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The issue of rates of return on foreign owned companies through foreign
direct investment. On Wednesday Oct. 25th.2000,at a meeting in Montreal, the
finance Minister of Canada Mr. Paul Martin in his opening address to the G20
group on promoting Globalization, stated that “globalization will have a more
human face with measures to ease financial crises and social safety nets to
protect the poorest”. The meeting concluded with all the participants agreeing
on a package of measures, which they say, will lead to more financial stability
in the world. From a political perspective this endorsement may seem realistic.
However this futuristic goal will require more foreign direct investment from
corporations and other sources of private enterprise at a time when most
expatriate firms are complaining about the decline of the (R.O.A) rate of return
of foreign owned companies, specifically in the U.S.A.
Firms based in one
country increasingly make investments to establish and run business operations
in other countries.U.S firms invested US$133 billion abroad in 1998,while
foreign firms invested US$193 billion in the US.Overall world FDI flows more
than tripled between 1988 and 1998,from US $192 billion to US$600.The share of
FDI to GDP is generally rising in both developed and developing countries. In
addition to this information the World Bank further stated that developing
countries received about one quarter of the world FDI inflows in 1998-1998 on an
average, though the share fluctuated quite a bit from year to year. It would
seem that this is the largest form of private capital inflow to developing
countries. This data will seem to encourage more foreign investment. Hence, one
will ask if there are truly low rates of returns on investment by foreign owned
companies.
If this is the case then why are there so many foreign direct
investment by small as well as multi-national corporations? In order to answer
this question there must be an examination of the actual low rates of return
from foreign-owned companies. This examination will be based on the performance
of U.S.owned companies. A research done by the Bureau of Economic Analysis (BEA)
provided new estimates of the rate of return for foreign –owned US nonfinancial
companies that are disaggregated by industry and valued in current-period prices
for the years 1988 to 1997.The new estimates. Along with company-level estimates
for US owned nonfinancial US companies, were used to examine factors that help
explain the low rates of return. The rate of return measure was the ( ROA) i.e.
the return on assets.. This is also looked at as the ratio of profits from
current production, plus interest paid to the average of beginning and end of
year total assets. Also profits from current production are profits that result
from the production of goods and services in the current period. Both profits
and assets are valued in prices of the current period. Profits reflect the value
of inventory withdrawals and depreciation on a current-cost basis. These have
been adjusted to remove the income from equity investments in unconsolidated
business and the expense associated with amortizing intangible assets. Total
assets reflect the current cost of tangible assets. These have been adjusted to
remove assets for which the return is not included in the numerator of the ROA
ratio e.g. equity investments in unconsolidated businesses and ammortizable
intangible assets.
The new ROA estimates for foreign-owned companies indicate
that: - The new current-cost estimates show that the average ROA of foreign
owned companies in 1988-1997 was 5.1 percent. In contrast, the historical-cost
estimates show an average ROA of 5.7 percent. - The ROA of all foreign non
financial companies was consistently below that of US owned non-financial
companies in 1988-1997,but the gap narrowed over time from nearly two percentage
points in 1988 to one percentage point in 1997.The narrowing of the gap appeared
to be related to age effects. Acquiring or establishing a new business add costs
such as startup costs that disappear over time. - ; Additionally, experience can
yield benefits, such as learning by doing that accumulates over time. - High
startup and restructuring costs related to acquisitions also lower the
profitability of foreign-owned companies. Newly acquired foreign-owned companies
showed very low or negative rates of return. - Many foreign –owned companies had
a tax-related incentive to shift profits from the US to their home country using
transfer prices. There are several other studies which indicate that there is a
decline in the rate of return on Foreign Direct Investment by US companies.
The
most recent study was done by Laster and McCauley.They used industry level
estimates of historical-cost return on investment and on sales for foreign-owned
companies from the Bureau of Economic Analysis.The consensus is that the reasons
for this decline are: Industry mix, i.e. US owned companies are concentrated in
low profit industries, Market share, age effects, intra firm-import content,
i.e. some foreign-owned companies might have made higher profits but they may
shift some of this profits using transfer prices, and finally, combined effects
involving one or several of the preceding reasons for the lower rate of return
on foreign investment. From the various studies conducted, industry patterns in
the ROA estimates indicated that the profitability of foreign-owned companies is
related to their market shares. Industries in which the profitability of
foreign-owned companies is relatively high, (such as petroleum and chemical
manufacturing) tend to be those in which the largest foreign-owned companies
have a significant share of the total US market for certain products. However,
in some industries, (such as stone, clay and glass products manufacturing and
rubber and miscellaneous plastic products manufacturing), the largest foreign
owned companies both are relatively and less profitable and have a significant
share of the total US market for certain products. In order for Mr. Martin and
his G20 disciples to fulfil there mandate they must consider the impact of low
return on investment by foreign direct investment companies in the US as well as
other countries.
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