C 59.2: F 76/6/ UPDATE/997 Foreign Direct Investment in the United States: An Update Review and Analysis of Current Developments A Report to the U.S. Congress in Response to Section 3(a) of the Foreign Direct Investment and International Financial Data Improvements Act of 1990. "^^TES o* U.S. Department of Commerce Economics and Statistics Administration Office of the Chief Economist September 1997 ^ 2 J m? ■■ {^°cuments Cotetiof) u-o. Depos!tOf7 Copy Foreign Direct Investment in the United States: An Update Review and Analysis of Current Developments A Report Submitted to the Committee on Energy and Commerce, the Committee on Ways and Means, and the Committee on Foreign Affairs of the House of Representatives, to the Committee on Finance, the Committee on Commerce, Science and Transportation, and the Committee on Foreign Relations of the Senate, and to the Joint Economic Committee of the Congress in Response to Section 3(a) of the Foreign Direct Investment and International Financial Data Improvements Act of 1990. U.S. Department of Commerce Economics and Statistics Administration Office of the Chief Economist September 1997 AKNOWLEDGEMENTS Foreign Direct Investment in the United States: An Update was issued under the direction of Lee Price, Acting Under Secretary for Economic Affairs of the Economics and Statistics Administration, U.S. Department of Commerce. Project directors of this report were initially Sumiye Okubo, at that time, the Director of the Office of International Macroeconomic Analysis and subsequently Carl E, Cox, the Director of the Office of Economic Conditions. Review and editing of the report was provided by Lester A. Davis of the Office of International Macroeconomic Analysis. Chapters 2, 3, 4 and 6 of the report were reproduced with minor editing from various recent issues of the Survey of Current Business, the monthly publication of the Bureau of Economic Analysis (BEA) of the Economic and Statistics Administration. Chapter 2 was prepared under the direction of Christopher L. Bach, Chief of BEA' s Balance of Payments Division. Chapters 3, 4, and 6 were prepared under the direction of Betty L. Barker, former Chief, and R. David Belli, Chief, of BEA' s International Investment Division. Authors of the individual chapters are indicated on those pages. Questions concerning the content of this report should be directed to the Office of the Chief Economist, Room 4868, U.S. Department of Commerce, Washington, DC. 20230. Phone:(202)482-1675. 11 FOREIGN DIRECT INVESTMENT IN THE UNITED STATES Review and Analysis of Current Developments '^ ' CONTENTS Page 1. Introduction and Overview, by Sumiye Okubo 1 2. The International Investment Position of the United States in 1995, by Russell B. Scholl 8 3. The Foreign Direct Investment Position in the United States on a Historical Cost Basis: Country and Industry Detail for 1995 and Changes in Geographic Composition Since 1982, by Sylvia E. Bargas 15 4. Foreign Direct Investment in the United States: New Investments in 1995 and Affiliate Operations in 1994, by Mahnaz Fahim-Nader and William J. Zeile. ... 21 5. Foreign-Owned U.S. Firms' U.S. Merchandise Trade, by Lester A. Davis 37 6. Differences in Foreign-Owned U.S. Manufacturing Establishments by Country of Owner, by Ned G. Howenstine and Dale P. Shannon 57 7 and 8: US-EU Foreign Direct Investment and Trade between US and EU Related Parties 77 7. US-EU Foreign Direct Investment, by Johanna L. Barraza 79 8. US-EU Goods and Services Trade between Related Parties, by Lester A. Davis . 93 9. Effects of Foreign Direct Investment in the United States on U.S. Technology Development, by Sumiye Okubo 127 APPENDIX Glossary of Foreign Direct Investment Terms 146 Pennsylvania State UniVe/s/fu iibrams NOV 2 1 mi Documents Collection U.S. Depository Copy 111 I Introduction and Overview Bv Sumive Oku bo ^ The rapid increase in foreign direct investment in the United States (FDIUS) in the 1980s raised serious concerns about possible negative impacts of foreign ownership of U.S. firms on the U.S. economy, employment, and technology competitiveness. The direct investment inflow surged in the late 1980s, peaked in 1989, dropped sharply between 1989 and 1992, and rose sharply between 1992 and 1995 ~ the last year covered in this report. Although media coverage has decreased since the 1989-92 decline in foreign direct investment inflows, the importance and effects of FDIUS continue to be of interest to policy makers. This is the fourth in the series of Congressionally mandated reports on foreign direct investment in the United States by the U.S. Department of Commerce. The report reviews changes in patterns and trends in foreign direct investment in the United States (FDIUS) and its impact on the U.S. economy. It updates previously reported information on FDIUS, including recent changes in stocks and flows, the operations of U.S. afFiHates of foreign firms and their international trade, and their acquisition and establishment of new affiliates.^ It analyzes the ' When this chapter was drafted, Director, Office of International Macroeconomic Analysis, Office of the Chief Economist, Economics and Statistics Administration, U.S. Department of Commerce; on June 22, 1997, became Associate Director for Industry Economics of the Bureau of Economic Analysis, Economics and Statistics Administration, U.S. Department of Commerce. ^ This report reproduces in Chapters 2,3,4 and 6 the most recent articles previously released by the Bureau of Economic Analysis in its monthly Survey of Current Business at the time this report was being drafted. The data on which these articles and the other chapters in this report characteristics of foreign-owned U.S. affiliates, using results of the Bureau of Economic Analysis (BEA)-Census data link project for 1991. The report also provides special coverage of bilateral related-party FDI flows and trade between U.S. and European Union (EU) parent and affiliate firms. Lastly, it assesses the influence of foreign direct investment on the U.S. development and transfer of technology. This report is required under the Foreign Direct Investment and International Financial Data Improvements Act of 1990, which seeks to improve information available on FDIUS to the U.S. Congress and the general public. To improve U.S. Government data on foreign direct investment, the legislation permits the Bureau of Economic Analysis (BEA) to exchange confidential data on FDIUS with the Bureau of the Census and the Bureau of Labor Statistics (BLS), and the Bureau of the Census to share its data on foreign-owned establishments with BEA. Each of the three previous reports reviewed developments in direct investment in major world economies, and trends in FDIUS and in the operations of U.S. nonbank and bank affiliates of foreign firms. The first report^ focused on definitions and measurement issues, macroeconomic and microeconomic theories of international investment, portfolio and direct are based were current at the time they were drafted. U.S. Department of Commerce, Economics and Statistics Administration, Office of the Chief Economist, Foreign Direct Investment in the United States: Review and Analysis of Current Developments— A Report in Response to a Request by the U.S. Congress, Washington, D.C., August 1991. investment flows, and the characteristics and performance of U.S. affiliates of foreign firms, in general, and in the five key sectors in which foreign ownership was the most significant- electronics, automobiles, steel, chemicals, and banking. The second report'* examined three widely and fi-equently raised issues about FDIUS: (1) the impact of U.S. affiliates on U.S. trade performance, (2) the influence of U.S. affiliates of foreign companies on U.S. technology development and transfer; and (3) the extent to which foreign-controlled companies shift their income away from the United States through transfer pricing practices. The third report^ highlighted new information available from the 1992 benchmark survey of FDIUS conducted by BEA, and examined the characteristics of U.S. affiliates by detailed industry groups, using the BEA-Census data link results for 1989 and 1990. In addition, it analyzed the occupational structure of foreign-owned manufacturing establishments, based on the results of the BEA-BLS data link project. Key Findings of This Report Foreign direct investment in the United States and the U.S. affiliates of foreign firms plays an increasingly important role in the U.S. economy. • The accumulated value of foreign direct investment in the United States rose between 1990-1995. The pace of accumulation picked up in 1993-95. This pickup reflects U.S. Department of Commerce, Economics and Statistics Admmistration, Office of the Chief Economist, Foreign Direct Investment in the United States: An Update, June 1993. U.S. Department of Commerce, Economics and Statistics Administration, Office of the Chief Economist, Foreign Direct Investment in the United States: An Update, January 1995. inflows to acquire existing firms, to establish new U.S. affiliates, and to expand existing U.S. affiliates. In 1995, the United Kingdom was the largest foreign direct investor in the United States (24 percent of the total), followed by Japan (19 percent), and the Netherlands (12 percent). In the U.S. manufacturing sector, foreign direct investment in U.S. firms tends to be in larger establishments. As is typical of larger establishments, these foreign-owned firms tend to employ higher skilled workers, to pay higher wages, and have higher labor productivity. These differences vary by country of ownership and industry, especially with respect to plant size and labor productivity. U.S. affiliates of foreign firms continue to account for a substantial share of total U.S. merchandise exports and imports and a dominant share of the overall U.S. merchandise trade deficit, accounting for more than 50 percent of the total U.S. merchandise trade deficit. Most of their international trade and their trade deficit are accounted for by firms in the U.S. wholesale trade sector. This reflects the significant use of U.S. affiliates to facilitate the distribution in the United States of products produced by the foreign parent companies. US and EU parent firms are major bilateral direct investors in affiliates in the European Union and in the United States, respectively. Moreover, the EU-owned shares of total FDIUS are larger than the EU shares of total U.S. merchandise trade. Bilateral US-EU direct investments increased rapidly over the past ten years, reaching record levels in 1995. The trade between US-EU related parties is a major factor in the overall trade between the two regions, and ownership of foreign affiliates is a key determinant of overall US-EU bilateral trade, accounting for nearly half of that total. • During the 1987-94 period, the U.S. affiHates' share of all U.S. firms' sales in high-technology industries was roughly double the size of their share of all U.S. sales in non-high technology manufacturing industries. In 1994, their shares were 24.8 percent and 12.9 percent respectively. Moreover, the afifiUates' share of sales in both industry groups rose substantially during that period. Nevertheless, over the period their share of total U.S. sales in non- high technology industries nearly doubled (from 6.8 percent to 12.9 percent) while their share of total U.S. sales in high- technology manufacturing industries rose from 17.4 percent to 24.8 percent. Deflning foreign direct investment Foreign investment is classified into two categories: direct and portfolio. Foreign investment is defined as direct when a foreign person or business directly or indirectly owns or controls ten percent or more of the voting securities of an incorporated U.S. business enterprise, or an equivalent interest in an unincorporated U.S. business enterprise. This definition of direct investment is specified in the International Investment and Trade in Services Survey Act.^ The ten-percent or more equity interest is deemed an indication of a long-term interest in, and a measure of influence over, the management of a firm. FDIUS includes investment in U.S. firms by foreign governments and private foreign investors. (See also the appendix of this report for a glossary of foreign direct investment terms.) Portfolio investment is any investment that is not direct investment, it can be in the form of bank accounts, bonds, or investments in securities amounting to less than 1 percent voting interest in a U.S. business enterprise. Update on foreign direct investment in the United States The pace of FDIUS inflows accelerated in the late 1980s, peaked in 1989, dropped sharply between 1989 and 1992, and rose again between 1992 and 1995. The value of net FDIUS inflows reached $60.2 billion in 1995, nearly as high as the $67.7 billion peak in 1989 (Figure 1-1). Figure 1-1 Net Inflow of Foreign Direct Investment in the United States, 1982-95 1982 84 86 Source: Bureau of Economic Analysis In 1995, the overall foreign direct investment position rose 1 1 percent on a historical cost basis, compared with a rise of 8 percent in 1 994 and a 9- percent increase in 1993 — considerably higher than the 2-percent increase in 1992, but still lower than the 16-percent average annual rate of growth seen during the 1982-90 period (Figure 1-2). On ^ Prior to 1 974, the percentage cutoff was 25 percent. Figure 1-2 FDI Position in the United States, by Type of Valuation Basis, 1994 & 1995 Billion % I Histoncal cost 1.000 - 13 Cirrent cost n Market value 1994 Source, Bureau of Economic Analysis. Table I -I Foreign Direct Investment Outlays, 1989-95 (billions of dollars) 1989 1990 199! 1992 1993 1994* 1995** Investment, total 71.2 65.9 25.5 15.3 26.2 45.6 54.4 By type of outlay: Acquisitions Establishments 59.7 11.5 55.3 10.6 17.8 7.7 10.6 4.7 21.8 4.5 38.8 6.9 46.5 7.9 By type of Investor: Foreign direct investors US affiliates 22.5 48.6 14.0 51.9 8.9 16.7 4.1 11.3 6.7 19.5 13.6 32.0 11.3 43.1 ^revised; **preliminary Note: data may not add to totals due to rounding. Source: Bureau of Economic Analysis, Economics and Statistics Administration, U.S. Department of Commerce. a current cost basis, the 1995 increase in the foreign direct investment position in the United States was $58,7 billion (to $638.5 billion), and on a market value basis, $247.3 billion (to $1,019,2 billion). Almost all of the difference in current cost versus market value increases is accounted for by price increases in owners' equity due to year-end 1994-95 stock price increases. Outlays for acquisitions of existing U.S. firms and establishments of new firms slowed down after the 1980s, falling steadily between 1989 and 1992, with the rate of decline in acquisitions falling twice as fast as that for new establishments. Foreign investors increased outlays for acquiring and establishing US. business enterprises in 1993, 1994, and 1995 (Table 1-1). As in the past, most of the outlays were to acquire existing firms. In 1995, the United Kingdom remained the largest foreign direct investor in the United States, with a cumulative investment position of $132,3 billion or 24 percent of the total, after surpassing Japan in 1994 as the largest foreign investor. In 1995, Japan was the second largest investor, with $108,6 billion, or 19 percent of the total, followed by the Netherlands, with $67,7 billion or 12 percent of the total (Figure 1-3). Figure 1-3 Foreign Direct Investment Position in the United States, Historical Cost Basis, Year-end 1995 Japan 19 4% Netherlands 12,1% United Kingdom 23.6% Other 44,9% Source: Bureau of Economic Analysis. Operations of foreign-owned U.S. affiliates accelerate The value added (gross product originating) of US, affiliates grew rapidly in 1993 and 1994. After dipping in 1992, the affiliates' gross product grew 7 percent in 1993 and 12 percent in 1994,^ the fastest since 1989. In comparison, the total value added of all U.S. private firms grew 5.2 percent in 1993 and 6.2 percent in 1994. Much of the increase in the affiliates' gross product in 1994 is due to the strong growth of operations of existing affiliates, rather than new investments, which account for about two-fifths of the total rise. This growth is reflected in the relative importance of U.S. affiliates in the U.S. economy. U.S. affiliates of foreign firms accounted for a rising share of the U.S. economy, increasing from a 5.9 percent share of U.S. GDP in 1992 to 6.0 percent in 1993 and 6.2 percent in 1994. The affiliates' share of U.S. GDP in 1994 was almost triple their 2.3 percent share in 1977 and substantially higher than their 4.5 percent share in 1987. Other aspects of the operations of foreign- owned U.S. affiliates also increased. • In 1994, U.S. affiliates' sales rose 9 percent. • Expenditures for new plant and equipment increased by 3.1 percent in 1993 and 8.0 percent in 1994, compared to a 12. 1 percent drop in 1992. • Employment in nonbank affiliates increased 1.1 percent in 1993 and 2.1 percent in 1994, after declining 3.2 percent in 1992 ~ the first decline since 1977. The affiliates' share of total U.S. employment rose steadily from 1.8 percent in 1977 to 5.3 percent in 1991, but remained flat at 5.1 in 1992, and edged down to 5.0 percent in 1993 and 1994. • Reported after-tax net income of nonbank affiliates rose to a new high of $13.4 billion in 1994, reversing four consecutive years of losses between 1990 and 1993. This sharp increase in operating profits reflected strong sales growth and a slow down in the growth Real gross product growth rates for these affihates are not available for 1993 and 1994, but these nominal growth rates were higher than the overall U.S. inflation rates of 2.6 percent in 1 993 and 2.2 percent in 1 994. Growth of gross product of all U.S. firms is also in nominal terms. of operating expenses, especially in employee compensation. Differences between foreign-owned and US- owned U.S. manufacturing establishments A comparison of the characteristics of foreign-owned and US-owned firms in the United States shows several significant differences. This comparison is based on the linked BEA and Census data on the operations of foreign-owned U.S. establishments in 1991, the most recent year available for these linked data. The data provide new, more detailed information about the nature of foreign-owned operations in the United States than is reflected in the previously reported data at the more aggregate enterprise level. The analysis examines the importance of country of ownership in explaining differences in industry mix and operating characteristics, and covers establishments owned by investors from six major countries ~ Canada, France, Germany, Japan, the Netherlands, Switzerland, and the United Kingdom. Compared to US-owned manufacturing establishments, foreign-owned manufacturing establishments tend to be much larger. That difference may account for the fact that they pay higher wages and have higher productivity (as measured by value added per production-worker hour). • The average plant size, or scale, of establishments of all six countries is much larger— twice as large when industry mix is taken into account— than that of US-owned establishments, particularly for Netherlands-, Japanese-, and German-owned establishments. • Compensation per employee in foreign- owned establishments is higher than for US- owned establishments, as foreign-owned firms tend to be concentrated in high-wage U.S. industries. It is especially high in Japanese-owned establishments, which on average pay 23 percent more than US- owned establishments in the same industry. • Foreign-owned establishments tend to concentrate in high labor-productivity industries (measured as value added per production worker hour), compared to US- owned establishments. Within industries, differences in productivity among establishments of the six countries appear to be mainly attributable to differences in plant size, capital intensity, employee skill levels, and location. Trade and foreign direct investment U.S. aflfiUates of foreign companies play an important role in U.S. trade. • In 1994, foreign-owned firms accounted for 22 percent of total US. exports, 33 percent of total U.S. imports, and for 70 percent of the overall merchandise trade deficit of all U.S. firms. • The U.S. merchandise trade deficit of foreign-owned U.S. firms reached a record $105.4 billion in 1994. • In recent years, affiliates that are largely or primarily wholesalers have accounted for about two-thirds of the total U.S. merchandise trade deficit of all foreign- owned U.S. firms. • Japanese-owned U.S. firms accounted for a large share of total U.S. merchandise trade deficit of foreign-owned U.S. firms (53 percent in 1994) and over half of the 1990- 94 rise in the deficit, even though the volume of their auto imports from Japan decHned. An examination of the linkages between bilateral US-EU direct investments and their relationship to overall bilateral US-EU trade performance shows that these linkages account for large shares of total U.S. exports and imports with all countries and even larger shares of total FDI in the United States and abroad. • The U.S. and EU parent firms are major bilateral direct investors in affiliates in the European Union and in the United States, respectively. These bilateral investments account for very large and growing shares of the total U.S. and EU FDI positions (accumulated values of stock of those investments) with all countries and reaching record levels in 1995. These shares of each others' total FDI are larger than their shares of each others' total merchandise trade. • Ownership of foreign affiliates is a key determinant of overall US-EU bilateral trade performance, as trade between related parties accounted for nearly one-half of the total bilateral US-EU trade. • From the perspective of the investor country, US-EU bilateral trade balances between U.S. parent firms and their EU affiliates and between EU parents and their U.S. affiliates have been in substantial surplus, which suggests that US-EU foreign direct investment has led to these export surpluses. • Total trade in goods between U.S. and EU related parties is roughly 5 times larger than trade in services. In recent years, US-EU related-party trade has incurred a small deficit in goods trade ($8.3 billion in 1993) and a nearly equal surplus in services trade. FDI and U.S. technology Recent data provide several insights into the relationship between foreign ownership of U.S. firms and U.S. technology developments in terms of the concentration of the foreign-owned affiliates' sales in high-technology industries, their R&D spending and the inflows and outflows of technology between the affiliates and their foreign parents. The data show that the U.S. affiliates' share of all U.S. firms' sales in high-technology industries is roughly double their share of all U.S. sales in non-high technology manufacturing industries. However, their share in non-high technology industries is growing more rapidly. When examined separately by manufacturing industry, the R&D spending to sales ratios (R&D intensities) of U.S. affiliates tend to be lower than that of US-owned firms. Because foreign investment is more concentrated in high- technology industries, the overall R&D intensity of U.S. affiliates was about the same ~ 3 percent —as that for US-owned firms in 1994. The dollar amount of affiliate R&D spending in manufacturing industries doubled between 1987 and 1994~rising at twice the pace of R&D spending by US-owned manufacturing firms, and increasing the affiliates' share of total U.S. R&D spending in manufacturing industries from 1 1 to 16 percent over that period. This very large rise in affiliates' R&D spending partly reflects the large number of foreign acquisitions of existing U.S. firms, along with increases in R&D by existing U.S. affiliates. The data on royahies and fees received by the affiliates from their foreign parents and on the affiliates' payments to them suggest that there has been a large net inflow of technology to the affiliates from their parents. However, their receipts (technology outflows) have been rising at a far more rapid pace than their payments (technology inflows). The International Investment Position of the United States in 1 995 Bv Russell B. Scholl The net international investment position of the United States at year-end 1995 was -$814.0 billion with direct investment valued at the cuiTent cost of tangible assets, and it was -$773.7 billion with direct investment valued at the cuiTent stock-market value of owners' equity (Table 2.1 and Figure 2.1). For both measures, the value of foreign assets in the United States continues to exceed the value of U.S. assets abroad. However, for direct investment valued on both bases, U.S. assets abroad continue to exceed foreign assets in the United States. For all other assets combined, foreign holdings in the United States substantially exceed U.S. holdings abroad, mostly reflecting large foreign private Table 2. 1 Summary Components of the U.S. Net Position (Billion $) 1994 1995 Net position: At current cost . -580.1 . -492.5 . -301.3 -8 1 4.0 At market value -773.7 US Government and foreign official assets -420.3 Direct investment: At current cost 1 99.5 24 1 .6 At market cost 287.0 281.9 US and foreign securities -463.2 -665.8 Bank and nonbank-reported claims and liabilities -15.0 30.5 and official holdings of U.S. bonds. The net position on both bases became more negative, primarily as a result of large net capital inflows to the United States in 1995 and as a result of greater price appreciation in U.S. securities than in foreign securities (Table 2.2). Price appreciation was more pronounced on the market-value basis than on the cuiTent-cost basis, because the relatively steep rise in U.S. stock Figure 2.1 Net International Investment Position of the United States, 1982-95 Trillion $ (2) With direct Investment position valued at current cost 1982 84 86 88 Trillion $ 90 92 94 95 4 3 2 1 (1) With direct investment position valued at market value Foreign Assets In US ^ — US Assets Abroad 1982 84 86 88 94 95 ' The author is an economist in the Balance of Payments Division , Bureau of Economic Analysis, Economics and Statistics Administration, U.S. Department of Commerce. This chapter was previously published as an article in the S\tn'ey of Current Business, July 1996. See that article for data not included in this chapter. Harlan W. King directed the preparation of estimates other than those of direct investinent; major contributors were Cliristopher A. Gohrband, Dena A. Holland, and Lori A. Trawinski. 8 Table 2.2 Changes in the Net International Investment Position, 1995 (Billion $) Current cost Market value Total change -233.9 -28 1 .2 Capital flows -116.6 -116.6 Price changes -119.9 -194.5 Exchange rate changes . . 6.5 27.4 Other valuation changes . -3.9 2.6 reduced cost of borrowing in the United States and the increase in U.S. corporate earnings. Foreign direct investment inflows strengthened with the continued growth in foreign acquisitions of U.S. businesses and strong affiliates' earnings. These private capital inflows were augmented by a record build-up in foreign official holdings of U.S. dollar assets. This article presents the major changes in U.S. assets abroad and in foreign assets in the United States, including direct investment valued both at current cost and at market value. prices not only increased the value of foreign portfolio holdings of stocks but also increased the value of foreign direct investment in the United States. The increase in the negative position was moderated by the appreciation of most European currencies against the U.S. dollar between year- end 1994 and year-end 1995, which increased the value of U.S. direct investment in Western Europe. In 1995, U.S. assets abroad increased sharply, following a slowdown in 1994. U.S. direct investment outflows reached record levels, bolstered by a surge in reinvested earnings that reflected strong affiliate profits abroad and high rate of reinvestment and by numerous large acquisitions. U.S. portfolio diversification into foreign securities, mainly by U.S. pension and mutual funds, strengthened with the recovery in stock and bond prices abroad and with relatively strong corporate earnings. In addition, U.S. bank-reported outflows recovered somewhat. Foreign assets in the United States increased substantially, buoyed by record net foreign purchases of U.S. bonds as U.S. bond markets rallied throughout most of the year. U.S. bond prices recovered strongly during 1995, as the slowdown in U.S. economic growth and the easing of U.S. inflation concerns contributed to a steep decline in U.S. long-term interest rates. Foreign net purchases of U.S. stocks accelerated, reflecting a large direct investment acquisition through an exchange of stock; in addition, holdings were augmented by the sharp rise in U.S. stock prices, which partly reflected the Changes in U.S. Assets Abroad Bank claims U.S. bank-reported claims increased $69.0 billion in 1995, to $761.3 billion, the first sizable increase in 5 years. Much of the increase reflected lending by U.S. securities brokers and dealers to international bond funds in the Caribbean and the United Kingdom through resale agreements to finance purchases of U.S. bonds. The increase also reflected a moderate recovery in bank lending, mostly by European-owned banking offices in the United States. In contrast, U.S. -owned banks in the United States reduced their claims on foreigners. International lending by U.S. -owned banks was sluggish despite the pronounced acceleration in international lending by banks worldwide, partly because of continued competition with efficient (low-cost) capital markets abroad. In addition, U.S. -owned banks were concerned about the riskiness of international loans and the persistence of especially low margins on international syndications. U.S. banks' claims on foreign banks payable in dollars increased $39.8 billion, to $526.1 billion. Lending by U.S. securities brokers and dealers to international bond funds in the Caribbean and the United Kingdom accounted for much of the increase (Table 2.3). U.S. banks' lending was moderate to affiliated offices in Western Europe, where mergers and acquisitions bolstered demand for bank credit. Lending was also moderate to Caribbean and Asian offices, where loan demand from emerging countries was buoyed by economic growth. In contrast, net repayments from unaffiliated banks abroad, mostly in the second half of the year, reflected a cutback in interbank lending by Japanese-owned banks in the United States. As a result of their mounting financial problems, Japanese banks encountered a large risk premium on borrowed funds in the interbank market that constrained their incentive to lend to that market. Table 2.3 U.S. Claims Reported by U.S. Banks (Billion $) 1994 1995 Total bank-reported claims .... 692.3 761.3 Bank own claims, payable in dollars... 486.3 526.1 On unaffiliated foreign banks I I 1.7 98.5 On own foreign offices 283.5 304.0 On other foreigners 91.1 123.6 Bank customer claims in $ 135.1 154.5 Total claims in foreign currency . 70.9 80.7 U.S. banks' foreign currency claims increased $9.8 billion, to $80.7 billion, mostly in the first half of the year when the dollar depreciated in exchange markets and when foreign currency lending by foreign-owned U.S. offices to Western Europe and Japan accelerated. U.S. banks' domestic customers' claims payable in dollars increased $19.4 billion, to $154.5 billion, as customers shifted from a large increase in deposits with banks overseas in 1994 to a large increase in purchases of foreign commercial paper placed in the United States (mostly by Europeans) in 1995. Foreign securities U.S. holdings of foreign securities increased $165.5 billion, to $721.7 billion, as an acceleration in U.S. net purchases during the recovery of stock and bond prices abroad in 1995 was augmented by significant price appreciation in the holdings (Table 2.4). Small exchange rate depreciation from year-end 1994 to year-end 1995 reflected nearly offsetting changes; British, Japanese, and Latin American currencies depreciated against the dollar, while several Western European cun^encies appreciated. Table 2.4 Changes in U.S. Holdings of Foreign Securities, 1995 (Billion $) Total change 1 65.5 Net U.S. purchases 99.0 Price changes 68.2 Exchange rate changes -1.6 U.S. holdings of foreign stocks increased $87.1 billion, to $41 1.1 billion; net purchases of $50.7 billion in 1995~the second strongest year on record—and price appreciation of $38.6 billion more than accounted for the increase. Exchange rate losses were small. U.S. investors, especially pension and mutual funds, stepped up their purchases of Japanese and European stocks considerably as prices recovered in those countries. Net purchases of emerging countries' stocks, particularly those of Asian countries, remained strong (Table 2.5). • Holdings of European stocks were bolstered by $21.3 billion in net purchases and $23.4 billion in price appreciation. Beginning in the second quarter, U.S. net purchases accelerated as economic growth and rising corporate earnings contributed to stock price increases of 12-13 percent ft-om year-end 1994 to year-end 1995. Exchange rate appreciation of several currencies also encouraged net purchases. • Holdings of Japanese stocks surged, reflecting a step-up to $19.4 billion in net purchases, mainly in the second half of the year when stock prices recovered sharply. Price appreciation of $6.1 billion 10 was largely offset by $5.2 billion in exchange rate depreciation of the yen, which occuiTed mostly in the second half of the year. Holdings of stocks from other Asian countries, mostly emerging countries, increased as a result of continued strong net purchases~$8.3 billion— and sizable price appreciation~$10.7 billion. Holdings of Latin American stocks declined, principally as a result of a $4.8 billion exchange rate loss. Table 2.5 U.S. Holdings of Foreign Stocks by Major Areas (Billion $) 1994 1995 Change Total holdings 324.0 411. 1 87.1 Western Europe ... . 142.1 186.8 44.7 Of which: United Kingdom . . 44.5 58.1 13.6 France 17.3 21.0 3.7 Germany 25.5 30.0 4.5 Netherlands 20.0 26.3 6.3 Canada 25.0 29.0 4.0 Japan 69. 1 90.4 2 1 .3 Latin America 22.6 20.3 -2.3 Of which: Mexico 15.9 12.8 -3.1 Other countries 65.2 84.6 19.4 U.S. holdings of foreign bonds increased $78.4 billion, to $310.7 billion, reflecting $48.3 billion in net purchases and $29.6 billion in price appreciation. Foreign new issues in the United States were sti'ong at $39.4 billion; however, they were down from the 1994 level, reflecting the large risk premiums that were placed on most issues of Latin American and other emerging countries after the Mexican peso crisis at the end of 1994. U.S. purchases of European and Canadian issues continued strong, accounting for nearly 60 percent of the new issues. Private coiporations accounted for three-fourths of new issues placed with U.S. investors; U.S. investors avoided new issues by governments in many emerging market countries. Redemptions were $10.6 billion. Net purchases of outstanding bonds were $19.5 billion, in contrast to net sales in 1994; net purchases were mostly in British gilt-edged bonds and, to a much lesser extent, in Japanese bonds. U.S. direct investment abroad and other private assets U.S. direct investment abroad at cun-ent cost increased $100.8 billion, to $880.1 billion; at market value, it increased $242.2 billion, to $1,301.1 bilHon (Table 2.6). Capital outflows surged to a record $95.5 billion, bolstered by numerous large acquisitions of affiliates in several countries, particularly in Europe: Net equity outflows nearly tripled to $36.3 billion; reinvested earnings increased substantially to $54.5 billion, reflecting growth in foreign affiliates' earnings and the share of those earnings reinvested; and intercompany debt outflows remained small at $4.7 billion. Record total outflows were encouraged by strong domesdc profits of U.S. parents, which reduced the need to repatriate earnings from affiliates abroad. In addition, lower borrowing costs resulfing from declining U.S. interest rates may have encouraged cross-border expansion. Table 2.6 Changes in U.S. Direct Investment Abroad, 1995 (Billion $) Current Market cost value Total change 1 00.8 Capital outflows 95.5 Equity capital 36.3 Intercompany debt 4.7 Reinvested earnings 54.5 Price changes 6.4 Exchange rate changes 6.3 Other valuation changes -7.4 242.2 95.5 36.3 4.7 54.5 I 17.8 27.2 1.7 At current cost, the position increased mostly as a result of capital outflows, which were augmented by small adjustments for price appreciadon in affiliates' capital equipment, 11 inventories, and land and exchange rate appreciation of European currencies. At market value, capital outflows were augmented by a substantial increase in the U.S. owners' equity that resulted from the worldwide recovery in stock prices fi^om year-end 1994 to year-end 1995 and by appreciation of European currencies. U.S. claims on unaffiliated foreigners reported by U.S. nonbanking concerns increased $37.5 billion, to $311.1 billion, mainly from continued heavy deposits in banks in the Caribbean and Europe. In 1995, overseas offices of foreign-owned banks in the United States drew heavily on U.S. funds to finance their loans to U.S. nonbank boiTowers. In contrast, in 1994, offices overseas of foreign-owned banks in the United States loaned their U.S. -borrowed funds to related banking offices in the United States, where loan growth surged. U.S. official reserve assets and other U.S. Government assets U.S. official reserve assets increased $12.7 billion, to $176.1 billion, mostly reflecting an increase in foreign cun-ency holdings. U.S. authorities' large acquisitions of Mexican pesos under reciprocal cunency aiTangements with Mexican authorities were only partly offset by sales of German marks and Japanese yen. In addition, price appreciation of gold and exchange rate appreciation on holdings of Gennan marks added to the increase in reserve assets. U.S. Government assets other than reserve assets increased $0.3 billion, to $81.5 billion; increases in credit disbursements slowed and were largely offset by repayments. The increase in U.S. Government assets included the acquisition of outstanding claims on the former Soviet Union from U.S. banks under credit guarantee programs, but these acquisitions were only half those in 1994. Changes in Foreign Assets in the United States Foreign official assets Foreign official assets in the United States increased $131.9 billion in 1995, to $677.9 billion, as record capital inflows were augmented by price appreciation, mostly in holdings of U.S. Treasury securities. Developing countries (including OPEC countries) acquired $86.7 billion of U.S. assets, reflecting large accumulations of dollar reserves by several countries in Latin America and Asia. Industrial countries acquired $23.1 billion, primarily reflecting exchange market intervention purchases of dollars in the first half of the year. Bank liabilities U.S. bank-reported liabilities to private foreigners and international financial institutions increased $25.3 billion, to $809.0 billion, a marked slowdown fi^om heavy borrowing fi^om abroad in 1994. The slowdown was partly due to reduced growth in U.S. demand for domestic bank credit as the U.S. economic expansion slowed, and it was partly due to a switch by foreign investors to U.S. Treasury securities as U.S. bond prices rose. U.S. banks' liabilities payable in dollars increased $4.3 billion, to $666.6 billion, reflecting a significant cutback in U.S. banks' overseas borrowing from the previous year's record (Table 2.7). U.S. -owned banks, after heavy reliance on overseas funding in 1 994 when U.S. demand for bank credit surged, reduced their liabilities, primarily with affiliated offices in Europe and the Caribbean. More than offsetting that decrease, foreign-owned banks in the United States increased their liabilities, mostly on affiliated foreign offices in Japan and other Asian counti-ies. Japanese-owned U.S. offices drew on home office fiinds to replace funds withdrawn by unaffiliated foreign banks, as the imposition of risk premiums on Japanese banks raised the cost 12 of their interbank funding. Other foreign-owned banks in the United States drew funds from unaffiliated banks in Latin America and Asia (except Japan) to re-lend to home offices abroad. An increase in dollar liabilities to nonbank foreigners mainly reflected borrowing by U.S. brokers and dealers through repurchase agreements with Caribbean residents and bank Table 2.7 U.S. Liabilities Reported by U.S. Banks (Billion $) 1994 Total liabilities 783.7 Bank own liabilities, payable in dollars 662.3 To unaffiliated foreign banks ... 1 70.6 To own foreign offices 395.6 To other foreigners 96. 1 Bank custody liabilities 3 1 .7 Total liabilities payable in foreign currencies 89.7 1995 809.0 666.6 171.9 392.2 102.5 30.1 112.3 deposits from Latin American residents. Other U.S. bank-reported liabilities, mostly payable in foreign currencies, increased $25.3 billion, to $142.4 billion; this increase also primarily reflected activities of foreign-owned banks in the United States. Their borrowing and lending in foreign currencies with Japan and Westem Europe accelerated in the first half of the year when the dollar depreciated in exchange markets. markets in the second half of the year. Japanese holdings increased substantially; strong purchases early in the year, mostly reflecting the large yield advantage of U.S. bonds over Japanese bonds, more than offset large sales in the latter part of the year that were attributable to the weakness of Japanese financial institutions. Westem European holdings increased, reflecting the rise in U.S. bond prices and large net purchases for the year, but there was some profit-taking in the fourth quarter. Caribbean holdings, largely by international bond mutual funds, also increased as a result of strong purchases, some of which were financed by bon^owing from U.S. brokers and dealers through repurchase agreements. Latin American holdings increased, partly reflecting local concerns that arose from financial problems Table 2.8 Changes in Foreign Holdings of U.S. Treasury Securities, 1995 (Billion $) Total change Net foreign purchases Price changes Exchange rate changes 122.4 99.3 23.2 -0.2 associated with the Mexican peso crisis at the end of 1994. Other U.S. securities U.S. Treasury securities Foreign holdings of U.S. Treasury securities increased $122.4 billion, to $389.0 billion, reflecting record net purchases and large price appreciation in U.S. Treasury bonds (Table 2.8). Net purchases were nearly three times the 1994 level and exceeded the previous record 1992 level, as U.S. bond prices rose more steeply than foreign bond prices and as the falling yield curve on dollar instruments attracted investment into long-term dollar instruments. Foreigners were also attracted by the dollar's recovery in exchange Foreign holdings of U.S. securities, other than U.S. Treasury securities, increased $245.8 billion, to $998.6 billion, reflecting record net purchases of U.S. bonds and sizable price appreciation of U.S. stocks (Table 2.9). Holdings of U.S. corporate and federally-sponsored agency bonds increased $1 19.3 billion, to $533.2 billion, as a result of strong net foreign purchases and a sharp rise in U.S. bond prices. U.S. borrowers issued a record amount of new bonds, mainly in the international bond market in response to declining bond interest rates. U.S. banking and other financial corporations were the largest 13 borrowers; most of the issues were straight fixed-rate bonds, though some were floating-rate notes. Nearly two-thirds of the issues were payable in U.S. dollars; most of the rest were payable in Japanese yen, Gennan marks, or Swiss francs. U.S. federally-sponsored agencies Table 2.9 Changes in Foreign Holdings of Other U.S. Securities. 1995 (Billions of dollars] Total change 245.8 Net foreign purchases 95.3 Price changes 1 49.5 Exchange rate changes Lj_ acquisitions; reinvested earnings increased to $13.3 billion, reflecting an increase in earnings after last year's retum to profitability after several years of losses; and intercompany debt inflows decreased to $7.4 billion. Capital inflows were encouraged by confinued economic expansion in the United States, by strong earnings growth of U.S. affiliates, by foreign parents' improved financial condition as a result of economic expansion abroad, and by the global consolidation in several industries, especially the health-care industry. At cuiTent cost, valuation adjustments were small and mostly offsetting. At market value, a large valuation adjustment reflected the price increase in owners' equity due accelerated their overseas issues, partly to broaden their investor base. Foreign holdings of U.S. stocks increased $126.5 billion, to $465.4 billion, largely due to the steep rise in U.S. stock prices. The 3 5 -percent surge in U.S. stock prices outpaced price increases in most other major world markets in 1995, but, the pickup in foreign purchases of U.S. stocks was limited. Net foreign purchases increased to $13.4 billion, but the increase was largely attributable to a portfolio-transaction offset to an exceptionally large foreign acquisition of a U.S. company through an exchange of stock. Net purchases from the United Kingdom and Caribbean accelerated, augmented by a step-up in Euroequity offerings by U.S. companies. Foreign direct investment in the United States and other liabilities Foreign direct investment in the United States at current cost increased $58.7 billion, to $638.5 billion; at market value, it increased $247.3 billion, to $1,019.2 billion (Table 2.10). Bolstered by continued growth in foreign acquisitions, capital inflows strengthened to $60.2 billion, an inflow surpassed only by the record of 1989: Equity capital inflows increased to $39.5 billion, mostly as a result of foreign Table 2.10 Changes in Foreign Direct Investment in the United States, 1995 (Billion $) Current Market cost value 58.7 247.3 60.2 60.2 39.5 39.5 7.4 7.4 13.3 13.3 1.0 187.1 -2.5 Total change Capital inflows 60.2 Equity capital Intercompany debt .... Reinvested earnings .... Price changes Exchange rate changes .... Other valuation changes . . . to the substandal rise in U.S. stock prices from year-end 1994 to year-end 1995. Liabilities to unaffiliated foreigners reported by U.S. nonbanking concerns increased $35.6 billion, to $232.9 billion. The increase represented substantial lending from Caribbean banking offices of foreign-owned banks in the United States to the U.S. nonbank sector, using deposit funds borrowed from the United States. 14 The Foreign Direct Investment Position in the United States on a Historical-Cost Basis: Country and Industry Detail for 1995 and Changes in Geographic Composition Since 1982 By Sylvia E. Bargas ' This chapter presents the country and industry detail underlying the foreign direct investment positions in the United States on a historical-cost basis—the only basis on which such detail is available.' Aggi-egate estimates of the investment positions on the cuiTent-cost and market-value bases are presented in chapter 2. Table 3.1 shows the aggregate direct investment positions on all three valuation bases. On a historical-cost basis, the position grew 11 percent ~ the fastest rate since 1989. That sti'ong growth was largely attributable to a global boom in mergers and acquisitions, which resulted in a substantial number of new direct investments. Favorable economic conditions, including declining interest rates and advancing equity markets worldwide also contributed to the strong gi-owth by providing a source of funds for mergers and acquisitions. In addition, developments in specific industries spurred Table 3.1 Alternative Foreign Direct Investment Position Estimates, 1994 & 1995 (Billion $) Historical Current Market cost cost value 579.8 771.9 58.7 247.3 60.2 60.2 -1.5 187.1 638.5 1,019.2 Position at year-end 1994 502.4 Changes in 1995: Total 57.7 Capital flows 60.8 Valuation adjustments -3.2 Position at year-end 1995^ 560.1 ^ Preliminary investment, particularly the trend towards consolidation in the worldwide pharmaceutical industry. As might be expected, developed countries accounted for the major portion of the increase in ' The author is an economist in the International Investment Division, Bureau of Economic Analysis, Economics and Statistics Administration, U.S. Department of Commerce. This chapter was previously published as part of an article in the Sun'ey of Current Business, July 1996. See that article for data not included in this chapter. The survey from which the data were drawn was conducted under the supervision of Gregory G. Fouch, assisted by Peter J. Fox, Nancy F. Halvorson, Tracy K. Leigh, Beverly E. Palmer, and Linden L. Webber, D. Richard Mauery and Karen Sellami programmed the tables. ^ Estimates on a historical-cost basis largely reflect prices at the time of investment rather than prices of the current or any other period. Historical cost is the basis used for valuation in company accounting records in the United States and is the only basis on which companies can report data in the direct investment surveys conducted by the Bureau of Economic Analysis (BEA). (For consistency, the estimates of earnings and reinvested earnings used in analyzing changes in the historical-cost positions are also on this basis and are not adjusted to current cost; country and industry detail for these items, like the positions, is not available with such an adjustment.) 