Foreign Ownership of Capital and Capital Movement
Economies grow by increasing the production of goods and services. Investment in capital is a key ingredient for economic growth. While foreign investment can help an economy grow, foreign capital has a higher chance of suddenly flowing out of a country (“capital flight”). Real world evidence reveals that investors have a strong and persistent home bias. During a panic, foreign-owned capital has a high risk for capital flight.1 However, even without a direct panic, barring capital controls, foreign-owned capital can move fairly easily in response to changes in trade and tax policy, including a trade war.
Trade War Scenarios
Previously, we examined the relationship between tariffs and the effective openness of the U.S. economy to foreign investment flows. We modeled stylized outcomes of five “trade-war” scenarios and found that, after a short-run boost to the economy, the U.S. economy was smaller in the long run. We compared five alternative trade-war scenarios to a scenario where openness remained at the 21st century average of 37 percent.2
- Small trade war, short: The U.S. economy is 21 percent open until 2021 and then reverts to the 21st century average of 37 percent.
- Small trade war, long: Same as (1), except the reversion to 37 percent open begins in 2026.
- Small trade war, permanent: The U.S. economy is 21 percent open indefinitely.
- Big trade war, short: Average tariff rates are increased another 3 percentage points to 6.27 percent. The U.S. economy is 13 percent open in 2021 and then reverts to the 21st century average of 37 percent over the course of 3 years.
- Big trade war, long: Same as (4), except the reversion to 37 percent open begins in 2026.
Our projections reflect changes in the openness of the U.S. economy to foreign investment flows. These projections do not account for other effects of changes to trade policy, such as adjustment costs from reallocating productive capital and labor and how trade can reduce the market power of domestic firms. Accounting for these effects would likely reinforce our results.
Trade and Foreign Capital
Reduced openness results in lower U.S. capital from two effects: (1) the reduction in foreign capital inflows and (2) the reduction of foreign purchases of U.S. government debt, which shifts domestic savings toward holding more U.S. government debt and less private capital -- that is, capital crowd out. This reduction is mitigated somewhat by the higher returns to capital which incentivize both U.S. households and foreigners to invest in U.S. capital. Figure 1 shows the level and the share of U.S. capital owned by foreigners under each scenario.
Metric
Note: We calculate the foreign share of U.S. capital in 2018 using data from the Federal Reserve.
Source: Board of Governors of the Federal Reserve System. Financial Accounts Matrix - Levels. Available at: https://www.federalreserve.gov/apps/fof/DisplayMatrix.aspx?t=Levels_matrix. The projections for the shares in future years are made using Penn Wharton Budget Model’s dynamic model.
Unsurprisingly, in the short-run, lower openness to foreign investment flows leads to a lower share of U.S. capital owned by foreigners. When the previous level of openness is restored, foreign capital investment flows increase. However, because of lower domestic capital, in the long-run, foreigners end up permanently owning a greater share of U.S. capital than if there had been no trade war. Longer trade war scenarios lead to foreigners owning a larger share of U.S. capital.
Intuitively, a trade war causes foreign capital to leave the U.S., increasing the amount of debt that must be purchased by U.S. households. This shift reduces the amount of total saving available for productive capital investment (the “crowd out effect”), thereby lowering GDP. As the trade-war subsides, foreign capital re-enters a U.S. economy that has less productive capital relative to the baseline economy without trade war. Domestic household saving does not increase nearly as quickly as the rise in foreign capital flows.
In a small, short trade war, the foreign ownership share is about 0.4 percentage points higher than the baseline no-trade war scenario in 2022. In a big, long trade war, the foreign share is about 1.5 percentage points higher in 2028: the amount involved is on the order of $1 trillion based on our calculations using data from the Federal Reserve.3 These share differences persist in the long run as the foreign ownership share rises from 29 today to 34.2 percent in 2049 in the case of a big, long trade war versus 32.6 percent for the no-trade war scenario.
Xiaoyue Sun contributed to this article.
