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Foreign Investment: The Job Creation Myth

By Jock O'Connell

Slightly different versions of this article appeared in the Los Angeles Times on December 4, 1988; the Sacramento Bee Forum section on December 18, 1988; and the Orange County Business Journal on February 13, 1989.)

During the waning days of his ill-starred presidential campaign, Massachusetts Gov. Michael S. Dukakis, doing his best to impersonate U.S. Rep. Richard Gephardt (D-Mo.), sought to capitalize on the public's growing apprehension over foreign investment in the United States.

For his efforts, the Democratic candidate was predictably labelled a protectionist (the dreaded "P" word) by Wall Street pundits. Even the Bee's Dan Walters got into the act just two days before the election. In one of those columns he writes from time to time that can only be described as pious harumphs, Walters implied that the concern voiced by Dukakis was a racist reaction to Asian investors.

Ironically, though, Dukakis' position seemed most at odds with the interests of rank-and-file Democrats whose well-being he professed to champion.

After all, aren't foreign investors the ones who are creating hundreds of thousands of new jobs for American workers at a time when U.S. companies are busily closing down factories, laying off personnel and moving their operations overseas?

This perception of foreign investment as an engine of job creation is not unique to blue- collar workers. It's also held by legions of state and local officials throughout the nation who are aggressively courting foreign investors and spending considerable amounts of taxpayer money in the process.

But what if foreign investment turns out to be something of a dud when it comes to job creation?

That just may be the case, according to new research indicating that foreign investment accounts for less than one percent of all new U.S. jobs and, in certain sectors of our economy, may even contribute to job losses. And because the role of overseas investment in creating new jobs is often exaggerated, state and local governments may not be making the most prudent use of public funds in trying to stimulate employment.

Overall foreign investment in the United States currently exceeds $1.5 trillion. Of this, $1.3 trillion are invested in government securities, bank deposits, and corporate stocks and bonds. Another $262 billion are classified as foreign "direct" investments (FDI) in manufacturing plants, retail stores, banks and real estate.

Nearly 3 million Americans are employed in what, for statistical purposes, are regarded as foreign-owned businesses, up from just 1.2 million a decade ago. About 300,000 of these jobs are in California. But before anyone assumes that foreigners were responsible for creating those jobs, hold on. As is customary in these matters, it's important to know how the government's statisticians came up with their figures.

As it turns out, there are three major reasons why the data inflate the significance of FDI as a source of new jobs.

First, the government's data do not distinguish full-time employees from part-time or seasonal employees. Second, federal officials regard a company as foreign-owned even if as little as 10% of its voting stock is held by foreigners. Thus, all employees of a company in which a foreign investor holds a minority interest are considered to be employed by that foreign investor. Third, because mergers and acquisitions are by far the most common form of FDI, the great majority of the jobs attributed to foreign investors actually existed before the new owners took over.

When Nestle, the Swiss conglomerate, bought out Carnation in 1985 for $3 billion, all of the thousands of Californians who worked for the Los Angeles-based food company became employees of a foreign company. Even though the acquisition itself created no new jobs, the ranks of Californians employed by a foreign investor rose substantially.

To be sure, an infusion of new capital and managerial skills can rescue a failing company, thereby saving jobs. More commonly, though, owners of newly acquired businesses move to cut costs, often through personnel reductions. For example, the Los Angeles Times recently reported that the acquisition of the Los Angeles-based Union Bank by the Japanese-owned California First Bank of San Francisco will result in the loss of at least 640 jobs as the two banks merge some of their operations.

Further contributing to our tendency to regard FDI in a positive light is that, while new investments are widely heralded, failures of foreign-owned businesses are seldom reported. Yet foreign-owned companies are subject to the same rules of economic life as domestic firms. They endure business cycles, hire new workers, lay off employees and sometimes go out of business. Jobs are created, but jobs are also destroyed.

According to a number of recent studies based on government data, FDI accounts for no more than 15,000 to 20,000 net new jobs annually, largely because the great bulk of FDI activity involves the acquisition of existing companies, not the so-called "greenfield" investments where new businesses are established from scratch.

Writing last summer in the New England Economic Review, Jane Sneddon Little, an economist with the Federal Reserve Bank of Boston, reported that FDI accounted for 19,000 net new jobs nationally in 1986.

