ECONOMIC AND BUDGET ISSUE BRIEF

Why Does U.S. Investment Abroad Earn Higher Returns 

Than Foreign Investment in the United States?

When the United States or any nation runs a currentaccount deficit—that is, when its total receipts from 

abroad (from exports of goods and services, unilateral 

transfers, and international investment income) falls 

short of its total payments (for imports, unilateral transfers, and returns on foreign investment in the nation)—it 

must finance that deficit by either borrowing from or selling assets to foreigners.1 Thus, foreign holdings of U.S. 

assets rise relative to U.S. holdings of foreign assets in 

each year that the United States runs a current-account 

deficit. After more than two decades of such deficits, the 

United States now has a smaller dollar value of foreign 

assets than foreigners have of U.S. assets. That difference 

(net U.S. liabilities to foreigners) reached $2.5 trillion at 

the end of 2004.

Despite their smaller holdings, U.S. residents have persistently earned more income on their assets abroad than 

foreigners have earned on their assets in the United 

States. Such net U.S. investment income showed a total 

surplus of $36.2 billion in 2004 and an annualized surplus of $6.1 billion in the first half of 2005. In other 

words, the rate of return on U.S.-owned assets abroad 

(measured as the ratio of investment income to assets) has 

been higher than the rate of return on foreign-owned 

assets in the United States. As long as that advantageous 

gap in returns continues, it will help to slow the rise in 

the nation’s current-account deficit.

The U.S. Advantage Comes 

from Direct Investment

Both U.S. and foreign firms make direct investments outside their home countries. For example, U.S. automobile 

CBO A series of issue summaries from

the Congressional Budget Office

NOVEMBER 30, 2005

Summary

At the end of 2004, foreigners owned $12.5 trillion 

worth of assets in the United States, $2.5 trillion 

more than the value of U.S.-owned assets abroad. 

That difference is a legacy of cumulative U.S. 

current-account deficits. Nevertheless, U.S. residents consistently earn more income from their foreign investments than foreigners earn from their 

larger U.S. investments, thereby holding down the 

size of the U.S. current-account deficit. That situation mainly reflects the fact that U.S. companies 

receive more earnings from each dollar’s worth of 

direct investment abroad (ownership of foreign subsidiaries) than foreign companies earn from their 

subsidiaries in the United States. 

Three factors may account for the difference in 

returns on cross-border direct investment. First, 

U.S. subsidiaries abroad have generally been in 

business longer than foreign-owned subsidiaries in 

this country, which contributes to their greater 

profitability. Second, in some cases, U.S. subsidiaries abroad face greater risks of political or economic 

disruptions than subsidiaries of foreign corporations face in the United States. U.S. investors may 

require higher returns because of that difference in 

risk; however, compensation for risk appears to 

explain a much smaller portion of the difference in 

returns than some analysts may believe. Third, 

some observers argue that U.S.-owned subsidiaries 

abroad appear to be more profitable because they 

overstate their profits—and foreign-owned subsidiaries in the United States understate their profits—

for tax reasons. However, the extent to which such 

misstatements affect the difference in returns is 

unknown.

—Douglas Holtz-Eakin

Director

1. International investment income, as measured in government statistics, includes income (interest and dividends, but not capital 

gains) earned on holdings of foreign stocks and interest-bearing 

assets as well as income from direct investment abroad (interest 

and dividends paid by foreign subsidiaries to their parent companies, plus those subsidiaries’ reinvested earnings).
2 CONGRESSIONAL BUDGET OFFICE

ECONOMIC AND BUDGET ISSUE BRIEF

Table 1.

Returns on Foreign and U.S. 

Cross-Border Direct Investment

Sources: Congressional Budget Office; Department of Commerce, 

Bureau of Economic Analysis.

Notes: Rates of return are based on definitions used by the Bureau 

of Economic Analysis. BEA reports only the market value, not 

the purchase cost, of cross-border portfolio assets and 

excludes capital gains and losses (changes in the market 

value of assets) from its measure of income from portfolio 

investment and direct investment. The return on direct 

investment includes estimates of reinvested earnings, a fundamental component of changes in the market value of companies, whereas the return on portfolio investment does not.

