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ECONOMIC REVIEW Additional copies of the ECONOMIC REVIEW may be obtained from the Research Department, Federal Reserve Bank of Cleveland, P. O. Box 6387, Cleveland, Ohio 44101. Permission is granted to reproduce any material in this publication providing credit is given. MARCH 1971 E X P E R I E N C E WITH S P E C I A L D R A W I N G RIGHTS Special Drawing Rights (SDRs) are a new type of international monetary reserve asset created by the Inter national Monetary Fund (IM F ). After several years of discussion and negotiation, these new reserve assets were initially created and made available to participating countries for use in official payments transactions on January 1, 1970. This article discusses the underlying economic conditions that led the IMF membership to develop the SDR facility, describes the more important operational aspects of SDRs and their use, and surveys the first year of experience with this new international reserve IN TH IS ISSUE Experience With Special Drawing Rights ............................ 3 asset. REASONS FOR DEVELOPING SPECIAL DRAWING RIGHTS The Special Drawing Rights facility was developed to assist in the provision of international reserves in quantities adequate to meet the combined desires of nations for Direct Foreign Investment of the United S ta te s ......... 15 reserves. Nations need international monetary reserves— gold, foreign exchange, SDRs, and reserve positions in the IM F —to help finance balance of payments deficits when they occur. 3 ECONOMIC REVIEW It is difficult to determine the amount of the growth of reserves has not kept pace with the reserve holdings that a nation's leaders would growth of trade. Therefore, the ratio of gross consider adequate for its needs. The amount reserves to annual deemed adequate would be influenced by the declined volum e international increased from $56 billion in 1955 to $78 billion commercial transactions, e.g., imports, exports, in 1969, an increase of 39 percent (see Table I). international capital movements, etc., and by the Over the same period, annual world imports grew likelihood and magnitude of speculative capital from $89 billion to $254 billion, an increase of and volatility of its imports for the world has substantially. World gross reserves movements. Speculative capital movements and 185 percent, causing the reserves-to-imports ratio changes in the volume and timing of commercial to fall from 63 percent to 31 percent. (The year transactions (which may also be speculative in 1970 was apparently an exception to this pattern. nature) may tend to alter the exchange rate of a Complete data are not yet available, but prelimi nation's currency or cause a deficit in its balance nary estimates indicate a growth in gross world of payments. reserves of 18 percent in 1970 compared with A measure sometimes used in efforts to assess growth in world trade of 13 percent.) Since 1955, the adequacy of reserve holdings—of individual the experience of most major trading nations has nations and of the world—is the ratio of gross been parallel to the overall pattern, with imports reserves to annual imports. Robert Triffin, after a experiencing strong growth, reserves growing less study of this ratio and the balance of payments ra p id ly , policy actions of twelve major trading countries declining substantially. United States gross reserves for the period 1950 through 1957, concluded actually fell from $23 billion in 1955 to $17 and the reserves-to-imports ratios billion in 1969; during this period, the United that: The overall record of these eight postwar years strongly suggests that States reserves-to-imports ratio declined from 184 percent to 44 percent. most of the major countries would aim Many observers, including Triffin, realized that at maintaining a reserve level of not the reserves-to-imports ratio was not a faultless less than 40 percent in most years, feel indicator of the need for reserves. Some econ impelled to adopt severe adjustment omists attempted to use the size of past inter measures if this level fell below, let us national payments imbalances as an indicator of say, 30 or 33 percent, and consider the appropriate level of reserves for a nation.2 2 themselves forced to adopt drastic measures of control in the face of any persistent or substantial contraction below that critical range.1 Both world gross reserves and world trade have grown substantially in the last fifteen years, but See, for example, Weir M. Brown, The External L iq u id ity o f an Advanced Country, Princeton Studies in International Finance, No. 14, (Princeton, New Jersey: Princeton University Press, 1964). Another important study examines both payments imbalances and imports in assessing the need for reserves; see George H. Willis and Fred L. Springborn, The Need fo r Inte rn a tio n al Reserves, U. S. Treasury Department, September 1967, printed in U. S. Congress, Joint Economic Committee, New Plan fo r 1 Robert Triffin, G old a nd the D ollar Crisis (New Haven: International Yale University Press, 1960), pp. 45-46. Session, 1967. 4 M onetary Reserves, 90th Congress, 1st MARCH 1971 TABLE I Gross Reserves and Annual Imports of the World and Major Industrial Nations Selected Years (mil. of $) World* United States United Kingdom Industrial Europet $ 55,903 89,300 $22,798 12,370 $ 2,390 10,809 $11,882 25,923 Canada Japan 1955 Gross reserves Annual imports^ Ratio of gross reserves to annual imports 62.6% 184.3% 22.1% $ 1,985 5,020 45.8% 39.5% $ 832 2,471 33.7% 1960 $ 60,510 119,000 Gross reserves Annual imports^ Ratio of gross reserves to annual imports 50.8% $19,359 16,051 $ 3,719 12,765 120.6% $20,094 39,422 29.1% $ 1,991 6,124 68.3% 32.5% $ 1,949 4,491 43.4% 1965 $ 70,710 175,200 Gross reserves Annual imports^ Ratio of gross reserves to annual imports 40.4% $15,450 23,186 $ 3,004 16,103 66.6% $29,923 64,370 18.7% $ 3,037 8,713 46.5% 34.8% $ 2,152 8,170 26.3% 1969 $ 77,580 254,300 Gross reserves Annual imports! Ratio of gross reserves to annual imports 30.5% $16,964 38,530 $ 2,527 19,956 44.0% $28,288 96,470 12.7% $ 3,106 14,250 29.3% 21.8% $ 3,654 15,026 24.3% * Coverage varies but always excludes Soviet Area countries. t Totals combined for the following nations: Austria, Belgium-Luxembourg, Denmark, France, Germany, Italy, Netherlands, Norway, Sweden, and Switzerland. I Imports are Cl F. Source: International Monetary Fund, International Financial Statistics, March 1956, December 1961, and December 1970 Although there was disagreement about which reserve growth were then, or might soon become, measure of the need for reserves was best, or inadequate. Furthermore, there was widespread indeed, if the need fo r reserves could be measured agreement at all, there was rather general agreement in the reserves might lead to undesirable com petition th at an inadequate global total of mid-1960's that there was a need for reserve among nations for shares of the existing stock of growth,3 and reserves. that the traditional sources of Competition for reserves could be ________ ___________________________________________ exhibited in such forms as restrictions on imports 3 For a study emphasizing the need for reserve growth per se, in contrast to the need for any level of reserves, see Fritz Machlup, The Need fo r M onetary Reserves, Reprints in International Finance, No. 5 (Princeton, New Jersey: Princeton University, October 1966). anc| on capital outflow s, or even in restrictions on , . , . domestic activity. The major sources o f reserve growth, prior to the birth of the Special Drawing Account o f the 5 ECONOMIC REVIEW IM F, were newly available gold and United States market.''5 United States balance of payments deficits may balance of payments deficits. However, depen dence on either or both of these sources of new result reserves entails serious disadvantages. A major dollars by foreign monetary authorities, thereby in increased holdings of United States disadvantage of depending on newly available gold adding to their gross reserve assets, as well as to for additions to the stock of free world reserves is those of the world as a whole. A serious disadvan that the supply of such gold, both from Soviet tage, however, of United States payments deficits gold sales and free world gold mining, is undepend as a continuing source of reserves is that as foreign able.4 For instance, annual gold sales to the free holdings of dollars increase relative to United world by the Soviet Union in the period from States holdings of gold, foreign confidence in the 1960 through 1965 ranged from $200 million to dollar as a reserve asset tends to decline. $550 million; in contrast, there were no Soviet HISTORICAL DEVELOPMENT OF SPECIAL DRAW ING RIGHTS gold sales in the years 1966 through 1970. During Discussion of the possibility of a global shortage 1960-1968, annual free world gold production averaged $1,352 million, with South Africa of international monetary reserves was stimulated accounting for 72 percent of the production. by the publication of Robert Triffin's book, Gold Discovery, depletion, and changes in gold pro and the Dollar Crisis in I9 6 0 .6 In 1963, two duction techniques and costs affect the quantity studies were commissioned on "the outlook for of newly mined gold. Most