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Instances of capital flight include the Asian Financial Financial Crisis in 1997, Argentina in 2001, Greece and Spain in 2012 and Britain in 2016. ↩
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We assume that tax policy is held fixed at 2018 rates. In reality, numerous tax provisions under current law expire or phase-out in future years. This assumption avoids explaining interaction effects but does not change the key insights. ↩
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Board of Governors of the Federal Reserve System. Financial Accounts Matrix - Levels. Available at: https://www.federalreserve.gov/apps/fof/DisplayMatrix.aspx?t=Levels_matrix. ↩
Year,No trade war,Small trade war_short,Small trade war_long,Small trade war_permanent,Big trade war_short,Big trade war_long
2018,0,0,0,0,0,0
2019,0,0,0,0,0,0
2020,0,-0.16793,-0.17753,-0.18916,-0.28146,-0.29225
2021,0,-0.14476,-0.16812,-0.20995,-0.34705,-0.37246
2022,0,0.37197,-0.15656,-0.23215,-0.23713,-0.37573
2023,0,0.37223,-0.1466,-0.25948,-0.02036,-0.39103
2024,0,0.37079,-0.14138,-0.29562,0.76694,-0.41157
2025,0,0.37003,-0.07241,-0.27517,0.76586,-0.3414
2026,0,0.36971,0.94082,-0.2494,0.76532,-0.06578
2027,0,0.3649,0.9309,-0.22345,0.75665,0.34378
2028,0,0.36308,0.92851,-0.197,0.75405,1.49514
2029,0,0.36013,0.92415,-0.16958,0.74999,1.48989
2030,0,0.35806,0.92092,-0.14132,0.74699,1.48571
2031,0,0.35663,0.91878,-0.11308,0.74473,1.48336
2032,0,0.35538,0.91675,-0.0843,0.74227,1.48221
2033,0,0.35392,0.91525,-0.05514,0.74052,1.48156
2034,0,0.35305,0.91386,-0.02479,0.73935,1.48106
2035,0,0.35242,0.91265,0.00638,0.73782,1.48072
2036,0,0.35165,0.91249,0.03744,0.73741,1.48126
2037,0,0.35137,0.91251,0.06982,0.73719,1.48243
2038,0,0.35112,0.91372,0.10636,0.73788,1.48576
2039,0,0.35174,0.9157,0.14498,0.73916,1.48999
2040,0,0.35234,0.91766,0.18592,0.74045,1.49461
2041,0,0.35324,0.92054,0.23105,0.74232,1.50125
2042,0,0.35411,0.92403,0.28085,0.74471,1.50804
2043,0,0.35564,0.92841,0.33659,0.748,1.51613
2044,0,0.35744,0.93388,0.39974,0.75215,1.52601
2045,0,0.35926,0.9403,0.47037,0.75714,1.53664
2046,0,0.36181,0.94752,0.55018,0.76295,1.54891
2047,0,0.36406,0.95451,0.63937,0.76819,1.56119
2048,0,0.36663,0.96196,0.74054,0.7737,1.57499
2049,0,0.3699,0.97151,0.85716,0.78136,1.59223
Year,No trade war,Small trade war_short,Small trade war_long,Small trade war_permanent,Big trade war_short,Big trade war_long
2018,28.86,28.86,28.86,28.86,28.86,28.86
2019,29.00604,29.00604,29.00604,29.00604,29.00604,29.00604
2020,29.74539,29.57746,29.56786,29.55623,29.46393,29.45314
2021,29.75116,29.6064,29.58304,29.54121,29.40411,29.3787
2022,29.75088,30.12285,29.59432,29.51873,29.51375,29.37515
2023,29.94806,30.32029,29.80146,29.68858,29.9277,29.55703
2024,30.08914,30.45993,29.94776,29.79352,30.85608,29.67757
2025,30.15304,30.52307,30.08063,29.87787,30.9189,29.81164
2026,30.27101,30.64072,31.21183,30.02161,31.03633,30.20523
2027,29.9075,30.2724,30.8384,29.68405,30.66415,30.25128
2028,29.92251,30.28559,30.85102,29.72551,30.67656,31.41765
2029,29.86071,30.22084,30.78486,29.69113,30.6107,31.3506
2030,29.81391,30.17197,30.73483,29.67259,30.5609,31.29962
2031,29.8462,30.20283,30.76498,29.73312,30.59093,31.32956
2032,29.87063,30.22601,30.78738,29.78633,30.6129,31.35284
2033,29.89762,30.25154,30.81287,29.84248,30.63814,31.37918
2034,29.95263,30.30568,30.86649,29.92784,30.69198,31.43369
2035,30.00581,30.35823,30.91846,30.01219,30.74363,31.48653
2036,30.05391,30.40556,30.9664,30.09135,30.79132,31.53517
2037,30.12701,30.47838,31.03952,30.19683,30.8642,31.60944
2038,30.25053,30.60165,31.16425,30.35689,30.98841,31.73629
2039,30.38464,30.73638,31.30034,30.52962,31.1238,31.87463
2040,30.51443,30.86677,31.43209,30.70035,31.25488,32.00904
2041,30.66941,31.02265,31.58995,30.90046,31.41173,32.17066
2042,30.84023,31.19434,31.76426,31.12108,31.58494,32.34827
2043,31.02722,31.38286,31.95563,31.36381,31.77522,32.54335
2044,31.23104,31.58848,32.16492,31.63078,31.98319,32.75705
2045,31.45361,31.81287,32.39391,31.92398,32.21075,32.99025
2046,31.6982,32.06001,32.64572,32.24838,32.46115,33.24711
