None of this is very complicated—so long as we remember Justice Oliver Wendell Holmes’ admonition to “think things instead of words.” When it comes to international trade and international transfers of wealth, the things are relatively straightforward, but the words are often slippery and misleading.
INTERNATIONAL INVESTMENTS
Theoretically, investments might be expected to flow from where capital is abundant to where it is in short supply, much like water seeking its own level. In a perfect world, wealthy nations would invest much of their capital in poorer nations, where capital is more scarce and would therefore offer a higher rate of return. However, in the highly imperfect world that we live in, that is by no means what usually happens. For example, out of a worldwide total of about $21 trillion in international bank loans in 2012, only about $2.5 trillion went to poor countries—less than twelve percent. Out of nearly $6 trillion in international investment securities, less than $400 billion went to poor countries, less than 7 percent. {786}In short, rich countries tend to invest in other rich countries.
There are reasons for this, just as there are reasons why some countries are rich and others poor in the first place. The biggest deterrent to investing in any country is the danger that you will never get your money back. Investors are wary of unstable governments, whose changes of personnel or policies create risks that the conditions under which the investment was made can change—the most drastic change being outright confiscation by the government, or “nationalization” as it is called politically. Widespread corruption is another deterrent to investment, as it is to economic activity in general. Countries high up on the international index of corruption, such as Nigeria or Russia, are unlikely to attract international investments on a scale that their natural resources or other economic potential might justify. Conversely, the top countries in terms of having low levels of corruption are all prosperous countries, mostly European or European-offshoot nations plus Japan and Singapore.{787} As noted in Chapter 18, the level of honesty in a country has serious economic implications.
Even aside from confiscation and corruption, many poorer countries “do not let capital come and go freely,” according to The Economist.{788} Where capital cannot get out easily, it is less likely to go in, in the first place. It is not these countries’ poverty, as such, that deters investments. When Hong Kong was a British colony, it began very poor and yet grew to become an industrial powerhouse, at one time having more international trade than a vast country like India. Massive inflows of capital helped develop Hong Kong, which operated under the security of British laws, had low tax rates, and allowed some of the freest flows of capital and trade anywhere in the world.
Likewise, India today remains a very poor country but, since the loosening of government controls over the Indian economy, investment has poured in, especially for the Bangalore region, where a concentrated supply of computer software engineers has attracted investors from California’s Silicon Valley, creating in effect the beginnings of a new Silicon Valley in India.{789}
Simple and straightforward as the basic principles of international transfers of wealth may be, words and accounting rules can make it seem more complicated. If Americans buy more Japanese goods than the Japanese buy American goods, then Japan gets American dollars to cover the difference. Since the Japanese are not just going to collect these dollars as souvenirs, they usually turn around and invest them in the American economy. In most cases, the money never leaves the United States. The Japanese simply buy investment goods—Rockefeller Center, for example—rather than consumer goods. American dollars are worthless to the Japanese if they do not spend them on something.
In gross terms, international trade has to balance. But it so happens that the conventions of international accounting count imports and exports in the “balance of trade,” but not things which don’t move at all, like Rockefeller Center. However, accounting conventions and economic realities can be very different things.
In some years, the best-selling car in America has been a Honda or a Toyota, but no automobile made in Detroit has been the best-selling car in Japan. The net result is that Japanese automakers receive billions of dollars in American money and Japan usually has a net surplus in its trade with the United States. But what do the makers of Hondas and Toyotas do with all that American money? One of the things they do is build factories in the United States, employing thousands of American workers to manufacture their cars closer to their customers, so that Honda and Toyota do not have to pay the cost of shipping cars across the Pacific Ocean.
Their American employees have been paid sufficiently high wages that they have repeatedly voted against joining labor unions in secret ballot elections. On July 29, 2002, the ten millionth Toyota was built in the United States.{790} Looking at things, rather than words, there is little here to be alarmed about. What alarms people are the words and the accounting rules which produce numbers to fit those words.
A country’s total output consists of both goods and services—houses and haircuts, sausages and surgery—but the international trade balance consists only of physical goods that move. The American economy produces more services than goods, so it is not surprising that the United States imports more goods than it exports—and exports more services than it imports. American know-how and American technology are used by other countries around the world, and these countries of course pay the U.S. for these services. For example, most of the personal computers in the world run on operating systems created by the Microsoft Corporation. But foreign payments to Microsoft and other American companies for their services are not counted in the international balance of trade, since trade includes only goods, not services.