Similarly, in an appearance before a committee of the California Legislature this past September, Douglas Woodward, a professor of economics at the University of South Carolina and co-author of a forthcoming book on foreign investment in the United States, testified that FDI is responsible for an annual average of only 15,000 net new jobs over the past decade.

These findings received further support in a study prepared last summer by the Congressional Economic Leadership Institute which found, among other things, that foreign investors in 1987 spent nearly 84 percent (or $25.6 billion) of their total outlays to acquire existing American companies.

Such revelations have important public policy implications at all levels of government. Recognizing there are large gaps in our knowledge about the activities of foreign investors, several members of Congress, led by Texas Congressman John Bryant, have been urging new reporting requirements. But it's at the state and local levels where the ramifications of these new analyzes may be especially unsettling.

Apart from helping to justify scores of expensive overseas trips each year by governors, legislators, mayors and other officials eager to bring home the bacon, the view that foreign investment is a major source of new jobs is also a big reason why 41 states maintain offices in cities around the world -- with no fewer than 35 states having Tokyo offices, amazingly just two short of the number of states maintaining offices in Washington, D.C.

Several states, notably in the South and Midwest, have been particularly assertive in trying to lure foreign companies. In many instances, state and local governments have offered such costly inducements as tax holidays, industrial development bonds, and employee training subsidies. Kentucky, for example, earlier this year offered Toyota a package of enticements that will eventually cost taxpayers in that state some $325 million.

Although California has wisely avoided such direct giveaways, we have not remained entirely aloof from the often fratricidal competition with other states for foreign investment. Since early 1987, the state has maintained offices in Tokyo and London at an annual cost of $1.5 million. While billed as trade and investment offices, both seem to be primarily engaged in luring foreign investment to California. To complement these efforts at home, an Office of Foreign Investment was also opened in Sacramento.

But by far the most significant step California has taken to insure the state's attractiveness to foreign investors was the effective repeal in 1986 of the unitary tax, a highly controversial method of taxing multinational corporations. Carrying a price tag of $200-250 million per annum in lost revenue, unitary tax reform legislation was enacted in part because foreign companies were threatening to forego investments in California so long as the unitary tax remained in force.

Fearing that a loss of overseas investment would have a deleterious effect on job growth in a state with a burgeoning population, state officials could not dismiss these warnings. No one at that time seriously doubted that foreign investment was creating lots of good jobs, especially in the manufacturing sector where wages tended to be higher.

In addition to the programs by the state, there are largely uncoordinated efforts being mounted by public officials throughout California to ensure their communities get a "fair share" of foreign investment funds. All our major cities have established programs to entice foreign investors, while scores of smaller municipalities have sponsored overseas forays by local leaders. In many cases, highly-paid consultants have been retained to help in devising investment strategies and in making the right contacts overseas.

So how many new jobs has FDI actually created in California?

If, as the latest research indicates, FDI accounts for fewer than 20,000 net new jobs nationally, then California, as the recipient of around 12% percent of all FDI in the United States, should get no more than 2,400 new jobs annually.

Even if we assume that California does somewhat better than average in squeezing new jobs out of FDI, the conclusion is inescapable. In a state where employment has been growing by an average of 345,000 jobs a year over the past decade, FDI is no major engine of job creation. By contrast, small, locally-owned businesses with fewer than twenty employees are responsible for 56% of net new jobs in California.

And that may not be the end of a sobering story.

Some economists are starting to suggest that FDI may actually contribute to a net lossof jobs in certain sectors of the U.S. economy. Specifically, researchers have noted a proliferating number of cases in which foreigners buying into complex manufacturing enterprises have been replacing their new acquisition's existing suppliers of goods and services with suppliers from overseas, thus depriving American companies of major customers.

Doubtless, reports of high-rise buildings and prominent U.S. firms being bought up by foreign interests disturb most Americans, accustomed as we are to being the one doing the purchasing. But just as ambiguous fears should not necessarily sour us on foreign investment, neither should be cling to untested assumptions about FDI's alleged virtues.

Those troubled by foreigners growing role in our economic life should keep in mind that total foreign investment in California still represents a small slice of the state's economy -- roughly equivalent in size to the Bank of America, as the Sacramento Bee recently reported. Likewise, officials responsible for creating new jobs for our growing populace must swallow the unpleasant truth that the nurturing of small entrepreneurs is not the stuff of which fabulous junkets are made.

Copyright (c) 1988 by J. A. O'Connell


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