Tag: investment

Anemic Business Investment Indicts U.S. Policies

Since the beginning of the Great Uncertainty – the period that began with the “stimulus,” the auto bailout, the push for another major entitlement program, Dodd-Frank, the regulatory dam burst, the subsidies for favored industries, and the proliferation of distinctly anti-business rhetoric from the White House – President Obama has appeared puzzled by the dearth of business investment and hiring. Go figure.

Nonresidential fixed investment fell off a cliff in 2009, and has yet to recover even in nominal terms. As a share of GDP and relative to the trend in investment growth prior to the 2008 recession, the picture is more troubling still. If tomorrow’s wealth and living standards are functions of today’s investment – and they are – reversing the decline in investment should be the economic priority of U.S. policymakers. 

Instead, the administration has been cavalier about the problem and aloof to real solutions, choosing to view investment as a casualty of partisan politics, as though business is intentionally holding back to sully the economy on this president’s watch. Such narcissism has obscured the White House’s capacity to grasp the power of incentives.

It’s not just domestic investment that is lagging. Foreign direct investment in real U.S. assets is also on the decline. The United States is part of a global economy, which means that U.S. and foreign based businesses can invest, hire, develop, produce, assemble and service almost anywhere they choose. And that means the United States is competing with the rest of the world to attract and retain investment. Of course, the implication of this – whether policymakers know it or not and whether they like it or not – is that globalization is serving to discipline bad public policy. Policies that are hostile to wealth creators chase them away, while smart policies attract them and harvest their fruits.

Business investment is ultimately a judgment about a jurisdiction’s institutions, policies, human capital, and prospects. As the world’s largest economy featuring a highly productive work force, world-class research universities, a relatively stable political climate, strong legal institutions, accessible capital markets, and countless other advantages, the United States has been able to attract the investment needed to produce the innovative ideas, revolutionary technologies, and new products and industries that have continued to undergird its position atop the global economic value chain. 

The good news is that the $3.5 trillion of foreign direct investment parked in the United States accounted for 17 percent of the world’s direct investment stock in 2011 – more than triple the share of the next largest single-country destination. The troubling news is that in 1999 the United States accounted for 39 percent of the world’s investment stock.

Senators Levin and McCain: Two Peas All Up in our iPods

Earlier this year, Senator Carl Levin (D-MI) announced that he will be retiring after many, many, many decades of lawmaking when his term expires in January 2015. But he doesn’t intend to make for the exits without sealing his legacy of disdain for America’s wealth creators. After holding hearings last September to shed light on the “loopholes and gimmicks” employed by U.S. multinational companies to avoid paying their “fair share” of taxes, Levin resumed his inquisition today by holding a hearing intended to publically shame one of America’s most successful and most bountiful companies:

Apple sought the Holy Grail of tax avoidance. It has created offshore entities holding tens of billions of dollars, while claiming to be tax resident nowhere. We intend to highlight that gimmick and other Apple offshore tax avoidance tactics so that American working families who pay their share of taxes understand how offshore tax loopholes raise their tax burden, add to the federal deficit and ought to be closed.

Man, the spite in those words is palpable.

At the outset, it is important to note that no illegalities have been alleged, nor have any likely been committed. Like most other U.S.-based multinational corporations, who face tax rates of 35 percent on profits repatriated from abroad, Apple has tax avoidance specialists on its payroll to figure out the most effective ways to minimize their tax burden. They’d be sued for corporate malfeasance by their shareholders if they didn’t.

Unlike foreign-based multinationals whose governments don’t tax their profits earned abroad (or do so very lightly), U.S multinationals are subject to double taxation—first in the foreign countries where they operate at local tax rates and then by the IRS, at up to 35 percent, when profits are brought home. Well guess what? That system discourages profit repatriation, depriving the economy of working capital, and it encourages elaborate, legal tax avoidance schemes.

Oddly, Senator Levin’s problem is not with these perverse incentives, but with the act of following them. Thank you, sir, may I have another! But even worse, Senator John McCain (R-AZ) acknowledges the faults and disincentives of the system, but still casts the blame on those following Congress’s incentive structure:

I have long advocated for modernizing our broken and uncompetitive tax code, but that cannot and must not be an excuse for turning a blind eye to the highly questionable tax strategies that corporations like Apple use to avoid paying taxes in America. The proper place for the bulk of Apple’s creative energy ought to go into its innovative products and services, not in its tax department.