Numbers may not add up to totals because of rounding.

companies have long owned subsidiaries in Europe, and 

European as well as Japanese automakers have set up subsidiaries in the United States.2 In addition, U.S. and foreign investors hold investments in their portfolios (such 

as bonds, stocks, loans, and bank deposits) from outside 

their home countries. As a whole, cross-border portfolio 

investment exceeds cross-border direct investment (see 

Table 1). However, balance-of-payments data reported by 

the U.S. Bureau of Economic Analysis (BEA) indicate 

that direct investment is largely responsible for the higher 

overall rate of return earned by U.S. investments abroad. 

U.S. residents’ direct investment in foreign countries has 

persistently yielded much greater returns than has foreigners’ direct investment in the United States (see 

Figure 1). Between 1982 and 2004, U.S. direct investment abroad earned an average return of 7.6 percent per 

year, while foreign-owned direct investment in the 

United States earned only 2.2 percent. With portfolio 

investment, by contrast, little difference existed between 

the average rates of return earned by foreigners and U.S. 

residents on their investments abroad: 5.2 percent and 

4.9 percent, respectively, over the 1982-2004 period.

As measured using BEA data, those rates of return do not 

include capital gains (changes in asset prices and currency 

valuation), which could make them a distorted indicator 

of true rates of return, especially during periods of large 

currency swings or relative movements in stock prices at 

home and abroad.3 Any distortion should be less severe 

for rates of return on direct investment, however, because 

income from direct investment includes reinvested earnings, which, over time, should approximately equal 

cumulative capital gains.

Why Does U.S. Direct Investment 

Earn Higher Returns?

The difference in returns on direct investment appears to 

stem partly from the longer presence of U.S. investments

2. In U.S. government statistics, U.S. direct investment abroad is 

defined as U.S. parent companies’ share of the market value of 

those foreign-located businesses of which U.S. residents own at 

least 10 percent. Foreign direct investment in the United States is 

defined analogously.

2,687 2.2

9,828 5.2 _____

Total 12,515 4.5

3,287 7.6

6,685 4.9 _____

Total 9,973 5.7

-600 -5.5

3,143 0.3 _____

Total 2,542 -1.2

Portfolio Investment

Direct Investment

Portfolio Investment

Direct Investment

End of 2004

(Billions of

Foreign-Owned Assets in the United States

U.S.-Owned Assets Abroad

Difference (Foreign minus U.S.)

Portfolio Investment

Direct Investment

U.S. dollars)

Annual Return,

1982 to 2004

(Percent)

Amount at the Average

3. Rates of return based on BEA data differ from those measured by 

some other researchers. For example, a recent analysis by PierreOlivier Gourinchas and Helene Rey—which measured rates of 

return using indexes of stock and bond prices in each country 

where assets are located and movements in the exchange value of 

the dollar relative to those countries’ currencies—did not find a 

larger gap in returns for direct investment than for portfolio 

investment. Compared with the BEA-based measure, however, 

that measure potentially introduced new distortions, such as the 

use of broadly based stock-price indexes that may not be representative of the makeup of U.S. investments abroad or foreign investments in the United States. See Pierre-Olivier Gourinchas and 

Helene Rey, “From World Banker to World Venture Capitalist: 

The U.S. External Adjustment and the Exorbitant Privilege” 

(paper prepared for the National Bureau of Economic Research 

Conference on G7 Current Account Imbalances: Sustainability 

and Adjustment, June 1-2, 2005), available at www.nber.org/

~confer/2005/cas05/rey.pdf.
ECONOMIC AND BUDGET ISSUE BRIEF

WHY DOES U.S. INVESTMENT ABROAD EARN HIGHER RETURNS THAN FOREIGN INVESTMENT IN THE UNITED STATES? 3

Figure 1.

Rates of Return on Direct Investment, 

1982 to 2004

(Percent)

Sources: Congressional Budget Office; Department of Commerce, 

Bureau of Economic Analysis.

abroad than of foreign investments in the United States. 

U.S. investments abroad may also earn higher returns 

because U.S. companies take greater risks by investing in 

some countries than do their foreign counterparts that 

invest in the United States. A third factor—that, for tax 

reasons, foreign-controlled multinational companies understate their profits in this country and U.S.-controlled 

companies overstate their profits abroad—might also be 

part of the explanation.

