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Why FDI Matters for U.S. Employment, Wages, and Productivity

    The Biden administration has made several proposals to reform the taxation of multinational corporations in the United States, including proposals to address profit shifting as well as a broader view that offshoring is bad for the US economy and that businesses should be encouraged to “reshore” as much activity as possible. Raising taxes on cross-border investment, contrary to the Biden administration’s assurances, would harm US economic growth and jobs. According to research, FDI creates jobs in the United States and increases workers’ earnings and productivity.

    Outbound foreign direct investment (FDI) and inbound FDI are two types of cross-border investment. Outbound FDI happens when a multinational company from the United States invests in another country, either by acquiring a controlling position in a company or by purchasing capital, such as for the construction of a new factory. When a foreign multinational makes a similar investment in the United States, this is known as inbound FDI.

    Outbound FDI is viewed as negative to the US economy by some observers, who believe that multinational corporations are substituting overseas labour for American workers, resulting in job displacement at home. While such substitution is possible, international activity is more commonly used to supplement rather than replace American business.

    Multinational corporations are among the country’s largest employers. In 2017, multinational corporations employed roughly one-fifth of the private sector workforce and more than half of the manufacturing workforce in the United States. They make up a much larger portion of total pay. U.S. multinationals pay over 60% of all wages earned in manufacturing alone. As previously said, their contributions to R&D are similarly enormous, accounting for two-thirds of all industrial R&D in the United States, as illustrated in the graph below.

    Multinational corporations account for a significant portion of income since they typically pay higher rates and provide greater benefits than equivalent private-sector employees. In 2017, both U.S. parents and U.S. affiliates of foreign multinationals earned more than $10,000 more in total remuneration per employee than comparable private sector enterprises in the United States. According to a McKinsey study, multinational corporations have accounted for approximately 40% of productivity increases since 1990, boosting wage growth across the US economy. Multinational corporations have aided in the transition of low-value-added occupations in the United States to high-value-added jobs, such as R&D and other service-based activities.

    Of course, as with the China shock, the change has imposed transition costs on specific areas in the United States. However, the evidence reveals that, while firms have extended their operations outside of the United States, it has not necessarily been at the expense of the American labour. Between 2004 and 2014, over 42% of US corporations that grew abroad also increased employment in the United States. About half of the multinationals that did downsize their global workforces also did so in the United States. Multinational corporations tend to grow their local and international activities as they become more profitable, and to decrease them as they become less profitable.

    According to one viewpoint, multinational corporations primarily operate outside of their home countries due to lower regulatory expenses and the availability of inexpensive labour. While such criteria influence some outsourcing decisions, in a globalised economy, U.S. companies sell to both domestic and international clients. As a result, many businesses find it more efficient to operate in countries closer to their international clients. Such “horizontal” FDI is most common: multinationals from the United States prefer to invest in middle-income nations like China rather than low-income countries like Africa. According to World Bank classifications, these middle-income countries accounted for just under half of employment at U.S. companies’ international affiliates in 2017, but the majority of investment remained in high-income countries.

    Nearly 95% of foreign affiliates of US corporations in the manufacturing industry sold at least some items to their local market between 1987 and 2011, and 37% sold completely to their local market. Even when looking at international affiliates of US multinationals that produce in other countries and subsequently export finished goods or intermediate inputs to the US, the majority of the exports are from developed countries. Only one-third of overall exports from the top ten nations that export to the United States come from emerging countries, primarily China and Mexico.

    FDI activity in the United States follows a similar pattern at the industry level. The top outbound FDI industries are also the largest incoming, according to Antras and Chor (2018)’s input-output measurements. That is, rather than focusing on cutting production input costs, most activity is largely focused on selling to final consumers in local marketplaces (either at home or abroad). Expanding market access allows U.S. corporations to be more profitable, resulting in earnings being spent in the United States and, in turn, raising salaries for U.S. workers.

    If cross-border investment taxes were raised, as President Biden urged, it would reduce US productivity, reduce US jobs, and result in lower earnings for many employees. In one study of developing countries, outward FDI was found to boost total factor productivity in the long run. Another study looked at 50 nations, including the United States, and discovered that outward FDI was linked to long-term economic growth. Another study revealed a generally positive relationship between local employment rates and outward FDI in the United States, however some locations saw rises in inequality between low- and high-skilled employees.

    Policymakers must step carefully when reworking the tax system for multinational firms; else, they risk imposing taxes on cross-border investment more generally, suffocating US growth.

    Learn more: 4 Things to Know About the Global Tax Debate