of the newly available the functioning of the international monetary gold is absorbed by industry and the arts and by system." These reports acknowledged the possi hoarders, and only the small remainder is available bility of a global shortage of reserves. Subsequent to studies and supplement world reserves. In fact, the remainder was actually negative in 1966, 1967, discussions on means of creating additional reserves culminated in 1967 in the IMF and 1968. As part of the so-called two tier system Board of Governors' acceptance of an "Outline of for gold, governments and central banks have a Facility Based on Special Drawing Rights in the generally refrained from purchasing gold in private International Monetary Fund." The substance of markets since March 1968. At that time, the this "Outline" was then put into the form of an governors of the central banks of seven major amendment to the Articles o f Agreement of the nations, including the United States, agreed that IMF that became effective on July 2 8 ,1 9 6 9 .7 "as the existing stock of monetary gold is suffi 5 cient in view of the prospective establishment of See Federal Reserve B ulle tin , March 1968, p. 254 and January 1970, p. 107. the facility for Special Drawing Rights, they no longer feel it necessary to buy gold from the ®Triffin, op. cit. 7 For further details on the events which led to amend ment of the Articles of Agreement, see Fritz Machlup, Remaking the Inte rn a tio n al M onetary System : The Rio 4 Data on gold production in the Sino-Soviet Bloc are Agreement and Beyond (Baltimore: The Johns Hopkins generally unavailable. The supply of new gold available to Press, 1968), pp. 3-6 and Joseph Gold, Special D rawing the free world is usually considered to be the •sum of gold Rights: newly mined in the free world plus gold sales to the free Series No. 13 (Washington, D. C.: International Monetary world from the Soviet Union. Fund, 1970), pp. 1-11. 6 Character and Use, second edition. Pamphlet MARCH 1971 Adoption of the amendment, which required approval by three-fifths of the members and four-fifths of the total votes, O did not, however, proportion to their IMF quotas. The United States received the largest amounts of SDRs in each of the first two allocations (867 million and 717 create any SDRs. The amended Articles provide million, respectively); for an allocation of SDRs only after the Managing granted the second largest amounts of SDRs (410 Director of the IMF has proposed an allocation million and the proposal has been approved by a simple Table II). and 300 and million, Great Britain respectively;) was (see majority of the votes of the Executive Directors of the IM F, and by 85 percent of the votes of the Board of Governors of the IM F. NATURE OF SPECIAL DRAWING RIGHTS The first proposal to allocate the new reserve Special Drawing Rights are credits on the books asset, approved by the Board of Governors of the of the newly created Special Drawing Account of IMF on October 3, 1969, provided for an allo the IM F. In contrast, the traditional operations cation of approximately 9.5 billion SDRs9 in three and steps: through the General Account. Although the IMF approximately 3.5 billion SDRs on transactions January 1, 1970, and approximately 3.0 billion operates SDRs on the first days of 1971 and 1972.10 SDRs separate. are allocated among the participating nations in O The number of votes that each IMF member nation has is roughly proportional to that nation's IMF quota. For the two of the IMF are carried out accounts, they are entirely The value of the SDR is defined as a certain weight of fine gold. Because the gold value cannot change (except through amendment of the IMF instance, the United States quota is at present 23.56 Articles o f Agreement), the SDR has a guaranteed percent of the total of the quotas in the IMF General gold value. The par values of currencies of IMF Account, and the United States has 21.45 percent of total votes in the General Account. member nations are expressed, directly or indi rectly, in terms of gold. If a currency were to be devalued in terms of gold, one SDR could then be 9 One SDR is equivalent to 0.888671 gram of fine gold. The United States dollar is also equal to 0.888671 gram of fine gold. exchanged for more units of that currency than it could have been exchanged for before the devalu ation. If all currencies were uniformly devalued, leaving their exchange rates unchanged but raising ^9The authority for the first three allocations of SDRs and the basis for calculating the amounts of the alloca the price of gold in terms of all currencies, the tions is Resolution Number 24-12, which may be found in gold value of the SDR would be unchanged. One IM F, Summary Proceedings o f the T w enty-fourth A nnual SDR could then be exchanged for more units of Meeting o f the Board o f Governors, September 29- any currency than prior to the devaluations. October 3, 1969 (Washington, D. C.: 1969), p. 326. The amounts of SDRs actually distributed in the first two Uses of SDRs. Only participating nations and allocations were 3,414 million and 2,949 million, respec the General Account of the IMF can own SDRs. tively. The main reason for the first two actual allocations Since being different from the expected allocations is that The SDRs cannot parties, they cannot be transferred to private be used directly in the Republic of China elected not to receive its allocations. China's first two allocations would have been 92.4 million SDRs and 59 million SDRs, respectively. markets to support the exchange rate of a nation's currency. Instead, a nation can transfer SDRs to 7 ECONOMIC REVIEW TABLE II Allocations and Holdings of Special Drawing Rights (mil. of SDRs) SDR Allocations January 1, 1970 SDR Holdings December 31, 1970 SDR Holdings as a Percent of Initial Allocations December 31, 1970 2,276.2 866.9 409.9 753.3 29.4 70.9 27.4 165.5 2,423.3 850.7 265.7 978.5 38.2 204.9 17.4 171.4 106% 98 65 130 130 289 64 104 201.6 105.0 3.2 87.4 25.2 37.8 124.3 121.8 257.6 76.7 3.2 144.1 27.2 37.8 182.1 146.3 128 73 100 165 108 100 146 120 171.2 107.0 2.0 74.9 25.7 34.8 117.7 128.4 Other developed areas 284.8 218.7 77 247.0 Less developed areas Latin America Middle East Other Asia Other Africa 853.1 330.0 77.4 277.7 168.0 481.9 272.2 9.3 98.7 101.7 56 82 12 36 61 747.6 275.9 81.1 242.4 148.2 3,414.0 3,123.9 92 2,949.4 -0 - 290.2 3,414.0 3,414.0 Participant Industrial countries United States United Kingdom Industrial Europe Austria Belgium Denmark France Germany (Federal Republic) Italy Luxembourg Netherlands Norway Sweden Canada Japan Country total IMF General Account TO TA L 8* 100% SDR Allocations January 1, 1971 1,954.8 716.9 299.6 692.2 18.7 69.6 27.8 160.5 -0 2,949.4 NOTE: Components may not add to totals because of rounding. * The General Account received no initial allocation of SDRs. Its holdings are expressed here as a percent of the total initial allocation to countries. Sources: International Monetary Fund, Inte rn a tio n al Financial February 1971 and Press Release No. 820, January 2, 1971 another participating country in exchange for a Statistics, the major use of SDRs. When a participating convertible currency and then use that currency in nation wishes to use SDRs to obtain currency, the market support operations. recipient may be determined in either of two The participating ways. The IMF will, if requested, designate one or nations in exchange for currency is expected to be more participating countries to accept the SDRs 8 transfer of SDRs among M ARCH 1971 and to provide convertible currency in return. dures through which the former may be converted Alternatively, an exchange of SDRs for currency into the latter.1 may be arranged by mutual agreement among the The guarantee of usefulness of SDRs is inherent nations involved. In the latter case, the nation in the provision that the IMF will designate a transferring the SDRs must, with some exceptions, nation that must accept SDRs tendered by a receive its own currency in return.11 participant and provide convertible currency in The United States can use SDRs to purchase dollar balances from other nations in either of the exchange. The Executive Directors of the IMF prepare designation plans listing participating two ways described above. The transfer of SDRs nations that may be assigned to receive SDRs and by mutual agreement may be of particular impor specifying the maximum amounts of SDRs that tance to the United States. The use of this method each may be directed to accept. The plans are can help to insure that when the United States prepared at three-month intervals for the following sells its SDRs it will be acquiring dollars from quarter. In general, a participating nation: those nations that are the most anxious to sell them. If the recipient of SDRs were designated by ...shall be subject to designation if its the IM F, the nations chosen might not be those balance of payments and gross reserve most anxious to sell dollars. Those nations anxious position is sufficiently strong, but this to sell might then use their excess dollar holdings will not preclude the possibility that a to purchase gold from the United States, perhaps participant with a strong reserve posi against this country's preference. tion will be designated even