Reversing Worrisome Trends: How to Attract and Retain Investment in a Competitive Global Economy

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Executive Summary

No country has been a stronger magnetfor foreign direct investment than the UnitedStates. Valued at $3.5 trillion, the U.S. stock ofinward foreign direct investment accounted for17 percent of the world total in 2011, more thantriple the share of the next largest destination.

Foreign direct investment is ultimately a judg-ment by the worlds value creators about a coun-trys institutions, policies, human capital, and

prospects. As the worlds largest economy, theUnited States has been able to attract the invest-ment needed to produce the innovative ideas, rev-olutionary technologies, and new products andindustries that have continued to undergird itsposition atop the global economic value chain.

But the past is not necessarily prologue. In-deed, while the U.S. claim to 17 percent of theworlds stock of foreign direct investment is im-pressive, the share stood at 39 percent as recent-ly as 1999. It has been 12 years since the annualvalue of U.S. inward FDI set a record high of

$314 billion, and since then, annual flows have

failed to establish an upward trend. The mostrecent figures show a decline of 35 percent, from$227 billion in 2011 to $147 billion in 2012.

To a large extent, these trends reflect theemergence of new, viable destinations for in-vestment resulting from inevitable demograph-ic, economic, and political changes. However,some of the decline is attributable to a deterio-rating U.S. investment climate, as reflected on a

variety of renowned business surveys and invest-ment indices measuring policy and perceptionsof policy.

The current U.S. business environment con-spires to deter inward investment and to en-courage companies to offshore operations thatcould otherwise be performed competitively inthe United States. A proper accounting of thesepolicies, followed by implementation of reformsto remedy shortcomings, will be necessary if theUnited States is going to compete effectivelyfor the investment required to fuel economic

growth and higher living standards.

Reversing Worrisome TrendsHow to Attract and Retain Investment in a

Competitive Global Economy

by Daniel Ikenson

No. 735 August 22, 2013

Daniel Ikenson is director of Catos Herbert A. Stiefel Center for Trade Policy Studies. Ikenson is author ofmany related studies, including Made on Earth: How Global Economic Integration Renders Trade PolicyObsolete.


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While theUnited States canclaim the largeststock of foreign

direct investmentby a factor of

three, its shareof global foreign

direct investmentstock declined

from 39 percentin 1999 to

17 percent in2011.

Introduction

Investment is the lifeblood of economicgrowth. The value of tomorrows output isa function of todays investments in facto-

ries, research centers, machines, technology,software, and training. Whether investmentcomes from domestic or foreign sources, itspurpose is to create value and wealth, a pro-cess that begets higher living standards. Inall but the rarest of circumstances, such aswhere a transaction poses obvious threatsto national security, investment should bewelcomed from sources both domestic andforeign.

Investment comes in many differentforms. Equity investment entails purchases

of shares in specific companies, industries,or funds. Purchases of debt issued by gov-ernments or corporations also constituteinvestment. The focus of this paper is directinvestment, which includes purchases andcontrol of real assets, such as buildings, fac-tories, equipment, and software.1

No country has been a stronger magnetfor foreign direct investment (FDI) than theUnited States. Valued at $3.5 trillion, theU.S. stock of inward FDI accounted for 17percent of the world total in 2011, which was

more than triple the share of the next largestdestination.2 For the period 20062011, U.S.inflows of FDI have averaged $221.3 billionper yearwell more than double the next sin-gle-country destination.3 That inward invest-ment has punched above its weight, contrib-uting disproportionately to increases in U.S.output, value-added, compensation, exports,and research and development spending.

It should not be surprising that globaldemand for U.S. factories, research and de-velopment facilities, office buildings, and

industrial machinery has been strong. For-eign companies seeking greater sales in theworlds largest market often require somephysical presence in that market. But size isnot all that matters.

Foreign direct investment (or its absence)is ultimately a judgment by the worlds val-ue creators about a countrys institutions,

policies, human capital, and prospects. Asan economy featuring a highly productivework force, world-class research universi-ties, a stable political climate, strong legalinstitutions, accessible capital markets, and

countless other advantages (including size)the United States has been able to attractthe investment needed to produce the inno-vative ideas, revolutionary technologies, andnew products and industries that have con-tinued to undergird the U.S. position atopthe global economic value chain.

But the past is not necessarily prologueIndeed, while the United States can claimthe largest stock of foreign direct investmentby a factor of three, the U.S. share of globalFDI stock declined from 39 percent in 1999

to 17 percent in 2011.4

It has been 12 yearssince the annual value of U.S. inward FDIset a record high of $314 billion. Since 2000,annual flows have failed to establish an up-ward trend. The most recent investment fig-ures indicate that U.S. FDI inflows declinedfrom $227 billion in 2011 to $147 billion in2012, a drop of over 35 percent.5

To a large extent, these trends reflect in-evitable demographic changes. Strong eco-nomic growth in developing countries hasfollowed periods of political stability and

economic liberalization, creating new op-portunities and inspiring confidence thatthese formerly higher-risk bets are viableindeed desirableplaces to invest in produc-tive activities.

However, some of the decline in U.S. shareis attributable, not to increasing absolute ad-vantages of investing in other countries, butto decreasing absolute advantages of invest-ing in the United States. A deteriorating U.Sinvestment climate is making other coun-tries relatively more attractive. Just as U.S

businesses have been reluctant to invest andhire since the Great Recession, foreign com-panies also have been reticent about invest-ing in the United States, and for many of thesame reasons: uncertainty and an increas-ingly inhospitable environment for business

Another contributing factor is U.S. outflows of FDI. Just as the United States is


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Although somepolicymakersrecognize theneed for reformothers seem tobe impervious tothe investment-repelling effectsof some of

the laws andregulations theycreate.

the destination for more FDI than anyother country, U.S. investors hold moreFDI abroad than the investors of any othercountry. Valued at $4.5 trillion in 2011, mostU.S.-owned FDI stock is located in Europe,

Canada, Japan, and other wealthy countries,but a growing share is going to developingcountries.6

Unlike ever before, the worlds producershave a wealth of options when it comes towhere and how they organize product devel-opment, production, assembly, distribution,and other functions on the continuum fromproduct conception to consumption. Asbusinesses look to the most productive com-binations of labor and capital, to the mostefficient production processes, and to the

best ways of getting products and services tomarket, perceptions about the business en-vironment can be determinative. In a globaleconomy, offshoring is an inevitable conse-quence of competition.7 And policy improve-ment should be the broad, beneficial result.

The capacity of the United States to con-tinue to be a magnet for both foreign anddomestic investment is largely a function ofits advantages, many of which are shapedby public policy. Considerations of taxes,regulations, trade openness, access to skilled

workers, infrastructure, energy policy, anddozens of other policy matters factor intodecisions about whether, where, and howmuch to invest. It should be of major con-cern that inward FDI has been erratic andrelatively downward trending in recent years,but why that is the case should not be a mys-tery. U.S. scores on a variety of renownedbusiness surveys and investment indicesmeasuring policy and perceptions of policysuggest that the U.S. business environmentis becoming increasingly less hospitable.

Although some policymakers recognizethe need for reform, others seem to be im-pervious to the investment-repelling effectsof some of the laws and regulations they cre-ate. Some see the shale gas and oil booms asmore than sufficient for overcoming policyshortcomings and attracting the necessaryinvestment. The most naive consider Amer-

ican companies to be tethered to the U.S.economy and obligated to invest and hire inthe United States, regardless of the qualityof the business and policy environments.They fail to appreciate that increasingly

transnational U.S.-based businesses are notobligated to invest, produce, or hire in theUnited States.

It is the responsibility of policymakers,however, to create an environment that ismore attractive to prospective investors. Cur-rent laws, regulations, and other conditionsaffecting the U.S. business environment areconspiring to deter inward investment andto encourage companies to offshore op-erations that could otherwise be performedcompetitively in the United States.

A proper accounting of these policies, fol-lowed by implementation of reforms to rem-edy shortcomings, will be necessary if theUnited States is going to compete effectivelyfor the investment required to fuel econom-ic growth and higher living standards.

Foreign Investment inPerspective

Americans are transacting with foreign-

ers more intensively than ever before. Overthe past 20 years, the value of U.S. trade as ashare of gross domestic product more thandoubled from 16 percent to 33 percent.8 In2012, the total value of imports and exportsof goods and services reached an all-timehigh of $5 trillion.9 If those trade statisticsgive a hint of the fact of increasing global in-tegration, the international investment fig-ures tell a compelling story about it.

