[Economic Report of the President (2007)]
[Administration of George W. Bush]
[Online through the Government Printing Office, www.gpo.gov]

 
CHAPTER 8


International Trade and Investment



The United States derives substantial benefits from open trade and
investment flows. Over many decades, increased trade and investment
liberalization has been an important catalyst for greater productivity
growth and rising average living standards in the United States.
Trade liberalization and globalization remain controversial subjects
because competition invariably raises both anxieties and opportunities.
Reducing obstacles to trade can help economies grow more rapidly in
the long run and create better, higher paying jobs. Increased
competition, however, can lead to hardships for others in the short run.
Constructive policies that help displaced workers train for and find
new work and increase the portability of pension and health benefits
can help to ease adjustment.
The key points in this chapter are:

 Engagement in the global economy through increased trade has
contributed to rising average living standards in the United States.
Firms engaged in international trade are more productive, have higher
employment growth, and are higher wage firms than domestically oriented
firms. Looking ahead, international trade liberalization in services
presents significant opportunities for U.S. workers, firms, and consumers.

 Foreign direct investment (FDI) flows into the United States
benefit the U.S. economy by stimulating growth, creating jobs, and
financing the current account deficit. FDI flows into the United States
also stimulate investment in research and development in high-technology
areas that promote innovation and competitiveness.

 U.S. direct investment abroad is an important channel of
global market access for U.S. firms. U.S. multinational companies have
contributed to productivity growth, job creation, and rising average
living standards in the United States.


Trade Liberalization: A Key Contributor
to the Strength of the U.S. Economy

Increased international trade has raised real incomes, restrained prices,
introduced greater product variety, spurred technological advances and
innovation, and raised living standards in the United States. Studies
have estimated that the annual payoff from U.S. trade and investment




liberalization to date, including from the Kennedy Round, the Tokyo
Round, the Uruguay Round, the North American Free Trade Agreement and
other free-trade agreements, is up to $1.5 trillion. These gains arise
through many channels: higher long-term levels of commerce in goods and
services that come from trade and investment liberalization; increased
product variety; more efficient allocation of resources; and better
transportation and communication technology. Some economists have
conjectured that trade liberalization alone has accounted for about
half of these gains, which implies that the annual income gain from
trade liberalization to date is over $2,500 per capita, or $10,000 for
an average American family of four. Existing studies suggest that U.S.
incomes could rise further by approximately $590 billion per year by
moving all the way to global free trade in goods and services.
International trade in goods and services exposes firms to foreign
competition and reduces their ability to charge high markups above
production costs. International trade also increases the variety of
goods available such as silk sweaters from China, wine from Australia,
and winter blueberries from Chile. Consumers value variety and one
study estimated that the U.S. economic value of increased varieties
through imports over the past three decades is equivalent to $350
billion per year, or 2.8 percent of gross domestic product (GDP).
Engagement in the global economy through increased trade has
contributed to rising average living standards in the United States.
Research shows that firms engaged in the international marketplace
tend to exhibit higher rates of productivity growth and pay higher
wages and benefits to their workers than domestically oriented firms.
Economists agree that the most important determinant of living
standards in a country is the average level of productivity, or output
per worker.
A free and open international trade regime is vital for a stable and
growing economy, both here at home and throughout the world. The United
States will continue to work aggressively toward multilateral trade
liberalization through the World Trade Organization's Doha Development
Agenda negotiations. The prospects for these negotiations to produce
significant benefits for this country and our trading partners,
particularly developing countries, demand that we promptly reach a
balanced and ambitious outcome.

Firms That Engage in International Trade Are Strong Performers

At the microeconomic level, firms engaged in international trade
outperform domestically oriented firms on many dimensions. Research has
shown
that firms engaged in international trade have higher productivity than
their counterparts engaged solely in domestic activity. One study found
that value added per employee, one simple measure of productivity, was
15 percent higher in manufacturing exporting firms than in firms that
did not export (controlling for industry effects, plant size, and
geographic location). And these productivity effects are reflected in
higher wages: the wages paid by manufacturing plants that export are 9
percent higher on average than wages paid by non-exporting plants of
the same size. Wages in service-oriented firms that export are, on
average, 13 percent higher than their purely domestic counterparts of
the same size.
One recent study that examined the dynamics of globally engaged firms
between 1993 and 2000 found that firms engaged in international trade
had a higher survival rate (65 percent) than the average for all firms
in the country (53 percent). In addition, a firm that began to trade
during this time period increased employment by nearly 100 percent on
average, while a firm that quit trading experienced a decline in
employment.
An increasing number of American workers are employed by firms
engaged in international trade. Between 1993 and 2000, firms that
trade increased employment by 9.8 million workers, and the share of the
American workforce employed by a firm engaged in trade increased from
40 percent to approximately 42 percent. Applied to today's workforce,
this result implies that over 57 million American workers are currently
employed by a firm that engages in international trade.

