The US External Balances ... Revisited

There have indeed been much flurry on this topic on the blogsphere and in general. The issue as we have talked about so much is not so much the current account deficit which indeed on a whole is huge (6.5% of GDP in 2006) yet behind this often cited figure lies the puzzling fact that whereas the trade balance indeed is in a whopping deficit the net income balance is slightly positive which again has inspired much talk about the sustainability of the US current account deficit. Some has even invoked the untracked flows of intangibles to argue that in fact the US current account deficit was more sustainable and crucially some has gone as far as to argue that the deficit in fact was not that big in the first place, yep you guessed it; this would be the dark matter proponents (Hausmann and Sturzenegger).

As I said, we have discussed this a lot and I have reported on it extensively here as AS. However, a recent working paper at BIS by Alexandra Heath (What explains the US net income balance?) delivers a highly readable and comprehensive contribution to the debate. Heath points specifically to the surplus on the income balance as a result of the higher income yielded on external equity as oppose to the income yield of external debt. Moreover, also the positive yield differential on FDI is scrutinized in some detail.

Despite a significant deterioration in the US net foreign asset position, there has not been a corresponding deterioration in the net income balance. In fact, there has generally been a net income surplus. Two factors have been particularly important for the positive net income balance over the past 15 years or so. The first is that the United States has a positive net external equity balance and a negative net external debt balance. This contributes to a net income surplus because the income yield on equity has been higher than the income yield on  debt.

The second factor is that the United States earns a persistently higher income yield on its foreign direct investment (FDI) assets than foreigners earn on their direct investments in the United States. This paper summarises the evidence from firm-level studies and time-series data for the United States, as well as cross-country comparisons, to weigh up alternative
explanations for this outcome. The evidence presented suggests that differences in income
yields on FDI are not explained by the presence of large stocks of unmeasured assets. Moreover, they do not appear to be related to different characteristics of the investment such as industry composition or riskiness. There is some evidence that differences in the average maturity of investment have had some effect on yield differentials, especially in the 1980s.

There are also incentives to minimise taxes that are consistent with the relatively low income yields earned on FDI in the United States, but no firm evidence that this is an important explanation.

The analysis is well written and I also think that the author's take on the dark matter thesis is fairly spot on. As such, this paper is well worth a closer look I have to say especially if any of you perhaps have a term paper coming up on a related subject.