though it A has a moderate balance of payments nation designated to receive SDRs must deficit.13 provide an "acceptable" convertible currency in return. At present, eight currencies are acceptable The IMF does not publish designation plans. to the IMF for use in SDR transactions: United The Fund has reported, however, that the first States dollar, British pound, French franc, Belgian designation plan listed 23 nations and a potential franc, total of 350 million SDRs; the second plan listed German mark, Italian lira, Netherlands guilder, and Mexican peso. The nation transferring 22 nations and a potential total of 342.5 million SDRs to a designated recipient may accept which SDRs; and the third plan listed 26 countries and ever of the eight currencies the other nation elects 201 million SDRs.14 to provide, or it may specify one of the following three currencies: United States dollar, British One restriction on the transfer of SDRs to another participant, either by designation or pound, or French franc. If the currency provided 12 For an explanation of the criteria for determining by the SDR recipient is not the currency specified acceptable convertible currencies and the mechanisms for by the SDR transferor, however, there are proce- providing and converting currencies, see Gold, op. t it . , pp. 36-47. •pj In certain transactions, which must be prescribed by the IM F, any currency acceptable to both parties may be 13Articles o f Agreement o f the In ternational M onetary Fund, Article X X V , Section 5(a)(i). given in exchange for SDRs. See Articles o f Agreement o f the Inte rn a tio n al M onetary Fund, Article X X V , Section 2(b)(ii). 14 International Monetary Fund, 1970 A n nual Report (Washington, D. C.: 1970), p. 31. 9 ECONOMIC REVIEW mutual agreement, is the "expectation” that SDRs represents a compromise between those nations will be sold only by nations that have a "need" to that wanted the new facility to provide only a line do so. The Articles o f Agreement state that: of credit and those that wished it to provide ...a participant will be expected to use unconditional reserves. Recipients of SDRs are its special drawing rights only to meet protected by the provision that no nation need balance of payments needs or in the accept additional SDRs if its holdings are three light of developments in its official times its net cumulative allocation. holdings of gold, foreign exchange, In addition to the transfer of SDRs from one and special drawing rights, and its nation to another in exchange for convertible reserve position in the Fund, and not currency, a nation may use SDRs to repurchase its for the sole purpose of changing the own currency from the IMF General Account. composition as When a nation “ borrows” from the IMF General between special drawing rights and the Account, it actually purchases foreign exchange total of gold, foreign exchange, and from the IMF with its own currency. It later of the foregoing reserve position in the Fund. 1 R "repays” its loan by repurchasing its currency The IMF cannot refuse to facilitate a transaction from the IM F. even if it believes that the nation using SDRs has Some other purposes for which a nation may no need to use them. The IMF could, however, use SDRs are to pay IMF assessments for the subsequently designate such a nation to receive operating SDRs. Account and to pay charges imposed on partici There are two quantitative restrictions on the expenses of the Special Drawing pants in the SDR facility. Each participant pays an use and receipt of SDRs. Although a nation may annual charge to the IMF based on its net use all of its SDRs, its holdings of SDRs must cumulative allocation of SDRs. In return, each average, over a five-year period, at least 30 percent participant receives interest from the IM F based of its net cumulative allocation. (The net cumu on its average holdings of SDRs. The rate of lative allocation is the sum of a participant's interest and the rate of charges must be equal; allocations of SDRs less its share of any cancel they are presently 1 1/2 percent per year. Obvi lations.) an ously, when a nation's average holdings of SDRs allocation is an owned reserve and 30 percent is are equal to its net cumulative allocation, the somewhat like a line of credit.16 This provision charges and interest payments exactly offset each In effect, then, 70 percent of 15A rticles o f Agreement o f the International Monetary other. If its average holdings exceed its net cumulative allocation, a nation will receive some Fund, Article X X V , Section 3(a). net interest; in the opposite case, charges paid will 16The 30 percent differs from a line of credit in that with the latter a borrower normally need only repay his exceed interest received. borrowing (with interest). In the case of a nation using In turn, the IMF may use SDRs, specifically, to more than 70 percent of its SDRs, it is necessary not only pay remuneration to participants on their creditor to restore SDR positions in the General Account and, as previ holdings to 30 percent of the net cumulative allocation but to restore holdings to a level sufficiently above 30 percent so that holdings average 30 percent over a five-year period. 10 ously mentioned, to pay interest to participants on their holdings of SDRs. SDRs may also be used in MARCH 1971 the IMF's distributions of its net income and when nations on January 1, 1970, and to 109 nations on the General Account purchases currencies from the first day of 1971.18 Each participating nation member nations to replenish its holdings of those received an allocation equal to 16.8 percent of its currencies. IMF quota in the first allocation and 10.7 percent SDRs and Gold. Special Drawing Rights are in the second allocation. In the first allocation, often referred to in the press as "paper gold." It individual allotments ranged from 866.9 million may be useful, therefore, to note the similarities SDRs for the United States to 504,000 each for and differences between SDRs and gold. One way Botswana and Lesotho. in which SDRs and gold are similar is that both are The first year of operation of the new SDR unconditional reserves in that they may be used at facility was recently concluded, and it is appro the discretion of the holder without the need for priate to examine the experience of that year. In approval from an outside agency. In addition, the following discussion, the absolute and relative SDRs are linked to gold in the sense that their unit amounts of SDRs used by nations are examined; of value is expressed in an unchanging physical usage of SDRs by developed nations is compared quantity of gold. with that of less developed nations; and the nature SDRs differ from gold in that interest is earned of the transactions is summarized. Similarly, the (or paid) on the amount by which a nation's SDR SDR receipts of nations are surveyed in terms of holdings exceed (or are less than) its net cumu their absolute and relative amounts, their sources, lative allocation. Also, there is no counterpart with and the level of development of their recipients. gold for the 30 percent restriction on the use of Receipts and uses of SDRs by the IMF General SDRs mentioned above. Perhaps the most signifi Account are also summarized. cant difference between these two reserve assets is For each month in 1970, with the exception of that SDRs can be created without cost (ignoring September and October, the IMF published a list costs of negotiation and consultation) in whatever of countries using SDRs and the amounts used, amounts are needed, whereas real resources must and a list of countries receiving SDRs and the consequent amounts received. However, the IMF publishes economic limitations on the amounts of gold that country holdings of SDRs as of the end of each be used to produce gold, with are produced. month and net transactions of a nation during any month may be easily deduced from these data. EXPERIENCE WITH SPECIAL DRAWING RIGHTS Some information is lost with this procedure on those occasions when a nation is both a receiver Of the 117 member nations of the IM F, 110 and a user of SDRs in the same month. In the have elected to be participants in the Special January through August period, however, there Drawing Account.17 SDRs were allocated to 104 were only four such occasions out of 198 times 18 17 IMF members that have elected not to be participants The five nations that became participants after the 1970 allocation are Barbados, Iraq, Nepal, Thailand, and in the Special Drawing Account are Ethiopia, Kuwait, Yemen Arab Republic. The Republic of China was a Lebanon, Libyan Arab Republic, Portugal, Saudi Arabia, participant but elected not to and Singapore. allocations. receive the first two 11 ECONOMIC REVIEW when SDRs were used or received. Thus, the data initial on experience with SDRs presented here are, when fifteen are in Africa, eleven are in Latin America, possible, based on actual receipts and uses of four are in Asia, and four are in the Middle East. allocations in the first twelve months, SDRs; for September and October, net monthly changes in country holdings of SDRs are used with the assumption that no nation was both a user and a recipient of SDRs within the same month. The impression given by the foregoing data that the