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The public mind is focused on outsourcing-those ships full of Chinese-made consumer goods clogging their way through the Port of Los Angeles to Wal-Mart and other retailers. But, that focus looks past an equally striking outcome of globalization, the continuing boom in direct U.S. investment overseas. And, U.S. corporations looking for the best return on possible investments face a full list of questions and concerns to address.
A few numbers underscore the strength of the investment move to overseas. A Congressional Research Service report to Congress states that U.S. investment overseas rose from a three-year [1990-1992] annual average of about $45 billion to an annual average of $190 billion in 2002-2004. Through 2005, American firms had invested a cumulative $2.07 trillion in other countries-somewhat over half of that in Europe; about one-sixth each in Asia and Latin America.
Unlike outsourcing, the investment trend is moving away from the world's low-cost economies. In 1996, the developing world received 37 percent of U.S. direct investment, a figure that declined to 25 percent in 2003. That report to Congress notes that patterns of overseas investment parallel shifts in the U.S. economy-that is, as the domestic economy has moved from extractive, processing and manufacturing industries to high technology and financial industries, investment overseas has shifted to similar endeavors.
Still, U.S. corporations looking to invest overseas want the best return on that investment. Getting that return, a host of trade and academic figures agree, starts with a clear-eyed recognition of both the opportunities and risks, and a concerted strategy for reducing the latter.
Here's a shortlist of what to consider:
This happens not only in 'emerging markets.' For example, Poland has been a major recipient of investment-the 37,745 jobs created there by foreign investment in 2005 is the total highest in Europe. Poland's recently elected government, however, has brought with it talk of nationalization-not, observers say, a likely prospect, but one that raises short-term uncertainty.
Key to smooth operation, several experts agree, is easy access to the local authority. One expert notes, “Certainly, transparency of government officials is very important.”
Within this general category, two matters apply in particular, depending on the nature of the business to be conducted.
One is the regulatory climate: “How burdensome is it? If you're in a regulated industry like pharmaceuticals, are they easy to deal with? If you're a financial institution, do local requirements conform to world standards?”
The second is intellectual property rights. A patent, one European trade expert notes, provides nothing more than the basis for a lawsuit. The outcome is anything but certain. He cites the experience on an engineering company in Ukraine, which, having concluded that the infringement lawsuit it was pursuing would simply wander on, ended up resuming business with the local company that had infringed its patent. He commented: “If the political system is not supportive, there's nothing you can do to enforce intellectual property.”
These and other matters must be addressed against any company's individual agenda-its reasons for going abroad, how long it plans to stay, and its tolerance for risk.
Reason for investing. Outsourcing may be driven by the lure of low-wage labor used to make consumer goods that are exported back to the home country, but a different pattern exists with direct investment. Indeed, according to the Congressional report cited, only about 9 percent of what is produced by U.S. direct investment overseas is exported back to the United States. Most commonly, that production is intended for the local market. The report states: the major share of U.S. investment is currently going to countries “where wages, markets, industries and consumer tastes are similar to those in the United States.” Christopher Short, Coface's head of export underwriting, comments, “You hear a lot about the opportunity in low-cost markets, but the downside can be inefficiencies, quality of product, delivery and things like that.”
Intended duration. Whether a corporation plans on becoming a 'permanent resident' or to take short-term advantage frames a number of things, including the value of incentives a prospective host country might offer. People, says Luxembourg's Georges Faber, “react to low salaries and incentives.” Often, he suggests, incentives are offered to compensate for something that is lacking-infrastructure, say. Most incentives are time-bound; if they are a compensation for something lacking, and that lack goes unaddressed, then the costs associated with it will remain once the incentive has expired. Then, Faber notes, some companies go 'location shopping' as soon as the incentive that drew them is exhausted. He adds, “I cannot believe it makes sense to move your factory every ten years. You will face a new environment and new procedures; you have to start again; you face new risks; there's a new government.”
Risk tolerance. This, of course, is something every company must judge for itself. Generally, says one official, when European companies consider foreign investment, “they accept less risk than American companies would do. On the other hand, taking risk can be rewarding.” Some U.S. companies, comments University of Tennessee professor Paul Dittman, “don't really think particular concerns are real. More likely, they think: 'Sure, something we'll happen, but we'll find a way to manage through it, just like everything else.'”