The Effects of Nontariff Barriers on International Trade

While trade can generate many economic benefits, governments at times
set up barriers to international trade. One of the more common and
harmful barriers is a nontariff barrier, a barrier behind the border
that is a policy (other than a tariff or tax) or official practice that
can unfairly inhibit competition. Unjustified nontariff barriers can
distort the prices and quantities of goods and services traded
internationally, restrict international investment, and reduce
economic welfare in exporting and importing countries. As tariffs have
fallen both in the United States and in many other countries, nontariff
barriers have increased in importance and are often cited as more
trade-restricting than tariffs. Nontariff barriers can arise as a result
of government policies aimed explicitly at protecting domestic firms
from international competition, or from rules or laws within a country
that effectively hinder trade (see Box 8-1).


------------------------------------------------------------------------
Box 8-1: Nontariff Barriers Restrict Trade


Unjustified nontariff barriers (NTBs) make it more difficult for
international goods and services to compete freely and fairly with
those produced domestically. Common examples of NTBs are burdensome or
nontransparent product standards or regulations. For example, in
Korea, pharmaceutical imports must be tested on Korean nationals, and
each individual batch produced must undergo testing. In China, the
process of standards certification for telecommunications and IT
products can be burdensome and unpredictable, as two separate Chinese
regulatory agencies each check for conformity to the same set of
standards. Other often-cited NTBs include investment restrictions,
government procurement laws, and lax enforcement of intellectual
property rights.
Measuring the effects of NTBs on trade is more difficult than
assessing the effects of tariffs, but some attempts have been made. A
growing body of evidence consistently shows that the economic welfare
gains from eliminating NTBs are at least as large as those obtained from
further tariff liberalization. One study shows that the U.S. payoff
from eliminating NTBs with just seven of our trading partners
(Australia, Canada, Germany, Italy, Japan, the Netherlands, and Great
Britain) would generate annual income gains of $90 billion for the
United States (0.72 percent of GDP), compared with $37 billion from
tariff liberalization (0.30 percent of GDP). These benefits arise
largely from the pro-competitive effects of increased international
trade and more efficient allocation of resources.
Tariff negotiations are fairly straightforward, and forums such as
the World Trade Organization (WTO) exist for this purpose. Members are
required to report their tariff schedule to the WTO each year, so
members know the tariff rate for each product in every country. However,
countries do not always agree on what constitutes a NTB and there is
no formal, consistent notification process, thereby making negotiations
aimed at addressing such barriers more complicated. Part of the policy
problem is making distinctions as to whether NTBs are warranted for
nontrade reasons (e.g., product safety standards) or whether they are
simply covert barriers to imports (nontransparent licensing requirements
for foreign firms). For instance, customary regulatory and legal
procedures within one country might be seen as complex and overly
burdensome to would-be exporters.
Apart from the challenges of identifying NTBs, policymakers face
difficulties in knowing which NTBs they should seek to dismantle
first. The U.S. Department of Commerce has surveyed its industry and
trade experts and country desk officers in an effort to identify the
most prevalent NTBs faced by U.S. exporters and to identify which
export products are most likely affected. The survey results suggest
that, on average, at least one NTB affects U.S. exporters for each major
product category in which they export to our main trading partners. For
instance, a problematic regulatory environment was cited as a problem
in 43 of the 49 countries covered by the survey, and was cited as the
top problem in 14 of those countries. The industries facing the most
NTBs included entertainment, pharmaceuticals, and information technology.
------------------------------------------------------------------------

International Trade in Services


Liberalizing trade in services is important for economic growth here
and abroad. As an economy grows and matures, services tend to increase
as a share of GDP and as a share of trade. The United States has a
global competitive advantage in services, yet services remain highly
protected abroad.
Services such as financial, insurance, transportation and storage,
telecommunications, express delivery, and business services generate 68
percent of world GDP but account for just under 20 percent of global
trade. While global advances in information and communications
technology are making services increasingly tradable, existing trade
barriers to services are significant. These barriers are currently
subject to negotiation in a host of bilateral, regional, and
multilateral trade talks.

U.S. Competitive Advantage in Services

A large and growing part of the U.S. economy and workforce is employed
in services. In 1800, 9 out of 10 American workers were employed in
agriculture; today that number is less than 1 in 10 (Chart 8-1). In
contrast, nearly 8 in 10 American workers are employed today in the
service sector.
The vast economic benefits from trade liberalization for services stem
in part from our competitive advantage in services. That is, the United
States can produce many services at a lower cost than our trading
partners, and our trading partners can produce some other set of goods
and services at a lower cost than the United States. When we trade our
lower cost services for their lower cost goods, we and our trading
partners gain from trade. Chart 8-2 shows the changing structure of
U.S. trade, which in part mirrors the changing structure of the U.S.
economy. Since the 1970s, the United States has consistently run a
surplus in services trade, with a $66 billion surplus in 2005.









