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Why Does U.S. Investment Abroad Earn Higher Returns than Foreign Investment in the United States 1 (November 2005)

handle is hein.congrec/cbo9479 and id is 1 raw text is: A series ofissue summaries from the Congressional Budget Office NOVEMBER 30, 2005 Why Does U.S. Investment Abroad Earn Higher Returns Than Foreign Investment in the United States? SummaryWhen the United States or any nation runs a current- Summaryaccount deficit-that is, when its total receipts from At the end of 2004, foreigners owned $12.5 trillion abroad (from exports of goods and services, unilateral worth of assets in the United States, $2.5 trillion transfers, and international investment income) falls more than the value of U.S.-owned assets abroad. short of its total payments (for imports, unilateral trans- That difference is a legacy of cumulative U.S. fers, and returns on foreign investment in the nation)it current-account deficits. Nevertheless, U.S. resi- must finance that deficit by either borrowing from or sell- dents consistently earn more income from their for- ing assets to foreigners.' Thus, foreign holdings of U.S. eign investments than foreigners earn from their assets rise relative to U.S. holdings of foreign assets in larger U.S. investments, thereby holding down the each year that the United States runs a current-account size of the U.S. current-account deficit. That situa- deficit. After more than two decades of such deficits, the tion mainly reflects the fact that U.S. companies United States now has a smaller dollar value of foreign receive more earnings from each dollar's worth of assets than foreigners have of U.S. assets. That difference direct investment abroad (ownership of foreign sub- (net U.S. liabilities to foreigners) reached $2.5 trillion at sidiaries) than foreign companies earn from their the end of 2004. subsidiaries in the United States. Despite their smaller holdings, U.S. residents have persis- Three factors may account for the difference in tently earned more income on their assets abroad than returns on cross-border direct investment. First, foreigners have earned on their assets in the United U.S. subsidiaries abroad have generally been in States. Such net U.S. investment income showed a total business longer than foreign-owned subsidiaries in surplus of $36.2 billion in 2004 and an annualized sur- this country, which contributes to their greater plus of $6.1 billion in the first half of 2005. In other profitability. Second, in some cases, U.S. subsidiar- words, the rate of return on U.S.-owned assets abroad ies abroad face greater risks of political or economic (measured as the ratio of investment income to assets) has disruptions than subsidiaries of foreign corpora- been higher than the rate of return on foreign-owned tions face in the United States. U.S. investors may assets in the United States. As long as that advantageous require higher returns because of that difference in gap in returns continues, it will help to slow the rise in risk; however, compensation for risk appears to the nation's current-account deficit. explain a much smaller portion of the difference in returns than some analysts may believe. Third, The U.S. Comes some observers argue that U.S.-owned subsidiariesAdatg abroad appear to be more profitable because they fo ietIvsm n overstate their profits-and foreign-owned subsid- Bt ..adfrinfrsmk ietivsmnsot iaries in the United States understate their profits-sietirhmconis.FrxapUS.uoobl for tax reasons. However, the extent to which such misstatements affect the difference in returns is1.Jtrtinlnvtmtinmamaurdn vrmntt- unknown.titcicueinoe(neetaddvdnsbunocptl -Douglas Holtz-Ea kin ast swl sicm rmdrc netetara itrs Directoraon diinds ais, foen bidis totreeirpats rompa trnsies, plus thoesbirninal rinvestedeanins).fll

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