less developed nations made greater use of SDRs is correct. Only 20 percent (five out of 25) The participant nations made substantial use of of the developed nations used 70 percent or more SDRs during the first year of operation of the new of their initial allocations during the first year, in scheme. During this period, 59 of the 104 nations contrast to 43 percent (34 out of 79) of the less that shared in the initial allocation used 857 developed nations that did the same. As a group, million SDRs. The two major users of the new the developed countries' holdings of SDRs at the asset, judged in terms of gross amount used, were end of 1970 were about 3 percent greater than the United States and Great Britain, with uses their initial allocation, whereas the combined totaling 160.5 million SDRs and 155.1 million holdings of the less-developed participants were SDRs, respectively. The nations using the next only 56 percent of the combined amount initially largest amounts were India (85.3 million), Italy allocated to them. The reduction in the SDR (50 million), and Indonesia (34.8 million). The holdings of less-developed countries as a group major users on a net basis (after receipts of SDRs reflects the tendency toward deficits in those are deducted) were the United Kingdom (144.2 countries' balances of payments. The tendency million), India million), and (81.8 million), Indonesia (34.8 Italy (28.3 million). The United toward deficit is a result primarily of those countries' urgent needs to import real resources. States ranked fourteenth as a net user of SDRs, having used only 16.2 million SDRs. In contrast, The purchase of convertible currency, usually 45 nations made no use of SDRs, except to pay United States dollars, from other participants was their the share of the assessment for operating expenses. major use of SDRs. Approximately 472 million of the 857 million SDRs used by partici pating nations were employed for that purpose. Of the four major net users, only Indonesia, The second most important use of SDRs was the which used 100 percent of its allocation, would be repurchase by nations of their own currencies considered a major user if judged by the criterion from the IMF General Account. A total of 293 of percent of allocation used. Fifteen of the 104 million SDRs were used, by 34 nations, in that original participants used (net) 100 percent, and way. Participants transferred 92 million SDRs to 39 nations used (net) 70 percent or more of their the IMF General Account to pay charges related to initial their use of the Fund's resources. Participants also allocations. five—Greece, Of Iceland, these 39 nations, only Turkey, Yugoslavia, and used relatively small amounts of SDRs to pay their as assessments for the cost of operating the Special developed nations. Among the 34 less-developed Drawing Account and to pay the amounts by nations that used 70 percent or more of their which New Zealand—are categorized by the 12 IMF their charges on cumulative allocations MARCH 1971 exceeded The major source of receipts of SDRs (other interest due on average holdings of than allocations) was transfers from other partici SDRs.19 During the first year of operation of the Special pating nations in exchange for convertible Drawing Account, 42 countries had SDRs trans currencies. Most of these transfers (totaling 291 ferred to them. The major recipients of SDRs, million SDRs) were to nations designated by the measured in terms of gross receipts of SDRs, were IMF to receive the SDRs. There were, however, at the United States (144.3 million SDRs), Belgium least six transfers (totaling 181 (134 million SDRs), Canada (57.8 million SDRs), between participants by mutual agreement. In five the of these transactions the United States transferred Netherlands (56.7 million SDRs), and Germany (56 million SDRs). Measured in terms of SDRs; net receipts of SDRs, the major recipients and the Kingdom was the transferor. The largest of the amounts received were the same, except that the transfers United December 23, 1970, when the United States is States was a net user of SDRs. As in the by other million SDRs) transaction, the mutual reported Belgium in exchange for United States dollars.20 SDRs 110 on million 16.2 million have sold occurred mentioned earlier, the United States used 160.5 SDRs, an amount to agreement United million SDRs to In addition to receipts of SDRs from other greater than its gross receipts. Another measure that can be used to compare the importance of nations as recipients of SDRs is participants in exchange for currency, some nations acquired relatively small amounts of SDRs net receipts of SDRs as a percent of initial SDR in other ways. Five countries purchased about one allocation (see Table II). Judged by that measure, quarter million SDRs from the IMF General Belgium was also the leading recipient, having Account to pay charges and assessments. These received by the end of December an amount of five nations had probably already used their entire SDRs equal to 189 percent of its initial allocation. initial allocations in other transactions. In April Some other major recipients were the Netherlands I970, some participating nations received SDRs as (65 percent), Canada (46 percent), Austria (30 interest (net of charges) on their holdings of SDRs. percent), Germany (28 percent), and Korea (23 In May, the IM F transferred approximately percent). Developed nations seemed to have a 18.4 million SDRs in partial payment of interest greater tendency to be recipients of SDRs than did due to nations that had creditor positions in the the Of 25 developed General Account.21 In September, the IM F paid nations, 12 recorded net increases in holdings of less developed nations. out 7.8 million SDRs as part of a distribution of SDRs; in contrast, only 12 of 79 less developed net income. Also in September, the IMF General nations were net recipients of SDRs. Account replenished its holdings of the currencies 20 19 In practice, only the difference between the charge on The Financial Times (London), December 31, 1970, p. 5. a nation's net cumulative allocation of SDRs and the interest on its average holdings of SDRs is paid to or 21 received by a nation. See International Monetary Fund, in the currencies of the recipients. Interest paid on The remainder of the interest due was paid in gold and By-Laws, Rules and Regulations, Twenty-Eighth Issue, creditor positions in the General Account is entirely (Washington, D. C.: October 20, 1969), p. 56. different from interest paid on holdings of SDRs. 13 ECONOMIC REVIEW of 12 countries by purchasing those currencies in Only 19 participants remained entirely on the amounts totaling the equivalent of almost $325 sidelines. million. Three nations elected to receive payments for their currencies in SDRs (totaling 67.5 million SDRs) in lieu of gold. At the end of December 1970, only one recipient approached the 300 percent of cumu lative allocation limit. That nation, Belgium, held The General Account does not receive allo 289 percent of its cumulative allocation. In cations of SDRs. It was, however, both a recipient contrast, 37 participants, 32 of which are cate and a user of SDRs during the first year as a result gorized by the IM F as less developed, had reduced of some of the previously described operations and their holdings of SDRs to less than 30 percent of transactions their initial allocations, raising the question of the of the participants. The General Account was a recipient of SDRs in each of the need first months of operation of the Special holdings. These nations can easily meet the 30 Drawing Account, and it used SDRs in eight of percent average requirement without purchasing those months. With gross receipts of almost 389 any SDRs, however, by merely limiting their use million SDRs, the General Account had a net of the allocation received in 1971 and the allo holding of over 290 million SDRs at the end of the cation scheduled for 1972. 12 for these nations to reconstitute their year. The General Account's holdings of SDRs, 8.5 It is probably too soon to assess fully the effects percent of the total outstanding, were greater than of SDRs on world commerce. However, the new the holdings of every participating nation, except reserve facility does carry with it the promise of the United States and Great Britain. a v o id in g th e restrictions on international commerce that might result from international CONCLUDING COMMENTS competition for shares of an inadequate world SDRs stock of reserve assets. If the creation of SDRs during the first 12 months of the operation of the does help to avoid the use of undesirable forms of Eighty-five nations used or received Special Drawing Account: 43 were users only; 26 competition for reserves, the substantial efforts were recipients only; and 16 (including the United that have gone into developing the SDR facility States) were both users and recipients of SDRs. will have been a wise investment for the world. 