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The Not-So-Great Foreign Investment Debate

by Jock O'Connell

(Versions of this article appeared in the Sacramento Bee Forum section on June 25, 1989, and in the Los Angeles Times Sunday Business section on July 9, 1989.)

With foreign acquisitions of U.S. businesses and real estate as common these days as politicians defending the flag, America's existing open-door policy toward foreign investment is coming under increasingly critical scrutiny.

As recent polls indicate, upwards of 80 percent of the American public want foreign investment in this country more closely regulated. Yet exactly how current policy ought to be changed -- or whether it ought to be changed at all -- is by no means clear.

In the short term, we have remarkably little choice in the matter. After a decade of consuming more than we produced, importing more than we exported, and spending more than we saved, the U.S. has become "hooked" on foreign money to finance the federal budget deficit and to provide investment capital for American industry.

Any steps which would hinder this infusion of foreign funds, without at the same time providing the U.S. economy with the financial equivalent of methadone, would be monumentally unwise.

The longer term economic and political consequences of extensive foreign investment in this country do merit careful examination, however.

But there's the rub. As a nation accustomed to debating major issues via twenty-second sound bites, the illuminating discussion of policy options we need is likely to be overshadowed by the more entertaining clash of polemics as the free trade crowd again does battle with its protectionist nemesis.

On one side of this rather simpleminded dispute are the acolytes of free trade who zealously believe that barriers to foreign investment's free flow violate natural law. On the other side are those who seem absolutely terrified that foreigners will soon be able to foreclose on the national mortgage and toss us all out on the street.

Between these two camps lies a rhetorical free-fire zone. Anyone skeptical about our current laissez-faire policy toward foreign investment risks being labeled a crypto-racist xenophobe. By the same token, those courting overseas investors are often portrayed as shortsighted commercial quislings eager to sell off the nation's economic patrimony.

Regrettably, but not surprisingly, neither side provides any real guidance in understanding, let alone resolving, the issue of rising foreign investment in the U.S.

For example, as the 21st century nears, the world's major economies are being knitted into an increasingly intricate web of interdependencies. But most resistance to foreign investment is rooted in an almost 19th century brand of nationalism.

To the "economic nationalists," international commerce takes place in a world of distinctive and essentially self-contained national economies. It's a world in which the interests of corporate America are largely identical with the interests of the U.S. economy.

It's also a world that doesn't exist.

With a steadily growing number of companies conducting business without much reference to national borders, the links between corporations and the countries in which they are headquartered are becoming increasingly ambiguous. Who "we" are in the battle against "them" is no longer evident when American firms move their operations overseas while more and more foreign companies set up shop here.

Despite these trends, economic nationalists steadfastly prefer American ownership of American assets. In doing so, they attach more significance to the owner's nationality than to the real benefits the enterprise yields to the community or the nation. American-owned corporations are thus presumably expected to be more public-spirited than American consumers, who are notorious for leaving patriotic feelings at home when they go shopping. The visceral nature of their perspective may also account for the regrettable tendency of economic nationalists to both exaggerate and confuse the relevant issues, often with the effect of obscuring legitimate concerns.

Perhaps their most conspicuous distortion involves the question of how much of America foreigners really own. By most popular accounts, foreigners -- who are invariably depicted as Japanese -- will wind up owning America before Donald Trump does.

(Interestingly, the British and Dutch continue to own more of our fixed assets. The Japanese, however, have emerged as the top overseas investor in the U.S. partly on the strength of their huge purchases of stock portfolios and government securities.)

The truth is that foreign investment in the United States, while not trivial, is not particularly awesome either. The numbers, though huge, must be viewed in perspective. America is still a very big place with a $5 trillion annual economy. Total foreign investment here currently approaches $1.78 trillion. Less than one-fifth of that amount -- some $329 billion -- is in the form of foreign direct investment (FDI), where foreigners acquire controlling interest in U.S. businesses or real estate. That represents under 2 percent of all fixed investment in the U.S. It's also well below a tenth of our gross national product.