The combined value of U.S.-owned assetsabroad and foreign-owned assets in the Unit-

ed States had already surpassed the $5 trillionmark 20 years ago. In 2012 that cross-borderengagement exceeded $46 trillion, a figuretriple the size of the U.S. economy and morethan nine times the value of U.S. trade.10

About 70 percent of that transnationalinvestment$32.5 trillionis privately heldin securities, government-issued debt, other


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Increasingly,a companys

success abroadwill be a

determinant ofits success at

home, andvice versa.

financial instruments, and real assets suchas land, factories, office buildings, other fa-cilities, and equipment. The market valueof these cross-border investments in real as-sets amounted to about $9.1 trillion in 2012,

with Americans owning $5.2 trillion worthof direct assets abroad and foreigners own-ing $3.9 trillion worth of direct assets in theUnited States.11

It is primarily through these cross-borderdirect investments that Americans trans-actas workers, consumers, producers, andcollaborators in the production of goodsand serviceswith people around the world.With 95 percent of the worlds populationliving outside U.S. borders, where economicgrowth has been and is expected to remain

stronger for many years, it is imperative thatAmericans develop, deepen, and broadentheir channels of commercial engagementwith the rest of the world. Increasingly, thesuccess of U.S. companies will depend ontheir ability to sell in foreign markets, incor-porate foreign intermediate goods and rawmaterials into their own output, and col-laborate effectively with foreign firms andworkers in production and supply-chain op-erations. Increasingly, a companys successabroad will be a determinant of its success

at home, and vice versa.An all-too-common portrayal of global-

ization presents the external 95 percent asa threat more than an opportunity. The 95percent are competitors, but not custom-ers or production partners. They will takeour jobs and dominate U.S. markets, butnot purchase our output or help U.S. com-panies succeed abroad. In this view, there isgreat peril, but little opportunity. The factssurrounding foreign direct investment tell avery different story.

Inward FDIWith a stock valued at $3.9 trillion, the

United States is the top single-country desti-nation for the worlds FDI outflows.12 Thereare plenty of reasons for that being the case,including the facts that the United States isthe worlds largest market and has a sound

legal system and a relatively transparentbusiness environment. More than $4 out ofevery $5 of that stock (84.2%) is owned byEuropeans, Canadians, and Japanese, withthe U.S. manufacturing sector accounting

for a full third of its value, making it the pri-mary destination for inward FDI.13

Foreign direct investment enters theUnited States through different channels,but the most common channels are throughacquisitions of U.S. companies or divisionsby foreign companies, mergers between for-eign and U.S. companies, foreigners creatingnew businesses in the United States (green-field investment), and expansion of existingforeign-owned companies through capitalexpenditures and acquisitions.

With some important exceptions, inwardinvestment generally has been welcomed inthe United States since the founding of therepublic. For example, foreign ownershipin some industries, such as shipping, avia-tion, communications, energy, mining, andbanking is restricted, and a statutory pro-cess exists to examine and ultimately blockprospective foreign acquisitions that aredeemed a threat to national security.14

Although the investment climate is relatively open, not everyone sees inward FDI as

beneficial. Among the common concernsregistered about inward investment are thatit can lead to layoffs and closures; it reducescompetition in the U.S. market; it replacesdomestic-based supply chains with foreignsupply chains, leading to further layoffs andclosures; it reduces exports and increasesimports; it has only a fleeting commitmentto the United States; it results in higher val-ue-added activities being stripped from theUnited States; it causes loss of proprietarytechnology; it shrinks the U.S. tax base; and

it can undermine national security throughloss of control over crucial industries.

Skepticism about FDI is nothing new. InhisReport on Manufactures in 1791, AlexanderHamilton wrote:

It is not impossible that there may bepersons disposed to look with a jeal-


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Between 2001and 2010, U.S.private sectorvalue-added,

measured interms of GDP,increased by39 percent, andfor affiliates, theincrease was56 percent.

ous eye on the introduction of foreigncapital, as if it were an instrument todeprive our own citizens of the profitsor our own industry; but, perhaps,there never could be a more unreason-

able jealousy. Instead of being viewedas a rival, it ought to be considered asa most valuable auxiliary, conducingto put in motion a greater quantity ofproductive labor, and a greater por-tion of useful enterprise, than couldexist without it.15

The data support Hamiltons perspective.According to recent congressional testimo-ny from Dartmouth economist MatthewSlaughter:

U.S. subsidiaries of global compa-niesdespite accounting for far lessthan 1% of U.S. businessesperformlarge shares of Americas productivity-enhancing activities that lead to high-er average compensation for Americanworkers.16

Slaughter notes that, in 2010, these subsid-iaries produced $649.3 billion in output,which was 5.8 percent of all private-sector

output; purchased $149 billion in newproperty, plant, and equipment, which was14.4 percent of all non-residential, private-sector capital investment; exported $229.3billion of goods, which was 18 percent ofthe U.S. total; performed $41.3 billion ofresearch and development, accounting for14.3 percent of the total performed by allU.S. companies; and purchased 80 percentof their intermediate goodsnearly $2 tril-lion worthfrom U.S. suppliers.17

Digging deeper into the data, the increas-

ing contribution of these subsidiaries, af-filiates, or insourcing companies to U.S.economic performance is unmistakable.Between 2001 and 2010, U.S. private sectorvalue-added (output measured in terms ofGDP) increased by 39 percent; for affiliates,the increase was 56 percent, which lifted theoverall average. In the manufacturing sector,

the relative contribution of affiliates to GDPis even more profound: overall U.S. manu-facturing sector value-added increased by 21percent over the decade, while it rose by 53percent for manufacturing-sector affiliates.

As average private-sector compensationper worker increased by 33 percent over thedecade, it increased by 40 percent at U.S. af-filiates to $77,409a 24 percent premiumover the private-sector average. Per workercompensation in the overall U.S. manufac-turing sector averaged $76,484 in 2010, ascompared to an average of $85,211 at manu-facturing affiliates. The smaller and shrink-ing differential11 percent in 2010, downfrom 15 percent in 2001speaks to the posi-tive impact of affiliates on U.S. workers in-

comes.18

Affiliates have demonstrated a strongcommitment to the U.S. economy, increas-ing their stock of U.S. property, plant, andequipment by 46 percent over the decadedouble the overall private-sector increase.U.S.-based companies also benefit from ex-posure to the best practices employed by af-filiates, many of which are world-class com-panies that know how to operate efficiently.While sales per worker in the U.S. privatesector amounted to $431,758 in 2010, it av-

eraged $632,777 among affiliatesa 47 per-cent premium. Just as they generate morerevenue per worker, affiliates get more reve-nue from their physical assets. In 2010, affil-iates fixed asset turnover ratio (a measure ofreturn on assets) was 53 percent higher thanit was for the U.S. private sector on average.

U.S. affiliates have raised average eco-nomic performance by boosting output,sales revenue, exports, employment, andcompensation. They have also demonstrateda strong commitment to the United States

with increasing levels of capital investment,reinvested profits, research and developmentspending, and cultivation of relationshipswith U.S. suppliers. And they have intro-duced industry best practices, as evidencedby the achievement of higher levels of value-added per worker, sales per worker, and re-turns on assets.


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Any trade deficitis matched byan investment

surplus, asthe dollars

that purchaseforeign goods

and services andforeign assets are

matched nearlyidentically by

dollars comingback to the

United States.

These data suggest that the alleged ill ef-fects of inward FDI are more bark than bite,and they make a compelling case for the ex-tension of maximum investment liberaliza-tion to currently restricted industries, such

as shipping, commercial aviation, and min-ing. While being mindful of the national se-curity implications of foreign acquisitionsis always prudent, the potential for an over-encompassing definition of national securityto give cover to protectionist or otherwise po-litical motives is also an ever-present danger.

Until the past few years, Chinese directinvestment in the United States has beenimmaterial.19 Some proposed high-profileChinese acquisitions of U.S. companies havecome under close scrutiny from the Com-

mittee on Foreign Investment in the UnitedStates (CFIUS), resulting in aborted trans-actions and post-acquisition divestment.As the volume and value of Chinese invest-ments in the U.S. economy increases in thecoming years, it is highly likely that acquisi-tions without any pertinent national secu-rity ramifications will be portrayed as threatsand thwarted by politicians acting throughan opaque CFIUS process. The recently pro-posed acquisition of Smithfield Foods for$4.7 billion by Shuanghui International, and

the close scrutiny the deal is receiving fromCFIUS at the urging of numerous politi-cians with constituents in the same industry,should raise concerns among those who rec-ognize the importance of foreign investmentto U.S. economic growth and job creation.Expansive definitions of national securitycan undermine U.S. economic security.

