The Return on U.S. Direct Investment at Home and Abroad

Abstract

A longstanding puzzle is that the United States is a net borrower from the rest of the world, yet it continues to receive net income on its external position. First, we confirm earlier work showing that this is because in the U.S. balance of payments the yield reported on U.S. direct investment abroad (USDIA) has been significantly above the yield on foreign direct investment in the U.S. (FDIUS). Second, we show that the yield on USDIA is very close to that earned by others on their foreign direct investments outside of the United States. This implies there is nothing unique, or particularly temporary, about the returns earned on USDIA. Third, we show that although the reported yield on USDIA is significantly above the yield that U.S. investors earn on their investments in the United States (USIUS), this positive gap largely disappears after one puts the two yields on the same, after-U.S.-tax, basis and accounts for differences in sovereign risk and earnings volatility. Finally, comparing the returns on FDIUS with USIUS, we find that some of the historical gap in favor of USIUS can be attributed to age effects associated with the investments and off-market pricing of intercompany debt that likely reflects tax management on the part of foreigners investing in the United States. Taken together, our results suggest the difference in yields underlying the U.S. net income puzzle is likely to persist so long as the United States is perceived to be a relatively safe place to invest and U.S. corporate tax rates remain above those levied elsewhere. This has implications for the long-run sustainability of the U.S. external position.

Keywords: Foreign Direct Investment, Returns Differentials, U.S. Current Account

JEL Classification: F21, F23, F3