The remaining $1.45 trillion are invested in portfolios of stocks, bonds, bank accounts, and government securities. Ironically, while economic nationalists are most animated when deploring FDI, portfolio investments represent a potentially greater threat to U.S. interests. Unlike direct investments in businesses or real estate, portfolio investments are highly liquid. And it is the prospect that foreigners will suddenly dump huge blocks of American stocks and bonds or refuse to buy U.S. Treasury notes that troubles the experts.

Apart from demanding closer monitoring of foreign investors' activities in this country, economic nationalists offer few practical remedies. Unfortunately, earnest concerns about the concentration of foreign ownership in certain key U.S. industries or the excessive degree to which the federal government relies on foreign funds to finance the budget deficit are usually overshadowed by more frenzied and indiscriminate attacks on foreign investment.

But if the economic nationalists' case is weak, the laissez-faire position, despite its veneer of official acceptance and respectability, is not much sounder.

Like their protectionist foes, the free traders are more absorbed with foreign direct investment than with portfolio investments. Part of the reason for this, one suspects, is that portfolio investment transactions seldom result in flattering newspaper photographs of hardhat-wearing public officials turning soil at new industrial plants.

In general, the laissez-faire position maintains that FDI: (1) creates new jobs; (2) generates new tax revenues; (3) often results in the transfer of valuable new technologies; (4) fosters the introduction of new management techniques; and (5) helps reduce the U.S. trade deficit.

At first glance, these assertions seem eminently reasonable, and there are certainly numerous individual cases in which communities have reaped most or even all of these benefits. However, when assessing the overall impact of FDI on the U.S., there is much less reason to believe these claims are valid.

For example, because over 86 percent of all FDI outlays in the U.S. over the past five years have gone for the acquisition of existing companies or real estate, foreign direct investment plays a surprisingly negligible role in job creation. The attention lavished on new manufacturing facilities or plant expansions obscures a more complex reality in which foreign-owned firms often lay off workers, eliminate jobs and even go out of business. Indeed, recent research indicates FDI has created fewer than 20,000 net new jobs annually in the U.S. in the past decade.

As for generating added tax revenues, that also turns out to be a suspect claim. In some cases, the cost to public agencies and to taxpayers of enticing a major investor to locate in the community frequently exceeds the level of new revenue the project might reasonably be expected to generate. More routinely, though, because a shift in ownership generally affects a company's tax liability, FDI may just as easily lead to revenue losses.

The twin claims regarding the transfer of new technologies and new management techniques are based on anecdotal evidence. If anything, there is plenty of contrary evidence to suggest that some foreign firms are buying U.S. companies to acquire new technology. And the introduction of new management styles may simply be a function of a change in ownership, without reference to the new owner's nationality.

Finally, the U.S. affiliates of foreign companies may actually contribute to the U.S. trade deficit. In 1986, for example, foreign-owned firms in the United States imported $124.5 billion in merchandise. At the same time, these firms exported only $50.7 billion, resulting in a $73.8 billion contribution to our trade deficit.

The balanced conclusion must be that foreign investment is neither an unmitigated boon nor a clear and immediate danger. But, to an extent unprecedented during the lives of most Americans, foreign investment is exerting an important influence over our economic and political affairs. And this new reality will persist as long as America is hobbled by massive deficits in our trade and in the federal budget. If nothing else, this prospect of a steadily increasing foreign role in our economy should give us pause to wonder whether a continued policy of indiscriminate neutrality toward foreign investment is still an acceptable posture for the United States.

America is rather unique among the major industrial powers for the freedom of access it affords foreign businesses. Other countries, including all of our major trading partners, are officially less comfortable with the idea of allowing outsiders to become part of the domestic economic landscape. Yet, it would be premature to suggest that we emulate the competition in this respect.

What is needed now is a systematic and objective review of the impact of foreign investment on the United States. Lacking such an analysis, policy-makers are more likely to be swayed by the pleadings of the complacent and the anxious rather than by a pragmatic and accurate grasp of reality.

Copyright (c) 1989 by J. A. O'Connell

For other articles by Jock O'Connell