This is just an accounting convention. Yet the American “balance of trade” is reported in the media as if this partial picture were the whole picture, and the emotionally explosive word “deficit” sets off alarms. Yet there is often a substantial surplus earned by the United States from its services, which are of course omitted from the trade balance. In 2012, for example, the United States earned $124 billion from royalty and license fees alone, {791} and more than $628 billion from all the services it supplied to other countries.{792} The latter was more than double the Gross Domestic Product of Egypt or Malaysia.{793}
The Wall Street Journal ’s comment on the trade deficit was:
On the list of economic matters to worry about, “the trade deficit” is about 75th—unless politicians react to it by imposing new trade barriers or devaluing the currency.{794}
With trade deficits, as with many other things, what matters is not the absolute size but the size relative to the size of the economy as a whole. While the United States has the world’s largest trade deficit, it also has the world’s largest economy. The American trade deficit was just under 5 percent of the country’s Gross Domestic Product in 2011—less than half that of Turkey and less than one-fourth that of Macedonia.{795}
When you count all the money and resources moving in and out of a country for all sorts of reasons, then you are no longer talking about the “balance of trade” but about the “balance of payments”—regardless of whether the payments were made for goods or services. While this is not as misleading as the balance of trade, it is still far from being the whole story, and it has no necessary connection with the health of the economy. Ironically, one of the rare balance of payments surpluses for the United States in the late twentieth century was followed by the 1992 recession.{796} Germany has regularly run export surpluses, but at the same time its economy has had slower growth rates and higher unemployment rates than those of the United States.{797} Nigeria has often had years of international trade surpluses and is one of the poorest countries in the world.
This is not to say that countries with trade surpluses or payments surpluses are at an economic disadvantage. It is just that these numbers, by themselves, do not necessarily indicate either the prosperity or the poverty of any economy.
Data on foreign inve
stments can also produce misleading words. According to the accounting rules, when people in other countries invest in the United States, that makes the U.S. a “debtor” to those people, because Americans owe them the money that they sent to the U.S., since it was not sent as a gift. When people in many countries around the world feel more secure putting their money in American banks or investing in American corporations, rather than relying on their own banks and corporations, then vast sums of money from overseas find their way to the United States.
Foreigners invested $12 billion in American businesses in 1980 and this rose over the years until they were investing more than $200 billion annually by 1998. By the early twenty-first century, the United States received more than twice as much foreign investment as any other country in the world.{798} As of 2012, foreigners bought $400 billion more assets in the United States than Americans acquired abroad.{799} That exceeds the Gross Domestic Product of many countries. Most of this money (60 percent) comes from Europe and another 9 percent from Canada{800}—together adding up to more than two-thirds of all foreign investment in the United States. Prosperous countries tend to invest in other prosperous countries.
Looked at in terms of things, there is nothing wrong with this. By creating more wealth in the United States, such investments created more jobs for American workers and created more goods for American consumers, as well as providing income to foreign investors. Looked at in terms of words, however, this was a growing debt to foreigners.
The more prosperous and secure the American economy is, the more foreigners are likely to want to send their money to the United States, and the higher the annual American balance of payments “deficits” and accumulated international “debt” rises. Hence it is not at all surprising that the long prosperity of the U.S. economy in the 1990s was accompanied by record levels of international deficits and debts. The United States was where the action was and this was where many foreigners wanted their money to be, in order to get in on the action. This is not to say that things cannot be different for other countries with different circumstances.
Some other prosperous countries invest more abroad than foreign countries invest in them. France, Britain, and Japan, for example, invest hundreds of billions of dollars more in other countries than other countries invest in them.{801} There is nothing intrinsically wrong with being a creditor nation, any more than there is anything intrinsically wrong with being a debtor nation. Everything depends on the particular circumstances, opportunities, and constraints facing each country. Switzerland, for example, has had a net investment in other countries larger than the Swiss Gross Domestic Product.{802} Vast sums of money come into Switzerland as a major international financial center and, if the Swiss cannot find enough good investment opportunities within their own small country for all this money, it makes perfect sense for them to invest much of the money in other countries.
The point here is that neither international deficits nor surpluses are inevitable consequences of either prosperity or poverty and neither word, by itself, tells much about the condition of a country’s economy. The word “debt” covers very different kinds of transactions, some of which may in fact present problems and some of which do not. Every time you deposit a hundred dollars in a bank, that bank goes a hundred dollars deeper into debt, because it is still your money and they owe it to you. Some people might become alarmed if they were told that the bank in which they keep their life’s savings was going deeper and deeper into debt every month. But such worries would be completely uncalled for, if the bank’s growing debt means only that many other people are also depositing their paychecks in that same bank.