Technological Change Is Fostering International Trade in Services

Services have become increasingly tradable, particularly knowledge-
based or information technology-enabled services that are beyond the
traditional notion of internationally traded services such as
transportation, travel, and tourism. For many of these services, a
physical commercial presence is necessary. For example, a financial
institution is able to offer a host of financial products to
international clients, but the multinational firm must still set up
intermediary branches to serve their clients overseas. Other services
can be delivered with virtually no physical presence. An increasingly
wide range of commercial transactions ranging from stock trades, to
manufacturing orders, to airline reservations, can occur almost
entirely over networked digital media located in many countries around
the world.
Trade in services previously involved high transaction costs between
businesses and customers. Technological innovations and changes in
global technology such as the Internet, information technology (IT)
hardware such as personal computers, and IT networks have greatly
reduced communication and transaction costs for trade in services.
Table 8-1 reports U.S. trade in private services. The largest
subcategories in ``other private services'' trade, which captures many of
the IT-enabled services, include financial and insurance services;
computer, management, and consulting services; and other business,
professional, and technical services.




Trade growth in ``other private services'' has far outpaced growth in
the rest of services. From 1995 to 2005, U.S. exports of ``other private
services'' grew 143 percent, compared with 44 percent growth in all
other services. The bulk of the overall trade surplus in services comes
from the ``other private services'' category, which accounted for 90
percent of the overall U.S. services trade surplus in 2005, up from 38
percent in 1995. In contrast, the surplus in more traditional services
(e.g., travel and transportation) has fallen. The surplus in ``other
private services'' has grown from $30 billion in 1995 to $60 billion in
2005, and the surplus in the rest of services has fallen from $48
billion to $7 billion. Many of these trends are consistent with the
global IT advancements that have fostered international trade in
services over the past decade.

High Barriers Restrict International Trade in Services

Barriers to trade in services are mostly regulatory and investment
restrictions and tend to be higher than trade barriers in merchandise.
For instance, U.S. banks that wish to offer retail banking services
abroad face a host of barriers that limit their ability to compete in
foreign markets. Examples of such barriers might be investment
restrictions that limit the number of bank licenses the country will
issue to a U.S. bank; requirements for U.S. banks to enter the banking
market through a joint venture with a domestic bank; or limits on the
degree of control that a U.S. bank can exercise over its foreign
affiliate. Foreign firms wishing to enter the U.S. airline industry
face ownership restrictions that limit their ability to compete with
domestic firms.
Despite such barriers, services trade is expected to continue to grow.
Research suggests that as countries' incomes grow, their demand for
services and their trade in services will each grow more than one-for-one
with income. U.S. producers are well-positioned to continue to engage in
increased services trade, as many have already incorporated the
technology in their operations to facilitate trade.


Looking Ahead to Larger Gains from Trade Liberalization

Despite decades of trade liberalization, the world economy is still
far from a global marketplace of unfettered trade. Many of the
remaining barriers lie in services, and the prospective gains for the
United States from further trade reform are substantial. While global
tariff liberalization in manufacturing and agriculture could generate
over $16 billion in income for the United States each year, the
prospective gains from services liberalization are immense: an estimated
$575 billion in annual U.S. income (4.3 percent of GDP). Summing up,
this is an additional $591 billion in annual income that will be foregone
in the absence of further trade reform.


The magnitude of the payoff to the United States from services trade
liberalization reflects a number of factors: the U.S. competitive
advantage in many services, the large share of services in the global
economy compared to the relatively small share of services in global
trade, and the high barriers to services trade. These barriers are often
regulatory in nature or involve restrictions on the form of investment,
such as foreign equity restrictions that limit foreign investors'
holdings and control in a company, transfer limitations on capital
flows, and the repatriation of profits. Removing these barriers would
free up capital to move across borders to the location with the highest
rate of return.
Developing countries also stand to benefit greatly from global
liberalization of services trade. The service sector share of GDP
exceeds the manufacturing share in most developing countries. The
increased availability and quality of services enhances the
competitiveness of manufactured goods, agricultural products, and
existing services. For instance, India stands to gain an estimated $12
billion in national income each year (1.7 percent of GDP) from removing
barriers to trade in services, and China stands to gain an estimated
$105 billion (4.0 percent of GDP) each year.

