When the foreign affiliates of U.S. multinational corporations engage in higher capital expenditures, the American multinationals also tend to increase investment back home.
There is a widespread popular perception that when American companies invest abroad they necessarily reduce economic activity and employment in the United States. But in their recent study, Foreign Direct Investment and the Domestic Capital Stock (NBER Working Paper No. 11075), authors Mihir Desai, C. Fritz Foley, and James Hines offer an alternative perspective: they conclude that greater foreign investment by U.S. multinational firms is actually linked to greater investments at home as well.
Desai, Foley, and Hines examine investment data covering a broad set of high-income countries during the 1980s and 1990s and confirm earlier findings that outbound foreign direct investment (FDI) appears to reduce aggregate domestic investment. However, when they focus solely on the domestic and foreign capital spending of U.S.-based multinational corporations, they find the opposite result. When the foreign affiliates of U.S. multinational corporations engage in higher capital expenditures, the American multinationals also tend to increase investment back home -- suggesting that foreign and domestic investment are complements, not substitutes. Specifically, the authors find that "an additional dollar of foreign investment capital expenditure is associated with 3.5 dollars of domestic capital expenditures by the same group of multinational firms, strongly suggesting a complementary relationship between foreign and domestic investment."
The common intuition is that a firm's resources are fixed, so a dollar invested abroad would necessarily mean one less dollar available to invest at home. "Unsurprisingly," the authors acknowledge, "growing overseas activities of multinational firms have become a source of economic insecurity for workers, managers, and tax collectors." But Desai, Foley, and Hines point out two reasons that such thinking may be misguided.
First, when financing new projects and investments, multinationals and their foreign affiliates can tap both world markets and local capital markets depending on many factors that can make different financing arrangements more or less advantageous -- such as financing terms and tax considerations. Second, the type of investment might make a difference. So-called "horizontal investment," whereby a multinational invests abroad in order to replicate business activities conducted at home, can (though need not) divert economic activity away from the home country. But "vertical" investments, in which production processes are broken into various stages around the world, often lead to situations in which foreign and domestic production activities complement one another. "Vertical foreign investments can raise the demand for domestic capital," the authors argue, "by permitting greater exploitation of intangible assets produced by domestic activity or by increasing the profitability of domestic production that can be combined with foreign output."
Desai, Foley, and Hines also consider the impact on their findings of the domestic savings rate and of the investments by foreign-owned firms in the United States, but find that the inclusion of these variables does little to affect the complementary relationship between domestic and foreign investment. For each extra dollar of domestic savings, U.S. capital spending by U.S. multinationals increases by 26 cents, whereas an additional dollar of capital spending by foreign-owned firms in the United States reduces domestic expenditures by U.S. multinationals by 1.9 dollars.
The authors conclude by underscoring that when multinational firms combine domestic production with foreign production, such firms can produce at a lower cost overall -- so each stage of the production process is therefore more profitable. "It is clear that the simple story, in which the world has a fixed stock of investment capital that can either go to one place or another," the authors conclude, "is due for rethinking." And the growing prominence of multinational corporations in an era of globalization makes such rethinking all the more pressing
-- Carlos Lozada