15 the position. The remainder of the chapter consists of two sections. The first section describes the changes in the position in 1995. The second section summarizes the changes in the positions by major area for 1982-95. Country and Industry Detail for 1995 The foreign direct investment position in the United States valued at historical cost—the book value of foreign direct investors' equity in, and net outstanding loans to, their U.S. affiliates—was $560.1 billion at the end of 1995 (Table 3.2 and Figure 3.1). The United Kingdom's position remained the largest ($132.3 billion, or 24 percent of the total). Japan's position was the second largest ($108.6 billion, or 19 percent), and Table 3.2 Foreign Direct Investment Position in the United States on a Historical-Cost Basis, 1982-95 1982 . 1983 . 1984 . 1985 . 1986 . 1987 . 1988 1989 . 1990 . 1991 . 1992 . 1993^ 1994'' 1995 P Position Percent fMiliion $) change 124,677 137,061 9.9 164,583 20.1 184,615 12.2 220,414 19.4 263,394 19.5 314,754 19.5 368,924 17.2 394,911 7.0 419,108 6.1 427,566 2.0 466.666 9.1 502,410 7.7 560,088 11.5 ^ preliminary. ' revised. the Netherlands' position was the third largest ($67.7 billion, or 12 percent). In 1995, the position increased $57.7 billion, or 1 1 percent, following an 8-percent increase in Figure 3. 1 Foreign Direct Investment Position in the US on a Historical-Cost Basis, 1982-95 Billion $ 600 1982 84 Source: U S. Department of Commerce, Bureau of Economic Analysis. Table 3.3 Change in Position, by Type of Capital Flow and Valuation Adjustment, in 1995 (Billion$) Total 57.7 Capital inflows 60.8 Equity capital 39.5 Intercompany debt 7.4 Reinvested earnings I 3.9 Valuation adjustments -3.2 Currency translation (*) Other -3.1 * Less than $50 million (+/-). 1994 and a 9-percent increase in 1993. Table 3.3 shows the change in position in 1995 by type of capital flow and valuation adjustment. The strong increase in the position in 1995, as well as the increase in 1994, reflected a number of factors. Continued economic expansion in a number of major investor countiies, such as the United Kingdom, may have increased the ability of parent companies in those countries to make new acquisitions and to contiibute additional capital to their existing U.S. affiliates, while reducing their need to draw funds from those affiliates. The continued strength of the U.S. economy enhanced the profit potential of new acquisitions, and the depreciation of the dollar against several European cuiTencies and the Japanese yen reduced the cost of acquisitions 16 in foreign-cuiTency terms. Industiy-specific factors also contributed to the increase in position. One such factor that was important in both 1994 and 1995 was the worldwide consolidation of the health-care industiy, which led to foreign acquisitions of U.S. pharmaceutical and biotechnology companies. As discussed elsewhere in this report, these factors had an even more pronounced effect on foreign investors' total outlays to acquire or establish U.S. businesses: In 1995, these outlays, including those financed by capital inflows from foreign parents, rose 19 percent, following a 74-percent increase in 1994.^ Capital inflows for foreign direct investment in the United States were $60.8 billion in 1995~their highest level in 6 years. In 1994, capital inflows were $49.9 billion. Nearly two-thirds, or $39.5 billion, of the 1995 total was accounted for by equity capital inflows, which were $5.0 billion higher than in 1994. The higher level of equity capital inflows reflected continued growth in acquisitions of U.S. businesses by foreigners. Reinvested eamings were positive for the second consecutive year after having been ' See "Foreign Direct Investment in the United States: New Investment in 1995 and Affiliate Operations in 1994" in chapter 4 of this report. Preliminary data from BEA's survey of new foreign direct investments, summarized in that article, indicate that total outlays to acquire or establish U.S. businesses were $54.4 billion in 1995, up from $45.6 billion in 1 994. Unlike the changes in the foreign direct investment position presented here, these figures cover only transactions involving acquisitions and establishments of new U.S. affiliates and include fmanctng other than that from the foreign parent, such as local borrowing by existing U.S. affiliates. In contrast, changes in the position reflect transactions of both new and existing U.S. affiliates—but only transactions with the foreign parent or other members of the foreign parent group-and valuation adjustments. Notwithstanding these differences, the two types of data are related. Any outlays to acquire or establish U.S. businesses that are funded by foreign parents (or other members of the foreign parent group) are part of capital inflows, a component of the change in the position. Data fi-om the new investments survey indicate that in 1995, foreign parent groups ftinded $31.5 billion, or 58 percent, of outlays to acquire or establish new U.S. affiliates, compared with $27.0 billion, or 59 percent, in 1994. negative for the previous 5 years. Reinvested eamings increased $9.2 billion, to $13.9 billion, reflecting increases both in eamings and in the share of eamings that was reinvested. Eamings increased $10.0 billion, following a $13.6 billion increase in 1994. The increases in eamings reflected both the strength of the U.S. economy and the entry of new U.S. affiliates into the direct investment universe; they may also have reflected the diminishing impact of the restmcturings that followed the wave of acquisitions in the late 1980's. (Restmcturings tend to depress reported earnings in the years immediately following the acquisitions.) The share of affiliate eamings that was reinvested increased to 59 percent from 34 percent in 1994. The increase reflected U.S. affiliates' tendency to maintain relatively stable eamings distributions despite fluctuations in eamings. Intercompany debt inflows were $7.4 billion, down from $10.7 billion. The decrease resulted fi"om a shift to outflows in U.S. affiliates' receivables. Changes by country.— The $57.7 billion increase in the foreign direct investment position in the United States in 1995 was concentrated among parents located in Europe. Outside Europe, the largest increases were by parents in Japan and Canada. The largest decrease in position was by parents in Other Westem Hemisphere countries. Table 3.4 shows the major changes in the positions in 1995 by area and country. Nearly 90 percent of the overall increase in the position in 1995 was accounted for by European investors, whose position rose 17 percent— a faster pace than that for any other major area. Within Europe, parents in the United Kingdom had by far the largest dollar increase, followed by parents in Switzerland, Germany, France, Sweden, and Ireland. Almost one-half of the increase in the position of British parents was in intercompany debt and resulted from parents extending loans to their U.S. affiliates. By industry, the largest increases in position were in manufacturing— particularly food— nonferrous 17 Table 3.4 Change in Position, by Area and Country in 1995 (Billion $) All countries 57.7 Europe 5 1 .3 of which: United Kingdom 2 1 .2 Switzerland 7.7 Germany 7.6 France 4.1 Sweden 2.8 Ireland 2.8 Japan 4.1 Canada 3.9 Other Western Hemisphere -2.6 mining, finance, and banking. In most of these industines, the increases resulted from lending by parents. In banking, however, the increase resulted from equity capital inflows and largely reflected acquisitions. The largest increases in the position of Swiss parents were in finance, manufacturing— particularly chemicals—and insurance. The increase in finance was more than accounted for by parents extending loans to their affiliates. The increases in chemicals and in insurance resulted from equity capital inflows. In chemicals, they reflected acquisitions; in insurance, they reflected capital contributions to existing affiliates. Almost all of the increase in the position of German parents was in the form of capital contributions to existing affiliates. The largest increases in position were in manufacturing— particularly chemicals— and in finance. In chemicals, the increase reflected capital contributions. In finance, the increase resulted from parents extending loans to their affiliates. Nearly one-half of the increase in the position of French parents was in finance and was due mostly to parents extending loans to their U.S. affiliates. The position was also boosted by positive valuation adjustments in insurance that were made to reflect affiliates' gains on their investment portfolios in 1995. The increase in the position of Japanese parents was more than accounted for by equity capital inflows, which were the largest of any country. Most of these inflows were capital contributions to existing affiliates. These inflows were partly offset by outflows in intercompany debt and by negative reinvested earnings in services and real estate, two industries that continued to show losses. By industry, the largest increases in the position were in banking and wholesale trade. In banking, two-thirds of the increase was accounted for by reinvested earnings. In wholesale trade, the increase was more than accounted for by equity capital contributions. More than one-half of the increase in the position of Canadian parents was in manufacturing, particularly food. Much of the remainder was in insurance. Reinvested earnings accounted for a large part of the increase in each of these industries. The increase in insurance also reflected equity capital contributions to existing affiliates. Almost all of the increase in the position of Swedish parents was in chemicals and reflected the ongoing consolidation in the pharmaceuticals industry. Most of the increase in the position of Irish parents reflected loans to affiliates, primarily in finance. The decrease in the posifion of parents in Other Western Hemisphere was the net result of large, partly offsetting debt flows between U.S. affiliates in finance and parents located in the Caribbean. Changes in Geographic Composition Since 1982 Between 1982 and 1995, the shares of the foreign direct investment position in the United States accounted for by direct investments from Asia and Pacific increased, while the shares accounted for by investors in most other areas 18 Europe 667% Africa 1% Canada 9.4 declined.'* The position grew from $124.7 billion at year-end 1982 to $560.1 billion at year-end 1995. The average annual growth rate during this period was 12 percent, and the yearly growth rate ranged from 2 percent in 1 992 to 20 percent in 1984. Of the $435.4 billion overall increase, 64 percent was accounted for by European parents and 26 percent by parents in Asia and Pacific. The most notable change in the geographic composition of the position was the increase in Asia and Pacific's share from 9 percent in 1982 to 22 percent in 1995 (Figure 3.2). Japan accounted for almost all of the increase, as investors acquired a large number of U.S. businesses during the late 1980's. During that period, Japan's large trade surplus and high savings rates generated a large volume of funds for investment, and Japan's low cost of capital and strong domestic currency provided incentives to make foreign direct investments. The positions of other Asian countries, though considerably smaller than that of Japan, also grew rapidly during the period, reflecting the strength of the newly industrialized economies in the area and the emergence of businesses capable of operating on a global scale. Europe accounted for roughly two-thirds of the position throughout 1982-95. The share peaked at 69 percent in 1987 but drifted downward thereafter, to 64 percent in 1995. Europe's predominant share of the overall position partly reflects cultural similarities and the large number of mature companies in these countries with the ability and resources to take advantage of investment opportunities beyond Figure 3,2 Foreign Direct Investment Position in the US on a Historical-Cost Basis, by Area, 1982 & 1995 1982 1995 Europe 66 4% aherWest Hemisphere 11.4% Middle East 3.5% aher West Hemisphere 4 1% Middle East 09% Asia & Pacific 8.9% Africa 02% Canada 8 2% Asia & Pacific 22.2% Source US. Department of Commerce, Bureau of Economic Analysis. "* Both position is shown on a historical-cost basis and is expressed in dollars and, thus, reflects changes in price levels over time, as well as changes in the real value of investment stocks. Nonetheless, major shifts in the shares of the position by broadly defined areas probably reflect real changes. their national and regional borders. Throughout the period, the United Kingdom, the Netherlands, and Germany had the largest shares; among these three countries, the positions of the United Kingdom and Germany grew at a faster pace than that of the Netherlands. Canada's share of the total position fell slightly, from 9 percent in 1982 to 8 percent in 1995, despite substantial growth in Canada's position in dollar terms. Canada continued to be a significant investor in the United States, reflecting its proximity and the high degree of economic integration between the two economies. Latin America and Other Western Hemisphere's share of the total position fell from 11 percent in 1982 to 4 percent in 1995. The sharp decrease was largely accounted for by a number of countries—notably Panama, the Bahamas, and the Netherlands Antilles—in which, for tax, regulatory, or other purposes, multinational companies headquartered in other countries hold U.S. investments. This form of investment has not kept pace with the overall growth in FDIUS. The Middle East's share of the total position fell from 4 percent in 1982 to 1 percent in 1995. The decrease reflected economic stagnation in many countries, which resulted from the decline of crude oil prices during the 1980's. More recently, funds available for foreign investment 19 were reduced by the need to rebuild the infiastructure destroyed by the Persian Gulf War. Changes among Middle East countries were large and partly offsetting. 20 Foreign Direct Investment in the United States: New Investment in 1995 and Affiliate Operations in 1994 Bv Mahnaz Fahim-Nader and William J. Zeile In 1995, outlays by foreign direct investors to acquire or establish businesses in the United States increased for the third consecutive year (Figure 4.1). Outlays increased 19 percent in 1995, to $54.4 billion, following increases of 74 percent in 1994 and 71 percent in 1993 (Table 4.1)." Despite the recent increases, outlays in 1995 remained well below the peak levels of 1988-90, when new investments from Japan were much higher (Figure 4. 2). The increase in outlays in 1995 reflected continued, albeit diminished, economic growth in the United States and abroad, as well as several factors specific to particular industries, and it coincided with a sharp increase in overall merger and acquisition activity in the United States. Additional highlights on new investment in 1995 are as follows: • Most— 58 percent— of the outlays in 1995 were financed with funds from foreign parents rather than from U.S. sources or from other foreign sources. As in the past, most new investment was accounted for by outlays to acquire existing companies rather than by outlays to establish new companies. Figure 4 1 Outlays for New Investment in the United States by Foreign Direct Investors, 1980-95 Billion S 60 r\ 40 / \ f 20 III 1 19B0 85 90 95 Source U S Department of Commerce, Bureau of Economic Analysis ' The authors are economists in the International Investment Division, Bureau of Economic Analysis, Economics and Statistics Administration, U.S. Department of Commerce. This chapter was previously published as article in the Sun^ey of Current Business, July 1966. See that article for data not included in this chapter,. The survey from which the data on new foreign direct investment in theUnited States were drawn was conducted under the supervision of Joseph F. Cherry III, assisted by Erik A. Kasari, Edward J. Kozerka, Nicole Leiker, and Ronald McNeil. The survey from which the data on U.S. affiliate operations were drawn was conducted under the supervision of David H. Galler, assisted by Juris E. Abolins, Chester C. Braham, Constance C. Deve, Beverly A. Feeser, Vincent Goins, Earl F. Holmes, Lonnie Hunter, Betty Jones, Carol Lefkowitz, Edna Ludden, Gregory McCormick, Sidney Moskowitz, Clarence D. Smith, Marie P. Smith, John R. Stames, Kimyetta Whitehead, Demetria Williams, and Dorrett Williams. The estimates of U.S. affiliate gross product were prepared by Ned G. Howenstine, Jeffrey H. Lowe, and Dale P. Shannon. Computer programming for data estimation and the generation of data tables was provided by Arnold Gilbert, Angela M. Roberts, Peter Bowman, and Suet Ng. ^ The estimates of outlays for 1995 are preliminary. The estimates for 1994 have been revised since the preliminary estimates were published last year, resulting in a downward revision of 3 percent to the estimate of total outlays. 21 Figure 4 2 Outlays for New Investment in the US by Foreign Direct Investors from Key Countries, 1989-95 ^ Japan United Kingdom 1989 90 91 92 93 Source US Department of Commerce. Bureau of Eccnomic Analysis. $320.1 billion in 1994.'* The increase reflected both the growth in new investments and the unusually strong growth in the operations of existing affiliates. The share of total gross product originating in private U.S. businesses that was accounted for by affiliates increased to 6.2 percent in 1994 from 6.0 percent in 1993 (Figure 4.3). Although the affiliate share remained small, it has increased substandally since 1986, when it was 4.3 percent. Unlike the growth in 1994, the growth in 1986-93 was mainly due to new investments rather than to expansions of existing operations. • By industi-y, more than one-half of the new investment outlays were in manufacturing. Within manufacturing, the outlays were largest in chemicals. • By investing country, the new investment outlays were largest for GeiTnany, followed by the United Kingdom. Most measures of the overall operations of nonbank U.S. affiliates of foreign companies— including existing as well as new affiliates—increased in 1994, the latest year for which such measures are available. "* The gross product of affiliates increased 12 percent to ^ A U.S. affiliate is a U.S. business enterprise in which there is foreign direct investment-tliat is, in which a single foreign person owns or controls, directly or indirectly, 1 percent or more of the voting securities of an incorporated U.S. business enterprise or an equivalent interest in an unincorporated U.S. business enterprise. An affiliate is called a "U.S. affihate" to denote that it is located in the United States; in this article, "affiliate" and "U.S. affiliate" are used interchangeably. "Person" is broadly defined to include any individual, corporation, branch, partnership, associated group, association, estate, trust, or other organization and any government (including any corporation, institution, or other entity or instnunentality of a government). A "foreign" person is any person resident outside the United States--that is, outside the 50 States, the District of Columbia, the Commonwealth of Puerto Rico, and all U.S. territories and possessions. Figure 4 3 US Affiliate Share of Gross Product Originating in Private Industries, 1977-94 1977 80 95 90 Source- US Department of Commerce, Bureau of Economic Analysis. Additional highlights of the operations of U.S. affiliates in 1994 are as follows: • The net income of affiliates surged to $ 1 3 .4 billion in 1994, following 4 consecutive years of losses. Profit-type return— operating profits on an economic-accounting basis— more than tripled to $30.5 billion. • Employment by affiliates increased 2 percent, following a 1 -percent rise in 1993. " The estimates of gross product and the other data items on affiliate operations for 1994 are preliminary. The estimates for 1993 are revised; for most of the key data items, the revisions from the preliminary estimates were small, resulting in changes to the totals by 0.5 to 2.5 percent. However, the revised estimates of net income show losses only about one-half as large as tlie preliminary estimates. 22 The increases in employment resulting from new investments were less than in 1993, but they far exceeded the decreases in employment resulting from sales and liquidations of foreign ownership interests. Merchandise exports and imports of affiliates increased at a slower pace than total U.S. merchandise exports and imports. As a result, the affiliate shares of total U.S. merchandise trade— 22 percent of exports and 33 percent of imports—were slightly lower than in 1993. By country of ultimate beneficial owner (UBO), British-owned affiliates continued to account for the largest share of total affiliate gross product; in 1994, their share increased to more than 21 percent.^ The share of Australian-owned affiliates dropped substantially, as a result of selloffs. Affiliates owned by foreign governments accounted for 4 percent of total affiliate gross product. Most countries had little or no government-owned investment, but the govemment-ovmed share was substantial for a few investing countries, including France, Italy, and several predominantly oil-producing countries. By industry, affiliate shares of all U.S. -business employment continued to be largest in mining and in manufacturing. Within manufacturing, the affiliate share was largest in chemicals. By State, the affiliate share of total business employment was largest in Hawaii; in 1994, the share dipped slightly to less than 12 percent. The affiliate share of ^ The UBO is that person, proceeding up a U.S. affihate's ownership chain, beginning with and including the foreign parent, that is not owned more than 50 percent by another person. The foreign parent is the first foreign person in the affihate's ownership chain. Unlike the foreign parent, the UBO of an affiliate may be located in the United States. The UBO of each U.S. affiliate is identified to ascertain the person that ultimately owns or controls and that, therefore, ultimately derives the benefits from owning or controlling theU.S. affiUate. manufacturing employment was largest in Delaware, increasing slightly to more than 27 percent. New Investment in 1995 Outlays to acquire and establish U.S. businesses, including both those made directly by foreign investors and those made through their existing U.S. affiliates, increased 19 percent to $54.4 billion in 1995, following a 74-percent increase in 1994 (Table 4.2).^ The growth in outlays for new foreign direct investment in the United States in 1995 coincided with, but was somewhat smaller than, a sharp increase in ^ The new investment data are limited to all U.S. business enterprises (including banks) that have total assets of over $1 million or that own at least 200 acres of U.S. land in the year they are acquired or established. U.S. enterprises tliat do not meet these criteria are required to file partial reports, primarily for identification purposes, but the data from these reports are not included in the accompanying tables. For 1995, the total assets of the U.S. enterprises that filed partial reports were only $143.9 milUon, or about 0. 1 percent of the total assets of $98.4 billion of the U.S. enterprises that filed complete reports. A U.S. business enterprise is categorized as "established" if (a) the foreign parent or its existing U.S. affiliate creates a new legal entity that is organized and begins operating as a new U.S. business enterprise or (b) the foreign parent directly purchases U.S. real estate. A U.S. business enterprise is categorized as "acquired" if the foreign parent or its existing U.S. affiliate (a) obtains a voting equity interest in a previously existing, separate legal entity that was already organized and operating as a U.S. business enterprise and continues to operate it as a separate legal entity, (b) purchases a business segment or operating miit of an existing U.S. business enterprise that is organized as a new separate legal entity, or (c) purchases through the existing U.S. affiliate a U.S. business enterprise or a business segment or an operating imit of a U.S. business enterprise, and merges it into its own operations rather than continuing or organizing it as a separate legal entity. The data on acquisitions do not cover the acquisition of additional equity in an existing U.S. affiliate by the foreign parent, the acquisition of an existing U.S. affiliate from a different foreign investor, or the expansions of plants by an existing U.S. affiliate. 23 overall merger activity in the United States.^ As in the past, most~85 percent—of the outlays in 1995 were to acquire existing U.S. companies rather than to establish new U.S. companies. The increase in outlays in 1995 occuiTed in an economic environment that was conducive to an increase in new investments. Real economic growth in the United States and in the major investor countries, though generally less rapid than in 1994, remained positive. In addition, the depreciation of the U.S. dollar against several major foreign cuiTencies lowered the costs of new U.S. investments in teiTns of foreign cuiTencies, and a decline in interest rates in the United States and abroad lowered the cost of external funds for mergers and acquisitions. In addition to these general economic factors, factors specific to particular industries appear to have motivated a number of large new investments. In chemicals and allied products, drug manufacturers' desire to realize economies of scale in research and marketing operations— partly in response to pressure from governments, insurance companies, and healthcare organizations to contain costs and hold down price increases— led a number of foreign companies to merge with or acquire dmg companies in the United States. In "finance, except depository institutions," European banks' desire to expand geographically— to broaden their range of services and to gain more direct access to the large U.S. capital market— resulted in a number of U.S. acquisitions. In both industries, some of the acquired companies became available for acquisition when diversified U.S. companies divested themselves of business segments unrelated to their core businesses. As in 1994, outlays in 1995 included more large investments than in the previous 3 years. In both years, there were four investments of $2 billion or more and eight investments of $1 billion or more (Table 4.3). Investments of $1 billion or more accounted for about three-eighths of total outlays in each year. By industry, outlays increased in all industries except wholesale trade, services, and "other industries." Increases were particularly large in manufacturing ($7.3 billion) and "finance, except depository institutions" ($3.6 billion). In manufacturing, increases in chemicals and allied products (particularly dmgs) and machinery (particularly industrial machinery and equipment) more than offset decreases in food and kindred products, primary and fabricated metals, and "other manufacturing." In "finance, except depository institutions," most of the increase was accounted for by "other finance." By counti'y, the four nations whose investors made the largest outlays in 1995— GeiTnany, the United Kingdom, Canada, and Switzerland— accounted for two-thirds of the total. Outlays by German investors surged $10.8 billion, to $14.2 billion, the largest level of outlays for that country since 1980, the first year that data on new investments were available. Outlays by Japanese investors, at $3.8 billion, increased for the second year in a row; however, despite the increase, these outlays were only about a fifth as large as those in the peak year of 1990 (Figure 4.2). Outlays by Japanese investors continued to be dampened by slow economic recovery in Japan, weak coiporate profits, and continued liquidity problems in the banking system. The portion of outlays financed with funds from foreign parents increased $4.5 billion, to $31.5 billion. The increase contributed to the overall increase in net capital inflows for foreign direct investment in the United States (FDIUS) recorded in the U.S. balance of payments accounts for 1995.^ Outlays financed with funds ^ In a news release dated December 29, 1 995, the Securities Data Company reported a 3 2 -percent increase in overall merger and acquisition activity in the United States in 1995. ^ In addition to outlays from foreign parents to acquire or establish U.S. affiliates, net capital inflows for FDIUS include foreign parents' fmancing of their existing U.S. affiliates. In 1995, net capital inflows for FDIUS increased $10.5 billion, to $60.2 billion. Estimates of these inflows appear in tables 1 and 5 in the article "U.S. International 24 from U.S. or other foreign sources increased $4.2 billion, to $22.8 billion. The total assets of newly acquired or established affiliates were $98.4 billion in 1995, up from $77.8 billion in 1994 (Table 4.4). Of the total, assets of businesses acquired in 1995 were $80.7 billion. U.S. businesses that were newly acquired or established employed 366,000 persons in 1995, up from 289,000 in 1994. In 1995, manufacturing and retail trade accounted for the largest shares of employment (36 percent each). Affiliate Operations in 1994 In 1994, the gross product of nonbank U.S. affiliates increased 12 percent, the fastest rate of increase since 1989. In contrast to the earlier years, much of the 1994 increase was due to expansions in existing operations; new investments played an important, but secondary, role. Affiliate sales increased 9 percent, and expenditures for new plant and equipment increased 8 percent; employee compensation increased a relatively modest 4 percent. Following 4 consecutive years of losses, the net income of affiliates surged to a positive $13 billion, the highest level in cuiTent dollars since at least 1977, when BE A began collecting annual data on affiliate operations. Employment by affiliates increased 2 percent in 1994, following an increase of only 1 percent in 1993 (Figure 4.4). New investments added 235,200 employees in 1 994--compared with 261,900 in 1993— but sales and liquidations reduced employment by only 161,000~compared with 239,900 (Table 4.5).'' Increases in Transactions, First Quarter 1996" in Sun'B}' of Current Business 76 (July 1996), pp. 61-101. ^ The increase in employment from new investments is smaller than the number of employees of newly acquired or established U.S. businesses in 1994 shown in Table 4.1 . The difference partly reflects differences in coverage and timing and the existence of some changes in nonbank affiliate employment that could not be categorized. For more Figure 4.4 Employment in Nonbank US Affiliates 1977-94 Million employees Annual percent change 25 Percent ctiange (rigtit scaie) 1977 80 85 90 Source US Department of Commerce, Bireau of Economic Analysis (5) employment from expansions of existing operations were also smaller than in 1993, as were employment decreases from affiliate cutbacks. In 1994, U.S. merchandise exports shipped by affiliates increased 7 percent, and U.S. merchandise imports shipped to affiliates increased 9 percent. For both exports and impoits, the rate of increase was slower than that for the corresponding all-U.S. totals. As a result, affiliates' shares of total U.S. merchandise exports and total U.S. merchandise imports fell slightly in 1994, to 22 percent and 33 percent, respectively. Sixty percent of the total merchandise imports by affiliates was accounted for by wholesale trade affiliates, which typically function as distiibution agents that buy and resell the goods they import with little or no further processing or assembly. Wholesale trade affiliates accounted for 50 percent of the merchandise exports of affiliates, and manufacturing affiliates accounted for 43 percent. Gross product In 1994, gross product originating in affiliates increased 12 percent to $320 billion, following an increase of 7 percent in 1993. information, see the note to Table 4.5, and see the appendix "Sources of Data" in Survey 75 (May 1995): 68-70. 25 Estimates of real affiliate gross product are not available, but these increases were well above the 2.2-percent and 2.6-percent increases in prices recorded for U.S. businesses in 1994 and 1993.'° The share of U.S. affiliates in total U.S. gross domestic product originating in private industries rose to 6.2 percent in 1994 from 6.0 percent in 1993 (Table 4.1). Except for a slight dip in 1992, the affiliate share has increased every year since 1985. The large increase in affiliate gross product in 1994 reflected unusually strong growth in the operations of existing affiliates. New investments played an important, but secondary, role, accounting for about two-fifths of the increase in affiliate gross product. In contrast, new investments accounted for about three-fourths of the increase in 1993." By industry.— Affiliates in manufacturing continued to account for almost one-half of the gross product of all affiliates in 1994. In contrast, for all U.S. businesses, manufacturing accounts for only one-fifth of total gross product.'^ Gross product of manufacturing affiliates increased 1 1 percent, slightly below the average ^^' The data used to estimate affiliate gross product are reported to BEA in current dollars. BEA's chain-type price index for the gross domestic product of nonfarm U.S. businesses, less housing, increased 2.6 percent in 1993 and 2.2 percent in 1994. The rates of price increase for affiliate gross product were probably lower, because affiliate gross product is heavily concentrated in manufacturing, where price increases have tended to be lower than in other industries. ' ' Based on tlie methodology used to construct the estimates in Table 4.5, the change in affiliate gross product fi-om new investments was estimated as the gross product of large affiliates that were acquired or established during the year plus the change in the gross product of large affiliates that had an increase in employment and had acquired another U.S. business during the year, '" Manufacturing accounted for 20 percent of the gross product origijiatijig in U.S. private industries m 1994. See "Improved Estimates of Gross Product by Industry, 1959- 94," Survey 76 (April 1996): 150. for affiliates in all industries combined. Within manufacturing, affiliate gross product increased more than 20 percent in two industiies: Industrial machinery and equipment and motor vehicles and equipment. The large increase in industrial machinery and equipment was mainly due to changes in the industry classification of affiliates with operations in more than one industry. The industries with the largest increases in the shares of affiliate gross product were communication and public utilities and wholesale trade. The increase in the share for wholesale trade, to 12.7 percent, reflected increases in the value added of existing affiliates. The increase in share for communication and public utilities, to 2.3 percent, was mainly accounted for by foreign acquisitions of minority shares in U.S. companies; as a result of these acquisitions, the share of affiliate gross product accounted for by majoiity-owned affiliates dropped to less than 30 percent (Table 4.6). However, majority-owned affiliates continued to account for more than two-thirds of affiliate gross product in most industries and for nearly 80 percent of the gross product of all nonbank affiliates combined. The largest decreases in the shares of affiliate gross product were in real estate and services. The drop in the share for real estate was largely accounted for by increased operating losses and partial selloffs by affiliates. The decrease for services was mainly due to selloffs. By country.~In 1994, affiliates with UBO's in the seven largest investing countries— the United Kingdom, Japan, Canada, Germany, the Netherlands, France, and Switzerland— continued to account for more than 80 percent of the gross product of all affiliates (Figure 4.5). The United Kingdom remained the largest investing country. The share of total affiliate gross product accounted for by British-owned affiliates increased to 21.5 percent after decreasing in 1993. Much of the increase was accounted for by acquisitions of minority-ownership interests in companies in the communication, wholesale trade, and mining industries. The share of Netherlands-owned affiliates also increased as a 26 Figure 4.5 Investing Country Shares in Gross Produc of All Nonbank US Affiliates, 1994 Canada 135 Netherlands 7.7 Germany 11 5 France 7 1 Switzerland 5.5 Japan 15 9 Other 17.3 Unrted Kingdom 21.5 Source: U.S. Department of Commerce, Bureau of Economic Analysis result of minority-stake acquisitions. Despite the prominence of transactions involving minority-ownership interests in these countries' new investments, majority-owned affiliates continued to account for more than 80 percent of the gross product of British- and Netherlands-owned affiliates (Table 4.7). Increases in the shares of Japanese-, German-, and French-owned affiliates were mainly due to increases in the gross product of existing affiliates. The increases in the shares of Japanese- and French-owned affiliates both followed decreases in 1993; the share of German-owned affiliates increased for the third consecutive year. The shares of Canadian- and Swiss-owned affiliates dropped substantially in 1994. The decrease for Canadian-owned affiliates was partly due to large decreases in the gross product of affiliates in the insurance industry. The decrease for Swiss-owned affiliates was mainly accounted for by selloffs. Among other investing countries, the shares of Australian- and Swedish-owned affiliates fell. The drop for Australian-owned affiliates was more than accounted for by selloffs of minority-ownership interests in several large companies in the primary metal manufacturing and transportation industries. As a result of these selloffs, the majority-owned-affiliate share of the gross product of Australian-owned affiliates increased from only 30 percent in 1993 to more than 80 percent in 1994. Selloffs of minority-owned affiliates also more than accounted for the drop in the share of Swedish-owned affiliates. Government-owned affiliates. —Although affiliates owned by foreign governments have accounted for a small share of the gross product of all nonbank affiliates (less than 5 percent recently), they have figured prominently in the affiliate operations of some investing countries—notably France, Italy, and several oil-producing countries.''' In 1989, affiliates of government-owned enterprises accounted for 40 percent of the gross product of all French-owned affiliates; however, the Government-owned share declined rapidly, to 16.2 percent in 1994. The decreases in the shares in 1990-91 largely reflected new investments by privately owned French companies, and the decreases in 1992-94 reflected the privatization of parent companies in France. Privatization was also the main factor behind a recent drop in the share of Government-owned affiliates in the gross product of affiliates with UBO's in Italy, from 24.9 percent in 1992 to 9.0 percent in 1994. Government-owned affiliates have continued to account for a dominant share of the gross product of affiliates with UBO's in Venezuela, Kuwait, and Saudi Arabia. Investments by government entities in Venezuela and Saudi Arabia have mainly been in the petroleum industry; investments by government entities in Kuwait have mainly been in real estate. ' ^ Government-owned affiliates include affiliates that are owned by foreign governments, government-owned or government-sponsored enterprises, quasi-govemment organizations or agencies, and government-run pension funds. 27 Share of U.S. employment In 1994, the share of total U.S. private-industry employment accounted for by affiliates was 5.0 percent, the same as in 1993. The share decreased in 1992 and 1993 after increasing steadily from 1.8 percent in 1977 to 5.3 percent in 1991. The recent decreases partly reflected the concentration of affiliate activity in manufacturing, in which recent employment gi'owth at the all-U.S. level has been much slower than in services and most other industries. By industry.— In 1994, as in most previous years, the shares of total U.S. private-industry employment accounted for by affiliates were largest in mining and manufacturing.''* Excluding peti^oleum and coal products, the affiliate shares within manufacturing were largest in chemicals and in stone, clay, and glass products.'"^ Among the major industries, the affiliate share in communication and public utilities increased the most, from 1.7 percent to 3.6 percent, reflecting new acquisitions. The affiliate share in mining decreased the most, from 14.6 percent to 13.6 percent, mainly because of selloffs of affiliates classified in the coal mining and primary metal industries. The affiliate share in manufacturing increased slightly to 11.8 percent. Within manufacturing, the largest increase was in apparel and other textile products, largely due to acquisitions (Figure 4.6). The affiliate share in chemicals also increased substantially, to slightly more than one-third, mainly as a result of acquisitions in dmgs. In both the apparel and chemicals industries, the affiliate share has increased every year since 1987, when BE A began collecting annual data on affiliate employment by industry of sales. ''' The employment data used to estimate shares are by industry of sales, a basis that approximates the establislinient-based disaggregation of the corresponding data for all U.S. businesses. '^ The precise share for petroleum and coal products cannot be calculated from the affiliate data. Figure 4 6 US-Affiliate Share of Total US-Private-Industry Employment, Key Manufacturing Industries, 1987-94 Percent 40 1967 68 89 90 91 92 Source US Depanment of Commerce, Bureau of Economic Analysis The largest decrease in the affiliate share within manufacturing was in stone, clay, and glass products. The decrease, from 20.7 percent to 19.6 percent, was more than accounted for by affiliate selloffs in glass products. By State.~In 1994, as in 1993, the share of private-industry employment accounted for by affiliates was highest in Hawaii, followed by Delaware, South Carolina, and North Carolina. The affiliate share dipped to 1 1.5 percent in Hawaii and to 10.7 percent in Delaware, continuing a downward trend in both States. In South Carolina, the affiliate share increased to 8.3 percent after dropping in 1993. In North Carolina, the affiliate share held steady at 7.6 percent. In manufacturing, the affiliate shares were highest in Delaware, West Virginia, Kentucky, and South Carolina. In all four States, the affiliate share was higher in 1994 than in 1993. Profitability The net income of affiliates~after-tax profits on a financial-accounting basis—jumped from -$4.4 bilHon in 1993 to a new high of $13.4 billion in 1994; the turnaround reversed 4 28 consecutive years of losses.'^ The jump resulted from a sharp increase in affiliate operating profits, as "profit-type retum"~before-tax profits generated from current production on an economic-accounting basis—increased from $8.8 billion in 1993 to $30.5 bilHon in 1994.'' (U.S. income taxes paid by affiliates also increased sharply, from $8.7 billion in 1993 to $17.1 billion in 1994.) In contrast, large changes in the net income of affiliates in 1992 and 1993 were mainly due to factors unconnected with profit-type return.'^ The increase in profitability in 1994 reflected increased growth in affiliate sales coupled with reduced growth in operating expenses, particularly labor costs: The growth rate for affiliate sales increased from 7.9 percent in 1993 to 8.9 percent in 1994, but the growth rate for employee compensation decreased from 6.0 percent to 4. 1 percent. By major industry, affiliate net income turned positive in 1994 in manufacturing, wholesale trade, and retail trade. Net income remained negative in real estate and services; however, affiliate losses in services were substantially smaller than in 1993. Profit-type return of affiliates increased in every major industry except finance and real estate. The increases were especially large in '^ Net income of affiliates is as shown in the affiHates' income statements; it includes capital gains and losses, income from investments, and other nonoperating income. " Affiliates' profit-type return is before deduction of income taxes or depletion charges, and it excludes capital gains and losses, income from investments, and other nonoperating income. For a more detailed description of this measure and for a comparison between it and the corresponding measure used in the U.S. national income and product accoimts, see "Gross Product of U.S. Affiliates of Foreign Companies," Survey 70 (June 1990): 53. ^^ The large losses reported for 1 992 on a net-income basis partly reflected one-time adjustments to earnings made by many affiliates to conform with the new accoimting standards for post-employment and post-retirement benefits and for deferred income taxes. The adjustments reduced net income substantially, but they had no effect on the pro fit- type-re turn measure. manufacturing and wholesale trade, partly reflecting substantial increases in sales growth.'^ Within manufacturing, profit-type return turned positive in primary and fabricated metals, machinery, and "other manufacturing." In some industries, profit-type return has been negative for several years (that is, affiliates have continued to incur losses from current operations). In 1994, as in earlier years, operating losses were particularly large for affiliates in real estate. Within services, profit-type return has been negative in the hotel and motion-picture industries, and within "other industries," profit-type return has been negative in transportation. Return on assets.~The return on assets for nonfinancial U.S. affiliates has been consistently lower than that for all U.S. nonfinancial corporations over the last decade (Figure 4.7)."^° '^ In both manufacturing and wholesale trade, the growth rates for affiliate sales increased from less than 9 percent in 1993 to about 1 1 percent in 1994. ^° For both groups of firms, the rates of return are measured as profit-type return plus interest paid as a percentage of total assets. In the computation of these measures, both the return and the assets generating the return are valued in prices of the current period. In Figure 4.7, rates of return of U.S. affiliates are compared with tliose of U.S. corporations because almost all U.S. affiliates are organized as corporations, and in terms of both their size and other aspects of their operations, Uie characteristics of U.S. affiliates correspond most closely to those of corporate businesses. The rate of return for U.S. domestic nonfmancial corporations is measured as the ratio of property income to the value of total assets. Property income includes returns to creditors as well as to shareholders and is computed as the sum of profits from current production—corporate profits with inventory valuation adjustment and capital consumption adjustment— and interest paid. As a "domestic" measure, this income excludes earnings on U.S. investments abroad and includes earnings generated by foreign-owned assets in the United States. Total assets of U.S. domestic nonfmancial corporations, as published by the Board of Governors of the Federal Reserve System in Balance Sheets for the U.S. Economy, 1945-94 (Washington, DC: June 1995), consist of tangible assets, measured at current-replacement cost (or at estimated 29 For U.S. affiliates, the rate of return during 1984-94 ranged from 2.8 percent in 1991 and 1992 to 6.5 percent in 1984. For all U.S. nonfinancial corporations, the rates were higher and more stable, ranging from 7.5 percent in 1986 to 9.3 percent in 1994. To some extent, the relatively low rates of retum for U.S. affiliates may reflect the newness of much foreign direct investment in the United States. The data on new investment indicate that initial rates of retum were particularly low for the companies acquired or established during 1984-94. An estimate of property income on an economic-accounting basis cannot be derived from the data on new investment, but an examination of the net income data for newly established or acquired affiliates suggests that the initial profitability of these affiliates has been very low or, in many cases, negative. For the newly established companies, profitability was often low because of startup costs. For many of the newly acquired companies, profitability was low or negative at the time of the acquisition and, in many cases, may have remained low for some time, as returns were reduced by restructuring costs, vvriteoffs, and other expenses. It is important to note that the relatively low rates of retum for U.S. affiliates may reflect the particular objectives of foreign direct investors. For example, some foreign investors may settle for a below-average rate of retum in order to gain access to the large U.S. market or to scarce raw materials, to take advantage of economies of scale and technological efficiencies in other parts Figure 4 7 Return on Assets of Nonfinancial US Affiliates & US Domestic Nonfinancial Corporations, 1984-94 Percent 10 US Domestic Nonfinancial Corps Nonfinancial US Affiliates 2 U I I I I I I I I I L 1984 86 88 90 92 94 Source U S Department of Commerce, Bureau of Economic Analsis of their worldwide operations, or to respond to differences across countries in the cost and availability of capital, the tax treatment of income, or tariff and nontariff barriers.'' market value, in the case of land), and financial assets. To obtain a domestic measure, the fmancial-asset component of the total assets has been adjusted by BEA, to the extent possible, to exclude claims on foreign assets. The rate of retum for nonfmancial U.S. affiliates is measured as the ratio of profit-type retum plus interest paid to the value of total assets. The profit-type retum used in this ratio incorporates an inventory valuation adjustment and a capital consumption adjustment. In the measure of total assets used for U.S. affiliates, fixed capital and inventories have been adjusted to current-replacement cost; in addition, the value of land has been converted to current-period prices, using general price indexes. "' For a discussion of the rates of retum on direct investment from a balance-of-payments perspective, see "Rates of Retum on Direct Investment," Survey 72 (August 1992): 79-86. 