Tuesday, September 2, 2014

Inversions and Globalization

I learned how to invert a matrix in college and I have never been the same. Which is one reason that all this political talk about inversions brings back some pretty sweaty moments at Georgia Tech. Some people think corporate inversions show that some American companies are not good citizens. Others use this occasion as a means to discuss corporate taxes and to point out how and why US taxes are too high. Still others shrug their shoulders and admit that inversions are part of a larger process going on and will be with us with or without taxes or flag waving.

What a nice way to start. I now have everyone mad at me!  But the truth is that a larger process called globalization is going on. Globalization has been going on a long time but clearly it took a leap forward after the Cold War melted.  Distance matters when it comes to trading things. If you live here, you trade more with Bloomington's Big Red Liquors than with a similar store in Seattle. But it is also true that when you take a little trip to Indianapolis to visit Aunt Hillary, you might go to Costco – since you don’t have one yet in Bloomington. Why don’t Bloomingtonians drive to Indianapolis every day for their JD if Costco is so good? Answer: the cost of distance. Whether you value your time or gas or wear and tear on your car or the chance of getting into a wreck in Martinsville, the cost of distance makes you buy most things close to home.

What happens if the cost of distance dramatically decreases?? Answer: you widen the size of your market.  The end of the cold war reduced the cost of distance. After the cold war it was safer to travel to more places. As formerly non-capitalist countries entered into global competition and offered lower priced goods it was as if someone had “shortened the road” there. Innovations and technological progress in shipping, communications, and travel also lowered the costs of doing business across continents and countries. Of course reductions in regulations, taxes, and corruption added a recognition of the improved ease and cost of transactions at distance.

Globalization is a word that describes how International trades have mushroomed since around 1990. It isn’t just greedy business people who trade more. Lower distance costs have promoted more tourism. Imagine in 1985 the Chinese being the largest groups of worldwide travelers. Churches cooperate more. International organizations meet and work together more. Governments find it easier to use Skype or Korean Air – to facilitate more frequent meetings.

That’s the backdrop. Globalization has slowed but it continues today.  In macroeconomics we often measure globalization through what are called the Balance of Payments Accounts (BOPA). These accounts measure legal cross-border transactions of an economic nature. If you are awake you noticed the word legal – so we are already admitting these measures are not perfect. But based on a lot of different information sources, nations routinely measure trade in goods, services, dividends, interest, charitable giving, bonds, stocks, bank accounts, real estate, corporate ownership positions, derivatives, and more. This information comes out quarterly. And yes, it often gets revised over time.

Pertinent to the question of inversions is the part of the BOPA called the Financial and Capital Accounts (FCA). FCA measure changes in international transactions that relate to cross-border trades in financial instruments and capital, including acquiring and merging with foreign companies. These trades are summarized in the International Investment Position (IIP). It is the IIP that is relevant to put today’s concern about inversions into perspective. You can find the kind of information I quote below at the Bureau of Economic Analysis (  http://www.bea.gov/international/index.htm#iip ).

Let’s start with one fact. At the end of the first quarter of 2014 foreigners owned US assets worth $29.1 trillion. That’s a lot of Taco Bells. Of course it wasn’t all Taco Bells. Foreigners owned approximately $16 trillion of US bonds and stocks. Add to that $5.7 trillion for enough ownership in US companies to give foreign owners some managerial control. While we are worried about money flowing out of the US please note that between 2012 and 2013, foreigners increased their ownership of US assets by about $2 trillion.

And we reciprocated the interest. By Q1 2014 we owned $23.6 trillion assets abroad, up from $22.5 trillion the year before. You own me. I own you. That’s part of globalization. Furthermore – in the last year you owned even more of us and we owned even more of you.

Some of you accountants are saying, hold on a minute. Who owns more of whom? We calculate the Net IIP by subtracting what foreigners own of us from what we own of them. The result in Q1 2014 was -$5.5 trillion. Foreigners owned $5.5 trillion more of us than we owned of them. Some people interpret this as a bad thing. Note the negative sign. Negative signs are usually interpreted negatively. J  But it sounds pretty cool to me. Foreigners like our US assets. Would you rather be in Argentina where people wouldn’t buy your assets with a ten foot pole?

Anyway, this -$5.5 trillion suggests an imbalance in which we have future financial obligations or debts to pay internationally. That could be viewed negatively but won’t be a problem so long as people believe we can pay those foreign debts. But there is more to it. All this buying of our assets leads to needs for dollars which leads to a robust demand for dollars that makes the value of the dollar higher than it might be otherwise. So this Net IIP isn’t all good. If American companies invested more abroad, it would reduce this imbalance – making us less of an international debtor and perhaps improving our competitiveness.

I know this is getting complicated. And it is. Politicians who call our companies traitors for inversions are doing what politicians always do – making up simple stories to please some of the voters. Don’t be fooled. Companies will continue to react to the cost of distance. Taxes may impact the cost of distance but taxes are only one of many factors. Let companies do what they think is right for their stakeholders and in the end they will do what is right for America. Let's not call them nasty names until they actually break laws. 


  1. Those yelling against inversions are also those who say that not paying taxes is unpatriotic.......then they do all they can to avoid paying taxes. The BK-TH deal is good for the U.S.! Tim Horton's has great donuts and good coffee. We should have access to those things without having to travel to the edge of the Arctic tundra.

  2. I'll give the Catfish King a call and have them mail you an order.