[Economic Report of the President (2009)]
[Administration of Barack H. Obama]
[Online through the Government Printing Office, www.gpo.gov]

 
CHAPTER 4

The Benefits of Open Trade and
Investment Policies

An open economy is characterized by receptiveness to foreign ideas,
technology, products, services, and investment. The United States
has one of the most open economies in the world, ranking very high
in common measures of openness to trade and investment. As a large
and diverse economy, the United States engages in more trade and
investment than any other country in dollar terms, and it also has,
on average, very low barriers to cross-border flows of goods,
services, and capital.
In the long run, open economic policies generate many benefits.
Trade and investment linkages with other countries increase
competition in domestic industries; enhance the purchasing power of
consumers; provide exposure to new products, services, and ideas
from abroad; and give domestic firms wider markets in which to sell
goods and services. In the short run, the interdependence among
open economies generally provides benefits--open economies may
rely on foreign borrowing or foreign demand for domestically
produced exports to cushion an economic downturn--but may also
create visible costs that obscure these benefits, as when foreign
investment shifts abruptly out of certain sectors or when foreign
demand for domestic exports falls. Nevertheless, any potential
negative effects from our openness to trade and investment do not
outweigh the enormous gains society has realized over decades from
this openness.
This chapter begins with a discussion of key facts about trade and
investment in the United States, followed by a discussion of the
benefits of free trade and open investment, and the policies that
the United States has taken to enhance both. These policies include
an increased number of free trade agreements (FTAs) and the strong
commitment of the United States to maintain openness to foreign
direct investment (FDI) while still addressing legitimate national
security concerns. The chapter continues with a discussion of
international development assistance, and concludes with a review
of issues that could affect future U.S. trade policy. The key
points of this chapter are:

 Openness to trade and investment has boosted U.S. economic
growth. Openness can also reduce the impact of shocks and
increase the resilience of the U.S. economy.
 The number of U.S. FTAs has increased greatly during this
Administration, and these agreements have contributed to the
growth in U.S. exports.
 Portfolio and direct investment into the United States reached
historic levels over the past decade, in part due to the
depth, diversity, and openness of U.S. financial markets and
the competitiveness of U.S. firms.
 The United States has maintained an open investment policy,
facilitating FDI flows between the United States and the world
while addressing legitimate national security concerns.
 U.S. development and trade initiatives, as well as U.S.
engagement in multilateral institutions such as the World
Trade Organization and the World Bank have helped increase
growth and foster political and economic stability in
developing countries throughout the world.
 Continued commitment to open economic policies throughout the
world will help ensure continued economic gains for the United
States and the rest of the world.

Trade and Investment in the United States

Trade in goods and services has played an increased role in the
U.S. economy over the past decade. As seen in Table 4-1, in the
first half of 2008, the United States exported goods and services
equivalent to 13.0 percent of Gross Domestic Product (GDP), and
imported goods and services equal to 18.1 percent of GDP. These figures
are the highest on record, considerably above figures from 2000, when
exports were equal to 10.9 percent, and imports 14.8 percent, of GDP.
The current account, which measures the net value of the flow of
current international transactions, is chiefly composed of the
difference between exports and imports. The U.S. current account
deficit widened over this period from 4.1 percent of GDP in the first
quarter of 2000 to a peak of 6.6 percent of GDP in the final
quarter of 2005. The current account deficit then narrowed to 4.8
percent of GDP at the end of 2007 before expanding slightly over
the first half of 2008.



As a matter of accounting, the current account deficit is mirrored
by net inflows of capital into the United States, which have
provided the financing that has allowed us to purchase more in
imports than we sell in exports. From Table 4-1, we can see that
net capital inflows into the United States were equal to 4.7
percent of GDP in the first half of 2008, a figure that
approximately matches the current account deficit, with a
discrepancy caused by measurement errors, omissions, and the
exclusion of certain types of capital flows for which only partial
data are available. The increase in net capital inflows looks
modest compared with the huge increase in capital inflows to and
outflows from the United States from 2000 to 2007, although the
data for 2008 imply a sharp decline to levels lower than those of
2000 as a percentage of GDP.

Openness to Trade and Investment Has Substantially Contributed to
U.S. Growth

Many studies have shown that greater openness to trade and
investment is associated with faster growth in the long run. There
are many ways to measure openness, including by looking at both the
extent of trade and investment and the size of barriers to these
flows. By either measure, countries that increased openness have
grown faster and have had greater increases in living standards
than countries that have remained less open. Research has not yet
conclusively determined the incremental gain in income that a
country receives from a specific increase in trade because the
exact change can depend on particular policies and circumstances.
In the current U.S. downturn that began at the end of 2007, trade
has improved the resiliency of the U.S. economy. Strong global
demand for U.S. goods and services in 2007 and the first half of
2008 boosted U.S. GDP growth in this period. As the trade deficit
declined, the improvement in net exports (exports minus imports)
became a sizeable contributor to U.S. growth in this period. Chart
4-1 shows real GDP growth and the contribution of net exports to
that growth since 2001. Net exports have accounted for over half of
real GDP growth in the past 2 years. Some of the recent U.S.
strength in net exports has likely been driven by the depreciation
of the dollar. The value of the dollar declined fairly steadily
from its peak in 2002 to the summer of 2008, when it reached a
level last seen in the mid-1990s. The depreciated dollar
contributed to the increase in exports and the decline in real
imports. In the second half of 2008, however, the value of the
dollar increased, in part reflecting increased international demand
for U.S. Treasury bonds in a time of global turmoil and rapidly
deteriorating global growth.
The deteriorating performance of foreign economies in the second
half of 2008 has recently reduced demand for U.S. exports. In the
most recent U.S. data through October, both imports and exports
have begun to decline, as they did during the global slowdown of
2001-02. The decline in exports will likely reduce the
contribution of trade to GDP growth in the short term, and net
exports may provide no boost to growth in the fourth quarter of
2008. Trade may still hold up better than other components of GDP,
however, as consumption and investment are expected to decline
enough to make overall GDP growth negative in the short term (see
the discussion of the near-term macroeconomic environment in
Chapter 1).
Strong global demand for goods drove up prices of a broad range of
commodities through the middle of 2008, but global weakness in the
second half of the year has reversed most of these gains. This is
good news for users, both consumers and producers, but raises some
concerns for the exporters that had benefited from the higher
prices. However, the broad-based decline in prices of oil, food,
and agricultural commodities has considerably eased earlier fears
of inflation.