Inward FDI and the Trade DeficitMany of those who express reservations

about inward investment are the same peo-

ple who issue warnings about the deleteriouseffects of the U.S. trade deficit. They assertthat the deficit is a drain on U.S. economicactivity and employment. By purchasingmore goods and services from foreignersthan foreigners purchase from Americans,the argument goes, U.S. factories, farmers,and service providers are deprived of sales,

which reduces domestic output, value-added, employment, and all of the second-ary and tertiary commercial activities thatwould have taken place. But their argumentrelies on the assumption that the dollars

sent to foreigners to purchase imports donot make their way back into the U.S. econ-omyan assumption that is incorrect.

The dollars that go abroad to purchaseforeign goods and services (imports) and for-eign assets (outward investment) are matchednearly identically by dollars coming back tothe United States to purchase U.S. goods andservices (exports) and U.S. assets (inward in-vestment). Any trade deficit (net outflow ofdollars) is matched by an investment surplus(net inflow of dollars).20

This process helps explain the absence ofany inverse relationship between trade defi-cits and jobs and between trade deficits anddomestic output, and severely weakens theclaims of trade and investment skeptics.

As Figure 1 demonstrates, if anythingthere is a positive relationship between thetrade deficit and GDP. In years when thedeficit is rising, GDP is increasing; when thedeficit is falling, GDP tends to level off andstagnate.

The trade deficit equals the excess of im-

ports over exports. Homing in on the rela-tionship between imports and GDP and be-tween imports and jobs, a very clear, strong,positive relationship is evident for nearly theentirety of the period. Only in the three mostrecent years has a growing economy (anemicas it has been) been contemporaneous witha declining trade deficit. It is worth noting,however, that the annual growth in importsin each of those years far exceeded the rate ofeconomic growth.21

As Figures 2 and 3 reveal, in years when

imports increase over the previous year, U.Soutput (as measured by GDP) and employ-ment tend to increase from the previousyear. In years when imports show a decline,output and employment also tend to de-cline. The high incidence of observations inthe upper-right and lower-left quadrants inboth graphs suggests positive relationships


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Investmentinflow providesthe capitalthat supportseconomic activitand job creation

between imports and output and betweenimports and jobs. In fact, as shown in Figure2, in only one of the 44 years observed didimports and output move in different direc-tions. In Figure 3, the relationship betweenimports and jobs is also demonstrated to bepositive. In 39 of the 44 years observed, themeasurements moved in the same direction.

If the trade deficit reduces economic ac-tivity and destroys jobs, why is there a posi-tive relationship between these variables?22One important reason is that investment

inflow provides the capital that supportseconomic activity and job creation.

Moreover, contrary to the admonitionsof deficit hawks, the trade deficit is not arunning tab that we or our children will haveto pay back to foreigners. Inward investmentused to finance the trade deficit comes pri-marily in the form of foreign purchases of

U.S. equities and direct investment. Theseare investments that produce real wealthand other benefits for American businesses,workers, and consumers. The portion of thetrade deficit that the American public willhave to pay back is that which finances theU.S. governments debt, which accounts forabout one-third of the value of all foreigninvestment and is not a failing of trade orinvestment policy, but a consequence of ex-cessive government spending.23

Outward FDIConsidering how the U.S. economy reaps

all of these benefits from inward investment,it is tempting to conclude that outward in-vestment is economically deleterious. Afterall, if activity-spurring, value-creating invest-ment flows from U.S. investors to locationsabroad, there will be less production, less

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Deficit GDP Linear (Deficit)

RealT

radeDeficit,

$USBillions

Figure 1Real GDP and the Real Trade Deficit, 19692012

Source: Bureau of Economic Analysis.

RealGDP,

$USBillions


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Outwardinvestment

and domesticeconomic activity

are usuallycomplementary,

as investmentabroad tends to

spur domesticactivity.

value creation, fewer jobs, a smaller tax base,

and less research and development spendingin the United States.

But that is not necessarily the case. Out-ward investment and domestic economic ac-tivity are usually complementary; investmentabroad tends to spur domestic activity be-cause local and foreign operations are oftensequential functions in the same supply chainor because there is more demand placed ondomestic administrative, accounting, humanresources, and other management functionsto support expanding activities abroad.

The clich about foreign outsourcingdescribes factories shutting down in theindustrial Midwest only to be resurrectedbolt-by-bolt, rafter-by-rafter in developingcountries to produce the same products forexport back to the United States. Yet in re-ality, most outward investment has beento serve purposes that cannot be fulfilled

practicably or cost-effectively in the United

States. Reaching potential foreign custom-ers without having any physical presencein their countries, for example, would be adifficult task. Marketing to foreign custom-ers, getting better acquainted with foreignproduct preferences, having retail locationsto serve demand abroad, performing post-sale and other customer-service activities,tapping into local expertise, or diversifyingmarket-specific risks are among several rea-sons to invest abroad that are highly unlikelyto be successfully replicated from within the

United States. Outward investment of thisnature and for these purposes might be con-sidered non-discretionary offshoring; theyare the steps that must be taken in order forU.S. companies to compete more effectivelyin the global economy.

U.S. companies invest abroad for a vari-ety of important reasons, but serving U.S

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-6.0%

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0.0%

2.0%

4.0%

6.0%

8.0%

-25.0% -15.0% -5.0% 5.0% 15.0% 25.0%

Figure 2Annual Changes in Real Imports and Real GDP, 19692012


AnnualPercentChangeinRealGDP

Annual Percent Change in Real Imports


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Over 90 percentof the value ofoutput fromforeign affiliates

of U.S.-basedcompanies issold in foreignmarkets.

demand from those foreign locations is notprominent among them. Referring to therecent growth of U.S. investments in China,Brazil, India, and Eastern Europe, Bureau ofEconomic Analysis economists Kevin Bare-

foot and Raymond Mataloni noted: Judg-ing by the destination of sales by affiliatesin those countries, the goal of the U.S. mul-tinational corporations expanded produc-tion was to primarily sell to local custom-ers rather than to reduce their labor costsfor goods and services destined for sale inthe U.S., Western Europe and other high-income countries. According to the data,over 90 percent of the value of output fromforeign affiliates of U.S.-based companies issold in foreign markets.24

For the unconvinced, it is worth notingthese findings of Harvard Business Schoolprofessors Michael E. Porter and Jan W. Rivkin:

[L]arge-scale relocations make up atiny fraction of all American job losses.From 2008 to 2010, mass layoffs (50or more jobs) involving relocationsoutside the U.S. resulted in the loss

of only 27,145 U.S. jobs, governmentstatistics show. In contrast, mass lay-offs not involving foreign relocationsresulted in nearly 5 million jobs lost.25

Outward investment benefits the U.S. econ-omy through numerous direct and indirectchannels. The pattern for outward FDI issimilar to that for inward FDI in the sensethat the overwhelming majority is locatedin rich countries. Nearly three-quarters ofthe $5.2 trillion stock of U.S.-owned direct

investment abroad is concentrated in Eu-rope, Canada, Japan, Australia, and Singa-pore.26 Contrary to persistent rumors, only

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-2.0%

0.0%

2.0%

4.0%

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-5.0% -3.0% -1.0% 1.0% 3.0% 5.0%

Figure 3Annual Changes in Real Imports and Non-Agricultural Employment, 19692012

Annual Percent Change in Real Imports

AnnualPercentChangeinNon-AgriculturalEmployment



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U.S. companiesmust be engaged

in foreignmarkets, because

95 percent ofthe worlds

population isoverseas.

1.3 percent of the value of U.S. outward FDIwas in China at the end of 2011.27

Even after factoring out U.S. investmentin foreign financial institutions, banks, andholding companies (which account for near-

ly two-thirds of the total outward stock), thebulk of outward U.S. FDI remains concen-trated in developed countries, with Europe,Canada, Japan, Australia, and Singapore ac-counting for 70 percent of all outward U.S.manufacturing FDI and Chinas share risingto a still modest 4.5 percent.28 U.S. investorsare also important participants in foreignprofessional services and information indus-tries, as well as their hospitality and whole-saling sectorsindustries that would allseem to require intensive physical presence.

With 95 percent of the worlds popula-tion overseas, where the rate of economicgrowth over the past decade well exceededthe U.S. rate, U.S. companies must be en-gaged in foreign markets. Nine of the 10largest U.S. multinational companies hadgreater revenues in foreign markets than inthe United States.29

In 2010, the total value of U.S. exportsto the world was $1.8 trillion, but majority-owned foreign affiliates of U.S. companieshad sold $5.2 trillion of goods and services

in foreign markets. In other words, for ev-ery dollar of U.S. exports, foreign affiliatesof U.S. companies made $3 in sales to for-eign customers. That ratio is even more pro-nounced for multinational corporations.