2047,31.96649,32.33055,32.921,32.60586,32.73468,33.52768
2048,32.25499,32.62162,33.21695,32.99553,33.02869,33.82998
2049,32.56921,32.93911,33.54072,33.42637,33.35057,34.16144
Year,No trade war,Small trade war_short,Small trade war_long,Small trade war_permanent,Big trade war_short,Big trade war_long
2018,28.86,28.86,28.86,28.86,28.86,28.86
2019,28.86,28.86,28.86,28.86,28.86,28.86
2020,29.8497,29.48669,29.4834,29.49211,29.33456,29.33295
2021,30.03741,29.63222,29.62034,29.61491,29.33955,29.33194
2022,30.2353,30.48835,29.76596,29.74392,29.57964,29.42905
2023,30.5884,30.84234,30.02099,29.98082,30.08418,29.6006
2024,30.93544,31.18957,30.26971,30.20862,31.45815,29.76716
2025,31.14132,31.39583,30.45057,30.36333,31.66494,29.89458
2026,31.38598,31.64102,32.02899,30.54841,31.91035,30.32032
2027,31.29785,31.55285,31.94255,30.49983,31.8232,30.76608
2028,31.47338,31.72828,32.1195,30.63684,31.99939,32.50724
2029,31.59596,31.85014,32.24318,30.73751,32.1225,32.63287
2030,31.72958,31.98387,32.37886,30.84671,32.2576,32.77034
2031,31.92106,32.17544,32.57179,30.99622,32.44985,32.96467
2032,32.10852,32.36325,32.76095,31.1433,32.63791,33.15663
2033,32.29932,32.55409,32.954,31.29295,32.83002,33.35241
2034,32.51186,32.76712,33.16817,31.45836,33.04403,33.56898
2035,32.72487,32.9808,33.38283,31.62436,33.25788,33.78604
2036,32.936,33.19242,33.59694,31.78874,33.47123,34.00238
2037,33.16734,33.42455,33.83084,31.96742,33.70451,34.23853
2038,33.43715,33.69465,34.10326,32.17459,33.97623,34.5136
2039,33.71715,33.97584,34.38643,32.38921,34.25857,34.79937
2040,33.9961,34.256,34.66851,32.60378,34.53985,35.08439
2041,34.29589,34.55704,34.97176,32.83409,34.84202,35.39156
2042,34.60967,34.87189,35.28915,33.07561,35.15835,35.71199
2043,34.93772,35.20153,35.62131,33.32914,35.48953,36.04734
2044,35.28083,35.54634,35.96928,33.59632,35.83633,36.39917
2045,35.64054,35.90755,36.33466,33.87755,36.2005,36.76751
2046,36.01941,36.28868,36.71947,34.17524,36.58432,37.15595
2047,36.42,36.69077,37.12487,34.49059,36.98841,37.56477
2048,36.83967,37.11208,37.54926,34.82363,37.41136,37.99353
2049,37.28296,37.55758,37.99911,35.17936,37.85995,38.44891
Year,No trade war,Small trade war_short,Small trade war_long,Small trade war_permanent,Big trade war_short,Big trade war_long
2018,100,100,100,100,100,100
2019,99.49651,99.49651,99.49651,99.49651,99.49651,99.49651
2020,100.3507,99.6931,99.71437,99.78307,99.56091,99.59191
2021,100.9622,100.0872,100.1261,100.2495,99.78045,99.84086
2022,101.6283,101.2134,100.58,100.7629,100.2233,100.1835
2023,102.1381,101.7218,100.7366,100.9843,100.5229,100.1474
2024,102.8126,102.3954,101.075,101.3933,101.9512,100.3019
2025,103.2776,102.8593,101.2298,101.6248,102.4129,100.2782
2026,103.6833,103.2646,102.6181,101.7547,102.8161,100.381
2027,104.6488,104.2298,103.5805,102.7482,103.7798,101.7018
2028,105.183,104.7636,104.1116,103.0658,104.3122,103.4681
2029,105.8111,105.3913,104.7371,103.5242,104.9388,104.0901
2030,106.4254,106.0053,105.3491,103.9569,105.5519,104.6988
2031,106.9519,106.5312,105.8729,104.2481,106.0767,105.2191
2032,107.492,107.0709,106.4103,104.5557,106.6149,105.7532
2033,108.0331,107.6113,106.9488,104.8604,107.1541,106.2883
2034,108.5443,108.1221,107.4569,105.114,107.6634,106.793
2035,109.0618,108.6387,107.9706,105.3717,108.1781,107.3032
2036,109.5898,109.1656,108.4948,105.6408,108.7035,107.8237
2037,110.0917,109.6664,108.9928,105.8635,109.2026,108.3174
2038,110.5341,110.1073,109.4307,105.9878,109.6417,108.7512
2039,110.9678,110.5395,109.8596,106.0911,110.072,109.1757
2040,111.4099,110.9802,110.2966,106.2,110.5102,109.6078
2041,111.8244,111.3929,110.7054,106.2576,110.9204,110.0119
2042,112.2225,111.7892,111.097,106.2804,111.3137,110.3984
2043,112.6035,112.168,111.4712,106.2663,111.6893,110.7672
2044,112.9672,112.5294,111.8277,106.214,112.0474,111.1186
2045,113.3115,112.8711,112.1651,106.1195,112.3864,111.4496
2046,113.6323,113.1899,112.4787,105.9751,112.7019,111.7569
2047,113.9318,113.4864,112.7696,105.7803,112.9946,112.041
2048,114.2139,113.7653,113.0424,105.5404,113.2693,112.3073
2049,114.473,114.0212,113.2924,105.2443,113.5211,112.5506