The Benefits of Free Trade

Free trade contributes to economic prosperity in many ways. One of
the greatest benefits of trade is that international differences in
prices allow countries to utilize their comparative advantage,
because trade gives a country access to goods and services at
relatively low prices, while simultaneously



allowing domestic producers to find profitable export markets in which
to sell goods that can be produced at lower prices at home than abroad.
Trade allows a nation to achieve higher overall consumption of goods
and services than would be possible if no trade occurred. Trade also
benefits consumers by increasing the number and variety of goods
available domestically.
Trade raises the productivity of domestic firms in multiple ways:
(1) Trade shifts production toward goods in which the country has a
comparative advantage, so that over time, capital and labor will
become concentrated in relatively more productive sectors, raising
national income; (2) trade connects domestic producers to new
technology and a greater variety of inputs, and it exposes them to
more competition; and (3) firms that gain access to new markets can
increase average productivity as unit costs fall, thus benefiting
from what economists call economies of scale in production. Because
trade allows the most productive firms and sectors to increase
their share of U.S. production, trade makes possible increases in
productivity, profitability, and wages that raise national
standards of living.
Firms engaged in export trade provide important benefits to the
economy. Exporting firms are a large engine of growth and
employment in the U.S. economy. In 2006, 20 percent of
manufacturing jobs were generated directly or indirectly by
exports. Not only do exporters play a major role in job creation,
but on average, productivity per worker is up to one-quarter higher
in exporting firms than in nonexporters, and exporters pay each
worker 13-18 percent more. Some of this exceptional
performance occurs because exporters tend to concentrate in
productive industries, but exporters also have higher productivity
and higher wages than nonexporting firms in the same sector.
Among exporting firms, multinational enterprises, which own and
control business operations in more than one county, account for an
important share of U.S. trade and productivity growth. In the
United States, U.S.-owned multinationals account for over one-half
of total exports, and over 90 percent of U.S. exports to
manufacturing affiliates were inputs for further processing. The
extent of trade in intermediate inputs is an indication that trade
is part of an increasingly complex chain, and companies have
substantially improved productivity through the development of
these global supply chains. Research shows that multinationals in
the United States, both U.S.-owned and U.S. affiliates of foreign
companies, were responsible for more than half of the increase in
U.S. nonfarm labor productivity between 1977 and 2000.
Trade, while broadly beneficial, does not reward all people
equally, and changes in trade can negatively affect some workers.
In some cases, workers can receive lower wages when trade
liberalization reduces the price of goods and services that they
produce, and workers can lose jobs when imports reduce domestic
production or jobs are relocated overseas. Over time, however,
increased trade has made the United States more productive and has
contributed to large increases in the U.S. standard of living.
Estimates of the gains to the United States from the postwar
increase in global trade and the reduction in global trade barriers
range up to $1 trillion dollars per year, or about $10,000 per
household. In other cases, the use of global supply chains has led
to the displacement of some U.S. workers, but as noted above,
multinational companies generate considerable benefits for
U.S. workers, generating high-wage jobs, substantial employment,
and considerable improvements to U.S. productivity.
Although some jobs are lost due to trade, there are many other
reasons for job loss in the United States, such as technological
change and domestic competition. The United States has several
programs to help workers adjust to displacements caused by trade.
Chief among these programs is Trade Adjustment Assistance (see Box
8-2 in Chapter 8), which provides benefits and training to workers
whose jobs are affected by trade and promotes their rapid
reemployment.

Free Trade Agreements

Trade policy is an important determinant of a country's
openness to trade, and hence of its growth. In the past 8 years,
U.S. policy has supported engagement in global free trade, which
has been most evident in the increase in the number of U.S. free
trade agreements (FTAs). FTAs are agreements that eliminate tariffs
on substantially all trade between two or more countries; U.S. FTAs
also reduce other barriers, such as restrictions on services trade
and investment. Before 2001, the United States had implemented FTAs
with three countries. To date, the United States has concluded FTAs
with 20 countries, including 16 in force, one approved by Congress
but not yet in force, and three concluded but not yet approved by
Congress. The United States has concluded FTAs with trading
partners on five continents and with three of our top 10 trading
partners. In addition, the United States is currently negotiating
FTAs with Malaysia and the members of the Trans-Pacific Strategic
Economic Partnership. Chart 4-2 illustrates the progress of U.S.
FTAs since 2000, from negotiation to the President's
signature to enactment by Congress to being fully in force.
FTAs can dramatically increase trade. U.S. exports to countries
whose FTAs came into force during this Administration increased 61
percent from 2000 to 2007, while U.S. imports from these countries
increased 26 percent. Recent research shows that, on average
worldwide, FTAs increase trade among member countries by about a
third after 5 years and more than double trade after 15 years.
Because many U.S. FTAs have been in force for less than 5 years,
the experience of other countries suggests that these FTAs may
continue to expand trade for another decade.
Increased duty-free trade has substantially reduced costs to U.S.
importers and exporters and also lowered prices for U.S. consumers.
In 2007, 41 percent



