Federal Reserve District, 7th ; Middle West

William A. Strauss

English

Research Papers in Economics

ESSAYS ON ISSUES THE FEDERAL RESERVE BANK MAY 1996
OF CHICAGO NUMBER 105
Chicago Fed Letter
Foreign direct investment
in the U.S. and Midwest
The globalization of the world’s
economies over the last two decades
has, in many ways, tied the U.S. econ-
omy to events and actions that take
place throughout the world.  One
measure of globalization is foreign
investment, both at home and
abroad.  Foreign investment is a two-
way flow—persons and entities invest
in a foreign country and, in turn,
that country’s citizens and corpora-
tions invest abroad.  Foreign direct
investment (FDI) refers to business
ownership as opposed to limited
portfolio investment.  Historical data
on FDI in the United States (FDIUS)
show that FDI annual capital flows
have grown considerably since 1980
(see figure 1).
To be classified as FDI, a foreign
person or entity must have a 10% or
greater share of ownership in a U.S.
firm.  U.S. firms that have FDI are
considered U.S. affiliates.  FDI may
take the form of newly established
businesses or acquisition of existing
businesses.  Since 1979, nearly 80%
of new investment outlays have been
acquisitions.
This Fed Letter will examine recent
industry and foreign ownership
trends in foreign direct investment
over the 1977–93 period for both
the U.S. and the Midwest.1
How extensive is foreign direct
investment in the U.S. and how
is it measured?
Several measures examine the size
of FDI in the U.S.  The accumu-
lated stock of FDI presents an over-
all measure of the level of FDI in
the U.S. economy.  Another measure
0
20
40
60
80
1970 ’75 ’80 ’85 ’90 ’95
billions of dollars
Source: U.S. Department of Commerce, Bureau of Economic Analysis,
"U.S. international transactions," Survey of Business (various years).
1. Annual FDI capital inflows
While the stock level of FDI has
grown substantially over the last
few decades, several measures of
FDI’s impact or presence in the
overall U.S. economy show U.S.
affiliates do not represent a substan-
tial share of U.S. businesses.
Employment at U.S. affiliates in
1993 represented only 5% of total
nonbank private employment.
However, this share varied consider-
ably by industry.  For example, em-
ployment by U.S. affiliates repre-
sented nearly 33% of total chemicals
and allied products employment
and nearly 21% of stone, clay, and
glass products employment.  Con-
versely, many nonmanufacturing
industries had much lower shares—
1.3% and 1.6% for construction and
agriculture, respectively.  In terms
of gross product, U.S. affiliates’
accounted for only 6.1% of total
gross product in 1993.  However,
their share had risen steadily from
just over 2% in 1977.2
Another measure, however, pre-
sents a different view of the impact
of FDIUS on the U.S. economy.
is the annual flow of
FDI collected by the
U.S. Bureau of Eco-
nomic Analysis (BEA).
Annual flow data pro-
vide several useful
pieces of information,
such as the attractive-
ness of the U.S. vis-à-
vis other countries
and the economic
state of foreign coun-
tries and their ability
to invest abroad.  In
some cases, trends in
FDI provide a first
look at future trends
in a foreign country’s
industrial policy.  An example of
this occurred in the 1980s, when
Japanese auto manufacturers set up
operations in the U.S. in response
to U.S. trade policy that had placed
voluntary export restraints (VER)
on Japanese auto exports to the U.S.
In 1977, the stock level (or posi-
tion) of FDI in the U.S. stood at
$35 billion (historical cost), with
the Netherlands, the United King-
dom, and Canada having the larg-
est shares.  By 1994, the stock of
FDI in the U.S. stood at $504 billion
(historical cost), with the United
Kingdom, Japan, and the Nether-
lands having the largest shares.
Most major countries’ share of
FDIUS changed substantially over
this period.  For example, Canada’s
share of FDIUS fell from nearly
18% in 1977 to 9% in 1994; the
Netherlands’ share fell from 21%
to 14%; and Japan’s share grew
from 5% to 20%.  The United King-
dom remains the largest share-
holder with 23% of total FDIUS
(up from 21% in 1977).In 1993, 23% of total U.S. merchan-
dise exports and 34% of imports
could be attributed to U.S. affiliates.