Matthew J. Slaughter found that in 2010,U.S.-based multinational companies export-ed $573.3 billion in goods to foreign mar-kets, while their foreign affiliates sold $3.7trillion worth of goods in those markets,for a greater than 6-to-1 premium.30 Thiswould seem to confirm the importance of

direct investment abroad to the success ofU.S. multinational companies. And successabroad begets success at home.

Slaughter adds:

Expansion abroad by U.S. companiestends to complement their U.S opera-tions, with more hiring and invest-

ment abroad often boosting hiring,investment, and R&D in their U.Soperations. And they create jobs inAmerica in other companies, not justin themselves. In particular, they cre-

ate jobs in small and medium-sizedAmerican enterprises that becomepart of their global supply networks.31

U.S. multinational corporations invest-ment in affiliates abroad is crucial to thesuccess of their U.S. operations, and imped-iments to outflows would likely adverselyimpact their U.S. employment, compensa-tion, and investment. According to Slaughter, U.S. parent companies account for largeshares of U.S. economic activity: they pro-

duce 23 percent of all private-sector value-added; they hold 42 percent of all private-sector capital investment; they account for45 percent of U.S. exports; and they conduct69 percent of all research and developmentexpenditures undertaken by the private sec-tor.32

U.S. parent operations are very muchcomplementary to the operations of theirforeign affiliates. In a recent Peterson Insti-tute for International Economics (PIIE) pa-per recommending corporate tax reforms to

spur more investment at home and abroad,Gary Hufbauer and Martin Vieiro argue thatMNCs which engage in FDI are in the bestposition to create jobs and promote pros-perity at home.33 They reinforce the pointthat outward FDI is not a substitute for, buta complement to, investment and economicactivity at home:

Better jobs, higher investment, largerexports, and more research and devel-opment (R&D) at home go hand

in hand with greater outward FDI.Unfortunately, and contrary to theseresearch findings, much of the recentdebate over corporate tax policy reflectsa zero-sum view of MNC activity.34

The performance of foreign affiliates andtheir U.S. parents points to complemen-


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The performancof foreignaffiliates andtheir U.S.

parents seemsto be positivelycorrelatedacross a range orelevant metricsimprovingor decliningcontemporane-ously.

tarity. Across a range of relevant metrics(depicted in Figures 49), the performanceof foreign affiliates and their U.S. parentsseems to be positively correlated, improv-ing or declining contemporaneously. An-

nual changes in affiliates and parentscapital expenditures, output (value-added),total compensation, and compensation perworker moved in the same direction in 8 ofthe 11 years measured. Such was the case forresearch and development spending in 6 ofthe 9 years measured. For employment, thecomplementarity was not as evident, withchanges moving in the same direction in 6of 11 years. However, in 3 of the 5 years whenemployment moved in opposite directions(affiliate employment increased and parent

employment decreased), there was no per-ceptible increase in employment at affiliatesto suggest substitutability. Also notable isthe fact that in all 11 years, compensation

per worker at U.S. parents increased over theprevious year.

For those still skeptical, Matthew Slaugh-ter offers these additional reassurances:

The worldwide operations of U.S.-headquartered multinational com-panies are highly concentrated inAmerica in their U.S. parents, notabroad in their foreign affiliates: In2010, U.S. parents accounted for 67.3percent of their companies worldwideemployment, 72.5 percent of capi-tal investment, and 84.3 percent ofR&D.35

The decline of both direct and indirect

impediments to trade and investmentaid-ed by other important trendshas openednew channels for connecting U.S. consum-ers to foreign producers and U.S. producers

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Annual Percent Change at Foreign Affiliates

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ualPercentChangeatU.S.

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Figure 4Annual Percent Changes at Foreign Affiliates and U.S. Parents Capital Expenditures(20002010)


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Americancompanies

investing abroadare accusedof pursuing

low wagesand lax labor,

environmental,and product-

safety standardsso they can cut

production costsand pad the

bottom line.

to foreign consumers, has improved oppor-

tunities for cross-border collaboration inproduction and design, has increased thelikelihood that worthy ideas get funded andappropriately marketed, and, ultimately, hasexpanded the global pie.

The Race to the BottomCanard

Like all businesses, multinational corpo-rations are committed to maximizing prof-

its for their shareholders. Globalizationsloudest critics detect malevolence in theirmotives. Foreign companies seeking to pur-chase U.S. businesses or make new invest-ments in production facilities in the UnitedStates are often portrayed as pursuing anopaque agenda that offends their concep-tions of the national interest. Whether it

is gaining access to proprietary U.S.-owned

technology, or knocking off U.S. competi-tors, or disrupting domestic supply chainssomething sinister or economically threat-ening is intimated about the transaction.

Meanwhile, U.S. companies that investabroad are accused of engaging in a race tothe bottom, fueled by an endless pursuit oflower wages and increasingly lax labor, envi-ronmental, and product-safety standards soas to shave a few cents off the cost of pro-duction and pad the bottom line. Through-out the election campaigns last year, Presi-

dent Obama and Governor Romney tradedaccusations over who was most guilty ofperpetuating this sin. Referring to Mr. Rom-ney, an Obama campaign news release saidAs a corporate buyout specialist, he mademassive profits by shuttering plants, firingworkers and investing in companies thatpioneered shipping of good American jobs

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Figure 5Annual Percent Changes at Foreign Affiliates and U.S. Parents Value Added(20002010)


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If low wages andlax standardswere the realdraw, U.S.

investmentoutflows wouldnot be so heavilyconcentrated incountries withhigher wages anmore stringentstandards thanour own.

overseas.36 In response, and referring to al-legations that stimulus money was ben-efitting foreign companies, Romney said: Iftheres an outsourcer-in-chief, its the presi-dent of the United States, not the guy whos

running to replace him.

37

Unfortunately,with the candidates droning on about theravages of shipping jobs overseas, the pre-dictable debate about offshoring that trans-pired generated more heat than light, andwas a lost opportunity to educate Americansabout the real determinants and benefits offoreign direct investment.

Contrary to the misconceptions so oftenreinforced in the media, offshoring is rarelythe product of U.S. businesses chasing lowwages or lax standards abroad. Businesses

are concerned about the entire cost of pro-duction, from product conception to con-sumption. Foreign wages and standards arebut a few of the numerous considerations

that factor into the ultimate investment andproduction decision.

Locales with low wages and lax standardstend to be expensive places to produce allbut the most rudimentary goods because,

typically, those environments are associ-ated with low labor productivity and othereconomic, political, and structural impedi-ments to smooth operation of cost-effectivesupply chains. Most of those crucial consid-erations favor investment in rich countriesover poor.

Indeed, if low wages and lax standardswere the real draw, then U.S. investment out-flows would not be so heavily concentratedin rich countries with higher wages and morestringent labor, environmental, and product

safety standards than our own.38

Likewise,the United States would not be the worldslargest single country destination for directinvestment. In 2011, the value of the stock

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nualPercentChangeatU.S.

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Figure 6Annual Percent Changes at Foreign Affiliates and U.S. Parents R&D Expenditures(20022010)


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Foreigninvestments,

jobs, and relatedactivities in

America, whichemploy more

than five million

U.S. workers,are the products

of foreigncompanies

engaging inoffshoring.

of foreign direct investment in the U.S. man-ufacturing sector alone amounted to $838billion, while the value of the stock of U.S.direct investment in foreign manufacturingsectors amounted to $589 billion.39 Thosefigures amount to a $250 billion manufac-turing insourcing surplus.

In the midst of last summers outsourc-ing brouhaha, the candidates were remissin failing to note that Europes Airbus hadannounced plans for a $600 million facil-ity in Mobile, Alabama, just down the road

from the $5 billion, 1,800-worker steel pro-duction facility belonging to German-basedThyssenKrupp, which was built there for itsproximity to the dozens of mostly foreign-nameplate auto producers, who employ tensof thousands of U.S. workers and generateeconomic activity supporting thousandsmore, all while providing U.S. consumers

with greater value from their automobilesthan they would be getting absent thoseforeign investments. Those investmentsjobs, and related activities are the productsof foreign companies engaging in offshor-ing. Why do they come to American shoresto produce instead of producing elsewhere?Because from an aggregate cost perspectivelocating here makes the most sense. Theyare not here because of low wages or lax en-forcement of labor and environmental stan-dards, but because all of the factors affecting

costs that each company uniquely considersweighin the aggregatein favor of locatingtheir respective activities here.

That such a large proportion of theworlds investment is located in rich coun-tries should be strongly persuasive evidenceeven to globalizations biggest skepticsthatother factors are of greater significance to

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Figure 7Annual Percent Changes at Foreign Affiliates and U.S. Parents Compensation(20002010)



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Parents


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Investment is ajudgment aboutthe virtues of ajurisdictions

business andpolitical climate

the investment decision than wages and en-vironmental standards.

