Is American FDI more productive and am I dizzy?

Dan Drezner writes:

Given the fact that foreigners currently have a net claim on $2.5 trillion in U.S. assets, one would expect the U.S. to be paying out a lot more in interest, dividends, and profits to foreigners than Americans would receive from their investments.

The weird thing is that, so far, this hasn't been true. Last year the U.S. earned $36 billion more on their foreign investments than foreigners earned in the United States. The question is, why?

It turns out Americans both (seem to) make riskier investments and earn a higher return on investment.  One extreme view (not Dan's) suggests the following:

Once assets are valued accordingly, the US appears to be a net creditor, not a net debtor and its net foreign asset position appears to have been fairly stable over the last 20 years.

For months this debate has been making my head spin. 

1. I think of FDI as often taking ten or more years to pay off.  Yes, we should account for the "dark matter" of superior investment performance but a country with older FDI will appear to have a stronger net asset position than is the case.  If we think of the U.S. as the more established foreign investor, the apparent superiority of our investments may be an accounting convention and simply a matter of their vintage.

2. If Americans are earning higher risk-adjusted rates of return by investing abroad, why don't foreigners buy U.S. multinationals until this difference goes away?

3. I also get dizzy pondering the difference between value productivity and real productivity.  We, and the world, should be happy if we can produce more widgets.  But should we be equally happy if we earn more money simply by buying widget inputs at lower prices?  Isn't this just a transfer from abroad?  Citing this as a true global benefit seems to invoke precisely the kind of mercantilist reasoning that we reject in other contexts.  Even more strongly, should we be so happy that the Japanese sometimes buy U.S. assets at such inflated prices? 

Yes, you might welcome wealth transfers, especially if you feel your economy or currency is about to collapse.  But what if these transfers are a one-time stock inherited from the past?  That means we have mismeasured the height of our perch but we would (if you buy the whole dollar pessimism argument) still collapse.  Do we have good reason to believe that an ongoing flow of these wealth transfers will continue in the future?

My bottom line, for now: The U.S. enjoys many intangible competitive advantages, ranging from demographics, a more entrepreneurial climate, and better TV shows.  These all affect the value of the dollar, and as you probably know, I have never bought into the dollar pessimism argument.  Even if we should consider superior FDI performance as another factor, it is unlikely to stand at the top of the list.

Continuing...as the now-to-be-tenured Dr. Drezner would say...Comments are open...Brad Setser commented on Dan's blog, and I have reproduced his remarks  beneath the fold...Addendum: Brad Setser has much more at his blog.

Dan -- As erg noted, I argue that the anecdotal evidence points to corporate tax arbitrage as a key explanation. But if you come across the definative b-school explanation, do let me know. So ask Bill Gates, or the big pharma CEOs with big profits in Ireland for the answer, not old George Soros.

I'll set aside my argument that investing in US dollar denominated assets is actually very risky for a foreign investors looking to maintain their real wealth in local currencies terms. The big current account deficit and all. Not everyone agrees with it.

But I don't think the US just is good at borrowing at low cost to buy high yielding assets argument works that well. For a couple of reasons. First, US returns abroad really aren't that good. The shocking thing is that reported foreign returns on their FDI are really bad -- less than they would have gotten holding long-term Treasuries generally. It isn't US skill, at least not skill at anything other than taking foreign direct investors for a ride that shows up in the data (now if FDI in the US doesn't want to show profits in the US for tax reasons, the story changes ... ). Second, most US FDI is just not in risky markets, nor are most US debt securities claims on risky places. Most US FDI is in the UK. lots more is in Switzerland. Throw in Japan, Canada and the Eurozone and you have a decent mental image of US assets abroad. Read the CBO report on this topic. Or look at the data the IMF has assembled on the sources of FDI in China (hint -- it ain't mostly coming from the US). US investors also own foreign bonds -- but they are mostly the securities issued in well developed markets that are almost as liquid as our own. UK, Japan, Canada, eurozone and the like.

We have lent tons of money to the Caymans too; I bet the Caymans also invests a lot in the US .... hhmmm? Maybe some b-school prof can help us out there. Or tax attorney.