- Returns on Foreign Direct Investment: Does the United States Really Do Better?
Over the past quarter century, the United States has undergone a striking shift from the world’s largest creditor nation, with a net international investment position equal to 11 percent of GDP, to its largest debtor, with a net indebtedness of $2.6 trillion or –20 percent of GDP at the end of 2006 (see table 1). Yet net income from U.S. foreign investments remained positive throughout this transition.1 This surprising state of affairs is highlighted in figure 1. According to official data, the strong continued income account performance reflects the fact that U.S. investors earn a significantly higher rate of return on their foreign assets than foreigners earn in the United States. But despite considerable recent research, analysts do not agree on whether the United States really does do better and, if so, why.
Some scholars argue that published data are implausible and suggest possible errors in the reported data for either income flows or estimated net asset position. For example, Ricardo Hausmann and Federico Sturzenegger argued that the value of the U.S. foreign asset position is understated, which leads to overstatement of the return on outward foreign direct investment (FDI). In particular, they believe that U.S. trade statistics fail to capture the full amount of U.S. exports of intangible capital.2 In contrast, Daniel Gros pointed to asymmetries in the data sources used to construct estimates of income and payments on foreign direct investment.3 He believes that U.S. payments to foreigners, and thus the return on inward FDI, are understated. Pierre-Olivier Gourinchas [End Page 177] and Hélène Rey changed the presentation of the data to emphasize the total return (inclusive of capital gains) and conclude that the United States earns a premium because it acts as an international venture capitalist, borrowing in relative safe short-term liabilities while investing in riskier long-term assets.4
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The purpose of this paper is to examine in greater detail some of the competing explanations for the apparent differential between the rates of return on U.S. foreign assets and liabilities. In particular, we focus on the rate of return on foreign direct investment. As we show, almost the entire return differential occurs in FDI, where American firms operating abroad appear to earn a persistently higher return than that earned by foreign firms operating in the United States. We first review a number of explanations in the literature for this differential. We then offer some new evidence on the potential role of income shifting between jurisdictions with varying rates of taxation.
In summary, we do not believe that the differential in returns is an illusion of bad data, as alleged by much of the recent discussion. Although the Bureau of Economic Analysis (BEA)—the statistical agency that collects and reports [End Page 178] the relevant data—is handicapped by unreliable source data, we believe that the existing accounts that it puts together are superior to suggested alternatives. However, we argue that the current literature places too little emphasis on the potential role for tax-related income shifting. In particular, we find statistically significant evidence of a substantial diversion of income to low-tax jurisdictions, suggesting that the reported earnings on FDI are distorted by efforts to avoid U.S. corporate taxation.
The following section examines the official statistics on the balance of payments (BOP) and the international investment position (IIP) of the United States. The third section discusses the main competing explanations, some of which assert that the official measures are incorrect. The fourth section contains our argument on tax considerations, and the last section concludes.
What Do the Published Data Show?
The official statistics on the U.S. external position are surprising in two respects. First, despite the enormous size of the nation’s...