International Trade and Investment

The Contributions of Outward FDI to the U.S. Economy

   A U.S. multinational company is headquartered in the United States and, through outward FDI, has affiliates (often production or marketing facilities) in other countries. Activities of U.S.-headquartered multinationals have contributed strongly to productivity growth in the United States, and thus to rising U.S. living standards.

   Because multinationals are engaged in cross-border investment and production networks, they are better able to enhance their organizational efficiency. Studies have shown that multinationals are more productive than firms that are focused primarily on domestic markets. By combining domestic production with foreign production, multinationals can produce at lower costs, earn higher profits, and pay higher wages and benefits. Domestic firms can benefit from outward FDI as multinationals are exposed to the world's best business practices that can be adopted by other U.S. firms.

         Basic Facts About U.S. Multinational Companies.

   U.S. multinationals are relatively small in number but have a disproportionately large economic footprint. Less than 1 percent of U.S. firms are multinationals, but these multinationals account for 20 percent of total U.S. employment and 25 percent of total U.S. output. In 2004, there were 2,369 U.S. multinationals with 22,279 foreign affiliates, with 21.4 million employees in the United States and 9 million workers abroad. The operations of U.S. multinationals are concentrated in the United States. In 2004, the combined value-added output of U.S. multinationals was $3.04 trillion. U.S. parents accounted for over 70 percent of this output and foreign affiliates for less than 30 percent.

   While U.S. multinationals have increased employment and output in an absolute sense, their share of the workforce has decreased slightly over the years while their share of output has remained fairly constant. U.S. multinationals employed 18.7 million American workers, or 25 percent of the workforce, in 1982 (the first year for which annual employment data are available). In 2004, those figures stood at 21.4 million workers and 20 percent, respectively. The value of output by U.S. parents was $1.3 trillion or 24 percent of the total private U.S. output in 1994 (the first year for which annual output data are available). In 2004, those figures were $2.2 trillion and 25 percent, respectively. In terms of recent trends, both employment and output by U.S. parents peaked in 2000 and then began to decline. Output rebounded in 2003 and employment rebounded in 2004, largely reflecting economy-wide trends.

         Why Do U.S. Firms Become Multinational?

   There are three conditions required for a firm to be willing to invest abroad: (1) the firm has specific assets that can be transported to foreign affiliates; (2) the host country has certain characteristics that make it attractive for the firm; and (3) the firm wishes to maintain control over its intellectual assets.

   Multinationals often face large costs and barriers to doing business abroad compared with domestic firms in the host country that are familiar with the local business climate. Physical and human capital are needed to establish an affiliate, and additional resources are needed to understand the local business environment (for example, regulations and tax laws, supply networks, cultural differences, and property rights). Thus, a multinational firm must have certain advantages to compensate for these costs. Three types of compensating advantages are commonly cited. One advantage is firm-specific resources or knowledge-based assets and services (such as technology, patents, trademarks, and managerial or engineering expertise) that can be used by the foreign affiliate. Another advantage is the location and characteristics of the host country such as market size, trade costs, and differences in the prices for key inputs such as land, labor, or capital. The existence of a large market or the high costs of trading with a certain country or region can motivate multinationals to produce and sell in foreign countries. Price differences in land, capital, or labor; transportation and telecommunications infrastructure; or good business practices can also motivate a multinational to invest and produce abroad.

   The third type of advantage is known as internalization advantage. A firm may choose outward FDI over giving a foreign company a license to produce its goods so that it can retain control of its intellectual assets. For example, a firm may be reluctant to reveal the details of its product's construction or its production process to a prospective licensee. There is also the danger that a licensee may produce a lower quality product and consequently reduce the value of the multinational's trademark. The difficulty of guaranteeing quality control, monitoring and managing employees, achieving a satisfactory licensing agreement, and enforcing patent or trademark rights all tend to favor outward FDI.