Age of U.S. Investments

The number of years that an overseas subsidiary has been 

in existence appears to have an important and positive influence on its rate of return in several ways.4

 First, establishing a subsidiary in another country is challenging, and 

experience may pay dividends. Second, profits of newly 

acquired or established companies tend to be dampened 

by high startup costs, such as spending for capital equipment or advertising. Those costs may be particularly high 

for foreign firms that must get to know a market outside 

their home base. Third, returns on newly acquired companies may be depressed because mergers and acquisitions tend to increase the book value of assets before they 

affect operating profits.5 Fourth, as unprofitable companies eventually exit a market, the average profitability of 

all subsidiaries begins to improve.

U.S. companies had been making significant direct 

investments in other countries for at least 20 years before 

the arrival of significant flows of foreign direct investment into the United States. New U.S. direct investment 

abroad consistently exceeded new foreign direct investment in the United States throughout the 1960s and 

1970s (see Figure 2). By 1976, the total value of foreign 

subsidiaries in the United States amounted to only $48 

billion, about 20 percent of the $222 billion value of U.S. 

subsidiaries abroad at that time. After 1980, however, 

new foreign direct investment in the United States increased and at times exceeded new U.S. direct investment 

abroad. By 2004, the value of foreign-owned subsidiaries 

in the United States had grown to $2.7 trillion, about 82 

percent of the $3.3 trillion value of U.S.-owned subsidiaries elsewhere. The rapid rise in new foreign direct 

investment in the United States since 1980 may very well 

have depressed the average rate of return on all foreignowned subsidiaries in this country.

As foreign-controlled companies become older, the pattern of returns on direct investment that has so far 

favored U.S. companies abroad could diminish. That 

development would erode the favorable returns and net 

inflows of income from direct investment and thus contribute to widening the current-account deficit.

Riskiness of Direct Investment

Some analysts argue that U.S. investments abroad may 

also earn higher returns because in some cases, U.S. companies take greater risks when they invest in foreign subsidiaries than foreign companies take when they invest in 

subsidiaries in the United States. Investments that involve 4. See, for example, L.A. Lupo, Arnold Gilbert, and Michael 

Liliestedt, “The Relationship Between Age and Rate of Return of 

Foreign Manufacturing Affiliates of U.S. Manufacturing Parent 

Companies,” Survey of Current Business (August 1978), pp. 60-66; 

and Raymond J. Mataloni Jr., “An Examination of the Low Rates 

of Return of Foreign-Owned U.S. Companies,” Survey of Current 

Business (March 2000), pp. 55-73.

1982 1985 1988 1991 1994 1997 2000 2003

-2

0

2

4

6

8

10

12

14

U.S. Return on Direct

Investment Abroad

Foreigners' Return on Direct

Investment in the United States

5. See David Laster and Robert N. McCauley, “Making Sense of

the Profits of Foreign Firms in the United States,” Quarterly 

Review, Federal Reserve Bank of New York (Summer-Fall 1994), 

pp. 44-75.
4 CONGRESSIONAL BUDGET OFFICE

ECONOMIC AND BUDGET ISSUE BRIEF

Figure 2.

Flows of Direct Investment, 

1960 to 2004

(Percentage of U.S. gross domestic product)

Sources: Congressional Budget Office; Department of Commerce, 

Bureau of Economic Analysis.

higher risk will not be undertaken unless they also offer 

the potential for higher rewards.6

The major risks of cross-border direct investment include 

economic or political instability that could impair the 

ability of subsidiaries abroad to maintain operations, generate profits, repay debts, and repatriate earnings to their 

parent companies. One possible indicator of the level of 

risk in a country is the credit rating of its government. 

The lower that rating is, the higher may be the risk that 

subsidiaries operating in that country could see their 

business interrupted. The private rating company Standard & Poor’s (S&P) gives the United States a rating of 

AAA, the highest credit rating it assigns.7

 The bulk of 

U.S. investments abroad are in other industrialized countries whose governments’ credit ratings are comparable to 

that of the U.S. government (see Table 2). Only about 20 

percent (by value) of U.S. subsidiaries abroad are located 

in countries whose credit ratings are significantly below 

that of the United States. Nevertheless, the Congressional 

Budget Office calculates that the average S&P rating for 

countries in which U.S. subsidiaries are located (weighted 

by the value of the subsidiaries) is BBB+, which is eight 

steps lower than the U.S. rating and not much higher 

than speculative status.