30 Table 4. 1 Selected Data on Newly Acquired or Established U.S. Businesses and on Nonbank U.S. Affiliates, 1977-95 Newly acquired or All nonbank U.S. affiliates Addendum: __^ established U.S. businesses Employment U.S. affiliate by newly share of acquired or gross product established originating U.S. businesses Outlays Employment' Employment Goss product in private industries^ as a percent of employment (millions (thousands of (thousands of (millions of by all nonbank of dollars) employees) employees) dollars) (percent) U.S. affiliates ' 1977 .. n.a. n.a. 1,218.7 35,222 2.3 n.a. 1978 .. n.a. n.a. 1 .429.9 42,920 2.5 n.a. 1979 .. n.a. n.a. 1,753.2 55,424 2.9 n.a. 1980 .. 12,172 292.5 2,033.9 70,906 3.4 14.4 1981 .. . 23,219 442.8 2,4 1 6.6 98.828 4.2 18.3 1982 .. 10,817 233.8 2,448.1 103,489 4.3 9.6 1983 .. 8,09 1 108.1 2,546.5 1 1 1 ,490 4.3 4.2 1984 .. 15,197 172.5 2,714.3 128,761 4.4 6.4 1985 .. 23,106 275.5 2,862.2 1 34,852 4.3 9.6 1986 .. 39,177 438.0 2,937.9 142,120 4.3 14.9 1987 .. . 40,310 394.1 3,224.3 1 57,869 4.5 12.2 1988 .. 72,692 736.3 3,844.2 190,384 5.0 19.2 1989 .. . 71,163 722.0 4,511.5 223,420 5.6 16.0 1 990 . . 65,932 474.3 4,734.5 239,279 5.7 10.0 1991 .. 25,538 249.0 4,871.9 257,634 6.0 5.1 1992 .. 15,333 141.5 4,715.4 266,333 5.9 3.0 1993 .. 26,229 289.1 ' 4,765.6 ^ 285.738 6.0 6.1 1994 .. . ^45,626 ^289.3 P 4,866.6 P 320,060 6.2 5.9 1995 .. . P 54.368 P 366.2 n.a. n.a. n.a n.a. ■" Revised. P Preliminary. n.a. Not available. ' See footnote 9 in text for more information. ^ For improved comparability with U.S. affiliate gross product, gross product originating in private industries was adjusted to exclude gross product originating in depository institutions and private households, imputed rental income from owner-occupied housing, and business transfer payments and subsidies. ' Because the data on new affiliates include bank affiliates, the percentages shown in this column are biased upward. In all years, the bias is less than I percentage point; in most years, it is in the range of less than 0.3 percentage point. 31 Table 4.2 Investment Outlays, Investments, and Investors, 1989-95 1989 Outlays (millions of dollars): Investments, total 71,163 Acquisitions 59,708 Establishments II ,455 Investors, total 71,163 Foreign direct investors 22,538 U.S. affiliates 48,625 Number : Investments, total 1 ,580 Acquisitions 837 Establishments 743 Investors, total 1 ,742 Foreign direct investors 727 U.S. affiliates 1 ,0 1 5 1990 1991 1992 1993 1994^ 1995 P 65,932 25,538 15,333 26,229 45,626 54,368 55,315 1 7,806 10,616 21,761 38,753 46,452 10,617 7,732 4,718 4,468 6,873 7,917 65,932 25,538 15,333 26,229 45,626 54,368 14,026 8,885 4,058 6,720 13,628 11,313 5 1 ,906 16,653 11,275 19,509 3 1 ,999 43,055 1,617 1,091 941 980 1,036 1,133 839 561 463 554 605 650 778 530 478 426 431 483 1,768 1,220 1,019 1.094 1,144 1,231 670 438 350 368 345 347 1.098 782 669 726 799 884 "" Revised. ^ Preliminary. Table 4.3 Number of Investments by Size of Outlays, 1989-95 1989 Total 1 ,580 $2 billion or more 4 $1 billion -$1.9 billion 6 $100 million - $999 million 110 $10 million - $99 million 483 Less than $ 1 million 977 1990 1991 1992 1993 1994^ 1995'' 1,617 1,091 941 980 1,036 1,133 5 1 1 4 4 6 1 1 4 4 74 45 28 47 71 76 499 273 252 252 273 335 1,033 771 661 679 684 714 Addenda: Percent of total outlays accounted for by: Investments of $1 billion or more 36 Investments of $ 1 00 million or more 74 40 12 19 39 37 73 59 42 64 78 76 '' Revised. '' Preliminary. 32 ra ON •4 OS a. u V *j c LU M iO c 3 00 (/> D 3 ■o >s ■o" 0) LU E 3 I/) OJ .. c u ^ O iS i OJ >^ _o CL £ ON o XI 00 01 E 3 T3 01 L. 3 < M V a. 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O) i_ ra ra i_ X % -" o S vo" i3 O ta O X 01 0) irt I- OJ 3 1- _o «< l_l — I/) r^ X ^ X f^ ° -^ ^ 3 o S" <-> • X '^ frt I" -P . 2 l/> U XI — O) (1) «J E Q.-C L- clQ — 01 c 3 J3 X 01 X 5 - - ta aj jz vO c ^ UO _Q ^ 01 o- 01 W J^ ■= * ^ o LO > Ll_ S S . ^ - Ja •^ O 5L — O Q- .E Z £ 33 Table 4.5 Sources of Change in Nonbank U.S. Affiliate Employment, 1989-94 (Thousands of employees) Line 1989 1990 1991 1992 1993 1994 1 Change in total affiliate employment 667.3 223.0 137.5 -156.5 50.2 1 01. 1 Change in employment of large affiliates resulting from: 2 New investments 596.6 481.6 291.1 101.7 261.9 235.2 3 Expansions of existing operations 125.1 107.9 107.4 1 4 1. 1 110.2 93.3 4 Sales or liquidations of businesses -123.2 -354.1 -152.2 -316.2 -239.9 -161.0 5 Cutbacks in existing operations -68.6 -126.5 -136.4 -132.2 -95.1 -70.8 6 Combinations of new investments and sales or liquidations of businesses 76.7 -16.9 -9.6 -18.0 6.3 -9.0 7 Change not accounted for in lines 2-6 60.7 1 31.1 37.3 67.1 6.8 13.4 NOTE.-Lines 2-6 cover large affiliates-that is, affiliates with more than 500 employees. Coverage is limited to large affiliates because a substantial number of small affiliates change their organizational structures and in such cases it is particularly difficult to determine the reasons for the changes. All of the change in an affiliate's employment is shown on one line, even if the change was not entirely attributable to that factor, because it was impossible to disaggregate the change in an affiliate's employment by source of change. Employment of new affiliates was classified in "new investments," and employment of affiliates that were liquidated or sold was classified in "sales and liquidations." For all other affiliates, classification depended on (I) whether the affiliate's employment increased or decreased, (2) whether the affiliate acquired another business during the year, or (3) whether the affiliate sold a business or business segment during the year. Line 2 equals the yearend employment of affiliates that were acquired or established during the year plus the change in employment of existing affiliates that had an increase in employment and had acquired another U.S. business during the year. Line 3 equals the change in employment of affiliates that did not acquire another U.S. business but had an increase in employment. Line 4 equals the employment at the end of the prior year of affiliates that were liquidated or sold during the year plus the change in employment of affiliates that had a decline in employment and sold a business or business segment during the year. Line 5 equals the change in employment of affiliates that did not sell a business or business segment but had a decline in employment. Line 6 equals the change in employment of affiliates that both acquired and sold a business or business segment during the year. Line 7 equals the change in employment of large affiliates not accounted for in lines 2-6 plus all changes in employment for affiliates with fewer than 500 employees. It includes changes resulting from the addition to the survey universe of affiliates that were required to report in earlier years but did not. 34 Table 4.6 Gross Product of Majority-Owned Affiliatesas a Percentage of that of All Nonbank U.S. Affiliates, by Industry of Affiliate, 1992-94 1992 1993 1994 All industries Petroleum Manufacturing Food and kindred products Chemicals and allied products Primary metal industries Fabricated metal products Industrial machinery and equipment . . . Electronic and other electric equipment Paper and allied products Printing and publishing Rubber and plastics products Stone, clay, and glass products Motor vehicles and equipment Instruments and related products Other manufacturing Wholesale trade Motor vehicles and equipment Other Retail trade Finance, except depository institutions Insurance Real estate Services Hotels and other lodging places Business services Motion pictures, including television tape and film Other Agriculture, forestry, and fishing Mining Construction Transportation Communication and public utilities 80.6 82.4 78.0 80.3 78.9 79.9 82.5 80.9 82.3 99.3 99.1 97.6 76.2 73.6 73.9 50.7 51.6 59.6 90.8 91.9 91.0 79.8 78.5 86.9 93.3 94.0 94.0 G G G 91.6 G H 91.9 92.3 :. 9 1 .9 85.4 89.4 93.4 77.0 75.9 75.9 98.0 95.9 93.3 H 79.2 82.2 94.8 95.6 95.2 99.5 99.8 99.8 93.2 94.0 93.5 78.4 75.9 74.9 28.7 49.7 79.8 G 59.3 66.3 77.5 76.0 73.9 81.1 72.9 78.0 84.6 88.0 86.6 83.7 82.7 84.9 98.4 F F 69.3 G H 60.5 66.7 64.2 77.0 73.8 80.4 81.0 80.6 80.0 44.3 26.8 29.0 60.3 25.9 NOTE. —Size ranges are given in cells that are suppressed to avoid disclosure of data of individual companies. The percentage size ranges are: C--0. 1 to 19.9; E-20.0 to 39.9; F-40.0 to 59.9; G-60.0 to 79.9; H--80.0 to 100. 35 Table 4.7 Gross Product of Majority-owned Affiliates as a Percentage of that of All Nonbank U.S. Affiliates, by Country of UBO, 1992-94 1992 1993 1994 All countries 80.6 78.0 78.9 Canada 66. 1 56.6 55.8 Europe 87.8 86.5 84.8 Belgium 95.7 97.0 98.7 Denmark H H 1 00.6 Finland 92.1 93.1 93.4 France 87.9 87.2 87.9 Germany 84.3 82.0 81.4 Ireland E E E Italy 87.7 90.7 88.5 Luxembourg 67.0 F F Netherlands 90.5 89.4 8 1 .3 Norway 74.8 74.7 75.0 Sweden 6 1 .8 72.0 94.9 Switzerland 92.4 92.2 91.1 United Kingdom 9 1 .9 88.2 84.8 Other 8 1 .7 83.7 79.8 Latin America and Other Western Hemisphere 80.3 77.2 82.4 Mexico 76.5 73.9 82.2 Panama 98.3 97.5 97.8 Venezuela G 65.6 69. 1 Bermuda 87.5 85.5 87.7 Netherlands Antilles 74.6 92.5 91.7 Other H 66.7 96.5 Africa E E F South Africa F F F Other C C E Middle East E 32.1 39.8 Kuwait 53.5 52.0 57.0 Saudi Arabia C 1 2.6 9.0 Other H 95.2 99.8 Asia and Pacific 74. 1 76.0 84.0 Australia 43.9 30.4 83.6 Hong Kong . 89.5 95.5 93.5 Japan 79. 1 82.5 83.0 Korea, Republic of 78.5 82.0 109.8 Taiwan 93.9 95.2 94.1 Other 75.4 87.3 88.1 United States G F E NOTES: Shares of more than 100 percent may result where the gross product of minority-owned affiliates is negative. Size ranges are given in cells that are suppressed to avoid disclosure of data of individual companies. The percentage size ranges are: C— 0. 1 to 19.9; E~20.0 to 39.9; F— 40.0 to 59.9; G-60.0 to 79.9; H-80.0 to 100. 36 Foreign-Owned U.S. Firms' U.S Merchandise Trade by Lester A. Davis^ Foreign-owned U.S. firms continue to account for a substantial share of total U.S. merchandise exports and imports and the dominant share of the overall U.S. merchandise trade deficit. Thus, these large shares and their trends provide important insights into the overall U.S. trade performance. Their contribution to the U.S. deficit is particularly important because the U.S. trade deficit has been growing sharply again since the 1991 U.S. recession. This chapter addresses several of the key issues underlying the trade of foreign-owned U.S. firms. It discusses (1) key factors affecting U.S. affiliate-foreign parent trade; (2) their contribution to U.S. trade and trade balance relative to that by other firms; (3) recent developments in their trade; (4) the effects of key macro economic developments on their trade deficit growth; and (5) the extent that U.S. production and wholesaling operations of foreign-owned firms changed their dependence on imported inputs. The data in this chapter cover developments up through 1994.^ The author is a senior international economist in the Office of International Macroeconomic Analysis, Office of the Chief Economist, Economics and Statistics Administration, U.S. Department of Commerce. 1994 is the most recent year for which detailed data are available on the trade of foreign-owned U.S. firms. For earlier analyses of U.S. trade performance of foreign- owned firms see: William J. Zeile, "Merchandise Trade The scope of this chapter is limited to the U.S. trade in merchandise by foreign-owned U.S. firms, including that with related and unrelated foreign firms. Not covered is their trade in services as the data on their trade in services is limited to that with related parties. Moreover, their trade in services with related parties is subject to several key limitations.^ Key Findings The contribution to the size and growth of the U.S. merchandise trade deficit by foreign- owned U.S. firms is proportionately far greater than their shares of U.S. exports and imports. In 1994, they accounted for 22 percent of total U.S. exports and a much larger 33 percent of total U.S. imports, but accounted for a very large 70 percent of the total U.S. trade deficit. of U.S. Affiliates of Foreign Companies," in U.S. Department of Commerce, Economics and Statistics Administration, Office of the Chief Economist, Foreign Direct Investment in the United States: An Update . January 1995; and Lester A. Davis, "U.S. Foreign Trade in Merchandise and Services by Foreign-Owned Firms," in U.S. Department of Commerce, Economics and Statistics Administration, Office of the Chief Economist, Foreign Direct Investment in the United States: An Update . June 1993. For a discussion of these data limitations, see chapter 8 of this report on US-EU related-party trade. 37 In recent years, foreign-owned firms appear to have increasingly behaved Uke US-owned firms with respect to their propensity to export relative to their total sales, however, but not with respect to their imports. Since 1980, foreign-owned firms' share of total U.S. exports has decreased and their share of U.S. imports has risen, with the result that their share of the total U.S. trade deficit has increased. In 1994, their U.S. merchandise trade deficit reached a record $105.4 billion—the net of an even larger $112.3 billion deficit with their foreign parent groups and a small $6.9 billion surplus with unrelated foreign firms Their trade imbalance appears to be driven by the parent-affiliate relationship. Parent firms tend to have export surpluses with their foreign affiliates, reflecting their effort to gain access to foreign markets for products produced by the parent firms. Affiliates that are largely or primarily wholesalers are major participants in foreign parent sales to their U.S. affiliates and other U.S. firms ~ in recent years, accounting for about two-thirds of the total U.S. merchandise trade deficit of all foreign- owned U.S. firms. Japanese-owned U.S. firms accounted for a major share of the total U.S. merchandise trade deficit of foreign-owned U.S. firms (53 percent in 1994) and over one-half of the 1990-94 rise in the deficit, notwithstanding the decline in the volume of autos imported from Japan. In 1994, Japanese-owned U.S. wholesalers accounted for over 80 percent of the total exports and imports of all Japanese-owned U.S. firms. Foreign-owned firms in U.S. high- technology industries incurred rising trade deficits between 1990 and 1994~with surpluses in 1994 only in industries producing industrial chemicals and synthetics and producing instruments and related products. Factors Underlying Affiliate-Parent Trade Links Understanding the differences in ownership of firms provides a vital key to understanding differences in the extent of their contributions to U.S. trade performance. Over the past several decades, the U.S. economy has become increasingly interdependent with those of our major trading partners. A key vehicle of this interdependence has been the large capital inflows that have enabled foreign firms either to establish new U.S. firms or acquire existing U.S. firms. A major component of the operations of those foreign-owned U.S. firms— one on which their sales directly and indirectly depend— has been their expanding exports and imports. Foreign-owned U.S. firms increase their exports and imports for reasons similar to those driving US-owned firms— to increase sales by expanding global market share, obtain economies of scale through operations as multinational corporations, and improve returns on investment and profits However, these reasons translate somewhat differently in the trade performance of foreign-owned than US-owned firms largely because of several key factors, including (1) differences in the geographic location of their parent firms, (2) differences or similarities in the principal industrial activity of the parents and foreign affiliates, (3) whether or not the foreign parent firm regards the operations of the U.S. affiliate as primarily complementary with those of the parent or independent of them, and (4) differences in relative costs, market growth rates, and technology change in the parent's country versus those in the United States. Decisions to operate an affiliate in a complementary or more independent mode may change over time in response to the wide range of factors that affect the operations of both parent and affiliate. Among these factors are those that change relative costs of production (including exchange rates, wages and productivity), differences in macroeconomic growth rates, and government rules such as those affecting national 38 treatment, and changes in taxes, other trade barriers, and product standards. Examples of complementary activities are seen in a major reliance by foreign parent firms to operate through U.S. affiliates that are wholesalers of products produced by the foreign parent, and affiliates that produce final goods from inputs produced by the parent. In many instances, wholesaling affiliates provide the parent with additional economies of scale and thus the opportunity for the parent to improve the price competitiveness of its products. The ability of manufacturing affiliates to rely on parent- produced inputs partly explains the shift in Japanese motor vehicle production from Japan to their U.S. manufacturing affiliates and the significant effect of this shift on U.S. trade in these products. This shift in production location is discussed fiarther in this chapter in the sections on the linkage to parent firms and on the affiliates' dependence on imported inputs. Foreign-Owned U.S. Firms' U.S. Trade in Perspective The U.S. trade of foreign-owned U.S. affiliates (FDIUS-based trade) is an important component of overall U.S. trade. Moreover a large share of FDIUS trade is between related parties— that is, between the affiliate and its foreign parent or that parent's other foreign- owned firms. That related-party share of the U.S. affiliates' trade is particularly important because it reflects that ability of major muhinational corporations (MNCs) to shift production location among its foreign and U.S. plant locations. These transactions are also important because they involve the well-known issues of "transfer pricing"— the ability to shift profit-taking among related firms; however, these FDI data do not lend themselves to dealing with this latter issue.. Understanding the importance of foreign- owned U.S. firms' U.S. trade (FDIUS-based trade) to the overall U.S. trade performance requires examining their trade not only in comparison with the total U.S. trade of all firms, but also separately in terms of their trade with related foreign firms and with all other foreign firms. It also is important to compare their trade with other U.S. multinational firms' trade, that is, comparing FDIUS-based trade with the U.S. trade between U.S. parent firms and their foreign affiliates and other firms located abroad (USDIA- based trade). A comparison of FDIUS-based and USDIA- based U.S. trade between related parties clearly illustrates the point that FDI generally results in a net trade surplus— that is, FDI generally stimulates net exports by parent firms in one country with their affiliated firms in other countries. Thus, the related-party share of total FDIUS trade deficit appears largely attributable not to some serious distortion in short-run cycHcal or exchange rate fluctuations, but rather to the typical practice of parent firms to establish foreign affiliates mainly to facilitate the sales of their products in foreign markets."* Over the past decade and a half, foreign- owned U.S. firms have accounted for one-third or less of total U.S. exports and imports, while conversely US-owned firms have accounted for two-thirds or more of total exports and imports. • The value of U.S. merchandise exports by foreign-owned U.S. firms has more than doubled between 1980 and 1994, rising from $52 billion to $114 billion-slightly less rapidly than the much larger exports by US- owned firms (Figure 5-1). • As a result, the foreign-owned firms' share of U.S. exports was somewhat higher before 1986 than after 1986. Exports by foreign- owned U.S. firms ranged between 24 and 28 percent between 1980 and 1985 and between 19 and 24 percent between 1986 and 1994, when they accounted for 22 percent of total exports (Figure 5-2). For a detailed comparison of FDIUS-based and USDIA-based related-party trade between the United States and the European Union, see chapter 8 of this report. 39 Figure 5-1 US Merchandise Exports by Foreign-Owned and US-Owned Firms, 1980-94 Billion dollars 400 : 300 US-ovwied ^^^^ 200 ^^y^ 100 Foreign-owned _ 1 1 1 1 1980 82 84 86 88 90 92 94 Figure 5-3 US Merctiandise Imports by Foreign-Owned and US-Owned Firms, 1980-94 Billion dollars 500 J I I L. 1980 82 84 85 88 90 Figure 5-2 Foreign-Owned US Firms' Shares of Total US Merchandise Exports and Imports, 1980-94 Imports • The value of imports by foreign-owned U.S. firms also more than doubled between 1980 and 1994, rising from $76 billion to $219 billion— slightly more rapidly than the much larger imports by US-owned firms (Figure 5- 3) As a result, the foreign-owned firms' share of U.S. imports rose irregularly over the 1980-94 period, ranging between 30 and 37 percent and accounting for 33 percent of total US. imports in 1994. Because the U.S. imports by foreign-owned U.S. firms have been more than twice as large as their exports throughout most of the period 1980- 94, their trade deficits have been very large ~ so large in fact that they have dominated the total U.S. merchandise trade deficits. Moreover, the size of their trade deficits has far overshadowed the smaller U.S. trade deficits of US-owned firms. Furthermore, almost all of the foreign-owned firms' trade deficit has been due to their trade with their foreign parent firms rather than with unrelated firms. • The overall deficit in U.S. merchandise trade of all firms in the United States (US-owned and foreign-owned) increased from much lower levels in the early 1980s to a 1987 peak of $152.4 billion, decreased to a 1991 low of $66.7 biUion— the lowest since 1983, and increased again to a near record $150.6 billion in 1994. • The trade deficit of foreign-owned firms sharply deteriorated from lower early- 1980s levels to an interim peak in 1987 of $95.4 billion, decreased slightly to $81.8 billion in 1991 and $80.5 billion in 1992, and thereafter increased to a record $105.4 billion deficit in 1994 (Figure 5-4). • The trade deficit of US-owned firms reached a record peak of $69.4 billion in 1984, and thereafter steadily improved, reaching a small $15.1 billion surplus in 1991 (a U.S. recession year). After 1991, their trade balance sharply deteriorated like that of foreign-owned firms, reaching a $45.2 billion deficit in 1994 (Figure 5-5), 40 Figure 5-4 US Merchandise Trade of Foreign-Owned Firms, 1980-94 Billion dollars 250 J_ _1_ _1_ _L- I I 80 82 64 S6 Source Bureau of Economic Analysis Figure 5-5 US Trade Balances of Foreign-Owned & U.S.-Owned Firms, 1980-94 Billion dollars 20 y. (20) '■ '~~»-^^^ U S -Oimed ^^^'-''^ ^^ (40) yv /^ \ (60) (80) X^ Forergn-Owned (100) 1980 82 84 B6 BB 90 92 94 Propensity to Export and Import One of the key economic issues concerning he behavior of foreign-owned firms is the extent hey do or do not behave similarly to US-owned iirms with respect to their propensity to export md import. This is a very difficult issue to examine because, among other factors, their trade performance differs widely across industries and imong the countries of ownership, and there is a ack of precision in the data available for such a :omparison In particular, it is reasonable to expect that the propensity to import is far higher for firms in the wholesale industry than in nanufacturing industries. Moreover, it is likely :hat the variation in propensity to import is greater across industries than in terms of ownership. The propensity ratios for foreign-owned firms can be calculated directly from the data reported by those firms, however, the ratios for US-owned firms must be estimated on the basis of netting out the data for foreign-owned firms from national aggregates that are only close proxies to those for the foreign-owned firms. Nevertheless, at least a simple aggregate comparison can be made in terms of the ratio of exports and imports to sales over time. In recent years, foreign-owned firms appear on average to have increasingly behaved like US- owned firms with respect to their propensity to export merchandise relative to their total sales of all goods and services, including exports. However, this is far from so with respect to their average propensity to import merchandise in terms of the ratios of that trade to their sales. • The ratio of merchandise exports to sales of foreign-owned firms was consistently higher for foreign-owned than US-owned firms throughout the entire period 1980-94 (Figure 5-6). Nevertheless, the propensity of foreign-owned firms apparently decreased sharply between 1980 and 1987, and thereafl:er, was only slightly higher than that for US-owned firms. In effect, since 1987 their export behavior has been very similar to that of US-owned firms • The ratio of merchandise imports to sales of foreign-owned firms remained far higher for Figure 5-6 Ratios of Exports to Sales by Foreign-Owned and US-Owned Firms, 1980-94 _i I I I I I I i_ 41 foreign-owned than US-owned firms throughout 1980-94~a roughly three times higher propensity to import (Figure 5-7). This difference in behavior between exporting and importing helps to explain why the trade deficit of these firms throughout the period was also very large relative to the trade deficit of US-owned firms. Figure 5-7 Ratios of Imports to Sales by Foreign-Owned and US-Owned Firms, 1980-94 02 18 016 14 012 01 008 006 004 Foreigrv owned 92 Figure 5-8 Ratios of Imports to Sales by Foreign-Owned Firms in 1994 Motor veh & eq prod jHIJi^H^H^I Electronic components ^^^^^|H Nonferrous metals I^^^I^B RubtDer products ^H^^H Petrolum ^^^^^| Average ^H^H Drugs ^^^H Audio, video & comm eq ^|^^H Beverages HH Ferrous metals H^| Industrial chemicals H^l Instruments & prod HH Textiles & apparel H^l Paper & products ^H Farm pr raw mat Vi'hisle p| Soaps, toiletries, etc ■ Nevifspapers 1 Retail food stores 1 Motion pictures I r , 1 , 1 , 1 , 1 , 1 , 6 1 2 3 4 5 Although the difference between foreign- owned and US-owned firms in their average propensity to import appears to be substantial, this difference is far narrower than the range in propensity to import among foreign-owned firms in individual industries. For example, the propensity ratio of foreign-owned firms in most individual industries to import merchandise in 1994 averaged 0.15, but ranged between less than 0.01 and 0.56 (Figure 5-8). In 1 994, the range in propensity to import by foreign-owned firms in individual industries was more than 8 times as large as the difference between the average propensity to import by foreign-owned and US-owned firms. Moreover, the propensity to import of foreign-owned firms in one-fourth of the U.S. industries was lower than that of the average for US-owned firms. There is also a large range in the propensity to export among foreign-owned firms in individual industries. In 1994 their export- propensity ratios ranged from less than 0.01 and 0.36— a range far greater than the relatively small difference in the average propensity to export of foreign-owned and US-owned firms (Figure 5-9), Moreover, the propensity to export of foreign-owned firms in nearly one-half of the US industries was higher than that of the average for US- owned firms. Foreign Parent-US Affiliate Trade Links Investment by foreign parent firms in their U.S. affiliates provides a vital bilateral linkage that largely determines the size and growth of their intra-firm trade transactions. Their bilateral trade balance is very different (their trade deficit so much larger relative to the size of their trade) from that of firms with no such links. The 42 Figure 5-9 Ratios of Exports to Sales by Foreign- ■Owned Firms in 1994 Farm pr raw mat whisle Instruments & prod ^^^^H Electronic components ^■^^^1 Industrial ctiemicais ^^^■1 Computers & office eq ■Ji^l Paper & products ■■■ Nonferrous metals ^^H Rubber products ^^H Drugs ^^1 Average jj^H Motor veti & eq whisle ^H Elec gds wtxjiesale ^H Textiles & apparel ■ Motor veh & eq prod ■1 Soaps, toiletries, etc ■ Beverages ■ Audio, video, & comm eq ■ Petroleum ■ Ferrous metals 1 Motion pictures 1,1. 1 C ) 01 02 3 4 asymmetry in that trade relationship with their parent firms is a major factor in explaining the far higher growth rate in their imports from parent firms than their exports to those or other foreign firms and to the rapid growth in their large overall U.S. trade deficit. • All of that growth in the trade deficit of foreign-owned U.S. firms was accounted for by their trade with their parent firms throughout the 1980-94 period, except for 1985-87, when their trade with other (unrelated) firms was in small deficit (Figure 5-10). • Over the 1980-94 period, imports of the affiliates from their parent firms more than tripled to $164 billion, while their exports to their parent firms slightly more than doubled to $52 billion (Figure 5-11). As a result, the trade deficit of the foreign-owned U.S. firms with their parent firms rose almost every year between 1980 and 1994, except 1991 Figure 5-10 Trade Balances of Foreign-Owned Firms with Parents & Other Foreign Firms, 1980-94 (20) Other foreign firms (40) - (60) - (BO) - Parent lirmsN \ (100) 1 1 1 1 1 1 1 1 Figure 5-11 Foreign-Owned Firms Trade with Parent Firms 1980-94 Billion dollars 200 Imports Exports and 1992, and reached a record $112 billion in 1994. Over the 1980-94 period, the foreign-owned U.S. firms exports to, and imports from unrelated firms roughly doubled in parallel. As a result, their trade with unrelated firms was in small surplus during most of those years, reaching a $10. 1 billion peak in 1989 and edging down to $6.9 billion in 1994 (Figure 5-12). Response to Macro Economic Factors The foreign trade of both foreign-owned and US-owned U.S. firms appear to be similarly responsive to cyclical and exchange rate 43 Figure 5-12 Foreign-Owned F rms Trade with Unrelated Firms 1980-94 Billion dollars 60 50 - ^ Exports /^ SURPLUS ^ / ^ " 40 SURPLUS / y Imports 30 1 t 1 1 1 ^ — ■"^DEFICIT 1 1 1 1 1 r 1 1 1 1 1980 82 84 86 88 90 92 94 Figure 5-13 Growth Rates of US Imports by Ownership of US Firm and Import Ongin, 1 989-94 Percent 20 US-owned firms Foreign-owned from other firms Foreign-owned from parents I L fluctuations in terms of their exports and imports. These responses to macro economic factors are only roughly reflected in the changes in direction of their trade deficits over the longer period. The trade deficits of both groups increased after 1982, both stopped increasing after 1987, and both increased again after 1992 (Figure 5-5). Moreover, the post- 1992 resurgence in the trade deficits of US-owned and foreign-owned U.S. firms in particular support that conclusion. However, this responsiveness is clearly demonstrated only by a separate examination of the export and import trends. Moreover, in the case of their exports, it is only clearly demonstrated by a separate examination of the trends in their exports to individual key markets because the aggregate value of those exports obscures the differences in the timing of the exports' responsiveness to those markets' recessions and recoveries. The U.S. 1991 Recession and Recovery U.S. imports by both foreign-owned and US- owned firms responded to recessions in U.S. domestic demand in 1982 and 1991 and to U.S. economic recovery thereafter. In 1991, the drop in the level of imports by foreign-owned and US- owned firms largely reflects the decline in domestic demand during the 1991 U.S. recession, as is reflected in changes in the growth rates of those imports (Figure 5-13). The similar strong recoveries in imports by both firm groups in 1993 and 1994 largely reflect the strong post- 1991 recovery in U.S. domestic demand. The post- 1991 recession recovery in U.S. imports by US- owned firms was more rapid than in imports by foreign-owned U.S. firms, with imports by US- owned firms rising by 48 percent between 1991 and 1994, while imports by foreign-owned U.S. firms rose by only 20 percent. • The level of imports by US-owned firms decreased in 1991 in response to the 1991 U.S. recession when their growth rate became negative, and then sharply recovered in 1992 in response to the U.S. economy's recovery. • The growth in total imports by foreign- owned firms were similarly slowed by the slackening in U.S. domestic demand during the 1991 recession. This response is more clearly revealed in terms of growth rates than merely the level of imports, as the growth in imports by foreign-owned firms from unrelated foreign firms continued to rise, not decline in level, in 1 99 1 . However, the growth rates of their imports from both parents and unrelated firms sharply slowed in 1991, with the former dropping in level and growth rate in 1991 and recovering in 1992, while the latter never decreased in level but slowed sharply in growth rate in 1991 and again in 1992 and recovered in 1992. 44 Recession and Recovery Abroad The levels of total U.S. exports by foreign- owned U.S. firms show no clear response to foreign cyclical changes, largely because the timing of the recent recessions in demand varied widely among individual major U.S. export markets. However, that response to cyclical change in key individual foreign markets is clearly reflected in the level of their exports to those individual markets, and particularly in changes in the growth rates of those exports For example, while the U.S. and Canadian recessions bottomed out in 1991, the recessions in Japan extended over several years and continued into at least 1994, and the recessions in France and Germany were largely in 1993. • Foreign demand appears to have sustained into 1992 the growth in the level of U.S. exports of foreign-owned U.S. firms, as recession in most major markets for those exports—particularly in Japan and Western Europe—lagged the 1991 U.S. recession, and aggregate exports of foreign-owned U.S. firms continued to rise in 1993. Nevertheless, some response to foreign recession is reflected in a slowing in the growth of their exports. The nominal (current dollar) growth rate of the total exports of foreign-owned firms dipped sharply from 7.2 percent in 1992 to 2.5 percent in 1993, before recovering to 6.7 percent in 1994. The growth rate of US-owned firms' exports also slowed, but by far less, down from 6.0 percent in 1992 to 4.6 percent in 1993, before recovering to 1 1.3 percent in 1994. • Exports of foreign-owned firms to Canada decreased in 1993 in a lagged response to the Canadian recession that bottomed out in 1991 and continued into 1992 (Figure 5-14). • Exports to Japan also decreased in 1993 in response to that economy's recession. • In contrast, their total exports to Europe continued to rise throughout the early 1990s, Figure 5-14 Growth Rates of US Exports by Foreign-Owned US Firms, by Country of UBO, 1989-94 40 30 20 10 (10) (20) |- J2il [P- -1_ _1_ _1_ Japan All Europe Germany France United Kingdom despite decreases in their exports to individual countries in response to differences in the timing of those decreases for some of those key markets. For example, the level of their exports to France decreased sharply in 1990 and were much lower in 1991 and 1992 than in the preceding several years. Their exports to the United Kingdom dropped in 1993 and then recovered in 1994. In contrast, their exports to Germany continued to rise throughout this period, reflecting no apparent recession response The value of U.S. exports also reflect the effect of other macroeconomic non-cyclical factors that affected their competitiveness — particularly the major swings in the U.S. dollar exchange rate after 1995, and particularly against the yen in 1995. Although the growth in total exports of foreign-owned firms merely slowed in 1993, as the level continued rising, this continued rise in level is wholly accounted for by differences in the timing of the response of their exports to their parent firms versus to other foreign firms. Their aggregate exports to other foreign firms did not drop in either 1992 or 1993, albeit they were virtually flat between 1990 and 1991, increased only slightly in 1992, but rose by 7.4 percent in 45 1993. In contrast, their exports to parent firms continued rising strongly through 1992, but dropped by 2.9 percent in 1993, before rising by 9.2 percent in 1994. Dollar Depreciation On a trade-weighted basis against all currencies, the U.S. dollar depreciated sharply from a 1985 peak to its 1988 rate and remained relatively flat until 1993. The implicit negative impact of that U.S. dollar depreciation during 1985-88 is not clearly reflected in changes in the aggregate value of U.S. imports by either foreign- owned or US-owned firms during the 1985-90 period (Figure 5-15). U.S. imports by both groups continued to rise strongly during this period and on into 1990. The effects of dollar depreciation (and, inversely, those of dollar appreciation) are obscured by the opposing effects of (1) the tendency of dollar depreciation to increase the total dollar value of imports because in these circumstances the foreign currency prices of imports translate into higher U.S. dollar prices, and (2) the tendency of those higher dollar import prices to reduce effective U.S. demand volume for imports. It also is very difficult to separate out the extent of those exchange rate effects from the effects of other factors, such as cyclical changes in domestic demand. In addition, exchange rate changes across countries do not generally closely coincide in timing or direction with foreign national cyclical changes and their effects on prices and available supply. For example, between 1988 and 1994, the value of the U.S. dollar remained relatively stable when weighted by U.S. trade with all countries. This average, however, obscures a major 1990-94 appreciation of the Japanese yen against the U.S. dollar (Figure 5-16). The 23 percent yen appreciation against the U.S. dollar during this period might have significantly contributed to a stalled growth in the nominal value of U.S. imports from Japan by Japanese-owned U.S. firms in 1991 and 1992. Nevertheless, that yen appreciation impact apparently was offset by other Figure 5-15 Indexes of Trade-Weighted U.S. Dollar Exchange Rate & Total Imports byForeign-Owned Firms 1985-90 140 **N ^S^^^ U S dollar 120 ~ ^^^ ^^^_ 100 80 fin 1- U S -owned firms' imports _ . _ . i.' a-- Foreign-owned firms' imports ....1 . 1 1 1985 86 87 88 89 Sources Treasury Dept and Dept of Commerce, Bureau of Economrc Analysis Figure 5-16 Indexes of Yen-Dollar Exchange Rate & Imports by Japanese-Owned Affiliates, 1987-94 1990=100 120 110 100 Japanese-o\Aned firms' imports Yen per dollar factors in 1993 and 1994, when the value of those imports increased, despite a continued decline in imports of Japanese automobiles. Imports by other U.S. firms from Japan only accounted for a small share of those imports. Importance of Particular Nationality of Parent Firms U.S. firms owned by parents located in four major country groups— Japan, the European Union, all other Europe, and Canada— account for most of the rise in the overall U.S. trade of foreign-owned U.S. firms, with Japanese-owned firms accounting for the dominant share of this trade. 46 Figure 5-17 Shares of Total US Trade of Foreign-owned US Firms by Country of UBO in 1 994 (Values in billon %) Exports Imports $1138 $2192 other ^^2 Other Europe ^^ ^^ urope y r \ SgX S392 \ / \ \ $63l\ V^^" / '^'l \ S101 4 \\ 27 ^ /All s^5i v\y°"^^^ \ $1014 \vyo„^^ Japa n\.^ 3^Canada '' " \^_ \^ , Canada ^'' $126 Figure 5-18 Shares of Total US Trade Deficit of Foreign-owned US Firms, by Country of UBO, in 1994 (value in billion $) Total Deficit $105 4 aher Europe $5 1 / \ 1 \BJ-12 / \ / $239 \ Japan ^'« ' ^;;;;~——-^ All aher \ \\^\^^ / \ \ \ ^V. /OPEC $3.4 \^ \$5 3 ^/canada ^ „3''^oulh Korea Japanese-Owned U.S. Firms In 1994, Japanese-owned firms accounted for by far the largest shares of the total exports (40 percent) and imports (46 percent) by foreign- owned U.S. firms (Figure 5-17). Japanese-owned firms also were the largest single contributors (53 percent) to the overall U.S. trade deficit of foreign-owned U.S. firms (Figure 5-18) and the largest contributors (49 percent) to the total U.S. merchandise trade deficit of all U.S. firms- foreign- and US-owned firms. ^ Between 1981 and 1994, the Japanese owned firms' exports more than doubled, reaching $45.1 billion in 1994; their imports more than tripled over the period, reaching $101.4 billion, and their trade deficit rose by more than five times its 1981 level to $56.3 billion in 1994. Nevertheless, over the entire 1981-94 period, their shares of total exports and imports by foreign- owned U.S. firms has varied within a relatively Bureau of Economic Analysis data on the trade of foreign-owned U.S. firms are reported in terms of "country of UBO" (ultimate beneficial owner) and "industry of affiliate" and "industry of UBO". These are not necessarily the same as country of destination or origin of the products traded nor the industries in which the goods would otherwise be classified if they were the primary product produced by that industry. Figure 5-19 Shares of All Foreign-Owned Firms' US Trade by Japanese-Owned US Firms, 1981-94 30 U I I I 1 I I I narrow range, with their import share exceeding their export share throughout the period (Figure 5-19). There has been little, if any trend in their export share since 1983. In contrast, their import share has been edging down since its peak in 1985. Their share of the deficit in the total U.S. trade of foreign-owned U.S. firms has varied irregularly throughout the period, always accounting for over one-half or more of the deficit, and averaging 56 percent of the deficit since 1980. A major share of the Japanese-owned affiliates' deficit was concentrated in the deficit of those affiliates that are classified primarily either as manufacturers or wholesalers of motor vehicles 47 and equipment.^ Until 1989, the combined trade deficit of Japanese-owned firms primarily in these two motor vehicle industries rapidly and steadily increased. Between 1989 and 1994, a significant shift occurred in the composition of this trade. • While the trade deficit of Japanese-owned firms in most other industries apparently continued to rise, the deficit in the combined motor vehicle and equipment manufacturing and the wholesaling industries decreased from an estimated $33 billion in 1989 to 1 992-94 average $23 billion deficit (Figure 5-20). • The 1993 $25 billion deficit reflected both a $3 billion increase in exports and a $5 billion decrease in imports from that in 1989. • As a result, between 1989 and 1993, the combined motor vehicle share of all Japanese-owned U.S. firms' total trade deficit shrank from about 66 percent to 49 percent. Figure 5-20 Trade Deficits of Japanese-Owned US Firms in Motor Vehicle & Eq. Manufacturing & Wholesaling and in All Other Industries, 1989-94* 90 91 92 93 I Motor vehicles & eq ^ Other industries ■ Data fof 1989-92 estimated by the author in absence of separate BEAdata It is diflficuh to discern the key product details in the trade of Japanese-owned US. firms classified as motor vehicle producers and as motor The combined value of exports of Japanese-owned firms in the motor vehicle and equipment manufacturing and wholesaling industries in 1989-92 was estimated by the author in the absence of published BEA data. vehicle wholesalers. During the past decade, some of the firms that are classified in BEA statistics as a U.S. wholesalers also manufactured motor vehicles and some of those classified as U.S. manufacturers also imported motor vehicles. Moreover, these BEA trade data are in terms of the industry of the affiliate, not the product they import or export. Nevertheless, available data suggest that Japanese-owned U.S. firms shifted to importing fewer finished motor vehicles to manufacturing more of them in the United States. This conclusion is partly supported by the 40 percent decrease in the number of autos imported from Japan between 1986 and 1994 that is reported by the Bureau of the Census (Figure 5- 21) (The implication of a shift toward less import dependence among foreign-owned U.S. firms in general is discussed further in a separate following section in this chapter). Figure 5-21 US Automobile Imports from Japan 1986 87 89 90 91 92 93 94 Most U.S. imports of automobiles produced in Japan are imported by Japanese-owned U.S. firms, and those autos account for a large share of their total US imports from Japan. Although the number of those auto imports decreased between the mid-1980s and 1994, the total value of all imports by Japanese-owned firms continued to rise, indicating that the value of their imports of motor vehicle parts and other products increased more than enough to make up any decrease in auto imports. According to Census Bureau data, over the 1986-94 period in which the volume of 48 U.S. auto imports from Japan decreased by 40 percent, the value of U.S. imports of automotive parts and equipment from Japan more than doubled. There appears to be increasing long-term pressure on the competitiveness of Japanese parents' auto production in Japan. These pressures stem from exchange rate adjustments and from the rising technological capabilities of low-end producers in East Asia. Other Foreign-Owned U.S. Firms The U.S. trade of U.S. firms owned by several other major trading partners, in addition to trade of Japanese-owned firms, also has been in large deficit relative to the size of their exports. The deficits of firms owned by parents located in the European Union equaled over one-half the value of their exports The deficits also were large relative to their exports for foreign-owned U.S. firms with parents located in Canada and other key import sources, such as Venezuela, Hong Kong, and South Korea. South Korean-owned firms accounted for the second largest share of the total $14.8 billion (16.3 percent) increase in the overall trade deficit of foreign-owned U.S. firms. Not only was the $3.5 biUion increase in the South Korean-owned firms' deficit relatively large compared with the $8.1 billion deficit increase by Japanese-owned firms, this increase was proportionately far larger relative to their exports than for Japanese-owned firms. Moreover, the South Korean-owned firms' deficit increase was nearly as large as the $3.8 billion increase in the deficit of firms owned by parents in the European Union . In contrast, the trade deficit increase of Canadian-owned firms ($437 miUion) between 1990 and 1994 was small compared to that of the Japanese and South Korean owned firms. Importance of Foreign Ownership Links to U.S. Wholesaling Affiliates The industry composition of U.S. affiliates of foreign-owned firms appears to be a major factor affecting their U.S. trade performance, and in particular, because of the large share of that trade that is concentrated in the wholesaling versus manufacturing industries. Moreover, where the preponderance of the aflfiliates are in wholesaling a major U.S. trade imbalance tends to occur, as those wholesaling affiliates primarily fianction as distributors in the U.S. market of the foreign parent's output, rather than mainly as independent firms that distribute US-produced products abroad. • In recent years, all foreign-owned U.S. firms whose primary line of business was wholesaling consistently accounted for about two-thirds of the overall U.S. trade deficit by all U.S. firms in all industries, aUhough they accounted for a far smaller share of total imports and exports. • This linkage to U.S. wholesaling affiliates is far more important for Japanese-owned firms than other foreign-owned firms. Affiliates in the wholesaling industry account for a far larger share of the total trade of Japanese-owned U.S. firms than of all other foreign-owned U.S. firms. In 1994, Japanese-owned wholesalers accounted for over 80 percent of the total exports, imports and trade deficit of all Japanese-owned U.S. firms (Figure 5-22). In contrast, for all other foreign-owned firms, wholesalers accounted for much smaller shares— 31 percent of the exports, 40 percent of the imports, and 54 percent of the trade deficit. Japanese-owned firms account for a dominant share of the overall trade of foreign-owned U.S. firms that are primarily wholesalers. • In 1994, Japanese-owned U.S. wholesalers accounted for 63 percent of the exports, 64 49 Figure 5-22 Wholesalers Shares of Japanese and Other Foreign-Owned Firms' Trade In 1994 (100) n other industries H Wholesalers mM Exports Imports Deficit Japanese-o\Mied firms Exports Imports Deficit Other foreign- owned firms percent of the imports, and 64 percent of the trade deficit of all foreign-owned U.S. firms classified primarily as wholesalers. Moreover, most of the trade of these Japanese-owned U.S. wholesalers was with their parent firms— 74 percent of their exports, 86 percent of their imports, and 95 percent of their trade deficit. This high share of the affiliates' imports clearly illustrates the importance to foreign parent firms of establishing US. affiliates to distribute their products in the United States. High-Technology Manufacturing Industries' Trade The overall U.S. trade performance appears to differ little between foreign-owned and US- owned U.S. firms in high-technology manufacturing industries, as in recent years the trade balances of both groups has significantly worsened.