These numbers have held steady
over time.  While this group has a
disproportionate share of U.S. ex-
ports and imports, it can be ex-
plained by the fact that the group
includes wholesalers and, in par-
ticular, motor vehicle and equip-
ment wholesalers.  In 1993, 53% of
exports shipped by U.S. affiliates
and 59% of imports shipped to U.S.
affiliates were in wholesale trade
industries.3  In addition, much of
this trade is intrafirm trade, that is,
trade with the affiliates’ foreign
parent or parent group.  In 1993,
45% of U.S. affiliates’ exports were
shipped to foreign parent groups,
and 75% of imports were shipped
from foreign parent groups.4
In late 1993, the BEA published a
study on the merchandise trade
of U.S. affiliates over the 1977–91
period.5  According to this report, in
most years, the affiliates’ trade defi-
cit (caused by more imports than
exports) accounted for more than
one-half of the total U.S. merchan-
dise trade deficit.  As mentioned
above, this large trade deficit can be
attributed principally to wholesalers
acting as distribution channels for
their parent companies.
In terms of ultimate beneficial own-
er (UBO), in 1991 Japanese-owned
affiliates accounted for the largest
share of both imports and exports
of U.S. affiliates, mainly in wholesale
trade.6  France, the United King-
dom, and Germany were the next
largest affiliate exporters and Ger-
many, the United Kingdom, and
Canada were the next largest affili-
ate importers in 1991.
While the level of FDI continues to
grow, the annual flows of FDIUS
(as shown in figure 1) vary from
year to year.  Over the 1970–95
period, annual capital inflows have
ranged from a low of $0.4 billion in
1972 to a high of $75 billion in 1995.
There are several reasons for this.
For one, macroeconomic conditions
both here and abroad affect invest-
ment decisions.  When the U.S.
economy is doing well, the U.S. is
a more attractive place to invest.
Even so, if foreign countries are
having internal problems, they may
have to slow or contract their over-
seas investment.  Exchange rates
also affect the flow of investment.
For example, when the dollar is
strong (against other countries’
currencies), investment in the U.S.
is more costly.  The opposite is true
when the dollar is weak.  Other fac-
tors that affect annual FDI flows
include regulation/deregulation of
capital markets, investment and/or
trade policies, and the growth of
emerging markets.
FDI in the Midwest
The impact of FDI on regional econ-
omies is more difficult to measure
because state-level data on FDIUS
are limited to number of affiliates,
employment at U.S. affiliates, and
some data on industry and country
of origin.  Measures such as stock
level and annual flows are not avail-
able at the state level.
Over the 1977–93 period, employ-
ment at U.S. affiliates in the Mid-
west grew by nearly 429,000 employ-
ees, accounting for 12% of affiliate
employment growth in the U.S.
Illinois had the largest absolute
increase in employment among
Midwest states with 162,000 employ-
ees, ranking sixth in the nation.
(California, Texas, and New Jersey
had the largest absolute employ-
ment increases in the nation over
the period.)  Of the Midwest states,
only Indiana’s total affiliate employ-
ment growth outpaced the nation’s,
with a 303% increase (see figure 2).
Nearly half of the Midwest’s affiliate
employment increase (207,000) oc-
curred over the 1987–93 period.  FDI
employment in Midwest manufactur-
ing firms accounted for about 72% of
this growth, and was growing at a rate
(76%) that was significantly higher
than the rest of the nation (54%).
Percent
1977 1993a change
(---thousands---)
Illinois 73.8 235.8 219.3
Indiana 30.4 122.6 303.4
Iowa 9.3 30.9 230.6
Michigan 41.1 148.6 261.2
Wisconsin 30.6 76.3 149.5
Midwest 185.3 614.2 231.5
Total U.S. 1,218.7 4,722.3 287.5
a1993 data are preliminary.
Source: U.S. Department of Commerce, Bureau
of Economic Analysis, “Foreign direct
investment in the United States,” diskette,
(various years).
2. Employment at U.S. affiliates
In 1991 (latest year of manufactur-
ing industry data available), Midwest
manufacturing affiliates accounted
for nearly 17% of all affiliate manu-
facturing jobs.  In the primary and
fabricated metals industries, nearly
