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THIS year's debate on the amounts and kinds of public assistance which the United States should provide to foreign countries has been particularly intense. Much attention has been directed to the question of the proper rôle of our Government in stimulating long-run economic development abroad. Some have argued the need for an increase of several billion dollars in foreign economic aid; others contend that United States assistance should be tapering off.
This difference of opinion is at least partly due to disagreement about the capacity of private investment to promote economic development abroad. And it seems clear that the present debate has not taken fully into account new analysis and factual information becoming available on the amounts and results of private investment abroad. The purpose of this article is to review the new evidence and to discuss the relation between government actions and private investment in economic development abroad.
The impression is widely held that United States private investment abroad has been running below a billion dollars a year, with little of that amount being invested in the underdeveloped areas. Yet conservative estimates suggest that last year capital expenditures abroad by United States investors were actually on the order of $5 billion. Between 35 and 40 percent of this amount was invested in underdeveloped areas. These capital expenditures have been rapidly expanding and in 1956 were about two and a half times the amount of United States economic assistance abroad.
The impression that private investment abroad is relatively small stems in part from the practice of measuring foreign investment in terms of a net balance-of-payments figure. This tells simply the size of the net flow of private investment dollars out of the United States. In calculating this figure the amounts considered to be new flows of dollars from the United States have been reduced by the amounts returned to the United States from the proceeds of liquidating old investments. Whether or not this figure is valid for balance-of-payments purposes, it is not adequate as a measure of the contribution of private investment to economic development.[i]
Even by this yardstick, however, United States private investment abroad is rapidly expanding. In 1954 the net outflow was $1,619 million in all private forms of direct, portfolio and short-term investment. In 1955 it was $1,153 million. Then last year it shot up to $2,746 million. The part of this figure made up by direct investment--the outflow from United States companies to foreign affiliates--jumped from $664 million in 1954 and $679 million in 1955 to $1,633 million in 1956. Though these figures reveal a large expansion in investments, they do not reveal its true magnitude.
In addition to this net outflow figure the Department of Commerce has regularly published estimates of the retained earnings of the foreign subsidiaries of United States corporations. These amounts, when added to the outflows mentioned above, raised the investment totals to $2,263 million in 1954 and $2,021 million in 1955. They will probably raise the total to about $3,900 million for 1956. But that will be the end of the published figures on the world-wide totals of United States private investments.
For some time the inadequacy of these figures has been obvious to those private investors who compared them with their own investment activities. For example, the balance-of-payments figure showed a net reduction of $22 million in the Latin American investment of the entire United States petroleum industry in 1954. Yet in that year alone the Latin American affiliates of our company, the Standard Oil Company (New Jersey), spent almost $200 million for new plant and equipment and in the search for oil. In this case the spending decisions were not made on one basis for investments with new dollars from the United States and on another basis for those using funds already abroad. In the Jersey company, and probably in most other companies, each new investment project abroad is considered upon the same basis without regard to the source of funds.
The degree to which total private investment abroad has been underestimated is suggested by the 1956 investment figures of the Jersey company. Last year the company would be shown on the net outflow basis as making total investments abroad of only about $289 million. In fact, new investments in property, plant, equipment and in the search for oil amounted to $686 million.
In January of this year, the Department of Commerce issued a pioneering study of private investment on a broader basis. The study was limited to a single area, Latin America, and a single year, 1955, but it is hoped that a world-wide study can be conducted on investment made in the year 1957.
The new study shows the gross amounts of capital expenditures by United States companies in Latin America. Thus, for the first time we have statistics comparable to those used in studying investment in the United States. We are familiar, for example, with the estimates that business expenditures for plant and equipment in the United States are now proceeding at a rate of somewhere between $35 and $40 billion a year. These domestic estimates include investments from all forms of retained income as well as those from newly contributed capital. Similarly, the gross investment shown by the Latin American study included investments from reinvested subsidiary profits and from income allocated to depreciation and depletion reserves by both branches and subsidiaries abroad. The Department of Commerce study revealed that the total of direct investments in plant and equipment, in mineral exploration and development, and in net working funds in the area was five times the net balance-of-payments outflow of direct investment to Latin America. The total was two and a half times the sum of the net outflow plus the reinvestment of foreign subsidiary earnings--the largest figure shown by the previous official data.