A company that found remarkable success by harnessing American ingenuity and the opportunities afforded by the U.S. economy should not be shifting its profits overseas to avoid the payment of U.S. tax, purposefully depriving the American people of revenue. It is important to understand Apple’s byzantine tax structure so that we can effectively close the loopholes utilized by many U.S. multinational companies, particularly in this era of sequestration.

Apple’s byzantine tax structure?

Should Apple be blamed for optimizing according to the legal incentives created by the likes of Senators Levin and McCain? Rather, the public would be better served if Senators Levin and McCain were hauled before a public panel to explain why the tax system they helped create and have failed to reform penalizes U.S. companies, and discourages domestic reinvestment.

The Myth of a Manufacturing Renaissance

Have you heard all the banter about a U.S. manufacturing renaissance? Numerous media reports in recent months have breathlessly described a return of manufacturing investment from foreign shores, mostly attributing the trend to rising wages in China and the natural gas boom in the United States, both of which have rendered manufacturing state-side more competitive. Today’s Washington Post includes a whole feature section titled “U.S. Manufacturing: A Special Report,” devoted entirely to the proposition that the manufacturing sector is back!

The myth of manufacturing decline begets the myth of manufacturing renaissance. This new mantra raises a question: How can there be a manufacturing renaissance if there was never a manufacturing “Dark Ages”?

Contrary to countless tales of its demise, U.S. manufacturing has always been strong relative to its own past and relative to other countries’ manufacturing sectors. With the exception of a handful of post-WWII recession years, U.S. manufacturing has achieved new records, year after year, with respect to output, value-added, revenues, return on investment, exports, imports, profits (usually), and numerous other metrics appropriate for evaluating the performance of the sector. The notion of U.S. manufacturing decline is simply one of the most pervasive economic myths of our time, sold to you by those who might benefit from manufacturing-friendly industrial policies with the abiding assistance of a media that sometimes struggles to distill fact from K Street speak.

What the Candidates Won’t Explain about Outsourcing

Like almost everything about the 2012 presidential campaigns, the bickering between the major party candidates over who is most responsible for shipping jobs overseas has been banal and utterly uninformative. While politicians have scared many Americans with hyperbolized sales pitches about the costs of foreign outsourcing, most people remain in the dark about the causes and benefits of outsourcing. What is foreign outsourcing anyway? Why do some businesses invest in sales operations, research and development, production and assembly operations, or the provision of services abroad? Are low wages and lax environmental and safety standards in poor countries really the magnets attracting U.S. investment? If so, why is 75% of U.S. direct investment abroad in rich countries? What explains the fact that the United States (high-standard, rich country that it is) is the number one destination in the world for foreign direct investment? Doesn’t the fact that businesses have options in our globalized economy serve to discipline some of the worst government policies?

As I suggested in this recent post:

In a globalized economy, outsourcing is a natural consequence of competition. And policy competition is the natural consequence of outsourcing. Let’s encourage this process.

Answers to the questions raised in this post and some other thoughts about outsourcing are expressed in this cool 4+ minute video produced by Cato’s Caleb Brown and Austin Bragg:

Topics:

Is Romney Going to Defend ‘Shipping Jobs Overseas’? No Way

The lead story in today’s Washington Post accuses Mitt Romney, while at Bain Capital, of investing in firms “that specialized in relocating” American jobs overseas. This gave cause to Obama political adviser David Axelrod to accuse Romney of “breathtaking hypocrisy,” which prompted Roger Pilon to spell out some differences between economics and “Solyndranomics” for the administration. Roger’s correct. But Romney—for running away from that record and playing to that same politically fertile economic ignorance that tempts devastating economic policies—is also worthy of his scorn. Romney should have written Roger’s words.

President Obama set the tone earlier this year during his SOTU address by demonizing companies that get tax breaks for shipping jobs overseas. By “tax breaks,” the president means merely that their un-patriated profits aren’t subject to double taxation. “Shipping jobs overseas” is a metaphor you’ll hear more frequently in the coming months, and Romney is more likely to deny any association with it than to defend it. That’s just the way he rolls.