What Really Drives the

Investment Decision?Investment is a judgment about the vir-

tues of a jurisdictions business and politi-cal climates. Policies that breed stability andpredictability are good. The importance ofthese determinants of investment varies bycompany, by situation, and by prospectivefunction to be performed. But, by and large,they include considerations such as thequality and skills of the work force; accessto ports, rail, and other transportation in-

frastructure; customs-clearance procedures;import duties; proximity of the prospectiveproduction location to the next or previouslink in the supply chain or to the final mar-

ket; the size of nearby markets; the overalleconomic environment in the host countryor region; the political climate; the risk ofasset expropriation; the regulatory environ-ment; taxes; and the dependability of the

rule of law, to name some.Although the United States has faredwell with respect to these investment deter-minants over the years, it is now faltering inmany respects, while facing greater competi-tion from once-slumbering economies thathave liberalized their markets, stabilizedtheir political systems, upgraded their laborskills, and strengthened their business andlegal institutions.

The Organization for Economic Co-oper-ation and Development (OECD) publishes

annually an index of foreign direct invest-ment restrictiveness for OECD membercountries and other countries. The index is acompilation of scores assigned to four types

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Figure 8Annual Percent Changes at Foreign Affiliates and U.S. Parents Employment(20002010)


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From 1997 to2012, U.S. foreigndirect investment

restrictivenesshas remained

unchanged,

but policyconsistency

means relativedecline when therest of the world

is reforming.

of investment restrictions, including limits

on foreign equity; screening or prior approv-al requirements of foreign investors; restric-tions on the activities of foreign personnelwho are key to the investment operations;and other restrictions on operations, includ-ing those with respect to domestic content,the establishment of branches, and restric-tions on profit or capital repatriation.40

The index is designed to reflect FDI re-strictiveness, as intended by the explicitrules governing foreign direct investment ineach economy. The scores are not adjusted

in any way to account for intensity (or lackthereof) of enforcement, nor do they reflectother laws, regulations, rules, practices, orcustoms that may influence or deter foreigninvestment.

Scores are assigned for each of the fourcategories based on the policies in effect on ascale of 0 to 1, where 0 means completely un-

restricted and 1 means completely restrict-

ed. Major sectors within each economy areassigned scores for each of the four catego-ries, as the rules tend to be more restrictivein some sectors than in others. Ultimately,those sector-specific scores are compiledinto an economywide index.41

Looking at the index from 1997 to 2012the U.S. score of 0.089 has remained thesame every year.42 Official U.S. laws and reg-ulations with respect to these four catego-ries of investment policy have not changedover the span of these years, which explains

the consistent index score. High scores forovert ownership restrictions in U.S. fisher-ies, utilities, maritime and air transporta-tion, and radio and television industries aremuted by the absence of ownership restric-tions in most other industries. But policyconsistency means relative decline when therest of the world is reforming.

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Figure 9Annual Percent Changes at Foreign Affiliates and U.S. Parents Compensation perWorker (20002010)

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The relativedecline ofU.S. investmentopenness should

be a majorconcern to U.S.policymakers,as the numberof viabledestinations fordirect investmenhas beenincreasing.

In 1997, the average score for all OECDcountries was 0.138, which was 55 percentmore restrictive than the United States. In2012, the OECD average was .081, whichwas 9 percent less restrictive than the United

States. As the United States stood still, OECDcountries, on average, became 41 percent lessrestrictive of foreign direct investment.

Between 1997 and 2012, all of the BRICScountries (Brazil, Russia, India, China, andSouth Africa) experienced significant invest-ment reform. Brazil improved from .113 to.086, which was a 24 percent reduction in re-strictiveness. Russia improved by 47 percent,from .338 to .178. Improving from .484 to.273, India became 44 percent less restric-tive. Chinas score improved from .633 to

.407, which is 36 percent less restrictive. AndSouth Africa improved from .102 to .054, a47 percent improvement.

In 1997, the U.S. score was better than 16of 34 OECD economies; in 2012, the U.S.score was better than only 9 of the 34 OECDeconomies. In 1997, the United States wasless restrictive than all nine developing coun-tries measured, but in 2012 it was better thanonly five of those nine developing countries.Overall, in 1997 the United States ranked18th out of 43 countries measured, but it fell

to 29th out of those original 43 in 2012.The relative decline of U.S. investment

openness, as measured by the explicit rules,should be a major concern to U.S. policy-makers, as the number of viable destina-tions for direct investment has been increas-ing. But the investment environmenttheattractiveness of an economy to invest-mentis not exclusively, or even primarily,a function of the rules explicitly governinginvestment. Openness is a necessary butinsufficient condition. Whether the invest-

ment comes depends on numerous othercompetitive factors.

The annualEconomic Freedom of the WorldReportincludes an index that measures thedegree to which the policies and institutionsof countries are supportive of economicfreedom.43 The index score reflects perfor-mance on 42 different variables that feed

into five broad measurement componentsof economic freedom: the size of govern-ment, the legal system and property rights,sound money, the freedom to trade interna-tionally, and regulation. To varying degrees,

each component contributes to the domes-tic investment environment.Overall, the United States ranked 18th

out of 144 countries in the most recent rat-ings, which the authors note is the latestscore in a substantial decline in economicfreedom during the past decade . . . Thechain-linked ranking of the United Stateshas fallen precipitously from second in 2000to eighth in 2005 and 19th in 2010 (unad-justed ranking of 18th).44

The Freedom to Trade Internationally

component, which is based largely on datapublished by the World Bank, the Interna-tional Monetary Fund, the World TradeOrganization, and the World Economic Fo-rum, provides a measure of some of the lawsand regulations that directly affect foreigninvestment, such as restrictions on foreignownership of assets and controls on theflow of capital. As the OECD index scoreconfirmed, U.S. performance with respectto those conditions has been declining rela-tive to other countries. Although the United

States ranked 18th overall, it ranked 57thon the Freedom to Trade Internationallycomponent.

But it is not just restrictions placed onforeign investment that are taken into ac-count by prospective investors. Foremost areanswers to questions about whether foreigninvestors want to be in a particular countryin the first place. The four other broad com-ponents measured by the Economic Freedomof the World Reportare probably more illumi-nating in that regard.

Relative to its overall score, the UnitedStates performs poorly on many of the indexcomponents, which all contain subcompo-nents that reflect on the investment climate.On Legal System and Property Rights,which includes consideration of the integ-rity of the legal system, protection of prop-erty rights, and regulatory restrictions on


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The UnitedStates performspoorly on manyof the Economic

Freedom of theWorld indexcomponents,

includingregulation

and size ofgovernment.

the sale of real property, the United Statesranked 28th.

The authors note a whopping 2 pointdecline in the U.S. score on this index com-ponent since 2000, and offer the following

possible explanation:

While it is difficult to pinpoint theprecise reason for this decline, theincreased use of eminent domain totransfer property to powerful politi-cal interests, the ramifications of thewars on terrorism and drugs, and theviolation of the property rights ofbondholders in the bailout of auto-mobile companies have all weakenedthe United States tradition of the

rule of law and, we believe, contrib-uted to the sharp decline of the Area2 rating.45

On Regulation, which includes credit mar-ket, labor market, and business regulations,the United States ranked 31st. For Size ofGovernment, which includes considerationof income and payroll taxes, the UnitedStates ranked 73rd. Taxes, regulations, se-curity of property, and the integrity of thelegal system are all important determinants

of investment flows, so policymakers shouldnot be cavalier about these declines.

As the authors note:

The approximate one-point declinein the summary rating between 2000and 2010 on the 10-point scale of theindex may not sound like much, butscholarly work on this topic indicatesthat a one-point decline is associ-ated with a reduction in the long-term growth of GDP of between 1.0

and 1.5 percentage points annual-ly. This implies that, unless policiesundermining economic freedom arereversed, the future annual growth ofthe US economy will be half its his-toric average of 3%.46

Even more revealing of the qualities and

conditions that may help to attract or re-pel investment is the Global CompetitivenessIndex, which is the basis for the analysis inthe World Economic Forums annual Glob-al Competitiveness Report. The purpose of

the report is to study and benchmark themany factors underpinning national com-petitiveness, which is defined by the WorldEconomic Forum as the set of institutions,policies, and factors that determine the lev-el of productivity of a country . . . [which]also determines the rates of return obtainedby investments in an economy.47 In otherwords, the factors considered are those thatwould directly influence investment loca-tion decisions.

The United States is ranked 5th on the

overall global competitiveness index for20112012, which is a weighted value re-flecting scores assigned for 12 broad criteriapresumed to affect competitiveness, in-cluding: institutions, infrastructure, macro-economic environment, health and primaryeducation, higher education and training,goods market efficiency, labor market effi-ciency, financial market development, tech-nological readiness, market size, businesssophistication, and innovation.

