Will Direct Foreign Investment Help On The Trade Front?

Although fears about the economic effects of growing foreign ownership of U.S. companies are hardly subsiding, most economists argue that such cross-country direct investment is a "positive sum game," benefiting foreign investor and host country alike. Foreign companies, they say, have not only provided the U.S. with vital investment funds but also have boosted the competitiveness of their U.S. affiliates through enhanced capital spending and transfers of technology and expertise.

While this implies an eventual positive effect on the U.S. trade balance, a recently released Commerce Dept. review of foreign direct investment trends in the U.S. provides scant evidence of such an effect. As the chart indicates, U.S. affiliates of foreign companies (American companies with at least 10% foreign ownership) have accounted for an ever-rising share of the merchandise trade deficit -- hitting 78% by 1989, the last year for which data are available.

To be sure, much of the deficit is related to a rise in imports by wholesale affiliates of foreign companies -- presumably purchased or set up expressly for that purpose. Still, foreign manufacturing companies in the U.S., especially Japanese-owned ones, continue to run trade deficits. A recent study by James Orr of the Federal Reserve Bank of New York, for example, estimates that in 1990, four industries with heavy foreign direct investment -- autos, steel, chemicals, and electronics -- ran trade deficits with their primary investing countries that equaled 42% of the entire U.S. merchandise trade deficit.

Many economists think this pattern will inevitably change as foreign affiliates grow increasingly competitive. Commerce reports that such affiliates spend far more than their domestic counterparts on plant and equipment--$12,200 per worker in 1988, for example, compared with a manufacturing average of $8,400. They also invest more on research and development and post faster growth in output.

The problem is, foreign-affiliated manufacturers tend to purchase inputs from abroad. According to a study published by the Institute for International Economics a few years ago, the average foreign company buys more than twice the value of imported inputs per worker -- capital goods, supplies, components--than the average U.S. company, and Japanese manufacturers import more than four times as much.

The Fed of New York's Orr predicts that this dependence on foreign suppliers will decline over time as the enhanced competitiveness of foreign-affiliated manufacturers leads to a growing displacement of imports and expansion of exports. By 1995, he says, the surge in foreign direct investment in U.S. manufacturing operations in the late 1980s could result in a $25 billion improvement in the trade balance from its projected level without such investment.

If an improvement fails to materialize, of course, the clamor by protectionists to stem the foreign investment tide may well grow louder. But the issue is already losing some urgency. Commerce reports that such direct investment increased by only $30 billion in 1990, less than half the average increase during the previous three years, and the slowdown appears to be continuing.

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