“Shipping Jobs Overseas” or Reaching New Customers? Why Congress Should Not Tax Reinvested …

  • Downloads
Share

Trade and globalization have become more inviting targets duringthe current economic downturn. As output falls and unemploymentrises, politicians in Washington are questioning not only importsbut U.S. companies that invest in production abroad.

The incoming president, Barack Obama, pledged during hiscampaign that, "Unlike John McCain, I will stop giving tax breaksto corporations that ship jobs overseas and I will start givingthem to companies that create good jobs right here inAmerica."1 That campaign refrain, echoed by a number ofother successful candidates, raises three basic questions:

Why do U.S. multinational companies establish affiliates abroadand hire foreign workers? What kind of tax breaks are theyreceiving? And should the new Congress and new president changeU.S. law to make it more difficult for U.S. multinationalcorporations to produce goods and services in foreigncountries?

Reaching millions of new customers

To demonize U.S. multinationals operating production facilitiesabroad is to indict virtually every major American company. Atlatest count more than 2,500 U.S. corporations own and operate atotal of 23,853 affiliates in other countries. In 2006, accordingto the U.S. Department of Commerce, majority-owned foreignaffiliates of U.S. companies posted $4.1 trillion in sales, createdjust under $1 trillion in value added, employed 9.5 million foreignworkers, and earned $644 billion in net income for their U.S.-basedparent companies.2

The primary reason why U.S. companies invest in affiliatesabroad is to sell more products to foreign customers. Certainservices can only be delivered on the spot, where the provider musthave a physical presence in the same location as its customers.Operating affiliates abroad allows U.S. companies to maintaincontrol over their brand name and intellectual property such astrademarks, patents, and engineering expertise. U.S. companies alsoestablish foreign affiliates because of certain advantages in thehost country- lower-cost labor, ready access to raw materials andother inputs, reduced transportation costs and proximity to theirultimate customers. Yes, the motivations can include access to"cheap labor," but labor costs are not the principal motivation formost U.S. direct investment abroad.

Politicians focus most of their attention on comparing exportsand imports, but the most common way American companies sell theirgoods and services in the global market today is through overseasaffiliates. In 2006, U.S. multinational companies sold $3,301billion in goods through their majority-owned affiliates abroad and$677 billion in services. For every $1 billion in goods that U.S.multinational companies exported from the United States in 2006,those same companies sold $6.2 billion through their overseasoperations. For every $1 billion in service exports, U.S.- ownedaffiliates abroad sold $1.6 billion.3

Contrary to popular myth, U.S. multinational companies do notuse their foreign operations as an "export platform" back to theUnited States. Close to 90 percent of the goods and servicesproduced by U.S.-owned affiliates abroad are sold to customerseither in the host country or exported to consumers in thirdcountries outside the United States. Even in Mexico and China,where low-wage workers are supposedly too poor to buy Americanproducts, more than half of the products of new and existing U.S.affiliates are sold in their domestic markets, whereas customers inthe United States account for only 17 percent ofsales.4

More Jobs Abroad, More Jobs at Home

Investing abroad is not about "shipping jobs overseas." There isno evidence that expanding employment at U.S.- owned affiliatescomes at the expense of overall employment by parent companies backhome in the United States. In fact, the evidence and experience ofU.S. multinational companies points in the opposite direction:foreign and domestic operations tend to compliment each other andexpand together. A successful company operating in a favorablebusiness climate will tend to expand employment at both itsdomestic and overseas operations. More activity and sales abroadoften require the hiring of more managers, accountants, lawyers,engineers, and production workers at the parent company.