of U.S. exports went to FTA partners, and over 98 percent of U.S.
products were eligible to enter these foreign markets duty free. In the
same year, 31 percent of U.S. imports came from FTA partners, and 95
percent of these imports entered the United States duty free. The
reduction in tariffs and quantitative limits, such as quotas, on goods
trade in FTAs provides important benefits. Countries gain over time
when they liberalize their own market, because capital and labor
relocate to sectors in which they will be used more efficiently.
Countries also gain immediately when FTA partners liberalize, because
this liberalization lowers trade costs and improves the competitive
position of exporters.
The size of initial foreign trade barriers is an important
determinant of potential export gains from FTAs. One reason that
U.S. exports to recent FTA partners increased more than imports
from them did, is that in most cases, prior to these agreements,
foreign tariffs were higher than U.S. tariffs. Many of these countries
apply relatively high tariffs to imports from non-FTA partners, so U.S.
FTAs considerably reduced costs to U.S. exporters and improved their
competitive position. In contrast, goods from these countries were
often already eligible to enter the United States duty free. Several
FTA partners also had prior preferential access to the U.S. market
under programs such as the Andean Trade Preferences Act and the
Generalized System of Preferences, which are discussed in the
development assistance section below.
U.S. FTAs also contain many beneficial nontariff provisions;
particularly important are investment and services liberalization.
Because of investment provisions in U.S. FTAs, U.S. companies that
operate abroad benefit from more transparent and less burdensome
regulation and greater certainty for investors. Developing
countries can benefit from an improved legal framework at home and
from the stability of permanent preferential access to U.S. markets,
which can make the countries more attractive to international
investment in all sectors. Liberalization of foreign services markets
can improve access to the telecommunications, financial services,
professional services, and other sectors. This access can generate
large trade and welfare gains because of the high barriers to services
trade in many countries.
Reducing barriers to investment and services can have large effects
on trade and even greater effects on economic welfare than tariff
liberalization does. FTAs have dramatically increased trade in some
sectors with preexisting low, or even zero, tariff rates,
demonstrating the positive effects of nontariff liberalizations.
International data on barriers to services trade and investment
flows are less precise than data on goods trade, so estimates vary,
but recent research on U.S. FTAs shows that increased investment
and reductions in services barriers can each provide more than
twice the gains in purchasing power than can tariff liberalizations
alone.
Quantifying the gains from FTAs is difficult because of the many
uncertainties involved in estimating the effects that these
agreements have on trade flows and on the behavior of producers and
consumers, and because data limitations make some benefits
currently unquantifiable. One series of reports that has focused on
only the gains from tariff liberalizations under all U.S. FTAs
finds that U.S. consumers gain about $22 billion in increased
purchasing power annually. Other studies, though necessarily more
speculative, have also included the gains from greater economies of
scale, more product variety, long-run gains from capital
accumulation, and reduced services barriers. These studies suggest
that cumulatively, U.S. FTAs, both those in force and those
pending, could increase U.S. purchasing power by about $150
billion, equivalent to about $1,300 per U.S. household, annually.

Reductions in Tariffs

The United States has one of the lowest average tariff rates in the
world. U.S. average tariff rates have been steadily decreasing as duty-
free imports from FTA partners have increased in the past decade.
The trade-weighted average tariff rate, which gives each of over
11,000 tariff rates a weight equal to the value of U.S. imports in
that sector, has been below 2 percent since 1999, and has now
fallen below 1.4 percent. Trade-weighted averages can be
misleading, however. Because high tariffs reduce trade, sectors
with high tariffs are counted less when weighting by trade. The
restrictiveness of U.S. tariffs is better measured by calculating a
single, ``uniform'' tariff that would produce the same volume
of trade (or the same purchasing power for U.S. consumers) if applied
to all sectors. Recent estimates of such a uniform tariff have been
near 5 to 6 percent for the United States. This higher value
captures a number of relatively high U.S. tariffs, particularly in
agriculture, that are not well represented by the average rate.
The U.S. ``uniform'' tariff rate of 5 to 6 percent is
lower than comparable estimates of tariff protection in major U.S.
trading partners, both developing and developed. As in the United
States, agricultural tariffs are a major source of other
countries' high rates of protection. Because high
agricultural protection is a global concern, efforts to reduce it
are best negotiated in multilateral institutions such as the World
Trade Organization (WTO), which is currently negotiating the Doha
Round of trade liberalizations (initiated in Doha, Qatar). The
United States and numerous other countries have proposed ambitious
reductions in both agricultural tariffs and trade-distorting
agricultural subsidies (see Box 4-1) that are critical to a
successful market-opening outcome of the Doha Round.

-----------------------------------------------------------------------
Box 4-1: Farm Subsidies