With the help of the Latin American study, the published balance-of-payments figures for 1956, and the reinvested-earnings estimates for earlier years, it is possible to hazard guesses on the totals for United States private investment abroad in 1956.[ii] On rough but conservative assumptions based on these sources it may be estimated that private United States capital investment abroad last year was $4,980 million, of which $3,700 million was in direct investment. On the same basis the total American investment in underdeveloped areas[iii] was $1,760 million, of which $1,430 million was in direct investment. Perhaps the most noteworthy aspects of the estimates are the large size of the total; the fact that the largest percentage of the investment--about 74 percent--is in the form of direct long-term investments in enterprises abroad controlled by the investors; and the fact that about 39 percent of the direct investment is now going to what are generally regarded as underdeveloped areas, exclusive of the underdeveloped areas in Europe itself.
Some have suggested that the investment in 1956 was likely to prove abnormally large because of several non-recurring investment projects, in particular the $176 million purchase of the Trinidad Oil Company and the payment of entrance fees by successful bidders for new oil concessions in Venezuela. There is no reason to believe, however, that there will not also be large individual investments in later years. Actually, the total of the entrance fees paid in Venezuela by American investors was about $247 million for the entire year 1956. In 1957 about $358 million will be paid on the concessions offered during just the first few months of the year.
Investments made during 1956 brought the stated value of United States private investment abroad to a level of almost $33 billion. Even this figure is a serious understatement, for although portfolio investments were counted at their market value, direct investments were considered at book values based on original costs. For the year 1955 the Department of Commerce studied a sample of the direct investments and found that their reasonable market values were about double the book values. Since direct investments are so large a percentage of the total investments, it is obvious that the $33 billion is a far from adequate measure of the great productive power of United States investments abroad.
Private investment is sometimes thought of primarily in terms of the dollar exchange it brings to foreign countries. The figures mentioned above show the rapid growth in the foreign exchange provided to developing countries by the net outflow of United States private investment. Sometimes this net outflow has been improperly calculated by offsetting earnings on past investment against new inflows of investment. Actually, a large fraction of profits is reinvested; the profits that are withdrawn are only part of newly-created wealth, not a subtraction from the existing wealth of foreign countries. The fear that has existed in some countries that profits on foreign investment would become a drain on foreign exchange has not been justified. Of course, some firms do repatriate a large part of their investments, but taken as a whole United States direct investors in recent years have invested abroad much more than they have withdrawn. In the aggregate, original investments are not withdrawn, they expand.
Furthermore, exclusive attention to foreign exchange aspects overlooks the contribution of the investment by private United States businesses of local funds, even inconvertible funds. Such funds could alternatively have been merely held idle or could have been invested only in safe properties or securities rather than in risk-taking enterprises. Whether United States businesses are bringing in new dollars or using local funds, it is their productive investment of this money that makes the contribution to economic development. Only the net inflow of foreign investment provides foreign exchange, but the entire gross amount of capital expenditures brings into play the technical and managerial knowledge and innovating insight of the investors. The technical skill is provided to make projects physically feasible. The managerial ability is made available to render the undertakings economically and financially valuable. Initiative is brought to bear in recognizing the existence of economic opportunity.
These factors other than capital may be considered instruments for improving the productivity of given resources. Here in the United States careful studies have shown that our economic growth has been the result far more of improvements in productivity than of increases in our stock of capital. Professor Moses Abramovitz's study for the National Bureau of Economic Research suggests that between 1869-78 and 1944-53 net output per capita in the United States would have increased only 14 percent if productivity had remained the same and if we had merely had the use of the additional capital which our savings had made possible. Happily, the productivity of a representative group of resources increased about 250 percent over the period. The same conclusion should be equally valid for underdeveloped areas. That shortage of managerial and technical ability is more significant than capital shortage would seem to be indicated by the inability of the underdeveloped countries to propose programs which would fully utilize the available funds of the International Finance Corporation, the International Bank for Reconstruction and Development and the Export-Import Bank.
A government program of assistance is not likely to impart the dynamism associated with the capital expenditures of private enterprise. With public funds it is possible to buy "packaged" plants and "turn-key" jobs, but the private owners will not be available to exert their more flexible efforts in rearranging the whole set of processes and practices of a country's productive machine.
