Foreign Investment and the Multinational Corporation: The Impact of U.S. Controls on Foreign Investment

September 25, 2007

The following speeches by John J. Powers, Jr., President and Chief Executive Officer of one of the largest pharmaceutical corporations in the world, Chas. Pfizer & Company, are presented to inform our readers of a prominent line of reasoning emerging within the U.S. international business community. As the "architect of Pfizer's rapid expansion outside the U.S." (about half the company's total sales now come from 58 plants in 31 countries), Powers is articulating a theory, developed through his experience, to justify overseas expansion. In both speeches, he speaks for the most dynamic, sophisticated sector of the big business community that desires an international class indentity above and beyond parochial national interests. His main point is that production created through foreign investment rather than through exports is more rational (i.e., more efficient and profitable) and creates global economic integration (i.e., U.S. hegemony). He fails to discuss however the domestic effect of overseas capital expansion, such as alterations in the occupational structure and maintenance of a hugh military-industrial complex to protect the multinational empire. Just as the national business elite advocated "free enterprise" and utilized government intervention, Powers rejects any restrictions on the free flow of capital to underdeveloped, rapidly expanding growth markets (i.e., the foreign investment curbs imposed by the Johnson administration), except when they benefit business. Such restrictions are irrational, both in terms of profits and the development of the corporation as an "agent" of social, economic, and cultural change. Change for whom and at what price? The scope and breadth of Powers'vision deserve close scrutiny, for overseas investments are steadly increasing and the power of those benefiting from this expansion is growing.

The Impact of U.S. Controls on Foreign Investment. A speech by John J. Powers, JR.

The Impact of The balance of payments of the United States has been in deficit every year but one since 1950. From 1950 to 1956 the deficits averaged U.S. Controls $1.5 billion. 1957 was a year of surplus. But in 1958 the deficit appeared again and increased substantially, and from that year to the present on Foreign the deficits have averaged $2.6 billion. Despite their persistence, there seems to be no general agreement as to the causes nor as to the cures, Investment leaving this important part of our foreign economic policy in a continuing state of uncertainty.

Let us examine for a moment one very important area of disagreement which has persisted throughout the last eight years of debate on this subject. First let us look at the overall picture. Between 1950 and 1966 the United States Government paid out net in military expenditures, grants, loans and for various services $87.6 billion. During the same period, corporations and private citizens brought into the country $59.0 billion in excess of all private dollar outflows. In short, during this period the government sector has been continuously in deficit, and the private sector continuously in surplus. But the surplus has not been sufficient to cover the public sector deficit.

The U.S. Government, however, has sought to grapple with the problem not so much by curtailing its own expenditures but by curtailing private sector investments and especially the direct investments of American business in production and marketing facilities abroad. Businessmen have reacted to this policy with astonishment. From their own experience they know that their direct investments have returned substantial income to their companies in the United States, far greater than the direct investment outflows; indeed, that is the whole point of making the investment. And a look at the statistics for all industry confirms the experience of the individual companies. In the overall national accounts, direct investments are seen to be a star performer in the balance of payments, as I am sure most of you have found in your own examination of the record. If then such an examination suggests so clearly that the primary reason for a continuing deficit lies in government disbursements, why is so little done to reduce them?

National policies affected

To begin with, whether and to what extent we can reduce these disbursements present difficult questions affecting basic national policies. And after two decades, vast global commitments have been built into our political system. Though the seeds of crisis have been contained in these policies, the crisis has developed slowly. And now that it is here, our approaches to issues of foreign policy have become ingrained habits, and the budgets involved some- what sacrosanct. It is true some effort has been made to hold down foreign aid or tie it to U.S. exports, but this has been due to Congressional pressure. Rather than face the disagreeable necessity of revising our commitments further, the whole thrust has been to look for alternatives, for expedients that is, that will permit us to continue the current level of government expenditures. I am not so unrealistic as to suggest the elimination or near elimination of military disbursements and AID programs. But how much evidence do we have that we have tightened the belt in the management of these huge outflows so as to minimize the heavy burden on our payments position? Why should the emphasis rest so heavily on expedients affecting the private sector, which is to such a large extent responsible for the inflow of dollars? Indeed, in the past several years there have been proposals for or use of expedients such as the interest equalization tax, restriction of bank loans, tourist taxes, reduction of free entry allowances, buy-American purchase policies, import surcharges, border taxes and border tax rebates. There are two expedients in particular upon which special stress has been laid. They are the restriction of direct investments abroad and the strong promotion of exports. These two are related and are the subject of my particular interest in this paper.

What are direct investments?