Government payments to the farm sector have been part of U.S. farm
policy since the 1930s, with the goal of increasing the standard of
living of American farmers. Although they benefit some farmers,
government payments can induce economically wasteful overproduction
by encouraging production of higher-cost goods that would be
unprofitable without subsidies. Thus, subsidies can generate costs
to taxpayers that exceed the benefits received by U.S. producers
and consumers. Due to the rise of large commercial farms, subsidies
have also become increasingly directed toward high-income farmers.
In 2006, farm households with an income over $100,000 received the
majority of government payments (compared with the median U.S.
household income of approximately $48,000). In addition to monetary
costs, farm subsidies can also raise other concerns. Some subsidies
require that land be reserved for specific crops, potentially
limiting the variety of foodstuffs in local communities, and
subsidy-induced production may raise fertilizer use, which
contributes to environmentally damaging runoff.
Despite the fact that farm income in the United States is forecast
to reach record levels in 2008, taxpayers will provide a projected
$13 billion in payments to U.S. farmers this year. In real terms,
direct government payments have come down by over half since 2000,
when they were the highest ever, even exceeding payments during the
farm debt crisis of the 1980s. This decline was driven primarily by
higher market prices for agricultural commodities, rather than by
policy initiatives to reduce support. For example, government payments
under several programs that provide support when commodity prices
drop below a threshold level have declined over 80 percent since
2005, while farm bills, such as the Food, Conservation, and Energy
Act of 2008, continue most existing support programs.
Agricultural subsidies are widespread in developed countries,
although they represent a lower share of gross farm receipts in the
United States than in the EU and in many other countries, including
Japan, Korea, and Canada. Because subsidies can impose greater
costs than benefits, reducing subsidies would increase incomes and
economic welfare; indeed, research suggests eliminating
agricultural subsidies in developed countries would increase U.S.
welfare by several billion dollars per year. In developing
countries, reducing subsidies would raise agricultural prices and
improve the lives of producers, although it could also raise the
cost of some food for consumers. Given the prevalence of
agricultural support, multilateral agreements are the single most
effective way to address this issue. The Doha Round of the WTO
trade talks has included negotiations on limiting subsidies with
the greatest potential to stimulate overproduction and distort
trade. In July 2008, as part of the Doha talks, the U.S. Trade
Representative announced that the United States was prepared to
limit this subset of subsidies to $15 billion annually, down from
the $22 billion limit offered in 2005. In the United States, these
subsidies have exceeded the proposed new $15 billion limit in seven
of the last 10 years.
-----------------------------------------------------------------------

The Benefits of Open Investment

The ability to either export excess savings in return for foreign
assets or to borrow savings and invest more than is saved within
the country can allow nations both to achieve higher income growth
than would otherwise be possible and to cushion temporary shocks to
the economy. Over time, the United States has benefited in both
ways. For example, foreign demand for secure investments has
lowered borrowing costs for the U.S. Government. There have also
been benefits from accumulating assets overseas: U.S. businesses
and investors have been able to make use of their foreign asset
holdings to diversify, reduce risk, and raise overall returns on
investments.
Economic growth has likely been supported by openness to foreign
investment in a variety of ways, including an increase in the
amount of capital available for investment; greater transfer of
technology; increased employment; and greater access to global
capital, goods, and services by domestic firms. Although still a
matter of debate among economists, foreign direct investment is
generally considered to convey all of these benefits in a
particularly straightforward fashion. According to the latest data
available from the Commerce Department, in 2006, U.S. affiliates of
foreign companies accounted for 6.1 percent of U.S. nonbank private
sector production, provided more than 5.3 million jobs to American
workers (4.6 percent of the U.S. workforce), spent $34.3 billion on
research and development (14 percent of U.S. expenditure on R&D),
and accounted for 19 percent of U.S. exports.
The benefits that a country receives are related to the volume and
composition of its investment flows. The net flow of investment
across borders is equal to the gap between the value of goods and
services that a nation exports and the value of the goods and
services it imports. This is also equal to the difference between a
nation's savings and its domestic investment. Nations that
save more than they invest domestically invest these extra savings
in the rest of the world, and in the process purchase foreign
assets, including bonds, equities, and FDI. Nations whose domestic
investment exceeds their savings receive investments from abroad
and, in doing so, sell assets to foreign residents.
The composition of investment flows is in part determined by the
willingness of the investor to accept greater risk in exchange for
a potentially higher return. Chart 4-3a provides a breakdown of
types of foreign assets accumulated by U.S. investors (including
the government), and Chart 4-3b shows the types of U.S. assets
accumulated by foreign investors. Relative to foreign investors in
the United States, U.S. private investors have been relatively
risk-tolerant in their holdings of foreign assets, particularly in
holdings of private portfolio stocks and FDI. Portfolio stocks
constituted 30 percent of total private foreign investment by U.S.
investors in 2007, whereas they constituted 17 percent for foreign
investors in the United States. Likewise, U.S. investors allocated 19
percent of their foreign holdings to FDI, whereas private foreign
investors only allocated 14 percent of their U.S. investments to FDI.
In keeping with their lower risk appetite, foreign private investors
held twice the share of bonds, including U.S. Treasury bonds, in their
U.S. asset holdings (24 percent of private investment) than U.S.
investors held in their foreign asset holdings (9 percent of private
investment). There was also a pronounced difference in official
government holdings. Foreign governments and official institutions held
17 percent of all U.S. assets owned by foreigners, whereas the U.S.
Government held only 2 percent of the total foreign assets in U.S.
residents' possession. The majority of foreign official
holdings of U.S. assets in 2007 were U.S. Treasury bonds and bonds
issued by government-sponsored enterprises (GSEs) such as Fannie
Mae and Freddie Mac.



U.S. Investment and Investment Policy

Since the early 1980s, the United States has received more capital
from foreign investors than U.S. residents invested abroad. Table
4-2 provides capital flow data for the years 2000 through 2007, the
latest available data. There are many aspects about the United
States that have proved attractive to foreign investors, including
the size, diversity, liquidity, and depth of U.S. financial markets.
According to one estimate, U.S. financial markets accounted for
approximately one-third of the world supply of financial assets in
2006 (the latest year for which data are available). The U.S. share of
the world supply of securities available to investors may even be much
higher, given that in many countries the fraction of a company's
shares available on the market may be much lower due to the large
controlling stake in the company held by the government, a financial
institution, or a family. In addition, U.S. markets offer strong
minority shareholder rights and other property rights, a large domestic
market, opportunities to invest in technological innovation, and
demographic trends that result in a younger and faster-growing
population than in most other advanced nations.
Much attention has been given to the large purchases of U.S. assets
by foreign governments (primarily central banks and sovereign
wealth funds; see Box 4-2). Although official flows (primarily
foreign exchange reserves invested in the United States) are
important, private flows are much larger. In 2000, for example,
total foreign capital inflows into the United States were $1,038
billion of which private capital flows were $995 billion, or 96
percent of the total. Since then the share of private flows has not
fallen below 68 percent, and it stood at 80 percent in 2007, the
last year for which data are available. FDI and other investment
flows are likely to be affected, even if only in the short to
medium term, by the current financial crisis. This is the subject
of Box 4-3.