The scores assigned to each of these 12

criteria are derived by weight-averaging thescores from individual survey questions. Forexample, there are 21 questions related tothe first criteria, institutions, includingconditions such as property rights, publictrust of politicians, judicial independence,transparency of government policymakingand more. There are nine questions thatfeed into the infrastructure score, six thatfeed into the macroeconomic environmentscore, 16 that comprise the goods market ef-ficiency score, and so on.

The relatively high weighted average U.Srank of 5th reflects a few obvious U.S. advan-tages, including market size (ranked 1st),university-industry collaboration in R&D(which feeds into the innovation criterionranked 3rd), strength of investor protec-tion (institutions; ranked 5th), availabilityof airline seats (infrastructure; ranked 1st)


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The U.S.government isfailing to tackleweaknesses inthe businessenvironment thaare making thecountry a lessattractive placeto invest.

inflation (macroeconomic environment;ranked 1st), extent of marketing (businesssophistication; ranked 3rd), and a few oth-ers.

On taxes and regulations, the U.S. ranks

poorly. On the Burden of GovernmentRegulation, the United States ranked 58thout of 142 countries with a score of 3.4 on ascale from 0-to-7, slightly above the globalaverage of 3.3. On the Extent and Effect ofTaxation, the United States ranked 63rd;on Total Tax Rate, % Profits, the UnitedStates came in 96th.

The United States ranked 24th on qual-ity of total infrastructure, better than ontaxes and regulations. The same goes fortechnological readiness and innovation.

Higher education generates bad scores forthe United States, but clearly not for lack ofspending.

Combine those impediments to invest-ment and hiring with the growing percep-tion that crony capitalism is on the rise(U.S. rank: 50th), that customs procedurespresent obstacles to global supply chains(58th), that U.S. public debt weighs heavilyon the economy (132 of 142), and that gov-ernment spending is on a treacherous path(139th), and it becomes more apparent why

an increasingly mobile business communityoften seeks the refuge and relatively warmembrace of foreign shores.

In a recent paper with colleague JanRivkin, renowned and prolific expert onbusiness strategy and competitiveness Mi-chael E. Porter wrote:

The question Where should welocate? is more prominent in theminds of executives than it has everbeen. Over the past three decades,

business activities have becomeincreasingly mobile, and more andmore countries have become viablecontenders for them. As a result, thenumber and significance of locationdecisions have exploded. Considerableevidence . . . suggests that the U.S. isnot winning enough of the location

decisions that support healthy jobgrowth and rising wages.48

Although high-end activities such as ad-vanced manufacturing and research and de-

velopment have been U.S. strengths over theyears, Porter and Rivkin worry that the Unit-ed States has been struggling to attract andretain those activities. They attribute theloss of location decisions to bad public poli-cies: The U.S. government is failing to tack-le weaknesses in the business environmentthat are making the country a less attrac-tive place to invest and are nullifying someof Americas most important strengths.49Their focus on policy failings is consistentwith their view that a location decision is,

in many respects, a referendum on a nationscompetitiveness.50

The authors surveyed nearly 10,000 Har-vard Business School alumni about theirexperiences with location decisions. Citinga complex tax code, an ineffective politicalsystem, a weak public education system,poor macroeconomic policies, convolutedregulations, deteriorating infrastructure,and a lack of skilled labor, survey respon-dents expressed great concern that businessconditions in the United States were erod-

ing relative to other countries.Of the respondents, 1,767 had been di-

rectly involved with a location decision inthe previous year, and 57 percent said thedecision was about moving activities outof the United States (which happened in 86percent of those cases); 34 percent said thedecision concerned whether to locate newactivities in the United States or elsewhere(half of the time the U.S. was chosen); andonly 9 percent said the decision was aboutwhether to move activities into the United

States from abroad (which happened three-quarters of the time).

The results of these several surveys helpexplain the declining U.S share of global in-vestment: the United States is losing groundto other countries partly because of percep-tions that its business and investment cli-mate have become less hospitable.


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The solution willrequire a full

accounting of therange of policies

and practicesin place that

are subvertinginvestment and

working at cross-purposes.

The Proper Role ofInvestment Policy

In June 2011, the Council of EconomicAdvisers published a paper titled U.S. In-

ward Foreign Direct Investment, which wasessentially a statement about the opennessof the United States to FDI and the benefitsof FDI to the U.S. economy. While it madevalid and important points, there wereno references to the declining U.S. shareof global inward FDI, no mentions of thegrowing perceptions that the U.S. policy en-vironment was becoming less hospitable toinvestment, and, thus, no discussion aboutU.S. policies that might be causing theseworsening perceptions.

Since then there have been expressions ofgreater understanding from the administra-tion and Congress that the United States isin a global competition to attract and retaininvestment. Administrative initiatives havebeen undertaken. Legislation has been intro-duced. Recognition of the problem is a goodstart, but the solution will require a full ac-counting of the range of policies and prac-tices in place that are not only subvertinginvestment, but working at cross-purposes.

The American public is entitled to a de-

gree of policy coherence. For example, ifattracting and retaining investment in theUnited States is vital to economic growth,why does the U.S. government promote bi-lateral investment treaties and investmentprovisions in trade negotiations that havethe primary effect of subsidizing offshor-ing? Official U.S. investment policy objec-tivesas reflected in the language of theState Departments negotiating templateknown as the Model Bilateral InvestmentTreaty (BIT)are to make other economies

as open to investment as the United States,to establish rules for treating foreign invest-ment and investors no less favorably thandomestic investment and investors, andto ensure that the rights of U.S. investorsabroad are sufficiently secured. U.S. negotia-tors even insist on an investor-state disputemechanism under which companies and

individual investors can circumvent localcourts and sue foreign governments in thirdparty, extra-legal tribunals for their beingdeprived of fair and equitable treatment,which could range from policies that have

some small tertiary effect on the investor upto expropriation of property.This policy approach may look reason-

ably enlightened from a rule of law perspec-tive, but one perverse effect of requiringforeign governments to agree to conditionsintended to homogenize the investmentclimates around U.S. standards is that itmitigates what are, in some cases, huge U.Sadvantages in the race to attract investmentWhen companies weigh their location de-cisions, considerations about the commit-

ment of the host government to transpar-ency and the rule of law and the risk of assetexpropriation are important variables in theequation. Policies designed to equalize at-tributes that are otherwise usually heavily inAmericas favor, for the purpose of providing extra guarantees and protections to U.Scompanies that invest abroad, are nothingless than subsidizing outward investmentInvestment is risky. Foreign investment iseven more so. But surely U.S. multinationalcompanies contemplating foreign invest-

ments are savvy and sophisticated enoughto measure and manage risk. By mitigatingtheir risks for them, U.S. policymakers areeffectively subsidizing and thus lowering thecost of offshoring, which means we shouldexpect to see more of it.

Instead, U.S. policymakers should workto create the conditions that put the UnitedStates in a stronger position to win moreof the location decisions of both foreign-headquartered and U.S.-based companiesPolicies that increase the benefits and lower

the costs of conducting economic activitiesin the United States would simultaneouslyencourage inward investment and discour-age discretionary outward investment.51

This will require an understanding of thedeterminants of investment location deci-sions and how public policy affects those de-terminants. (Reconsideration of the Model


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If we want theUnited States tobe the best placeto do business,we need to lookat what weredoing right,what were doinwrong and how

we can eliminatebarriers toinvestment in thUnited States.

BIT would be a good start.) It will also re-quire a commitment to fixing the problemsthat detract from the overall appeal of theUnited States as an investment destination.

Some policymakers make it to this point

of the analysis only to come to the wrongconclusion: that inducing investment in theUnited States by raising the absolute cost ofinvesting abroad is equivalent to inducinginvestment here by reducing the absolutecost of investing in the United States. Thatis false. Both approaches may reduce the rel-ative cost of investing in the United States,but only the latter approach reduces the ab-solute cost of producing anywhere.

President Obama has made mention onmany occasions of his desire to end tax give-

aways to companies that ship our jobs over-seas. The brouhaha over Apples and othercompanies tax minimization schemesper-fectly rational and legal strategies to contendwith the byzantine U.S corporate taxhasprompted some policymakers to considerways to make it more expensive for com-panies to operate abroad and to keep theirprofits there. Policies that would penalizecompanies for offshoring, such as assessingthem higher tax rates, stripping them of theireligibility for tax credits or tax deductions, or

subsidizing domestic competitors who vowto keep operations stateside, also reduce therelative cost of conducting activities in theUnited States. But they do so by raising theabsolute cost of investing abroad. Policiesdesigned to discourage offshoring by raisingits absolute cost reduce economic welfarebecause U.S.-based multinational compa-nies, who account for a significant share ofdomestic economic activity, will become lesscompetitive and less capable of providing thejobs, compensation, capital investment, and

research and development required by theU.S. economy.