Countries with low ratings must pay comparatively 

higher rates of interest to borrow in international capital 

markets. U.S. companies presumably would not have 

committed their money to subsidiaries in those countries 

unless they expected returns on investments to be high 

enough to offset the higher risks. Over the past 10 years, 

the average yield on U.S. corporate bonds with a rating of 

BBB has exceeded the average yield on AAA-rated bonds 

by about 0.8 percentage points. Comparing that gap with 

the gap in returns between U.S. direct investment abroad 

and foreign direct investment in the United States—

about 4 percentage points over the past 10 years—suggests, albeit roughly, that risk compensation is unlikely 

to account for more than one-fifth of the difference in 

returns in favor of U.S. direct investment abroad over the 

past decade or so.8

The riskiness of cross-border direct investment may 

depend on other factors as well, such as the industries 

being invested in. Differences in types of industry are not 

likely to cause much difference in the risks faced by U.S.-

owned and foreign-owned subsidiaries, however—mainly 

because U.S. direct investment abroad is concentrated in 

roughly the same industries as foreign direct investment 

in this country.

Overall, it appears reasonable to infer that no more than a 

modest portion of the higher return that U.S. companies

6. Just as investors typically require a higher expected return on a 

lower-rated bond to compensate for the higher risk being taken, 

they would also require a higher return for investing directly in 

countries with a lower credit rating. The correspondence between 

country-risk ratings and corporate-risk ratings is described in 

Richard Cantor and Frank Packer, “Determinants and Impacts of 

Sovereign Credit Ratings,” Economic Policy Review, Federal Reserve Bank of New York, vol. 2, no. 2 (October 1996), pp. 37-53. 

1960 1965 1970 1975 1980 1985 1990 1995 2000

0

0.5

1

1.5

2

2.5

3

3.5

U.S. Direct

Investment Abroad

Foreign Direct Investment

in the United States

7. S&P ratings have a maximum range of AAA to D. Ratings from 

AAA through BBB- are known as “investment grades,” signifying 

very low likelihood of default; ratings from BB+ through CCCare “speculative grades,” with increasingly high likelihoods of 

default; D is the rating given to a country that is in default.

8. The bond calculation is based on the interest rates that the bonds 

are scheduled to pay. Riskier bonds are more likely to default, 

however, so the difference in actual returns between BBB-rated 

and AAA-rated bonds would probably be lower than 0.8 percentage points. Like the bond calculation, the gap of 4 percentage 

points between rates of return on cross-border direct investment 

excludes actual capital losses.
ECONOMIC AND BUDGET ISSUE BRIEF

WHY DOES U.S. INVESTMENT ABROAD EARN HIGHER RETURNS THAN FOREIGN INVESTMENT IN THE UNITED STATES? 5

Table 2.

Regional Risk of U.S. Direct 

Investment Abroad

Sources: Congressional Budget Office; Department of Commerce, 

Bureau of Economic Analysis; Standard & Poor’s.

Notes: Weighted-average ratings use the probabilities of default 

associated with the various letter ratings. For details of how 

those ratings were calculated, see Juann H. Hung and 

Angelo Mascaro, Return on Cross-Border Investment: Why 

Does U.S. Investment Abroad Do Better? CBO Technical 

Paper 2004-17 (December 2004).

n.a. = not applicable.

a. The rating for a region is the weighted average of the ratings for 

the countries that compose the region.

earn on direct investment abroad is compensation for 

their greater exposure to risk. Unlike the age effect, which 

can be expected eventually to lessen the U.S. advantage 

and thus widen the current-account deficit, the comparative-risk effect has no necessary implication for the direction of future returns—it could continue to favor the 

United States or diminish.

Do Multinational Companies Shift Profits 

Out of the United States?