One countervailing advantage available to U.S. corporations today is the far greater availability and reliability of information. Christopher Short of Coface North America notes that his firm has more than doubled the number of countries on which it is able to provide detailed assessments. The world, he notes, “has become an easier place for us to assess.” One aspect of that is the economic opening of the former Soviet Union and Eastern Europe-where, prior to 1990, both solid data and opportunities for investment were sharply circumscribed.
A quick look at the factors Coface considers in making its own risk assessments shows how general among experts agreement is on the categories of risk that need to be addressed. That list includes institutional instability; growth vulnerability; foreign currency liquidity crisis; external over-indebtedness; sovereign financial vulnerability and banking sector's fragilities.
However these factors add up, there appears to be a slight trend away from the low-cost economies as a site for investment. A 2006 Ernst & Young survey of European corporate executives asked each for up to three 'preferred sites' for direct investment. In the 2005 survey, China, named by 52 percent of respondents, led the list, followed by the U.S. (39 percent), with India a distant third. In 2006, China and the U.S. each pulled a 41 percent response, followed by Germany, India and Poland. Interestingly, substantial differences were revealed when the 'type' of investment was specified: China ranked first for investment in production facilities; India, first in call centers, with the United States and Germany tied for first for research and development centers.
Even the supposedly crucial issue of wage rates weighs differently in different industries, as one U.S.-based private sector expert on East Asia commented. In the textile industry, he noted, Asia offers both significant wage and efficiency advantages, “Which is why you see growing textile business in China and declining textile business in the developed countries.” On the other hand, financial giants like Citicorp and the British-based HSBC, have expanded into Asia to get in on booming economies: “They aren't there to off-shore stuff, but to serve the local markets. Since most of their revenue and costs are local to each place, wage rates don't make much difference to them.”
One common thread that emerges is the advice that companies considering investing overseas probe beneath the surface. This is true, for example, in such seemingly straightforward matters as wage rates. Even within Western Europe, there is marked country-to-country variation in the difference between salaries a company pays to its employees and that company's total labor costs. For example, if a company pays a married employee with two children a salary of 100,000 euros, its total labor cost ranges from 105,000 euros in the Netherlands to 149,000 euros in France. Employee 'take home' pay is likewise affected, ranging from 73 percent of gross pay following tax and social security deductions in Luxembourg down to 52 percent in Belgium. Worth investigating as well, some European countries apply lower income tax rates to foreign nationals employed by foreign-owned firms: in the Netherlands, for instance, American employees of U.S.-owned firms generally pay about three-fifths the tax rate assessed that country's nationals.
Beyond direct labor cost is the issue of labor flexibility. Here, Western Europe is by American standards at a disadvantage. Commonly, these countries limit the number of overtime hours that can be worked-often, in any given week: “If a company has a lot to produce in a week, they can be blocked.”
The need for a deeper look also applies to tax rates. One European trade official noted that while potential U.S. investors are keen to know a country's nominal corporate tax rate, they are insufficiently curious to learn what, in each country, was-and wasn't-taxable.
A few numbers underscore the strength of the investment move to overseas. A Congressional Research Service report to Congress states that U.S. investment overseas rose from a three-year [1990-1992] annual average of about $45 billion to an annual average of $190 billion in 2002-2004. Through 2005, American firms had invested a cumulative $2.07 trillion in other countries-somewhat over half of that in Europe; about one-sixth each in Asia and Latin America.
Unlike outsourcing, the investment trend is moving away from the world's low-cost economies. In 1996, the developing world received 37 percent of U.S. direct investment, a figure that declined to 25 percent in 2003. That report to Congress notes that patterns of overseas investment parallel shifts in the U.S. economy-that is, as the domestic economy has moved from extractive, processing and manufacturing industries to high technology and financial industries, investment overseas has shifted to similar endeavors.
Still, U.S. corporations looking to invest overseas want the best return on that investment. Getting that return, a host of trade and academic figures agree, starts with a clear-eyed recognition of both the opportunities and risks, and a concerted strategy for reducing the latter.
Here's a shortlist of what to consider:
Political Stability
Corina Muller Monaghan, vice president for political risk at Coface North America, a leading underwriter of trade insurance and related products, noted: “Some U.S. companies are naïve when they enter into a trade transaction or investment in an emerging market. They rely mostly on a country's financial rating and do not consider political and sovereign risks.” Most emerging markets, she added, “have a complex political system. Government attitude towards foreign investment and trade could therefore shift radically with each new election.”This happens not only in 'emerging markets.' For example, Poland has been a major recipient of investment-the 37,745 jobs created there by foreign investment in 2005 is the total highest in Europe. Poland's recently elected government, however, has brought with it talk of nationalization-not, observers say, a likely prospect, but one that raises short-term uncertainty.
