Washington’s Gridlock and Foreign Investment

Thilo Hanemann is Research Director at the Rhodium Group, an economic research firm based in New York. Jacob Kirkegaard is leader of Rhodium Group’s advanced economies practice and a senior fellow at the Peterson Institute for International Economics.

The government shutdown and frequent political log-jams in Washington have caused concern among foreign investors about the attractiveness of U.S. government securities. The immediate default may have been averted, but severe damage has been done to prospects for attracting foreign direct investment to the U.S. economy. Unlike large foreign portfolio investors, global businesses have numerous choices when they decide where to locate new plants and production capacity. The increasing political uncertainty and inability to pass even basic legislation are significant setbacks to efforts to return levels of foreign direct investment (FDI) in the United States back to pre-crisis levels.

For decades, the United States has been the world’s primary destination for foreign direct investment, bringing significant benefits to the US economy. Today, foreign firms provide more than 5 million jobs for American workers and account for a significant share of U.S. exports and research spending. In the aftermath of the financial crisis, FDI inflows dropped sharply and only slightly recovered to $160 billion in 2012 (compared to more than $300 billion in 2008). Boosting FDI to pre-crisis levels has become a goal of the Obama administration and Congress alike. The federal government initiated the “Select USA” program to coordinate state-level investment promotion efforts. The House recently passed legislation that would require the federal government to study barriers to FDI and to make efforts to remove those barriers. These are good efforts to promote FDI, but they are meaningless in light of the political stalemate undermining the most important determinants of foreign investment: political stability and sustainable economic growth.

The historically low level of private investment is the single most important reason for the slow U.S. recovery after the crisis and the dependence on (now declining) fiscal and (still large) monetary stimulus. The prospects of political gridlock, government shutdowns, and even a potential government default  is a major reason for why private businesses delay these investments in new plants, products and businesses. Because multinational firms have more location choices than domestic U.S. firms, foreign investment is particularly sensitive to the perception of political risk. A return to political stability is therefore imperative for the United States to spur higher levels of FDI and sustain its position as the world’s leading destination for foreign direct investment.

With the immediate threat of default eliminated, government now needs to quickly restore essential elements of the U.S. regulatory system for foreign investment, like getting the Committee on Foreign Investment in the United States (CFIUS) back up and running. Then Democrats and Republicans must come together to craft a long-term plan for the United States’ fiscal future, one that will restore not only the historical balance between U.S. federal spending and revenue, but also—rather than simply continue to rely on old budgets through the so-called continuing resolution process—set the right priorities for investment in infrastructure, research, and education that will safeguard the country’s long-term growth prospects and attractiveness to foreign capital. Only then can the toxic cloud of political uncertainty be lifted and the United States once again offer the most attractive opportunities for global investors.