Foreign Direct Investment

International trade in goods and services is an important channel of
international commerce, but it is not the largest channel. For many
U.S. firms, foreign direct investment (FDI) is a more significant path
to accessing foreign markets than are exports.
FDI is investment of foreign assets into domestic structures,
equipment, and organizations (e.g., a manufacturing plant, an R&D
facility, an office or a warehouse), whether in the form of acquisition
or ``greenfield'' establishment. FDI is distinguished from passive
portfolio investment (FDI does not include foreign investment in the
stock market). Only the former can confer managerial or operational
control. The two types of foreign direct investment are inward FDI and
outward FDI. Inward foreign direct investment is generally understood
to imply ownership by a foreign person or corporation of at least a
10-percent stake in a U.S. business enterprise. Similarly, outward
foreign direct investment is ownership by a U.S. person or corporation
of at least a 10-percent stake in a foreign business' operation abroad.
A foreign automaker building or buying a production plant in the United
States is an example of inward FDI, while a U.S. automaker building or
buying a production plant in China is an example of outward FDI.
Before we examine each type of FDI and its importance to the U.S.
economy, it is useful to define some of the terms that are commonly
encountered when discussing FDI. A multinational corporation is a
business enterprise
(i.e., the parent) headquartered in one country that has at least a
10-percent ownership stake in a foreign business enterprise (i.e., the
affiliate) in another country. That 10-percent ownership stake is the
minimum stake used by many statistical agencies around the world,
including those in the United States, for identifying meaningful
managerial influence over the affiliate.
A majority-owned U.S. affiliate is an affiliate of a foreign-owned
company that is located in the United States and has at least 50
percent foreign ownership (we focus on majority-owned U.S. affiliates
here but use the term ``U.S. affiliates''). Similarly, a majority-owned
foreign affiliate is a foreign affiliate with at least 50 percent U.S.
ownership.
U.S. firms are more reliant on FDI for the international delivery of
services than they are for the international delivery of goods. While
services are becoming increasingly tradable, their actual delivery
often requires some physical presence, for example, distribution and
express delivery services. Even with widespread use of ATMs and
electronic banking, financial or retail banking often requires physical
presence in the country in which services are being offered. Based on
data from the Bureau of Economic Analysis for 2004, the ratio of sales
by U.S.-owned services affiliates abroad to total U.S. services exports
was 5.5, compared to 2.5 for goods. That is, U.S. firms deliver over
five times the value of services through their foreign affiliates as
they do through cross-border trade. Similarly, U.S. firms deliver 2.5
times the value of goods through their foreign affiliates as they do
through cross-border trade.

Contributions of Inward FDI to the U.S. Economy

The United States receives inward FDI from firms and individuals
located in countries from all over the world. Countries with the largest
FDI positions in the United States include Great Britain, Japan,
Germany, and Canada. These funds support firms across the U.S. economic
landscape, from food, mining, and manufacturing firms to service
sectors such as finance, telecommunications, and wholesale and retail
trade. Every state in the United States is a recipient of foreign
direct investment.

Presence of U.S. Affiliates

Decades of trade and investment liberalization both here and abroad
have encouraged the growth of multinationals and global supply chains.
Today, U.S. affiliates of foreign multinationals account for an
important part of the U.S. economy. In 2004, the latest year for which
data are available, U.S. affiliates owned $5.5 trillion in assets and
had $2.3 trillion in sales. They produced $515 billion of goods and
services inside the United States and accounted for 5.7 percent of
total U.S. private output-up from 3.8 percent in 1988. U.S. affiliates
employed 5.1 million workers or 4.7 percent of the
U.S. workforce in 2004--up from 3.6 percent in 1988. While historical
data show upward trends in the presence of U.S. affiliates, since 2000
U.S. affiliate investment, output, and employment have leveled off or
decreased slightly.

Microeconomic Benefits to the U.S. Economy

Inward FDI provides a number of benefits to the U.S. economy at the
microeconomic level. Research has shown that multinationals are more
productive than firms focused primarily on domestic markets. The
relatively high productivity of U.S. affiliates of foreign-owned firms
is attributable, in part, to their relatively high levels of investment
in physical capital, R&D, and exporting and importing. Specifically,
while U.S. affiliates account for 5.7 percent of output and 4.7 percent
of employment, they account for a disproportionately high share of
U.S. exports (19 percent), imports (26 percent), physical capital
expenditures (10 percent), and R&D expenditures (13 percent) (see
Chart 8-3). Studies show that all of these activities are correlated
with strong productivity performance. (Chapter 2 discusses productivity
growth and long-run effects on the standard of living.)