Key to smooth operation, several experts agree, is easy access to the local authority. One expert notes, “Certainly, transparency of government officials is very important.”
Legal Stability
Two concerns common to business, notes one private sector expert on East Asian trade, are the preservation of capital and the rate of return on that capital. Regarding the first, he urges companies considering investing abroad to “look at the legal environment-whether there are sound commercial laws that respect property rights-and whether there is a judicial system that acts with probity and can adjudicate disputes and protect investors' rights.” Further, as Coface's Monaghan notes, countries often have legal systems that “are new and inexperienced, which makes it difficult for foreign investors to settle disputes.”Within this general category, two matters apply in particular, depending on the nature of the business to be conducted.
One is the regulatory climate: “How burdensome is it? If you're in a regulated industry like pharmaceuticals, are they easy to deal with? If you're a financial institution, do local requirements conform to world standards?”
The second is intellectual property rights. A patent, one European trade expert notes, provides nothing more than the basis for a lawsuit. The outcome is anything but certain. He cites the experience on an engineering company in Ukraine, which, having concluded that the infringement lawsuit it was pursuing would simply wander on, ended up resuming business with the local company that had infringed its patent. He commented: “If the political system is not supportive, there's nothing you can do to enforce intellectual property.”
Economic Stability
Georges Faber, executive director of the Luxembourg Board of Economic Development, comments, “If you are operating in a stable economy that doesn't face major problems of public debt or deficit, then the country is less likely to raise taxes.” It's not only a tax question; equally important is the strength of the local currency. Of particular interest is the Chinese yuan, which most observers regard as seriously overvalued in real terms. One academic observer noted, “If the yuan was allowed to float-which I don't think China will let happen-then a company that achieved a 25 percent savings by operating in China would see that savings wiped out.”Infrastructure
The general question here is: how well do things work? Things like ports and roads and telecommunications. Are improvements being professionally planned and carried out; are promises kept? In Ireland, for example, investors who are quite happy with the work force and tax climate have nonetheless complained that promised highways have simply not been completed. And, beyond the physical infrastructure, consider the state of the business infrastructure-banking services and the like. Finally, “you need to look particularly telecommunications, because an awful lot of business these days is conducted over the Internet.”Logistics
Clearly, the importance of location depends on why you are there-it matters more to a distribution operation than to a call center. Jochum S. Haakma, managing director of the Netherlands Foreign Investment Agency, points not only to the Port of Rotterdam and the river and rail network his country serves, but also suggests the value of what might be called 'cultural logistics.' That is, the high proportion of Dutch who are multi-lingual facilitates trade and marketing throughout the continent.Quality of Life
This is something of a catchall-everything from climate, to cultural amenities to the quality of education likely to be available to the children of Americans posted abroad. Indeed, sometimes it involves a rather unlikely catch. Dutch investment officials report that several years ago an American business chose to locate in the Netherlands rather than in Great Britain. The reason? British regulations then required a six-month quarantine of the chief executive's dog, while the Netherlands only needed confirmation that the pet had received all appropriate vaccinations.These and other matters must be addressed against any company's individual agenda-its reasons for going abroad, how long it plans to stay, and its tolerance for risk.
Reason for investing. Outsourcing may be driven by the lure of low-wage labor used to make consumer goods that are exported back to the home country, but a different pattern exists with direct investment. Indeed, according to the Congressional report cited, only about 9 percent of what is produced by U.S. direct investment overseas is exported back to the United States. Most commonly, that production is intended for the local market. The report states: the major share of U.S. investment is currently going to countries “where wages, markets, industries and consumer tastes are similar to those in the United States.” Christopher Short, Coface's head of export underwriting, comments, “You hear a lot about the opportunity in low-cost markets, but the downside can be inefficiencies, quality of product, delivery and things like that.”
Intended duration. Whether a corporation plans on becoming a 'permanent resident' or to take short-term advantage frames a number of things, including the value of incentives a prospective host country might offer. People, says Luxembourg's Georges Faber, “react to low salaries and incentives.” Often, he suggests, incentives are offered to compensate for something that is lacking-infrastructure, say. Most incentives are time-bound; if they are a compensation for something lacking, and that lack goes unaddressed, then the costs associated with it will remain once the incentive has expired. Then, Faber notes, some companies go 'location shopping' as soon as the incentive that drew them is exhausted. He adds, “I cannot believe it makes sense to move your factory every ten years. You will face a new environment and new procedures; you have to start again; you face new risks; there's a new government.”