-----------------------------------------------------------------------
Box 4-2: Sovereign Wealth Funds

A sovereign wealth fund (SWF) is a state-owned investment fund.
While there is no widely recognized definition of a SWF, typical
hallmarks include that it holds foreign financial assets; makes
some long- or medium-term investments that are riskier than the
safe, liquid assets that make up official foreign currency reserves
held for balance of payments or monetary policy purposes; and has
few or no defined obligations, such as paying pension benefits or
other specific liabilities. Nations may create SWFs for many
purposes, including to earn higher returns on foreign currency
holdings in excess of desired reserve assets, stabilize fiscal
revenues, save wealth across generations, or fund development
projects. SWFs are typically funded through commodity exports such
as oil, gas, or diamonds, or through transfer of official foreign
reserves accumulated as a result of large trade surpluses. Examples
of some large SWFs include the United Arab Emirates' Abu
Dhabi Investment Authority, Norway's Norges Bank Investment
Management, the Government of Singapore Investment Corporation, and
the China Investment Corporation.
Sovereign wealth funds have existed at least since the 1950s, but
the amount of money estimated to be in such funds has increased
dramatically in the past 10 to 15 years. One recent study estimates
that SWFs currently manage $3.6 trillion in assets, and that total
could rise to $10 trillion by 2015, although recent decreases in
commodity prices will lower this projection. In 2006-2007,
the amount of assets held by SWFs was large compared to the amounts
held by private equity ($0.8 trillion) and hedge funds ($1.9
trillion), but was dwarfed by the assets held by insurance
companies, mutual funds, and pension funds (on the order of $20
trillion each).
Sovereign wealth funds have the potential to promote global
financial stability by acting as long-term, stable investors that
provide significant capital to the system. They are not typically
highly leveraged and would therefore not be under pressure to sell
off assets for the purpose of meeting debt obligations. At the same
time, the performance incentives that SWFs face remain opaque, and
like all large, concentrated investors, SWFs could cause market
volatility by abruptly shifting their asset allocations to avoid
losses. The extent to which SWFs act as a stabilizing force in
financial markets is an open empirical question that may be
difficult to answer due to the lack of transparency of many SWFs.
Foreign investment, including investment by SWFs, provides capital
to U.S. businesses, improves productivity, and creates jobs. The
United States is currently the largest recipient of SWF investment.
Investment from SWFs has helped to shore up financial institutions
during the credit crisis: sovereign wealth funds invested an estimated
$92 billion in global financial institutions from January 2007 to July
2008.
The increasing size of SWFs in global financial markets has
prompted some concern, however. For recipient countries, ownership
of sensitive assets by foreign governments may pose national
security concerns. High-profile investments by SWFs may also
provoke a protectionist backlash against foreign investment. In
April 2008, the Organization for Economic Co-operation and
Development (OECD) published investment policy principles for
countries that receive SWF investment, endorsing long-standing OECD
principles against protectionist investment barriers and for
nondiscriminatory treatment of investors. The principles stress
that when additional investment restrictions are required to
address legitimate national security concerns, then investment
safeguards by recipient countries should be transparent and
predictable, proportional to clearly identified national security
risks, and supportive of accountability.
Countries that own SWFs have also raised concerns about the
governance and accountability of these funds, and recognize that it
is in their interest to ensure that their money is invested well.
In October 2008, a group of 23 countries with SWFs published the
Generally Accepted Principles and Practices, known as the
``Santiago Principles,'' for sovereign wealth funds. The
voluntary principles stress that SWFs should be transparent and
accountable and should make investment decisions based on
commercial principles. Adherence to these principles not only will
help ensure that SWFs are well managed, but will have the
additional benefit of reassuring recipient countries that SWF
investments are financially stable and are economically and
financially motivated.
-----------------------------------------------------------------------

-----------------------------------------------------------------------
Box 4-3: The Effect of the Current Economic Slowdown on Foreign
Investment into the United States.

The large capital inflows into the United States over the past
decade have led to many benefits described in this chapter. It is
too early to say definitively how the financial crisis will affect
these inflows. There are two aspects to this issue. First, there is
the question of whether the supply of credit that net-saver nations
provide to the rest of the world will be reduced. This credit has
primarily flowed from Asian economies (including Japan's), whose
combined current account surplus (a measure of capital outflows) was
$608 billion higher in 2007 than it was in 1997, and Middle East
economies, whose combined current account surplus was $253 billion
higher in 2007 than in 1997. To the extent that the recent slowdown in
global economic activity reduces demand for Asian exports and petroleum
products (as well as other commodities), the net savings available from
these nations may fall if savings rates do not rise sharply. Moreover,
foreign countries' savings are also likely to decline if
governments decide to engage in higher spending to boost their flagging
economies, thereby lowering the amount of government saving. Such
spending would reduce the gap between national saving and domestic
investment and reduce the supply of credit to the rest of the world,
raising world interest rates.
The second question is whether the cost of foreign savings to the
United States will rise. This depends on U.S. demand for foreign
savings and the relative desirability of U.S. assets for foreign
investors. The rising U.S. demand for foreign savings over the past
decade is evident in Table 4-2. To add further evidence, the
current account deficit of the United States (equal to net capital
inflows) was $591 billion higher in 2007 than in 1997, and the
United States received net investment from the rest of the world
equal to 1.3 percent of world GDP in 2007, compared with average
net foreign investment in the United States equal to
0.7 percent of world GDP from 1994 to 2001. Although predictions
vary, U.S. imports and exports are both anticipated to fall
sharply, likely leading to continued high levels of net capital
inflows, and therefore high demand for foreign savings. If other
nations that have relied on net capital inflows also maintain their
same level of demand for foreign savings as well, unchanged demand
in the United States for a potentially shrinking supply of global
savings would tend to raise the cost of obtaining these inflows.
Yet the cost of foreign savings has not increased for the United
States, and this primarily reflects an increase in the relative
desirability of U.S. Treasury bonds for global investors. The net
inflow of foreign savings into U.S. Treasuries has permitted the
U.S. Government to borrow at a relatively low cost, and this has so
far helped cushion the impact of the crisis on the U.S. economy.
The relative desirability of U.S. Government bonds reflects a
seismic decrease in global investors' appetite for risk. This
has generated enormous demand for low risk assets such as U.S.
Treasuries. If global investors' appetite for risk returns,
demand for Treasuries will likely fall and whether the cost of
foreign savings will rise for the United States will depend on the
relative attractiveness of U.S. investments compared to
opportunities abroad.
-----------------------------------------------------------------------