An increase in private investment activity in a country reveals its benefits in various direct and indirect ways, and the indirect may be as important as the direct. In direct fashion, successful investments provide:
--greater income to governments through royalties, income taxes, and other forms of exactions;
--more varied and abundant supplies of commodities and energy for consumption and for use in expanding other industries;
--increased money incomes and often improved medical and educational services for the working force.
Specific calculations of the extent of these various benefits for one area were included in the recent Latin American study already mentioned. For example, it was estimated that in 1955 United States investors paid $1.1 billion in taxes and other payments to Latin American governments. Last year our own company and its affiliates paid to foreign governments or collected for them a grand total of more than $1.8 billion in taxes and other payments required to conduct the various phases of the petroleum business. In the size of such payments there lies an obvious answer to those who argue that private investors cannot build highways, dredge ports or provide technical experts on urban sanitation, and that therefore United States public assistance must be provided. The activities of private investors are already providing monies that can be used for such purposes. And in addition, of course, private investors often literally provide roadways, ports and health experts in connection with their investment projects.
The likely indirect benefits of a new investment from the United States may be summarized as:
--encouragement of new local enterprises to supply goods and services to the new investment project;
--training of workers in new technical skills that they may later transfer to other activities;
--introduction of new concepts of the possibilities of personal advancement through economic endeavor;
--demonstration of the possibilities of doing business successfully on a high-volume-low-profit-per-unit basis while fully recognizing a company's responsibilities to the public, in action and information.
For one outstanding example of some of these attributes perhaps we can be pardoned one more reference to the Jersey Standard family. Several decades ago the development that is now the Creole Petroleum Corporation, the largest investor in Venezuela, got under way in almost wholly self-contained field camps isolated from the local economy and community. As these settlements grew, Creole gradually, and through conscious policy, sought to contribute to economic and civic development in the surrounding communities. This often has required financial backing, but the company's long-range objective is to be able to concentrate more fully on the business it knows best, the oil business. It is a slow process, sometimes involving temporary inconvenience, and there is a long way to go. Service functions are being transferred to independent local enterprises. Creole and its employees are increasingly able to buy their power and water, their housing, their supplies and groceries from Venezuelan companies which are an indirect result of private investment from abroad. Similarly, Creole and other investors from abroad have provided thousands of workers with new and transferable skills, have introduced into the country new concepts of the possibility of individual advancement, and at the same time have set high standards of efficient business operation.
Such benefits as these accrue to developing nations whether the private investment is in extractive industry or in a manufacturing or other type of enterprise. In this connection it might be pointed out that the investments of the oil industry are by no means limited to extraction. Somewhere between a third and a half of all foreign investments by the oil industry are actually in marketing, manufacturing and transporting facilities. We do not intend, however, to be in any way apologetic about extractive investments. The important thing for all concerned is that the investments be suitable to the economic circumstances. An oil well may be the only sensible investment for the middle of a desert.
The statistics of foreign investment are sometimes presented with petroleum investment excluded on the grounds that the resulting figures are a fairer indication of the investment prospects of the bulk of the underdeveloped areas; it is maintained that there are only a few selective opportunities for large extractive investments. In our own experience, however, we have been forcibly impressed by the large number of areas that could hope for sizable investments in the minerals field if only outright prohibitions or discouraging policies were removed.
With the growth achieved over the last few years in the absolute level of private investment abroad, it seems likely that the various benefits brought by foreign enterprise will become more widely understood. The result may be that the climate for private investment will improve in many areas. Most countries have not frozen their policies against foreign private investment, and the visible examples of successful coöperation with private investors around the world should influence their future policies. Private investment--not only from the United States but from other sources--is already making massive contributions to economic development abroad, and nothing is so likely to succeed as success.
It is, of course, conceivable that there will be further actions of the type exemplified by the expropriation of the Suez Canal Company. Other foreign governments may seek short-run economic advantage at the expense of the long-run confidence necessary to attract investment. It will become increasingly apparent, however, that, in cold dollars-and-cents terms, expropriation is not likely to provide even a short-run economic advantage. This would certainly seem likely to be Egypt's experience. There are few shortcuts to wealth, and today the actions and policies of foreign governments are the most important factors in determining whether private investments will be attracted to their countries.
