StaffPAPERSFEDERAL RESERVE BANK OF DALLASNo. 3February 2008The Globalization of U.S. Business InvestmentMark A. Wynne and Erasmus K. KerstingStaffPAPERS is published by the Federal Reserve Bank of Dallas. The views expressed are those of the authors and should not be attributed to the Federal Reserve Bank of Dallas or the Federal Reserve System. Articles may be reprinted if the source is credited and the Federal Reserve Bank of Dallas is provided a copy of the publication or a URL of the web site with the material. For permission to reprint or post an article, e-mail the Public Affairs Department at [email protected] Papers is available free of charge by writing the Public Affairs Department, Federal Reserve Bank of Dallas, P.O. Box 655906, Dallas, TX 75265-5906; by fax at 214-922-5268; or by phone at 214-922-5254. This publication is available on the Dallas Fed web site, www.dallasfed.org.StaffPAPERS Federal Reserve Bank of DallasThe Globalization of U.S. Business InvestmentMark A. WynneVice President and Senior Economist Director, Globalization and Monetary Policy InstituteFederal Reserve Bank of DallasandErasmus K. KerstingPh.D. CandidateDepartment of EconomicsTexas A&M University AbstractThis paper documents some key facts about foreign direct invest-ment flows by U.S. businesses overseas and foreign businesses in the Unit-ed States. We show how the pattern of flows has evolved, examine the sources and destination of these flows, document associated employment and productivity gains, and show how investment-related sales compare with traditional exports. While the United States is a net debtor to the rest of the world, direct investment overseas by U.S. businesses exceeds direct investment in the U.S. by foreign businesses. Furthermore, U.S. businesses seem to earn more on their foreign investments than foreign firms earn on their U.S. investments. The globalization of business invest-ment is a long-standing phenomenon, but it has accelerated in recent years and become a source of concern for some, as it is intimately related to the debate on offshore outsourcing. Yet contrary to what some think, the bulk of U.S. investment overseas is in other high-income countries. And foreign investment in the U.S. has been an important source of employ-ment growth in recent years.JEL codes: F21, F23Keywords: Foreign direct investment, outsourcing, tax avoidanceWe thank Anil Kumar and Erwan Quintin for helpful comments on an earlier draft.No. 3, February 2008StaffPAPERS Federal Reserve Bank of Dallas2At the end of 2006, the United States was a net debtor to the rest of the world, to the tune of $2.540 trillion. U.S.-owned overseas assets of $13.755 trillion were offset by foreign-owned assets in the U.S. of $16.295 trillion. This negative net international investment position reflects more than two decades of current account deficits, and the largest single com-ponent of the current account deficit is the trade deficit.Just as the U.S. trade deficit is a composite of a deficit in goods trade and a surplus in services, so, too, the country’s negative net international investment position is a composite of a very large deficit in holdings of official assets and a surplus in foreign direct investment. U.S. official re-serve assets amounted to $219 billion at the end of 2006.1 By contrast, foreign official assets in the U.S. totaled $2.770 trillion, primarily reflect-ing Asia’s extraordinary reserve accumulation in recent years. However, in one respect, the U.S. continues to be a net creditor vis-à-vis the rest of the world. At the end of 2006, the value of U.S. foreign direct investment (FDI) overseas was $2.856 trillion (valued at current cost), while FDI in the U.S. was $2.099 trillion.2 This paper offers an overview of recent trends in global FDI, with a fo-cus on the United States. In addition, we document empirical evidence on the effects of FDI, particularly recent results showing that multinational firms generally outperform their domestic peers. Finally, we contribute to the literature investigating the employment effects of U.S. investment overseas. Our analysis suggests that employment overseas by U.S. multi-nationals mostly complements domestic employment.When a U.S.-based firm wants to sell its products in a foreign market, it has two options: It can produce in the United States and export to the foreign market, or it can set up shop overseas. The choice of which course to pursue depends on a myriad of factors, including the existence of bar-riers to trade (either shipping costs or tariffs or both), the importance of physical proximity to customers, taxes, and so on. The traditional, text-book approach to thinking about how countries interact tends to empha-size interactions through exporting and importing. Yet increasingly, U.S. businesses are setting up operations overseas to produce and sell directly into foreign markets. For example, in recent years Ireland has become a major platform for U.S. businesses seeking to sell into the single European 1 This figure differs from the weekly statement on the value of U.S. international reserves issued by the Treasury Department due to the latter’s valuation of gold holdings at a fixed price of $42.2222 per fine troy ounce rather than the market price, which has been closer to $800 an ounce in recent months.2 The Bureau of Economic Analysis (BEA) reports the value of foreign direct investment three ways. The historical cost method values assets and liabilities at their book value. This measure is the easiest to compile but of limited value. The BEA’s featured measure of direct investment values assets in current-period prices. Investment in plant and equipment is valued using the current cost of capital equipment; investment in land is valued using general price indexes; investment in inventories is valued using estimates of the replacement cost of inventories. Finally, the BEA reports a measure of direct investment at market value, where the equity component of the direct investment position is valued using indexes of stock market prices.StaffPAPERS Federal Reserve Bank of Dallas3market. Likewise, since the 1980s, many Japanese auto companies have opened plants in the United States to produce for the American market.U.S. firms may also invest abroad to take advantage of lower labor costs. For example, the big