Foreign Direct Investment into the United States

For statistical purposes, the United States defines foreign direct
investment (FDI) as the acquisition of at least 10 percent of an
existing U.S. business, or the establishment of a new business, by
a foreign person. The business acquired or formed as a result of
the FDI is known as a U.S. affiliate of the foreign parent. Outlays
for new FDI into the United States rose in 2006 and 2007, and the
rate of increase of spending for new FDI greatly exceeded the rate
of increase of U.S. merger and acquisition activity. Of total new
FDI outlays into the United States of $277 billion in 2007, $255
billion (92 percent) was for the acquisition of existing U.S.
firms, while $22 billion (8 percent) was for the establishment of
entirely new businesses, according to preliminary data. In 2006,
the three countries with the greatest production (or value added)
by U.S. affiliates as a share of total U.S. affiliate production
were the United kingdom (19.6 percent), Japan (12.3 percent), and
Germany (11.0 percent). The three biggest industry recipients of FDI
new investment outlays in 2007 were manufacturing (49 percent), finance
and insurance (9 percent), and real estate and rental and leasing
(7 percent).
U.S. affiliates of foreign businesses are a large force in the U.S.
economy, and their importance has increased in certain ways. Over
the past 20 years, U.S. affiliates have increased their contribution to
U.S. production from 3.8 percent of U.S. private sector production in
1988 to 6.1 percent of production by 2006 (the latest year available).
The employment share of U.S. affiliates reached 4.6 percent in 2006. In
2007, newly acquired or established U.S. affiliates employed 487,600
people (including 147,500 in manufacturing and 143,600 in retail).
Although U.S. affiliates of foreign businesses are distinguished by
relatively high wages and productivity, these attributes may
reflect the nature of the industries to which FDI is attracted
rather than any special attribute of foreign ownership itself.
However, the ability to sell a business to foreign investors
interested in acquiring new technology creates an incentive for
entrepreneurs to innovate by increasing the potential rewards.
There are other benefits as well. Studies that investigate the
unique benefits of FDI, as opposed to other forms of foreign
financing, typically claim that FDI can introduce new technologies
to domestic industries and increase the nation's growth rate
as these new technologies are adopted and spread throughout the
economy.
Efforts to measure technological spillovers have often come to
conflicting conclusions about the extent of these benefits. Many
studies indicate that the benefits of FDI for the host country
depend heavily on context. One recent study, for example, finds
results that are sensitive to the level of worker education in the
region where the investment is being made. Its findings indicate
that FDI stimulates economic growth most for U.S. States where
worker education exceeds certain threshold levels.
U.S. affiliates may be most productive if they are located near
other firms with similar technical and knowledge requirements, or
near a large number of workers with specialized skills and
suppliers with specialized inputs. A recent study that finds that
U.S. affiliates tend to cluster in specific areas (often with other
U.S. affiliates with parents from the same country). For example,
Connecticut and South Carolina tied for the largest U.S. affiliate
share of private industry employment at 7.1 percent. Most of the
U.S. affiliates in Connecticut were controlled by Dutch businesses,
whereas the U.S. affiliates in South Carolina were heavily
associated with German businesses.

Foreign Investment Policy

The perception that openness to foreign investment must be traded
off against security is misguided. Foreign investment gives
investors in other countries an economic stake in the prosperity of
the United States, creating an incentive to support policies that
are good for U.S. growth and stability. Nonetheless, foreign
acquisition of assets or businesses may create a risk to national
security if production of key resources could be disrupted or if
sensitive information or technologies may be disclosed. The Exon-
Florio provision of the Defense Production Act of 1950, which
became law in 1988, provides for the President or the
President's designee to review certain foreign investments in
the United States. If a transaction threatens to impair national
security, the President is authorized to prohibit the transaction.
In October 2007, the Foreign Investment and National Security Act
of 2007 (FINSA) became effective, amending Exon-Florio in various
ways, including by codifying the structure, role, process, and
responsibilities of the interagency Committee on Foreign Investment
in the United States (CFIUS), which has been designated by the
President to undertake Exon-Florio reviews since 1988. Although
FINSA expands government oversight of some foreign acquisitions, it
also increases the transparency and predictability of the CFIUS
process. With the publication of final regulations in November
2008, FINSA is now fully implemented.