Many removable obstacles to private investment are well known: first, the host of restrictive measures which normally accompany attempts to peg exchange rates at unrealistic levels; second, the forms of protection for entrenched interests; and third, shortsighted attitudes regarding possible expropriations or governmental failures to abide by agreements with foreign investors. Other obstacles are more subtle; there are many devious ways by which a foreign government can lead private investors to the conclusion that they would be well advised to invest their funds elsewhere.
But in the United States we must not be blind to the influence of our own Government, whose actions can strongly affect the level of private investment abroad, both directly by measures it takes itself and indirectly through its influence on investment climates abroad. In determining what economic opportunities are open to United States citizens and companies, and in advancing United States foreign policy interests, it is essential that a proper relation be established between Government actions and the international private investment process.
Probably of greatest importance to foreign investment is the Government's policy in taxing income from abroad. There are at the moment three features of our tax law which reduce the burden of United States taxes on income from investment abroad: foreign income taxes may be credited against the United States taxes which would otherwise be payable on income from abroad; investments in the Western Hemisphere meeting certain limiting conditions are entitled to a 14-point reduction in the rate of United States tax; and the income of subsidiaries incorporated abroad is left free of United States tax until the income is distributed as dividends. These provisions allow the United States investor substantial freedom from double taxation on income from abroad. If United States law took no cognizance of foreign taxes at all, then in many cases United States investors would find that their total tax bill was considerably larger than their total income. Even if, in calculating taxable income, United States laws permitted only a deduction of foreign taxes (rather than their application as a credit against U.S. taxes), investors would be faced with combined taxes as high as 85 percent of income before taxes.
Despite the three provisions mentioned above, there are still several basic defects in our system of taxing income from abroad. Tax burdens are imposed more on the basis of form than of economic substance. For example, the income from an investment made by a branch of a United States corporation in a foreign country is taxed currently by the United States even though all the income is invested in the foreign country and none of it brought back to the United States. Yet at the same time the income in a neighboring country from a similar investment by a local corporate subsidiary of the same United States corporation is not taxed currently by the United States if the income is reinvested and none distributed as dividends. This distinction seems all the more arbitrary when it is realized that the choice between using a branch or a foreign subsidiary is often dictated by regulations or political conditions in the country in which an investment is being made. Incidentally, the British Government announced in April its intention of revising its tax law so that the income of certain categories of British companies earning all their income abroad would not be taxed until the profits were distributed. This action will deserve study in the United States as a means of removing an obvious inconsistency in our tax law.
Another more basic defect in our system results in failure to encourage investment in underdeveloped areas. The system now ensures that ultimately the same high burden of tax must be paid by an investor abroad on earnings from a primitive economy with a low rate of tax as on earnings from a venture in the stable surroundings of the United States. Consequently, investment in underdeveloped countries with low tax rates is handicapped, any foreign government's tax incentive programs for attracting investment are thwarted, and foreign governments are encouraged to raise their tax rates at the expense of the United States Government, since higher foreign tax rates would normally not increase the total tax burden on the investor but would instead only increase his credit against United States taxes. The system does not ensure that all United States investors abroad pay equivalent taxes to the United States Government; it ensures only that they pay equally high taxes. Taking this situation into account, several high-level commissions and, on at least three occasions, the President himself, have recommended to Congress that the 38 percent corporate tax rate now applying to certain investments in the Western Hemisphere be extended to investment income from all foreign areas. The lower tax rate would offer little encouragement to investment in developed countries having tax rates substantially as high as those in the United States, but it would assist investment elsewhere.
The Administration does not appear to be pressing this proposal, although the British, meanwhile, plan a sharp reduction in the corporate tax on some types of investment abroad. There is some possibility, however, that progress will be made in implementing the announcement made by Secretary of the Treasury Humphrey at the Rio Economic Conference in 1954. This was to the effect that the United States Government was willing to modify its tax system in particular cases to provide that the effective United States tax rate would not be raised when a particular country lowered its tax rate for a limited period to attract investment. So far no treaties providing for this sort of treatment have reached the stage of signature.