Risk tolerance. This, of course, is something every company must judge for itself. Generally, says one official, when European companies consider foreign investment, “they accept less risk than American companies would do. On the other hand, taking risk can be rewarding.” Some U.S. companies, comments University of Tennessee professor Paul Dittman, “don't really think particular concerns are real. More likely, they think: 'Sure, something we'll happen, but we'll find a way to manage through it, just like everything else.'”
One countervailing advantage available to U.S. corporations today is the far greater availability and reliability of information. Christopher Short of Coface North America notes that his firm has more than doubled the number of countries on which it is able to provide detailed assessments. The world, he notes, “has become an easier place for us to assess.” One aspect of that is the economic opening of the former Soviet Union and Eastern Europe-where, prior to 1990, both solid data and opportunities for investment were sharply circumscribed.
A quick look at the factors Coface considers in making its own risk assessments shows how general among experts agreement is on the categories of risk that need to be addressed. That list includes institutional instability; growth vulnerability; foreign currency liquidity crisis; external over-indebtedness; sovereign financial vulnerability and banking sector's fragilities.
However these factors add up, there appears to be a slight trend away from the low-cost economies as a site for investment. A 2006 Ernst & Young survey of European corporate executives asked each for up to three 'preferred sites' for direct investment. In the 2005 survey, China, named by 52 percent of respondents, led the list, followed by the U.S. (39 percent), with India a distant third. In 2006, China and the U.S. each pulled a 41 percent response, followed by Germany, India and Poland. Interestingly, substantial differences were revealed when the 'type' of investment was specified: China ranked first for investment in production facilities; India, first in call centers, with the United States and Germany tied for first for research and development centers.
Even the supposedly crucial issue of wage rates weighs differently in different industries, as one U.S.-based private sector expert on East Asia commented. In the textile industry, he noted, Asia offers both significant wage and efficiency advantages, “Which is why you see growing textile business in China and declining textile business in the developed countries.” On the other hand, financial giants like Citicorp and the British-based HSBC, have expanded into Asia to get in on booming economies: “They aren't there to off-shore stuff, but to serve the local markets. Since most of their revenue and costs are local to each place, wage rates don't make much difference to them.”
One common thread that emerges is the advice that companies considering investing overseas probe beneath the surface. This is true, for example, in such seemingly straightforward matters as wage rates. Even within Western Europe, there is marked country-to-country variation in the difference between salaries a company pays to its employees and that company's total labor costs. For example, if a company pays a married employee with two children a salary of 100,000 euros, its total labor cost ranges from 105,000 euros in the Netherlands to 149,000 euros in France. Employee 'take home' pay is likewise affected, ranging from 73 percent of gross pay following tax and social security deductions in Luxembourg down to 52 percent in Belgium. Worth investigating as well, some European countries apply lower income tax rates to foreign nationals employed by foreign-owned firms: in the Netherlands, for instance, American employees of U.S.-owned firms generally pay about three-fifths the tax rate assessed that country's nationals.
Beyond direct labor cost is the issue of labor flexibility. Here, Western Europe is by American standards at a disadvantage. Commonly, these countries limit the number of overtime hours that can be worked-often, in any given week: “If a company has a lot to produce in a week, they can be blocked.”
The need for a deeper look also applies to tax rates. One European trade official noted that while potential U.S. investors are keen to know a country's nominal corporate tax rate, they are insufficiently curious to learn what, in each country, was-and wasn't-taxable.
Sidebar: Where to go for additional information:
- For background, contact the investment promotion agency of the country in question.
- Contact the U.S. Chamber of Commerce branch or affiliate.
- Make 'off the record' contact with U.S. businessmen or bankers who have been 'on the ground' for some years.
- For basic background, one excellent source is the country-by-country descriptions in the CIA's World Fact book (https://www.cia.gov/cia/publications/factbook/index.html)
- Coface North America makes available detailed assessments of economic, political and other factors for 152 foreign countries, at www.coface-usa.com.
- The U.S. government annually publishes a highly detailed National Trade Estimate Report on Foreign Trade Barriers, with country-by-country information on legal, environment, trade and other factors, available from the U.S. Trade Representative's Web site, at www.ustr.gov.
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