^ Between 1990 and 1994, the trade For the purpose of this paper, the following manufacturing industries are identified as high-technology industries: industrial chemicals; drugs; computers and office equipment; audio, video and communication equipment; electronic components; rubber products; miscellaneous plastic products; and instruments and related products. This list does not exactly conform with Figure 5-23 Foreign-Owned & All US Firms' US Trade in High-Tech Manufacturing Industries, 1990 &94 (50) • 166 G ^_ @ 1990 • rl ^U ■ 1994 ■ 19 6 31 3 22 6 m 29 6 1 mm liftsL 1 -30 ■76 1 ■A 3 1 1 Exports Imports Balance Exports Imports Foreign-cwned fimis All US firms 'Based on the US Dept of Commerce "DOC-S" definition of high-technology industries. Foreign-owned excludeds data on fimis in industnes producting aerospace industnes and ordinance deficit of foreign-owned U.S. firms in high- technology manufacturing industries more than doubled from $3.0 billion to $7.6 biUion (Figure 5-23). During this same period the trade balance of all U.S. firms in high-technology manufacturing industries (US-owned and foreign-owned) worsened firom a surplus of $24 billion in 1990 to a deficit of $4 billion.' The trade balances of foreign-owned U.S. firms in individual high-technology manufacturing industries have been in deficit for some industries and in surplus for others (Table 5-1). Moreover, the trade deficits of most of the foreign-owned firms in individual high-technology manufacturing the so-called DOC-3 list of high-technology industries due to the limitations of the BEA data. For example, it does not include the aircraft industry, wliich is included in the large BEA category for "other transport equipment". The trade of foreign-owned U.S. firms in this industry is not expected to be large. Q The change in trade deficit of US-owned high technology industries can not be estimated directly by deducting the deficit of foreign-owned U.S. firms from that for all U.S. firms because U.S. Census-based trade data on an industry' basis do not exactly match BEA FDI-based trade data, and because of the lack of separate data on the trade of foreign-owned U.S. firms in the aircraft industry. However, the size and direction of the two data sets reported above suggest that the growth in the trade deficit of the US-owned firms was large. 50 Table 5-1 US Trade of Foreign-Owned US Firms in Selected High- Technology Manufacturing Industries in 1994 (Billion dollars) Exports Imports Balance Total 2 1 .9 29.6 -7.6 Industrial chemicals & synthetics 8.8 6.6 +2.2 Drugs 3.6 6.1 -2.5 Computers & office eq. . I.I 3.4 -2.2 Audio, video & comm. eq. 2.4 6.8 -4.3 Electronic components & accessories 1 .8 2.4 -0.6 Rubber products 1.2 2.2 -I.I Plastics products 0.4 0.7 -0.3 Instruments & related products 2.6 1.4 +1.2 industries has been large relative to the level of their exports. In contrast, the trade balances of those in industrial chemicals and in instruments and related equipment have been in surplus. The aggregate trade deficit of foreign-owned U.S. firms in high-technology manufacturing industries is smaller in absolute and relative terms than the trade deficit of foreign-owned firms in all other (non-high-technology) industries. Between 1990 and 1994, while the trade deficit of these foreign-owned U.S. firms in high-technology manufacturing industries increased from $3 billion to $8 billion, the deficit of foreign-owned firms in all other industries increased from $88 billion to $98 biUion (Figure 5-24). Dependence on Imported Inputs The extent to which foreign-owned U.S. firms are dependent on imported inputs has gained increased attention because of the growing US. trade deficit, and the high visibility of foreign- owned firms in key U.S. sectors, such as autos. Figure 5-24 Foreign-Owned Firms' Trade in High-Tech & Non-High-Tech Manufacturing Industries 1990 & 1994 Exports Imports Exports Imports High-Tech Manufacturing Non-High-Tech Manufacturing electronics and chemicals. The newly available data obtained from the BEA FDI benchmark surveys now provide insights into this issue. Measurement of dependence on imported inputs differs according to the coverage of foreign-owned firms: (1) all firms in each year, or (2) only a constant panel of firms over the entire multi-year period. Comparison of the results suggests that over a multi-year period the "all 51 firm" coverage of the input dependence measure is biased upward, as foreign-owned firms measured on a panel basis became less import dependent over time. All Foreign-Owned Firms The following summarizes the recent BEA comparison of changes in the import content embodied in the output of foreign-owned U.S. manufacturing firms with that of foreign-owned wholesaling firm.s and with that of all U.S. manufacturing firms. ^ The BEA data show that on average the import share of all inputs used by all foreign- owned U.S. manufacturing firms changed little between 1987 and 1991 (the latest year for which such data are currently available), and averaged between 16 and 17 percent (Figure 5-25).^° In contrast, the import content share of inputs used by those firms primarily in wholesaling was twice as large as those in manufacturing but declined during the 4-year period from 41 percent to 34 percent in 1991. Dependence on imported inputs was substantially higher for foreign-owned than US- owned firms, although the shares for both groups were relatively small. While no exactly comparable data are available, an indicator of their difference in import dependence is illustrated by the 1991 share of inputs by foreign-owned U.S. manufacturing firms, compared with the 1989 import share of inputs used by US-owned parent manufacturing companies. These imported input shares were 17 percent for foreign-owned U.S. manufacturing firms, and 1 1 percent for US- See Zeile (January 1995) cited above, and Zeile . "Imported Inputs and the Domestic Content of Production by Foreign-Owned Manufacuiring Affiliates in the United States," revision of paper presented at NBER Conference on Geography and Ownership Bases for Economic Accounting, Washington, DC, May 1995 (revised draft September 7, 1995). Figure 5-25 Shares of Imports in Total Inputs Purchased by Foreign-Owned US Firms, 1987-91 F!1 All rndustnes I Manufacturers 1987 88 89 Source Zeile (January 1995), Table 6-9, page 62 Figure 5-26 Import Shares of Total Inputs Purchased by Foreign-Owned US Firms, by Country of Ultimate Beneficial Owner, 1991 Canada ^HHH|||l2 7 Netherlands ^|H|^HH^'^ France ^|^^^^^^^| 10 Swlzerland ^^^^^^^ 10 1 United Kingdom ^m^| 9 2 ^^^^^^ 1.1,1. 10 20 30 4C Percent Source: U S Department of Commerce, Bureau of Economic Analysis owned parent firms. The import dependence of firms in al industries averaged 20 percent in 1991 across al countries of ownership, but varied widely, ranging for the major countries fi'om over 31.7 percent fo Japanese-owned firms to over 9.2 percent fo: U.K. -owned firms (Figure 5-26). The average import dependence also variec widely among individual industries owned b] foreign parents in each country. For example, th( import ratios for Japanese-owned firms, whicl averaged 32 percent in 1991, varied from wel over one-half of the inputs to virtually nc imported inputs (Figure 5-27). 10 Zeile (January 1995), Table 6-9, page 62. 52 Figure 5-27 Import Shares of Total Inputs Purchased by Japanese-Owned US Firms, by Industry of Affiliate, 1991 Computers & office eq Motor vehicle & eq mfg Electronrc components Wholesale trade Audo. video & comm eq Average all mdustnes ™ ■ 39 2 1383 1381 1 1.1. ^^^^^ ^^^^5 ^^^^^ 125 9 istnjments & related prod Non-ferrous metals ■ 19 7 1 ■ Textiles & appareJ 104 ...J J Chemicals Food products Retail trade Ferrous metals ■ 28 72 10 20 30 40 50 ' Percent Source U S Department of Commerce, Bureau of Economic A/iatysis. Figure 5-28 Import Content of Output & Share of Total Inputs Purchased by Foreign-Owned US Motor Vehicle & Eq. Mfrs. fv| Import content H Imported inputs ' Data based on constant panel of firms Source Zeile (May 1995), Table 4 'anel of Foreign-Owned Firms from 62 to 42 percent (Figure 5-28) 11 Changes over time in the share of aggregate nputs used by all foreign-owned manufacturing irms do not provide a direct measure of changes n the dependence of those firms on imports. The iggregate data include the rapid increase in breign ownership through acquisition of existing irms, establishment of new firms, expansion of ilready foreign-owned firms, and changes in the composition of foreign ownership of the firms in erms of the industries in which they are located. One way of abstracting from the statistical effects of those factors in order to more clearly examine changes in dependence on imported nputs would be to create a statistical panel of irms for the entire time period. Data based on a )anel comprising the same foreign-owned firms hroughout 1988-92 show that foreign-owned J.S. firms in four out of nine major manufacturing ndustries decreased their import content ratio, hose in one industry—instruments and related )roducts— already had very low import content, md the import content of those in the remaining bur industries was either stable or showed no ;ustained trend. Foreign-owned firms in the notor vehicle and equipment manufacturing ndustry made a particularly large decrease in the mport content share of their output from 54 to 35 )ercent, and a correspondingly large decrease in he import share of their total purchased inputs Relation to U.S. Economic Growth From an accounting standpoint, the US. exports of foreign-owned firms contribute an apparently small but important share of the total growth of the U.S. economy and jobs between 1986 and 1990. In 1994, their exports accounted for an estimated 1.6 percent of total U.S. GDP — about one-fourth of the total contributed by all firms' U.S. exports This 1994 level of export contribution to GDP has roughly prevailed since 1990 (Figure 5-29) and is substantially higher than Figure 5-29 Foreign-Owned US Firms' Export Shares of GDP & Import Shares of GD Purchases (GDPur), 1980-94 ercent 35 Imports* share of GDPur J I I I I I I L Zeile, (May 1995), Table 4. 53 the preceding low of 1.0 percent in 1987, but not higher than the previous peak at the beginning of the 1980s. Over the long term, these exports can be expected to have contributed proportionately to economic growth, although the data on exports of foreign-owned firms are not available in terms of constant dollars by which to estimate that growth contribution in real dollar terms. Although these shares of the overall U.S. economy may seem small, they take on more significance when translated into the estimated number of U.S. jobs they support. Based on rough estimates, in 1994, goods exports by foreign-owned firms supported about 1.6 million of the total 6.8 million U.S. jobs supported by all goods exports.'^ A similar accounting estimate can be made of the shares of U.S. gross domestic purchases supplied by goods imported by foreign-owned U.S. firms. In 1994, their imports supplied about 3.1 percent of the total U.S. gross domestic purchases ~ one-third of the total supplied by all firms' U.S. goods imports. This import share of gross domestic purchases has roughly prevailed since 1988 and is substantially higher than the preceding low of 2.3 percent supplied in 1983. 12 This rough estimate of the jobs supported by these exports is based on the national averages reported in studies by the U.S. Department of Commerce on the number of jobs supported by all U.S. merchandise exports. For example, see: Lester A. Davis, U.S. Jobs Supported by Goods and Services Exports, 1983-94, U.S. Department of Commerce, Economics and Statistics Administration, Office of the Chief Economist, November 1996. 54 CO E 12 c CO I) c CO O I c fS ^g T3 = (0 (D T3 ,? O CO 's (0 CO TO o 1- CO ■D c a a> O o 00 8. E o Q. X LU O c CO CD 8. £ o Q. X LU CO 3 o c _tg CO cn 8. E o Q. 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OJ X 0) in cn b E M— M if) c ZD § — cr m <" CT OJ _- a> O CO 1 ) 13 O 1 1 o t- co « * OOOOOOOOOOOOOOOOOOOOCDCDCDCD CDCDCDCDCDCDCDCDCDCD02CDCDCDCD 55 Table 5-3 U.S. Trade of Foreign-Owned Firms with Foreign Parent Groups and witii Other Foreign Firms (Million dollars) Exports Imports Balance Total Parents Other Firms Total Parents Other Firms Total Parents < Other Firms 1980 52,199 20,983 31,216 75,803 47,010 28,793 (23,604) (26,027) 2,423 1981 64,066 26,911 37,155 82,259 52,196 30,063 (18,193) (25,285) 7,092 1982 60,236 25,024 35,212 84,290 51,915 32,375 (24,054)' (26,891) 2,837 1983 53,854 22,577 31,277 81,464 54,802 26,662 (27,610) (32,225) 4,615 1984 58,186 27,072 31,114 100,489 70,451 30,038 (42,303) (43,379) 1,076 1985 56,401 25,900 30,501 113,331 81,740 31,591 (56,930) (55,840) (1,090) 1986 49,560 21,873 27,687 125,732 93,418 32,314 (76,172) (71,545) (4,627) 1987 48,091 19,109 28,982 143,537 108,201 35,336 (95,446) (89,092) (6,354) 1988 69,541 26,425 43,116 155,533 118,362 37,171 (85,992) (91,937) 5,945 1989 86,316 34,276 52,040 171,847 129,926 41,921 (85,531) (95,650) 10,119 1990 92,308 37,764 54,544 182,936 137,458 45,478 (90,628) (99,694) 9,066 1991 96,933 42,222 54,711 178,702 132,166 46,536 (81,769) (89,944) 8,175 1992 103,925 48,767 55,158 184,464 137,799 46,665 (80,539) (89,032) 8,493 1993 106,615 47,350 59,265 200,599 150,789 49,810 (93,984) (103,439) 9,455 1994 113,774 51,722 62,052 219,172 164,066 55,106 (105,398) (112,344) 6,946 Source: Bureau of Economic Analysis, Survey of Current Business, July 1996. 56 Differences in Foreign-Owned U.S. Manufacturing Establishments by Country of Owner By Ned G. Howenstine and Dale P. Shannon ' This chapter examines the characteristics of foreign-owned U.S. manufacturing estabHshments. In an earher pubHcation, a profile of foreign-owned U.S. manufacturing estabHshments, or plants, showed that these establishments pay higher wages and are more productive than U.S. -owned establishments. However, the differences were found to be largely attributable to differences in industry mix, plant scale, and occupational mix, rather than to foreign ownership per se} This chapter extends the earlier analysis by examining whether the industry mix and operating characteristics of foreign-owned U.S. manufacturing establishments vary by country of owner and by examining the reasons for these variations.^ The analysis covers establishments owned by investors from six major investing countries—Canada, France, Germany, Japan, the Netherlands, and the United Kingdom— and is based on data for 1991, the most recent data available. The following are the key findings of the analysis: The U.S. manufacturing establishments of each of the major investing countries tend to be much larger, pay higher wages, and be more productive than the U.S. -owned establishments. However, these tendencies vary by country of owner, particularly in the cases of plant scale and productivity. Some of these variations are due to differences in industry mix— that is, to differences among countries in the industry distribution of their U.S. establishments— and some are due to differences within the same industries. With respect to differences in industry mix: • The establishments of all six countries tend to be concentrated in industries with large establishments. This tendency is strongest for Netherlands-, Japanese-, and German-owned establishments. When the ' The authors are economists in the International Investment Division, Bureau of Economic Analysis, Economics and Statistics Administration, U.S. Department of Commerce. This chapter was previously published as an article in the Survey of Current Business, March 1996. See that article for data and the analytical appendix not included in this chapter. ^ See "Characteristics of Foreign-Owned U.S. Manufacturing Establishments," Survey of Current Business, (January 1994: 34-59). ' For convenience, the establishments of U.S. affiliates of foreign companies are referred to in this chapter as "foreign-owned establishments," even though the percentage of foreign ownership in a U.S. affihate may be as low as 10 percent. (A U.S. affiliate is a U.S. business enterprise that is owned 10 percent or more, directly or indirectly, by a foreign person.) The data analyzed here are not adjusted for percentage of foreign ownership. Thus, for example, the employment data include all employees of a given establishment, even though the foreign investor may own less than 1 00 percent of the affiliate to which the establishment belongs. However, most affiliates are majority owned (that is, they are owned more than 50 percent by direct investors); majority-owned affiliates accounted for 86 percent of the manufacturing employment of all U.S. affiliates in 1991. 57 effects of differences in industry mix are isolated from those of within-industry differences, these three countries' estabHshments were found to be over twice as large, on average, as U.S. -owned establishments. • The establishments of all six countries tend to be concentrated in high-wage industries. This tendency is strongest for Japanese-owned establishments and weakest for British-owned establishments. When the effects of differences in industry mix are isolated from those of within-industry differences, the compensation per employee of Japanese-owned establishments is found to be 23 percent higher, on average, than that of U.S. -owned establishments. In contrast, the compensation per employee of British-owned establishments is only 3 percent higher. • The establishments of all six countries show a strong tendency to be concentrated in high-labor-productivity industries. This tendency is strongest for Netherlands-owned establishments and weakest for French- and British-owned establishments. When the effects of differences in industry mix are isolated from those of within-industry differences, the value added per production- worker hour of Netherlands-owned establishments is found to be 60 percent higher than that of U.S. -owned establishments, and that of French- and British-owned establishments is about 20 percent higher. With respect to differences within industries : • The establishments of all six countries tend to be significantly larger than U.S. -owned establishments in the same industries. The differences range from 4.5 times larger for German-owned establishments to 3.5 times larger for British- and Netherlands-owned establishments. • The establishments of five of the six countries differ little from U.S. -owned establishments in the degree to which their output results from their own production or from production originating elsewhere. However, Japanese-owned establishments rely more heavily on production originating elsewhere than the establishments of the other countries; that is, a relatively large share of the output of Japanese-owned establishments reflects materials purchased from others. The ratio of purchased materials to output for Japanese-owned establishments is 10 percent higher than that for U.S. -owned establishments in the same industries; the ratios for the establishments of each of the other five countries are all within 3 percent of the ratio for U.S. -owned establishments. The establishments of the six countries maintain larger materials inventories relative to value added than do U.S. -owned establishments in the same industries. For Japanese-owned establishments, the ratio of materials inventory to value added is 62 percent higher than that of U.S. -owned establishments. The ratios of the other foreign-owned establishments ranged from 35 percent higher for Geraian-owned establishments to 14 percent higher for Canadian-owned establishments. Compensation rates within given industries vary among the establishments of the six investing countries largely because of differences in plant scale, capital intensity, and location. However, even after these factors are accounted for, wage rates of French-owned establishments are about 6 percent higher, and wage rates of British-owned establishments are about 4 percent lower, than those of the other foreign-owned establishments. Labor productivity varies significantly among the establishments of the six countries. Most of this variation appears to be attiibutable to differences in plant scale, capital intensity, employee skills, and location. Nevertheless, even after these 58 factors are accounted for, value added per production-worker hour of British-owned establishments is about 5 percent higher, — and that of Japanese-owned establishments is about 12 percent lower, than that of the other foreign-owned establishments. These findings are based on 1991 data for a sample of the U.S. manufacturing establishments of the six major investing countries that was extracted from the Census Bureau's Annual Survey of Manufactures (ASM) through a joint project of the Bureau of Economic Analysis (BEA) and the Census Bureau."* The establishments in the sample accounted for over three-quarters of the manufacturing employment of all foreign-owned U.S. manufacturing establishments in 1991. The remainder of this article consists of three sections. The first section outlines the economic rationale for the variations in the characteristics of foreign-owned operations by country of owner. The second examines whether the variation in the concentration of foreign-owned establishments in industries with particular attributes depends on the country of the establishments' owners. The third investigates within-industry differences in the operating characteristics of foreign-owned establishments that have different countries of ownership. ■* For data covering the universe of foreign-owned U.S. manufacturing establishments, see Foreign Direct Investment in the United States: Establishment Data for Manufacturing, 1991 (Washington, DC: U.S. Govenmient Printing Office, September, 1994). The data are classified by country of ultimate beneficial owner (UBO). The UBO is that person, proceeding up a U.S. affiliate's ownership chain, beginning with and including the foreign parent, that is not owned more than 50 percent by another person. The foreign parent is the first foreign person in the affiUate's ownership chain. Economic Rationale for Country-of-Ownership Differences The questions of why foreign direct investment occurs and of why the characteristics of foreign-owned operations may vary by country of owner have been studied extensively. According to one widely accepted explanation of direct investment, foreign investors are more likely to be active in industries with particular attributes, and in a given host country, the characteristics of the plants owned by investors from one foreign country tend to differ from those owned by investors from other foreign countries. This explanation follows fi-om the premise that foreign investors face inherent disadvantages when investing abroad: They are less familiar with the general business environment and frequently with the language in the host country than local entrepreneurs, and they must manage their foreign investments from a distance. To offset or overcome these disadvantages and to compete successfully abroad, the foreign firm making the investment must possess specific advantages—such as specialized knowledge, goodwill, advanced technology, marketing skills, or production-management or other organizational capabilities.^ Typically, these firm-specific advantages are not distributed evenly across industries and countries. As a result, the industries in which the investments are made are likely to depend on the country of the investor. In addition, because the investor must structure its foreign businesses in a way that will exploit these advantages, the characteristics of a business owned by a particular foreign country are likely to differ from those of businesses that are domestically owned or that are ' This theory was first developed by Stephen H. Hymer. See Stephen H. Hymer, The International Operations of National Firms (Cambridge, MA: MIT Press, 1976). 59 owned by other foreign countries.^ For example, if a foreign-owned U.S. plant utilizes a technology developed by its foreign parent, that plant may require more capital or a different mix of employee skills than a U.S. -owned plant or a U.S. plant owned by a foreign investor from another country. Although firm-specific advantages may lead to differences in operating characteristics, economic theory suggests that under competitive market conditions, payments for factors of production should be the same in foreign— and domestically owned businesses. For example, the wages paid to workers of the same skill level should be the same. However, in the United States, wage rates differ substantially across industries for the same occupations, and some analysts have suggested that these differences may be the result of less than perfectly competitive labor markets.^ If labor markets are not fully competitive—for example, due to differences in unionization or to regionally segmented labor markets— businesses owned by investors from one foreign country may be able to pay different wages to workers of the same skill level than those paid by domestically owned businesses or businesses owned by investors from other foreign countries. ^ For a discussion of both the theoretical and empirical literature on how the variations in the characteristics of foreign-owned businesses depend on the country of the foreign owner, see Jolin H. Dunning, Multinational Enterprises and the Global Economy (Wokingham, England: Addison-Wesley, 1993). ^ For this interpretation of wage-rate differentials, see Edward M. Graham and Paul R. Krugman, Foreign Direct Investment in the United States (Washington, DC: Institute for International Economics, 1995). According to other analysts, the difficulty of measuring some economic factors makes it appear as if imexplained wage differentials exist; see Lawrence F. Katz and Lawrence H. Summers, "Industry Rents: Evidence and Implications," Brookings Papers on Economic Activity, Microeconomics 1989 (Washington, DC: Brookings Institution, 1989) and the comments by the discussants. Industry-Mix Differences Overall, foreign-owned manufacturing establishments tend to have larger plants, pay higher wages, and be more productive than U.S. -owned establishments. These differences persisted throughout the rapid expansion in foreign direct investment in U.S. manufacturing over the 1988-91 period for which data on foreign-owned manufacturing establishments are now available (Tables 6.1 and 6.2). Some of these differences vary substantially by country of investor, and the variations reflect both industiy-mix and within-industry differences. In this section, the industry mix of the establishments of each of the six major investing countries is compared with that of U.S. -owned establishments.^ Plant Scale As can be seen in Table 6.3, the tendency to be concentrated in industries with larger- than-average plant scale (value added per establishment) varies considerably by counti-y of owner.^ The table shows, for each country, * The discussion in the remainder of the chapter is based on an analysis of data for 1991 , but data for 1988-90 were also examined. The results for these years were consistent with those for 1991. ' Table 6.3 covers 457 of the 459 four-digit Standard Industrial Classification (SIC) industries for which data on all U.S. manufacturing establishments are available from the ASM; data for 2 industries are suppressed in order to avoid the disclosure of data for individual establishments. Value added, as measured by the Census Bureau's ASM, is the numerator for plant scale. It differs from BEA's national income and product accounts measure of gross product: Value added includes purchased services but excludes indirect taxes, and it reflects inventory change valued at book value rather than at replacement cost. In the ASM, value added is calculated as the value of shipments plus the net change in fmished goods and work-in-process inventories less the cost of materials consumed. Because the number of manufacturing establishments is not shown in the Census Bureau's ASM publications, average plant scale for U.S. -owned establishments was 60 Table 6. 1 Selected Data for Foreign-Owned and All U.S. Establishments in Manufacturing, 1988-91 No. establishments (1 ,000s)' 9 Value added (billion $) 132 Shipments (billion $) 303 Employment (millions) 1 .5 Foreign-owned establishments All U.S. establishments Foreign-owned establishments as a percentage of all U.S. establishments 1988 1989 1990 1991 1988 1989 1990 1991 1988 1989 1990 1991 10 162 372 1.8 12 177 418 2.0 13 184 423 2.0 363 1.262 2,683 19.1 363 1,308 2,793 19.0 378 1,326 2,874 18.8 374 1,314 2,826 18.1 2.5 10.4 I 1.3 8.1 2.9 3.2 3.4 12.4 13.4 14.0 13.3 14.5 15.0 9.5 10.6 I I.I ' Consists of operating establishments and administrative and auxiliary establishments. Because the number of establishments is not shown in the CensusBureau's ASM publications, data on the number of U.S. manufacturing establishments are from the Census Bureau's annual County Business Paterns. both an overall measure of the plant scale of foreign-owned establishments in relation to that of U.S. -owned establishments (first column) and a measure of the relative plant scale of foreign-owned establishments that isolates industry-mix effects (second column).'*' Specifically, the second column shows how the plant scale of foreign-owned establishments would compare with that of U.S. -owned establishments if in each industry, plant scale were the same for the two groups of establishments and if the only difference were in computed using the total value added from the ASM and the number of U.S. manufacturing establishments shown in the Census Bureau's Count}' Business Patterns. 1991: United States (Washington DC: U.S. Government Printing Office, 1993). '" In the measures on the "all countries" line in the table, the plant scale of all foreign-owned establishments is compared with that of U.S. -owned establishments. These "all-countries" measures are provided for reference but are not discussed in the text. the distribution of establishments by industry." Differences across countries in this measure indicate the extent to which country of ownership influences the concentration of foreign-owned establishments in industries with large plant scale. As the second column indicates, Netherlands-, Japanese-, and German-owned establishments tend to be more concentrated in industries with large plant scale than the establishments of the other countries.'" The " The values in the second column can be expressed algebraically as ^-Ep,^5;-s,) p * 100 where P is average plant scale for all industries, p, is plant scale for industry i, and s, is the share of the ith industry in the total number of establislmients for all industries. Variables with the superscript a denote data for foreign-owned establishments. '^ Several of the industries with relatively large plants that have significant numbers of Netherlands-, Japanese-, and German-owned establishments are in chemicals 61 Table 6.2 Plant Scale, Wage Rates, and Labor Productivity of Foreign- and U.S.-Owned Establishments in Manufacturing, 1988-91 Foreign-owned establishments U.S.-owned establishements 1988 1989 1990 1991 1988 1989 1990 1991 Ratio of foreign-owned establishments to U.S.-owned establishments (percent) 1988 1989 1990 1991 Plant scale: Value added per establishment (millions)' 16.7 18.0 17.3 17.1 3.3 3.3 3.2 3.2 Wage rates: Production wages per hour (dollars) 11.84 12.08 12.57 12.88 10.57 10.81 11.04 11.33 Labor productivity: Value added per production-worker hour (dollars) 70 73 74 77 49 51 52 54 Output per production- worker hour (dollars) ^ 161 169 173 177 104 108 112 116 510 542 539 533 112 112 114 114 142 144 140 141 155 157 154 153 ' Plant scale is computed by dividing value added by the number of operating establishments. ^ Output is measured as shipments plus the change in finished goods and work-in-process inventories. concentration of British-owned establishments is the weakest, but it is still significant compared with that of U.S.-owned establishments.'^ Wage Rates The concentration of foreign-owned U.S. manufacturing. For example, all three countries have numerous establishments in various industries in the industrial inorganic and organic chemicals groups (SIC 281 and 286) and in pharmaceutical preparations (SIC 2834). " A comparison of the values in the second column with those in the first column indicates that the overall measure of relative plant scale is both significantly larger for each country and more variable across countries than the measure that isolates industry-mix effects. The overall measure tends to be larger and more variable because it reflects not only the differences in industry mix, but also the differences within industries; see the section "Within-Industry Differences." Table 6.3 Plant Scale of Foreign-Owned Establishments Relative to That of U.S.-Owned Establishments, 199! Percent Country of owner Overall difference Industry mix differences All countries 501 203 Canada 633 202 France 459 207 Germany 623 232 Netherlands 688 237 United Kingdom . . 407 1 74 Japan 535 234 Note.-This table was constructed using data for 457 four-digit SIC industries, including those that do, and do not, have foreign-owned establishments. 62 establishments in industries with above-average compensation per employee tends to vary among the six countries, but the variation is not as large as that in plant scale. Japanese-owned establishments show the strongest tendency to operate in high-wage industries; when the effects of differences in industry mix are isolated from those of within-industry differences, compensation per employee of Japanese-owned establishments is found to be 23 percent higher than that of U.S. -owned establishments (second column of Table 6.4). Gennan-owned establishments are also heavily concentrated in high-wage industries. British-owned establishments have the weakest concentration in high-wage industries.'"* Japanese- and German-owned establishments may be relatively heavily concentrated in industries that have high compensation per employee because these industries typically have an employee mix weighted toward skilled occupations. Japanese- and Gennan-parent companies that invest abroad often have firm-specific advantages that are technology related—advantages that usually occur in industries employing relatively large numbers of skilled, and thus highly paid, workers. Table 6.4 Compensation per Employee of Foreign- Owned Establishments Relative to That of U.S.-Owned Establishments. 1991 Percent Country of owner Overall difference Industry mix differences All countries 116 110 Canada 118 109 France 119 III Germany 122 116 Netherlands 115 109 United Kingdom . . 108 103 Japan 121 123 Note. --This table was constructed using data for 457 four-digit SIC industries, including those that do, and do not, have foreign-owned establishments. productivity—value added per production-worker hour and output per production-worker hour— show similar results (columns 2 and 4 of Table 6.5).'^ According to both measures, the tendency to be concentrated in high-labor-productivity industries is strongest for Netherlands-owned establishments and weakest Labor Productivity The concentration of foreign-owned establishments in industries with high labor productivity tends to vary significantly by country. Two measures of labor ''' Among the high-wage industries in which the employment of Japanese-owned establishments are concentrated are blast furnaces and steel mills (SIC 3312), tires and inner tubes (SIC 3011), semiconductor and related devices (SIC 3674), motor vehicles and car bodies (SIC 3711), and household audio and video equipment (SIC 3651). Among the high- wage industries in which the employment of German-owned establishments are concentrated are a number in chemicals manufacturing, including pharmaceutical preparations (SIC 2834), noncellulosic organic fibers (SIC 2824), industrial organic chemicals, nee (SIC 2869), cyclic crudes and intermediates (SIC 2865), and plastic materials and resins (SIC 2821). " Output is measured as shipments plus the change in finished goods and work-in-process inventories. Productivity is measured using both output and value added because the two measures provide different advantages. For example, output, unlike value added, reflects the contribution of intermediate inputs to production; however, value added avoids the double counting that can occur in the output measure when one establislmient provides materials used by other establishments in the same industry. For a discussion of the advantages and disadvantages of the two alternative measiu'es of productivity, see William GuUickson, "Measurement of Productivity Growth in U.S. Manufacturing," Monthly Labor Review 118 (July 1995): 13-28. Both value added per production-worker hour and output per production-worker hour measure productivity relative to a single input-labor. However, the variation in each measure may reflect differences in the use of other inputs, such as capital and intermediate inputs. 63 for French- and British-owned establishments 16 Within-Industry Differences This section examines the tendency of the foreign-owned establishments of the individual countries to have different characteristics within industries. In addition to differences in plant scale, wage rates, and labor productivity, this section also examines differences within industiies in the degi"ee to which the output of the establishments results from their own production or from production originating elsewhere and differences in the size of their materials inventories relative to their production. As before, each country's manufacturing establishments are compared with U.S. -owned manufacturing establishments. Plant Scale In the same industries, the establishments of all six countries tend to have significantly larger plants than U.S-owned establishments, and the within-industry differences vary by country (column 7 of Table 6.6). For a given country, the within-industry difference is measured as the difference in plant scale that would have resulted if the industry distribution of the country's establishments were the same as that of U.S. -owned establishments and if the only difference between the two groups of establishments were in the plant scale in each industry.'^ These differences range from 4.5 '* Netherlands-owned establislinients are concentrated in a number of high-labor-productivity industries within chemicals manufacturing and in petroleum refming. The high labor productivity in these industries partly reflects their capital-intensive production processes. " Using the notation from footnote 1 1 , the values shown in column 7 of table 6.6 can be expressed algebraically as Table 6.5 Labor Productivity of Foreign-Owned Establishments Relative to That of U.S.-Owned Establishments, 1991 Percent Country Value added per hour Output per hour of owner Overall Industry Overall Industry difference mix difference mix differences differences (1) (2) (3) (4) All countries 142 126 153 133 Canada .... 162 127 158 140 France .... 134 116 138 120 Germany . . 155 134 144 129 Netherlands 179 160 226 203 United Kingdom 153 124 144 121 Japan 106 125 150 129 Note.— This table was constructed using data for 457 four-digit SIC industries, including those that do, and do not, have foreign-owned establishments. p -Ts.ipf-P,) p * 100 In contrast to Tables 6.3-6.5 in the section "Industry-Mix Differences," which cover industries both with and without foreign-owned establishments, Tables 6.6-6.9 and 6.1 1-6.14 cover only industries with foreign-owned establishments. Differences in industry mix occur because the intensity of foreign investment varies across industries; thus, when relative investment intensities are analyzed, industries with no foreign investment must be accounted for in the same way as industries with extensive foreign investment. When within-industry differences are analyzed, only industries with foreign-owned establishments are included, because industries that do not have foreign-owned estabUshments provide no information about the within-industry differences between foreign- and U.S. -owned estabhshments. Because the number of industries in which the six coimtries have establislmients varies, the number of industris in Table 6.6 (column 1 ) varies by country. In addition to within-industry differences (column 5), the overall differences in the table (column 4) reflect differences in industry mix and the interaction of industry mix and within-industry differences. Because Table 6.6 covers only industries with foreign-owned establislunents, the industry-mix effects implicit in Table 6.6 differ from those shown in Table 6.3. 64 Table 6.6 Plant Scale of Foreign- and U.S. -Owned Establishments, 1991 Country of owner Number of industries' Thousands of dollars US-owned establish- ments All countries la m. 410 3,373 Foreign- owned establish- ments M. 19.209 Differences Overall Within- difference industry differences^ Foreign-owned relative to US-owned establishments (in percent) m. 15.835 ia 9.431 Overall difference (Cols. 3/2 xlOO) (6) 569 Within- industry differences (Cols. (2+5)/2 xlOO) (7) 380 Canada 173 3,129 23,976 20,847 8,987 766 387 France 160 3,977 15.957 11,980 11,756 401 396 Germany 174 2.914 24,053 21,139 10,328 825 454 Netherlands.... 98 3,811 25,753 21,942 9,989 676 362 United Kingdom 272 3,342 14,336 10,994 8,173 429 345 Japan 181 3,482 25,519 22,037 10,418 733 399 ' The all-countries line covers the four-digit SIC industries in which at least one of the six countries has establishments. The line for a country covers those four-digit SIC industries in which that country has establishments. ^ Measured as the difference in plant scale that would have resulted if the industry distribution of the foreign-owned establishments were the same as that of U.S.-owned establishments and if the only differences between the two groups of establishments were in the plant scale in each industry. Note.— Plant scale is measured as value added per establishment. times larger than U.S.-owned plants for GeiTnan-owned establishments to 3.5 times larger for British- and Netherlands-owned establishments. The plants of the other three countries are roughly 4 times as large as those of U.S.-owned establishments. Large plants may be sought out by foreign investors because the income and other benefits that normally accrue to such plants tend to offset the inherent disadvantages foreign investors face when investing in the United States and when subsequently operating their U.S. businesses. For example, foreign investors may concentrate their investments in relatively large plants in order to spread the comparatively high fixed costs that they incur over a larger volume of output. Operating large plants may also benefit foreign investors by simplifying the organizational structure, reducing the number of units that must be managed, and lowering the number of local business environments with which they must become familiar. Purchased Materials Establishments may differ in the degree to which their output results from their own production or from production originating elsewhere. The extent to which establishments rely on production originating elsewhere can be measured by the ratio of the value of purchased materials to the value of total output for each country's establishments. Based on this measure, the differences among the establishments of all the countries except Japan are relatively small (column 7 of Table 6.7).'^ Japanese-owned '* Column 7 shows within-industry differences in the ratio of cost of materials to total output. The cost of materials consists of materials obtained from all suppliers, whether U.S. or foreign. The cost of materials consists of charges for materials consumed or put into production during the year, including freight charges and other charges incurred by the establishment in acquiring these materials. It also includes the cost of fuel consumed. 65 Table 6.7 Ratio of the Cost of Purchased Materials to Output of Foreign- and U.S.-Owned Establishments, 1991 Country of owner Nunnber of industries' US-owned establish- ments Perc Foreign- owned establish- :ent Diffei rences Foreign-owne US-owned es (In pel id relative to tablishments Overall Within- rcent) Overall Within- (\) (2) ments (3^ difference (4) industry differences^ (S) difference (Cols. 3/2 xlOO) (6) industry differences (Cols. (2+5)/2 xlOO) (7) All countries . 410 53.4 55.3 1.9 0.9 104 102 Canada 173 54.4 51.2 -3.2 -1.3 94 98 France 160 55.5 53.5 -2.0 1.5 96 103 Germany 174 49.8 49.2 -.7 -1.2 99 98 Netherlands.... 98 48.1 47.3 -.8 -1.5 98 97 United Kingdom 272 52.6 49.6 -3.0 -.8 94 99 Japan 181 50.9 64.8 13.8 5.2 127 110 ' The all-countries line covers the four-digit SIC industries in which at least one of the six countries has establishments. The line for a country covers those four-digit SIC industries in which that country has establishments. ^ Measured as the difference in the ratio of the cost of purchased materials to output that would have resulted if the industry distribution of the output of foreign-owned establishments were the same as that of U.S.-owned establishments and if the only differences between the two groups of establishments were in the ratio of the cost of purchased materials to output in each industry. establishments rely much more heavily on purchased materials than do the establishments of the other five countries.'^ The heavy reliance on purchased materials by Japanese-owned establishments is consistent with the tendency of Japanese parent companies to rely on subcontracting in their production. It may also result because more Japanese-owned manufacturing plants are new, compared with those of the other five countries. As shown in Table 6.8, outlays to establish new businesses in Table 6.8 Share of Total Outlays to Acquire Existing Business and Establish New Businesses in Manufacturing, by Country of Affiliate Ownership Country of investor Percent Canada 4 France 2 Germany 3 Netherlands 6 United Kingdom 2 Japan 14 '' A recent analysis of BEA's enterprise data also found that Japanese-owned U.S. companies tend to rely on production originating elsewhere to a much greater extent than do other foreign-owned U.S. companies. William J. Zeile, "Imported Inputs and the Domestic Content of Production by Foreign-Owned Manufacturing Affiliates in the United States," in Geography and Ownership as Bases for Economic Accounting, ed. Robert E. Baldwin, Robert E. Lipsey, and .T. David Richardson (Chicago: University of Chicago Press, forthcoming in 1996). manufacturing as a share of total outlays to acquire existing businesses and establish new businesses in manufacturing was much higher for 66 Table 6.9 Ratio of Materials Inventory to Value Added of Foreign- and U.S.-Owned Establishments, 1991 Country of owner Number of industries' m. US-owned establish- ments ill Percent Foreign- owned establish- ments M. Differences Overall Within- difference industry differences^ m. M. Foreign-owned relative to US-ownedestablishments (In percent) Overall difference (Cols. 3/2 xlOO) (6) Within- industry differences (Cols. (2+5)/2 xlOO) (7) All countries 410 8.9 9.8 0.8 2.1 109 123 Canada 173 9.2 7.3 -1.9 1.3 79 114 France 160 8.9 8.2 -.7 1.7 92 119 Germany 174 9.1 10.0 0.9 3.2 110 135 Netherlands.... 