Wellesley Economist Says U.S. Foreign Direct Investment Is a Casualty of the Trade War

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July 1, 2019

The United States’ investment in other countries, an economic engine for poor countries in particular, has diminished sharply over the past two years because of changes in corporate tax laws, according to Joseph Joyce, Wellesley’s M. Margaret Ball Professor of International Relations and professor of economics. 

On his blog about global finance, Capital Ebbs and Flows, named one of the top 100 economic blogs of 2019 by Intelligent Economist, Joyce recently wrote about a global trend driven in part by tax policies under the Trump administration and the effect on U.S.-based multinational companies of the reduced corporate tax rate. “The changes in the tax law made it beneficial for companies based in the U.S. to bring the money back home as opposed to retaining the funds abroad in, say, a country like Ireland or Luxembourg,” he said.

When a multinational company based in the United States or elsewhere establishes a subsidiary in another country, that’s known as foreign direct investment (FDI). If the corporate tax rate in the foreign country is lower, the company benefits from having a smaller tax liability. As long as the profits were kept abroad, the company did not have to pay additional U.S. taxes. But with its new tax provisions, the U.S. gave domestic companies an incentive to repatriate the earnings they had kept abroad to avoid higher domestic taxes. 

The tax changes are one component of the U.S. trade war with China and other trading partners, said Joyce. The United States has imposed tariffs on goods imported from China and a range of other countries, and the overall trend has both had a chilling effect on business investment and contributed to a global economic slowdown that shows signs of getting worse, said Joyce.

The changes especially affect emerging market economies that depend on foreign investment as a source of external finance. Joyce cited the McKinsey Global Institute report that the value of FDI worldwide increased from 46 percent of global GDP in 2007 to 57 percent in 2016 (from $25 trillion to $41 trillion). But these investments fell in 2017 and 2018. A significant amount of the decline is a consequence of U.S. companies responding to the tax law changes, said Joyce.

Foreign multinational companies that have operations in the U.S. will also benefit from lower taxes. The United States has drawn a very large amount of FDI from foreign companies in the past because of favorable trade policies in other areas. However, the restrictions on trade will cause them to reassess locating facilities , said Joyce.

“In fact, the U.S. is the largest recipient of FDI. But foreign companies are hesitating now because of all the uncertainty over U.S. trade policies,” Joyce said in an interview. If the U.S. government imposes tariffs on “intermediate goods” (goods that companies use in making the final products customers buy), “then it becomes more expensive to produce here.”

Joyce pointed out that the tax change is part of a wider strategy by the government to “undo expansion by multinationals by persuading U.S. firms to return their operations to the U.S.” But one effect of cutting taxes has been an increase in the deficit, said Joyce. Corporate tax revenues fell from 2017 to 2018, despite the favorable economic environment.