saw the biggest hit with a 37 percent decline. Part of the explanation is fewer megadeals and corporate restructurings – the large value of those in previous years inflated the overall value of FDI flows.

Tax reform in the United States has also set in motion a shift in FDI flows. Most outward FDI from U.S. companies is in the form of more than $3.2 trillion in retained earnings held overseas. Changes to the U.S. corporate tax regime prompted a 78 percent increase at the end of 2017 in companies reinvesting overseas earnings in the United States. The inward investment took the biggest bite from FDI into the European Union.

Another major factor was China’s FDI outflows which reversed for the first time since 2003, declining 36 percent largely in response to the government’s restrictions on capital outflows directed to investments in assets such as real estate, hotels and entertainment facilities.

Wait and see?

According to A.T. Kearney’s annual Foreign Direct Investment Confidence Index, 77 percent of responding companies said FDI will be more important for corporate profitability in coming years and 79 percent said they intend to increase FDI over the next three years, pending their assessments of the availability of quality targets, the macroeconomic environment, and their availability of funds.

But in reality, multinationals may be taking a wait and watch stance as trade tensions between the United States and China escalate. At the same time, a number of countries have implemented tighter screening of proposed investments, citing national security concerns associated with foreign ownership of strategic technologies and other assets. Overall, the investment policy climate is becoming less, not more, favorable with greater restrictions and regulations than liberalization.

Investor confidence in the United States is still strong

On A.T. Kearney’s index, developed markets dominate 22 of the top 25 spots on the list of countries considered the top targets by corporate investors. Despite trade tensions and risks of economic downturn, these economies offer relatively stable regulatory environments, legal protections, skilled workers and the availability of technological and innovation capabilities, all qualities multinational companies seek in FDI targets. Size and market potential matter too. China, India and Mexico are emerging markets where multinationals must be players to be globally competitive.

For the seventh year running, the United States tops the index as the most attractive target for FDI. FDI inflows to the United States fell 18 percent in 2018, part of a broader decline in FDI flows to developed markets and fewer large mergers and acquisitions, but the United States still receives more FDI than any other country.

China, which held the top spot from 2002 to 2012, dropped to seventh. European countries hold 14 of the top 25 spots. The only emerging markets on this year’s list were China, India, Taiwan and Mexico. Singapore holds the 10th position and South Korea the 17th spot. Notably, the United Kingdom is holding steady in fourth place, despite the uncertainties surrounding Brexit.

The transition from physical to digital

FDI accounts for 39 percent of capital flows for developing countries as a group and around one-quarter for the least developed countries. FDI is less volatile than liquid financial assets and more resilient during global economic and financial downturns.

Unfortunately for developing countries particularly outside Asia, there’s not only less foreign direct investment to go around, the type of FDI is slowing changing too. As digital technologies become more diffuse, companies are shifting to “asset light” forms of international production. In more cases, companies no longer need the same level of physical production assets or employees overseas to achieve growth. The drop in the value of announced greenfield investments may be a sign that growth in global value chains is stagnating.

A more nuanced conversation in U.S. politics

Global FDI flows are critical for growth in developing and developed markets alike, including the United States. Multinationals are stronger in their home economies when they diversify, and we should seek to have a more nuanced conversation about the role of FDI in the U.S. economy – including its impact on job creation and job shifting – rather than simply demagoguing the companies who invest overseas or the foreign companies who invest here. An evidence-based and comprehensive policy dialogue would better serve American workers in the long run.

Key resources:

• To keep track of global FDI flows, consult UNCTAD’s annual reports which include statistics and analysis of investment policy trends. Access the 2018 Global Investment Report here.
• Economists Theodore Moran and Lindsay Oldenski debunk some prevailing myths about the strength of the U.S. manufacturing base and the role of FDI in an excellent policy brief found here.