On May 10,
Treasury Secretary Hank Paulson led a small panel discussion about
the importance of foreign direct investment in the American
economy. Just a few hours earlier, a government report was released
showing a trade deficit of $63.9 billion in March, nearly 10
percent higher than in February. The trade deficit is a favorite
bogeyman of those who predict a coming economic apocalypse, so the
latest figures are certain to be much cited. The coincidence of the
trade figures and the Paulson panel just might goad policymakers to
focus on the real economic issue in play. Trade "imbalances" in
goods and services pose no danger as long as they are
counterbalanced by a surplus of investment. Fortunately, the U.S.
enjoys exactly such a surplus. The potential danger, then, is
radical policy changes that would worsen the investment climate.
Investors need certainty, and uncertainty is a growing concern,
according to Paulson's panel.
A Trade Surplus with
exports were $126.2 billion, or barely two-thirds of the $190.1
billion in total imports, according to the U.S. Bureau of Economic
Analysis. The result was a trade deficit $6.0 billion larger than
By country, the
U.S. had the largest trade surpluses with Hong Kong ($1.3
billion), Australia ($1.3 billion), and Singapore ($0.9 billion).
The largest trade deficits in March were with China ($17.2 billion,
compared to $18.4 billion in February), Europe ($8.9 billion,
compared to $7.2 billion in February), OPEC ($8.9 billion, compared
to $7.0 billion in February), Japan ($7.1 billion), and Mexico
Notably, the top
three largest U.S. trade surpluses came from the 2007 Index of
Economic Freedom's three freest countries: Hong Kong,
Singapore, and Australia. This indicates that the United States can
compete in a more liberalized trading environment. The other
implication is that trade restrictions in less free economies are
hindering exports from the U.S.
The good news is
that exports are still growing, up $1.8 billion for goods in March
to $90.2 billion. Services exports grew $0.4 billion to $36.1
billion, primarily in financial, insurance, and
Imports grew even
faster, which may seem counter-intuitive given the weaker exchange
rate. However, the combination of long-term contracts and a
short-term dollar decline inevitably leads to a short-term widening
of the trade gap before it narrows, which is known as the
"J-Curve." Imports of goods alone increased $7.8 billion in March.
But this should turn around if the dollar stabilizes.
Two decades ago,
investors from Japan famously snapped up American movie studios,
manufacturers, and even famous properties like the Rockefeller
Center. Foreign investors were also eager to get in on the ground
floor of the Internet revolution and participated heavily in
private equity deals in U.S. startups during the late 1990s.
According to the Council of Economic Advisors, "U.S. affiliates
owned $5.5 trillion in assets and had $2.3 trillion in sales."
Foreign multinational employment accounts for 4.7 percent of all
U.S. jobs, and those jobs pay $15,200 more, on average, than purely
A useful framework
for thinking about economic issues is to identify differences
between levels and changes, or "stock" versus "flow." For example,
a nation may have no stock of fresh water but receive a regular
flow of thousands of gallons from rains. America enjoys a healthy
stock of foreign investment from abroad and continues to enjoy a
very large flow of new inbound investments. But there is a
qualitative difference in the two.
own a total stock of over $9 trillion in U.S. assets, according to
2005 CEA data. The assets are composed of four basic types, and the
largest portion is foreign direct investment (FDI, $2.8 trillion).
This type of investment goes directly into companies and
infrastructure and, so, is considered the best in terms of creating
high-value jobs for U.S. workers. Inward FDI is more stable and
less liquid than other sorts of capital inflows, demonstrating
long-term foreign investor confidence in the U.S. economy.
U.S.-based multinational companies, a key source of FDI, also
contribute to the U.S. economy by exposing domestic firms to the
best business management techniques.
The other three
types of foreign investment are corporate stocks, private bonds,
and U.S. Treasury bonds and bills. Each of these types comprises
about $2 trillion of the total investment stock.
But the stock is
only part of the story, because it includes investments that have
accumulated over decades, even centuries. What about the flow of
investments in recent years? Professor Menzie Chin, an economist at
the University of Wisconsin, writes that the U.S. has become overly
reliant on bond financing and that FDI has been drying up
significantly. In the last five years, only one in 10
dollars invested in the U.S. has been in FDI, while eight have been
in bonds. This is a cause of concern.
If investors lose
faith in the investment process, including things like cumbersome
approval rules and strict travel restrictions, then they will
react, often by investing elsewhere. The visa waiver issue in
particular has become a point of contention for America's friends.
One investor reaction has been a shift toward passive investments
in the U.S., which are much more liquid. The danger is that if the
demand for passive investments flags, U.S. interest rates will
implication for Congress is to tread very carefully in regulating
capital markets and playing politics with the international
economy. The Dubai Ports World imbroglio was nothing short of a
fiasco in terms of the signal it sent to foreign investors. Ongoing
saber rattling about exchange rates and punitive tariffs may seem
to be harmless rhetoric, but it has an impact. American legislators
who are talking tough do not intend to scare away good jobs, but
that appears to be the result.
Tim Kane, Ph.D., is Director of
the Center for International Trade and Economics at The Heritage