one out of every four affiliate manu-
facturing jobs in the U.S. were in
the Midwest.  Over the 1987–91
period, Midwest employment
growth in the metals industries
exceeded that of the nation (70%
versus 56%).  In the food and food
products industry and the machin-
ery sector, Midwest affiliates ac-
counted for nearly one out of every
five affiliate manufacturing jobs.
Employment growth in these two
industries also outperformed the
nation over the 1987–91 period.
Food and food products employ-
ment increased 88%, compared
with 68% for the nation.  In the
machinery industries, Midwest em-
ployment increased 84%, compared
with 51% for the nation.
The composition of affiliate employ-
ment by country of origin of the
largest investor, or UBO, changed
for both the U.S. and Midwest over
the 1977–93 period.  In 1977, Cana-
da held the largest share of affiliate
employment in the Midwest with a
23% share, followed by the United
Kingdom and the Netherlands.  The
same three countries held the larg-
est shares of affiliate employment insmall, with two excep-
tions—total employ-
ment in certain indus-
tries and level of
merchandise trade.
Certain industries,
such as chemicals and
allied products, have a
large share of their
total employment in
firms with FDI. In
addition, U.S. affili-
ates account for a
disproportionate
share of both mer-
chandise imports and
exports.  However, at
least with imports, a
significant part of this
trade is by motor vehicle and equip-
ment wholesalers, which conduct a
large share of their business with a
foreign parent.
 Is there cause for concern?  As
mentioned above, certain U.S. in-
dustries have a more notable for-
eign presence than others, but they
have had for quite some time.
Much of this can be accounted for
by large multinational firms.  On
the other hand, industries that have
traditionally been U.S.-owned are
facing stiff competition from “new”
competitors, such as Japan, that
have seized opportunities to enter
the U.S. market.  In the face of this
competition, there has been in-
creased public concern over the
growing levels of FDI in the U.S.,
with particular emphasis on the
degree of control one country’s, or
group of countries’, citizens may
gain on the U.S. economy through
their investment in U.S. businesses.
However, this concern must be
weighed against FDI’s potential
benefits—the introduction of new
technologies, new job creation, or
keeping a U.S. business open that
may have otherwise closed.  To
some, FDI indicates a preference by
investors for the business climate or
natural advantage of a state, region,
or nation.
—Linda Aguilar
Regional economist
1For the purposes of this article, the
Midwest is defined as the Seventh Feder-
al Reserve District, which encompasses
Iowa and major portions of Illinois,
Indiana, Michigan, and Wisconsin.
2Gross product is an economic account-
ing measure of production.
3Mahnaz Fahim-Nadir and William J.
Zeile, “Foreign direct investment in the
United States,” Survey of Current Business,
May 1995, pp. 57–81.
4Ibid.
5William J. Zeile, “Merchandise trade of
U.S. affiliates of foreign companies,”
Survey of Current Business, October 1993,
pp. 52–65.
6The BEA defines a UBO as “that person,
proceeding up the affiliate’s ownership
chain, beginning with and including the
foreign parent, that is not owned more
than 50% by another person.”  Person in
this definition can be an individual or
group of persons.  The foreign parent is
the first person outside the U.S. that has
a direct investment (more than 10%
ownership).
7State totals do not add to total U.S.  State
totals include every plant of a U.S. affili-
ate within that state, whereas total U.S.
includes only total number of affiliates.
Michael H. Moskow, President; William C.
Hunter, Senior Vice President and Director of
Research;  Douglas Evanoff, Assistant Vice President,
financial studies; Charles Evans and Kenneth
Kuttner, Assistant Vice Presidents, macroeconomic
policy research; Daniel Sullivan, Assistant Vice
President, microeconomic policy research;  William
Testa, Assistant Vice President, regional programs;
Anne Weaver, Manager, administration;  Helen
O’D. Koshy, Editor.
Chicago Fed Letter is published monthly by the
Research Department of the Federal Reserve
Bank of Chicago.  The views expressed are