First, direct investments. What do we mean by direct investments? Not portfolio investments nor bank deposits. But rather plant, equipment, inventories, warehouses, accounts receivable, and people, skilled and unskilled, of all colors, religions and languages. Direct investments are prosperous and productive business enterprises providing goods and services, giving employment, upgrading industrial skills, paying taxes, and in many cases giving a major stimulus to industrial and sociological development in a community or even in a nation.

The significance of such investments is now substantial. Since 1950 they have been growing at a rate of 10% per year. The average rate of worldwide growth of GNP is about 5% a year, so that such investments are growing at twice the rate of production. It is estimated that deliveries to markets from the foreign facilities of U.S. companies amount to $110 billion or about four times the value of exports delivered to those markets (value of exports: 1965, $26 billion; 1966, $29 billion). It has been aptly pointed out that U.S. companies are creating a third economy in markets abroad. There is the U.S. domestic economy, the Soviet economy, and next in order of magnitude, U.S. business abroad.

I have already referred to the contribution of direct investments to the balance of payments. It is important to note that from 1950 to 1966 these investments returned in dividends and royalties and fees alone $20 billion in excess of all outflows. But as every individual company knows, the returns were much greater than this. They included also the net inflows resulting from the trade of parent companies with their affiliates, that is, the surplus of exports to affiliates over imports from affiliates.

In highlighting the contribution of direct investments to the balance of payments, I do not intend to deprecate the importance of exports, or rather what is commonly called the trade surplus, that is, the surplus of exports over imports. I am saying, however, that in order to obtain a just and useful comparison of the relative contributions to the balance of payments of direct investments and the trade surplus, it is necessary to make some key adjustments. We must, as already suggested, reduce the trade surplus by the amount of the net inflow due to trade of parent companies with affiliates, and also it is necessary for fair comparison to eliminate those supported exports which were financed by the U.S. Government, particularly under the AID program.

Contrasts in official policies

Making these adjustments for the years 1964, 1965, and 1966 (the only three consecutive years for which figures are available), we find that the trade surplus for these years cumulatively was $5.7 billion and the direct investment surplus was $6.1 billion. There are thus two major contributors to the balance of payments, the trade surplus and the surplus derived from direct investment, but interestingly the public policy towards each of these contributors is not the same as one might expect, but quite different. Every effort is directed by the government to increasing exports while restrictions are placed on direct investments.

What is the justification for such different treatment of the two star performers? Direct investments, it is now conceded, make a substantial net contribution to the balance of payments, but it is pointed out the inflows in any one year are the result of investments made in earlier years; and similarly, the accumulated inflows are the results of the investments of the years prior to those included in any selected period of years. Looking at the matter from the point of view of the short run then, it is argued that the returns from previous investments can be regarded, so to speak, as vested. Therefore,the argument continues, we can cut down current outflows while still preserving the previous rate of inflows and thus gain a short-term advantage, even admitting there will be a longterm disadvantage.

Payback on direct investments

But what is the short term? There has been much discussion on this point since this rationale of restriction of direct investment was first advanced some seven years ago. Recently, Professor Behrman argued before the Joint Economic Committee that the payback period for outflows of U.S. dollars for manufacturing investment abroad is about 2 1/2 years on the average. If this is right - and I must say, this estimate comes close to my own experience - this is a very short term indeed. In fact, 2 1/2 years have already elapsed since the Voluntary Program was first introduced as an emergency measure. By now, therefore, we are experiencing a loss as a result of many investments that were not made and which would now be returning net inflows to the United States.

Isn't the short term too short to justify this course? And beyond that, is there really such a clearcut advantage in the short term when we restrict direct investments? There are two distinct approaches to this last question. The economist who often has the ear of government tends to apply a marginal analysis, thinking in terms of an additional increment of investment outflow and the returns to be ascribed to that additional increment. He tends to think of a new project more as if it were merely an investment than part of a gradually growing and developing business organism. He asks what is the rate of return, with the implication that investments will always seek the highest rate of return at any moment in time, regardless of other factors. The businessman, on the other hand, asks what is the market opportunity. Above and beyond the rate of return or payback on a single project he asks what is the relation of the investment to the whole operation. In short, he makes a basic judgment as to the potential of the market and the need, for example, to move now to establish, expand or protect market position. The economist sees restriction on direct investment as yielding a statistical advantage in the short run. The businessman sees it as an immediate infringement on the effectiveness of a going business operation resulting not later but now in loss of market share, financial strength or such intangibles as morale of personnel.

Government export promotions

I will come back later to this question of the short and long run in connection with the discussion of the Mandatory Program. Meanwhile, it is important to say a word about the other expedient for improving the balance of payments which is of special significance to business, namely government promotion of exports. For years, successive administrations have exhorted businessmen to export and save the country. These exhortations are being heard again. They have not brought substantial results in the past. They will not now, because government export promotion programs are founded on an illusion - the illusion that American international business is still what is used to be 30 years ago - largely a matter of swapping exports and imports. While the textbooks on international economics still labor to expound in great detail the nature and causes of trade, the world has moved on.