Some analysts suggest that the returns to foreign-owned 

companies operating in the United States might be artificially low because those companies shift profits out of the 

country to minimize their worldwide tax costs. For the 

same reason, U.S.-owned companies might overstate 

their profits from direct investment abroad. U.S. and foreign governments direct considerable effort to uncovering 

and discouraging such profit-shifting activities. And 

researchers have detected some evidence that suggests that 

profit shifting probably occurs. Because of a host of difficulties, however, the large volume of research that has 

been conducted has found only indirect and weak evidence of profit shifting. As a result, the role of profitshifting as an explanation for the U.S. advantage in 

returns on direct investment remains largely unknown.

Businesses always have an incentive to minimize their 

overall tax payments. Multinational corporations can do 

so by shifting profits into and out of the United States, or 

among their subsidiaries in countries with different tax 

rates, in various ways. One method is using “transfer pricing” schemes—that is, manipulating the price that a 

company charges for a product or service it supplies to an 

affiliated company. For example, a subsidiary in a hightax country could sell its products at low (or even belowcost) prices to affiliates in low-tax countries, or it could 

buy products from those affiliates at artificially high 

prices.9 Another way in which companies can shift profits 

from their higher-tax home countries to lower-tax countries is by licensing or selling their intellectual property to 

foreign subsidiaries at less than fair prices, after research 

and development costs have been incurred and claimed as 

expenses in the home country. In that case, the subsidiaries’ rates of return are artificially high because they underpay royalties and license fees or because they underpay to 

acquire intellectual property rights. In addition, multinationals can shift profits through third-party debt, intracompany debt, or tacit agreements with unaffiliated companies.10 Such transactions can lower the taxable profits 

of subsidiaries in high-tax countries and increase the taxable profits of subsidiaries in low-tax countries.

The existence of foreign tax havens that impose virtually 

no taxes on corporate profits—and of countries (such as 

Ireland) that impose relatively low taxes on income of 

AAA 11

AA+ 54

A- 16

A- 1

BBB- 1

BBB- 17

____ ___

Total (Weighted 

average) BBB+ 100

the United States AAA n.a.

Latin America and Other 

Western Hemisphere

Memorandum: 

Rating for Foreign Direct 

Asia and Pacific

Middle East

Africa

Investment Assets in 

Canada

Standard & Poor’s

Country Ratinga

Europe

Share of U.S.

Direct Investment

(Percent)

Location of U.S. 

Direct Investment

9. Tax regulations generally require that transactions between subsidiaries of the same multinational company be conducted using 

“arms-length” prices (that is, prices charged between unrelated 

companies). However, cross-country differences in tax rates create 

incentives for foreign-controlled companies to deviate from that 

standard, particularly with goods and services that do not have 

well-established, or market-based, reference prices.

10. Given the methods that BEA uses to report international investment income, however, intracompany debt manipulations do not 

affect rates of return computed using balance-of-payments data.
6 CONGRESSIONAL BUDGET OFFICE

ECONOMIC AND BUDGET ISSUE BRIEF

foreign-owned companies—has led to the widely held 

view that multinational corporations have significantly 

understated their profits from operations in the United 

States through various schemes. That view is supported 

by the fact that the rate of return on U.S.-owned direct 

investment in Ireland was nearly three times higher than 

the rate on overall U.S. direct investment abroad from 

1999 to 2003, and the rate on U.S. direct investment in 

Bermuda (a popular tax haven) was almost twice that 

overall rate. The combined average return on direct 

investment in those two countries accounted for about 

one-fifth of the overall return on U.S. direct investment 

abroad during the 1999-2003 period.

Nevertheless, the large number of empirical studies conducted so far have not been able to establish the degree to 

which profit shifting out of the United States explains the 

difference in returns that favors U.S. direct investment 

abroad. Researchers have found only indirect and weak 

evidence that foreign-controlled companies in the United 

States have been shifting profits elsewhere.11 As for U.S. 

direct investment abroad, the evidence is stronger that 

U.S.-controlled multinationals have engaged in profit 

shifting through transfer prices or other methods.12

However, such multinationals have been found to have 

shifted profits both into and out of the United States, 

perhaps because some U.S.-controlled companies abroad 

have nontax reasons to want to transfer profits to their 

parent companies in the United States (such as to avoid 

capital controls or in response to political instability). 

