Their results show that in 2017 global FDI of almost $40 trillion included real FDI of $25 trillion and phantom FDI of about $15 trillion. Moreover, the share of phantom FDI in total FDI has risen from above 30% in 2009 to just below 40% in 2017. Luxembourg reported the largest amount of phantom FDI of $3.8 trillion, followed by the Netherlands with around $3.3 trillion. The largest stock of real FDI, on the other hand, was located in the U.S., which also owned the largest amount of outward FDI. China has been a significant recipient of inward FDI (but see below), as were the United Kingdom, Germany and France. The authors also found evidence of “round tripping,” i.e., supposedly inward foreign investment that is actually held by domestic investors. In the case of China and Russia about 25% of real FDI is owned by investors in those countries.
Another investigation of the data on international capital was undertaken by Antonio Coppola of Harvard, Matteo Maggiori of Stanford’s Graduate School of Business, Brent Neiman of the University of Chicago’s Booth School of Business and Jesse Schreger of the Columbia Business School, and they report their results in “Redrawing the Map of Global Capital Flows: The Role of Cross-Border Financing and Tax Havens.” Global firms have increasingly issued securities through affiliates in tax haven, and these authors seek to uncover the ultimate issuers of these securities. Their results allow them to distinguish between data reported on a “residency” basis based on the country where the securities are issued versus a “nationality” basis, which shows the country of the ultimate parent.
The authors begin with data from several databases that allows them to uncover global ownership chains of securities through tax haven nations such as Luxembourg and the Cayman Islands. They use this mapping to determine the ultimate issuers of securities held by mutual funds and exchange traded fund shares that are reported by Morningstar. Finally, they use their reallocation matrices to transform residency-based holdings of securities as reported in the U.S. Treasury’s International Capital data and the IMF’s Coordinated Portfolio Investment Survey to nationality-basis holdings.
Their results lead to a number of important findings. Investments from advanced economies to emerging market countries, for example, have been much larger than had been reported. For example, U.S. holdings of corporate bonds in the BRIC economies (Brazil, Russia, India and China) total $99 billion, much larger than the $17 billion that appears in the conventional data. U.S. holdings of Chinese corporate bonds alone rises from $3 billion to $37 billion, and of Brazilian bonds the total increases from $8 billon to $44 billion. These figures are even higher when the U.S. subsidiaries of corporations in emerging markets which issue securities in the U.S. are accounted for. Similarly, holdings of common equities in the emerging markets by investors in the U.S. and Europe are much larger when the holdings are reallocated from the tax havens to the ultimate owners. This is particularly evident in the case of China.
The reallocation also shows that the amount of corporate bonds issued by firms in the emerging markets has been more significant than realized. While the issuance of sovereign bonds is accurately reported, the issuance of corporate bonds has often occurred via offshore subsidiaries. These bonds are often denominated in foreign currencies, so their reallocation to their ultimate issuers results in an increase in foreign currency exposure for their home countries.
As in the previous study, Coppla, Maggiori, Neiman and Schreger also find that some “foreign” investment represents domestic investment routed through a tax haven, such as the Cayman Islands. These flows are particularly significant in the case of the U.S. In addition, some FDI flows to China should be classified as portfolio, since they reflect foreign participation in offshore affiliates that is channeled to China. FDI positions are not revalued as often as portfolio holdings, and as a result the authors claim that China’s net foreign asset position is overstated.
The results of these ground-breaking papers have important implications. First, the international ownership of capital is more concentrated than realized. The “Lucas paradox” of international capital flowing from developing to advanced economies was based on misleading data. The U.S. and several other advanced economies have large stakes in the emerging markets. Second, some of emerging markets are more vulnerable to currency depreciations than the official data suggest because their corporations have issued debt through subsidiaries in ta haven countries. Third, multinational corporations have been successful in shielding their income from taxation by using tax havens. The OECD has been working to bring this profit shifting under control, but effective reform may require a fundamental change in how multinationals are taxed by national governments.
Excellent article. Thanks. Looks like the 60’s counterculture understood capitalism fairly well. Slightly more contemporary pop culture gets it correct too. My wife was working online while I read this and multi-tasking with an episode of NCIS playing on the TV just behind me.
“Ziva David : What do you know about the American Dream?
Special Agent Anthony DiNozzo : Well, let’s see: I’m a white male, between the ages of 18 and 49, with a loud mouth and a gun… I *am* the American Dream.”
A bit later in that episode (Outlaws and In-Laws) DiNozzo expands his definition of the American Dream to those waiting to win Lotto jackpots or be adopted by a rich benefactor like Little Orphan Annie.
Of course there are lot more kinds of arbitrage to cross border capital flows than just tax evasion and socioeconomic camouflage. Labor cost, resource cost, and regulatory evasion being the first cross border price arbitrage gambits that come to mind. Pop culture can tell us as much as anyone about how we got here, but none can tell us how that we are going to leave except maybe coronavirus. I will be 72 next month.
In absolute terms the funding of a race to the top may be more profitable than funding a race to the bottom, certainly for GDP but possibly even for the capitalist investor and managerial classes themselves. However, a race to the bottom certainly extends greater superiority and self-esteem to the capital investor and managerial classes than a race to the top which reduces inequality and increases economic mobility. The various gambits of arbitrage available from cross border capital flows are the essential building blocks of a race track to the economic bottom for labor.
Susan Strange 101.
https://en.wikipedia.org/wiki/Susan_Strange
Books:
Casino Capitalism
States and Markets
Rival States, Rival Firms: Competition for World Market Shares
The Retreat of the State: The Diffusion of Power in the World Economy
Mad Money: When Markets Outgrow Governments
Most of the above books were published in the late 1980’s and 1990’s. Nothing changes or it has even gotten worse. Sigh