Development Assistance Initiatives

The United States benefits from increased trade as other economies
grow and become more open, but the main benefits of development
assistance programs include improving the lives of disadvantaged
populations, increasing economic and political stability abroad,
and fostering closer ties to the United States. The United States
has many long-standing economic assistance commitments, including
those funded through the United States Agency for International
Development (USAID), the Departments of State and Defense, and
funding for multilateral development institutions such as the World
Bank. Under this Administration, the United States has initiated
and expanded specific economic assistance programs in developing
economies, particularly those that practice good governance; make
trade a prominent feature of their development plans; and
demonstrate a commitment to taking ownership of the reforms,
planning, and logistics required for the success of development
programs and projects. Economic assistance programs, including
trade capacity building (TCB) programs, are provided primarily by
the Millennium Challenge Corporation (MCC) and USAID, and
investment promotion programs are provided by the Overseas Private
Investment Corporation (OPIC). The United States offers developing
countries, particularly the least developed, preferential access to
the U.S. market through several preferential trade programs. The
United States also has health and education initiatives such as the
President's Emergency Plan for AIDS Relief (PEPFAR).
To put these programs in context, U.S. spending on four of these
initiatives from fiscal year 2000 to 2007 is shown in Chart 4-4.
MCC has had a steady increase in funding since its inception in
2004. Spending on ``Other TCB'' in Chart 4-4 does not
include TCB funds that are already included in spending by MCC and
OPIC; overall, TCB funding rose to $2.3 billion in 2008. The
highest spending from 2004 through 2006 was on PEPFAR, reaching $4
billion in 2007. The MCC, TCB, and OPIC, in addition to trade
preference



programs, are each discussed below, while PEPFAR is described in the
section on health programs in Chapter 7.

Millennium Challenge Corporation

In 2002, the President announced the creation of the Millennium
Challenge Account (MCA), a new bilateral initiative aimed at
reducing poverty through investment programs, or compacts, of up to
five years with countries that practice good governance, provide
economic freedoms, and invest in their people's health and
education. The Millennium Challenge Corporation (MCC) was set up to
administer the MCA, and the importance of the MCC's focus on
reducing poverty through economic growth is supported by research
showing that economic growth is an important precursor for poverty
reduction. In recognition of this relationship, before approving
projects, MCC gathers evidence that the problems to be addressed by
potential MCC-funded projects are indeed critical constraints to a
country's growth. The strong commitment by MCC to near-
universal application of cost-benefit analysis and rigorous,
state-of-the-art project evaluation will allow the development
community to better understand and learn important lessons about
the effectiveness of various types of aid projects. Without making
advances in knowledge about which projects are effective, U.S.
efforts to improve the lives of targeted populations may not
ultimately succeed. Given that most of MCC's compacts are
currently in progress, it is too early to evaluate whether MCC has
met its objectives.

Trade Capacity Building

An important goal of U.S. trade policy is to create opportunities
for individuals and companies in developing countries. Trade
capacity building (TCB), also called Aid for Trade, helps
developing countries build capacity so that they can take advantage
of global markets and implement trade rules. Top priorities for
this aid are to develop infrastructure, strengthen financial
markets, improve customs operations, develop sound business
environments, and facilitate trade. The United States is the
largest single-country donor of TCB assistance, spending $2.3
billion in the 2008 fiscal year, and it has committed to provide
$2.7 billion in annual spending by 2010.
A key component of TCB is improving key physical infrastructure
needs--such as transportation, ports, telecommunications,
electricity, and water--in developing regions. In recent
years, the United States has supported road building in rural
Colombia, pipeline rehabilitation in Georgia, and the construction
of a new international airport in Ecuador. TCB funds also
strengthen developing countries' financial infrastructure. A
number of programs are aimed at improving the productivity and
business practices in micro-, small-, and medium-sized businesses,
and at improving lending to these businesses.
Trade facilitation is another important part of TCB. Trade
facilitation funds are used chiefly to modernize customs practices,
promote exports from developing countries, and provide business
support and training to help firms participate in global markets.
Improvements in these areas are often key to generating new trade
and investment flows in these countries. For example, trade may
increase because improved customs practices reduce costs and
shorten delivery times. The United States has supported projects to
improve the flow of goods at the kenya-Uganda border and along the
route from coastal Namibia to South Africa. Investment may increase
because trade facilitation addresses areas of chief concern to many
international investors; a 2007 survey reported that customs and
ports improvements are the highest priority for international
investors in some emerging markets.
Recent U.S. trade agreements, such as the Dominican Republic-
Central America-United States Free Trade Agreement, include a
formal Committee on TCB to help trading partners implement the
agreement and to smooth the transition to new trading regimes. The
United States also promotes TCB more broadly. For example, the
United States supports efforts by the WTO and the OECD to expand
worldwide funding for Aid for Trade. This aid helps developing
countries, particularly least-developed countries, enhance trade-
related skills and improve infrastructure needed to expand trade
and benefit from trade agreements. Along these lines, the Africa
Global Competitiveness Initiative, announced by the President in
2005 to build on the African Growth and Opportunity Act, provides
technical assistance to bolster the trade competitiveness of
African countries. This initiative has been credited with
supporting $35 million in exports by African Growth and Opportunity
Act beneficiaries in 2007. The United States also supports the
Integrated Framework that coordinates efforts by six multilateral
organizations (including the International Monetary Fund, the World
Bank, the WTO, and other organizations) to reduce poverty in
developing countries by better integrating trade into national
development strategies.

Investment Promotion Programs

The United States also facilitates investment in emerging and
developing countries by U.S. companies through the Overseas Private
Investment Corporation. According to the corporation's 2007
annual report, it has supported over $177 billion in U.S.
investment abroad through its pioneering use of U.S. Government-
backed political risk insurance, direct loans, guaranties, and
equity funds. These investments, which help provide crucial
opportunities to households and firms in developing economics, also
contribute to increased foreign asset holdings of U.S. residents.
In addition, bilateral investment treaties foster market-oriented
investment policies in partner countries, and support international
standards for investment protection. In February 2008, the
Administration signed a bilateral investment treaty with Rwanda.
When implemented, it will bring the number of U.S. bilateral
investment treaties in force to 41. The U.S. Government is pursuing
investment treaties with key emerging markets, as demonstrated by
the 2008 announcements of treaty negotiations with China, India,
and Vietnam.