14 MARCH 1971 DIRECT F O R E I G N I N V E S T M E N T OF THE UNITED STATES In recent years, the importance of United States the United States economy. In recent years, and direct investments in foreign countries has received especially since World War II, the United States increased attention. The rapid increase in the has been one of the few countries that exported number substantial amounts of capital and, at the same and size of United States-controlled foreign firms and the repatriated income from time, these investments has resulted in an awareness of investment and production. The United States continually expanded its own domestic the role of foreign direct investment. This article transferred reviews the history of United States direct foreign grants and loans and through private investments, investment and the distribution of direct invest largely direct investments. capital both through government ment by geographic areas and industry groups. The article is concerned with private direct foreign investment and the repatriated income generated D EFIN IN G DIRECT FOREIGN INVESTM ENT by accumulated direct foreign investment; it does Direct foreign investment is both a stock and a not discuss the other forms of United States flow concept. That portion of the assets of foreign foreign investment and mentions only in passing business enterprises owned by United States resi related indirect effects on the economies of the dents represents the existing stock of United capital exporting and recipient countries. These States direct foreign investment. From the point indirect effects are difficult to measure and are of view of the balance of payments, direct foreign influenced by factors such as the source of the investment is the flow of United States capital into investment funds, the use made of the funds, foreign businesses in which a United States resi monetary and fiscal policies, and tariff and trade dent or an affiliated group of residents have or policies in the countries involved. Economic growth, which depends to a large obtain significant control. The capital movements associated with direct foreign investments are extent upon the ability of an economy to increase viewed as foreign extensions of the management the quantity of capital goods used in the produc interests of the parent firm in the United States. tion of goods and services, can be accelerated For balance of payments purposes, the distinc through the use of external capital. Thus, the tion savings of a capital-surplus nation can be used to equity securities and direct foreign investment is stimulate the growth process of a capital-short made between on the long-term basis of investments in foreign ownership. A foreign nation. Through this process, European countries investment is considered to be direct if the United contributed significantly to the early growth of States individual or firm owns or obtains more 15 ECONOMIC REVIEW than 10 percent of the foreign enterprise.1 A earnings of foreign subsidiaries of United States United States investment in a foreign enterprise is corporations; and also considered direct if all United States residents foreign assets that result from political actions (2) changes in the value of together hold 50 percent or more of the voting abroad. These latter transactions do not involve a stock of the firm, even if no individual or affiliated transfer of funds between the United States parent group holds as much as 10 percent. and its foreign affiliate. The outflows of capital included in the direct It is important to distinguish between direct foreign investment portion of the United States foreign investment and the other forms of private balance of payments account are: foreign investment, such as bank loans and port (1) United funds folio investments. A bank loan or credit to a invested overseas by United States parent corpor foreigner is generally a financial transaction with ations; (2) transfers by the United States parent no equity interests acquired. Portfolio investments corporation to the foreign affiliate (or to foreign may include the purchase of foreign stocks or States sources of short- and long-term residents as compensation for the acquisition of bonds by United States residents. Unlike a stock equity interest) of funds that were borrowed purchase, a bond purchase does not involve an abroad by the United States parent or its affiliates; equity interest. Moreover, portfolio investments and (3) reinvested earnings of foreign branches of involving stock purchases are generally smaller in United States corporations. (Such earnings are dollar volume than would be required to obtain a considered as profits of the parent firm and thus controlling interest (10 percent or more) and are represent an outflow of funds from the United not considered to be direct investments. States.2 ) Items not included in the balance of The method of measurement of direct foreign payments report (although they affect the net investment used in the United States balance of worth payments accounts can be confusing with respect of the investments) are: (1) reinvested 1 For a more detailed definition of direct foreign invest to the actual dollar outflow involved in direct ment, see D ictio n a ry o f Econom ic and Statistical Terms, foreign investments, because recorded capital out U. S. Department of Commerce (August 1969). flows do not necessarily involve any dollars leaving 2 the A foreign branch of a United States corporation is United States. For example, if a parent considered to be an integral part of the parent firm and company ships goods or provides services to its earnings of the branch are considered as part of the foreign affiliates for credit, the transaction is earnings of the parent firm. Thus, earnings of foreign branches that are reinvested are considered to be an recorded as a capital outflow, even though dollars outflow of funds from the United States. In contrast, a do not leave the United States. Also, in parent- foreign subsidiary of a United States corporation is branch relationships, foreign branch profits are incorporated abroad and is considered to be a separate recorded as an inflow of funds (income) into the unit and earnings of this foreign subsidiary are not looked at as earnings of the parent firm. Only dividends and United States from direct foreign investments, but interest remitted to the parent corporation by a foreign the amount of profits actually retained by the subsidiary are considered as income inflows; reinvested foreign branch and reinvested is recorded as a earnings of a foreign subsidiary are not considered to be a direct capital outflow since no transfer of funds takes place between the United States parent firm and its foreign affiliate (subsidiary). 16 foreign investment (outflow of funds). Capital outflows related to direct foreign invest ments, therefore, may not only involve transfers of MARCH 1971 CHART 1 . GROWTH IN BOOK VA L U E OF UNITED STATES DIRECT FOREIGN I N V E S T ME N T 1914 -19 6 9 B IL L IO N S OF DOLLARS THROUGH 1914 $ 2 .7 191S THROUGH 1919 $1 . 2 1920 THROUGH 1929 $ 3 .7 1930 THROUGH 1943 $ 0 .3 1944 THROUGH 19S8 $ 1 7 .5 1959 THROUGH 1969 $ 4 5 .4 CUMULA T IV E THROUGH 1969 $70.8 I ........... - ............ 0 5 10 h___________ 15 20 x ______A_____ 25 30 : ______ i_______ I_______ i_______ *___________ 35 40 45 50 55 60 65 70 75 SOURCE OF DATA: U . S . DEPARTMENT OF COMMERCE dollars, but also credits to finance the export of lated to $7.6 billion. The continued growth in United States goods and services or intra-company direct foreign investment, to this point in time, showed specific periods of increased activity, such book transactions. as the original HISTORY OF DIRECT FOREIGN INVESTM ENT investment in Latin American mining, petroleum, and railroads prior to 1914 and the expansion of these investments that was United States did not begin to make stimulated by the need for raw materials during significant direct foreign investments until late in World War I. Following World War I, manufac the nineteenth century. In 1897, the total book turing holdings were greatly increased, particularly value United States direct foreign in Canada and Europe, and large investments were investments was only $0.6 billion; but by the end made in petroleum, agriculture, and public utilities of 1914, it reached $2.7 billion (see Chart 1). in The (stock) of Latin America. The accumulation of direct Nearly one-half of this investment was located in foreign investment ceased during the depression Latin America; Canada and Europe received the years, when foreign currencies depreciated and major share of the remainder. By 1929, the book investments already made in extractive industries value of direct foreign investment had accumu and agricultural production were hard hit by the 17 ECONOMIC REVIEW sharp drop in world commodity prices. World War investment is somewhat misleading, because book II also kept direct foreign investment at a low value does not necessarily represent the market level; as a result, the total accumulation in book value of these United States foreign assets. Instead, value between 1930 and 1943 amounted to only book value is the sum of the value of such assets as $0.3 billion. carried on the books of the foreign affiliate. They Although United States firms again began expanding abroad soon after World War II, the are neither capitalized earnings nor current market values. annual flow of investment funds did not rise above the 1925-1929 average until above the 1929 1947, nor much The accumulated book value of $70.8 billion does not necessarily represent the accumulation of level until 1956. The annual past outflows of capital from the United States. In outflow of direct investment was restrained by addition to being financed by funds obtained from postwar dislocations in Europe, a strong domestic parent firms in the United States, additions to demand for capital, exchange restrictions abroad, and uncertainty about the political and economic book value of affiliates of United States firms are financed by reinvested earnings and the overseas future of Europe. sale of equities. 