On the other hand, if you are simply buying things on credit, then that is a debt that you are expected to pay—and if you run up debts that are beyond your means of repayment, you can be in big trouble. However, a bank is in no trouble if someone deposits millions of dollars in it, even though that means going millions of dollars deeper in debt. On the contrary, the bank officials would probably be delighted to get millions of dollars, from which they can make more loans and earn more interest.
For most of its history, the United States has been a debtor nation—and has likewise had the highest standard of living in the world for most of its history. One of the things that helped develop the American economy and changed the United States from a small agricultural nation to an industrial giant was an inflow of capital from Western Europe in general and from Britain in particular. These vast resources enabled the United States to build canals, factories and transcontinental railroads to tie the country together economically. As of the 1890s, for example, foreign investors owned about one-fifth of the stock of the Baltimore & Ohio Railroad, more than one-third of the stock of the New York Central, more than half the stock of the Pennsylvania Railroad, and nearly two-thirds of the stock of the Illinois Central.{803}
Even today, when American multinational corporations own vast amounts of assets in other countries, foreigners have owned more assets in the United States than Americans owned abroad for more than a quarter of a century, beginning in 1986.
Obviously, foreign investors would never have sent their money to America unless they expected to get it back with interest and dividends. Equally obviously, American entrepreneurs would never have agreed to pay interest and dividends unless they expected these investments to produce big enough returns to cover these payments and still leave a profit for the American enterprises. These investments usually worked out largely as planned, for generations on end. But this meant that the United States was officially a debtor nation for generations on end. Only as a result of lending money to European governments during the First World War did the United States become a creditor nation. Since then, the U.S. has been both, at one time or another. But these have been accounting details, not determinants of American prosperity or economic problems.
While foreign investments played a major role in the development of particular sectors of the American economy, especially in the early development of industry and infrastructure, there is no need to exaggerate their over-all importance, even in the nineteenth century. For the American economy as a whole, it has been estimated that foreign investment financed about 6 percent of all capital formation in the United States in the nineteenth century.{804} Railroads were exceptional and accounted for an absolute majority of foreign investments in the stocks and bonds of American enterprises.{805}
In various other countries, the role of foreign investors has been much greater than in the United States, even though the large American economy has received more foreign investments in absolute amounts. In the early twentieth century, for example, overseas investors owned one-fifth of the Australian economy and one-half that of Argentina.{806}
Neither the domestic economy nor the international economy is a zero-sum process, where some must lose what others win. Everyone can win when investments create a growing economy. There is a bigger pie, from which everyone can get bigger slices. Massive infusion of foreign capital contributed to making the United States the world’s leading industrial nation by 1913, when Americans produced more than one-third of all the manufactured goods in the world.{807}
Despite fears in some countries that foreign investors would carry off much of their national wealth, leaving the local population poorer, there is probably no country in history from which foreigners have carried away more vast amounts of wealth than the United States. By that reasoning, Americans ought to be some of the poorest people in the world, instead of consistently having one of the world’s highest standards of living. The reason for that prosperity is that economic transactions are not a zero-sum activity. They create wealth.
In some less fortunate countries, the same words used in accounting—especially “debt”—may have a very different economic reality behind them. For example, when exports will not cover the cost of imports and there is no high-tech know-how to export, the government may borrow money from some other country or from some international agency
, in order to cover the difference. These are genuine debts and causes for genuine concern. But the mere fact of a large trade deficit or a large payments deficit does not by itself create a crisis, though political and journalistic rhetoric can turn it into something to alarm the public.
Lurking in the background of much confused thinking about international trade and international transfers of wealth is an implicit assumption of a zero-sum contest, where some can gain only if others lose. Thus, for example, some have claimed that multinational corporations profit by “exploiting” workers in the Third World. If so, it is hard to explain why the vast majority of American investments in other countries go to richer countries, where high wage rates must be paid, not poorer countries whose wage rates are a fraction of those paid in more prosperous nations.
Over the period from 1994 to 2002, for example, more U.S. direct investment in foreign countries went to Canada and to European nations than to the entire rest of the world combined.{808} Moreover, U.S. investments in truly poverty-stricken areas like sub-Saharan Africa and the poorer parts of Asia have been about one percent of worldwide foreign investment by Americans. Over the years, a majority of the jobs created abroad by American multinational companies have been created in high-wage countries.
Just as Americans’ foreign investments go predominantly to prosperous nations, so the United States is itself the world’s largest recipient of international investments, despite the high wages of American workers. India’s Tata conglomerate bought the Ritz-Carlton Hotel in Boston and Tetley Tea in Britain, {809}among its many international holdings, even though these holdings in Western nations require Tata Industries to pay far higher wages than it would have to pay in its native India.
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