It is simply not possible in this decade of the 20th Century to establish a business effectively in most world markets in most products by exporting. I say most markets and most products because there are always some exceptions. By constant stress on exports, we perhaps obscure the facts of life of business abroad, or more specifically, the fact that successful market penetration usually requires building warehouses, creating and training an organization; it requires local sales promotion,and very likely, in the end building plants or assembly lines to back up the marketing effort; in short, it requires direct investment.

Direct investment a must

To those who argue that direct investment is an alternative to exports, or that the process damages our international position because it involves export substitution, I would say that we would like nothing better than to sit in New York and manage an export operation. How very much simpler it would be to do that than to put down roots abroad, establish local organizations, build plants, negotiate with governments, and manage assets in foreign countries. Why don't we do it? Are we wrong? Is this a vast management error? I do not think so. We have not gone the exporting route because we can't get the business that way. Wherever we put a plant, where before we were exporting, it is because it was necessary to maintain and expand our business. If we had not done it in most cases, we would have lost the exports anyway and not gained more business through local production and distribution.

As Mr. Charles Stewart of the Machinery and Allied Products Institute recently pointed out so well, there is one central fact about international business that cannot be ignored, neither by an individual company nor by government. To obtain, hold and improve market position abroad requires an integrated approach in terms of direct investment in local plants, exports, licensing, and so on, operating throughout the world, in both developed and developing countries.

Central policy error

The central error of current policy is the effort to segment and splinter international business operations - approving exports, discouraging direct investments, varying the permitted outflows and the required inflows between groups of countries, and to apply these highly distorting and detailed controls to the delicate structure of international trade and investment in the belief that the effects will be temporary and that there will not be serious economic and political repercussions.

Now - what of the Mandatory Program? What can we say of a more specific nature about it? With this program we have moved into a new phase in the process of increasing restriction. It is no longer a question of holding down outflows and bringing back earnings to the extent possible while maintaining the health of the business and the necessary momentum of growth. In Western Europe, the Mandatory Program requires that many companies actually remove from their overseas businesses, earnings required for their health and growth.

Most companies seem to pay out in dividends in the neighborhood of 50% of their earnings so that it would not be unreasonable to insist on the return of earnings to the United States of this amount or even somewhat more, at least for companies that are relatively mature in international business. Certainly in this emergency, no company should be allowed to hold dividends back in order to earn interest abroad. As it is, however, many companies will be obliged to borrow solely in order to fulfill the requirement to remit a proportion of earnings, in many cases over 90% from Schedule C countries. And some will have to borrow again in order to repay the loan. And the introduction of such distortions into a business is not in the future. The business is weakened immediately -in the short run. It is surprising that it is difficult to convince some of this fact, though I suspect if the larger companies of the United States were asked to withdraw from operations 90% of their United States earnings this year, there would be a tremendous outcry, and the charge would rightly be made that we were drastically distorting the structure of the economy. By the same token, we are distorting by the current Mandatory Program the structure of that important third economy, American business abroad.

"Seed corn" parallel

There is no doubt that every businessman would wish to cooperate with the Administration in a short-term emergency. It is always possible to conduct an "efficiency campaign" in busi- ness, to squeeze for a while, cut costs, postpone some investments in order to provide larger immediate returns, all on the assumption that other measures will be taken promptly in the time thus bought, to permit the momentum of the business to be resumed before opportunities are lost or competition moves ahead. But we cannot forget that in restraining direct investment we are economizing on seed corn. I sup- pose one could conceive of circumstances severe enough to warrant eating some of the seed corn. But obviously the emergency must be both serious and brief, and it is crucial that effective plans for finally correcting the imbalance in our payments position meanwhile be implemented.

Though various programs have been initiated in the past seven years, they have focused on temporary benefits, ignored root causes, and therefore have not been effective. Once again in the Mandatory Program, attention is focused on temporary improvements in order to buy time. The alarming thing is that, as you remem- ber, this same approach has been used in various ways since 1961. (At that time, the official view was that equilibrium would be reached in 1963.) In 1965, in 1966, in 1967, and now in 1968 with the tightening of restrictions over direct investment, we have had a repetition of assurances that each new stage was only temporary. It is surely relevant to ask, however, after seven years, what have we bought with these repeated short-term measures? And to question whether present policy has the elements to correct the basic problem of the deficit.