Overall, the balance of studies has fallen short of indicating the extent to which profit shifting has contributed to 

Figure 3.

Statutory Corporate Tax Rates in the 

United States and Foreign Countries, 

1996 to 2004

(Percent)

Sources: Congressional Budget Office; KPMG International, Corporate Tax Rate Survey (various issues).

Notes: U.S. and foreign corporate tax rates include national and 

local statutory rates.

The weighted foreign corporate tax rate is the weighted 

average of the statutory tax rates of 21 countries (Australia, 

Austria, Belgium, Canada, Denmark, Finland, France, Germany, Ireland, Italy, Japan, Luxembourg, Mexico, the Netherlands, New Zealand, Norway, South Korea, Spain, Sweden, 

Switzerland, and the United Kingdom), with each country 

weighted by its share of total foreign-owned direct investment assets in the United States.

the higher returns earned by U.S. direct investment 

abroad.

Two factors may help explain that (perhaps surprising) 

result. First, it is very difficult to measure the extent of 

mispricing, especially for services provided by intangible 

assets. Second, profit-shifting activities are influenced not 

only by differences in countries’ tax rates but also by the 

distribution of profits and losses among parent and affiliated companies. Much of the research on profit shifting 

was conducted at a time when foreign-owned subsidiaries 

may have had little incentive to transfer income out of 

the United States, both because their average profits may 

have been low as a result of their “youth” and because the 

average corporate tax rate in some foreign countries was 

11. See, for example, Laster and McCauley, “Making Sense of the 

Profits of Foreign Firms in the United States”; Mataloni, “An 

Examination of the Low Rates of Return of Foreign-Owned U.S. 

Companies”; and Harry Grubert, Another Look at the Low Taxable 

Income of Foreign-Controlled Companies in the United States, Working Paper No. 74 (U.S. Treasury Department, Office of Tax Analysis, October 1997), available at www.treas.gov/ota/ota74.pdf.

12. See, for example, Harry Grubert and John Mutti, “Taxes, Tariffs, 

and Transfer Pricing in Multinational Corporation Decision Making,” Review of Economics and Statistics, vol. 73 (1991), pp. 285-

293; David Harris and others, “Income Shifting in U.S. Multinational Corporations,” in Alberto Giovannini, Glenn Hubbard, 

and Joel Slemrod, eds., Studies in International Taxation (Chicago: 

University of Chicago Press, 1993), pp. 277-302; and James R. 

Hines Jr. and Eric M. Rice, Fiscal Paradise: Foreign Tax Havens and 

American Business, Working Paper No. 3477 (Cambridge, Mass.: 

National Bureau of Economic Research, October 1990), available 

at papers.nber.org/papers/w3477.v5.pdf.

1996 1997 1998 1999 2000 2001 2002 2003 2004

0

34

36

38

40

42

U.S. Corporate Tax Rate

Weighted Foreign

Corporate Tax Rate
ECONOMIC AND BUDGET ISSUE BRIEF

WHY DOES U.S. INVESTMENT ABROAD EARN HIGHER RETURNS THAN FOREIGN INVESTMENT IN THE UNITED STATES? 7

higher than the U.S. rate (see Figure 3). Researchers may 

be able to get a more precise estimate of tax-related 

profit-shifting activities in the future, especially with data 

on how U.S. multinationals respond to a recently granted 

tax holiday on repatriated foreign profits.13

13. Under the American Jobs Creation Act of 2004, repatriated foreign profits will be taxed at a maximum rate of 5.25 percent provided they are used to stimulate investment in the United States. 

Businesses have a one-year window (which closes in 2005 or 2006, 

depending on the company) to take advantage of the lower tax 

rate.

This brief summarizes the findings of Juann H. Hung 

and Angelo Mascaro, Return on Cross-Border Investment: Why Does U.S. Investment Abroad Do Better? 

CBO Technical Paper 2004-17 (December 2004). 

For more information about the current-account deficit, see Congressional Budget Office, The Decline in 

the U.S. Current-Account Balance Since 1991 (August 

6, 2004), and Recent Shifts in Financing the U.S. Current-Account Deficit (July 12, 2005), all available at 

www.cbo.gov.