The first decade of the 21st century was a mixed period for the world economy. It began with the September 11, 2001, terrorist attacks and the economic gloom that followed. However, the US and global economies soon bounced back. The years after 2003 were ones in which the world witnessed a surge in cross-border capital flows and relatively high growth in emerging markets. And then, 2007 saw the onset of a global crisis that is still with us.

Much of the discussion on economic performance during these years has focused on finance, especially in the case of the US. That is not surprising. It is home to the world's reserve currency, was the recipient of large capital inflows, was the location through which global cross-border flows were substantially mediated and was the country in which the 2007-08 financial crisis began.

But global flows consist not only of financial flows, but flows of direct investment mediated through affiliates of transnational firms. In this too, the US is a major player. According to Unctad's World Investment Report 2011, in 2010, the US accounted for FDI outflows of $328.9 billion out of total world outflows of $1.3 trillion, or about a quarter of global outflows. A question that arises then is how US multinationals, which were the principal carriers of these flows, performed during those years.

Shift in importance

The recently released preliminary results of the 2009 benchmark survey of US multinational companies permits an assessment of this performance. On the surface it appears that the performance of US MNCs has followed economic trends in the US and the rest of the world. The value added by both parents and majority owned foreign affiliates (MOFAs) of US multinationals, that grew at 4 per cent during 1999-2004, slowed to almost half that at 2.2 per cent during 2004-09.

However, this deceleration in growth seems to have been accompanied by a shift in the relative importance of parents and MOFAs in the aggregate performance of US MNCs. Thus, in both 1999 and 2004, parent firms accounted for more than three-quarters of value added by US MNCs, with the figures standing at 76.8 and 78.1 per cent, respectively.

But matters have changed since, with the share of parent firms in value added by US MNCs falling by close to 10 percentage points to 68.3 per cent in 2009 (Chart 1). In sum, while operations of parent companies still dominate the activities of US MNCs, there appears to have been a significant shift in US multinational operations away from parent firms at home to affiliates abroad.

This shift appears far more dramatic when seen in terms of the relative rates of growth of value added by parent firms and MOFAs of these multinationals. Over the decade 1989-99, value added in both parent firms and MOFAs grew at broadly similar rates of 6.7 and 7 per cent per annum respectively (Chart 2). During 1999-2009, on the other hand, those rates stood at a remarkably different 1.7 per cent and 7 per cent, respectively.

These differences were substantial in both the sub-periods 1999-2004 and 2004-09, with the figures being 2.8 and 8 per cent, respectively, in the first, and 0.7 per cent and 5.9 per cent, respectively, in the second. In sum, the overall performance of US multinationals would have been far worse if the slowdown in value added delivered by affiliates located abroad was not much lower than that delivered by parent firms producing in the US itself.

This better performance of MOFAs was of particular importance because in the US, parent firms of US multinationals performed much worse than all private US companies in terms of value added growth, even though employment trends in the two groups of firms was not too different. Value added in parent firms of US MNCs grew at less than 1 per cent per annum, whereas that of all private companies in the US grew at 4.1 per cent during 1999-2009.

Emerging markets

An issue of importance is the set of geographical areas where this better performance of MOFAs helped shore up the bottomline of US multinationals. Table 1 suggests that the evidence, though along expected lines, is still stark. In absolute terms, the value added by affiliates in the developed countries of Canada and Western Europe dominated the activities of US multinationals in 1999 and in 2009, though to a lesser degree in the latter. In both years these developed areas accounted for more than 50 per cent of the value added by MOFAs in all locations.

But what is remarkable is that over the period 1999-2009, when MOFAs had come to play a more important role in the activity of US MNCs, the rate of growth of value added in MOFAs located in emerging markets, especially in Eastern Europe, and in China and India, grew at double digit rates. These rates, in the 20-25 per cent per annum range, were significantly higher than in the developed countries. Emerging markets have become important locations outside the US for sustaining the growth and profitability of US multinationals.

An obvious question that arises is whether this better performance of affiliates in emerging markets is because of an accelerated process of offshoring aimed at reducing costs by exploiting their cheaper labour force. If true, this would mean that US multinationals were protecting their profits at the expense of production and employment at home. However, if this were the case, a significant share of the production abroad by these affiliates would have been imported back to the US to cater to the erstwhile home market of the parent firms. This, however, does not seem to be the case.

To quote the study by the US Bureau of Economic Analysis based on the 2009 benchmark data reported in the Survey of Current Business: “Between 1999 and 2009, production by foreign affiliates shifted away from high-income countries toward emerging markets, but the purpose for production abroad appears to be unchanged. The longstanding tendency for foreign affiliates to serve as a means for parents to access foreign markets rather than as a low-cost base of production from which to sell to their US customers was evident in both 1999 and 2009. In both years, about 90 per cent of the goods and services produced by foreign affiliates were sold to foreign customers.

However, the importance of the individual foreign markets shifted away from high-income, highly developed economies toward emerging markets. High-income countries' share of value added of foreign affiliates worldwide fell 9 percentage points, to 75 per cent in 2009 from 84 per cent in 1999.”

What needs noting is that in the case of China, where the increase in valued added by MOFAs was substantially in manufacturing, about two-thirds of total output was sold to local consumers in both 1999 and 2009. On the other hand, the share of the output of these affiliates sold to US customers fell from 16.3 per cent to 10.2 per cent between 1999 and 2009.

But US multinationals were engaged not just in manufacturing, but are increasingly occupying the services space in countries they migrate to. Thus, increases in value added of foreign affiliates during 1999–2009 were quite substantial in the “other industries” category (which includes retail trade) and in the information sector, especially software publishing.

To US advantage

The implications of this evidence need noting. When multinational firms from the developed countries chose to set up production capacities in developing countries during the 1950s, 1960s and 1970s, the tendency was attributed to the high tariffs and quantitative restrictions imposed by developing country governments to protect their home markets. Multinational firms shut out of these markets were seen as opting to create capacities to cater to them in order to jump over those protectionist walls. But this was to have changed after the wave of trade liberalisation in the 1980s and after, when quantitative restrictions were lifted and tariffs reduced drastically, because these markets could be catered to by multinationals based on production at home. This trend was also seen as being facilitated by changes in technology. The revolution in transport and communications has reduced costs and increased the ease of communication so substantially that: (i) managerial control of internationally dispersed capacity has become easier; and (ii) the share of transport costs (for inputs purchased and outputs sold) in total costs has fallen dramatically in the case of many commodities.

If despite these developments the activities of US multinationals through affiliates in emerging markets have grown rapidly, it must be because these markets are growing rapidly, demand in them is diversifying to services of various kinds, these economies have advantages as locations and transport costs do matter. Catering to the fast-growing markets in these countries requires locating production and distribution facilities there, even though we are in a globalised world. Since in the process US multinationals are performing better than they would have done, it is clearly the case that the better performance of developing countries such as China and India in recent years has been to the advantage of the US, or at least its multinationals.

The idea that these countries benefit from US markets, and accumulate foreign exchange surpluses which then finance a rising US trade deficit is not all true. Firms other than affiliates of US multinationals located in these countries are indeed successful exporters to the US. But the traffic is not one way and mercantilist in nature. US multinationals benefit from the large and growing markets in some of these countries. The problem is that the benefit accrues to US capital, and not the economy or most of the people of the US.

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