September 21, 2015

Why a MAC charge on FDI will Stimulate FDI

A common question from ABDC Now! readers: 
"Why not exempt foreign direct investment from the MAC?  Imposing a MAC charge on all incoming capital would discourage investments in physical assets that could improve American manufacturing's productivity and international competitiveness,"
The answer is quite simple and revolves around two issues -- (a) the need to create a level playing field that minimizes the risk of distortions, evasion, and high administrative costs, and (b) the fact that, because of its very design, the MAC creates a natural bias in favor of FDI.

First, all incoming capital should be subject to the MAC because, as shown by the experience of other countries, once you start trying to discriminate between "good" and "bad" capital inflows, you open wide the gates to high administrative costs, distortions, evasion, and even corruption. Foreign investors will do whatever it takes to get their capital classified as "good" and thus not subject to the MAC, and as a result, enforcing the rules will require very costly administrative efforts that are likely to fail.

Second, and even more important, the MAC is designed in a way that actually creates a bias in favor of foreign direct investment from two perspectives:

(a) FDI commonly involves long-term investment with a relatively high yield on investment. The impact of the small one-time MAC charge might discourage rapid in-and-out investments in America's financial markets, but it becomes almost invisible when calculated as a share of the return on a typical direct investment, which may average 10-15 percent per year over an economic life of 10-20 years.

If the MAC is set at 50 basis points and half the total investment is financed from US domestic sources, the lifetime burden of the MAC is barely over one tenth of one percent -- a fraction of the daily average variation in the USD/EUR rate, for example.

(b)  A MAC can be expected to reduce the dollar's current overvaluation, which has been estimated at somewhere between 15 percent and 25 percent relative to the rate that would yield a true balance of imports and exports /a. On average, this would reduce the implicit "overvalued dollar tax" of about 20 percent to zero, allowing made-in-America goods to be sold for up to 20 percent more in America compared to current import prices and up to 20 percent more in export markets and still remain profitable. The increase in profit as a percentage of selling price depends almost entirely on the current profit percentage, but if the current profit rate is only 10 percent (e.g. a profit of 10 on a product selling for 100, raising the selling price to 120 would mean raising the profit from 10 to 30, a two-hundred percent increase in the rate of profit.

Comparing costs to benefits, 50 basis point initial cost of the MAC on foreign capital brought in would be totally overwhelmed by the benefit of increasing the rate of profit by say 200 percent. /b

In short, the MAC is a very small price to pay for a dramatic increase in the incentive to invest in America!

America Needs a Competitive Dollar - Now!

/a Note that the recent lower estimate by Bill Cline at the Peterson Institute reflected the change needed to reduce the US trade deficit to three percent of GDP, not to zero. Leaving the deficit at three percent would mean an leaving an extra three to four million workers unemployed in America. Hence the ABDC-Now! choice of truly balanced external trade as the goal for American trade policy.
/b The following screenshot of a simple back-of-a-spreadsheet model shows the basic calculations:

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