The reinvestment by multinationals as a capital flow: Crises, imbalances, and the cash-based current account. (June 2022)

• Record Type: Journal Article
• Authors: Hansen, Erwin; Wagner, Rodrigo
• Is Part Of: Journal of international money and finance. Volume 124(2022)
• Publication Date: 2022-06
• Subjects: Foreign direct investment -- External balance -- Corporate saving -- Global imbalance -- Repatriation tax -- TCJA; TCJA Tax Cuts and Jobs Act of 2017 -- FDI Foreign Direct Investment; F32 -- F21 -- F38 -- F41 -- G3; International finance -- Periodicals; Foreign exchange -- Periodicals; Finances internationales -- Périodiques; Change -- Périodiques; Foreign exchange; International finance; Periodicals; 332.04205
• DOI: 10.1016/j.jimonfin.2022.102615
• Languages: English
• ISSNs: 0261-5606

Abstract

Highlights: We explore the empirics of retained earnings FDI (REFDI), accounting for half of global FDI. REFDI behaves similar to savings in its procyclicality. It also relates to Feldstein-Horioka. REFDI lowers the probability of macroeconomic crises and sudden stops Overall, REFDI is stronger in countries receiving more FDI. Vulnerability assessment should adjust for REFDI. We offer new cash-based indicators for that. Abstract: When the affiliate of a foreign corporation saves a dollar of its profits, the host country records it as an inflow of retained earnings foreign direct investment (REFDI). If invested, this dollar arithmetically generates a current account deficit, even though cash does not cross borders. This study explores the empirical macroeconomic of REFDI, which globally comprises half of FDI inflows. Using international capital flows (1980–2018), we show that REFDI behaves like national saving in its procyclicality. Unpacking FDI in the analysis also makes a difference for the investment cycle. Moreover, we decompose the long run saving-to-investment correlation, finding a role for REFDI in the Feldstein-Horioka puzzle. Adjusting the current account for REFDI matters since REFDI lowers the probability of macroeconomic crises and sudden stops. Overall, REFDI is stronger in countries receiving more FDI and it was also strong during the recent commodity boom. We are not challenging that the balance of payments works on nationality and accrual bases. However, our results suggest that the external balance assessment of countries should adjust for REFDI because it tends to have a different propensity to be invested and to build-up vulnerabilities.