If policymakers want to retain and attractmore investment, compulsion is the wrongapproach. The recently introduced Global In-vestment in American Jobs Act of 2013 takesa more reasonable tack.52 Despite its popu-list-sounding title, the legislation would:

direct the Secretary of Commerce, incoordination with the heads of oth-er relevant Federal departments andagencies, to conduct an interagen-cy review of and report on ways to

increase the competitiveness of theUnited States in attracting foreigndirect investment.53

The Findings section of the bipartisan Sen-ate bill acknowledges the importance of for-eign direct investment to the U.S. economyand national security, acknowledges that theUnited States is facing growing competitionfor investment from the rest of the world,acknowledges that the U.S. share has beendeclining, advises legislators to consider the

likely impact of their bills on Americas ca-pacity to attract investment, references someof the Obama administrations efforts topromote the United States as an investmentdestination, and sets the table for a compre-hensive assessment of the policies that bothrepel and attract foreign investment.

Senator Bob Corker (R-TN), one of thebills cosponsors, remarked: If we want theU.S. to be the very best place in the worldto do business, we need to take a close lookat what were doing right, what were doing

wrong and how we can eliminate barriersthat diminish investment in the U.S.54

What is so refreshing about the bill isthat its premise is not that the practices offoreign governments or the greed of U.S.corporations that allegedly ship jobs over-seas are to blame, but that U.S. policy andits accumulated residue have contributed toa business climate that might be deterringforeign investment in the United States, andthat changes to those policies could serve toattract new investment. This kind of think-

ing is long overdue.Comprehensive tax reform should be on

the table, given that the United States has atax code with the highest corporate tax rateamong OECD countries and an extraterrito-rial system that subjects corporate earningsabroad to punishingly high rates of taxationupon repatriation. PIIEs Hufbauer and Vie-


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Investment

deterrents canbe found in the

millions of pagesof the U.S. Code

and theFederalRegister.

iro argue convincingly in a recent paper that[r]educing the U.S. corporate tax rate is cer-tainly the most efficient way to encouragedomestic investment and associated gainsin production and jobs.55

In January 2011, President Obama issuedExecutive Order 13563 under the headingImproving Regulation and Regulatory Re-view. Section 1 states:

Our regulatory system must protectpublic health, welfare, safety, and ourenvironment while promoting eco-nomic growth, innovation, competi-tiveness and job creation. It must bebased on the best available science. Itmust allow for public participation

and an open exchange of ideas. It mustpromote predictability and reduceuncertainly. It must identify and usethe best, most innovative, and leastburdensome tools for achieving regu-latory ends. It must take into accountbenefits and costs, both quantitativeand qualitative. It must ensure thatregulations are accessible, consistent,written in plain language, and easyto understand. It must measure, andseek to improve, the actual results of

regulatory requirements.56

If the burgeoning, increasingly uncheckedregulatory state is identified as an impor-tant impediment to investing in the UnitedStates, President Obama should reissue hisExecutive Order, but with a much greatersense of urgency and seriousness, includingexternal reviews with goals and firm dead-lines included.

If a badly incoherent U.S. energy policyone that leaves investors guessing about

whether and to what extent the administra-tion will restrict gas and oil exports next yearand the year after, and about whether solarenergy will be subsidized or taxed in 2014is found to be deterring capital-intensive,job-creating investments, the public shouldbe made aware of the decisionmaking pro-cess that has produced the impasse.

If the fact that U.S.-based producerswhose intermediate goods and capital equip-ment purchases accounted for over 60 per-cent of imports in 2012, are competitivelydisadvantaged by higher production costs

than their foreign competitors on account ofthe customs duties they must pay for thoseinputs, permanently eliminating all dutieson production inputs should be an optionon the table.

If U.S. producers access to crucial rawmaterials is frustrated by the hundreds ofantidumping and countervailing duty mea-sures imposed at the behest of one or twodomestic suppliers, reforming the traderemedy laws to include a public-interest pro-vision and to permit full and formal consid-

eration of the downstream consequences ofsuch restrictions would be wise.57

If a dearth of skilled workers is cited as aninvestment deterrent, the spotlight shouldbe shone on U.S. education and immigra-tion policy failures with the goal of findingthe right solutions.

If liability costs on account of waywardclass-action suits and other legal systemabuses are keeping investors at bay, majortort reform should be seriously considered.

Investment deterrents can be found in

the millions of pages of the U.S. Code andtheFederal Register. In almost every instance,these deterrents were not designed to impedeforeign investment. It is just that foreign in-vestment is a verdict about the efficacy of acountrys institutions, policies, and potential

In the conclusion to his recent bookabout the adverse accumulated impacts ofpublic policy on U.S. manufacturing, authorAndrew Smith provides a summary that aptly applies to the investment situation:

[N]o one person or group set outwith the intention of crippling themanufacturing sector by making aseries of hostile policy choices. Eachnew policy, each new program, eachnew rule had at heart a good inten-tion to make our system better. Foran entire generation we stood at the


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Governments arin competitionto attract thefinancial,

physical, andhuman capitalnecessary tonourish highvalue-added,innovation-driveneconomies.

top of the world and saw over thehorizon a seemingly endless bounty ofprogress. Under the gilded light, thesmall costs of a little stricter rule here,a little excess compensation there, a

few more restrictions elsewhere simplylooked like pebbles on the smoothpavement running endlessly ahead.A nation as phenomenally wealthy asthe United States could afford to havea highly litigious society with jack-pot judgments, could afford the mostexpensive health care system in theworld funded by its employers, couldafford to give labor unions destruc-tive power over the workplace, couldafford to let government run wild

with excessive regulation, could afforda complex and dysfunctional tax sys-tem, and could afford a featherbeddeddisability system for its workers. It hasturned out, however, that these areluxuries we can no longer afford. Onlythe wealthiest nations can get awaywith programs like these, for a time,and as the rest of the world catches upto the West, and to the United Statesin particular, our ability to devote somuch of our national wealth to these

inefficiencies is no longer sustainable.We are simply not rich enough to dothis any longer.58

Conclusion

Empowered by greater mobility and moreviable investment location alternatives,companies have greater flexibility than everbefore when it comes to deciding where toconduct functions including research and

development, design, manufacture, sales,customer service, and other activities.

Some policymakers believe that it is theobligation of U.S. multinational firms to en-sure that they are doing their part to maxi-mize U.S. employmentthat these compa-nies have a responsibility to hire and retainU.S. workers. They will do that if the condi-

tions are right, but they are under no obli-gations except to maximize profits for theirshareholders.

U.S. policymakers, however, do have anobligation to maintain smart policies. They

may find it convenient to chide U.S. compa-nies for sending jobs overseas or to say theyare being un-American, but the fact is thatpolicy and its accumulated residue weighheavily on decisions about where to locateproduction and other-supply chain func-tions.

In a global economy, where investors haveoptions, governments are in a competitionwhether they know it or not and whetherthey like it or notto attract the financial,physical, and human capital necessary to

nourish high value-added, innovation-driv-en, 21st-century economies. Punitive poli-cies will only chase away the companies withthe capital needed to fuel growth.

In a global economy, offshoring is anatural consequence of business competi-tion. And policy competition is the naturalresponse to offshoring. This global compe-tition in policy is a positive development,and a properly functioning feedback loopshould serve as a check against bad policies.

U.S. policymakers are deluding them-

selves if they think the United States neednot compete to earn its share with goodpolicies. The decisions we make now withrespect to immigration, education, energy,trade, entitlements, taxes, and the role ofgovernment in managing the economy willdetermine the health, competitiveness, andrelative significance of the U.S. economy inthe decades ahead. Offshoring is a checkagainst bad policy. Its increase tells us thatreform is in order.

Notes1. The U.S. Bureau of Economic Analysis trackscross-border investment of all kinds, as well asthe operations of U.S.-headquartered multina-tional companies, their foreign affiliates, and theU.S. affiliates of foreign-headquartered multina-tional companies. Foreign affiliates are at least 10percent owned by a U.S. parent (10% of the vot-


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ing shares are owned or controlled by the parent)and U.S. affiliates are at least 10 percent ownedby a foreign parent. The BEA distinguishes andseparately tracks the operations of affiliates thatare 1050 percent owned and those that are morethan 50 percent owned by a U.S. or foreign par-ent. Data cited in this paper concerning affiliate

performance are for these majority-owned enti-ties. See www.bea.gov.