Since the regulations were announced, companies have been bombarded with inquiries as to how the regulations are affecting them and will affect them and, as you all well know, it has been difficult to give a precise answer. For one thing, we have had to spend many man hours examining the regulations and interpreting them with respect to our business. After three months, it is still difficult to be precise about the impact of the program. It appears that the policy is to grant few or no exemptions until a company has proved it cannot make available funds from any other part of its worldwide operations and has exhausted all its borrowing resources. Relief, it seems, will only be granted when credit can no longer be obtained. I say that it is difficult to be precise about the impact of the regulations on the operations of the company, but perhaps that was not quite an accurate statement because this policy in effect seems to suggest that a company will get relief only when it is in serious financial condition.

The regulations in short will be forcing it to expand its borrowings to the limit of its credit and then it must hope and trust it can secure the necessary relief to permit its grave financial position to be alleviated. It is not necessary to underline before an audience of this kind the difficulties and dangers of making any plans under such conditions. Moreover, it would appear that in many cases it is not so much an exemption that is granted, as a delay, with the understanding that anything conceded must be returned in the near future. On these points, we will probably be able to speak with more certainty as patterns of decisions begin to emerge from the Office of Foreign Direct Investments.

Other impacts assessed

There are other impacts of the program. There is no doubt, for example, that to a significant degree, though difficult to measure, companies with little or no current activity abroad have been discouraged or prevented from taking advantage of rapidly growing world markets, with permanent effects on the com- petitive position of the United States in those markets and permanent losses to the balance of payments. There is another impact also of great significance. I have in mind the effect of the program on the relations of U.S. companies with local governments and communities and their efforts to be accepted as corporate citizens seeking to serve the interests of the countryof which they are residents. It has not always been easy, but most U.S. companies abroad have won a high degree of local acceptance because they have become sensitive, if they were not so at the outset, to the policies and attitudes of host countries.

The Voluntary Program to a degree, and the Mandatory Program decisively, cry to the high heavens that such companies are in fact American companies and that the U.S. Government has the right to reach in and direct how the earnings are to be distributed despite local stockholders, despite national sensitivities, and, in Europe, despite the secondary effects on local capital markets. At a time of rising nationalism these programs unfortunately confirm the worst fears of the host country that the affiliates of U.S. companies are in fact aliens in the national economy, subject to laws and regulations of a foreign state. I would predict that this new and radical extraterritorial claim will cause reactions and affect our operations abroad for years to come.

Future direct investments policy

What then should be the policy towards direct investments? The logic of the matter seems clear. In the relatively short period since the early 1950's, U.S. international business has built up dollar-earning assets which have become the major contributor to our balance of payments. Why not continue the process? It is working. It will continue to work if we do not ourselves kill it. It has been argued that all segments of the economy must make a sacrifice in the common cause and that therefore the private sector, far from expanding its operations abroad, must also take a cut. But such an argument makes no sense if the cut is counterproductive, if the so-called sacrifice is, in fact, a sacrifice of the end we are seeking, namely, an improvement in the balance of payments. And, unhesitatingly, I say that it is on this point that I rest my case.

As to the Mandatory Program, I can see no basis for continuing it beyond 1968, and its administration in the remaining months of this year should be on a more flexible and realistic basis, obtaining whatever belt-tightening gains there may be in it without diminishing valuable American assets abroad. Most important, we must attack the basic causes of our problem, and I mean the excess of government outflows over private inflows, and also, though time does not permit more than a mention of it here, bring about changes in our international monetary system that would improve the overall adjustment process.

Dangers of indifference

I recognize that most of those present at this meeting are concerned with the problem of interpreting the regulations, seeking relief, if possible, and bringing about the best possible adaptation of the company to the hard circumstances imposed upon it. This, of course, is an important objective. At the same time, we cannot be indifferent to the longer term problem of bringing about a change in the policy. It is difficult for business leaders to criticize government policy at a time of emergency ant run the risk of appearing unpatriotic. And yet we must speak the truth of the matter as we see it. Certainly if we do not discuss these crucial issues in terms of our experience and discuss them publicly, then we cannot expect our views to be considered in the making of policy. The fact is, these are complex matters, and no one has a monopoly on economic wisdom with respect to them.

Businessmen must continue, therefore, day in and day out, to explain their operations abroad and relate them to major current issues such as the balance of payments and world economic growth and development. They must, at the very least, urge on the United States Government, policies that make economic sense, that harness the dollar-earning power of business operations abroad to the needs of U.S. foreign policy, without weakening those operations. They must reassert the priority, now being lost, of the freer flow of investment and trade which, in an era of unrelieved political crisis, has been perhaps our brightest international achievement - and more than that, a necessary basis for ultimate peace in the world.

Tags: John J Powers, Pfizer, foreign investment, elite

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