98 8.3 7.2 -I.I 1.3 86 116 United Kingdom 272 8.5 8.8 0.3 2.3 103 127 Japan 181 8.2 14.2 6.0 5.1 172 162 ' The all-countries line covers the four-digit SIC industries in which at least one of the six countries has establishments. The line for a country covers those four-digit SIC industries in which that country has establishments. ^ Measured as the difference in the ratio of the materials inventory to value added that would have resulted if the industry distribution of the value added of foreign-owned establishments were the same as that of U.S.-owned establishments and if the only differences between the two groups of establishments were in the ratio of the materials inventory to output in each industry. Japan than for any of the other five countries (Table 6.8).'° When a newly built plant begins operations and its workforce is relatively inexperienced, activities in the plant many cover only a few production stages; as the plant matures, it may be able to substitute its own production for production originating elsewhere. In addition, because foreign owners may be unfamiliar with the U.S. business environment when they first set up their U.S. plants, newly built foreign-owned plants may be more likely to rely on materials purchased from their foreign owners. '' Inventories To some extent, the variation in the use of purchased materials is paralleled by a variation in the size of materials inventories relative to value added. The ratio of materials inventories to value added for Japanese-owned establishments is 62 percent higher than that for U.S.-owned establishments within the same industries, by far the largest difference for any country (column 7 ^° The data in the tabulation, which are from BEA's survey of U.S. businesses acquired or established by foreign direct investors, are averages for 1987-91 and cover only the plants built when a new U.S. business enterprise (a new U.S. affiliate) is created. New plants built by existing U.S. affiliates and plant expansions by existing U.S. affiliates are not covered. ^' Numerous studies have shown that newly built foreign plants of multinational companies tend to have large imports from their parent companies. One of the first studies was Raymond R. Vernon, "International Investment and International Trade in the Product Cycle," Quarterly Journal of Economics 80 {M2cy 1966): 190-207. 67 of Table 6.9). However, the establishments of the other five countries also maintained relatively large inventories of materials; the ratio ranged from 35 percent higher for German-owned establishments to 14 percent higher for Canadian-owned establishments. The finding that Japanese-owned establishments have unusually large materials inventories is somewhat surprising, given Japanese companies' reputation for keeping inventories at a minimum through their "just-in-time" system of deliveries from suppliers. One reason for the large inventories may be the particularly heavy reliance by these establishments on purchased materials, much of which are imported."" Because these materials typically travel over longer distances and by different modes of transportation than materials purchased domestically, imported materials may be shipped less often and in larger quantities than domestically purchased materials. Thus, Japanese-owned plants that rely on imported materials may have to caiTy comparatively large inventories in order to ensure that their supply is not intermpted. The differences among the establishments of the other five countries in their reliance on imported materials also appear to partly explain the differences in the relative size of their materials inventories. Wage Rates Compensation rates vaiy considerably among establishments of the major investing countries; an analysis shows that these variations appear to largely result from factors typically associated with variations in compensation rates, such as location and plant scale. When these factors are controlled for, only British- and French-owned establishments appear to have compensation rates that differ fi-om those of the other foreign-owned establishments in the same industries. Although the within-industry variation in compensation per employee among the establishments of the six countries is smaller than that for any of the characteristics examined so far, it is significant. Compared with U.S. -owned establishments in the same industries, the differences in compensation per employee ranged from 9 percent higher for French-owned establishments to 1 percent lower for Japanese-owned establishments (Table 6.10, column 1)}^ '"' According to Zeile, imported materials account for a large portion of the purchased materials of the Japanese-owned U.S. affiliates; see "Imported Inputs and the Domestic Content of Production." ^' For other studies of compensation rates of foreign-owned U.S. manufacturing establishments, using the BEA-Census Bureau data, see Robert E. Lipsey, "Foreign-Owned Firms and U.S. Wages," National Bureau of Economic Research Working Paper No. 4927 (November 1994) and J. Bradford Jensen and Mark Doms, "A Comparison Between Operating Characteristics of Domestic and Foreign Owned Manufacturing Establishments in the United States," in Geography and Ownership as Bases for Economic Accounting. Using 1987 data, Lipsey foimd a somewhat different pattern, particularly with regard to Japanese-owned establishments, than that found in this article. He found that the within-industry compensation rates of the Japanese-owned estabhslmients in manufactming are higher than those of U.S. -owned estabhshments, while this article finds that Japanese-owned establishments' compensation rates are sUghtly lower. The disparity may reflect differences in the level of industry detail used. Lipsey used published data on foreign-owned establishments, generally at the two-digit SIC level, presumably to avoid the sometimes high degree of suppression in the published data at finer levels of detail. In contrast, the analysis in this article is based largely upon data at the four-digit SIC level. Thus, Lipsey's finding may actually reflect industry-mix effects; specifically, in many two-digit industries, Japanese-owned establisliments are concentrated in the four-digit industries with the highest compensation rates. Doms and Jensen, in their analysis based on 1987 data, controlled for differences in industry mix and several other factors and found that wage rates of foreign-owned establishments vary by country of owner. They also found that Japanese- and Australian-owned establisliments pay lower production-worker wages than other foreign-owned estabhslmients. 68 Table 6.10 Compensation per Employee of Foreign- and U.S.-Owned Establishments, 1991 Country of owner Number of industries' Dollars US-owned establish- ments All countries . m. i2}_ 410 34,541 Foreign- owned establish- ments ill 39,754 Differences Overall Within- difference industry differences^ Foreign-owned relative to US-ownedestablishments (in percent) m. 5,214 ill 1.401 Overall difference (Cols. 3/2 xlOO) (6) 115 Within- industry differences (Cols. (2+5)/2 xlOO) (7) 104 Canada 173 34,804 40,654 5,850 1,679 117 105 France 160 36,403 41,544 5,141 3,374 114 109 Germany 174 34,376 42,228 7,852 2,642 123 108 Netherlands.... 98 36,787 38,605 1,818 1,821 105 105 United Kingdom 272 35,202 37,350 2,148 684 106 102 Japan 181 36,852 41,209 4,356 -551 112 99 ' The all-countries line covers the four-digit SIC industries in which at least one of the six countries has establishments. The line for a country covers those four-digit SIC industries in which that country has establishments. ^ Measured as the difference in the compensation per employee that would have resulted if the industry distribution of the employment of foreign-owned establishments were the same as that of U.S.-owned establishments and if the only differences between the two groups of establishments were in the compensation per employee in each industry. The following analysis examines the extent to which the variation in within-industry compensation rates is attributable to differences in occupational mix, location, plant scale, and capital intensity. Because data limitations make it impossible to use the compensation- per-employee measure for certain aspects of the analysis, this analysis also uses two alternative measures of compensation rates—payroll per employee and hourly wage rates of production worker s.^"^ Occupational mix. —Compensation rates may vary because the establishments of the six countries have different occupational mixes. Although detailed occupational data are not available from the ASM, a breakdown of total employment and total payroll between two broad groups— production workers and nonproduction workers— is available. ■^^ Nonproduction workers are usually considered to be higher skilled, on average, than production workers. A comparison of payi'oll per employee for the two groups ^'* Compensation covers benefits as well as wages and salaries; payroll covers only wages and salaries. ^' Production workers are workers— up through the line-supervisor level— at an operating establishment who are engaged in fabricating, processing, assembling, inspecting, receiving, storing, handling, packing, warehousing, shipping (but not delivering), maintenance, repair, janitorial and guard services, product development, auxiliary production for a plant's own use (power plant, for example), record keeping, and other services closely associated with these production operations at the estabUshment. Nonproduction workers are workers engaged in factory supervision above the line-supervisor level and workers engaged in the following activities: Sales (including drivers/salespersons), sales delivery (highway truck drivers and their helpers), advertising, credit, collection, installation and servicing, clerical and routine office fimctions, executive, purchasing, fmancial, legal, persormel (including cafeteria and medical personnel), professional, and technical. 69 Table 6.1 I Payroll per Employee of Production and Nonproduction Workers of All U.S. Establishments and Foreign-Owned Establishments, 1991 [Dollars] All U.S. establishments Foreign-owned establishments SIC Production Nonproduction Production Nonproduction code Industry workers workers workers workers Manufacturing 23, 1 39 38,002 26,220 42,43 1 20 Food and kindred products 20,346 31,638 23,086 34,597 2 1 Tobacco products 34,829 46,345 (D) (D) 22 Textile mill products 1 6,725 33.348 1 8,768 38,639 23 Apparel and other textile products .. . 12,324 28,304 14,353 28,196 24 Lumber and wood products 18.119 30,737 19.790 31.828 25 Furniture and fixtures 1 6.96 1 33.340 (D) (D) 26 Paper and allied products 28.023 41.814 29.698 45,135 27 Printing and publishing 21,878 30.706 25.309 31.946 28 Chemicals and allied products 31.013 43.874 33.281 46.739 29 Petroleum and coal products 37.989 48.647 39.695 5 1 ,284 30 Rubber and misc. plastics products ... 20,567 36,290 25,352 39,110 31 Leather and leather products 13,402 32,760 15,576 28,978 32 Stone, clay, and glass products 24.100 34.250 26,752 37,261 33 Primary metal industries 29,390 40,245 32, 1 67 41 ,968 34 Fabricated metal products 23,694 36,462 26,374 39,169 35 Industrial machinery and equipment .. 25,757 39,578 25,827 41,209 36 Electronic and other electric equipment 22,299 40.714 22.529 40.580 37 Transportation equipment 32,792 44.072 28,350 41,502 38 Instruments and related products 25,842 44,759 24,032 42,742 39 Miscellaneous manufacturing industries 16,899 32,613 19,960 36,385 D Suppressed to avoid disclosure of data of individual companies. SIC Standard industrial classification supports this view: For both all U.S. establishments and foreign-owned establishments, payroll per employee of nonproduction workers is significantly higher than that of production workers for total manufacturing and for each two-digit SIC manufacturing industry (Table 6.11).'' 26 Payroll per employee rather than compensation per employee is shown in Table 6. 1 1 because data on employee benefits by type of worker are not available fi^om the ASM. Educational attainment, which is an indicator of employee skill level, is also higher for nonproduction workers than for production workers; see Eli Berman, John Bound, and Zvi Griliches, "Changes in the Demand for Skilled Labor Within US Manufacturing Industries: The role of occupational mix in explaining wage differences can be examined by comparing variations in wages of production workers with variations in compensation per employee of all workers. This comparison indicates whether variation by country in the ratio of nonproduction workers to production workers is a source of inter-country differences in overall rates of pay. Across the establishments of the six countries, the range of within-industry differences is somewhat narrower for hourly wage rates of production workers than it is for Evidence from the Annual Survey of Manufacturing," Quarterly Journal of Economics 109 (May 1994): 367-97. 70 Table 6. 1 2 Production-Worker Wages per Hour of Foreign- and U.S.-Owned Establishments, 1991 Country Number of Dc illars Foreign-owned relative to of owner industries' US-owned establish- ments Foreign- owned establish- Differences US-owned es On pe tablishments Overall Within- rcent) Overall Within- ments difference industry differences^ difference (Cols. 3/2 xlOO) industry differences (Cols. (2+5)/2 xlOO) (\) (T\ (3) (A\ r5) (6) (7) All countries 410 11.37 12.87 1.50 0.31 113 103 Canada 173 11.52 13.46 1.95 0.11 117 101 France 160 11.66 13.36 1.69 0.80 115 107 Germany . . . 174 11.43 13.30 1.87 0.78 116 107 Netherlands. 98 11.61 12.00 0.38 (a) 103 100 United Kingdom 111 11.53 11.87 0.34 0.26 103 102 Japan 18! 12.13 13.74 1.61 -0.17 113 99 ' Greater than -0.005 and less than 0.005. ' The all-countries line covers the four-digit SIC industries in which at least one of the six countries has establishments. The line for a country covers those four-digit SIC industries in which that country has establishments. ^ Measured as the difference in the production-worker wages per hour that would have resulted if the industry distribution of the production-worker hours of foreign-owned establishments were the same as that of U.S.-owned establishments and if the only differences between the two groups of establishments were in the production-worker wages per hour in each industry. compensation per employee of all workers (column 7 of Table 6.12 and column 7 of Table 6.10, respectively), suggesting that differences in occupational mix may explain some of the variation in compensation rates. However, in some cases, the differences in the hourly wage rates of production workers are wider than those in the compensation per employee of all workers.'^ Location." Wage rates may also vary by country of owner because the establishments of one country may be more (or less) concentrated than the establishments of other countries in ^^ Lipsey found that differences in occupational mix played a role in explaining why compensation rates are higher in foreign-owned establishments than in U.S.-owned establishments only for German-owned establishments, and even in this case, occupational mix only explained part of the difference. See "Foreign-Owned Firms and U.S. Wages." geographic areas where wages are relatively high (or low). However, even after controlling for differences in distributions of employment across States (see column 2 of Table 6.13), payroll per employee still varies considerably."^^ This variation may exist partly because, as discussed earlier, the establishments of the six countries tend to be concentrated to different degrees in high-wage industries. Furthermore, this concentration may not be uniformly distributed across States. Controlling for differences in State-by-industry distributions (see column 3 of 28 Payroll per employee rather than hourly wage rates or compensation per employee was used in this section because the all-U.S. data source for these comparisons. County Business Patterns, 1991, provides data only on total payroll and employment. For the establishments of each country, the relative payroll-per-employee measure in column 2 of the table is smaller than that in column 1 , indicating that each country's establishments tend to be more concentrated in high-wage States than the U.S.-owned establishments. 71 Table 6.13) significantly narrows the differences in payi"oll per employee across the establishments of the six countries."^ Other factors.~In addition to occupational mix and location, other factors may influence compensation rates. One is the extent to which the employees of the establishments are unionized. Data are not available from the ASM on the number of employees who are in unions, but such data are available from BEA's 1992 benchmark survey of foreign direct investment in the United States.^" Because the benchmark survey data are collected on an enterprise basis, they are not directly comparable with the establishment data from the ASM. However, the enterprise data do suggest that there is little relationship between unionization rates and the variation in compensation rates of the establishments of different countries, once differences in industry mix are taken into " For the establishments of each country, the relative payroll-per-employee measure in column 3 of the table is smaller than that in column 2, indicating that each country's establishments tend to be concentrated in the higher-wage industries within individual States. The conclusions based on the measures shown in Table 6.13 are subject to two important qualifications. First, in constructing column 3, the differences in the industry distributions were controlled for by using data at the three-digit SIC level, because all-U.S. data on payroll per employee within States is not available at the four-digit level. Rough calculations indicate that if foirr-digit, rather than three-digit, industry data had been used, the relative payroll-per-employee measure shown for Japanese-owned estabhshments would probably have been less than 100 percent instead of the 101 percent shown. Second, the boundaries of labor markets may not coincide with State boundaries. Wage rates in one part of a State may be higher than those in another part of the State (for example, wage rates may be higher in urban areas than in rural areas). As a consequence, State data may not always gauge accurately whether foreign-owned establishments have a tendency to be located in areas where wages are particularly high (or low). '" See U.S. Department of Commerce, Bureau of Economic Analysis, Foreign Direct Investment in the United States: 1992 Benchmark Survey, Final Results (Washington, DC: U.S. Government Printing Office, September 1995). Table 6. 1 3 Payroll per Employee: Foreign-Owned EstablishmentsCompared With U.S.-Owned Establishments, 1991 (Percent) After adjustment Country for differences in of owner Overall distributions Across Across states states and industries (I) (2) ( 3 ) Canada 119 107 98 France 114 109 98 Germany .... 120 115 101 Netherlands.. 118 104 102 United Kingdom 107 10! 98 Japan 114 106 101 Note.—Column I shows payroll per employee of foreign-owned establishments relative to that of U.S.-owned establishments before controlling for account. The variation in compensation rates may also reflect differences in plant scale and capital intensity. It was previously found that at the all-countries level, differences in compensation rates between foreign- and U.S.-owned establishments are significantly correlated with differences in plant scale. Because the size of foreign-owned plants depends on the country of owner, the variation in compensation rates may partly reflect differences in scale. Capital intensity could influence compensation rates if higher skilled labor tends to be required in plants that use large amounts of capital. In addition, if skill levels are higher in capital-intensive plants, employee training may be relatively expensive and the plants may pay higher wages to reduce employee turnover and the associated training costs. Combined effects. —The prior analysis suggests that variation in compensation rates among the six countries' establishments is associated with variations in industry composition, occupational mix, location, plant 72 scale, or capital intensity. In order to deteiTnine whether differences in compensation rates remain once these factors are simultaneously taken into account, multiple regression equations were estimated in which the dependent variable was hourly wage rates of production workers, and the independent variables were plant scale, capital intensity, control variables for four-digit SIC industry and for location (State), and dummy variables to indicate residual country-of-ownership differences."" Six equations—one for each country— were estimated. In each case, the observations were the individual establishments of the six countries. In the equation for each country, the variable for country of owner was used to test whether the establishments of that country differed from the establishments of the other five, once the industry and State controls and the other independent variables were taken into account. "*■ Key findings of this analysis are discussed below. The regression analysis indicates that among the establishments of the six countries, the variation in hourly wage rates largely results from differences in industry mix, location, plant scale, and capital intensity. However, even after these factors are taken into account, the wage rates of French-owned establishments are about 6 percent higher, and those of British-owned establishment are about 4 percent lower, than those of the other foreign-owned establishments. These results are based on tests that assume that the relationship between hourly wage rates ^' The sample data used to estimate the regreession equations differ somewhat in coverage from those used in the analysis of the preceding sections. It should also be noted that, in the regressions, capital intensity was measured indirectly using a proxy variable, because the data needed to measure it directly are not available. 32 An ahemative to estimating a separate regression equation for each country is to estimate a single equation that includes country-of-ownership variables for five of the six countries, with the sixth country serving as a the base. In general, the results from this alternative method, which are presented in the appendix, are consistent with those from the separate regression equations. and both plant scale and capital intensity is the same for the establishments of each country (that is, that the regression coefficient for each variable is the same for each country). In order to check whether the effect of a pailicular country's ownership may reflect differences in the relationship between the other independent vaiiables and country of ownership (slope effects) rather than any overall country-of-ownership effect (intercept effect), a second set of regression equations was estimated in which the relationship between wage rates and both plant scale and capital intensity can vary depending on the country of owner. The results from the second set of equations indicate that the relatively high production-worker wage rates in French-owned establishments are due to a stronger positive relationship between wage rates and capital intensity for those establishments than for the establishments of the other five countries. Further, French-owned establishments with the same capital intensity as the establishments owned by the other countries tend to have higher production-worker wage rates than the other establishments and the higher the capital intensity, the larger the gap between the wage rates of French-owned establishments and those of the other establishments. The reasons for the relatively high compensation rates for French-owned establishments and the relatively low compensation rates of British-owned establishments are unclear. The differences in the compensation rates may reflect differences in the firm-specific advantages that enable foreign companies to invest successfully in the United States. For example, the advantages of parent companies in one foreign country may stem from production-management or other organizadonal capabilities rather than from the possession of advanced technology. If so, compensation rates of that country's establishments may be relatively low, because these establishments are less likely than those of other countries to use technologically complex production processes that require relatively large numbers of high-skill, 73 high-wage production workers. Variations in the skill mix of production workers were not controlled for in this analysis, and they may be the source of some of the differences in the wage rates of foreign-owned establishments by country of owner. Labor productivity The variation in labor productivity across the establishments of the six countries appears to be largely attributable to differences among the establishments in factors such as plant scale and employee skill level. However, some evidence suggests that once these factors are taken into account, the labor productivity of British-owned establishments tends to be somewhat higher, and the labor productivity of Japanese-owned establishments somewhat lower, than that of the other foreign-owned establishments. Whether labor productivity is measured as value added per production-worker hour or as output per production-worker hour, the labor productivity of the establishments of the six countries varies significantly from country to country, but each country's establishments have higher labor productivity than U.S. -owned establishments in the same industries." Using the value-added measure, the labor productivity of French- and Netherlands-owned establishments is particularly high relative to that of U.S. -owned establishments~40 percent and 38 percent higher, respectively (Table 6.14, column 7). In contrast, the labor productivity of Japanese-owned establishments is only 7 percent higher. Using the output measure, the differences in labor productivity range from 43 percent higher for Netherlands-owned establishments to 8 percent higher for Canadian-owned establishments (Table 6.15 column 7). If the within-industry differences in labor productivity for the establishments of the six countries are ranked, both measures of " The value-added and the output measures each have unique advantages as measures of labor productivity (see footnote 15). productivity yield similar rankings, except that the Japanese-owned establishments rank sixth on the basis of the value-added measure and third on the basis of the output measure. This disparity may reflect a tendency for the operations of Japanese-owned establishments to be structured differently fi-om those of the establishments of the other countries. That stmctural differences exist is suggested by the earlier finding that the ratio of purchased materials to output tends to be much larger for Japanese-owned establishments than for the other establishments. The remainder of this secdon evaluates the extent to which variation in labor productivity by country of owner reflects differences among the establishments in factors that often influence labor productivity—plant scale, capital intensity, and employee skill levels. It was previously found that at the all-countries level, the labor productivity of foreign-owned establishments differed significantly from that of U.S. -owned establishments and that most of this difference was attributable to differences in industry mix, plant scale, capital intensity, and employee skill level. In order to determine if this finding holds across countries, multiple regression equations that simultaneously take these factors into account were estimated for each country. In the regressions, the dependent variable was labor productivity and the independent variables were plant scale, capital intensity, employee skill level, control variables for four-digit SIC industry and for State, and dummy variables to indicate residual country-of-ownership differences. Separate equations were estimated for the value-added and the output measures of labor productivity. In addition, because an establishment's output embodies purchased materials as well as its own value added, a measure of the use of purchased materials relative to total output was included as an independent variable in the equations using the output measure. When the value-added measure was used as the dependent variable, the regression results suggest that most of the differences in labor 74 Table 6.14 Value Added per Production-Worker Hour of Foreign- and U.S.-Owned Establishments, 1991 Country of owner Number of industries' (1) US-owned establish- ments (2) Do Foreign- owned establish- ments (3) liars Diffe rences Foreign-owne US-owned es (In pel ;d relative to tablishments Overall difference (4) Within- industry differences^ (S) -cent) Overall difference (Cols. 3/2 xlOO) (6^ Within- industry differences (Cols. (2+5)/2 xlOO) (7) All countries . 410 53 80 27 7 150 114 Canada 173 54 91 37 8 169 114 France 160 59 74 16 24 126 140 Germany 174 50 87 37 15 174 130 Netherlands... 98 63 109 46 24 173 138 United Kingdom 272 56 84 27 13 149 124 Japan 181 58 65 7 4 113 107 ' The all-countries line covers the four-digit SIC industries in which at least one of the six countries has establishments. The line for a country covers those four-digit SIC industries in which that country has establishments. ^ Measured as the difference in the value added per production-worker hour that would have resulted if the industry distribution of the production-worker hours of foreign-owned establishments were the same as that of U.S.-owned establishments and if the only differences between the two groups of establishments were in the value added per production-worker hours in each industry. productivity across the establishments of the six countries are attributable to differences in plant scale, capital intensity, employee skill level, industiy, and location. However, even after these factors are taken into account, the labor productivity of British-owned establishments is about 5 percent higher, and the labor productivity of Japanese-owned establishments about 12 percent lower, than that of the establishments of the other countries. These results were based on regressions in which it was assumed that the relationships between labor productivity and plant scale, capital intensity, and employee skill level are the same for the establishments of each country. A second set of equations was estimated in which this assumption was relaxed. The results of these regressions suggest that the relatively high labor productivity of British-owned establishments reflects a stronger positive relationship between labor productivity and capital intensity for those establishments than for the establishments of the other five countries. Further, British-owned establishments with the same capital intensity as the other establishments tend to have higher labor productivity than the other establishments and the higher the capital intensity, the larger the gap between their productivity and that of the other establishments. When the output measure was used as the dependent variable, no systematic differences in productivity were found across the establishments of the six countries once differences in industry mix, location, use of purchased materials, plant scale, capital intensity, and employee skill were taken into account. These results are based on regression equations in which it was assumed that the relationships between labor productivity and the use of purchased materials, plant scale, capital intensity, and employee skill level are the same for the establishments of each country. A second 75 Table 6.15 Output per Production-Worker Hour of Foreign- and U.S.-Owned Establishments, 1991 Country Number of Dollars Foreign-owned relative to of owner industries' US-owned Foreign- Differences US-owned establishments establish- owned On percent) ments establish- Overall Within- Overall Within- ments difference industry difference industry differences^ differences (Cols. 3/2 (Cols. (2+5)/2 xlOO) xlOO) (I) (2) _Q} (4) (5) (6) (7) All countries . . 410 115 182 67 20 158 117 Canada 173 119 188 69 10 158 IDS France 160 133 160 26 57 120 143 Germany 174 100 165 65 24 165 124 Netherlands.... 98 122 210 88 40 172 133 United Kingdom 272 120 168 48 25 140 121 Japan 181 119 194 75 39 163 133 ' The all-countries line covers the four-digit SIC industries in which at least one of the six countries has establishments. The line for a country covers those four-digit SIC industries in which that country has establishments. ^ Measured as the difference in the output per production-worker hour that would have resulted if the industry distribution of the production-worker hours of foreign-owned establishments were the same as that of U.S.-owned establishments and if the only differences between the two groups of establishments were in the output per production-worker hours in each industry. set of regression equations was estimated in which this assumption was relaxed. Like the results of the value-added regressions, the results of these regressions suggest a stronger positive relationship between labor productivity and capital intensity for British-owned establishments than for the establishments of the other countries. These results also suggest that the positive relationship between the use of purchased materials and labor productivity is stronger for Japanese-owned establishments than for the other establishments. In contrast, the results suggest that for Canadian-owned establishments, high labor productivity is associated with lower, rather than higher, use of purchased materials. A number of factors that were not taken into account in this analysis may explain the differences in the labor productivity of British- and Japanese-owned establishments. For example, the productivity, like the wage rates, of foreign-owned establishments may be influenced by the firm-specific advantages of the establishments' parent companies. The variation in labor productivity may also reflect a variation in the average age of the foreign-owned establishments by country of owner. Many Japanese-owned establishments are relatively new. Productivity in new plants may be relatively low because these plants often operate at less-than-full capacity and because they may incur training and other costs that are not incurred in older plants.^"* " In "Qiaracteristics of Foreign-Owned U.S. manufacturing Establishments," outliers were controlled for by limiting the analysis to only those four-digit industries with six or more foreign-owned establishments. That approach was rejected for this study because of the relatively small mmiber of four- digit industries in which individual investing countries own six or more establishments. 76 7 and 8 US-EU Foreign Direct Investment and Trade between US and EU Related Parties us Exports E U Imports US Imports E U Exports Foreign direct investment (FDI) and trade are key economic linkages between the United States and the European Union. These linkages account for large shares of total US exports and imports with all countries and even larger shares of total FDI in the United States and abroad. They also account for similarly large shares of total EU FDI and trade with non-EU countries. The following two chapters (7 and 8) primarily focus on the linkages between those bilateral US-EU direct investments and their relationship to bilateral trade performance. • CH 7 US-EU Foreign Direct Investment, and • CH 8 US-EU Goods and Services Trade between Related Parties. These chapters are not intended to provide an in-depth description of the contributions of those investments nor the operations of the foreign owned firms on the overall economic and employment performance to the US and EU economies. The analysis examines the linkages between parent and foreign affiliate firms, which from the US perspective are primarily described in terms of US direct investment abroad (USDIA) and foreign direct investment in the United States (FDIUS), and the trade between these related firms — related-party trade. These relationships are examined in the aggregate and at the individual US and EU industry and EU country levels. The following two papers describe those US-EU linkages—focusing on the transactions involving the 1 2 countries that were members of the EU before 1995.^ These papers cover FDI in both goods producing and services producing industries, and the bilateral related-party trade by firms in goods and services producing industries and their trade in goods and services. The distinction between transactions of affiliates in goods producing and in services producing industries (including wholesaling) is important to interpreting these parent-affiliate relationships and their contribution to overall national trade performance. The following two chapters show that the relative importance of individual key industries is substantially different in terms of FDI and of the related firms' trade transactions. In particular, substantially less than ^ The twelve EU countries are Belgium, Denmark, France, Germany, Greece, Ireland, Italy, Luxembourg, Netherlands, Portugal, Spain, and United Kmgdom. Not included in these data are Austria, Finland, and Sweden. 77 one-half of the bilateral FDI flows and accumulated stock are in manufacturing industries and far more than one half are in services industries, especially wholesaling. In sharp contrast, only about one-half of the bilateral goods trade is between related parties whose affiliates are in manufacturing and about one-half are in wholesaling. This analysis also provides some insights into the often asserted point that, on balance, FDI results in net export growth rather than net displacement of exports. The primary sources of data on FDI in these chapters are the U.S. Department of Commerce's Bureau of Economic Analysis (BEA) and Eurostat, an agency of the European Commission. The primary sources of the data on bilateral trade are the U.S. Department of Commerce's Economics and Statistics Administration, and its Bureau of Economic Analysis and Bureau of the Census, and the International Monetary Fund's Direction of Trade. 78 US-EU Foreign Direct Investment by Johanna L. Barraza^ The United States and the European Union (EU) countries have long been at the forefront of rising international economic integration. The importance of the US-EU economic relationship is reflected in the recent undertaking of the "Transatlantic Business Dialogue" proposed in December 1995. This integration is particularly notable in terms of US-EU investment linkages, especially in the form of direct investment as their bilateral shares of each others' total foreign direct investment are larger than in their bilateral shares of their total international trade. For example, the EU accounts for far larger shares of US direct investment abroad (USDIA) and of foreign direct investment in the US (FDIUS) than do our NAFTA trading partners, which account for far larger shares of US trade than the EU. To simplify the following discussion, US direct investment in the European Union is frequently referred to as USDIEU and EU direct investment in the United States is referred to as EUDIUS . In addition, the following analysis of EU FDI covers only the 12 countries that were members of the EU at the end of 1994. For the purpose of showing the relative importance of the bilateral FDI linkage between US and EU firms, the EU countries are treated as a single economic unit. This exclusion of intra- EU FDI from total EU FDI measurement recognizes that, although these members clearly are independent countries, the barriers to intra- EU direct investment have virtually disappeared and that there is currently a high degree of economic integration among the EU member economies in terms of their firm ownership and the EU markets they serve. Nevertheless, for the purpose of describing the composition of EU FDI, the key national locations of US investment in the EU and of EU investment in the United States are highlighted. In summary, this analysis highlights several key points on the bilateral importance of US-EU direct investments. • US and EU firms are major bilateral direct investors in EU and US firms, respectively. • These bilateral direct investments account for very large shares of the total US and EU FDI positions (the accumulated values of the stock of those investments) with all countries. • Their shares of each others' total foreign direct investment are larger than their shares of each others' total merchandise trade. • In each of the past 10 years the EUDIUS and USDIEU stock positions increased significantly, reaching record levels in 1995. • In most of the past 10 years, the current value of EUDIUS flows averaged twice the size of USDIEU flows. Nevertheless, by 1995, on a historical cost basis the ^ The author is a graduate research intern in the Office of International Macroeconomic Analysis, Office of the Chief Economist, Economics and Statistics Administration, a position sponsored by a Woodrow Wilson Public Policy Fellowship. 79 EUDIUS position led the USDIEU position by only 3 percent. • In recent years, the composition of the bilateral US and EU FDI flows has differed significantly in terms of the different types of sources—equity, intercompany debt flows (both borrowings and repayments), and reinvested earnings. • In contrast, the bilateral US and EU FDI investment positions are very similar in terms of their composition of the key industries in which the US and EU affiliates are located, and similar in terms of the composition of the EU countries in which US-owned affiliates are located and in which the parents of EU-owned US firms are located. Measurement Issues The following analysis is based on US data, because of several key differences between the US official data reported by the Bureau of Economic Analysis (BEA) and the official EU FDI data published by Eurostat. The BEA and Eurostat data differ in four key respects (1) the minimum share of investment ownership or control by a single person is 10 percent for US data and 20 percent for EU data, (2) Eurostat data exclude reinvested earnings produced by foreign direct investments, which account for a significant share of FDI flows , (3) Eurostat currently reports only FDI flows data for the EU, as stocks data are not expected to be available until 1997, and (4) BEA FDI data are reported in US dollars and Eurostat data are reported in ecus on a weighted national EU national currency to ecu basis. Both the Eurostat and BEA aggregate EU data are affected by weighting. In addition, for the aggregate EU data, both the Eurostat values in ecus and BEA data in dollars have the undesirable characteristic of significantly reflecting fluctuations in exchange rates in addition to the variafions in the actual FDI stocks and flows. Several other limitations also adversely affect the BEA data on US-EU FDI. • The BEA FDI stock data used in this discussion are on a historical-cost basis, as opposed to current cost or market value bases, as as historical cost is the only basis on which BEA reports detailed data on the USDIEU and EUDIUS stock position by country, by industry. Historical cost is the basis used for valuation in company accounting records in the United States and is the only basis on which companies can report data in the direct investment surveys conducted by BEA. Moreover, for consistency, the estimates of earnings and reinvested earnings used in analyzing changes in the historical-cost posifions are also on this basis and are not adjusted to current cost, country and industry detail for these items, like the positions, is not available with such adjustment.^ BEA obtains historical-cost based data for all countries and industries; however, these data are not published for some individual EU countries and industries in order to avoid disclosure of the operations of individual firms.. • Comparison of BEA reported historical- cost FDI stock values over time in any one time series in terms of their absolute dollar For an extensive discussion of these valuation issues, see: Raymond J. Mataloni, Jr., "A Guide to BEA Statistics on U.S. Multinational Companies", U.S. Department of Commerce, Economics and Statistics Administration, Bureau of Economic Analysis, Survey of Current Business, March 1995, pp. 38-55, and J. Steven Landefeld and Ann M. Lawson, "Valuation of the U.S. Net International Investment Position", Survey of Current Business, May 1991, pp. 40-49. See also for a discussion of this issue: Christian Bellak and John Cantwell, "Foreign direct investment-how much is it worth? Comment on S. J. Gray and A. M. Rugman, United Nations Conference on Trade and Development, Division on Transnational Corporations and Investment, Transnational Corporations, Vol. 5, No. 1, April 1996, pp. 85-100. 80 growth or growth rates can incur significant biases because each of these values reflects the accumulated value of the stock of investment in current and prior years at the price levels in those years. Therefore, comparison of two separate time series also can be biased by differences in the timing of the bulk of the FDI reflected in the end period value and by differences in the degree of price inflation reflected in those values. No data are available for adequately adjusting for these biases at the bilateral level. • Some EUDIUS data for 1983-85 are publicly available only for the 10 EU countries, excluding Portugal and Spain, and for the 10 EU countries' data, none are available for Denmark or Ireland prior to 1987, and none are available for Greece or Portugal for 1994-95. For 1994-95, some industry by country data are suppressed to avoid disclosure of individual firm's operations. • Finally, for 1995, while aggregate stocks and flows data are available, detailed flow data by country and industry were not yet available when this chapter was prepared. A comparison of available BE A and Eurostat data on EUDIUS capital flows shows a substantial higher BEA than Eurostat level when both are compared in dollar values (Figure 7.1).^ The direction and relative consistency in this difference in values for 1984-93 suggest that it may primarily reflect the larger ownership coverage of the US BEA 10 percent minimum ownership compared with the EU Eurostat 20 percent minimum ownership. A corresponding substantially higher level in BEA than Eurostat EUDIUS stocks data also can be expected, even though this cannot yet Figure 7.1 BEA and Eurostat EUDIUS Capital Flows Data, 1984-93* (excludes reinvested earnings) $ Billions 40 A ..•••••.. 30 20 / ■••...-•■ ■••. / 10 '--^^^^Zly' ^^ ' ^^""""^V^Tiratflt 984 86 88 90 92 1 984-85 BEA excludes data lor Portugal and Spain , be demonstrated until the Eurostat FDI stocks data are published as expected in 1997. No similar general difference between the BEA and Eurostat USDIEU flow data levels was apparent (Figure 7.2). The lack of such a difference in values possibly may be due to the exclusion from the Eurostat data of reinvested earnings. Figure 7.2 BEA and Eurostat USDIEU Capital Flows Data, 1984-93 (excludes reinvested earnings) $ Billions BEA 20 .A 15 10 //~\ \s,-'"/ '^ 5 — —-=«="'" — \ -5 , — J V 1984 86 88 90 92 Bilateral US and EU FDI Compared Bilateral Importance in Total US and EU FDI The Eurostat values are in US dollars converted from ecus at current market exchange rates. The United States and the EU are major participants in each others' total FDI. BEA data on the US FDI position abroad show that the EU 81 is the United States' most important investment partner. In 1995, the EU accounted for roughly one-half of total stock position of US direct investment abroad and total foreign direct investment in the United States. Eurostat publishes no data on the EU FDI data that are comparable to the BE A data. Eurostat so far has published only FDI flow, not stock position data, and the coverage of Eurostat FDI flows coverage is smaller than BEA data because of Eurostat's higher minimum ownership share required to be considered as FDI and because it excludes reinvested earnings from FDI totals Nevertheless, Eurostat data show that'* in 1993 about 40 percent of total third-country EU flows were accounted for by the United States. Compared with other economic partners, the EU is far more important to total US FDI than to total US goods trade performance. While the EU accounted in 1995 for 42 percent of total US FDI stock position abroad and 55 percent of that in the United States, the EU accounted for far smaller shares of US trade performance in 1995—21 percent of total US goods exports and 16 percent of total US goods imports. This relative difference in importance of the two types of economic linkages sharply contrasts with the US links with its NAFTA partners Canada and Mexico. Our NAFTA partners account for much smaller shares of total US FDI— 13 percent of US FDI abroad and 9 percent of FDI in the US— than their far larger shares of US goods trade~38 percent of exports and 34 percent of imports. Total annual bilateral US-EU foreign direct investments are a very small share of the total investments in both domestic and foreign firms in either the US or EU economies. A sense of the order of magnitude of FDI flows can be shown when compared with gross investment in the US economy fi^om all sources. For example, in 1995, the total flows of foreign direct investment in the United States by all foreign parent groups equaled 5.7 percent of the total US gross private domestic investment (USGPDI) and that by EU parent groups equaled 3.7 percent of the total. Similarly, the total flows of FDI by US parent groups in all of their foreign affiliates abroad equaled 8.8 percent of the total USGDPI and that in EU affiliates equaled 3.4 percent of the total . Although the US-EU FDI flows are a small share of total US and EU national investment, these bilateral direct investment flows account for much larger shares of their total national investment in some of the key US and EU industries. These FDI investment shares are particularly large for EU investment in the US chemicals industry and for US investment in the EU autos industry. The foreign-owned firms are also particularly important in key individual industries when measured in terms of the size of the foreign-owned firm asset value, employment and other indicators.