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How Are Trade And Investment Related?
Information Courtesy Congressional Research Service, IF11016
What are the main kinds of capital flows?
Generally, the two main kinds of capital flows are foreign direct investment (FDI) and foreign portfolio investment (FPI). FDI involves the acquisition of real assets such as real estate, a manufacturing plant, or controlling interest in an ongoing enterprise by a person or entity from another country.155 Foreign portfolio investment involves the purchase of foreign equities or bonds, loans to foreign residents, or the opening of foreign bank accounts. FDI often involves a long-term commitment and can have the advantage of stimulating direct employment for the host country. By contrast, portfolio investments are extremely liquid and can be withdrawn often at the click of a computer mouse. In addition, official capital flows are generated by governments for various purposes, such as humanitarian assistance and other foreign aid.
Which is larger—trade or capital flows?
It depends. From 1990 to 2019, global trade in goods and services, as measured by exports, grew more than five times, from about $4 trillion a year to $25 trillion. From 1990 to 2017, gross capital flows, as measured in the balance of payments accounts (direct, portfolio, and other official investments), expanded from around $1 trillion a year to about $4 trillion—but with a precrisis peak of more than $12 trillion in 2007, which showed significant growth since the 1990s. During this period, there was also an explosion in growth in other types of capital flows, known as foreign exchange and over-the-counter derivatives markets. These markets facilitate trade in foreign exchange and other types of assets. While the capital flows associated with these markets do not directly relate to transactions in the balance of payments, they do affect the international exchange value of the dollar, which in turn affects prices of goods and services and the cost of securities. The latest survey of the world’s leading central banks indicated that the total daily trading of foreign currencies was $6.6 trillion in the second quarter of 2019.
Why do companies invest abroad?
Broadly, firms invest abroad to increase their profits. However, a range of factors can influence a firm’s decision to invest. Multinational corporations (MNCs) generally invest abroad because they possess some special process or product knowledge or special managerial abilities, which give them an advantage over foreign firms. Major determinants of FDI include the presence of competitive advantages, resources such as low-cost labor in a host country, and greater commercial benefits through an intra-firm relationship as opposed to an arm’s-length relationship between the investor and host country. MNCs are motivated by more than a single factor and likely invest abroad not only to gain access to low-cost resources, but to improve efficiency or market share. FDI has supported the development of global value chains by multinational corporations (MNCs), which source production globally. In addition, many firms find it advantageous to operate close to their customers in foreign countries, where tastes and preferences may differ from the home market. Foreign markets also enable MNCs to access various resources, such as a well-educated work force, which might contribute to a firm’s R&D activities. Last, some FDI transactions involve mergers and acquisitions, which can help make a firm become more globally competitive.
What are international investment agreements (IIAs)?
International investment agreements (IIAs) establish binding rules on investment protections. While multilateral agreements of the World Trade Organization (WTO) address some investment issues to a limited extent, there are no comprehensive multilateral rules on investment. IIAs have thus become the primary vehicle for promoting investment rules—there are over 2,600 IIAs in force globally. The United States negotiates IIAs based on a “model” Bilateral Investment Treaty (BIT), to reduce restrictions on foreign investment, ensure nondiscriminatory treatment of investors and investment, and advance other U.S. interests. The agreements also generally include provisions to safeguard a government’s right to regulate in the public interest and provide for national security and prudential exceptions. U.S. IIAs typically take two forms: (1) BITs, which require a two-thirds vote of approval in the Senate; or (2) investment chapters in free trade agreements, which require simple majority approval of implementing legislation by both houses of Congress. The USTR and State Department negotiate U.S. IIAs. While U.S. IIAs are a small fraction of IIA agreements worldwide, they are often viewed as more comprehensive and of a higher standard than those of other countries.
How many IIAs does the United States have?
The United States has bilateral investment treaties (BITs) in force with 40 countries, most of which are with developing countries (see Figure 20). The latest BIT ratified by the U.S. Senate, with Rwanda, entered into force in 2012. The United States had been pursuing BIT negotiations with China and India, but both talks have stalled for several years. The United States also has 14 FTAs in force covering 20 countries, most of which include chapters on investment. The U.S.-Mexico-Canada Agreement (USMCA) represents the United States’ most recent set of investment commitments in a U.S. trade agreement.
What is investor-state dispute settlement (ISDS)?
Investor-state dispute settlement (ISDS) enables private investors to bring claims against host country governments for alleged violations of investment agreements before an international arbitration panel. ISDS provisions are intended to establish a binding and impartial procedure for settling disputes, with proceedings conducted under the auspices of the World Bank-affiliated International Centre for Settlement for Investment Disputes (ICSID) or comparable rules. While a successful claim by an investor can result in monetary penalties, a country cannot be compelled to change its laws over a decision. Globally, the number of ISDS cases has expanded significantly with the significant growth of global FDI in recent decades. U.S. investors account for nearly one-fifth of investment claims worldwide. Although there have been 17 cases brought by foreign investors against the United States as of 2020, the U.S. government has yet to lose a case.
ISDS provisions are included in the majority of U.S. BITs and FTAs. Nearly all ISDS cases brought against the United States were under the 1994 North American Free Trade Agreement (NAFTA). The use of ISDS, however, has become a subject of debate within recent U.S. trade negotiations. At the center of the debate is ensuring robust investor protections, while protecting the government’s right to regulate in the public interest. The Trump Administration departed from past practice with major changes to ISDS under the NAFTA renegotiation. The U.S.- Mexico-Canada Agreement (USMCA), which entered into force in July 2020, eliminates ISDS between the United States and Canada and places specific limits with respect to Mexico in sectors in which U.S. companies are heavily invested, such as the energy sector. ISDS was also a major point of contention in previous negotiations for the Transatlantic Trade and Investment.
What is the Committee on Foreign Investment in the United States (CFIUS)?
Foreign investment, particularly by firms that are owned or controlled by a foreign government, can raise concerns about national security. CFIUS is an interagency committee that assists the President in overseeing the implications of foreign investment transactions for U.S. national security interests. The committee is composed of nine Cabinet members, two ex officio members, and other members as appointed. CFIUS was originally established by an executive order in 1975 with broad responsibilities and few powers. The authority to review foreign investments, known as the Exon-Florio provision, was formally established in 1988 with the passage of P.L. 100-418. In 2007, the Foreign Investment and National Security Act (P.L. 110-49) established CFIUS in statute and expanded the committee’s role in reviewing FDI transactions that could affect “homeland security” and “critical industries.” The Secretary of the Treasury serves as chairman of CFIUS, and a designated lead agency conducts a “risk-based analysis” of the national security threat posed by mergers, acquisitions, or takeovers that result in control of a U.S. firm by a foreign investor. The President has the authority to block proposed or pending transactions. To date, the law has been used six times to block a foreign acquisition of a U.S. firm, although a number of investments have been withdrawn before reviews were completed.
The Foreign Investment Risk Review Modernization Act of 2018 (FIRRMA, P.L. 115-232, Title XVII), signed into law in August 2018, amended the CFIUS review process and expanded the scope of transactions subject to review, to include certain noncontrolling investments in U.S. businesses involved in critical technology, critical infrastructure, or sensitive data and certain real estate transactions.