At the firm level, U.S. affiliates pay higher compensation (wages and
benefits) on average than their counterparts in the rest of the U.S.
economy. In 2004, an average U.S. worker employed by a U.S. affiliate
of a foreign-owned firm received $63,400 in annual compensation compared
to $48,200 for workers in the rest of the economy. Research suggests
that this difference is largely attributable to above-average labor
productivity at U.S. affiliates. Part of this productivity advantage
reflects these firms' ability to integrate production processes across
borders and their organizational efficiency. Another part reflects
differences in plant size, capital intensity (that is, higher use of
capital relative to other factors, such as labor, in the production
process), and employee skill level. The data also suggest that these
firms have higher levels of efficiency (how well labor and capital
inputs are used), the gains of which are passed on, in part, to workers.
In other words, firms can break up their production process across
borders to lower average costs and realize increased productivity and
revenues, which can be shared with workers through higher compensation
and/or captured by firm owners as higher profits (see Box 8-2).

Macroeconomic Benefits to the U.S. Economy

Inward FDI provides a number of benefits to the U.S. economy at the
macroeconomic level. For instance, inward FDI is an additional source
of investment that helps to modernize the U.S. capital stock. Another
benefit is that it provides a source of financing for the U.S. current
account deficit, which measures net flows of goods and services between
the United States and the rest of the world. As the United States
continues to run a current account deficit, foreigners continue to
accumulate U.S. assets, and inward FDI is one of the main ways in which
they do so.
The accumulation of FDI flows over a period of time results in a stock
of assets, or the gross foreign investment position. In 2005, the inward
FDI position at market value totaled $2.8 trillion and was the largest
component of foreign holdings of U.S. assets. Other components were
U.S. Treasury securities ($2 trillion); corporate stocks ($2.1
trillion); and corporate and other private bonds, excluding official
holdings ($2.3 trillion) (see Chart 8-4).
The share of foreign holdings is not concentrated in any particular
class of assets, which implies a general broad-based confidence in the
U.S. economy. Inward FDI is generally considered to be the most stable
among the four types of assets shown in Chart 8-4--that is, the least
subject to sudden withdrawal. FDI flows are generated by long-term
risk-return considerations and are far less liquid and less reversible
than portfolio investments. Therefore, FDI flows provide stability to
U.S. capital flows because they are not easily reversed for short-term
considerations.



------------------------------------------------------------------------
Box 8-2: Multinationals Bring New Products and Processes to the Host
Country

The benefits to the U.S. economy from inward FDI mirror those of many
other countries. A growing body of evidence across countries and
industries demonstrates that globally engaged firms tend to be strong
performers--such firms are more productive, pay higher wages, and
generate beneficial productivity side effects that accrue to domestic
competitors. The three case studies that follow provide a snapshot of
the benefits of inward FDI.

Increasing Living Standards in the United States
Infineon Technologies of Munich, Germany, built a state-of-the-art
manufacturing plant in Richmond, Virginia, using leading-edge
technology to produce dynamic random access memory products that are
used in computers. The Richmond company's annual payroll exceeds $100
million, with average wages that are nearly double average Virginia
salaries. Over 3,000 North American workers are employed by this
German-headquartered multinational, with over 1,750 workers in Richmond
alone. The firm has built extensive ties with its customers and
suppliers worldwide, and many advanced technology suppliers have
emerged in Virginia to support Infineon and other semiconductor
firms. Semiconductors are now Virginia's second largest export.
Enhancing Productivity for Mexican Producers and Retailers
One case study documents impressive efficiency gains for Mexico's
domestic soap producers once Wal-Mart entered its retail sector.
Wal-Mart helped improve Mexico's retail sector by improving the way
Mexican retailers interacted with their suppliers. These changes
brought about efficiency improvements such as modernization of
warehousing, distribution, and inventory management; triggered greater
use of information technology in supply management; and required
delivery trucks to have appointments and drivers to carry standard
identification cards. These innovations have been adopted by other
retailers and producers outside of Mexico's soap industry. Mexican
soap producers improved their productivity and have gained market share
in key export markets, including in the United States.


Improving Banking and Telecommunication Services for Czech
Manufacturers

The change toward a freer and more open investment climate in the
Czech Republic was followed by the entrance of foreign-owned banks and
telecommunication firms. These foreign-owned service providers helped to
improve the availability, range, and quality of services. These
improved services contributed to better performance of Czech
manufacturing firms that rely on services as inputs. For instance,
foreign banks accelerated the processing of loan applications, offering
decisions to small and medium Czech enterprises within 2 days, compared
to a previous waiting period of several weeks. Foreign banks were among
the first to offer Internet and remote banking services, including ATMs,
which save individual customers and business clients days and sometimes
weeks in transaction times. The time needed to send a fax went from hours
(or sometimes days for rural areas) to just minutes following the
liberalization of the telecommunication sector.
------------------------------------------------------------------------

Is Inward FDI on the Decline?