^ Several types of motives for FDI are frequently mentioned as explanations for large foreign direct investments.^ Direct investment in both the US and EU is frequently made to gain access to their respective large and prosperous markets. It also is particularly important in order to meet local standards and design requirements, to overcome national tariff and quota barriers, to provide in-country research and development facilities for product development, and to facilitate product distribution. Access probably is a more important factor in the case of US-EU FDI than lower labor costs as both markets are among the highest paying in terms of wage rates and are the largest and wealthiest markets in the world. For extensive data on the relative size of foreign- owned firms in the US, compared with the overall industry size, see for example. Office of the Chief Economist, Economics and Statistics Administration, U.S. Department of Commerce, Foreign Direct Investment in the United States: An Update, January 1995. Eurostat, "European Union Direct Investment, 1 984- 1993". For more on the determinants of foreign direct investment, see "US Multinational Companies Operations in 1991 ," Survey of Current Business, (July, 1993, number 73). 82 Relative Size of Bilateral FDI Stocks and Flows Over the entire 1985-95 period, based wholly on BEA historical cost data, US direct investment position in the EU (USDIEU) and EU direct investment position in the United States (EUDIUS) both grew rapidly, averaging annually 13.2 percent and 11.2 percent, respectively. Throughout this entire period, EUDIUS at least slightly exceeded USDIEU. In 1995, the EUDIUS position reached a record $309 billion, and was 3.0 percent larger than the USDIEU record position of $300 billion (Figure 7.3). During that 10-year period significant differences occurred in the growth rates of these investment positions. While USDIEU grew relatively steadily throughout that period, EUDIUS during mid-period first accelerated sharply and then stopped growing before growing sharply in the last three years of the period. As a result, there was no significant difference in size in the very small gaps between the USDIEU and EUDIUS stock values at the period beginning and ending (Figure 7,4).^ In large measure, these fluctuations in EUDIUS stocks are consistent with the timing of the 1991 US recession and recovery thereafter. In contrast, the steady growth in total USDIEU stocks fails to reflect the overall cyclical slow- down in European economies largely after 1991. Over the entire period, 1984-94 EUDIUS flows averaged twice the size as USDIEU flows , although in 1991-94 they averaged at similar levels (Figure 7.5). However, fluctuations in these aggregate national FDI capital flows, like income, are usually sensitive to cyclical fluctuations in the aggregate demand of the country or countries in which they are being invested. In the US-EU relationship, aggregate EUDIUS flows appear vary more widely cyclical than USDIEU flows, as the variations in aggregate national demand for investment in the •7 As pointed out earlier in this chapter, comparison of stocks on a historical-cost basis can be biased and substantially different from their relative value on a current- or market-cost basis, for which no detailed data are available. Figure 7.3 USDIEU and EUDIUS Direct Investment Accumulated Stock Positions, 1983-95 $ Billions 300 EUDIUS 250 200 /^-■■' USDIEU 150 /^ .-'''''' 100 \::::::::^ 50 1 1 1 J 1 1 1 1 1 1 1 1 1 1 983 85 87 89 91 93 95 Figure 7.4 Annual Growth Rates in USDIEU and EUDIUS Direct Investment Positions, 1983-95 Percent 25 A 20 15 /\ ' / \ ^v''"*'- USDIEU _ 10 / \ .^\"^ — ••. ^j%:f' 5 ' \ ■-■ / ELDIUS "■■•■• '' \ / ' 983 85 87 89 91 93 95 Source U S Department of Commerce. Bureau of Economic Analysis. $ Billions 50 I Figure 7.5 USDIEU and EUDIUS Direct Investment Capital Flows, 1983-94 1983 85 87 89 91 93 95 Source: US. Department of Commerce. Bureau of Economic Analysis 83 12 individual EU economies is minimized by differences in their cyclical patterns. In contrast, EU investors in the United States respond to variations in the investment demand of only one country's economy. When the US economy is in a recession (as in 1991), the EUDIUS flows can be expected to clearly reflect a corresponding decline in investment . In contrast, USDIEU investors have faced a wide range of cyclical economic conditions in the individual EU countries at any one time which tend to even out the fluctuations in the aggregate level of all USDIEU. The fluctuations in aggregate FDI capital flows also reflect a number of major one-time factors. For example, the quadrupling in EUDIUS flows between 1985 and 1987 appears to reflect a rapid rise in EU investors' demand for US assets in response to the rapid decrease in the cost of those US assets to EU investors in terms of EU currencies as a resuh of the rapid depreciation of the US dollar. Compositional Differences between USDIEU and EUDIUS Throughout at least the past 10 years there has been a very similar concentration in USDIEU and EUDIUS among the industries in which the affiliates produce goods and services. There also is a strong similarity between the concentration among EU countries in which USDIEU affiliates are located and in which EUDIUS parents of US firms are located. However, the composition of USDIEU and EUDIUS FDI flows substantially differ among the key sources of funding that contribution to the accumulated FDI stock. Moreover, the relative importance among those types of funding sources has varied widely between years. Funding Sources . The sources of funding for USDIEU and EUDIUS have differed significantly in recent years. The three sources of FDI funding are ( 1 ) equity capital flows, (2) inter- company debt flows, and (3) reinvested earnings. A much larger share of USDIEU than EUDIUS capital flows have been mainly in the form of reinvested earnings, and considerably less as equity flows and intercompany debt flows. This difference in capital flow composition can be mostly attributed to the higher income levels earned by USDIEU than EUDIUS affiliates over the 1985-95 period (Figure 7.6). The level of income earned by EUDIUS affiliates rose sharply after a record 1991 low, largely due to the positive effect on those earnings of the US recovery from the 1990-91 recession. $ Billions 40 I Figure 7.6 Direct Investment Income Earned by USDIEU and EUDIUS Affiliates, 1983-94* •Excludes USDIEU data for affiliates in Portugal and Spam in 1983-85 Source US Department of Commerce, Bureau of Economic Analysis. Country Composition Since 1982, in terms of the stock of investment, the United Kingdom has been both the largest investor in the United States and the largest host country for US direct investment abroad, except in 1992, when Japan was the larger investor. France, Germany, and the Netherlands, are the next most important US-EU investment partners. In 1995, 33 percent of all USDIEU stock was invested in affiliates located in France, Germany, the Netherlands, and the UK, and 5 1 percent of the EUDIUS in foreign parent groups (FPGs) located in these four countries. The EUDIUS figures are based on country of foreign parent group (FPG) and can differ substantially from data based on the location of the ultimate beneficial owners (UBO), particularly 84 in the case of Netherlands' ownership. The Netherlands serves as a home for holding companies for firms fi^om all over the world, and it is not unusual for firms to make investments through their Dutch holding companies. For example, when FDIUS is accounted for on a UBO basis, a French company that purchases a US firm through its Dutch holding company will be listed as the UBO while the Netherlands will be listed as the country of FPG. Table 7. 1 compares EUDIUS by UBO and FPG countries of ownership in 1994, the most recent year for which comparable data are available. This comparison shows that the Netherlands direct investment position in the United States is far higher~33 percent—on an FPG than on a UBO basis. Table 7.1 EU Country FDIUS Positions, by Basis of Ownership in 1994 (Billion dollars) Country Belgium Denmark France Germany Italy Luxembourg . . . Netherlands . . . Spain . , United Kingdom UBO basis 2.9 1.5 38.4 44.2 4.1 0.6 53.0 1.3 110.7 FPG basis 3.6 1.9 33.5 39.6 2.4 2.1 70.6 1.8 113.5 Source: Bureau of Economic Analysis. Industry Composition . The two most important industries in which affiliates are located in both USDIEU and EUDIUS are (1) manufacturing and (2) finance, insurance, and real estate (FIRE). These sectors have been growing rapidly since 1983, particularly in and with the UK, succeeding petroleum as the dominant industry in the US-EU investment relationship. The wholesale industry is another important US- EU industry, which has declined in importance for EUDIUS since 1983, but remained relatively stable for USDIEU. USDIEU Composition The composition of FDI flows in terms of sources of capital fijnding has been a key factor affecting the growth in the USDIEU position. The growth in the USDIEU position between 1985 and 1991 depended primarily on the reinvestment of the earnings in these US holdings in the European Union, which accounted annually for over one-half of the total flows, except for 1989 (Figure 7.7). After 1990, equity capital accounted for an increasing share of these flows. Figure 7.7 USDIEU Capital Flows by Type of Funding Source, 1983-95 $ Billions 50 I ■10 - -20 9 Reinvested I I Equity 1983 85 87 89 91 93 95 Source: US Department of Commerce, Bureau of Economic Analysis Intercompany loans in 1989 and again in 1993 were by far the largest fianding source of USDIEU flows. In contrast, intercompany debt repayments in 1990 significantly offset the contribution to the USDIEU stock position of capital outflows and reinvested earnings. These debt transactions were largely accounted for either by loans from US parents to their UK investment bank affiliates (1989 and 1993), or loan repayments by UK investment bank affiliates to US parents (1990). In recent years, there have been two major fluctuations in the annual aggregate levels of the individual types of fianding of USDIEU capital 85 flows. In 1990, the repayment of loans by UK financial aflBliates increased sharply and reinvested earnings in EU affiliates dropped sharply. In addition, loans by affiliates to their US manufacturing parents increased. In 1993, aggregate FDI flows reached a record level due to larger US acquisitions in the UK manufacturing and transportation industries. In 1993, these USDIEU flows also reflected large intercompany debt flows to UK financial affiliates and continued reinvestment of affiliate earnings.* In terms of industry composition , the overall USDIEU position in 1995, the largest shares were in the EU FIRE and manufacturing industries, accounting for about 36 percent each of the total position. The USDIEU position in the FIRE industries has increased over ten-fold from $9.7 billion in 1983 to $104 billion in 1995, while the USDIEU position in the manufacturing industries increased over three-fold during this same period. Wholesale trade and banking have also experienced significant growth, leaving only the petroleum industry as a stagnating sector of USDIEU. In terms of country of affiliate composition , the USDIEU position in the UK is the most important, more than quadrupling in size between 1983 and 1995 (Figure 7.8). The magnitude of this position is accounted for primarily by the FERE industries, although most of the USDIEU in petroleum is in the UK, as well as a considerable amount of manufacturing investment. Since 1950, the United States tended to have large growing investment positions in France, Germany, and the Netherlands, but countries such as Belgium, Ireland, Italy, and Luxembourg, have seen large increases in their USDIEU positions as well, primarily in manufacturing. EUDIUS Composition The sources of capital flow funding for Figure 7.8 US Direct Investment Position in tiie United Kingdom, by Industry. 1983-95 $ Billions 140 i — — — S Petroleum D Manufacturing B Wholesale OFIRE D Other 1983 85 87 89 91 93 95 Source: U.S. Department of Commerce, Bureau of Economic Analysis. The 1 995 USDIEU capital flows surpassed those of 1 993 due to record reinvested earnings. EUDIUS have historically relied more on equity flows and intercompany debt, as EUDIUS aflBliates generally have earned less than USDIEU aflBliates (Figure 7.6). The record $40 billion peak in EUDIUS flows in 1987 can be largely attributed to dollar depreciation, US economic growth, corporate restructuring in the United States, and the availability of large dollar holdings in several developed countries with trade surpluses. The sharp rise in EUDIUS flows between 1985 and 1989 resulted in a two-and-a- half fold increase in the EUDIUS position from $82 billion in 1983 to $212 billion in 1989. After the 1989 peak, EUDIUS capital flows dropped in each of the next three years primarily in response to the onset of the US 1991 recession (Figure 7.9). The negative reinvested earnings on EUDIUS in 1989-93 indicate that these investments in the United States were either incurring losses or paying dividends to their parents in excess of their current earnings. Leading up to the 1 99 1 recession, the earnings of EU-owned US affiliates were probably slowing down due to decreased aggregate demand in the sluggish US economy, which dampened income available for reinvestment. There were also negative intercompany debt flows in 1990 and 1992, particularly by EU-owned US affiliates in the US finance and petroleum industries that made repayments on their outstanding debt. In 1993- 95, capital flows recovered with the US economy 86 Figure 7.9 EUDIUS Capital Flows by Type of Funding Source, $ Billions 1983-95 50 I Reirwested I I Equity I \i ■ ■ ■ ] Intercompany debt flows I earnings I — I capital flows Source: US Department of Commerce, Bureau of Economic AnatysiS- Parcant 250 Figufo 7.10 Annual Growth of EUDIUS Position Accounted for by Affiliate Parent Gnsup, 1983-95 -100 1983 85 87 89 ■ France D. Gemiany ■ Nettieiiands O UK D Italy I Source: Bureau of Economic Analysis 91 93 95 Belgium B Ireland ■ OltierEU12 recovery. Reinvested earnings shifted from negative to positive 1993, and most of the increase was due to loans to US financial affiliates by their British parents. In 1994, reinvested earnings were positive for the first time since 1988, and equity capital flows increased.^ In terms of the composition of EUDIUS by industry of affiliate , the EU positions in the US FIRE and manufacturing industries more than quadrupled between 1983 and 1995. Although the position in the US petroleum industry was 52 percent larger in 1995 than 1983, that position reflected a decline from $34 billion in 1990 to $24 billion in 1995, due to decreased equity flows and reinvested earnings, along with large negative intercompany debt flows representing loan repayments to EU parents. The EUDIUS position in the US wholesale trade industry nearly tripled between 1983 and 1995, while the EUDIUS position in banking more than tripled between 1983 and 1995. In terms of the composition by country of foreign parent group , during the 1980s EUDIUS was dominated by France, Germany, the UK, and the Netherlands (Figure 7.10). The EUDIUS positions of France, the UK, and Germany, more than quadrupled from 1983 to 1995, while the EUDIUS position of the Netherlands more than doubled. Much of the growth in the UK's investment in the United States occurred in 1987 and is attributed to a sharp appreciation of the pound against the dollar, and the deregulation of UK capital markets. The latter provided an opportunity to British parents to finance large acquisitions in the United States by issuing their shares in the London stock market. Several smaller EU countries substantially increased their investments in the United States in the early 1990s -- Luxembourg's EUDIUS position doubled, both Denmark and Spain's positions tripled, and Ireland's position grew five fold. In contrast, the position of most larger EU countries except France grew far slower. 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'-' -3 x: = 3 W Q o 90 00 u-1 -H 1/1 tN OO U1 '* (N I^ (N VO O t-~ (N (N m O — ' m 00r*^f<^OrNlt^O\00(Nt^ ^^ r- O 00 ^^ ^^ fN ON 00 o ro 1^ VO i-iu^ 3 ■% 00 3 t o (N r- [^ NO fi NO '~i(N— lOOQ— ICO Tfr~oOf<^in'~'rN)in<^rN|'~^— iOn r<-iTtin(NrN| r~t^— — • mNO I 00 ro dm 1 00 m 00 —I (N rr ON Q'S-OOnOQCnIOn -3- — ONC^rt-— ^ in (v^ m NO -r^ in ^- NO in — iI^QONOQQi^f^I^Qnm O m, 00 (d 00 Q r^ in fN •^ r^ i^ — c ro in in " 00 mt 00 mt Q ►J 2 cu c/3 D UJ E sa ^ 00 c u c U T3 -3 2^ 00 r- fN Q ro On oo '"' fN fN — ' —I On fN ►-I Jll 3 T3 £M^ E S ' fN m o 00 C 2 00 -o ^ >^ ^ ^ -^ ■« ^ I T3 'e o C o l-Ll £ o 3 n) u 00 ^ ■i CQ 3 ■> ■•5 .S E E c3 a. a Q. p 3 u en Q a c3 oo iS b ts T3 ii r 3 Q ° 91 tu lo m Q Q 00 in Q Q OO o\ ON m S" NO a\ tN 8 r- m >o ON ON f-l - --^ O NO ■rr ■^ o ON 00 ■-^ -^ r«-) O r^ NO o\ Ai r«i t — in 1—1 1^ MD m t~~— 1 — 1 r~- NO •-^ ^ ON ^ o ON NO R S ?: 1 Q> in ON o /-l in ^ in NO OO m Q^ C^ m 00 tr- 00 r 1 — 1 r- in ON m xi- .-^ I— 1 l—< in i/^ fNl O NO in m 00 iri u 00 00 NO ^ 00 ON r- [^ ON . ^^--''''^^ 150) ^***'*«^ All count nes ^^ ^ Figure 8.2 U.S.-EU12 Goods Trade in 1993 between All Parties, Related Parties, and Other Parties* $billion 120 100 80 60 40 20 (20) - 97 1 979 48.7 56 5 1 1 Exports 1-^ Imports □ Balance 48.7 40 4 \ ■' s 1 7 8 i 1 ■ 1 1 1 1 -8 3 1 All parties Related parties * Related parties include USDIA and FDIUS bases Other parties The aggregate trade balance between US-EU related parties has been in deficit for most of the 1983-93 period (Figure 8.3). That deficit ranged between $14 billion in 1987 and $2 billion in 1984, and was $8.3 billion in 1993. However, the US-EU related-party deficit has accounted for a very small share of the overall US goods trade deficit with all countries over that ten-year period. This is an estimated minimum, as these data do not cover (1) a small share of the US-EU trade that is conducted by non-majority owned US affiliates (USDIA- based affiliates) located in the EU, and (2) trade between EU parent groups and unrelated US parties. In contrast, that $8.3 billion US-EU related- party deficit in 1993 was far larger than the $1.0 billion overall US-EU trade deficit, as it offset the nearly as large $7.3 billion US-EU trade surplus between unrelated firms. Trade Between Unrelated Parties EU-US trade between unrelated firms, including the trade of US and EU MNCs with unrelated firms, accounts for a slightly larger share of total US-EU trade than that between US-EU related parties. • In 1993, trade between unrelated parties accounted for 58 percent of total US exports to the EU and 50 percent of the imports. • The US trade balance between unrelated parties was in surplus by $7.3 billion, in contrast of the $8.3 billion deficit between the related parties. These unrelated-party trade data are less than perfect as they are computed as a residual and, therefore, are known to include related party trade, for which separate data are not available, between (1) US parents and their EU affiliates that are not majority-owned (measured on the USDIA basis), and (2) trade between EU-owned 98 us affiliates and the firms in the EU they own, that is, the US affiliates' EU affiliates (measured on the FDIUS basis). Nevertheless, the distortion probably is not large. For example, in 1993, US exports by EU-owned affiliates to their own affiliates in all countries was $4.6 billion (4.7 percent of total US exports to the EU), and their imports from their EU affiliates in all countries was $4.6 billion, (4.7 percent of total US imports from the EU). Substitutionality versus Complementarity between FDI and Exports A key issue with respect to foreign direct investment is its impact on the economy of the parent country through its impact on the parent country's exports to the country in which the affiliate is located. Specifically, in the context of this chapter, the issue is whether bilateral US-EU FDI generally has a complementary, neutral, or substitutional impact on US and EU exports. A very superficial approach to answering this question is to compare on an accounting rather than causal basis (1) the EU shares of total USDIA stock and of total FDIUS stock, with (2) the shares of total US and EU goods exports that are accounted for by their exports to each other. That comparison suggests, for example, that in 1993 the export shares are much smaller than the corresponding FDI shares (Figure 8.4). In 1993, a 21 percent share of total US goods exports was shipped to the EU ~ about half as large a share as the 43 percent EU share of the total stock of US direct investment abroad. Similarly, a 17 percent share of total EU external goods exports was shipped to the US market — about one-third as large a share as the 54 percent EU share of the total stock of foreign direct investment in the US. If believed, this very superficial explanation would suggest that on balance, foreign direct investment abroad is on average a substitute for exports. That approach, however, is misleading because, among other factors, the shares are Figure 8.4 US and EU12 Shares of US and EU12 Goods Exports and EU Shares of USDIA and FDIUS Stocks in 1993 EU12 21% EU12 43% US exports USDIA stocks us 17% EU12 54% EU exports* ' EU exports outside of the EU FDIUS stocks dependent on trade and foreign direct investment patterns and practices in other regions of the world, not just for the US and EU markets. Moreover, the export shares are based on trade with all parties rather than being decomposed on a basis consistent with related-party trade. Furthermore, the US and EU are well known to be more open to FDI than are most other countries. A more insightful alternative accounting approach to this US-EU issue is an examination based on their related-party trade — one that accounts for both exports and imports. The following examination based on related-party trade suggests that on balance, foreign direct investment abroad and trade for both the United States and the EU is significantly complementary, even though the data are not based on either a directly demonstrated causal basis nor on a counter-factual basis. USDIA and FDIUS Trade Comparisons Although the US deficit in overall related- party trade was relatively small during the past 99 decade, much larger imbalances have occurred in the separate balances of USDIA and FDIUS related-party trade. Moreover, those US imbalances have been persistently opposite in direction — almost mirror images of each other. The USDIA trade has been in substantial surplus and the FDIUS trade in substantial deficit that has moved in opposite directions from the US trade perspective Although the trade imbalances with the EU have been opposite in value from the US trade perspective (a USDIA trade surplus and a FDIUS trade deficit), both of those imbalances have been in surplus from an investor country perspective. That is, the separate US-EU trade of both the US and the European parent groups have been in substantial surplus. The similarity of those balances in terms of parent ownership supports the often cited thesis that outward foreign-direct investment supports net exports. • Between 1983 export surplus and 1993 the USDIA ratio and the FDIUS import surplus ratio were both substantial ~ both more than 50 percent (Figure 8.5). The FDIUS import ratio was somewhat larger than the USDIA export ratio during most of that decade. parents and their US affiliates (FDIUS) was far larger than the trade surplus between of US parents with their foreign aflfihates (USDIA) (Figure 8.6). For example, in 1993— The FDIUS affiliate imports from their parents exceeded their exports to their foreign parents by $23.5 billion. The USDIA parent exports to their foreign affiliates exceeded their imports from their affiliates by $1 5. 1 billion. Figure 8.6 US-EU12 USDIA and FDIUS Related-Party Goods Trade Balances, from a US Perspective, S billion 50 40 30 20 10 CO) (20) (30) in 1993 . ■ 289 34.9 ^^ "■ ^^M 13 e 11 5 i ^^■iiip ■ - H Exports ^ Imports □ Balance -23 5 USDIA trade FDIUS trade Figure 8.5 U.S.-EU12 Trade Surplus Ratios in Goo(ds Trade Between Related Parties--USDIA and FDIUS Bases from an Investor Country Perspective* ^ ^ " ' USDIA ratio of US expat suplus lo experts; FDIUS ratio c^ US import surplus to imports. In dollar terms, over the past decade the US-EU trade deficit between foreign Macro and Micro Economic Trade Determinants Trends and levels of US-EU trade between related parties reflect a wide range of macro and micro economic determinants. For example, cyclical variations in US domestic demand greatly affect trends in US imports , and cyclical shifts in EU domestic demand have corresponding effects on the trend in US exports. Other related macroeconomic factors, such as aggregate investment and exchange rates, also effect US-EU trade. Their impact is evident in changes in the rate of growth of aggregate US imports, imports 100 from all EU parties, and from EU related parties (Figure 8.7). Similarly, the relative levels of related-party exports and imports in any one year reflect to a substantial degree, but not necessarily proportionately, the same macroeconomic factors that affect aggregate demand here and abroad in that year. is reflected in the demand for US exports by foreign parents, US-owned European affiliates, and other EU parties. The pre- 1985 dollar appreciation undoubtedly exerted a major impact on US price competitiveness in Europe, but not necessarily uniformly across all three groups of European importers. Figure 8.7 Growth Rates in U.S. Goods Imports from All Countries, EC-12, and between EC-12 Related Parties ercent All countnes 30 20 -^ EC-12 '\ _ EC-12 related parties 10 ; \ \- - ^'i^-^-.. \y ^ - -r^y^^^^^r^ ^"- 1 1 1 1 1 1 1 1 1 J 1984 86 88 90 92 Figure 8.8 Growth Rates in U.S. Goods Exports between EU-1 2 Related-Parties and from Other Parties (20) - (40) Within the framework of macroeconomic determinants of the aggregate trade, both the trends and levels in exports and imports are also expected to be significantly affected by microeconomic factors, such as the trend and composition of FDI, and the effects of factors such as technology that determine here and abroad the composition of the operations of foreign- owned firms, including their international trade. Among these factors are technological innovation, which has been a major factor, for example, in US exports of aircraft, chemicals, computers, and electronic components. The direct impact of foreign macroeconomic determinants on annual variations in aggregate US exports is not readily apparent because of the generally diverse variations in economic conditions across countries in any one year (Figure 8.8). Some macroeconomic influence on these US exports is reflected in recent years only in the form of the post- 1990 general European economic slowdown. The malaise of this period Moreover, as US exports by foreign-owned affiliates to their parents are much smaller than those by US parents to their EU affiliates, the grov^h rates of aggregate exports to EU parent groups appear to be proportionately more affected by differences among them in import demand (Figure 8.8). For example, almost all of the sharp 1986-88 fall and recovery in the growth of US exports to foreign parents is accounted for by exports to parents located in only two countries ~ Italy and the Netherlands. In contrast, the influence of US macroeconomic determinants on annual variations in aggregate US imports is readily apparent, particularly in terms of annual growth rates of US goods imports by all three groups of importers ~ USDIA and FDIUS imports from related parties and imports from unrelated parties. These data show that imports by US parents from their foreign affiliates and imports of US foreign-owned affiliates from their foreign parents are both significantly affected by the same factors that 101 determine aggregate US imports from the EU (Figure 8.9). In turn, these imports reflect the influence in US growth rate of aggregate US demand measured in terms of gross domestic demand. In particular, the macroeconomic impact of the slowdown in economic growth going into the 1991 US recession and the post- 1991 recovery is clearly reflected in the trend in all US imports from the EU from both US-owned MOFAs and foreign parents, as well as other EU parties. Figure 8.9 Growth Rates in US. Goods Imports between EU-1 2 Related-Parties and from Other Parties Percent 50 USDIA 40 ■ \ FDIUS Other parties 30 Av 20 -N^. An. 10 (10) .y-^ \\:^^,i^^. '•■■' '"'•.,*' *•, -^ / 1 1 1 1 1 1 1 1 1 1 1984 B6 88 90 92 The extent that comparative advantage of US and EU firms is reflected in their overall revealed competitive advantage is dependent on the assumption that the US import and EU import markets are relatively open. However, the large mirror image imbalances in that trade — large USDIA export surpluses and large FDIUS import surpluses ~ suggest that this necessary assumption is not sufficient to explain the overall revealed performance. On the contrary, a major share of the overall US-EU trade performance, and thus the overall performance in that trade, clearly significantly depends on the nationality of related- party ownership. Country Composition of FDI and Trade The basic nature of MNC related-party trade, particularly within the European Community, is an effort to bridge national boundaries, in order to gain market access that leads to increased production and distribution efficiencies through economies of scale. This goal was greatly facilitated by the reduction of intra-EU customs barriers. These developments also have reduced the reliability and availability of EU data measuring intra-EU trade transactions. As a result, the validity of a detailed analysis of related- party trade data on an EU country-by-country basis is on weak ground. Moreover, as mentioned above, BEA related-party trade data are not available exactly on the basis of country of destinafion or origin. Nevertheless, the BEA data on the country composition of FDIUS and USDIA trade between related parties probably are reasonable measures of the EU country shares of the actual US-EU related-party trade. These data show that the goods trade between US-EU related-parties is largely accounted for by the same EU countries that account for most of the stock of bilateral US-EU foreign direct investment. Moreover, that concentration has not significantly changed over the 1983-93 decade. • The great bulk of the FDI stock among European related parties (both parents and affiliates) is largely accounted for by the firms of four countries — France, Germany, the Netherlands, and the United Kingdom (Figure 8.10). • These four countries account for over 80 percent of the total US-EU trade between related-parties — 83 percent of the US exports and 85 percent of the imports in 1993 (Table 8.1). The shares in 1993 were slightly higher for FDIUS trade and slightly lower for USDIA trade. 102 Figure 8.10 Shares of US-EU12 Combined USDIA and FDIUS FDI Stocks and Related-Party Trade, by Key EU Country of Affiliate or UBO, in 1993* ercent 120 100 80 60 40 20 Other EU-12 countnes UfiSsd ttingcteiM Germany France Other EU-12 countnes ■ Urif*^ tWngtiom France FDI stock Trade ' FDI stock on a histoncal value basts; total trade is sum of related-party exports and imports Table 8.1 Share of Total US-EU Related-Party Goods Trade Accounted for by Four EU Countries in 1993 US Combined related parties USDIA FDIUS Exports Imports 83.3% 85.4% 80.1% 72.8% 91.2% 90.3% Industry Composition of US-EU FDI and Trade Only a rough approximation of the composition of US-EU trade between related parties is possible in terms of the major industry groups producing the traded goods, and none is possible in terms of the products traded, because BEA data on that trade is limited in detail, scope and bases. The principal limitations in these data are: • Classification of trade in terms of industry of the affiliate, which is not necessarily the industry of the product traded, nor the industry of the parent. • Attribution of all trade by the affiliate and parent by the principal industry of the affiliate regardless of the secondary industries in which the affiliate participates. • Classification of trade by country of ultimate beneficial owner (UBO), not necessarily the country of destination or origin of the trade. • For FDIUS data by industry of affiliate, data are available for only four EU countries: France, Germany, the Netherlands and the United Kingdom. • For USDIA trade data, industry disaggregation is available only for majority-owned affiliates (MOFA) in the EU, as data for all affiliates are available for only the four EU countries: France, Germany, the Netherlands and the United Kingdom. • Considerable suppression of industry trade data by individual country of affiliate. All of the following discussion is based on data reported according to industry of affiliate, as BEA data on US-EU related-party trade according to industry of parent are not separately available. The data that are available suggest that the national location of the parent firm largely determines whether the individual industry trade balances are positive or negative. The data show that the parents' trade with their affiliates in most major industries is in surplus for both US parents' trade and EU parents' trade: • The USDIA industry balances of US parents' trade with their EU affiliates are almost wholly in surplus, • The FDIUS industry balances of EU parents' trade with their US affiliates are mainly in deficit and thus from the EU perspective are mainly in surplus. The largest shares of the US-EU related-party goods trade and their trade balances are 103 accounted for by affiliates located in manufacturing industries and in wholesaling (Figure 8.11). This is the case for both USDIA trade and FDIUS trade. Figure 8.11 US-EU12 USDIA and FDIUS Goods Trade, Total (Exports plus Imports) and Balance, Shares by Industry of Affiliate in 1993 66% USDIA Trade* 47% 37% 54% FDiUS Trade Trade balance 43% 51% Total trade Trade balance E] Manufacturing Q Wholesaling | Other indusries * MOFA trade only Much of this trade between related firms can be expected to be between parents and affiliates that are both classified as in the manufacturing sector, particularly for trade in inputs to flirther manufacturing. The foreign-owned affiliates in the United States that probably account for much of that trade include many well known US and foreign corporate names in the metals, chemicals, pharmaceuticals, and auto industries.^ These industry shares are based on US data that are adversely affected by the problem of classifying affiliates by the primary industry of their operations and the need to avoid disclosure of individual firm's operations. Much of the US imports in related-party trade can be assumed to be resold (wholesaled) as a part of the normal operations of firms classified primarily as manufacturers. Conversely, much of the US imports are by foreign-owned US firms that are primarily wholesalers that also are US manufacturers . Manufacturing Affiliates Although the related-party trade data are in terms of industry composition, not product composition, probably much more than one-half of the products traded are manufactures. About one-half of the total combined exports and imports involve USDIA and FDIUS affiliates in the manufacturing industry. Moreover, a major share of the goods traded by affiliates that are wholesalers can be expected to be manufactured goods (Figure 8.12).^° For example, in 1993 the US imports by EU-owned affiliates in the US motor vehicle wholesaling industry accounted for nearly one-half of the total US imports by all EU- owned affiliates in the US wholesaling sector. In the related-parties trade of affiliates in the manufacturing sector, there are major parent- affiliate similarities and differences in industry composition. A key example of similar composition ~ affiliates in the chemicals industries are among the largest industry shares of exports and imports in both FDIUS and USDIA trade(Figures 8.13 and 8.14). For examples of US firms acquired by EU parents, see the annual series of reports on FDI transactions, the last issue of which covered transactions in 1994: U.S. Department of Commerce, International Trade Administration, Foreign Direct Investment in the United States, 1994 Transactions . This conclusion also is significantly supported by an examination of the annual acquisitions of affiliates in the United States which shows that a large share of the acquisitions in the United States by EU parents in EU manufacturing industries are affiliates in the US wholesaling industry. See various annual issues in: U.S. Department of Commerce, op cit. 104 Figure 8.12 US-EU12 Combined USDIAand FDIUS Related-Party Goods Trade, by Industry of Affiliate, in 1993 $ billion U.S. exports U.S. imports * FDIUS data includes on^ related-party trade with UBOs in four EU countnes France. Germany. Nettieflands and the United Kingdom " Understates total to the extent of data suppressed by BEA. and therefore included in "other" Figure 8 13 US-EU Goods Trade between USDIA Related Parties, with UBOs in EU12 Countries, by Industry of Manufacturing Affiliate, in 1993 168 1 57 78 ■ D 11.4 1 'otai mar :;hemical Mon-elec Dlhef 42 ufactunn s ric 5.3 g Exports Imports Figures 13 US-EU Goods Trade between USDIA Related Parties, with UBOs in EU12 Countries, by Industry of Manufacturing Affiliate, in 1993 168 1 57 7.8 H Total manufactunng [3 Chemicals E3 Non-olectric □ Othef 11 4 Exports Imports In contrast, there are several key industry differences in the industry composition among affiliates: • Affiliates in the computer and office equipment industry have very large shares of USDIA exports and imports, but very small shares of FDIUS exports and imports. • Affiliates in the transport equipment industry have a very large share of USDIA imports. • Affiliates in instruments and related products industry have large shares of the USDIA exports and imports. • Affiliates in the electrical and electronics equipment industry have a large share of FDIUS imports. Wholesaling Affiliates A key insight into the cause of US and EU parent firms having surpluses in their US-EU related-party trade is provided by the fact that their EU and US affiliates classified as wholesalers account for a large share of the US-EU related- party trade. In 1993, wholesaling affiliates accounted for 36 percent of USDIA exports of US parents to all of their foreign affiliates and 49 percent of FDIUS exports of foreign parents to their US affiliates. Although related-party trade by industry of parent is not available, the inference of available data is that US and foreign parents both rely on their foreign affiliates that are primarily wholesalers to distribute a large share of the output produced by those parents. This inference is supported by the earlier conclusion that FDI supports a large net export surplus of parents to their affiliates. This is flirther supported at the industry level by the net trade balances between related parties with affiliates in leading industry of affiliate groups such as chemicals. In both the USDIA and FDIUS relationships exports of parents to affiliates greatly exceeded imports from them in virtually all manufacturing and other 105 industries. It is further supported by the fact that many of the acquisitions of wholesaling affiliates are by foreign parents that are manufacturers of products such as foods, metals, chemicals, pharmaceuticals, and auto industries.^' For both USDIA and FDIUS, over one-half of the imbalances are attributable to trade of affiHates in the wholesaling industry. In 1993, wholesaling affiliates accounted for 54 percent of the total USDIA export surplus and for 5 1 percent of the FDIUS import surplus . High-technology Goods Trade On an industry basis, high-technology industries account for about one-third of total US exports to the EU and about one-fifth of the total US imports from the EU (Figure 8.15).'^ Moreover, the US high-technology trade balance with the EU is in surplus, while that in other products is in deficit. For example, in 1993. the US-EU high-technology trade surplus on an industry basis was $15.4 bilHon, in contrast to a US-EU trade deficit of $16.3 billion in other goods. Moreover, while US-EU trade in high- technology products has been in substantial surplus, the US high-technology trade with most other regions has been in deficit. US-EU related-party trade in high-technology goods is very likely, although not necessarily, to account for a large share of the total US-EU related-party trade because such a large share of total US-EU trade is accounted for by high- technology trade. Unfortunately, the related-party trade data provide no direct evidence on the extent that any net US-EU export surplus in high- technology products helps to offset the net import surplus in other products, because of the lack of industry disaggregation in the related-party trade data. 11 12 Op cit. Department of Commerce (1994). Figure 8.15 US-EU12 Total Goods Trade, Total High-technology Trade, and Total Related-Party Trade in 1993* $ billion 120 . ■ Tolal 97 97.9 High-technology ■ ■ l~l Related partes 1 35,1 40 3 1 489 1 1 207 ^B ^^m Exports * High-lechnology data on a DOC-3 industry basis Imports Based on the DOC-3 definition of US high- technology industries. Impact of Trade Barriers Barriers to the access of goods and services to foreign markets continue to be an important issue in particular instances. With the advent of the Uruguay Round reduction in import barriers, the impact of other barriers such as standards and effects of linkages between parent and foreign- owned affiliates have become relatively much more important determinants of trade than in the past. However, BEA FDI data cannot be used to examine the effect of those barriers on US-EU related-party trade on a country of destination basis, as the BEA FDIUS-based data are not reported by EU-12 country of destination for UBO's that are located only in the EU-12 countries. Moreover, the BEA data are too highly aggregated to examine the existence of any significant relationship between US-EU trade and specific trade and other barriers to foreign sales. The Motivations for FDI and Related-Party Trade A clear motivation for foreign parent firms to invest in and trade with their foreign affiliates is the closer proximity to the ultimate foreign buyer 106 and the ability to be more responsive to business and technical needs. Other motivations include the need to overcome third-country discrimination produced by the elimination of internal trading area trade barriers, such as the EU common external tariff and reduction of intra-EU barriers, and the similar reduction in intra-NAFTA barriers. There is no easy way to determine, in the absence of FDI, whether US-EU trade level would have been greater in the aggregate or with any one of the EU members. Moreover, there is no clear way of determining from these related-party trade data the extent that those trade barriers are currently more significant for particular product groups. A key reason this is not feasible is that the BEA related-party trade data are aggregated into very large groups for which cross product comparisons of trade restrictions are very difficult. Moreover, any conclusions must first take account of national comparative advantages in particular products. The extent to which trade between an MNC partner (either parent or affiliate) and unrelated parties also is partly determined by the fact that the MNC partner also is related to other parties in these US and European markets. Many major firms in one region that export to the other region are represented by large sales networks in the importing region that are not considered affiliates, but are key factors contributing to the export sales to independent foreign firms in the importing region. For example, many major aircraft producers mainly export directly to independent foreign firms with the sales assistance of other related and unrelated firms. Thus, it is not clear whether FDI can be said to generally have been a key determinant of such trade between unrelated parties. 