Why We Need Foreign Investment

Hardly a week goes by without another headline about a foreign acquisition of a major U.S. company or landmark piece of real estate. The Japanese purchase of a stake in Rockefeller Center, in particular, unleashed strong emotions all across America. The Rockefeller Center deal is a symbol of America’s relative decline in the world; it raises fears that our economic sovereignty is at stake.

But is the fear justified? Does the United States need a new policy to limit the sale of our assets to foreigners? It may already be too late for the voice of reason to be heard, but it is worth trying to think in a calm way about the costs and benefits of foreign investment in this country.

The most important point to understand is that U.S. dependence on foreign money is not new--in fact, our dependence on foreign money is less now than it has been for quite some time. The United States must sell foreigners IOUs of one kind or another to pay for the excess of our imports over our exports, so our dependence on foreign money is simply the flip side of our trade deficit. But the trade deficit has fallen recently; as a share of gross national product it was lower in 1989 than it has been since 1983. So the sudden furor over foreign investment in our country isn’t really about money.

What the fuss is really about is control. Until 1987, most foreign money pouring into the United States was “portfolio” investment, aimed at earning income but not at establishing control. Since the early 1980s, for example, Japanese investors have put substantial sums into U.S. government and corporate bonds; the United States must pay interest on these bonds, but the Japanese bondholders do not get any say in the operations of U.S. firms.

It is only in the past three years that foreigners have started to use a large fraction of their money for “direct” investments, creating subsidiaries in the United States either from scratch or by buying existing U.S. firms. That is, the foreigners are actually bringing less money here, but they are using it in a more aggressive way.

The Japanese, in particular, have almost completely changed the way that they use their money. In 1986 Japan’s current account surplus was $86 billion; only $14 billion was used for direct investments. By 1989 the Japanese surplus had been eroded by increased imports and tourism to the still hefty sum of $60 billion--but more than $40 billion was used to buy or extend control over foreign firms.

But so what? Why does direct investment get people so upset?

One reason may be simply that direct investments are more visible. Economists have been warning the public about America’s growing foreign debt for years, but until now that has been an abstract notion--you can’t walk down the street and see that foreign debt, and most people have just tuned the warnings out. When the Japanese buy Columbia Pictures, or Rockefeller Center, or much of downtown Los Angeles, that’s a different matter. Suddenly the reality of the U.S. plunge into debt has become unavoidable.

Growing U.S. indebtedness is not news, however, and the answer to our dependence on foreign capital is straightforward and familiar: increase our own domestic savings so that we don’t need the foreign money. But the only sure way to increase savings is to eliminate the budget deficit, and the only practical way to do that is to raise taxes, and none of that is going to happen soon. It there something that we can or should do in the meantime?

Bear in mind that we need foreign money. We cannot simply tell foreigners not to invest here at all unless we are prepared to save enough to finance our own investment--and we aren’t. So if we restrict one kind of foreign investment we will have to attract foreign investors another way. If we won’t let them buy our companies, we will have to sell them bonds. And since they prefer to buy companies, we will have to bribe them to take bonds instead, either by offering a higher interest rate or by making the bonds cheap with a weaker dollar. So any restrictions on foreign direct investment will carry a cost.

This cost might be worth paying if we thought that when foreigners acquire control of a U.S. firm, they would use that control in ways detrimental to our interests. That is the real issue in the debate over foreign investment: Will foreign firms act differently from U.S. firms, in ways that hurt our country?

Most opponents of foreign investment have refused to face this issue squarely. They prefer to pose the issue as one of national sovereignty--do we want decisions that affect the livelihood of American workers to be made in Osaka? The problem with this kind of argument is not that it is unfair to the foreigners, who aren’t in business for our health, but that it is too generous to American firms, who aren’t in business for our health either. We can be sure that Japanese managers will often be ruthless about closing unprofitable operations in the United States. So are American firms. It will not provide any comfort to a laid-off worker to know that the order to close his plant came from New York or Chicago instead of Tokyo.

The right question is how foreigners will behave differently. And there is one accusation about foreign firms that, if true, would be a serious reason to restrict foreign investment in the United States. It is that foreign firms will strip the sophisticated activities out of their U.S. subsidiaries. The high-skill jobs, the research and development, will be shifted from Cleveland to Yokohama; the United States will be left with assembly plants where only routine, low-paid jobs are available.

If this were true, it would be a serious problem. But it is an accusation whose truth can be tested--and it isn’t true. Recently, Edward M. Graham of Duke University and I carried out an extensive study of foreign direct investment in the United States, and we found no evidence at all that foreign firms keep the sophisticated activities at home. Foreign firms in general, and Japanese firms in particular, are virtually indistinguishable from U.S. firms in terms of value added per worker, wage rates and R&D.; They do import more, but that is a much less important issue, and does not warrant the widespread alarm over foreign investment.

In the end, the fuss over Rockefeller Center may itself be a good symbol of the irrationality of much of the current debate. For what can the Japanese do with Rockefeller Center that would hurt U.S. interests? Start using imported Rockettes? It is hard to think of a more innocuous investment in economic terms. The only damage is to our complacency--and for that shock we should thank the Japanese, not blame them.