the authors’ and are not necessarily those of
the Federal Reserve Bank of Chicago or the
Federal Reserve System.  Articles may be
reprinted if the source is credited and the
Research Department is provided with copies of
the reprints.
Chicago Fed Letter is available without charge
from the Public Information Center, Federal
Reserve Bank of Chicago, P.O. Box 834,
Chicago, Illinois,  60690-0834, 312-322-5111.
ISSN 0895-0164
Japan        UK       Germany  Canada
                           (----------------------percent-----------------------)
Illinois 19.1 20.9 11.3 11.6
Indiana 27.7 15.7 11.9 12.2
Iowa 20.7 18.1 19.3 14.1
Michigan 5.4 18.5 19.3 18.5
Wisconsin 10.4 22.3 11.7 20.4
District 19.0 19.0 14.4 13.6
U.S. 15.3 20.7 12.0 14.0
Note: Data are preliminary.
Source: U.S. Department of Commerce, Bureau of Economic
Analysis, “Foreign direct investment in the United States,”
diskette, (July 1995).
3. Employment by country of UBO, 1993
the U.S., but the United Kingdom
held the largest share.  By 1993,
Japan and the United Kingdom
were tied for top rank in the Mid-
west, each having a 19% share (see
figure 3).  Germany held the next
largest share with 14%, and Cana-
da’s share had fallen to just under
14%.  The United Kingdom re-
mained the largest country of origin
for the entire U.S. in 1993, but its
share fell from 24% to 21%; Japa-
nese-owned affiliates increased their
share of employment from 6% to
15%.  The latter group showed the
largest growth in employment in the
Midwest among countries with U.S.
affiliates in both absolute terms
(adding 107,000 employees) and
percentage terms (more than 11
times its 1977 level).
The number of affiliates in the U.S.
rose to 8,179 in 1992, up from
2,999 in 1977.  The states with the
largest increase in number of affili-
ates over this period were Califor-
nia, New York, and Texas.7  Illinois
ranked fifth, with an increase of
957 affiliates.  The five Midwest
states combined realized an in-
crease of 2,724 affiliates.
Conclusion
While foreign investors continue to
invest in the U.S. via U.S. businesses,
their overall presence remainsP
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Sources: The Midwest Manufacturing Index (MMI)
is a composite index of 15 industries, based on
monthly hours worked and kilowatt hours.   IP rep-
resents the Federal Reserve Board industrial pro-
duction index for the U.S. manufacturing sector.
Autos and light trucks are measured in annualized
units, using seasonal adjustments developed by the
Board.  The purchasing managers’ survey data
for the Midwest are weighted averages of the sea-
sonally adjusted production components from the
Chicago, Detroit, and Milwaukee Purchasing Man-
agers’ Association surveys, with assistance from
Bishop Associates, Comerica, and the University of
Wisconsin–Milwaukee.
Motor vehicle production
(millions, seasonally adj. annual rate)
Mar. Month ago Year ago
Cars 4.7 6.1 6.9
5.7 5.6 5.0 Light trucks
1993 1995 1996
Manufacturing output indexes
(1987=100)
Feb. Month ago Year ago
MMI 145.9 144.3 142.5
123.9 124.3 126.1 IP
Purchasing managers’ surveys:
net % reporting production growth
Mar. Month ago Year ago
MW 49.8 55.3 57.2
53.7 44.3 46.2 U.S.
1994
100
120
140
160
Manufacturing output indexes, 1987=100
MMI
IP
The Midwest Manufacturing Index rose slightly less than the industrial produc-
tion index for the nation in February, but was revised slightly upward in January
to show a modest gain, versus a 0.3% decline nationwide.  The region should
get a boost over the next few months from GM’s efforts to recapture some of its
strike-related production loses.
Midwest manufacturing activity may have plateaued in March, but the underly-
ing trend in the region continues to be positive.  The composite index of pro-
duction from the region’s purchasing managers’ surveys dropped to 49.8%,
which corresponds to virtually no change in production.  The Detroit survey
accounted for the bulk of the decline, which may reflect the GM strike.
Tracking Midwest manufacturing activity

The heartland keeps beating

http://www.chicagofed.org/digital_assets/publications/chicago_fed_letter/1996/cflmay96.pdf

The heartland keeps beating

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Research Papers in Economics