Overseas investment encourages domestic investment

There is a widespread popular perception that when American companies invest abroad they reduce economic activity and employment in the United States. But a recent paper from the National Bureau of Economic Research offers an alternative perspective: greater foreign investment by U.S. multinational firms is actually linked to greater investments at home as well.

The authors examine investment data covering a broad set of high-income countries during the 1980s and 1990s and confirm earlier findings that outbound foreign direct investment (FDI) appears to reduce aggregate domestic investment. However, when they focus solely on the domestic and foreign capital spending of U.S.-based multinational corporations, they find the opposite result:

When the foreign affiliates of U.S. multinational corporations engage in higher capital expenditures, the American multinationals also tend to increase investment back home.

This suggests that foreign and domestic investment are compliments, not substitutes.

They estimate that an additional dollar of foreign investment capital expenditure is associated with 3.5 dollars of domestic capital expenditures by the same group of multinational firms.

The paper concludes that a multinational firm that combines domestic production with foreign production can produce at a lower cost overall, so each stage of the production process is more profitable.

Source: Carlos Lozada, Does Overseas Investing Reduce Domestic Investment? NBER Digest, August 2005; based upon: Mihir Desai, C. Fritz Foley, and James Hines, Foreign Direct Investment and the Domestic Capital Stock, National Bureau of Economic Research, Working Paper, No. 11075, January 2005.

For text: http://www.nber.org/digest/aug05/w11075.html

For abstract: http://papers.nber.org/papers/w11075

For more on Economic Issues: http://www.ncpa.org/iss/eco/

FMF Policy Bulletin/ 25 October 2005