FREE ESSAY ON RATES OF RETURN

RATES OF RETURN

The issue of rates of return on foreign owned companies through foreign direct
investment.
On Wednesday Oct. 25th.2000,at a meeting in Montreal, the finance Minister of Canada Mr.
Paul Martin in his opening address to the G20 group on promoting Globalization, stated
that "globalization will have a more human face with measures to ease financial crises
and social safety nets to protect the poorest". The meeting concluded with all the
participants agreeing on a package of measures, which they say, will lead to more
financial stability in the world. From a political perspective this endorsement may seem
realistic. However this futuristic goal will require more foreign direct investment from
corporations and other sources of private enterprise at a time when most expatriate firms
are complaining about the decline of the (R.O.A) rate of return of foreign owned
companies, specifically in the U.S.A.
Firms based in one country increasingly make investments to establish and run business
operations in other countries.U.S firms invested US$133 billion abroad in 1998,while
foreign firms invested US$193 billion in the US.Overall world FDI flows more than tripled
between 1988 and 1998,from US $192 billion to US$600.The share of FDI to GDP is generally
rising in both developed and developing countries. In addition to this information the
World Bank further stated that developing countries received about one quarter of the
world FDI inflows in 1998-1998 on an average, though the share fluctuated quite a bit
from year to year. It would seem that this is the largest form of private capital inflow
to developing countries. This data will seem to encourage more foreign investment. Hence,
one will ask if there are truly low rates of returns on investment by foreign owned
companies. If this is the case then why are there so many foreign direct investment by
small as well as multi-national corporations?
In order to answer this question there must be an examination of the actual low rates of
return from foreign-owned companies. This examination will be based on the performance of
U.S.owned companies.
A research done by the Bureau of Economic Analysis (BEA) provided new estimates of the
rate of return for foreign -owned US nonfinancial companies that are disaggregated by
industry and valued in current-period prices for the years 1988 to 1997.The new
estimates. Along with company-level estimates for US owned nonfinancial US companies,
were used to examine factors that help explain the low rates of return. The rate of
return measure was the ( ROA) i.e. the return on assets.. This is also looked at as the
ratio of profits from current production, plus interest paid to the average of beginning
and end of year total assets. Also profits from current production are profits that
result from the production of goods and services in the current period. Both profits and
assets are valued in prices of the current period.
Profits reflect the value of inventory withdrawals and depreciation on a current-cost
basis. These have been adjusted to remove the income from equity investments in
unconsolidated business and the expense associated with amortizing intangible assets.
Total assets reflect the current cost of tangible assets. These have been adjusted to
remove assets for which the return is not included in the numerator of the ROA ratio e.g.
equity investments in unconsolidated businesses and ammortizable intangible assets.
The new ROA estimates for foreign-owned companies indicate that:
- The new current-cost estimates show that the average ROA of foreign owned companies in
1988-1997 was 5.1 percent. In contrast, the historical-cost estimates show an average ROA
of 5.7 percent.
- The ROA of all foreign non financial companies was consistently below that of US owned
non-financial companies in 1988-1997,but the gap narrowed over time from nearly two
percentage points in 1988 to one percentage point in 1997.The narrowing of the gap
appeared to be related to age effects. Acquiring or establishing a new business add costs
such as startup costs that disappear over time.
- ; Additionally, experience can yield benefits, such as learning by doing that
accumulates over time.
- High startup and restructuring costs related to acquisitions also lower the
profitability of foreign-owned companies. Newly acquired foreign-owned companies showed
very low or negative rates of return.
- Many foreign -owned companies had a tax-related incentive to shift profits from the US
to their home country using transfer prices.
There are several other studies which indicate that there is a decline in the rate of
return on Foreign Direct Investment by US companies. The most recent study was done by
Laster and McCauley.They used industry level estimates of historical-cost return on
investment and on sales for foreign-owned companies from the Bureau of Economic
Analysis.The consensus is that the reasons for this decline are:
Industry mix, i.e. US owned companies are concentrated in low profit industries, Market
share, age effects, intra firm-import content, i.e. some foreign-owned companies might
have made higher profits but they may shift some of this profits using transfer prices,
and finally, combined effects involving one or several of the preceding reasons for the
lower rate of return on foreign investment.
From the various studies conducted, industry patterns in the ROA estimates indicated that
the profitability of foreign-owned companies is related to their market shares.
Industries in which the profitability of foreign-owned companies is relatively high,
(such as petroleum and chemical manufacturing) tend to be those in which the largest
foreign-owned companies have a significant share of the total US market for certain
products. However, in some industries, (such as stone, clay and glass products
manufacturing and rubber and miscellaneous plastic products manufacturing), the largest
foreign owned companies both are relatively and less profitable and have a significant
share of the total US market for certain products.
In order for Mr. Martin and his G20 disciples to fulfil there mandate they must consider
the impact of low return on investment by foreign direct investment companies in the US
as well as other countries.