The increase of inward FDI since the late 1980s has coincided with
the generally solid performance of the U.S. economy, along with a surge
in U.S. worker productivity that has occurred since 1995. Recently,
however, some trends have developed with respect to FDI in the United
States that may be cause for concern. First, while the U.S. affiliate
share of U.S. output has grown over the past two decades, it has
stagnated and even declined in recent years. Second, the U.S. affiliate
share of employment has declined, from 5.1 percent in 2000 to 4.7
percent in 2004. Third, the share of inward FDI in the U.S. capital
account--that is, FDI in the United States as a share of all the assets
owned by foreign interests--has declined since 1999. It is not yet clear
whether these are benign and temporary trends or whether this
development is symptomatic of deeper issues with respect to the
attractiveness of the United States as a country in which to make direct
investment. To ensure that inward FDI remains a strong, positive force
in the U.S. economy, foreign investors in the United States must
continue to receive fair and equitable treatment as a matter of both law
and practice.
Historically, the United States has opposed the use of government
actions that distort, restrict, or place unreasonable burdens on foreign
investment. No property can be expropriated pursuant to U.S. law unless
it is done for a public use with payment of just compensation. The
United States has historically provided a domestic environment
conducive to investment by providing foreign investors fair and
equitable treatment based on the national treatment principle: foreign
investors should be treated no less favorably than domestic investors
in like circumstances. Moreover, while taking every neces-sary step to
ensure that foreign investments do not jeopardize national security,
the Administration recognizes that our economic vitality depends on our
openness.

The Contributions of Outward FDI to the U.S. Economy
A U.S. multinational company is headquartered in the United States
and, through outward FDI, has affiliates (often production or marketing
facilities) in other countries. Activities of U.S.-headquartered
multinationals have contributed strongly to productivity growth in the
United States, and thus to rising U.S. living standards.
Because multinationals are engaged in cross-border investment and
production networks, they are better able to enhance their
organizational efficiency. Studies have shown that multinationals are
more productive than firms that are focused primarily on domestic
markets. By combining domestic production with foreign production,
multinationals can produce at lower costs, earn
higher profits, and pay higher wages and benefits. Domestic firms can
benefit from outward FDI as multinationals are exposed to the world's
best business practices that can be adopted by other U.S. firms.


Basic Facts About U.S. Multinational Companies

U.S. multinationals are relatively small in number but have a
disproportionately large economic footprint. Less than 1 percent of
U.S. firms are multinationals, but these multinationals account for
20 percent of total U.S. employment and 25 percent of total U.S.
output. In 2004, there were 2,369
U.S. multinationals with 22,279 foreign affiliates, with 21.4 million
employees in the United States and 9 million workers abroad. The
operations of U.S. multinationals are concentrated in the United
States. In 2004, the combined value-added output of U.S. multinationals
was $3.04 trillion. U.S. parents accounted for over 70 percent of this
output and foreign affiliates for less than 30 percent.
While U.S. multinationals have increased employment and output in an
absolute sense, their share of the workforce has decreased slightly
over the years while their share of output has remained fairly
constant. U.S. multinationals employed 18.7 million American workers,
or 25 percent of the workforce, in 1982 (the first year for which
annual employment data are available). In 2004, those figures stood
at 21.4 million workers and 20 percent, respectively. The value of
output by U.S. parents was $1.3 trillion or 24 percent of the total
private U.S. output in 1994 (the first year for which annual output
data are available). In 2004, those figures were $2.2 trillion and 25
percent, respectively. In terms of recent trends, both employment and
output by U.S. parents peaked in 2000 and then began to decline. Output
rebounded in 2003 and employment rebounded in 2004, largely reflecting
economy-wide trends.


Why Do U.S. Firms Become Multinational?

