Is the Reinvestment of Multinationals a Capital Flow? Local Saving and the Current Account

Abstract

When a foreign company located in a country saves a portion of its profits it is classified as Foreign Direct Investment (FDI), although cash does not cross borders and resources were produced locally. We show that the more multinationals are important vis-a-vis national corporations, the larger is this Retained Earnings FDI (RE-FDI). Note that RE-FDI arithmetically widens the current account deficit if companies use them for capital expenditures. After showing that standard measures of saving (National and Domestic) are insensitive to multinationals' saving decision, we propose new indicators that treat the saving of all corporations located in the country as equal: Gross Local Saving (GLS) and Local Current Account (LCA). For example countries like Ireland and Chile have higher local current account than in the BoP, while “headquarter countries” like the US or the UK have even deeper local current account deficits. Empirically we show that, first, FDI is under some circumstances more procyclical than other flows, but mostly because of the locally generated RE-FDI and its relationship to investment. In many dimensions the cyclical behavior of RE-FDI is closest to the one of National Savings rather than to other types of capital inflows. While RE-FDI comoves positively with national savings, the rest of FDI comoves in the opposite direction. Second, as countries become more financially open they increase their RE-FDI, and the commodity boom was a significant factor behind RE-FDI in commodity countries. Finally we explore the relation between capital flows and crises. The explanatory power of current account deficits gets stronger when excluding this retained earnings FDI. In fact, this type of local saving is negatively correlated with crises. Also, the stock of RE-FDI is found to be more “protective” of macroeconomic crises. Our results suggest macro-prudential monitoring should complement its analysis with local saving measures.