107 II. TRADE IN BUSINESS SERVICES BETWEEN US-EU RELATED PARTIES Trade in private business services is an increasingly important component of the overall economic relations between US and EU related parties although they are a smaller share of the total compared with trade in goods. Transactions for which there are useable data on US-EU related-party trade in services that are reported by BEA cover the two main categories of services: (1) royalties and license fees and (2) other private services'. No data are separately available on services provided between related parties in the form of travel, transportation, or passenger fares. ^ The trade in services is measured in terms of receipts by US firms (US parents or EU affiliates in the United States) from EU related firms and payments by US firms (US parents or EU affiliates in the United States) to EU related firms. In this paper, for ease of identifying these services transactions and comparing them with goods trade, the receipts are frequently referred to as exports and the payments are frequently referred to as imports even though they do not directly measure the corresponding physical services transactions. The basis of measurement of these transactions is generally significantly different from, and the difficulty of measuring them significantly greater than the measurement of goods trade, partly because the availability of the data is more limited. Nevertheless, several key conclusions emerge fi'om the following discussion of US-EU related-party trade in services. Other private services include education, financial ser\'ices, insurance, telecommunications, business, professional and technical services, and other services. By their nature, US international payments or receipts for travel or passenger fares services are not expected to include any significant transactions between US-EU related-parties. • US-EU trade in services between related parties has been rising rapidly in recent years— reaching a total for exports plus imports of $23.2 billion in 1993 and $29.9 billion in 1995. • The US trade in services between US-EU related parties has been consistently and in growing surplus, reaching $9.0 billion in 1993 and $11.3 billion in 1995 - their 1993 surplus in services trade of $9.3 billion slightly larger than their 1993 deficit in goods trade of $8.3 biUion, • The US-EU trade performance in services transactions differs sharply in both size and direction of their trade balances (surplus versus deficit) in terms of ownership of the trading partners, that is, in the trade balances (1) between US- owned EU affliates and their US parents (USDIA trade), and (2) between foreign- owned US affliates and their EU parents(FDIUS trade). • In most respects this difference in direction of services trade balances between USDIA and FDIUS services trade is similar to their differences direction of goods trade balances—with USDIA trade in surplus and FDIUS trade in deficit. US-EU Related-Party Services Trade Data Bilateral international transactions in services between related parties are much more difficult to measure than those for goods trade, For example, goods trade is largely measured directly in terms of the value of those goods, as they physically move between geographical bodies and are reported by the firms involved to customs authorities. In contrast, services trade is measured only indirectly in terms of receipts or payments for those services as reflected in financial accounting documents of firms. As a result of these measurement problems, there is a far less direct relationship between the 108 reported and market values of the services exchanged, and to the timing of that exchange, the geographic location where the service is produced and rendered, and the industries producing and using the service. Moreover, for some international services transactions, no transactions are reported at all, as in the case of technology information frequently transferred electronically or by direct contact between US and foreign nationals. Furthermore, unlike goods trade where the goods are measured in terms of their physical movement across national boundaries, services trade is measured in terms of the exchange of services between nationals and foreigners, largely without regard to their geographical location at the time the service is rendered. For example, a US export of (receipts for) educational services rendered by a US parent firm to its EU affiliate can be in the form of training provided to the affiliate's employees at a site in the United States or by the parent's US employees to the affiliates' employees at a site in the European Union. Detailed data on the composition of trade in services between US and EU related parties are not regularly published by BEA. The bilateral related-party services trade data on which these transactions are reported in this paper were obtained fi'om publicly available unpublished BEA data. The related-party services trade data available from BEA cover two broad categories: (1) royalties and license fees, and (2) other private business services. No related-party data are presently available on payments or receipts for travel, transportation, or passenger fares. Separate USDIA-based data are collected but not reported by BEA on US parent firms' payments to (imports from) their EU affiliates for royalties and license fees. These data are included only in the aggregate payments by US parents to all of their European affiates, with no detailed data available by EU country or industry. Royalties and license fees are receipts or payments for technology and other intangible property rights, as well as transactions involving copyrights, trademarks, franchises, broadcast rights and other intangible rights. Other private services include education, financial, insurance, telecommunications, business, professional, technical, and other services such as rentals for use of tangible property and film and television tape rentals. The most recent data in this paper on the composition of US-EU related-party trade in services are for transactions in 1995; however, the most recent data available on US-EU related-party goods trade at the time this paper was prepared were for transactions in 1993. Both the services and goods trade data are based on BEA FDI surveys. The time series data on both USDIA and FDIUS based services trade presented here begin with transactions in 1987, as the earliest year for which FDIUS based data are reported by BEA on a consistent basis are for 1987. Consistent USDIA data are available from BEA beginning with 1982. Relative Importance of Total US-EU Related-PartyTrade in Services Over the period 1987-95, both total US-EU related-party exports and imports of services have increased fairly steadily and rapidly. In 1995 exports reached a record $20.6 billion—one and one-half times greater than their 1987 value, and imports reached a record $9.3 billion (Figure 8.16). The growth in US related-party imports of services, unlike the imports in goods, reflected no significant slowing due to the 1991 US recession. The US exports of these services in 1993-94, however, apprear to reflect the slowdown in EU economic growth. Nevertheless, in 1995 these services exports surged ahead. The US trade balance in services between US-EU related parties has been in substantial and rising surplus throughout the 1987-95 period because US exports to EU related-parties have consistently been over twice as large in value as were imports. The surplus rose from $4.9 billion in 1987 to $11.3 billion. in 1995, with imports equal to less than one-half the value of exports. 109 Figure 8.16 US-EU Related-Party Trade in Services 1987-95 Billion $ 25 Receipts (exports) Payments (imports) Share of Total Services Trade US-EU trade in services between related parties has been a dominant factor in the total US- EU trade of those services and a surprisingly important factor in the world-wide total of US related- and unrelated-party services trade. Over the years, related parties on a combined USDIA and FDIUS basis account for a major share of the total US-EU trade in services and a large share of total US world-wide trade in those services, as measured in terms of the total of royalties and license fees and other private business services (excluding travel, transportation and passenger fares). In 1995, the total value of receipts (exports) and payments (imports) for US-EU related-parties trade in these services reached $29.9 billion and accounted for 23 percent of total US world-wide trade in services with related and unrelated parties, and 62 percent of the total US-EU trade in services (Figure 8.17). Moreover, the related-party data on services trade show that US-EU trade is by far the single most important component total US world- wide services trade between all US and foreign related parties. In 1995, US- EU related parties accounted for 51 percent of that total. The comparable shares for exports and imports are nearly equal to the share for total two- way trade in these services. However, the near equality in the size of the related-party export and import shares should not be interpreted as a near balance in US and EU revealed comparative advantage in the trade of these services, as the exports and imports differ greatly in total value and in terms of related-party ownership. For example, in 1995, US services exports in US-EU related party trade were over twice as large as that in imports, as exports reached $20.6 billion and imports reached $9.3 billion. Comparison of Services and Goods Trade Compared with US-EU trade in goods between related parties, the total value of trade in services is much smaller; however, the net US performance in terms of trade balance has been much more favorable. For example, in 1993, the value of US services exports to (receipts) and imports from (payments) from related parties were a relatively small compared to their trade in Figure 8 17 US-EU Related-Party Shares of US Services Trade in 1993 Exports US Trade with World Imports Total US-EU RP 28% All other All other US Trade with EU 12 All other All other All other All other Exports Imports Total Data cover total royalties and fees and other private business services, and exclude travel, transportation and passenger tares. 110 goods. Those US related-party services exports to the EU reached $16.1 billion~40 percent as large as goods exports, and imports reached $7. 1 billion~14.6 percent as large as goods imports (Figure 8.18). Figure 8.18 US-EU Related Party Trade in Services and Goods in 1993 BiffionS 60 50 - 40 - 30 - 20 - 10 (10) (20) Exports Imports Balance 48.7 Services Goods The surplus in services trade between US-EU related-parties steadily rose throughout the 1987- 95 period — rising from $4.9 billion in 1987 to $9.0 billion in 1993 and $11.3 billion in 1995. Their trade surplus in services trade contrasts sharply with their deficit in the US-EU related- party goods balance, which has been in deficit over the same period by varying amounts and was $8.3 billion in 1993 — a nearly equal opposite value to the services surplus (Figure 8.19). Moreover, the exports of services reflects a far stronger performance than goods exports relative to their total trade in services and goods, as the services surplus is far larger relative to the total services trade than is the goods deficit relative to the total goods trade. The consistent surplus in US-EU related party trade in services, compared with the consistent deficit in goods, suggests that the US firms on average have a revealed comparative advantage in services relative to goods production. Moreover, most of the surplus in the export of services is accounted for by the surplus in royalties and license fees. This performance seems to demonstrate that a US comparative Rgure8.19 US-EU Related-Party Trade Balances in Goods and Services, 1987-95 Billion i 15 (5) (10) (15) (20) advantage in services is mainly based on intellectual property, such as technology, produced by the US parents that is used by their EU affiliates. Composition of US-EU Related Party Services Trade by Type of Ownership The US-EU trade performance in services differs sharply in terms of ownership — that is, according to whether it is between US parents and their EU affiliates (USDIA-based trade) or between EU parents and their US affiliates (FDIUS-based trade). ^ USDIA services trade is in surplus, and is much larger than FDIUS services trade which is in deficit. Thus, the large growing overall surplus in US-EU related party services trade is mainly attributable to the larger, and in surplus, services trade between US parents and their EU affiliates. In this paper, USDIA payments for (imports of) royalties and license fees are based on the total US parents' payments of royalties and license fees to their affiliates in all European countries, as separate data are not available by individual EU countries and therefore for aggregate exports of these services to the 1 2 EU countries. However, the use of this larger coverage is likely to produce little overall distortion in the analysis because these services payments to (imports from) all of Europe are very small compared to other related party imports and probably almost all of those imports are accounted for by those imports from their affiliates in the EU countries. Ill In 1995, USDIA exports reached a record $16.6 billion, far outweighing USDIA imports of $3.6 billion, which resulted in a export surplus of $10.8 billion. In contrast, FDIUS exports reached a record $4.0 billion, two-thirds as large as the FDIUS imports of $5.7 billion, which explains their $1.7 billion deficit (Figure 8.20). Figure 8.20 US-EU Related-Party Services Trade in 1995 on USDIA and FDIUS Bases Billion S 20 (5) I Exports n imports @ Balance -•^^S^ USDIA FDIUS The far larger trade in services on USDIA basis than FDIUS basis illustrates the important role that US multinational firms play in the overall US trade performance not only in their overall trade, but in particular in their trade with their affiliates. Moreover, this is particularly important in terms of net trade performance, as parent firms tend to have export surpluses, as is the case with both US goods and services trade with the EU on the USDIA basis. In contrast, US affiliates of foreign parents tend to have US deficits in both US-EU trade in goods and services. For example, in 1995, the US-EU USDIA based trade in services was in surplus by $13.0 bilUon and the FDIUS trade in services was in deficit by $1.7 billion. Composition of US-EU Related Party Services Trade by Type of Service Both types of services exports and imports ~ royalties and license fees and all other private services — between US and EU related parties rose fairly steadily between 1987 and 1995, except for the 1993-94 slowdown in exports of these services. Both types of exports and imports reached record values in 1995. Royahies and license fees have been consistently much larger in exports than other services and much smaller in imports. In 1995, exports of royalties and license fees reached $12.0 billion compared with $8.5 billion in exports of other services. In contrast, in 1995, imports of royalties and license fees reached $3.0 billion compared with $6.3 billion in imports of other services (Figure 8.21). Figure 8.21 US-EU Related- Party Trade in Services by Type of Service and Ownership in 1995 Royalties and License Fees Exports Imports FDIUS ' 90% Other Private Business Sen/ices / FDIUS Almost all (93 percent) of the exports of royalties and license fees between US-EU related parties in 1995 are accounted for by exports of US parent firms to their EU affiliates. Conversely, almost all (90 percent) of the imports of royahies and license fees are accounted for by imports by EU-owned US affiliates from their EU parents. This reversal of relative imporance in terms of ownership suggests that, regardless which countries are involved (the US or the EU), parent firms are by far the dominant source of intellectual flows between parents and foreign affiliates—a clearly almost wholly one-direction dominance. As pointed out earlier in this paper, in 112 services trade as in goods trade between related parties, foreign direct investment tends to support an export surplus in services trade. This point also explains why the much larger exports of US parents than by foreign-owned US affiliates is a vital determinant of the overall US services trade performance. The direction in flows of transactions in other private services , in sharp contrast to that in royahies and license fees, is roughly in balance between originating parties. In 1995, 63 percent of the total value of other US private business services exports was accounted for by US parents exports to their EU affiliates. Similarly, 52 percent of the total US business services imports were accounted for by imports from their EU affiliates. Composition of US-EU Related Party Services Trade by EU Country The composition of US-EU related party trade in services is reported in terms of the EU nationality of the EU parent of the US-owned EU affiliate. That services trade, like in their goods trade, has been consistently dominated by the same four EU countries — the United Kingdom, Germany, the Netherlands, and France. In 1993, these four countries accounted for 74 percent of the total US exports of services in US-EU related party trade, 89 percent of the imports, and 62 Figure 8.22 US-EU Related Party Services Trade, by EU Country of Affiliate or Parent in 1993 '}'^/}/V/yZ ' '■'- ■- '//-^'^'K'/ □ Oh>er Q Germany n France |^ United KJr>gdom [7] Netherlands '^^//^^^/^/^M^ Exports Imports Balance Data tcr US parents' payments of royalties arxJ fees to EU affiliates are for all Eiropean coijitnes percent of the export surplus (Figure 8.22). In US exports, no one of these four countries was particularly dominant in either of the two types of services trade ~ services exports paid for by royalties and license fees or other private business services. In contrast, in US imports, the United Kingdom accounted for a particularly large share of both types of services. In 1993, the United Kingdom accounted for 55 percent of the royahies and license fees paid for imports of services, and 40 percent of the imports of other business services. Almost all royahies and license fees accounted for by US payments to the United Kingdom were for imports of services by UK-owned US firms fi'om their UK parents. In contrast, most of the US imports of other business services accounted for by the United Kingdom were for imports of those services by US parents from their UK affiliates. Composition of US-EU Related Party Services Trade by Industry of Affiliate In addition to the previously discussed limations on these related-party data, the data by industry of affiliate are also limited by the lack of data on the industry of the parent firms and the lack of data on imports of servces accounted for by royalties and license fees by US parents from their EU affiliates. Nevertheless, available data show that US and EU related parties exchange a wide range of intellectual property and other private business services. These services also range widely in terms of the primary goods and services industries of the US and EU affiliates and whether the services are contributions to the affiliates' further production of goods and services or are merely distributed by the affiliates as wholesalers or retailers. Roughly one-half of the total USDIA exports, and FDIUS exports and imports are accounted for by US and EU affiliates in manufactuirng industries. This is the case for both royalties and license fees and other private business services. Only in USDIA exports does trade with wholesaling affiliates account for a significant 113 Table 8.2 Shares of US- EU Business Services Trade Accounted for by Manufacturing Affiliates in 1993 (value in million dollars; shares in percent) Types of transactions Total value USDIA: US exports (receipts), total $ 13.321 Royalties & license fees 8,158 Other business services 5,163 US imports (payments), total 3.269 Royalties & license fees 162 Other business services 3,107 FDIUS; US exports (receipts), total 2.471 Royalties & license fees 333 Other business services 2,408 US imports (payments),total 3.820 Royalties & license fees 1 ,770 Other business services 2,050 Shares of affiliates primarily engaged in-- Manufacturing 61% 71 46 na na 50 47 42 48 63 81 47 Wholesaling 13% 17 7 na na 7 12 45 8 13 8 18 "na" -- not available. share of their total US-EU trade in services. Table 8,2 shows the shares in 1993 accounted for by affiliates in manufacturing industries. US-EU related-party trade in services by wholesaling affiliates appears to be as significant as that with affiliates in manufacturing only for exports of royalties and license fees earned by US parents (FDIUS-based US exports). In 1993, wholesaling affiliates accounted for 45 percent of the total for those services receipts. Nevertheless, those royalties and license fees receipts by US owned EU wholesalers are only relatively large in terms of their share among all industries, as their total value is relatively small compared with other types of services transactions. Affiliates in other industries are notable in several other instances in value terms and shares of total US-EU trade in services in 1993. More often than not, these affiliates are in US and EU industries that primarilly produce chemicals and produce non-electric machinery (Industrial machinery and equipment) such as computers, but not in the industry producing electronic components. They include— • Of total US receipts for royalties and license fees earned by US parent firms for services exported to their EU affiliates (USDIA based exports)- • 19 percent were received from EU affiliates that primarily produce chemicals and allied products, and • 33 percent were received from EU affiliates that primarily produce non- electric machinery, • Of total US payments for other business services imported by US parents from EU affilates, 43 percent were paid to EU affiliates producing non-electric machinery. • Of total US payments for royalties and license fees for services imported by US 114 affiliates from their EU parents, 63 percent were paid to US affiliates that primarily produce chemicals and allied products. The large shares of the exports and imports of services between US-EU related parties for which royalties and license fees are received and paid suggests that the transfer of technology is an important "two-way street" between them. 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C/3 o CO < JF LL fc < c/) q2 :$ -=- ^ B w Q LU O LU o 03 CD O _co 03 c o O ™ 2 10 < CD CO Z) = ^^^ CO 03 Q D _- J:f 1 CO Q H LU t: CO CL O "S CO CO 116 Table 8.4 U.S.-Europe Goods Trade, Total All Firms: between U.S.-EU Related Parties, and between Those Related Parties and Other Parties in 1993 (values in million dollars) US Trade with-- Europe total EU-12 * FU-15 *■ Other* Value Share Value Share total Total US trade with all firms: US EXPORTS 119,785 96,973 81.0% 101,501 84.7% 18,284 US IMPORTS 119,082 97,941 82.2% 105,493 88.6% 13,589 US BALANCE 703 (968) ~ (3,992) - 4,695 Total US Trade by US-EU Related Parties: USDIA, nonbank: US EXPORTS, total** 37.321 31,142 83.4% 31,788 85.2% 5,533 To all foreign affiliates ~ ~ ~ ~ — — By US parents - ~ - - ~ - By other US firms - ~ ~ ~ ~ — To MOFAs 36,074 32,055 88.9% 32,953 91.3% 3,121 By US parents 32,709 28,931 88.4% 29,730 90.9% 2,979 By other US firms 3,364 3,125 92.9% 3,226 95.9% 138 US IMPORTS, total" 19,041 16,955 89.0% 16,955 89.0% 2,086 From all foreign affiliates — — — — ~ ~ By US parents ~ — — ~ — ~ By other US firms - ~ - - — - From MOFAs 18,153 17,126 94.3% 17,612 97.0% 541 By US parents 14,553 13,787 94.7% 14,201 97.6% 352 By other US finns 3,599 3,339 92.8% 3,411 94.8% 188 FDIUS, nonbank: US EXPORTS To foreign parent group To others To foreign affiliates*** To unaffiliated foreigners By US MOFAs US IMPORTS From foreign parent group From others From foreign affiliates*** From unaffiliated foreigners By US MOFAs 45,983 13,980 32,003 5,472 26,530 69,349 45,515 23,834 5,238 18,596 36,260 11,493 24,767 4,613 20,154 56,011 34,944 21,067 4,572 16,315 78.9% 82.2% 77.4% 84.3% 76.0% 80.8% 76.8% 88.4% 87.3% 87.7% 39,541 12,235 27,296 5,168 22,149 62,248 39,961 22,287 4,859 17,248 86.0% 87.5% 85.3% 94.4% 83.5% 89.8% 87.8% 93.5% 92.8% 92.8% 6,442 1,745 4,707 304 4,381 7,101 5,554 1,547 379 1,348 Note: data may not add due to rounding. Total US trade with all firms are exports by country of destination and imports by country of origin. USDIA-based trade is by country of affiliate and FDIUS-based trade is by country of ultimate beneficial owner (UBO). "-" is not available. * Data for some EU countries are suppressed and therefore are included in the residual "Other". ** Total may exceed trade of MOFA due to suppression and inclusion of non-MOFA trade in the residual "Other. *** Also included under USDIA trad to the extent that this trade is between (1) US firms that are affiliates of EU-owned parents and (2) EU fimns that are majority-owned affiliates (MOFAs) of that US firm. 117 Table 8.5 U.S.-EU12 Goods Trade: Total All Firms, between U.S.-EU Related Parties, and between Those Related Parties and Other Parties in 1993 (values in million dollars) Value* Sharft Total US trade with all firms: US exports US imports US balance US-EU Trade between US-EU Related Parties: US exports, total USDIA: to foreign affiliates** FDIUS: to foreign parents US imports, total USDIA: by US parents** FDIUS: by US affiliates US balance, total USDIA** FDIUS US-EU Trade by US-EU Related Parties with Unrelated Parties US exports, total USDIA: to MOFAs by unaffiliated US fimis FDIUS: to unaffiliated EU firms US imports, total USDIA: from MOFAs to unaffiliated US fimns FDIUS: from unaffiliated EU firms US balance, total 3,125 US-EU Trade between Other Unrelated Parties: US exports 33,270 34.3% US imports 29,056 29.7% US balance 4,214 Note: total US trade with all firms are exports by country of destination and imports by country of origin. USDIA-based trade is by country of affiliate and FDI US-based trade is country of ultimate beneficial owner (UBO). * Data for some EU countries are suppressed and therefore are included in the residual "Other" ** Understates the USDIA-based and total trade between related parties to the extent that the foreign firm is a minority-owned affiliate of the US parent. 96,973 97,941 (968) 100.0% 100.0% 40.424 28,931 11,493 41.7% 29.8% 11.9% 48,731 13,787 34,944 49.8% 14.1% 35.7% (8 307) 15,144 (23,451) Parties: ?3,?79 3,125 20,154 24.0% 3.2% 20.8% 19,654 3,339 16,315 20.1% 3.4% 16.7% 118 Table 8.6 U.S.-EU-12 Goods Trade, Total All Firms and Between Related Parties in 1993 (values in million dollars; shares in percent) Trade between- _ Total Related parties Value Share . Unrelated oarties Value Share of tots Total, all parties: Exports 40,424 41.7% 56,549 96,973 100.0% Imports 48,731 49.8% 49,210 97,941 100.0% Balance (8,307) na 7,339 (968) na Combined USDIA&FDIUS: Exports 40,424 63.5% 23,279 63,703 65.7% Imports 48,731 71.3% 19,654 68,385 69.8% Balance (8,307) na 3,625 (4,682) na USDIA:* Exports 28,931 90.3% 3,125 32,056 33.1% Imports 13,787 80.5% 3,339 17,126 17.5% Balance 15,144 na (214) 14,930 na FDIUS:** Exports 11,493 36.3% 20,154 31,647 32.6% Imports 34,944 68.2% 16,315 51,259 52.3% Balance (23,451) na 3,839 (19,612) na Between other unrelated parties: Exports — — 33,270 33,270 34.3% Imports — — 29,556 29,556 30.2% Balance ~ — 3,714 3,714 na Note: Total, all parties trade are exports by country of destination and imports by country of of origin. USDIA-based trade is by country of affiliate and FDIUS-based trade is by country of ultimate beneficial owner (UBO). * Only includes trade of MOFAs. Trade of less than majority U.S. -owned foreign affiliates is included with trade "Between other unrelated parties". ** Excludes trade of foreign-owned U.S. firms with their foreign affiliates abroad. This trade is included with trade of USDIA related parties. 119 Table 8.7 USDIA Goods Trade between US Parents and Their EU-12 MOFA in 1989 and 1993 (values in million dollars; shares in percent) L S exports I S imports US balance Countrv of affiliate 1989 1993 1993 share 1989 1993 1993 sharR 1989 1993 EU-12, total* 25,592 28,931 100,0% 10 751 13 787 100,0% 14,841 15,144 Belgium 2,072 2,201 7.6% 897 792 5.7% 1,175 1,409 Denmark 137 160 06% 150 83 0.6% (13) 77 France 3,300 3,689 12.8% 1,456 1,905 13.8% 1,844 1,784 Germany"" 4,911 6,955 24.0% 1,767 1,605 11.6% 3,144 5,350 Greece 45 33 0.1% 16 1 0.0% 29 32 Ireland 1,170 698 2.4% 586 1,711 12.4% 584 (1,013) Italy 1,625 1,403 4.8% 520 697 5.1% 1,105 706 Luxembourg 96 169 0.6% 104 d 0.0% (8) d Netherlands 3,453 4,611 15.9% 852 1,017 7.4% 2,601 3,594 Portugal 81 123 0.4% 30 d 0.0% 51 d Spain 1,673 963 3.3% 731 355 2.6% 942 608 United Kingdom 7,028 7,928 27.4% 3,643 4,502 32.7% 3,385 3,426 Note: Trade is by country of affiliate. * Individual country data do not add to total due to suppressed data. " Data for 1989 include only the Federal Republic of Germany. Table 8.8 FDiUS Goods Trade between EU-Owned US Affiliates and Their EU-12 Parents in 1989 and 1993 (values in million dollars; shares in percent) Country of UBO EU-12, total* Belgium Denmark France Gemiany** Greece Ireland Italy Luxembourg Netherlands Portugal Spain United Kingdom Note: Trade is by country of ultimate beneficial owner (UBO). * Individual country data do not add to total due to suppressed data. ** Data for 1989 include only the Federal Republic of Germany. US exnorts US imnorts US balance 1989 1993 1993 sharft 1989 1993 1993 share 1989 1993 8,989 11493 100 0% 30,489 34,944 100,0% (?^ 500^ (23,451) 38 71 0.6% 549 502 1.4% (511) (431) 18 55 0.5% 305 429 1.2% (287) (374) 3,012 4,678 40.7% 5,155 4,543 13.0% (2,143) 135 2,021 2,515 21.9% 14,247 15,955 45.7% (12,226) (13,440) - - 0.0% - - 0.0% 7 8 0.1% 2 169 0.5% 5 (161) 1,190 801 7,0% 97 1,820 5.2% 1,093 (1,019) 14 43 0.4% 217 352 1.0% (203) d 929 1,422 12.4% 2,573 4,123 11.8% (1,644) (2,701) — — 0.0% - — 0.0% d 2 14 0.1% 88 146 0.4% (86) (132) 1,754 1,886 16.4% 6,234 6,904 19,8% (4,480) (5,018) 120 Table 8.9 Combined USDIAand FDIUS US-EU12 Goods Trade between Related Parties in 1993 (values in million dollars; shares in percent) US exports US imports Cniintrv of affiliate or of UBO USDIA FDIUS, Total Total share USDIA FDIUS Total Total share EU-12, total* 28,931 11,493 40,424 100,0% 13,787 34,944 48731 100,0% Belgium 2,201 71 2,272 5.6% 792 502 1294 2.7% Denmark 160 55 215 0.5% 83 429 512 1.1% France 3,689 4,678 8,367 20.7% 1,905 4,543 6448 13.2% Germany 6,955 2,515 9,470 23.4% 1,605 15,955 17560 36.0% Greece 33 - 33 0.1% 1 - 1 0.0% Ireland 698 8 706 1.7% 1,711 169 1880 3.9% Italy 1,403 801 2,204 5.5% 697 1,820 2517 5.2% Luxembourg 169 43 212 0.5% d 352 d 0.0% Netherlands 4,611 1,422 6,033 14.9% 1,017 4,123 5140 10.5% Portugal 123 - 123 0.3% d - d 0.0% Spain 963 14 977 2.4% 355 146 501 1.0% United Kingdom 7,928 1,886 9,814 24.3% 4,502 6,904 11406 23.4% Note: USDIA-based trade is by country of affiliate and FDIUS-based trade is by country of ultimate beneficial owner (UBO). * Individual country data do not add to total due to suppressed data. 121 00 Si « CO ^ = C/3 C < c TO ■Jo O in ■^ CO g 5? 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C 3 3 W 3 LL o 3 O 3 * t TD OT 126 EFFECTS OF FOREIGN DIRECT INVESTMENT IN THE UNITED STATES ON U.S. TECHNOLOGY DEVELOPMENT by Sumiye Okubo' Introduction^ Rising globalization has raised a number of questions about the effects of operations of foreign-owned U.S. firms on U.S. science and technology development. The most frequently asked questions include: Do foreign-owned firms contribute to U.S. technological capability? Are their parent firms acquiring or estabUshing U.S. firms in order to acquire U.S. technologies? Are the R&D facilities established in the United States intended to aid their sales in the United States -- as facilities for tailoring products and services to the U.S. market, and laboratories for developing new products and processes? Are they also listening posts for gaining access to U.S. scientific and technology developments to aid their parent When this chapter was drafted. Director, Office of International Macroeconomic Analysis, Office of the Chief Economist, Economics and Statistics Administration, U.S. Department of Commerce; on June 22, 1997, became Associate Director for Industry Economics of the Bureau of Economic Analysis, Economics and Statistics Administration, U.S. Department of Commerce. ^ This chapter builds on the analysis, and updates data, presented in "Influence of Foreign Direct Investment on the Development and Transfer of U.S. Technology," published in Foreign Direct Investment in the United States: An Update (Washington, D.C.: U.S. Department of Commerce, June 1993), pp. 52-76. The author wishes to thank Lewis Alexander, Lester Davis, and William Brown for helpful comments and suggestions and Lisa P. Conley for statistical and graphics assistance. firms? Are they a source of technologies that "spill over" to aid the development and use of technology by US-owned firms? These questions cannot be answered definitively. Nevertheless, data that are available provide some important indirect evidence. This chapter addresses these questions, in terms of three general types of indicators. • The chapter first looks at the extent of operations of foreign firms' U.S. affiliates in high-technology industries for evidence that these firms may have pursued strategies to significantly acquire U.S. technologies. • It then looks at their R&D spending and other R&D activities in the United States to assess the possible impact on U.S. technology development. • It also examines available data on royalties and license fees to examine the extent that U.S. affiliates of foreign firms are sending technology to their foreign parents, or are receiving technology from them. The sources of data are the Bureau of Economic Analysis (BEA) FDI surveys and the BEA-Census Data Link project for 1987 and 1992. The data on R&D spending and technology transactions are in terms of the industry aggregations, rather than product classifications. Comparisons of technology-related activities by US-owned and foreign-owned firms over time are 127 difficult because R&D expenditures by newly acquired foreign-owned firms cannot be separated from those of existing foreign-owned firms. Moreover, much of the increase in R&D spending by affiliates reflects acquisitions of existing U.S. firms by foreign owners, rather than increases in spending by foreign-owned firms over time. This chapter provides several key conclusions about the relation between foreign- ownership of U.S. firms and U.S. technology developments, notwithstanding these and other data limitations on detailed industry and product data: • Foreign-owned firms' share of all U.S. firms' sales in high-technology industries were roughly double in size of their share in non- high-technology industries~24.8 percent and 12.9 percent respectively in 1994. Moreover, the affiliates' shares in both industry groups rose substantially during 1987-94, ahhough more rapidly in non-high technology than high-technology industries. • In individual high-technology industries, foreign-owned firms account for a majority of the sales only in the audio-video equipment industry. However, the affiliates' share of total sales in each of the high- technology industries has been rising. • German, U.K., and Japanese parent firms own U.S. firms that account for a large share of all U.S. high-technology affiHates' sales, although none of these parent firms appear to have concentrated their investments in high-technology industries. • R&D spending of U.S. manufacturing affiliates doubled between 1987 and 1994, growing at an average annual rate of 13 percent, compared with 7 percent for all U.S. firms. As a resuh, their share of total R&D spending in U.S. manufacturing industries by all firms rose from 11 to 16 percent. • Over three-fourths of total R&D spending by the affiliates is by those in high-technology industries. To the extent that R&D spending equates with technological capabilities, R&D spending has contributed more to the capabilities in high-technology than non-high technology industries. When examined separately by manufacturing industry, the R&D spending to sales ratios ( R&D intensities ) of U.S. affiUates tend to be lower than that of US-owned firms. Because foreign investment is more concentrated in high-technology industries, the overall R&D intensity of U.S. affiliates was about the same — 3 percent — as for US-owned firms in 1994. The data on royahies and license fees suggest that there has been a large net inflow of technology to U.S. affiUates from their foreign parents. The relative importance of technology flows between the affiliates and their parents is also reflected in a measure of the "payback" for the affiliates' R&D spending. The ratio of the affiliates' royalties and fees receipts from their parents to the affiliates' total R&D spending tripled between 1987 and 1994. Definition of High-Technology Industries The technology capability and activity of U.S. affiliates are, by definition, a part of the overall U.S. capability and activity. At issue is the effect of their operations on the U.S. aggregate technology capability and on US-owned firms. The approach used in this chapter in examining the relation between FDIUS and overall U.S. technology development is to compare the performance of foreign-owned and US-owned firms in high-technology goods and services industries. High-technology industries are those that use new, advanced, or leading-edge technologies. Industries are frequently classified as high- technology by using the classification scheme developed by the Department of Commerce for 128 studying U.S. high-technology goods-producing industries (DOC-3 definition).^ The analysis in this chapter is based on DOC-3, to the extent possible using BE A industry categories. Three high-technology services producing industries are also included to reflect the growing importance of high technology embodied in the U.S. services sector: "Computer and data processing services" (SIC 737); "Engineering, architectural, and surveying services" (SIC 871); and "Research and testing services" (SIC 873) (Table 9-1). Most of the analysis in this chapter uses FDIUS data at the enterprise (firm) level, published by BEA, because these data are the most current available. These data, however, are not separately available for each DOC-3 detailed industry groups. Therefore, when enterprise data are used, several industries have been aggregated, and several DOC-3 industry groups have been excluded."* Table 9-1 High-Technology Industries Industry Manufacturing industries: Industrial chemicals & synthetics . . Drugs & medicines SIC 281,282 365 372-376 class 286 Ordnance Engines, turbines, & parts Computers & office machines .... Video, audio, & communications equipment 348 351 357 3ftft Electronic components ^67 Instruments & related products . . . Other transportation equipment . . Services industries: Computer & data processing services 38 379 7^7 Engineering, architectural, & surveying services 871 Research & testing services 873 Lester A. Davis, Technology Intensity of U.S. Output and Trade, Office of Trade and Investment Analysis, U.S. Department of Commerce, International Trade Administration, July 1982. This classification scheme is often referred to as the "DOC-3" definition. When BEA enterprise data are used, the FDI for high- technology industries shown in the tables are understated by excluding the "ordnance" industry, "engines, turbines, and parts" industry, and "research and testing services," and overstated by including some low-technology industries, such as "industrial organic chemicals," under industrial chemicals, and "ship and boat building, railroad equipment, and miscellaneous transport equipment," under the broad "other transportation equipment" category. Although classified as high-technology under DOC-3, the "engines, turbines, and parts" (SIC 351) industry and the "ordnance and accessories" (SIC 348) industry are excluded because FDI data for these industries are not classified separately, but are, instead, combined with data for two other three- digit industries within the metal products group (SIC 34). The "engines, turbines, and parts" industry is excluded because the FDI data for this industry are suppressed in some years to avoid disclosure of data for individual companies. On the other hand, "other transportation equipment" has been included in its entirety because over 70 percent of this group is accounted for by "aircraft and parts" (SIC 372) and "guided missiles and spacecraft" (SIC This chapter uses establishment (plant) level data, which are classified at the DOC-3 level of disaggregation, to provide additional details on U.S. affiliates, but the data for all industries are only available for 1987 and 1992 (from the project that links BEA and Census data). Establishment data for manufacturing industries are also available for 1988-1991. 376). Similarly, "industrial organic chemicals" represents 40 percent of industrial chemicals and synthetics. Data on the high-technology services industries are available only after 1983, and "research and testing services" are not reported separately over time. The latter is included in the analysis when data are available. The BEA-Census data link project provides data on the number, sales, payroll, and employment of establishments (plants) of U.S. affiliates of foreign firms in all industries at detailed four-digit SIC categories in 1 987 and 1 992. For 1 988-9 1 , the link data cover manufacturing only. 129 Extent of Foreign Direct Investment in High Technology Industries Foreign investment in U.S. high-technology industries has taken place in the context of their rapid increase in investment in all U.S. industries, and particularly in the U.S. manufacturing sector. The overall FDIUS position in all U.S. industries rose rapidly in the 1980s, especially in the second half of the decade, and tripled between 1985 and 1995, from $184.6 billion to $560.1 billion. During this period, foreign parent firms placed a larger share of their investment in the U.S. manufacturing than in any other sector. The FDIUS position in manufacturing rose by 253 percent and in the finance and insurance sectors rose by 243 percent (Figure 9-1). Figure 9-1 FDIUS Position, by Industry of Affiliate 1985-95 Brilion i 250 Marufactiring 1985 87 89 Source: Bireau of Econofnic Analysis. U.S. affiliates of foreign firms accounted for a rising share of the U.S. manufacturing sector. Between 1980 and 1994, their share of total industry assets in manufacturing grew from 8.3 percent to 17.7 percent, and of value added grew from 7.9 percent to 13.2 percent (Table 9-2). Between 1987 and 1994, their share of U.S. manufacturing sales rose from 9. 1 percent to 15.5 percent. U.S. affiliates' growing shares of U.S. manufacturing sales reflect the increasing importance of these firms in both U.S. high- technology and non-high technology manufacturing industries Table 9-2 Estimated Share of Assets & Gross Product of All U.S. Businesses in Manufacturing Accounted for by Affiliates of Foreign Companies (in percent) Gross product Assets (val je added) Sales 1980 . 8.3 7.9 ^_ 1987 . 13.2 10.5 9.1 1990 . 18.6 13.8 13.6 1992 . 16.9 13.9 14.4 1993 . 17.6 12.8 15.0 1994 . 17.7 13.2 15.5 Sources: U.S. Department of Commerce, Foreign Direct Investment in the United States: An Update (Washington, D.C.: U.S. Department of Commerce, June 1993); Survey of Current Business, \u\y 1996; U.S. Bureau of the Census, Quarterly Financial Report for Manufacturing, Mining, and Trade Corporations, Second Quarter, 1996 Foreign-owned firms in U.S. high-technology industries as a whole Sales data provide an indication of the extent to which foreign firms have given priority to high- technology industries versus non-high-technology industries. Sales in technology-intensive industries are smaller than sales in non-technology intensive industries for both U.S. affiliates and US-owned firms. However, during the 1987-94 period, the U.S. affiliates' share of all U.S. firms' sales in high technology industries was roughly double the size of their share of all U.S. sales in non-high technology manufacturing industries. In 1994 their shares were 24.8 percent and 12.9 percent respectively (Table 9-3). Moreover, the affiliates' share of sales in both industry groups rose substantially during that period. Nevertheless, over the period their U.S. sales in non-high technology manufacturing industries grew more rapidly (14.2 percent) than their sales 130 Table 9-3 Sales of US Afllliates in High Technology and Non-High Technology - - . _ Manufacturing Industries Dollar Amount (in billion dollars) Share of Total US Sales (in percent) High- Non-High High- Non-High technology technology technology technology industries industries industries industries 1987 . . . 91.7 133.4 17.4 6.8 1990 . . . 137.6 258.8 21.4 11.4 1992 . . . 154.9 276.3 22.6 12.1 1993 . . . 167.0 301.3 24.2 12.4 1994 . . . 181.0 337.6 24.8 12.9 Annual rate of growth( percent): 1887-94 . 10.2 14.2 Sources: Bureau of Economic Analysis and Bureau of the Census. in high-technology industries (10.2 percent).^ Individual high-technology industries At the individual industry level, data from the BEA-Census data link project shov;' that foreign- ^In Table 9-3, the affiliates' shares for 1990, 1993 and 1994 are based on industry of sales data from BEA's inter- period surveys, and shares for 1 987 and 1 992 are based on detailed data from the BEA-Census Data Link Project. Data on U.S. affiUates sales by mdustry of sales approximate data by establishment from the BEA-Census Data Link Project, but are not exactly equivalent. BEA data on employment and sales are collected on both an industry of affiliate and an industry of sales bases. The latest year for which data from the Data Link Project are available is 1 992. Industry classifications for data published under the Data Link Project are more detailed than the annual FDIUS data. See William J. Zeile, "Foreign Direct Investment in the United States: 1 992 Benchmark Survey Results," Survey of Current Business, July 1 994, for definitions. US-owned sales are derived by subtracting U.S. affiliates' sales from all U.S. sales. owned U.S. establishments account for a rising share of operations in the individual high- technology manufacturing industries.^ US-owned establishments dominate the sales of each U.S. high-technology industry, except for the sales of the audio and video equipment industry (Table 9- 4). Foreign-owned U.S. establishments have long dominated U.S. sales in this industry, with their share of total U.S. industry sales rising from 53 percent in 1987 to 64 percent in 1992. Foreign-owned U.S. establishments held market shares between 25 and 50 percent of total The latest data available from the BEA-Census Bureau data link are for 1 992. It should be noted that the link data are on an establishment basis while BEA's data on the operations of U.S. affiliates are on an enterprise basis. Sales totals of individual industries and shares of the all U.S. totals vary, depending on whether establishment or enterprise data are used. Sales data on an enterprise basis used in this report are classified by "industry of sales". 131 Table 9-4 Affiliates' Shares of Establishments in All U.S. Industries and in All U.S. High-Technology Industries, 1987 and 1992 (in percent) 1987 1992 n/a 9.9 No. of Employ- Payroll Sales establish- ment Industry ments All U.S. Industries I.I 3.7 4.7 All High-Technology Manufacturing & Services Industries 1.8 7.1 8.5 High-Tech. Manufacturing 4.9 9.0 11.4 Inorganic chemicals 23.8 19.3 18.9 Plastics & synthetics 1 8.4 38.2 37.9 Drugs 8.0 19.4 21.6 Industrial organic chemicals .. 14.7 24.7 25.4 Ordnance & accessories 3.2 7.6 7.2 Engines & turbines 4.5 6.0 5.7 Computers & Office Equipment 2.7 7.0 6.4 Household audio & video eqpt. 2.8 33.8 35.1 Communications Equipment . . 5.9 13.9 12.3 Electronic components & access. 3.1 9.2 9.1 Aircraft & parts 2.5 1 .9 1 .6 Guided missiles, spacecraft ... 2.8 (D) (D) Instruments & related parts .. 3.1 7.4 6.9 High-Technology Services: .... Computer & data processing . I.I 3.5 4.4 Engineering & architectural .. . 0.6 2.1 2.7 Research, development & testing 2.5 4.0 4.8 No. of Employ- Payroll establish- ment ments 1.7 5.8 7.5 Sales 10.7 2.5 10.4 10.6 13.9 11.5 6.4 13.5 13.4 16.3 25.2 26.5 21.8 21.0 29.6 34.2 26.0 41.2 41.5 39.9 23.6 14.2 33.4 36.1 32.9 24.7 21.3 32.0 32.3 28.7 9.2 4.2 11.8 10.3 12.9 3.7 4.8 5.7 6.0 4.2 5.7 5.0 12.7 13.2 11.7 52.8 5.6 39.7 41.8 64.0 14.7 5.2 16.3 17.1 18.9 9.2 4.1 12.6 12.8 13.0 1.7 4.3 4.1 3.5 2.6 (D) 2.9 0.7 0.6 (D) 7.2 4.2 11.7 11.3 11.8 __ 1.7 5.3 6.3 6.4 3.9 1.9 4.9 5.9 5.6 3.6 1.0 5.4 6.4 7.2 4.0 3.9 6.6 7.6 7.3 Notes: (D) - Suppressed so that confidential information on individual companies would not be divulged. Totals exclude values of industries that are suppressed. Sources: Bureau of Economic Analysis and Bureau of the Census, U.S. Department of Commerce. U.S. industry sales in four other high-technology industries between 1987 and 1992; • In plastics and synthetics , their share rose from 34 percent to 40 percent. • In industrial inorganic chemicals , their share grew from 25 percent to 30 percent. • In industrial organic chemicals , their share rose form 25 percent to 29 percent. • In drugs and medicines , their share increased from 24 percent to 33 percent. In 1992, their smallest participation was in aircraft and parts. ^ with less than 3 percent of total industry sales, and in high-technology services industries, with only about 7 percent of total sales. In terms of employment and payroll , U.S. affiliates accounted for a rising share of the employment in ail high-technology industries, US firms in aircraft and parts and guided missiles and spacecraft are shielded from foreign acquisition by, among other factors, the Exon-Florio amendment to the Defense Production Act. Data on guided missiles and spacecrafl have been suppressed to avoid disclosure. 132 rising from 7.1 percent to 10.4 percent between 1987 and 1992, while payroll rose from 8.5 to 10.6 percent over the same period. Employment by high-technology U.S. affiliates grew by 13.0 percent between 1987 and 1992, from 489,100 to 554,542 workers, compared to aU U.S. high- technology firms which grew 6.0 percent annually ~ rising from 4.9 million to 5.2 million workers. Much of this increase in employment share might be attributed to the large number of foreign acquisitions of U.S. high-technology firms, and not necessarily from growth of employment of existing U.S. affiliates. According to unpublished BEA data, during this period, between one-fourth and three-fourths of the total annual increases in employment in high-technology industries occurred as a resuU of acquisition. Among the high-technology industries, as in the case for sales, the U.S. affiliates' shares of total employment and growth of the total number of workers varies widely. The largest shares are in inorganic chemicals , plastics and synthetics . drugs , and audio, video, and communications equipment industries; and the fastest growing shares are in the aircraft and parts , drugs . instruments , and electronic components industries. Although growing rapidly, the share for aircraft and parts remains small. The share for high- technology services industries remains less than 1 percent, but employment in these industries is rising relatively quickly. and less so for Japan (23 percent). As a share of total services sales, high technology sales were much lower for these countries and especially low for Japan. ^ Data from the BEA-Census data link project provide a more detailed picture, than the annual BEA surveys, of the extent of concentration of U.S. affiliates of foreign firms in each industry (US affiliates' share of total industry sales). The data link shows that in 1 992, affiliates of Japanese, German, and British parents had five percent or less of total U.S. sales in each of the high- technology manufacturing industries, with few exceptions (Table 9-6):^ • In all high-technology industries, the most dramatic increase in share of total industry sales was in the Japanese-owned affiliates' share of all U.S. industry sales in the video and audio equipment industry, rising from 32.2 percent in 1987 to 44 percent in 1992. Japanese-owned affiliates also raised their share of sales from 1.8 percent to 7 percent in computers . • German-owned affiliates had 5 percent of total drugs and medicines industry sales and 12 percent of total industry sales in plastics and synthetics industry in 1992. • British-owned affiliates had 1 1 percent of total industry sales in drugs .'" and 8 percent Ownership of high-technology affiliates by country of parent Data on FDIUS by country of ownership show that U.S. affiliates of Japanese, U.K., and German parent firms account for a large share of all U.S. high-technology affiliates' sales. Broad industry enterprise-level data for 1994 show that U.S. affiliates of these three countries accounted for more than 50 percent of all high-technology affiliates' sales (Table 9-5). As a share of total manufacturing sales, high-technology manufacturing sales were especially important to Germany (39 percent) and the U.K. (34 percent), Sales of high-technology affiliates of Canadian and Dutch parents in a number of these industries are suppressed to avoid divulging confidential information on individual companies. The five countries, Japan, the United Kingdom, the Netherlands, Canada, and Germany, represent over 70 percent of total FDIUS in 1994. Data by country of parent are not separately available for the individual high-technology services industries. '"Although data for Swiss firms were not available separately for 1987, in 1992, Swiss-owned establishments accounted for 8.3 percent of all U.S. industry sales in drugs. 