There are three conditions required for a firm to be willing to invest
abroad: (1) the firm has specific assets that can be transported to
foreign affiliates; (2) the host country has certain characteristics
that make it attractive for the firm; and (3) the firm wishes to
maintain control over its intellectual assets.
Multinationals often face large costs and barriers to doing business
abroad compared with domestic firms in the host country that are
familiar with the local business climate. Physical and human capital
are needed to establish an affiliate, and additional resources are
needed to understand the local business environment (for example,
regulations and tax laws, supply networks, cultural differences, and
property rights). Thus, a multinational firm must have certain
advantages to compensate for these costs. Three types of compensating
advantages are commonly cited. One advantage is firm-specific
resources or knowledge-based assets and services (such as technology,
patents, trademarks,
and managerial or engineering expertise) that can be used by the
foreign affiliate. Another advantage is the location and
characteristics of the host country such as market size, trade costs,
and differences in the prices for key inputs such as land, labor, or
capital. The existence of a large market or the high costs of trading
with a certain country or region can motivate multinationals to produce
and sell in foreign countries. Price differences in land, capital, or
labor; transportation and telecommunications infrastructure; or good
business practices can also motivate a multinational to invest and
produce abroad.
The third type of advantage is known as internalization advantage. A
firm may choose outward FDI over giving a foreign company a license to
produce its goods so that it can retain control of its intellectual
assets. For example, a firm may be reluctant to reveal the details of
its product's construction or its production process to a prospective
licensee. There is also the danger that a licensee may produce a lower
quality product and consequently reduce the value of the
multinational's trademark. The difficulty of guaranteeing quality
control, monitoring and managing employees, achieving a satisfactory
licensing agreement, and enforcing patent or trademark rights all tend
to favor outward FDI.


The Organization of Multinational Production

There are two main organizational strategies for multinational
production. One strategy is vertical FDI, whereby the multinational
geographically fragments the production process and carries out
different stages of production at different locations. In contrast,
horizontal FDI occurs when the multinational conducts the entire
production process in the host country to sell locally through its
affiliates.
Vertical FDI establishes cross-border production networks. A
multinational firm may perform many activities--for example, R&D,
assembly, marketing, and sales--that require different mixes of capital,
more- or less- skilled labor, land, and other inputs. Separating these
activities across borders (and across the parent company and affiliate
companies) enables the firm to locate each activity in countries with
relatively low costs for each activity's intensively used inputs.
Because each stage of the production process is carried out in the
optimal location in terms of the input mix, vertical FDI production
networks can allow firms to take advantage of differences in
comparative advantages across countries and produce at an overall lower
unit cost. Trade between U.S. parents and their affiliates (``intra-firm''
trade) has risen over time, accounting for 20 percent of total U.S.
goods exports in 2004, and 14 percent of total goods imports.
Horizontal FDI can allow U.S. multinationals better access to foreign
markets. Ninety-five percent of the world's consumers live outside
U.S. borders. Companies can reach foreign markets through FDI or
exporting. But for U.S. multinationals, the predominant mode of
serving foreign markets is
through FDI and affiliate sales (producing and selling locally), not
exporting. In 2004, U.S. multinationals sold $2.3 trillion of goods
abroad through affiliate sales compared to $400 billion through exports
(see Chart 8-5). In other words, for every $1 of exports in goods, U.S.
multinational firms sold $5.84 through their foreign affiliates, up from
$3.40 ten years earlier.
A common allegation is that U.S. multinationals set up production
plants to serve as export platforms back to the United States. However,
the data do not support this claim. In 2004, sales by foreign affiliates
of U.S. multinationals totaled $3.2 trillion. Most of these sales were
to customers outside of the United States; 89.6 percent of total sales
were to foreign customers and 10.4 percent were to U.S. customers.


Outward FDI Complements Domestic Economic Activity

Studies show that economic activity abroad by U.S. multinationals
complements domestic economic activity. One dollar of additional
foreign capital spending is associated with $3.50 of additional domestic
capital spending. Firms combine home and foreign production to generate
final output at a lower cost than would be possible in just one country,
resulting in increased output and profits. Further, when multinationals
hire abroad, they also expand employment here at home, making
multinationals an important force behind job creation in the United
States (see Box 8-3).





From a broader perspective, U.S. multinationals enhance U.S.
competitiveness by engaging in the same activities and possessing the
same characteristics that make the U.S. economy competitive in world
export markets. Research has shown that the competitiveness of U.S.
multinationals tends to be driven by relatively high levels of R&D
and highly skilled labor. Studies have also shown that U.S. firms tend
to control larger shares of world markets in industries with high
levels of R&D and highly skilled labor. Because their competitive
interests largely coincide with broader U.S. economic interests, U.S.
multinationals make the economy as a whole more competitive.


------------------------------------------------------------------------
Box 8-3: U.S. Multinational Companies and U.S. Jobs

In recent years, many observers have expressed dismay that U.S.
companies have expanded their operations overseas, claiming that when
U.S. firms hire workers in foreign countries, they reduce the number of
jobs available to U.S. workers. The idea that U.S. multinationals
hiring abroad are ``exporting jobs'' relies on at least two assumptions:
first, that jobs abroad at foreign affiliates are substitutes for
domestic jobs at U.S. parent companies; and second, that when U.S.
parent companies expand overseas, they do not change the overall scale
or scope of their domestic activities. However, in looking at historical
data regarding the activity of U.S. multinationals, we see exactly the
opposite: when U.S. companies expand their employment abroad, they also
tend to expand domestically.