Outsourcing has been portrayed as a betrayal of American workers by companies that only care about the bottom-line. Well, yes, caring about the bottom line is what companies are supposed to do. Corporate officers have a fiduciary duty to their shareholders to maximize profits. It is not the responsibility of corporations to tend to the national employment situation. It is, however, the responsibility of Congress and the administration to have policies in place that encourage investing and hiring or that at least don’t discourage investing and hiring. But for the specific financial inducements that politicians offer firms to invest and hire in particular chosen industries—Solyndranomics—this administration (and the 110th-112th Congresses) has produced too many reasons to forgo domestic investment. Let’s not blame companies for following the incentives and disincentives created by policy.

There’s also the economics. Contrary to the assertions of some anti-trade, anti-globalization interests, countries with low wages or lax labor and environmental standards rarely draw U.S. investment. Total production costs—from product conception to consumption—are what matter and locations with low wages or lax standards tend to be less productive and thus less appealing places to produce.

The vast majority of U.S. direct investment abroad (what the president calls “shipping jobs overseas”) goes to other rich countries (European countries and Canada), where the rule of law is clear and abided, and where there is a market to serve. The primary reason for U.S. corporations establishing foreign affiliates is to serve demand in those markets—not as a platform for exporting back to the United States. In fact, according to this study by Matt Slaughter, over 93 percent of the sales of U.S. foreign affiliates are made in the host or other foreign countries. Only about 7 percent of the sales are to U.S. customers.

Furthermore, the companies that are investing abroad tend to be the same ones that are doing well and investing and hiring at home.  Their operations abroad complement rather than supplant their U.S. operations.

During his unsuccessful 2004 presidential campaign, candidate John Kerry denigrated “Benedict Arnold companies” that outsourced production and service functions to places like India. Earlier this month, Senator Kerry introduced a bill in the Senate that effectively acknowledges that anti-investment, anti-business policies may be responsible for deterring foreign investment in the United States and for chasing some U.S. companies away. Maybe he should talk to the president—and Romney.

‘Subsidy Risk’ in Green Tech

Two-and-a-half years ago, I attended a venture capital conference that focused a good deal on “clean tech.” I wasn’t impressed.

[T]he current vogue for “clean tech” differs from the information technology revolution that has done so much for the economy and society. Venture investors may be turning to government subsidy and regulatory advantage for their portfolio businesses, rather than producing to meet a market demand. “Going green” may mean “going red” in at least two senses—a more socialist political economy and a government even deeper in debt.

Essaying to instill some doubts among investors who were banking on “political will,” I asked pointedly how VCs assessed subsidy risk and the vagaries of public policy. The responses weren’t insightful or memorable.

Some vindication of my doubts comes in an article called “The Crisis in Clean Energy” ($) by David Victor and Kassia Yanosek in the July/August Foreign Affairs.

In the United States, most clean-energy subsidies come from the federal government, which makes them especially volatile. Every few years, key federal subsidies for most sources of clean energy expire. Investment freezes until, usually in the final hours of budget negotiations, Congress finds the money to renew the incentives—and investors rush in again. As a result, most investors favor low-risk conventional clean-energy technologies that can be built quickly, before the next bust.

Elsewhere, they write, “With clean energy suffering from long time horizons, high capital intensity, and a heavy dependence on fickle public policies, some Silicon Valley venture firms are scaling back or even canceling their ‘clean tech’ investment arms.”

Alas, Victor and Yanosek don’t call for the federal government to clear the field so entrepreneurialism can flourish. They offer three bland “shifts in approach” that amount to more of the same. Until the federal government does clear the field, watch for the subsidy muddle in green tech to suppress profound innovations while government-directed investment brings modest returns to investors/tax-consumers at the expense of taxpayers.

More on the Ex-Im Bank

Last week I blogged about Sen. Dianne Feinstein’s (D-CA) proposal to devote $20 billion of the Export-Import Bank’s funds to promoting manufacturing exports, and why that was a bad idea.