133 Table 9-5 Sales of Affiliates in High-Technology Industries by Selected Country of Parent and by Industry of Sales, 1 994 (billions of dollars) Industry In manufacturing industries Industrial chemicals & synthetics Drugs & medicines Computers Audio, video, & communications . equipment Electronic components Instruments Other transportation equipment In services industries Computer & data processing services . Engineering & architectural services . . Research & testing services High-technology share of total affiliates' sales in: All manufacturing industries All services industries All United Countries Japan Germany Kingdom 154.0 26.7 24.2 28.3 50.5 3.7 11.9 7.2 30.4 1.2 4.7 10.6 10.6 5.2 0.4 0.2 24.0 7.6 1.8 0.7 13.4 6.5 1.0 1.9 19.5 2.3 4.0 5.8 5.6 0.2 0.5 2.0 23.1 9.0 2.9 1.0 2.2 0.3 5.7 1.7 7.3 0.7 1.6 I.I 6.8 1.2 0.3 2.9 ales in: 30.5% 23.3% 38.7% 34.4% 2.5% 1.1% 2.4% 3.5% Source: U.S. Department of Commerce, Bureau of Economic Analysis, Foreign Direct Investment in the United States, Operations of U.S. Affiliates of Foreign Companies, Preliminary 1 994 Estimates, July 1996. Table 9-6 Affiliates' Shares of Sales by All Establishments in U.S. High-Technology Manufacturing Industries, by Selected Country of Parent, 1987 and 1992 (In percent) Industry Ail high-tech/total manufacturing 1.3 Industrial inorganic chemicals 1 .4 Plastics & synthetics 9.2 Drugs & medicines d Ordnance & accessories 0.0 Computers & office eqpt 0. 1 Household audio/video eqpt 0.0 Communications eqpt 1 .0 Electronic components & access. 0.1 Aircraft & parts d Instruments I.I 1987 Germany UK 2.2 Japan 1.3 2.3 1992 Germany UK 1.8 Japan 3.2 7.3 d 2.4 7.8 0.3 1.0 d 11.9 1.3 3.7 8.5 d 5.2 10.7 1.5 d 0.0 d 4.5 0.0 0.5 1.8 0.4 0.9 7.0 0.1 32.2 d d 43.4 2.6 1.4 d 1.3 2.9 I.I 0.0 1.2 0.6 4.7 0.8 d d I.I d 1.9 0.4 1.8 3.4 1.3 Source: U.S. Department of Commerce, Bureau of Economic Analysis & Bureau of the Census, Foreign Direct Investment in the United States: Establishment Data for 1 987 and for 1 992. 134 share of total industry sales in the industrial inorganic chemical industry in 1992 -- slightly higher than in 1987. R&D Activities of Foreign-owned Firms Neither BEA data nor the data from the BEA-Census data link can provide direct information about foreign parents' strategies — i.e., whether they sought to gain major market shares in any single high-technology industry, or to exploit a competitive advantage in that sector. However, one way of gauging the strategies of foreign-owned firms and their contribution to U.S. science and technology development is to examine the extent of their R&D efforts in the United States and their international technology transfer activities. R&D by US affiliates, by definition, contributes to the aggregate U.S. technological capability. U.S. affiliates have established a number of in-house R&D facilities in the United States. Data on royalty and license fees also suggest that U.S. affiliates are increasing their technological capability with technologies purchased from their foreign parents, and the technological advances produced with their R&D spending is being shared with their foreign parents and other firms. Aggregate R&D spending by U.S. affiliates in all industries rose at a faster rate of increase than spending by US-owned firms, growing at 1 3 percent annually between 1987 and 1994, compared to 6 percent for US-owned firms. This rise, of course, reflects not just increases in spending by existing U.S. affiliates, but also the inclusion of R&D spending by newly acquired U.S. firms. The ratios of R&D spending to sales of U.S. affiliates and US-owned firms in all U.S. industries changed little over the period, averaging about 3 percent for both groups of firms throughout the 1987-94 period. The R&D to sales ratios for high-technology and non-high-technology manufacturing industries were not significantly different for US- and foreign-owned firms. For individual high-technology industries, however, the ratios differed ~ the affiliates' ratios of R&D spending to sales on average between 1987 and 1994 were lower than the average for US-owned firms in all high-technology industries, except for firms producing computers and office equipment. (A comparison of the affiliates' and US-owned firms' technology intensities in high-technology industries is provided later in this chapter.) R&D spending in high-technology industries In 1994 and earlier years about three-fourths of the R&D spending by U.S. affiliates was in high-technology manufacturing industries. Aggregate R&D spending by U.S. affiliates of foreign firms in all manufacturing industries account for a small, but rapidly rising share of total spending by all companies. Data from the National Science Foundation (NSF) show an average annual increase in R&D spending by all U.S. manufacturing firms of 7 percent between 1987 and 1994, fi-om an aggregate of $61 .4 billion in 1987 to $97.1 billion in 1994.'' In contrast, R&D spending by U.S. affiliates rose at a 13 percent average annual rate — twice the average rate for all U.S. firms, and more than doubling fi-om $6.5 billion in 1987 to $15.6 billion in 1994. As a resuh, the affiliates' share all U.S. manufacturing industries' R&D spending rose from 11 to 16 percent over the 1987-94 period. The largest share of the affiliates' R&D spending is in the medicines and drugs industry— 35 percent of their total spending in National Science Foundation, Division of Science Resources Studies, Research and Development in Industry, 1994. Both BEA and NSF survey data are collected at the enterprise level, and exclude contract research by companies at universities and private laboratories. NSF, but not BEA, also collects and reports data that include contract research. BEA began collecting and reporting these latter data in 1 992. NSF R&D data from 1 992 to present cover a substantially different and much larger set of companies than in the past. 135 manufacturing industries in 1994, followed by 15 percent in industrial chemicals and 1 1 percent in the audio, video, and telecommunications equipment industry. The medicine and drugs industry also led in terms of the growth of the affiliates R&D spending— quadrupling in value between 1987 and 1994— and also led in share of total affiliate spending in high-technology industry spending— the share rising from 24 percent in 1987 to 47 percent in 1994. The very rapid rise in affiliates' R&D spending reflects both the large number of acquisitions of existing U.S. firms and increases in R&D by existing U.S. affiliates. However, the relative importance of the two sources of technology cannot be determined from available data. Acquisitions of existing U.S. firms provide foreign parents access to new U.S. technologies, as well as advances in their technological capability. The more rapid increase in aggregate R&D spending by U.S. affiliates than by all U.S. firms is reflected in the rise in affiliates' share of total U.S. company-fiinded R&D expenditures in all U.S. manufacturing industries (Figure 9-2). Most of the growth in affiliates' R&D spending during the 1985-94 period was by Japanese- and Swiss- owned affiliates, followed by UK-owned, German-owned, and French-owned affiliates. The U.S. affiliates' share of R&D spending in all high-technology manufacturing industries increased from 13 percent in 1987 to 22 percent in 1994. In some high-technology industries, affiliates' R&D spending represents a relatively large share of total U.S. company-flinded R&D spending, but the share size and their growth vary widely among industries. The most dramatic share increases occurred in drugs , audio, video, and communications equipment , and computers and office equipment . • In the drugs industry, affiliates' share of total R&D spending grew from 27 percent in 1987 to 47 percent in 1994. • The share of R&D spending in the audio, video, and communications equipment ffercent 20 Figure 9-2 U.S. Affiliates' Share of All Company R&D Performed in US Manufacturing Industries 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 Sources; Bureau of Economic Analysis and the National Science Foundation. industry almost tripled between 1987 and 1994, from 10.7 percent to 27 percent. Affiliates in the computer and office equipment industry tripled their share of R&D spending from 4.5 percent in 1987 to 15 percent in 1994. In the industrial chemicals and synthetic materials industry, affiliates accounted for a very large but declining share of total R&D expenditures — 54 percent in 1987 and 42 percent in 1994. In the electronic components industry, affiliates' share remained relatively stable between 1987 and 1994, at 10.6 percent and 1 1 percent, respectively. In each of the other high-technology industries, U.S. affiliates' share of R&D spending in 1994 was relatively small (less than 10 percent). Comparison of R&D intensities of foreign- owned and US-owned firms US-owned and foreign-owned manufacturing firms do not differ significantly in terms of proportion of resources they devote to R&D, in terms of the ratio of R&D spending to sales 136 (R&D-intensity ratio)/^ Changes in R&D intensities hinge on the growth of R&D spending relative to growth of sales. • US-owned firms in all manufacturing industries had a 2.4 percent R&D-intensity ratio in 1987 and 2.9 percent 1994, and U.S. affiliates in manufacturing had a 2.9 percent R&D-intensity ratio in 1987 and 3.0 percent in 1994. • For firms in high-technology manufacturing industries, the R&D-intensity ratios appear to be converging ~ the ratio for U.S. affiliates slowly rose from 5 percent in 1987 to 5.3 percent in 1994, while that for US- owned firms slowly fell from 7.3 percent in 1987 to 6.1 percent in 1994 (Figure 9-3). Figure 9-3 Ratio of R&D to Sales in High-Technology Manufacturing Industries, US Affiliates & US-owned Firms, 1987-94 US-owned Firms 1987 88 89 90 91 92 93 94 Source Bureau of Economic Analysis. Bureau of the Census, and National Science Foundabon The R&D intensity ratios in non-high- technology manufacturing industries gradually increased for both sets of firms — for U.S. affiliates, rising from 1 .4 percent to 1.8 percent between 1987 and 1994, and for US-owned firms, rising from 1.3 percent to 2. 1 percent (Figure 9-4). 12, Comparable ratios for firms in other industries are not available; as data on R&D spending in these other industries are not collected. Figure 9-4 Ratio of R&D to Sales in Non-High-Technology Manufacturing Industries, US Affiliates & US-owned Firms, 1987-94 1987 88 89 90 91 92 93 94 Source Bureau of Economic Analysis, Bureau of the Census, and National Science Foundation During 1987-94, in individual high- technology manufacturing industries, the difference in R&D-intensity ratios varied widely between US-owned firms and US affiliates. During most of this period, the R&D intensity of the affiliates in each of these industries was less than that of US-owned firms. • In industrial chemicals . R&D-intensities moved in opposite directions between 1987 and 1994 — dropping for U.S. affiliates and rising for US-owned firms (Figure 9-5A). This shift reflects two diverging trends: for U.S. affiliates, sales grew more than five times faster annually than R&D spending, and for US-owned firms, the annual growth in sales was less than half the rate of growth of R&D expenditures. • Medicine and drug firms had the highest R&D intensity of all high-technology industries (Figure 9-5B) In this industry, US-owned firms increased R&D spending more rapidly than sales, resuhing in a steadily rising ratio of R&D to sales. In contrast, U.S. affiliates showed little change in R&D intensity from 1987 (9.6 percent) to 1994 (10.0 percent). • In computers and office equipment , US- owned firms had a much higher average R&D intensity than U.S. affiliates until 1993. However, the data on R&D spending for all 137 Figure 9-5A Ratio of R&D to Sales for U.S. Affiliates and US-Owned Firms: in Industrial chemicals 1987-1994 Percent 10 U.S. Owned US. Affiliates \ 1 ■■-■•■ 1 ■■"■■.. 1 ■>■>. 1 III r 87 92 93 Soixces: Bureau of Economic Analysis, Bureau of the Census, and National Science Foundation. figure 9-5C Ratio of R&D to Sales for US AfTiliates and US-Owned Firms in Computer & Office Equip. 1 987-94* 87 88 89 90 91 92 93 9.4 * Change m 1992-93 raUo for US-owned firms reflects, among other factors, major classificalion change See text SoLTces; Bureau of Economic Analysis, BtreaLfn of the Census, and the National Science Foundatioa Figure 9-5B Ratio of R&D to Sales for U.S. Affiliates & US-Owned Firms in Drugs & Medicines, 1987-94 Percent 20 US. Affiliates Sources; Bureau of Eccjnomic Analysis, Bureau of the Census, and the National Science Foundation, Rgure 9-5D Ratio of R&D to Sales for US Affiliates and US-Owned Firms in Audio, Video, & Comm. equip., 1987-94 Percent 20 Sources; Bureau of Economic Analysis, Bureau of the Census, and National Science Foundation. 20 U.S. firms show a major break in the series because of reclassification of firms by NSF from computer hardware to software producers (Figure 9-5C).'^ In the household audio, video, and communications equipment industry, U.S. affiliates' R&D intensity rose steadily from 4.4 percent in 1987 to 6.7 percent in 1994, while that of US-owned firms fell, as they reduced the level of their R&D spending over the period (Figure 9-5D). 13t In this industry, firms were reclassified in the 1 992 NSF survey because many firms had shifted fi"om computer hardware production (manufacturing) to computer software production (services). US affiliates in electronics components experienced rapid growth in sales (14.5 percent a year) between 1987 and 1994, while reducing the level of R&D spending over this period; thus, their R&D-intensity ratio declined steadily (Figure 9-5E). US- owned firms had a relatively stable R&D to sales ratio. In instruments and related products , the R&D intensity of US-owned firms rose steadily over the 1987-1994 period, and throughout this period, was almost double that of U.S. affiUates, which maintained a relatively stable ratio (Figure 9-5F). In other transport equipment , the R&D intensities for both sets of firms were almost 138 Figure 9-5 E Ratio of R&D to Sales for US Affiliates and US-Owned Firms in Electronic Components, 1987-94 Percent Sources; Bureau of Economic Analysis, Bureau of rhe Census, and National Science Foundation. Figure 9-SG Ratio of R&D to Sales for US Affiliates and US-Owned Firms in Other Transportation Equipment, 1987-94 Percent - 1 1 ..••* 1 U.S. Affiliates T 1 U.S. Owned .--■ 1 - 87 89 90 92 93 94 Sources: Bureau of Economic Analysis, Bureau of the Census, and Naitonal Science Foundation. Figure 9-5F Ratio of R&D to Sales for US Affiliates and US-Owned Firms in Instruments & Related Products, 1987-94 Percent U.S. Owned Sources: Bureau of Economic Analysis, Bureau of the Census, and National Science Foundation equal at around 4 percent throughout the period (Figure 9-5G). The extent that these changes in R&D- intensity ratios, or the ratios of R&D to sales, are due to changes in the activities of existing U.S. affiliates versus changes in ownership (i.e., shifts from domestic to foreign ownership and vice versa) cannot be determined. R&D facilities Besides R&D spending, another way of gauging how U.S. affiliates could contribute to, or gain access to, U.S. technological capability is through looking at data on acquisition or establishment of R&D facilities in the United States. Acquiring a U.S. firm and its R&D facilities gives foreign parents access to U.S. R&D results, which can be transferred abroad, much as US-owned firms can sell or otherwise transfer technology to firms located abroad. Claims are sometimes made that access to U.S. technology through acquisition of U.S. firms is a major method by which foreign firms acquire U.S. high- technology. However, the magnitude and extent of this kind of transfer are hard to verify empirically. Moreover, case studies of a number of publicized foreign acquisitions indicate that a U.S. firm is acquired more often than not because it lacks capital, and/or lacks a willing U.S. buyer, rather than because a foreign firm paid a premium just to acquire its technology. It is difficult to substantiate the assertion that foreign firms buy small U.S. high-technology firms to "strip" U.S. technologies. ''^ The effects of U.S. affiliates' ownership of R&D facilities on overall U.S. technology capability depends on several key factors. The possible effects include: ^^ 14> National Academy of Engineering, Foreign Participation in U.S. Research and Development: Asset or Liability? (Washington, D.C.: National Academy Press, 1996), pp. 69-70. 15f See John H. Dunning, "Multinational enterprises and the globalization of innovative capacity," Research 139 • Imported and US-made products better tailored for local U.S. market needs; i.e., adapt, improve, and/or test products and/or processes needed to meet local market conditions and standards; • A presence maintained near major US. innovating centers, that is, to provide the foreign parent with access to results from nearby U.S. research centers of universities, corporate laboratories, or other research institutions, as well as access to U.S. scientists and engineers. • Rationalization of the domestic and international research activities of the foreign firm, in order to take advantage of economies of scale and scope. These efforts to rationalize stem from global competitive pressures, the growth of large technically advanced national and regional markets, increasing R&D costs, and shortening of product-life cycles. They have led to a rapid increase in cross-border alliances between U.S. and foreign firms (especially since the late 1970s),^' • Improved access to required inputs that are available only in the United States, for example, as in the case of mining (materials research). Studies indicate that R&D facilities of U.S. affiliates have tended to focus primarily on the immediate technical needs of their own production, including design work, incremental. Policy, V. 23 (1994), pp. 67-88. National Academy of Engineering, National Interests in an Age of Global Technology (Washington, D.C.: National Academy Press, 1991), pp. 26-29; National Academy of Hngmeermg, Foreign Participation in U.S. Research and Development: Asset or Liability? (Washington, D.C.: National Academy Press, 1996), pp. 19-22. See also. National Research Council, US-Japan Strategic Alliances in the Semiconductor Industry (Washington, D.C.: National Academy Press, 1992), and US-Japan Technology Linkages in Biotechnology (Washington, D.C.; National Academy Press, 1992). process-oriented applied R&D, and R&D needed to meet U.S. technical standards or regulations.'^ In a recent survey of foreign-owned R&D laboratories in the United States, respondents listed among the most important activities of the laboratories: developing new product ideas; obtaining information on developments in U.S. science and technology, gaining access to high- quality scientists, engineers, and designers; and customizing products for the U.S. market. The rank ordering of importance of these factors differs among industries and among U.S. affiliates in each industry. For example, technology-driven activities are important to industries, such as biotechnology and computer software, while market-driven activities are important to manufacturers of consumer products, such as autos 18 Moreover, the purpose of having U.S. affiliates with R&D facilities in the United States may change over time. For instance, R&D activities of Japanese-owned auto firms have shifted from mainly meeting environmental regulations and gaining U.S. auto design capability to other purposes that include research in new materials and electric vehicles. Electronics companies have been locating their R&D laboratories near customers, close to U.S. research universities, and in areas with large numbers of scientists and engineers, such as in Silicon Valley or the Research Triangle in North Carolina.'"' European firms — particularly German Ibid, National Academy of Engineering, 1996, p. 64. 1 8 Richard Florida, "Foreign Direct Investment in Research and Development: Scope, Performance, and Activities of Foreign- AJfiliated R&D Laboratories in the United States," Center for Science and International Affairs, John F. Kennedy School of Government, Harvard University, draft, January 1996. '^See Donald Dalton and Manuel Serapio, Jr., "Foreign Research Centers in the U.S. and U.S. R&D Abroad," U.S. Department of Commerce, Technology Administration, Japan Technology Program, (Washington, D.C.), draft, June 1995. 140 Table 9-7 Foreign -Affiliated R&D Laboratories in the United States R&D Spending and Employment by Country of Ownership, 1994 Country Europe, total . . . Germany France United Kingdom Switzerland . . . . Netherlands . . . . Sweden Asia, total Japan Korea Other, total Canada R&D Spend ng R&D Spending Number (^millions of $) Employment per employee 100 $3,250 33,618 $96,531 31 699 1 2,4 II 63,241 23 702 9,913 111,113 18 1.030 4,846 114,520 13 656 3,834 1 30,049 7 93 997 122,231 3 26 362 93,827 84 772 17,279 104,835 81 737 1 6,80 1 110,465 3 35 478 95,555 2 70 1,498 140,000 2 70 1,498 140,000 Source: Richard Florida, Survey of Foreign -Affiliated R&D Laboratories in the United States (Center for Economic Development, Carnegie Mellon University, 1995). firms ~ moved their biotechnology research to the United States because of public opposition and an unfavorable regulatory environment for biotechnology research and manufacturing in Europe.^" An estimated 75 percent of German investment in biotechnology is overseas, mostly in the United States. German government regulations on biotechnology research became less restrictive in January 1995, and now compare favorably with other European countries; but they remain more restrictive than in the United States and Japan. ^' The number and size of R&D facilities of U.S. affiliates differ significantly by country of 20 Emily Arakaki, "Trends in Foreign Direct Investment in U.S. Biotechnology," m Foreign Direct Investment in the United States, U.S. Department of Commerce, Economics and Statistics Administration, August 1 99 L 21 Susan Redelstorff, "Biotechnology in Germany," Market Research Reports, U.S. Department of Commerce, International Trade Administration, September 13, 1995; Ernst and Young, European Biotech '96, March 1 996, Ernst and Young, European Biotech '95, March 1995. foreign parent. A recent survey shows that among them Japanese-owned companies have the largest number of R&D facilities, but have spent less on R&D on a per employee basis than firms owned by several other countries (Table 9-7). Canadian- owned firms had the highest expenditures per employee, followed by Swiss-owned and Dutch- owned firms. ^^ Technology Transfer between U.S. Affiliates and Their Foreign Parents Technological innovations and knowledge generated by one firm's research often flow to other firms in and outside its own industry. The available data do not, however, provide a direct means to determine the extent to which foreign acquisitions of high-technology U.S. firms have resulted in technology transfer abroad. There is anecdotal evidence that U.S. affiliates of foreign 22 Op. cit., Florida, pp. 8-10, Table 6. 141 firms provide benefits to other U.S. firms and the U.S. economy in general in the fiarm of technology spillovers from the U.S. affiliates' R&D facilities to US-owned facilities, and that these spillovers are sizeable. The magnitude of license fees also suggests that these spillovers could be large. However, the magnitudes and the channels of transmission of the effects of these spillovers are not clear. As foreign direct investment in the United States increases, the impact of foreign firms on the U.S. economy can be expected to rise. Thus, the need for better understanding of technology spillovers is increasingly important. A contribution can be made by refining and extending the various models and techniques that have been developed to estimate the technology spillover effects of foreign-owned companies. A few researchers have attempted to assess the extent and magnitude of technology spillovers from multinational corporations. Using different methodologies, they have found positive spillovers from multinationals to their affiliates." The impact of technology transfer appears to be larger for newly established affiliates.^'* Additional research work could contribute to understanding the extent and impact of technology spillovers, not only from R&D performed by U.S. affiliates but also from R&D performed by their foreign parents. The principal means for transferring technology is through the international sale of technology. These sales are usually measured in terms of a proxy variable, such as payments and receipts of royalties and license fees between See Edwin Mansfield, "R&D and Innovation: Some Empirical Findings," in R&D, Patents and Productivity, Z. Griliches, editor (Chicago: University of Chicago Press, 1984), pp. 127-148; M. Ishaq Nadiri, "Innovations and Technological Spillovers," NBER Working Paper No. 4423 (Cambridge: National Bureau of Economic Research, August 1993). Gunnar Fors, R&D and Technology Transfer by Multinational Enterprises (Stockholm, Sweden; Industrial Institute for Economic and Social Research, 1996). companies. Royalties and license fees are payments for the sale and use of intangible property rights, such as patents, industrial processes, trademarks, copyrights, franchises, know-how, and other intellectual property rights. Use of this measure, however, has problems. Some observers believe that U.S. and foreign multinational corporations also often use these fees to shift costs from their affiliates in a low-tax to a high-tax country to minimize tax obligations. To the extent that these fees reflect such transfer pricing, this measure misstates technology transfer (payments and receipts) between foreign parents and their U.S. affiliates. The data on royalty and license fees suggest that there has been an overwhelmingly large net inflow of technology to U.S. affiliates from their foreign parents rather than a net outflow. Net payments by U.S. affiliates to their foreign parents have increased from $378 million in 1980 to $3,279 bilUon in 1995 (Table 9-8). Although receipts by 1995 were one-third as large as payments, over the 1980-95 period they rose much more rapidly than payments. A ratio that can be used to examine affiliate- parent technology flows is the ratio of (1) affiliates' receipts from royalties and license fees from their parents to (2) the affiliates' R&D spending. This ratio tripled between 1980 and Ideally, royalties for payments for copyrights to books, musical recordings, trademarks, and franchises are not for technical know-how of industrial processes, and therefore, should be deducted from the sum of royalty and licensing fees. However, the data are not available separately for affiliated parties. Patent licensing fees represent about 70 percent of total royalties and license fees paid between unaifiliated parties, and thus, the values discussed in this section are overstated to the extent that they include royalty payments not related to technology transactions. Moreover, how well patents measure outputs of technology and how well licenses measure payments for this know-how is problematic. These issues are extensively discussed in the literature on the economics of R&D and technical change. For a discussion on the limitations of these data, see Mary Ellen Mogee, "Toward International Licensing by US-based Firms: Trends and Implications," Technology Transfer, Spring 1 99 1 , pp. 1 4- 1 9. 142 Table 9-8 US Affiliates' Royalties and License Fees Payments to, and Receipts from, Their Foreign Parents : (millions of dollars) Table 9-9 Ratio of US Affiliates' Receipts of Royalties and Fees from Their Foreign Parents to the Affiliates' Total R&D Spending Net Ratio of Payments Receipts Payments Total R&D spending receipts from technology to 1980 ... 426 48 378 (million $) R&D spending 1981 ... 487 74 413 1982 ... 394 69 325 1980 2, 1 69 2.21 1983 ... 465 60 405 1981 3,110 2.38 1984 ... 665 68 597 1982 3,744 1.84 1985 ... 568 102 466 1983 4, 1 64 1.44 1986. .. 799 180 619 1984 4,738 1.44 1987 ... 1,083 150 933 1985 5,240 1.95 1988 ... 1,244 122 1,122 1986 5.804 3.10 1989 ... 1.632 349 1,283 1987 6.521 2.30 1990 ... 1.967 383 1,584 1988 7.834 1.56 1991 ... 2.830 576 2,254 1989 9,465 3.69 1992 ... 3.191 793 2,398 1990 11,522 3.32 1 993 . . . 3,130 771 2,359 1991 1 1 .872 4.85 1 994 . . . 3.562 998 2,564 1992 13.695 5.79 1995. .. 4,718 1,439 3,279 1993 1994 14,199 15,602 5.43 6.40 Notes: R eceipts and Paym ents are before deduction of withholding tax. Source: Bureau of Economic Analysis. Notes: Receipts are before deduction of withholding tax. Source: Bureau of Economic Analysis. 1995 ~ reaching 6.4 percent in 1995 (Table 9-9). That increase suggests that U.S. affiliates are increasingly selling more technology to their parent firms relative to their total spending to develop or create technology. Stated simply, the payback from their R&D spending in the United States is increasing in terms of technology sales to their parents. U.S. high-technology affiliates represent a rising share of the total royalties and license fees transactions between all affiliates and their parents. Payments by U.S. high-technology affiliates in 1995 account for more than one-half of the total payments to foreign parents by all U.S. affiliates in the manufacturing and services sectors, up from less than 40 percent in 1983. Similarly, receipts of high-technology affiliates from their foreign parents in 1995 are about one- fourth of the total receipts by all U.S. affiliates, up from 11 percent in 1983 (Table 9-10). British, German, and Japanese parent firms account for almost 60 percent of total royalties and license fee payments by U.S. affiliates in high-technology industries, with the United Kingdom leading the group in 1994. Much of the attention on the issue of technology transfer has focused on Japanese- owned firms because of Japan's history of ready adoption of, and dependence on, foreign technology, and because of the high profile given by the media to the rapid growth in Japanese acquisition of U.S. firms in the last half of the 1980s. The data indicate that on average, Japanese-owned affiliates appear to buy more technology from their parents than they sell to their parents, compared to affiliates with parents in other countries, but there are wide differences across industries by country of parent: • Net payments (payments minus receipts) by Japanese-owned affiliates ($784 million) in 143 Table 9-10 Royalties and License Fees: Payments to and Receipts from Foreign Parents by U.S. Affiliates in Manufacturing and Services Industries and in High-Technology Industries, 1983-1995 (millions of dollars) Manufacturing Of which high-technology Services Of which high-technology Manufacturing Of which high-technology Services Of which high-technology 1983 1987 Payments Receipts Payments Receipts 234 98 14 33 4* 2 755 371 41 3* 94 II* 3* 1991 1995 Payments Receipts Payments Receipts 1771 921 104 10* 200 2921 101 1696 102 250 6* 75 550 157 177 37 *Number understated because it excludes industry data that have been suppressed to maintain confidentiality of company information. Source: Bureau of Economic Analysis unpublished data. ail industries in 1995, were almost double those by German affiliates ($389 million) or Swiss affiliates ($349 million), but were two- thirds that of U.K. affiliates ($1, 170 million). • For high-technology manufacturing affiliates, net payments varied widely: in 1995, for Japanese affiliates, they were $36 million; f3r German affiliates, $99 million; and for Swiss affiliates, $164 million. In 1994, net payments were for Japanese affiliates, $78 million; for British affiliates, $6 million, for German affiliates, $192 million; and for Swiss affiliates, $136 million. In addition, the extent and direction of the affiliates' technology transfers vary among U.S. industries. In industries such as steel and autos, in which advanced process technology is important, affiliates of Japanese firms have brought advanced technology into the United States. ^^ With respect to technologies, such as in computer software and biotechnology in which Japan lags, some studies suggest significant technology may have been transferred from the United States to Japan through affiliates as well as by other types of strategic alliances." One study of Japanese investments into the United States shows that Japanese firms tend to establish more new plants in R&D-intensive industries than in other ^^Richard Florida and Martin Kenney, "Restructuring in Place: Japanese Investment, Production, Organization, and the Geography of Steel," Economic Geography. Also see Martin Kenney and Richard Florida, "The Japanese Transplants: Production, Organization, and Regional Development," Journal of the American Planning Association, Vol. 58, No. 1, Winter 1992. See National Research Council, Office of Japan Affairs, US-Japan Technology Linkages in Biotechnology; US-Japan Strategic Alliances in the Semiconductor Industry (Washington, D.C.: National Academy Press, 1992). 144 industries, but that joint ventures appear preferred if U.S. technology is sought. ^^ The data on royalties and license fees provide no information on the importance of the particular technologies that are transferred; e.g., whether or not the technology is "key" or "critical." Future Research A number of key issues remain to be answered on the relation between FDI and technology development. Research on these issues has been hampered in part by data limitations. These limitations, and therefore the need for fiarther research, include: foreign firm is motivated to acquire the U.S. firm and its technology. ^^ In addition, questions about differences in Japanese company strategies versus European or Canadian firms' strategies to access U.S. technology similarly remain unaddressed. And, finally, additional research is needed to estimate the impact of FDIUS on U.S. technological capability in terms of the technology spillover effects between foreign-owned and US-owned firms. Lack of separate data on output, employment, R&D spending, and other performance measures for acquisitions of existing high-technology affiliates versus newly created establishments. The role of U.S. affiliates in high-technology niche markets (i.e., 4-digit SIC versus 3-digit SIC categories) is lacking. Existing data cannot be used to identify corporate linkages, and thus, the extent that differences in technology performance is fostered by corporate linkages (e.g., keiretsu relationships) among foreign firms and their affiliates cannot be determined. Because of minimum reporting requirements, very small firms do not report details on R&D spending and other operations data. As a result, there is no way to determine motivations for acquiring these small firms. However, some observers have concluded that the size of the affiliate, at least in the electronics industry, indicates why the 28t Bruce Kogut and Sea Jin Chang, "Technological Capabilities and Japanese Foreign Direct Investment in the United States," The Review of Economics and Statistics, Vol. 73, No. 3 (August 1991), pp. 401-413. 29r For one point of view, see Phyllis A. Genther and Donald Dalton, Japanese -Affiliated Electronics Companies: Implications for U.S. Technology Development (Economics and Statistics Administration and Technology Administration, U.S. Department of Commerce, NTIS, March 1991). 145 APPENDIX Glossary of Foreign Direct Investment Te rm s Following are important terms describing foreign direct investment and the operation of foreign- owned affiliates in the United States as used in this report and by the U.S. Department of Commerce, Bureau of Economic Analy- sis (BE A). Benchmark Year The year for which BEA conducts a benchmark survey, or census, of foreign direct investment in the United States. Benchmark surveys are normally taken once every five years, timed to coincide with the eco- nomic censuses conducted by the Census Bureau (years ending with 2 or 7). They are BEA's most comprehen- sive surveys of FDI, both in teniis of the amount of detail collected and number of firms covered. They are designed to cover the universe of U.S. affiliates in value terms . For example, in the 1992 benchmark survey, all U.S. affiliates of foreign persons were required to report operating, financial, balance of payments, and direct investment position data if the affiliate's total assets, sales, or net income were at least $1 million. Although the affiliates required to report account for only 70 percent of the total number of affiliates in the universe, they accounted for virtually all of the universe in terms of value. BEA's quarterly and annual direct investment surveys are less comprehensive and cover only a sample of companies. Reporting in the annual survey is limited to affiliates with more than $10 million in total assets, sales, or net income (positive or negative), and fewer operating and financial details are required. Reporting in the quarterly survey is limited to affiliates with more than $20 million in assets, sales, or net income. Data from the sample surveys are linked to data from the most recent benchmark survey and, for most items, are ex- panded to universe levels. Enterprise and Establishment The data reported to BEA by U.S. affiliates are for the fully consolidated affiliate enterprise. In many instances, an affiliate will comprise two or more estab- lishments or plants. Data reported to some other agencies on the operations of U.S. companies may be for the operations of individual establishments within the enterprise. For years beginning with 1987, BEA and the Cen- sus Bureau have obtained establishment data for U.S. affiliates by linking BEA company-, or enterprise-, level data on foreign direct investment with the Census Bu- reau plant-, or establishment-, level data for all U.S. companies. BEA's data have also been linked with Bureau of Labor Statistics (BLS) plant-, or establish- ment-, level data for all companies for years beginning with 1989. BEA's enterprise data are needed for analyzing the overall significance of, and trends in, direct investment and for compiling the U.S. international transactions accounts, the international investment position of the United States, and the U.S. national income and product accounts. The establishment data are needed for analyz- ing the activities and importance of U.S. affiliates in specific industries. BLS has discontinued its link project with BEA due to lack of funding. BEA and the Census Bureau have completed the linking of data from BEA's 1992 economic census data for all U.S. establishments and the results were published in May 1997. Iffundingisnot forthcoming, the BEA-Census link project will be con- ducted only every 5 years thereafter (that is, only in benchmark or economic census years). Foreign Direct Investment in the United States (FDIUS) Foreign investment in an enterprise in the United States is classified as foreign direct investment when ownership or control, directly or indirectly, by a foreign person amounts to 10 percent or more of the voting securities of an incorporated U.S. business enterprise, or an equivalent interest in an unincorporated U.S. business enterprise. Such an enterprise is referred to as a foreign- owned U.S. affiliate. The flows of FDI during a given period are re- corded in the U.S. balance-of-payments capital ac- count, and the accumulated stock of FDI is recorded in 146 the U.S. international investment position at the end of a given period. FDI capital flows cover investment in both new and existing U.S. affiliates by their foreign parents and other members of their foreign parent groups (see definition below). — —■ Like other items in the balance of payments, direct investment capital flows may not always reflect actual flows of funds across national borders. For example, foreign parents' shares of the affiliates' reinvested earn- ings are included as a direct investment capital inflow, with an offsetting amount recorded as an income pay- ment (outflow)in the current account, even though the funds never actually crossed national borders. FDI positions are generally smaller than the total assets of U.S. affiliates, because they only cover posi- tions held by foreign parents and other members of the foreign parent group, rather than the total assets held by all investors in the affiliate, includingU.S. residents. For example, unlike the FDI position in an affiliate, which equals the sum of the foreign parent group's equity in, and net outstanding loans to, its U.S. affiliate, the U.S. affiliate's total assets are equal to the sum of ( 1 ) total owners' equity in the affiliate held both by members of the foreign parent group and by all other U.S. persons, and (2) total liabilities owed by the affiliate both to members of the foreign parent group and to all U.S. persons. Outlays for new foreign direct investments in the United States consist of outlays to acquire or establish U.S. affiliates, regardless of whether the invested funds are raised in the United States or abroad. If the funds are raised in the United States, no capital inflow occurs. If the funds are raised abroad by a member of the foreign parent group and used to finance the U.S. acquisition or establishment of an affiliate , a direct investment capital inflow occurs. Foreign-Owned Affiliate in the U.S. A business in the United States in which there is sufficient foreign investment to be classified as direct foreign investment. To determine fully the foreign owners of a U.S. affiliate, three entities must be identi- fied: the foreign parent, the ultimate beneficial owner, and the foreign parent group. All of these entities are "persons" in the broad sense: thus, they may be individu- als; business enterprises; governments; religious, chari- table, and other nonprofit organizations; estates and trusts; and associated groups. A U.S. affiliate may have an ultimate beneficial owner (UBO) that is not the immediate foreign parent; moreover, the affiliate may have multiple ownership chains above it, if it is owned at least 1 percent by more than one foreign person. In such cases, the affiliate may have more than one foreign parent, UBO, and foreign parent group. Foreign Parent The first foreign person outside the United States in an affiliate's ownership chain that has direct invest- ment in the affiliate. Foreign Parent Group (FPG) In many cases, a U.S. affiliate is only one unit in a global network of corporate affiliations. Thus, a U.S. affiliate may have a foreign parent who, in turn, is owned by a direct investor of a third country or who has affiliates in other countries. The foreign parent group consists of (1) the foreign parent, (2 ) any foreign person, proceeding up the foreign parent's ownership chain, that owns more than 50 per- cent of the person below it, up to and including the UBO, and (3 ) any foreign person, proceeding down the owner- ship chain(s) of each of these members, that is owned more than 50 percent by the person above it. In the U.S. balance of payments, transactions of U.S. affiliates with all members of the FPG, not only transactions with foreign parents, are shown as transactions with "affili- ated" foreigners. Also, equity and debt positions in the affiliate held by all members of the foreign parent group are included in the foreign direct investment position in the United States. The following diagram illustrates relationships and transactions that could occur between a U.S. affiliate and members of the FPG. Company A is a U.S. chemical company owned 50 percent by Company B, a Nether- lands finance affiliate, which is owned 100 percent by Company C, a French manufacturing company. No single investor has more than 50 percent ownership of Company C. Like Company B, Company D, a British company, is owned 1 00 percent by Company C . There- fore, Company A's foreign parent is Company B; Com- pany A's UBO is Company C. Company A's FPG consists of Companies B,C, and D. Company D is in the FPG because, even though it does not have an ownership inno/ UBO Company C (France) inn°A 1 T T Foreign Parent Company B (Netherlands) Member of FPG Company D (United Kingdom) 50% 1 Divid r ] end T US, Affiliate Company A Intercompany loan 147 interest in the U.S. affiliate, it is more than 50 percent owned by Company C, the UBO. If Company A receives a loan from Company D, the transaction would be treated as a direct investment transaction in the balance of payments accounts, be- cause Company D is part of the FPG. The flow would be recorded as an intercompany debt inflow from the United Kingdom. If Company A pays dividends to Company B, the transaction would be recorded as a direct investment income payment between the United States and the Netherlands in the U.S. balance of payments because the dividends are paid directly to the foreign parent (not the UBO). If the Netherlands company (Company B) then passes on the dividend to the French UBO (Company C ), this transaction would not be a U.S. -to- foreign transac- tion; it is a foreign-to-foreign transaction and as such is not recorded in the U.S. balance of payments. (It would, however, be recorded in the balance of payments ac- counts of France and the Netherlands). The direct investment position of both Company B and Company D are equal to the book value of their cumulative debt or equity transactions with Company A over time, and are calculated at yearend. For Company B, the position is equal to its equity (mcluding reinvested earnings) in Company A plus any net outstanding loans by it to Company A. Company D has an investment position with Company A equal to the remaining balance of the loan. The position of Company C in Company A is zero because it has no direct equity interest in Com- pany A and has made no loans to Company A. Industry of Affiliate Data on the operations of U.S. affiliates owned by foreign investors are classified in BE A data both in terms of the "industry of affiliate" and the "industry of sales". Classification of an affiliate by "industry of affili- ate" is based on a three-stage procedure: First, the major industry group accounting for the largest percentage of its sales is determined. The major industry goups are: (a) agriculture, forestry, and fishing, (b) mining, (c) petro- leuin, (d) construction, (e) manufacturing, (f) transporta- tion, communication, and public utilities, (g) wholesale trade, (h) retail trade, (i) finance, insurance, and real estate, and (j) services. Second, within the group the two-digit International Surveys Industry (I SI) in which sales are largest is determined. Third, within the two- digit industry the three-digit ISI industry in which sales are largest is determined. This procedure is designed to avoid assigning an affiliate to a two-digit subindustry that is outside its major industry, or a three-digit subin- dustry outside its two-digit industry. When classified by "industry of sales," affiliate sales and employment data are shown not only for the affiliate's primary industry, but also for its associated secondary industries. This classification method roughly approximates the distribution that would result if the data were reported and classified by industry of estab- lisliment. Nonbank Affiliate An affiliate classified other than as a depository institution (banks, savingss and loan associations, or credit unions) in the ISI coding system. Ultimate Beneficial Owner (UBO) of an Affiliate The "person" proceeding up the U.S. affiliate's ownership chain, begiiming with and including the for- eign parent, that is not owned more than 50 percent by another person. The UBO consists only of the ultimate owner; other affiliated persons are excluded. If the foreign parent is not owned more than 50 percent by another person, the foreign parent and the UBO are the same. The UBO, unlike a foreign parent, may be a U.S. person. 148 "^U.S. GOVERxNKENT PRINTING OFFICE: 1997-432-946/60126