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ifdp1057

ifdp1057

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Published by Cait Harvey

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Published by: Cait Harvey on Dec 10, 2012
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 Board of Governors of the Federal Reserve SystemInternational Finance Discussion PapersNumber 1057October 2012The Return on U.S. Direct Investment at Home and AbroadbyStephanie E. CurcuruCharles P. Thomas
NOTE: International Finance Discussion Papers are preliminary materials circulated to stimulatediscussion and critical comment. References in publications to International Finance Discussion Papers(other than an acknowledgment that the writer has had access to unpublished material) should be clearedwith the author or authors. Recent IFDPs are available on the Web atwww.federalreserve.gov/pubs/ifdp/ .This paper can be downloaded without charge from the Social Science Research Network electroniclibrary at http://www.ssrn.com/.
 
 
The Return on U.S. Direct Investment at Home and Abroad*
Stephanie E. Curcuru**Charles P. ThomasBoard of Governors of the Federal Reserve SystemOctober 2012Abstract
A longstanding puzzle is that the United States is a net borrower from the rest of the world, yet continuesto receive income on its external position. A large difference between the yields on direct investment athome and abroad is responsible and this paper examines potential explanations for this differential. Wefind that most of the differential disappears after one adjusts for the U.S. taxes owed by the parent onforeign earnings, the sovereign risk and sunk costs associated with investing abroad, and the age of foreign direct investment in the U.S.. Taken together, our results suggest most of the difference in yieldsshould remain as long as there is a difference in tax rates between the United States and the countries inwhich U.S. firms invest, and U.S. investments are perceived as relatively safe. This has implications for the long-run sustainability of the U.S. current account deficit which will depend, in part, on the long-run behavior of this income.JEL Classification: F21, F23, F3Key Words: Foreign direct investment, returns differentials, U.S. current account
*The authors thank Ralph Kozlow and participants at the International Finance Seminar at the Federal ReserveBoard, the CRIW/NBER Joint Conference on Wealth, Income and Financial Intermediation, and an anonymousreferee for comments and suggestions. We thank Corinne Land for excellent research assistance. The views in this paper are solely the responsibility of the authors and should not be interpreted as reflecting the views of the Board of Governors of the Federal Reserve System or of any other person associated with the Federal Reserve System.**Corresponding author at: Federal Reserve Board, 20
th
St. and C St. NW, Washington, D.C. 20551 USA. Tel.:2022440658; fax: 2028724926; email: stephanie.e.curcuru@frb.gov
 
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1. Introduction
A longstanding puzzle is that the United States is a net borrower from the rest of the world, yetsomehow manages to, on net, receive income on its external position. Net investment incomereceipts reported in the U.S. balance of payments (BOP), the top line in Figure 1, have continuedto grow even while the net liabilities position, the bottom line, has also grown. This situation hasmystified economists for almost a quarter-century:“Clearly, if our investments abroad are yielding a positive return,their capital value must be positive not negative. Is this a defect of the figures on current flows, or is it a defect of the balance-sheetfigures?…” (Milton Friedman, 1987)
1
 The income received on the U.S. external position plays an important role in one of the biggestissues confronting international macroeconomists—the sustainability (or lack thereof) of the U.S.current account deficit. Net income receipts, which equaled 33% of the goods and services balance in 2010, provide a significant stabilizing force for the current account. Futuresustainability will depend, in part, on the persistence of these net income receipts. So anunderstanding of what is generating this income will help economists assess how the U.S.imbalance might evolve.A single asset class is responsible for the puzzle. Net income receipts in the BOP oweentirely to a difference between the yields (income divided by the position) on direct investmentclaims and liabilities (Hung and Mascaro 2004, Bosworth et al. 2008, Bridgeman 2008, Curcuru,Dvorak and Warnock 2008). The aggregate yield on U.S. cross-border claims averaged 140 basis points per year higher than that paid on U.S. cross-border liabilities from 1990-2010, shown inthe first columns of Figure 2.
 
The next columns show that the main driver of this difference wasforeign direct investment (FDI); the average yield received on U.S. FDI claims was an
1
Personal correspondence with Charles Thomas, June 1987.

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