When U.S. Multinationals Hire Abroad They Also Expand Domestic Employment

Over the last two decades (1984-2004), U.S. multinationals expanded
employment at their foreign affiliates by 3.8 million and at their
parents by 3.2 million (see chart). In other words, the long-run data
show that when U.S. multinationals hire abroad they also expand domestic
employment. There have been short-run anomalies to this historical
trend that largely reflect economic business cycles both here and abroad.
For instance, between 1990 and 2000, for each job U.S. multinationals
created abroad they created nearly two at home. Between 2000 and 2003,
U.S. multinationals continued to expand employment abroad, albeit at a
slower pace, while decreasing their U.S. payrolls. Since 2003, both U.S.
parent company and affiliate employment have risen.
One study found that as U.S. companies expand employment abroad,
increase their compensation of foreign workers, and invest in their
overseas operations, they also increase their hiring, employee
compensation, and investment in the United States. Thus, rather than
being



substitutes for one another, the domestic and foreign operations of
U.S. multinationals have tended to be complements. Consider the
operations of General Electric. According to its latest annual report,
since 2001 this multinational has expanded foreign employment by 3,000
while also expanding domestic employment by the same amount.
One reason for the complementary relationship between domestic and
foreign activity is that a firm may change the overall size of its
operations and expand both at home and abroad. Alternatively, a firm
may change the scope of its operations and change the mix of its
activities (for example, manufacturing, services, or R&D). In fact, it
is common for parent companies in one industry to own foreign
affiliates in another industry. In 2004, U.S. parent companies
primarily engaged in manufacturing owned over 15,000 foreign
affiliates, but over 6,500 of these affiliates specialized in areas
outside of manufacturing.
In sum, the decision of a firm to expand abroad is based on many
factors, and it may be part of a larger overall expansion strategy or
a change in the scope of its operations. It is difficult to predict
beforehand what such an expansion means for U.S. workers and the U.S.
economy. The only way to tell the effect is to examine the data, and
thus far the data show that, over the long run, when U.S. multinational
firms hire abroad, they also hire at home.
------------------------------------------------------------------------




Good Performance Features of U.S. Multinationals
U.S. multinationals differ from the average U.S. firm in a number of
ways. For example, while U.S. multinationals account for 25 percent of
total U.S. output and 20 percent of employment, they account for a
disproportionately high share of U.S. goods exports (49 percent), goods
imports (31 percent), physical capital expenditures (29 percent), and
research and development (68 percent) (see Chart 8-6). In fact, U.S.
affiliates and multinationals combined conduct over 80 percent of all
private sector R&D in the United States. Also, the plants operated by
these companies tend to be larger in size than the U.S. average. These
differences are important because each of them--international trade,
capital expenditure, research and development, and plant size--is
associated with high labor productivity. And because of the strong
link between labor productivity and employee compensation (see
Chapter 2), this higher productivity is a potential benefit to U.S.
workers.
U.S. multinationals pay higher average compensation than firms in
the rest of the economy. In 2004, U.S. workers employed by U.S. parent
companies received an average of $57,800 in annual compensation,
compared to about $46,800 for workers in the rest of the economy. The
relatively high productivity of U.S. multinationals may be one of the
causes for the difference in compensation.





U.S. multinationals have had high productivity growth over at least
the last three decades, and because they make up a sizeable part of the
overall U.S. economy, they have been one of the main drivers of overall
U.S. productivity growth during this period. U.S. multinationals
accounted for over half of U.S. productivity growth between 1977 and
2000, and for half of the increase in
U.S. productivity growth between 1995 and 2000. During this 5-year
period, productivity at U.S. multinationals surged, growing 6.0 percent
annually.


Conclusion

Engagement in the global economy through increased trade and
investment has contributed to rising average living standards in the
United States. Further trade liberalization, particularly in services,
could bring even larger gains to American consumers, firms, and workers.
Advancing free and fair trade in multilateral, regional, and bilateral
negotiations will help to ensure that America continues to derive
benefits from international trade. This includes renewal of the Trade
Promotion Authority and a successful outcome of current global trade
talks, the World Trade Organization's Doha Development Agenda
negotiations.

Both inward and outward FDI have contributed to higher levels of
productivity in the United States. Inward FDI contributes to
productivity growth, provides a source of financing for the current
account deficit, and generates high-paying jobs for American workers.
Outward FDI is an important channel of market access for U.S.
multinational companies. U.S. multinationals are an important force
behind job creation in the United States and have contributed to
productivity growth and rising average living standards in the U.S.
economy.
In order to continue to derive important economic benefits from
global economic engagement, the United States must continue to break
down barriers to trade and investment abroad, and keep our markets
open to international trade and secure protections for foreign investors.