14 countries3 agreed to establish Direct Foreign Investment Income. The growth external (for nonresidents) convertibility for their of United States direct foreign investment out currencies; flows was accompanied by a parallel growth of the In 1958, in the same year, the European Economic Community (EEC) or Common Market inflow of direct investment income.5 With the was formed by six of these countries.4 These exception of 1957, direct investment income events stimulated a rapid advance in United States exceeded direct investment outflow in every year direct foreign investment, as confidence in the during economies of Europe returned. Even more impor royalties7 from direct foreign investments are the 1950-1969 period.6 If fees and tantly, United States firms sought to establish added to recorded income, the total annual return themselves within the EEC tariff barriers in order from to service the growing European market more exceeded annual direct investment ouflow even in efficiently. 1957 (see Chart 2). During the 1950-1954 period, Between 1958 and 1969, the book value of United States direct foreign investment increased 5 accumulated direct foreign investment Income from United States direct foreign investments consists of dividends and interest paid by subsidiaries, by $45.4 billion to reach $70.8 billion at yearend branch profits of United States parent firms, and all 1969. This total book value of direct foreign retained earnings of branches. 3 ^ h e more detailed discussion of developments in direct Austria, Belgium, Denmark, Finland, France, The Federal Republic of Germany, Ireland, Italy, Luxem foreign investment income and outflow is confined to the 1950-1969 period because an upward trend began in bourg, the Netherlands, Norway, Portugal, Sweden, and income flows during this period while outflows showed the United Kingdom. some rather sharp fluctuations. 4 Belgium, France, The Federal Republic of Germany, 7 Fees and royalties from direct foreign investments area Italy, Luxembourg, and the Netherlands. The EEC was separate item in the United States balance of payments formally established by the Treaty of Rome, signed in accounts and are not included in the item “ income from 1957. direct foreign investments." 18 MARCH 1971 CHART 2 . U N IT E D S TA TES D IR E C T F O R E IG N IN V E S T M E N T OUTFLOW AND INCOME B IL L IO N S OF OOLLflRS SOURCE: U . S . OEPRRTHENT OF COMMERCE LAST EN TRY: 1969 capital outflow for direct foreign investments foreign investment income exceeded direct foreign averaged $677 million per year, while income from investment outflows by $2,569 million; if fees and accumulated direct foreign investments averaged royalties $1,475 million per year, for an average annual included, the surplus amounted to $3,938 million. surplus of income over outflow of $798 million Income from United States direct foreign invest per year (see Table I). If fees and royalties from direct foreign investment are added to this average ment has proven to be one of the more stable and consistently growing group of receipts in the surplus, returns from accumulated direct foreign United from direct foreign investments are States balance of payments. Although investment exceeded outflow by an average of other segments of our international accounts have $928 1950-1954 fluctuated substantially in response to economic period. The slight decrease in the average annual and political disturbances, income from direct surplus from direct foreign investments from the foreign investments has remained an important 1950-1954 period to the 1955-1959 period was source of foreign exchange earnings. million per year during the due to the sharp increase in direct investment outflows in 1956 and 1957 and not to a decrease Direct Investment Outflow. The aggregate annual capital outflow for direct foreign invest in income derived from accumulated foreign direct ment fluctuated widely during the 1950-1969 investment. The rather slow annual growth of the period but was relatively stable during the surplus of direct investment income over outflow 1950-1955 portion of this period (see Chart 2). from the 1960-1964 period to the 1965-1969 This stable period was followed by two years of period was also due to above average outflows of heavy direct investment outflow. Specifically, in direct investment funds during two years of the 1956 and 1957, United States firms made large latter period—1965 and 1966. By 1969, direct foreign petroleum investments, with the purchase 19 ECONOMIC REVIEW TABLE I development of oil resources in the Middle East and to a large increase in outflows to Canada to United States Direct Foreign Investment Annual Average Outflows and Income 1950-1969 (mil. of $) refinance existing credits from the United States of finance and trading affiliates. The 1965 United States-Canadian Auto Products Trade Agreement8 Annual Average 19501954 Capital outflow Income Surplus: Income over Outflow Fees and royalties Total surplus $ 19551959 19601964 19651969 677 1,475 $1,554 2,136 $1,868 2,995 $3,295 4,628 798 130 928 582 244 826 1,127 572 1,699 1,333 1,151 2,484 also stimulated investment in the transportation equipment industry in Canada, and these invest ments were reflected in a continued high level of capital outflow in 1966. Earnings of foreign affiliates, particularly in the petroleum industry, leveled off in 1965 and 1966, and the affiliates had difficulties in financing increased working Source: U. S. Department of Commerce capital needs out of internal funds. As a result, of oil concessions in Venezeula accounting for a there was an increase in outflows from United large share. In 1957, $900 million was added to oil States parent firms to meet these working capital investments in Latin America; $770 million of this needs. Following these two peak years of direct was invested in Venezuela. Oil leases accounted for foreign investment outflow, the flow of such funds $360 million of the $770 million investment. decreased to slightly more than $3 billion annually After 1957, United States direct foreign invest ment outflows increased compared with and remained at that level through 1969. Factors the Influencing Investment Flows. The 1950-1955 period and showed a general upward leveling of investment outflows from 1967through trend for the remainder of the period under 1969 was the direct result of policy actions taken discussion. This trend was stimulated, in part, by by the United States. During 1964, the United the previously mentioned agreement to reestablish States became increasingly aware of its continuing convertibility of the major European currencies balance of payments deficit. Consequently, since and by the formation of the Common Market in 1965, there has been some emphasis on limiting 1958. direct foreign investment outflows as part of a A new phase in international business began in program to It control the balance of payments the late 1950's. Until that time. United States deficit. was assumed direct foreign investment was characterized by an payments deficits early in the 1960's were tempo emphasis on investments in petroleum and other rary; and that if some restraint were placed upon raw material extraction projects. Starting in the the late 1950's, however, direct foreign investments in immediate imbalance in the United States inter outflow of dollars that the balance of in the short-run, the manufacturing and trade were steadily increased, national accounts might be overcome, thus gaining and these flows of funds were largely directed to g Europe. shipped to the United States free of duty, while similar The sharp increase in direct investment outflow in 1965 can be attributed to large capital expendi tures by United States firms for exploration and 20 Under the agreement, Canadian autos and parts can be United States exports to Canada are exempt from duty only when prescribed rules for use of Canadian goods and services are met in the manufacture and sale of the automobiles. MARCH 1971 time for long-range influences to have an effect on international are usually used to establish new production income and expenditure relation facilities, and additional national income is gener ships. Because of the continued book value growth ated through: (1) wages paid to those employed in of funds the facilities; (2) purchases of locally produced borrowed abroad, there was also the belief that foreign direct materials; and (3) taxes paid by the employers and income past direct foreign employees, as well as from interest and dividends investment would continue at a relatively high paid to local residents who may have helped to from investment accumulated through level during the period that foreign investment finance the