None the less, action in the fields of tax legislation and of tax treaties appears to be the most effective way our Government can help create the proper framework for private investment in economic development abroad. Of course, other aspects of Government policy should not be neglected. Efforts should be continued to improve the legal basis for investments abroad through the negotiation of modern treaties of friendship, commerce and navigation. And there seems to be room for improvement in the diplomatic support of the proper interests of United States investors abroad.
The time has not yet come to end the Government's investment guaranty program, but some limitations might be appropriate. Although the program has probably been the principal undertaking by the Government specifically for the encouragement of private investments abroad, its accomplishments thus far have not been impressive. Under the program, for a small fee, insurance is provided against the limited political risks of loss from expropriation, inconvertibility of currency, and war. The insurance is available on new investments in countries which have signed governmental agreements providing in general that in case of insured losses the private investors' claims may be transferred to the United States Government to be pursued on a diplomatic level. The program has expanded slowly over the nine years of its existence. At the end of March this year the first warrisk agreements were still under negotiation, but insurance was available against one or both of the other two types of risk in 33 countries; $143,000,000 of insurance had been written, with no payments on losses yet being made; authority exists for an additional $385,000,000 of insurance.
In one sense, this insurance appears to be available on too generous a basis. Now that European economic recovery has been so successful and economic assistance is no longer being provided to most European countries, there does not seem to be any reason why Government assistance should continue to be available on new investments in Germany, for example. On the other hand, insurance which promotes investment in Korea or Pakistan, for example, would seem to be an appropriate adjunct of the foreign assistance program.
There are inevitably many inter-relations between our private foreign investment and our large program of public assistance abroad. The Fairless Committee has estimated that, on a gross basis, the total of United States economic assistance in the fiscal year 1956 was $1.7 billion, not including United States assistance provided through the international lending institutions. This figure probably approached $2 billion in the calendar year 1956. Of this sum, about $1.6 billion went to the underdeveloped areas, as defined above. Some of the assistance was dictated more by short-run political considerations than by interest in long-run economic development, but even if the entire $2 billion were considered economic development, the sum would be only about 40 percent of the total of private capital expenditures abroad during the year.
Of course, there are some countries which receive no public assistance, while in others private investment from abroad is only a fraction of the total foreign economic aid, as for example, in Korea and Viet Nam. In the underdeveloped areas as a whole, economic aid is about equal to, or a little less than, the private investment expenditures.
In attempting to establish a proper relation between these two sources, both contributing to economic development abroad, we face a dilemma. On the one hand, public assistance obviously can help to create economic conditions attractive to private investment. On the other hand, by providing relief to governments under pressure of need, it may delay actions that would remove obstacles to investment. Obviously, aid should not be given to a project which private investors are willing to undertake by themselves alone. Nor should aid be given when a few simple and obvious actions by the foreign government would make private investment feasible. But a nice problem of judgment often arises in guessing whether aid encourages investment or confirms governments in policies which discourage investors. It is more than a question of simple bargaining; it is a matter of guessing economic and political reactions within a foreign country. Judgment will depend on specific circumstances and cannot be embodied in general principles. Undoubtedly, there will be circumstances in which for compelling reasons of foreign policy the decision will be made to provide public assistance even though it is believed that the recipient has the power and the opportunity to change its basic policies in such a way as to attract ample private investment. But clearly, great effort should be exerted to limit the number of such cases to a minimum.
The question naturally arises whether better use of private investment could be made once the decision is taken to give public aid. The Fairless Committee commented that, "Foreign areas can get the most from economic coöperation with us if they accept us for what we are, that is, a nation in which the reservoir of industrial ability, skills and capital resides, not in government but in private hands." The group went on, therefore, to suggest that "the large areas between purely private and purely public projects should be more fully explored."
In a sense the area in between is already being tested by the guaranty program, but in many of the underdeveloped areas where the United States is providing substantial assistance the limited insurance device is not sufficiently strong to persuade private investors to undertake industrial projects now being financed by the United States on a government-to-government basis. In these circumstances the Fairless report concluded that it was preferable to supplement the guaranty program by the joint use of public and private funds in projects that otherwise would not attract private interests. To make a project feasible, the Government might make fixed-interest loans to a private company set up to operate the enterprise. Alternatively, the Government might buy participating debentures or bonds that could be converted into stock when they were sold by the Government. Such arrangements would save the taxpayers' funds, support the private sector in foreign economies, and instill a greater awareness in our aid officials of the obstacles to private investment abroad.