Trade Preference Programs

Four U.S. preference programs are among the central elements of
U.S. trade policy to promote growth and stability in developing
countries. These programs provide preferential duty-free access for
thousands of products that would otherwise be subject to duty upon
entry to the United States. The U.S. Generalized System of
Preferences, for example, provides duty-free access to the U.S.
market for over 3,400 products from 132 beneficiary developing
countries, and provides even broader duty-free access for products
from 44 least developed countries. In addition to the Generalized
System of Preferences, U.S. preferential trade programs include the
African Growth and Opportunity Act, the Caribbean Basin Initiative,
and the Andean Trade Preference Act. These programs have been
successful in increasing and diversifying developing
countries' exports, which better integrates these countries
into the global trading system and expands choices for U.S.
manufacturers and consumers. These programs have also improved
economic stability, promoted internationally recognized labor
rights, and provided adequate and effective means to secure and
enforce property rights, including intellectual property rights.
Researchers have cautioned that preference programs can have
negative consequences if preferences divert limited resources in
developing countries to sectors that would not otherwise be
competitive. Research on specific U.S. programs, however, suggests
that in general these programs have increased exports and improved
welfare.
These programs have generated many successes. The Generalized
System of Preferences has a large and geographically diverse
impact. For example, for 15 beneficiary countries, more than one-
third of their exports to the United States received preferential
duty-free access under the program in 2007. Under the Caribbean
Basin Initiative and the associated Haiti Hope Act, Haiti--the
poorest country in the Western Hemisphere--increased apparel
exports to the United States by 75 percent between 2000 and 2007.
These benefits helped to preserve an important sector of the
Haitian economy. The African Growth and Opportunity Act has also
been successful in increasing trade. For January to October 2008,
exports from the original African beneficiary countries to the
United States increased over 250 percent compared to the same
period in 2001, and exports that entered the United States duty
free under the program exceeded $50 billion, up almost 700 percent.
U.S. exports to sub-Saharan Africa more than doubled in the same
period, totaling over $15 billion in 2008 through October.

Trade Policy Going Forward

Notwithstanding the rapid increase in U.S. regional and bilateral
trade and investment agreements, the multilateral trading system
remains at the heart of U.S. trade policy. The rules-based
multilateral system of the WTO is the essential foundation of an
increasingly integrated global economy, and the WTO remains the
single best forum to generate progress on many global trade and
investment issues. Such issues include reducing trade-distorting
support and protection for agricultural sectors maintained by many
countries, both developing and developed; and liberalizing trade
barriers and burdensome restrictions on FDI in services sectors in
developing countries.
The United States must continue to lead international efforts to
address these and similar issues in order to expand the benefits of
open markets and economic integration. In particular, the WTO Doha
Round remains a top U.S. trade policy objective, with the goal of
concluding an agreement that creates new trade flows in agricultural,
industrial, and services markets that will expand global economic
growth, development, and opportunity. The United States and many other
countries remain committed to reaching a successful final agreement
that achieves an ambitious market-opening outcome for both
developed and developing countries.
In the history of global trade liberalization, there has not been
smooth and uniform progress toward ever lower barriers. There have
been long periods of inactivity or, worse, periods of rising
protectionism. Previous periods of economic hardship have often
coincided with an increase in protectionism and economic
isolationism; for example, the use of nontariff barriers such as
quotas rose in the 1970s and 1980s. In the current troubled
economic environment, an increase in protectionism at home or
abroad could further slow global economic progress. Limiting trade
would jeopardize the strongest engine of growth of the past 2 years
in the U.S. economy. In the short term, the United States must
provide global leadership to oppose any resurgence of
protectionism, while continuing to recognize and support the
extensive benefits that an open trade and investment environment
conveys.
In the longer term, the forces of greater global economic
integration appear strong. During this Administration, as the
United States implemented FTAs with 13 countries, more than 100
other countries put more than 75 other FTAs into force. Other
nations will press forward and so must the United States to avoid
becoming economically disadvantaged in foreign markets. The United
States should continue to pursue free trade agreements and, in
particular, put into force those that have already been negotiated.
The growth in bilateral agreements further emphasizes the
importance of multilateral initiatives such as the WTO Doha Round,
which can magnify gains by simultaneously reducing barriers in many
countries, ensure that the benefits of market access are shared
more widely among nations, and lead to transparent and less complex
global trading rules.

Conclusion

The United States' commitment to openness in trade and
investment and promotion of open markets abroad has led to a
greater diversity in consumer choices, more exposure to new
technologies and ideas, and higher levels of investment and
economic growth than would otherwise have been possible. Openness
to trade and investment has contributed to higher U.S. standards of
living and has allowed the United States some structural
flexibility to cushion economic shocks. On balance, strong links to
other economies are likely to increase the resilience of the U.S.
economy in the short and long term, even taking into account the
potential for negative shocks, such as a decline in demand for U.S.
exports. Short-run hardships will surely occur, and it may take
some time for current weaknesses to be resolved, but the U.S.
commitment to openness provides substantial benefits in both the
short and long run.
With regard to trade, the U.S. commitment to openness has been most
evident in the increased number of U.S. free trade agreements.
These agreements have improved the competitiveness and performance
of U.S. producers abroad and have provided substantial savings for
U.S. producers and consumers at home. In investment, the United
States has benefited from inflows of capital from abroad. Although
it is unclear how future flows will be affected by the current
crisis, U.S. investors have historically earned high returns on
their investments abroad. The recent reform of the Committee on
Foreign Investment in the United States represents a careful effort
to remain open to foreign investors while safeguarding national
security.
U.S. development assistance has supported openness in developing
and emerging economies through investment in infrastructure, trade
capacity building, trade preference programs, and investment
promotion. U.S. efforts to relieve poverty and promote economic
growth and stability have helped numerous developing countries. In
addition, the United States' continued promotion of trade
with developing countries will improve their access to, and ability
to benefit from, global markets.