facility. Benefits may also be derived outflow was limited. It was assumed that long- from the managerial and technical skills and range foreign investment income would, therefore, product technology that often accompanies the not suffer appreciably. capital flow. On the other hand, the flow of President foreign capital may, in part, merely substitute for Johnson called for the support of United States domestic investment in the recipient country and, business leaders to limit voluntarily their direct to the extent that substitution may take place, no To this end, in February 1965, foreign investment outflows. In December 1965, net the voluntary restraint program was tightened. The economy. leveling o ff in the outflow of direct foreign investment in 1966 and the reduction in 1967 benefits would accrue to the recipient Similarly, capital exports in the form of direct foreign investment may increase employment reflected the cooperation of United States corpo opportunities in the country that is exporting the rations with the voluntary restraint program. By capital. For example, some foreign investments 1968, however, it was deemed desirable, as part of result in an increase in the volume of United States a broader series of balance of payments measures, merchandise exports, such as machinery for a new to reduce the level of direct foreign investment factory and later raw materials or semi-finished outflow goods for that factory; thus, the level of United further; therefore, mandatory controls were placed on private capital outflows.9 Since States production and income is raised. Moreover, these measures were imposed, the outflow of some foreign investments are made for facilities direct foreign investment funds has leveled off at that produce industrial materials needed domes about $3 billion per year. tically, and the lack of these supplies could affect the American economy. In contrast, if a foreign OTHER FACTORS IN E VA LUATING direct investment is made to establish a facility to FOREIGN INVESTM ENT produce a good which is in direct competition The effects of direct foreign investment on a with a United States export, the level of exports of nation's economy cannot be evaluated solely on that good from the United States may be reduced. the basis of derived income. For example, in Many problems associated with foreign invest countries receiving these investments, the funds ments are political, but the same problems would g a national economy. For example, if a corporation be economic issues if considered in the context of For details of these control programs, see the 1970 General B ulletin, published in the Federal Register, Vol. located in the eastern United States made an 35, No. 196, October 7, 1970. investment in production facilities in the West, any 21 ECONOMIC REVIEW changes that might occur in either region as a 212 percent (see Table II). In 1969, the book result of this investment would be considered as value of United States direct foreign investment in economic. However, if the same corporation made Canada accounted for about 30 percent of the a similar investment in a foreign country, political total questions could arise since the receiving country abroad. The annual flow of direct investment book value of all American investments might consider the investment as an expansion of funds from the United States to Canada fluctuated foreign control of business in the country, and this widely during the might be looked at with disfavor. East-West trade low of $302 million in 1961 and a peak of $1,135 restrictions fall million in 1966. The sharp increase in investment into the political (as well as 1955-1969 period, reaching a economic) category. The separation of economies ouflow in 1965 and 1966 reflects the stimulus by national boundaries, combined with differences given to potential Canadian auto production by in laws, policies, and institutions, complicates an the 1965 United States-Canadian Auto Products evaluation of the impact of direct investments. Trade Agreement. Such an evaluation would be relatively simple if direct foreign investment in the manufacturing considered in relation to a domestic economy. (The 1965-1966 upswing in industry category of Table II also reflects United States investment in Canadian auto production OUTFLOW AND INCOME BY GEOGRAPHIC LOCATION AND IN DUSTRY GROUP Although the aggregate annual capital outflow facilities.) Also, capital flows to Canada were exempt from the 1968 mandatory controls placed on direct investment. As shown in Table II, the annual increase in of direct foreign investment and the income from the book value of United States direct foreign this accumulated investment have shown a rela investment in Canada, as well as in the other tively stable growth pattern, year-to-year fluctu geographic areas, usually exceeded the annual ations have occurred in the area and industry capital flow from the United States to Canada and distribution of the totals. These fluctuations are the other areas. This reflects the fact that a the result of a number of causes including: the portion of the capital expenditures by foreign discovery and development of new sources of raw affiliates of United States firms is financed by materials; completion of scheduled investment funds obtained abroad (retained earnings of sub programs; international agreements, such as the sidiaries, foreign borrowing, etc.). Unusually large formation of common market areas; and relatively (or small) direct foreign investment outflows in short-term changes in flows connected with such any one year generally result from special situ factors as exchange restrictions or changes in ations in the recipient country (for example, the exchange rates and interest rate differentials. United States-Canadian Auto Products Trade Agreement). Canada. Canada has received the largest volume of United States direct foreign investment. The relative size of repatriated income from Canada and direct investment in Canada shifted in Between 1955 and 1969, the book value of direct 1961. Between 1955 and 1960, capital flows to investment in Canada grew from about $6.8 billion United to slightly more than $21 billion-an increase of exceeded income received from these affiliates (see 22 States affiliate corporations in Canada MARCH 1971 TABLE II United States Direct Foreign Investment Total Book Value, Capital Outflow, and Income 1955-1969 (mil. of $) Country and/or Area Total world Book value Capital outflow Income Canada Book value Capital outflow Income Latin America Book value Capital outflow Income EEC * Book value Capital outflow Income United Kingdom Book value Capital outflow Income Other Europe Book value Capital outflow Income Rest of world Book value Capital outflow Income 1955 1956 1957 1958 1959 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 $19,395 $22,505 $25,394 $27,409 $29,827 $32,778 $34,667 $37,226 $40,686 $44,386 $49,328 $54,711 $59,486 $64,983 $70,763 823 1,951 2,442 1,694 1,599 1,654 1,181 1,372 1,976 2,416 3,418 3,623 3,154 3,209 3,070 2,768 3,050 3,134 3,963 4,045 4,518 1,912 2,171 2,249 2,121 2,228 2,355 3,670 4,973 5,639 6,761 353 293 7,795 601 326 8,769 678 335 9,470 421 315 10,310 417 345 11,198 471 361 11,602 302 464 12,133 314 476 13,044 365 455 13,796 239 634 15,223 912 703 16,999 1,135 756 18,097 403 790 19,535 625 851 21,075 619 762 6,031 167 672 6,844 618 800 7,434 1,163 880 7,773 299 641 8,120 218 600 8,387 95 641 8,236 173 730 8,424 - 32 761 8,662 69 801 8,894 143 895 9,391 176 869 9,826 190 965 10,265 184 1,022 11,033 477 1,049 11,667 271 1,049 1,773 76 75 1,429 145 70 1,680 96 83 1,908 106 81 2,208 180 134 2,644 282 144 3,104 277 193 3,722 485 247 4,490 588 232 5,426 807 275 6,304 857 366 7,584 1,143 321 8,444 852 398 9,102 438 434 10,194 648 453 1,427 32 153 1,649 282 210 1,974 172 173 2,147 63 192 2,477 190 281 3,231 589 217 3,554 196 239 3,824 170 211 4,172 124 199 4,547 206 276 5,123 317 270 5,657 381 251 6,113 353 274 6,694 363 275 7,158 284 327 402 22 38 483 61 34 497 19 26 519 21 25 639 114 28 806 91 35 1,084 252 53 1,384 214 68 1,678 217 76 2,136 355 103 2,558 305 132 2,967 285 157 3,369 275 178 3,701 200 196 4,202 226 246 2,725 121 651 3,047 175 690 3,381 149 709 3,710 168 809 3,949 69 753 4,210 102 872 4,649 346 977 5,042 368 1,126 5,678 419 1,197 6,390 462 1,344 7,300 742 1,428 8,039 443 1,418 9,082 831 1,632 10,210 715 1,951 11,261 631 2,275 2,197 46 195 2,419 116 239 2,361 199 210 2,558 177 169 2,848 231 249 3,013 158 337 3,061 72 296 3,183 91 314 3,369 65 293 3,569 88 399 3,785 98 443 4,315 220 524 4,876 316 596 5,435 383 645 5,635 52 664 5,899 392 1,026 7,355 1,173 1,163 9,055 1,408 1,276 9,822 649 1,169 10,324 410 1,100 10,944 455 1,143 12,151 747 1,303 12,661 538 1,578 13,652 810 1,654 14,334 739 1,922 15,298 1,013 1,798 16,205 876 1,778 17,404 1,103 1,989 18,887 1,181 2,288 19,985 1,022 2,635 6,623 224 383 7,561 390 375 8,009 432 429 8,673 269 460 9,707 468 549 11,152 802 550 11,936 460 710 13,212 680 741 14,937 716 660 16,931 997 876 19,339 1,494 1,095 22,058 1,730 1,118 24,167 1,211 1.193 26,414 905 1,275 29,450 1,122 1.325 4,676 161 308 5,169 273 394 5,970 404 335 6,356 86 202 6,947 262 330 7,635 278 319 7,536 188 364 8,089 248 417 8,727 297 451 9,552 552 543 10,932 766 625 12,133 716 625 13,039 390 740 14,247 556 776 15,692 873 1,014 