In April the Administration recommended the creation of a development fund which would provide loans to foreign countries on terms more favorable than are possible through existing institutions. The proposal was welcomed by the Senate's special committee on foreign aid as a possible encouragement to private enterprise, and later the President told Congress, "A major purpose would be to promote--not impede--the flow of private investment, and to this end the fund should have authority to engage in appropriate financing operations." Presumably, then, this new fund will make it possible for the Government to participate in joint projects with private investors.
In these various ways, especially in the fields of income taxes and of administration of foreign assistance, the United States Government has the power to take actions that would facilitate investment abroad, but as elsewhere the analogy applies that it is easier to pull a string than to push it. The climates created by foreign governments and foreign communities will remain the principal factor determining the levels of private foreign investment.
There is reason to hope that foreign officials anxious to further the welfare of their countries will observe and take heed of the accumulating evidence of what private investment can accomplish in the field of economic development. Among the clear-cut results available for observation are the examples of Canada, Venezuela and Peru, which are largely free from obstacles to investment. If, as we may expect, there is considerable improvement over the next few years in the receptivity to investment in many areas abroad and in the relevant policies of our Government, we are convinced that we will witness a veritable explosion of interest in foreign investment.
The potential for growth is large. The basic factors are present to create the indispensable economic opportunity; there is a growing demand for raw materials and for sources of power in developed countries and for manufactured goods in the underdeveloped areas. That investors are making use of this opportunity is shown by the rapid growth in the total statistics on foreign investments, and is also borne out in the day-to-day experience of law firms and banks that assist new investors in going abroad.
Private investment abroad should continue to expand geographically as well as in total volume. This is not to say that the need for economic assistance programs will abruptly end. In the years to come there may well be political developments and emergency situations justifying such assistance. There is a clear relation, however, between increased private investment and reduced need of public assistance for general economic development abroad. Even in those countries with which we have important military obligations, and in which external assistance is now large in relation to the domestic economies, growth in private investment can reduce the need for assistance. Also, many of those countries now receiving only economic aid have excellent opportunities to attract sizable amounts of private investment, thereby reducing their reliance on public assistance. This appears to be true even in such countries as India and Indonesia where both public assistance and private investment are now small in relation to the tasks of economic development. In both of these countries it seems clear that the small flow of private investment--in view of the vast known and probably even larger unknown physical resources and the developing consumer markets--is largely attributable to internal political situations and attitudes.
There is no reason beyond human remedy why all countries --to the immense benefit of their citizens--could not partake fully of the burgeoning of international investment which we believe possible, and likely, in the next few years.
[i] In practice, arbitrary and economically meaningless methods have been used in classifying what were and what were not balance-of-payments contributions merely on the basis of the corporate source of the funds invested. The investments of the foreign branches of United States corporations have been considered a net outflow of capital even though actually a large part of the investments were from net earnings retained abroad without passing through foreign exchange markets. At the same time, the reinvested net earnings of subsidiary foreign corporations and reinvested depreciation and depletion reserves abroad have not been considered a net outflow even though there were the same possibilities for withdrawing these funds through the exchange markets as there were for branch earnings abroad.
[ii] Preliminary figures for portfolio and short-term investment and for the balance-of-payments net outflow of direct investment in 1956 have already been published, though several country totals have to be estimated on the basis of 1955 figures. Compilations of reinvested subsidiary earnings during 1956 are not yet available but may be estimated conservatively by continuing the rate of growth experienced in 1955, despite the known acceleration in other kinds of investment. Direct investment from depreciation and depletion reserves, etc., will probably never be known, but again a conservative estimate may be made by assuming that in Latin America such investment will in 1956, as in 1955, be equal to 5.9 percent of the existing value of direct investment at the beginning of the year. In other areas a 4 percent rate may be assumed to be on the safe side.
[iii] For the purpose of this estimate the underdeveloped areas were taken to be all areas outside the United States, Canada, Western Europe, Australia, New Zealand, South Africa and Japan.