But I realize that my recent call to “X Out the Ex-Im Bank” will be facing some very entrenched interests in Washington, and some well-funded lobby groups. The Bank has historically attracted bipartisan support, and a renewal of its charter sailed through the House Committee on Financial Services earlier this year. The Washington establishment loves this program.

My friend and long-time Ex-Im Bank supporter Gary Hufbauer of the Peterson Institute for International Economics published a critique a few weeks ago of my analysis, and calls for a doubling of Ex-Im’s authorization cap (from $100 billion to $200 billion). His piece is a fair characterization of my arguments, and at least Gary tries to counter them with actual facts and analysis (not always a given in an increasingly poisonous trade policy environment).  But it seems to me that Gary focuses his critique on my assessment of the effectiveness of the Bank. That’s fair enough, of course, but I tried in my paper to make the point that the efficiency or efficacy of the Ex-Im Bank’s activities is kind of irrelevant. The important point, which Gary did not address, is that it is simply not the proper role of the federal government to be in this business at all, even if they can operate “efficiently” (which I do not concede in any case). Where in the Constitution is the federal government authorized to be involved in the export credit business (a business, by the way, that benefits mainly large, profitable companies)?

My opposition to the Bank, in other words, is at a more fundamental level.  On an empirical level—and this is where Gary’s critique is focused—can markets work well enough in trade finance, and if not, can government intervention work better? Gary points to the Bank’s low default rate as evidence that private markets are missing good opportunities:

These figures suggest that the Ex-Im Bank plays a large role in facilitating exports to countries that encounter reluctance from private banks but nonetheless are not ‘bad risks.” Judging by its low default rate, the Ex-Im Bank’s risk assessment seems more correct than the private market.

But I would argue that its low default rate suggests the Ex-Im Bank’s backing is unnecessary. We don’t know that private credit wasn’t available to finance those exports. And even if it wasn’t, private credit not always being available on terms that the trading partners would like does not necessarily signify market failure. So a finance company missed an opportunity that may have paid out. So what? Maybe they had even better opportunities available to them that we (and bureaucratic Washington) don’t know about, or they simply wanted to hold on to their capital for future investment or to meet new reserve standards. The would-be exporter might miss out, but government intervention to direct that private capital (either through mandates, or siphoning it through the Ex-Im Bank) would come at another producer’s or bank shareholders’ expense.

Gary argues that:

Ex-Im’s capability should be strengthened so that the United States can respond when official finance offered by other countries violates the principles of fair competition…Successful multilateral negotiations…are certainly a superior option to tit-for-tat retaliation…[but]…without sufficient leverage…it is difficult to see what will bring China and India to the negotiating table.

But will China and India (and others) see higher Ex-Im funding as “leverage” to bring them to the table, or will it be seen as just the next step in the escalating arms race of subsidized export credit? I suspect, and fear, the latter.

Gary rejects my call to dismantle the Ex-Im Bank, and in fact suggests the government increase the scope of Ex-Im financing to cover 5 percent (rather than the current 2 percent) of total U.S.exports. That seems pretty arbitrary to me. Why stop at 5 percent? Heck, with the Ex-Im Bank being “self-financing” and all, why not go for 100 percent?

Lastly, Gary repudiates my “orthodox free-market reasoning” and the suggestion, attributed to me, that “… the dollar exchange rate alone determines the volume of U.S. exports or the size of the U.S. trade deficit.”  Exchange rates do not equilibrate to keep trade balances at zero, but to keep them in line with the savings and investment balance. The United States has been running persistent deficits because savings has fallen short of investment for many years.

Similarly, Gary takes issue with my analysis on the net effect of Ex-Im financing on jobs:

 …nor do we agree that free markets are sufficiently self- regulating to ensure a constant and low rate of unemployment…If [that proposition] described the American economy, the United States [unemployment would not be stuck at 9 percent-plus.

Here Gary seems to ignore the many interventions in labor markets that can keep unemployment high, no matter what the exchange rate. I’m certainly not under any illusions that the U.S. economy would be totally free market were it not for the existence of the Ex-Im Bank, and I don’t think my paper implied that, either.

Gary and I, not to mention others who study the Ex-Im Bank, will no doubt continue to debate these issues as the Ex-Im Bank’s charter expiry date comes closer.