Industrial Group Mining and smelting Book value Capital outflow Income Petroleum Book value Capital outflow Income Manufacturing Book value Capital outflow Income Other, including trading and utilities Book value Capital outflow 1ncome p Preliminary. * European Economic Community. Source: U. S. Department of Commerce 23 ECONOMIC REVIEW Table II). By 1961, however, interest and divi Latin America. By 1969, the accumulated book dends paid to United States parent firms plus value of United States direct foreign investment in profits of branches of United States corporations Latin America was second only to that in Canada, exceeded to when such investment is divided by the geographic Canadian affiliates. Except for the peak invest areas selected for Table II. However, between the direct investment outflow ment years of 1965 and 1966, income from direct 1955 and 1969, the relative growth of book value investment in Canada exceeded direct investment of direct foreign investment in Latin America (93 outflow to Canada every year during 1961-1969. percent) was considerably less than that in other There is, of course, a time lag from when a capital geographic areas. Historically, the direct invest investment is initiated to when returns from the ment emphasis in Latin America has been in the investment begin. Thus, the 1961 shift reflects a mining, smelting, and petroleum industries. The buildup of income from past accumulation of slower growth in the book value of direct invest investment expenditures in Canada. ments in Latin America reflects the general trend United Kingdom. United States firms have also toward greater emphasis in recent years on invest made relatively large direct investments in the m ents United Kingdom. Between 1955 and 1969, the increasingly toward the industrialized countries. in manufacturing industries—directed book value of direct investment in the United Purchases of oil concessions in Venezuela had a Kingdom rose from about $1.4 billion to nearly major influence on the large capital outflow of $7.2 billion—an increase of 402 percent. Both Latin capital outflow from United States parent firms to $900 million was added to petroleum investments United Kingdom affiliates and income from these in Latin America in 1957, with $770 million going affiliates the to Venezuela. By the end of 1957, the book value 1955-1969 period. In particular, the sharp increase of United States direct investments in Venezuela fluctuated considerably during America in 1957. As mentioned earlier, in direct investment outflow in 1960 reflects the reached $2.7 billion—nearly one-third of the total acquisition of a minority interest in an existing for the entire Latin American area. Mining invest automobile in the United ments in Mexico and Peru also contributed to the manufacturing firm (The increase in capital outflows in large increase in Latin American direct investment 1960 in the foreign manufacturing industry cate in 1957. The sharp drop in direct investment gory also reflects this acquisition as well as a outflows to Latin America in 1960 was largely the general upturn in direct investment in foreign result of the cessation of investment flows to manufacturing facilities.) The decrease in direct Cuba. However, the United States direct invest investment income from the United Kingdom in ments 1963 resulted in large part from the heavy use of immediately Kingdom. in Cuba that written were seized were not off. The negative capital undistributed profits in place of capital funds from outflow to Latin America in 1962 reflects the United States parent firms. A large volume of write-off of the seized Cuban investments. dividend delayed payments 1964; 1963 comparatively was With the exception of 1957, income from direct investment in increase in direct investment income in 1964 investment outflow in reflects these delayed payments. 1955-1969 period. Income the for large 24 until scheduled Latin America each exceeded direct year during from the the Latin MARCH 1971 American investments was also considerably larger fact that a large share of the direct investments than from the other geographic areas of the world were made more recently in the EEC than in other shown in Table II. A large proportion of direct geographic areas, and returns on these investments investment in Latin America is in the petroleum, are just beginning to build up. Liberal use has also mining, and smelting industries; the returns from been these investments are generally greater than from subsidiaries for capital expansion, which, in turn, investments in manufacturing, trade, and utilities. delays income flows to parent firms in the United (This fact is also reflected States. In addition, many petroleum refining affil in the substantial made of income from direct investment in the area cate iates in gory losses. "rest of world” and in the petroleum the retained earnings of EEC Europe have traditionally had branch industry category. Investment in the petroleum The large capital outflow to the EEC in 1966 is and extractive industries represents a large propor largely the result of overseas borrowing. That is, tion of the book value of direct foreign investment because of tight money conditions in the United in "rest of world".) States and the direct investment control program, The slowdown in the growth of direct invest domestic corporations borrowed funds through ment income from Latin America that began in foreign bank loans and other foreign sources. A 1967 may reflect the influence of several factors: a large share of these funds were transferred to other preceding increase in less profitable manufacturing foreign affiliates and are counted as capital out investments; nationalization of some United States flows from United States parent firms to their operations in several Latin American countries; the foreign affiliates. (The borrowing is, however, a trend toward a larger share of equity interest being credit item in the balance of payments accounts held by local residents; and increased taxes and and thus has no net effect.) Direct investment royalty payments by petroleum corporations to outflows to the EEC tended to slacken following host countries. the 1966 peak, due in part to the United States Common Market. Another area where large Direct Investment Control United States direct investments have been made is from 1965 the EEC. The combined book value of investment beginning in 1968).10 However, the book value of in the EEC countries increased from about $1.2 direct investment in the EEC continued to climb billion in 1955 to nearly $10.2 billion in 1969—an because funds from foreign sources were used to increase of 769 percent (see Table II). During the finance capital expenditures. through program 1967 and (voluntary mandatory five year period 1955-1959, the average annual increase in the combined book value of United States direct investment in EEC nations was $207 SUMMARY United States direct foreign investment has million; this figure rose to $536 million during the increased rapidly in recent years and reached a 1960-1964 period and reached an annual average book value of $70.8 billion at the end of 1969. of $778 million during 1965-1969. This During the period under review, direct invest growth was particularly strong in the 1958-1969 period, when $45.4 billion was added ment outflows to the EEC continually exceeded direct investment income. This may reflect the 25 ECONOMIC REVIEW to the book value. Both direct foreign investment over outflow would have amounted to $3,938 outflow and direct investment income have an million in 1969. important influence on the United States balance Late in the 1950's, there was a decided shift in of payments. With the exception of only four the area and industry distribution of United States years (1928, 1929, 1931, and 1957), direct invest direct foreign investment. Until the immediate ment post-World War II period, direct foreign invest income has exceeded direct investment outflow in every year since 1919. In 1969, this ment had been concentrated in the extractive and surplus of income over outflow amounted to petroleum industries, with heavy investments $2,569 million—a major offsetting item to the being directed toward Latin America and Canada. depressed merchandise trade surpluses of recent After the late 1950's, the emphasis shifted to years and to the deficits resulting from continued investments in manufacturing, and an increasing high foreign military expenditures and private volume of such investment funds was directed short-term capital flows. If fees and royalties from toward Canada and western Europe. Large direct direct foreign investment (not included as direct investments, however, continued to be made in investment income in the balance of payments foreign petroleum facilities, particularly in the accounts) were included, the excess of income Middle East and Venezuela. 26 SPECIAL ANNOUNCEMENT The 1970 Annual Report o f the Federal Reserve Bank o f Cleveland is now available. This year's report describes the Bank and its operations at the start o f the 1970's. Requests fo r copies should be directed to the Research Department, Federal Reserve Bank o f Cleveland, P. 0 . Box 6387, Cleveland, Ohio 44101.
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