2. United Nations Conference on Trade andDevelopment, World Investment Report 2012:Towards a New Generation of Investment Poli-cies (2012), Annex Table I.2, p. 173. In 2012, ac-cording to the U.S. Bureau of Economic Analysis,the stock of U.S. foreign direct investment was

valued a $3.9 trillion, but there is no correspond-ing figure for the value of the world stock in 2012.

3. Ibid., Annex Table I.1, p. 169. The next larg-est destinations over this period were the UK($103.3b), China ($99.7b), and Belgium ($96.4b).

4. United Nations Conference on Trade and De-velopment, http://unctadstat.unctad.org/TableViewer/tableView.aspx.

5. United Nations Conference on Trade andDevelopment, Global FDI Recovery Derails,Global Investment Trends Monitor 11 (January 23,2013): 6.

6. Bureau of Economic Analysis, InternationalInvestment Position, 19762012, http://www.bea.gov/international/index.htm#iip. The market val-ue of the stock of outward U.S. FDI in 2012 was

$5.2 trillion.7. The terms outward direct investment, out-ward foreign direct investment, outward FDI, andoffshoring are used interchangeably throughoutthe paper. The term outsourcing, often mistak-enly used to refer to what is really offshoring, willbe avoided to the fullest extent possible.

8. Council of Economic Advisors, EconomicReport of the President, 2013, Table B-1.

9. U.S. Department of Commerce, Bureau ofthe Census, Foreign Trade, http://www.census.gov/foreign-trade/data/index.html.

10. U.S. Department of Commerce, Bureau ofEconomic Analysis, International InvestmentPosition of the United States, Table 1, http://www.bea.gov/international/index.htm#iip.

11. BEA, International Investment Position.

12. Ibid. This figure is the market value of theU.S. stock in 2012.

13. The BEA provides investment stock by in-dustry and by country on a historical cost basisonly. Historical cost data are available for 2011but not 2012. Whereas the market value of thestock of inward U.S. FDI was $3.9 trillion in2012, it was $3.5 trillion in 2011. The historicalcost was $2.5 trillion in 2011, and the manufac-

turing sector stock, accounting for one-third ofthe total, was $838 billion.

14. See Michael V. Seitzinger, Foreign Invest-ment in the United States: Major Federal Statu-tory Regulations, Congressional Research Ser-

vice, January 26, 2009.

15. Secretary of the Treasury Alexander Ham-ilton, cited in Michael V. Seitzinger, ForeignInvestment in the United States: Major FederalStatutory Regulations, Congressional ResearchService, January 26, 2009.

16. Testimony of Matthew J. Slaughter before

the United States House of RepresentativesCommittee on Energy and Commerce, Subcom-mittee on Commerce, Manufacturing, and TradeDiscussion of The Global Investment in Ameri-can Jobs Act of 2013, April 18, 2013.

17. Ibid.

18. Bureau of Economic Analysis, InternationalData, Direct Investment & Multinational Com-panies (MNCs), http://www.bea.gov/iTable/index_MNC.cfm.

19. Valued at less than $1 billion in 2009, Chi-

nese direct investment in the United States hasbegun to increase. There has been a spate of ac-quisitions and proposed acquisitions of U.S. com-panies by Chinese suitors since 2010. Accordingto the BEA data, the stock of Chinese FDI in theUnited States as of the end 2011 was $9.5 bil-lion. However, a more recent accounting by theRhodium group (www.rhg.com) puts that figureat about $25 billion, which includes deals in thepipeline that might not yet have been consum-mated. In any event, Chinas share of the $2.55trillion of U.S. FDI stock is no more than 1 per-cent of the total.

20. Technically, the outflow of dollars to buy

imports and foreign assets, plus remittances andprofits paid to foreigners, equals the inflow ofdollars to buy U.S. exports and U.S assets, plusremittances and profits paid to Americans byforeigners. Rearranging terms, the identity thatholds is: Current Account = -Capital Account.

21. Council of Economic Advisers, Economic Report of the President (2013), Table B-2, Real GrossDomestic Product (19642012). Between 2009


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and 2010, real import growth was 12.5% and realGDP growth was 2.4%; between 2010 and 2011,real import growth was 4.8% and real GDP growthwas 1.8%; between 2011 and 2012, real importgrowth was 2.4% and real GDP growth was 2.2%.

22. Note that import value is being used in-

stead of the trade deficit (import minus exports)because the occasional large annual swings invalue of the deficit makes for large year-over-yearpercentage changes, which are difficult to plotalongside annual changes in GDP or employ-ment.

23. BEA, U.S. International Investment Position.

24. Kevin B. Barefoot and Raymond J. MataloniJr., Operations of U.S. Multinational Companiesin the United States and Abroad: Preliminary Re-sults From the 2009 Benchmark Survey, Survey ofCurrent Business (November 2011): 35, http://www.bea.gov/scb/pdf/2011/11%20November/1111_

mnc.pdf.

25. Michael E. Porter and Jan W. Rivkin, Choos-ing the United States,Harvard Business Review 90,no. 3 (March 2012): 8091.

26. BEA, Balance of Payments and Direct In-vestment Position Data, (May 17, 2013). Thecountry- and industry-specific allocations forinvestment are based on 2011 historical value fig-ures, as the market value figures by country andindustry are not tracked by the BEA and the mostrecent allocated values are for 2011, http://www.bea.gov/international/di1fdibal.htm.

27. Ibid.

28. Ibid.

29. Mergent Online (database), Mergent, Inc.,American University Library, http://www.mergentonline.com, data obtained on March 19, 2013.These are the top 10 companies by revenue, ex-cluding banking and financial industry firms.

30. Matthew J. Slaughter, American Compa-nies and Global Supply Networks: Driving U.S.Economic Growth and Jobs by connecting withthe World (December 2012): 28.

31. Ibid., p. 3.

32. Ibid., p. 10.

33. Gary Hufbauer and Martin Vieiro, Corpo-rate Taxation a US MNCs: Ensuring a Competi-tive Economy, Peterson Institute for Interna-tional Economics Policy Brief Number PB13-9(April 2013).

34. Ibid.

35. Slaughter, American Companies and Glob-al Supply Networks, p. 5.

36. Jon Greenberg, Obama Says Tax Code Re-wards Firms for Shifting Jobs Overseas, Politifact.

com, http://www.politifact.com/truth-o-meter/statements/2012/oct/08/barack-obama/obama-says-tax-code-rewards-firms-shifting-jobs-ov/.

37. Obama Stimulus Program Sent JobsAbroad, GOP Says, Wall Street Journal, July 10,2012, http://online.wsj.com/article/SB10001424052702303292204577519181071135146.html.

38. Eighty percent of U.S. outward foreign di-rect investment is in Europe, Canada, Bermuda,

Australia, Singapore, and Japan.

39. BEA, Balance of Payments and Direct In-vestment Position Data (May 17, 2013), http://

www.bea.gov/international/di1fdibal.htm.

40. OECD, FDI Restrictiveness Index, http://www.oecd.org/investment/fdiindex.htm.

41. Ibid.

42. Ibid.

43. James Gwartney, Robert Lawson, and JoshuaHall, et al., Economic Freedom of the World 2012 An-nual Report, Fraser Institute (2012): v.

44. Ibid., p. vi.

45. Gwartney et al.,Economic Freedom of the World,2012 Annual Report, p. 17.

46. Ibid.

47. Klaus Schwab, The Global CompetitivenessReport 20112012, World Economic Forum(2011).

48. Porter and Rivkin, Choosing the UnitedStates.

49. Ibid.

50. Ibid.51. The term discretionary refers to invest-ment that goes abroad, but doesnt really haveto. It is investment in activities that could beperformed in the United States if perceptions ofthe U.S. policy environment were more favorable.The term is used to distinguish investment inthese activities from investment in activities thatrequire a foreign presence.


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52. The Global Investment in American JobsAct of 2013, S. 1023 and H.R. 2052.

53. Ibid.

54. Office of Senator Bob Corker, Corker,Klobuchar Introduce Bill to Help Encourage

More Global Investment in the U.S., ImproveAmerican Competitiveness, press release, May23, 2013.

55. Hufbauer and Veiro, p. 11.

56. Exec. Order No. 13,563, 76 Fed. Reg. 3821(Jan. 18, 2011), Improving Regulation and Regu-latory Review.

57. For a detailed discussion of this problemsee Daniel Ikenson, Economic Self-FlagellationHow U.S. Economic Policy Subverts the National

Export Initiative, Cato Institute Trade PolicyAnalysis no. 46, May 31, 2011.

58. Andrew O. Smith, Sand in the Gears: HowPublic Policy Has Crippled American Manufacturing(Washington: Potomac Books, 2013).


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Transcript of Reversing Worrisome Trends: How to Attract and Retain Investment in a Competitive Global Economy