by Joseph Joyce
The sharp contraction in economic activity in the first half of 2020 due to the COVID pandemic was followed by a slow and uneven recovery in the second half of the year. The decline slowed global trade and capital flows, although not as much as initially expected. The economc slowdown also lowered investment income and remittances, the two main forms of international factor income payments. (There is also rent received on property.) Will these also recover as economic growth resumes?
Net investment income appears in the current account of the balance of payments as part of net primary income. For most countries FDI income is the largest component of investment income, followed by portfolio (equity and debt) income and other (mainly bank) income. The largest net recipients of FDI income are the U.S., Japan, Germany and France, all home countries for multinationals. Emerging markets economies that attract FDI flows, such as India and China, are major net payers of FDI income. Ireland, which attracts multinationals with its low corporate tax rates and its proximity to continental Europe, also records large FDI income deficits.
The latest issue of the OECD’s FDI in Figures reports FDI income for 2020 for the OECD area. Total FDI receipts were $1.80 trillion and payments were $1.04 trillion, which result in net FDI income payments of $418 billion. Almost three-quarters of the OECD income earnings were paid out to the parent countries, with the remainder reinvested in the host countries.
As expected, the 2020 FDI income flows represented declines from those of 2019, which the OECD attributed to the pandemic. The percent changes—a drop in receipts of 16% and of 15% in payments—were similar to those recorded during the global financial crisis. Moreover, the 2019 earnings were below those of 2018 due to slowing economic growth.
A recovery in FDI income will depend in part on the future course of FDI flows. Global FDI flows decreased by 38% in 2020 to $846 billion, their lower level since 2005. When scaled by GDP, they represented 1% of world GDP, the lowest relative level since 1999. In the OECD area, much of this decline was driven by disinvestments from Switzerland and the Netherlands, which serve as financial centers for companies with headquarters in other countries. The OECD reports a rise in cross-border mergers and acquisitions in the second half of 2020 and the first quarter to 2021.
The outlook for FDI-associated income also depends on the outcome of the talks sponsored by the OECD to harmonize the rules governing how tax rights are determined amongst jurisdictions, and also to set a minimum global tax rate. Multinational firms have been able to take advantage of the differences in corporate tax rates among nations by basing their operations in tax havens such as Luxembourg and Bermuda. If the negotiating parties come to an agreement, multinational firms will have to reassess the locations of their operations. They are most likely to cut back their use of the tax havens, but how they will restructure their activities and the impact on global supply chains is not clear.
There is also uncertainty over the impact of government policies on multinational investments. The U.S. and Chinese governments have indicated that they want to build up their respective domestic capacities in a number of areas, and will use trade and financial restrictions to promote domestic suppliers while limiting foreign access. Controls on inward FDI, for example, are used to deny foreign firms and governments access to domestic technology. Trade barriers also inhibit companies from expanding their operations, and the Biden administration has indicated that it will take an aggressive response to what it perceives as unfair Chinese policies.
Remittances fared better in 2020, according to the World Bank, falling to $540 billion, only 1.6% below the previous year’s level. With the exception of China, remittances exceeded the total of FDI flows and financial assistance to developing countries. The true value may be higher since not all remittances are recorded. The largest recipients in absolute terms were India, China, Mexico, the Philippines and Egypt, all countries with large labor forces. The U.S. was the largest source of the remittances, followed by the United Arab Emirates, Saudi Arabia and the Russian Federation.
Why were remittances so strong? Gabriella Cova of the Atlantic Council writes that many migrants believed that conditions in their home countries were worse than in their host countries, and continued to send money home. Consequently, the reminttances were counter-cyclical for the recipient countries, partially offsetting the domestic economic contraction. The migrants who retained jobs in “essential” sectors were able to send money to their home countries. Moreover, the appreciation of the dollar increased the domestic values of their payments.
The future for migrants and their remittances, like FDI, is also uncertain. Developed countries with aging workforces will increasingly need migrants to take the place of native-born workers. On the other hand, the closure of borders during the pandemic may reinforce the trend to technological solutions. Japan, for example, has been developing robotic care for the health sector. Border control is a contentious area of public policy, although the pandemic also demonstrated the need for workers to undertake basic tasks in food production, distribution and delivery.
International factor payments have become increasingly important components of the balance of payments. Depending upon their value, they can either offset or amplify a trade account deficit (see Forbes, Hjortsoe and Nenova 2016). They also distinguish GDP from GNP, and can affect income inequality in both the home and host countries. The COVID pandemic disrupted them, particularly FDI income, and their future depends on how capital and labor flows are restructured after the pandemic.