Consider Caterpillar Inc., the Peoria, Illinois-based companyknown for making giant earth-moving equipment. From 2005 through2007, the company enjoyed booming global sales because of stronggrowth in overseas markets, especially those with resourcesextracted from the ground. According to the company's 2007 annualreport, Caterpillar earned 63 percent of its sales revenue abroad,including $1 billion in sales in China alone. As a result,Caterpillar ramped up employment at its overseas affiliates duringthat time from 41,238 to 50,788, an increase of almost 10,000workers. During that same three-year period, the company expandedits domestic employment from 43,878 to 50,545, a healthy increaseof 6,667.5

Caterpillar's experience is not unusual for U.S. multinationalcompanies. A 2005 study from the National Bureau of EconomicResearch found that, during the 1980s and 1990s, there was "astrong positive correlation between domestic and foreign growthrates of multinational firms." After analyzing the operations ofU.S. multinational companies at home and abroad, economists MihirA. Desai, C. Fritz Foley, and James R. Hines Jr. found that a 10percent increase in capital investment in existing foreignaffiliates was associated with a 2.2 percent increase in domesticinvestment by the same company and a 4 percent increase incompensation for its domestic workforce. They also found a positiveconnection between foreign and domestic sales, assets, and numbersof employees.6 "Foreign production requires inputs oftangible or intellectual property produced in the home country,"the authors explained. "Greater foreign activity spurs higherexports from American parent companies to foreign affiliates andgreater domestic R&D spending."7

The positive connection between foreign and domestic employmentof U.S. multinational companies has continued into the currentdecade. As Figure 1 shows, parent and affiliate employment havetracked each other since the early 1980s. More recently, employmentrose briskly for parents and affiliates alike in the boom of thelate 1990s, fell for both during the downturn and slow recovery of2001 through 2003, and then rose again from 2003 through2006.8 Although the numbers have not been reported yetfor 2007 and 2008, it's likely that the loss of net jobs in thedomestic U.S. economy will be mirrored by much slower growth oroutright decline in foreign affiliate employment.

Modest Investment in China and Mexico

Investment in China and Mexico drew the most fire on thecampaign trail. In a primary debate in Texas in February 2008,then-senator Obama said, "In Youngstown, Ohio, I've talked toworkers who have seen their plants shipped overseas as aconsequence of bad trade deals like NAFTA, literally seeingequipment unbolted from the floors of factories and shipped toChina."9 That makes for a good sound-bite in the heat ofa campaign, but it does not accurately reflect the broader realityof outward foreign investment by U.S. manufacturers.

Media Name: ftb36-chart1.gif

Outflows of U.S. manufacturing investment to Mexico and Chinahave been modest by any measure. Between 2003 and 2007, U.S.manufacturing companies sent an average of $2 billion a year indirect investment to China and $1.9 billion to Mexico. That palesin comparison to the average $22 billion a year in directmanufacturing investment "shipped" to Europe during that sameperiod, but talking about equipment being unbolted from the floorsof U.S. factories and shipped to England just doesn't have the samebite.10 The modest annual outflow in investment to Chinaand Mexico is positively dwarfed by the annual $59 billion inflowof manufacturing investment to the United States from abroad duringthose same years11 and the average of $165 billion peryear that U.S. manufacturers invested domestically in plant andequipment.12

The fear of manufacturing jobs being shipped to China and Mexicois not supported by the evidence. While U.S. factories werefamously shedding those 3 million net jobs between 2000 and 2006,U.S.-owned manufacturing affiliates abroad increased theiremployment by a modest 128,000 jobs. An increase in 172,000 jobs atU.S.-owned affiliates in China was partially offset by an actualdecline of almost 100,000 jobs at affiliates inMexico.13 The large majority of factory jobs lost in theUnited States since 2000 were not "shipped to China" or anywhereelse, but were lost to automation and other sources of increasedefficiency in U.S. manufacturing.

U.S. manufacturing investment in China remains modest comparedto the huge political investment that candidates and pundits havemade in making it an issue. U.S. direct investment in China remainsa relatively small part of China's overall economy, and a smallpart of America's total investments abroad. Of the nearly 10million workers that U.S. affiliates employ abroad, fewer than 5percent are Chinese; Americanowned affiliates employed just as manymanufacturing workers in high-wage Germany in 2006 as they did inlow-wage China.14

"Tax breaks" Keep U.S. CompaniesCompetitive

Politicians are not usually specific about exactly what "taxbreaks" they want to repeal. The biggest tax exemption for U.S.companies that invest abroad is the deferral of tax payments for"active" income. U.S. corporations are generally liable for tax ontheir worldwide income, whether it is earned in the United Statesor abroad. But the relatively high U.S. corporate tax rate is notapplied to income earned abroad that is reinvested abroad inproductive operations. U.S. multinationals are taxed on foreignincome only when they repatriate the earnings to the United States.Not surprisingly, the deferral of active income gives U.S.companies a powerful incentive to reinvest abroad what they earnabroad, but this is hardly an incentive to "ship jobsoverseas."

Such deferral may sound like an unjustified tax break to some,but every major industrial country offers at least as favorabletreatment of foreign income to their multinational corporations.Indeed, numerous major countries exempt their companies from payingany tax on their foreign business operations. Foreign governmentsseem to more readily grasp the fact that when corporations havehealthy and expanding foreign operations it is good for the parentcompany and its workers back home.15

If President Obama and other leaders in Washington want toencourage more investment in the United States, they should lowerthe U.S. corporate tax rate, not seek to extend the high U.S. rateto the overseas activities of U.S. companies. Extending high U.S.tax rates to U.S.-owned affiliates abroad would put U.S. companiesat a competitive disadvantage as they try to compete to sell theirgoods and services abroad. Their French and German competitors inthird-country markets would continue to pay the lower corporate taxrates applied by the host country, while U.S. companies would beburdened with paying the higher U.S. rate. The result of repealingtax breaks on foreign earnings would be less investment in foreignmarkets, lost sales, lower profits, and fewer employment and exportopportunities for parent companies back on American soil.

Politicians who disparage investment in foreign operations arewedded to an outdated and misguided economic model that glorifiesdomestic production for export above all other ways for Americansto engage in the global economy. They would deny Americans accessto hundreds of millions of foreign customers and access tolower-cost inputs through global supply chains. In short, theywould cripple American companies and their American workers as theytry to compete in global markets.


Notes
  1. Transcript, "Barack Obama's Acceptance Speech," New YorkTimes, August 28, 2008,
  2. Raymond J. Mataloni Jr., "U.S. Multinational Companies:Operations in 2006," Bureau of Economic Analysis, U.S. CommerceDepartment, Survey of Current Business, November 2008,Table 17.2, p. 43.
  3. Mataloni, Tables 3 and 17.2; and Council of Economic Advisers,Economic Report of the President 2008, Table B-106.
  4. Mataloni, p. 36.
  5. Caterpillar Inc., Annual Report 2007, p. 37.
  6. Mihir A. Desai, C. Fritz Foley, and James R. Hines Jr.,"Foreign Direct Investment and Domestic Economic Activity,"National Bureau of Economic Research, Working Paper no. 11717,October 2005, p. 1.
  7. Ibid., p. 3.
  8. Mataloni, Table 1, p. 27.
  9. Quoted in Steve Chapman, "Why Are These PeopleSo Ashamed of NAFTA?" Reason Online, February 28, 2008.
  10. U.S. Bureau of Economic Analysis, International EconomicAccounts, "U.S. DirectInvestment Abroad: Balance of Payments and Direct InvestmentPosition Data".
  11. U.S. Bureau of Economic Analysis, International EconomicAccounts, "Foreign DirectInvestment in the U.S.: Balance of Payments and Direct InvestmentPosition Data".
  12. U.S. Census Bureau, "U.S. Capital Spending Patterns:1999-2006," U.S. Department of Commerce, October 7, 2008.
  13. U.S. Bureau of Economic Analysis, International EconomicAccounts, "U.S. Direct InvestmentAbroad: Financial and Operating Data, Employment by Country andIndustry 1999-2006".
  14. Mataloni, Table 18.2, p. 45.
  15. For a more detailed discussion of the impact of U.S. corporatetaxation on the activities of U.S. multinationals, see ChrisEdwards and Daniel J. Mitchell, Global Tax Revolution: The Rise of Tax Competition and the Battleto Defend It (Washington: Cato Institute, 2008), esp.Chapter 6.