Robert Hess, Executive Managing Director, Consulting, Newmark Grubb Knight Frank and Rajeev Thakur, Managing Director, Newmark Knight Frank Global Corporate Services Practice, Location Strategy and Optimization Practice (Location USA 2010)
The United States continues to be the leading destination for foreign direct investment (FDI) and the foremost investor in other economies. From 2008 to 2009, the United States received $320 billion of investment and invested nearly $344 billion in various parts of the world. Considering these figures, it appears that the United States has been a very attractive investment destination due to its low-risk profile as compared to other leading global economies. However, the economic downturn, its effects, and resulting public policies have created new risks and opportunities for companies planning to invest in America.
The U.S. Market for Investment
According to independent research firm CreditSights, in 2009, the U.S. credit market looked safer than Europe's. CreditSights predicted that default rates in Europe would continue to rise. The fact that the United States tends to lead Europe by eight to 12 months in the economic cycle would make Europe a less secure prospect for investment. In the last year, economic crises in Iceland, Greece, and Ireland threatened to spill into Spain and Italy.
The U.S. Federal Reserve has proactively managed the credit crunch and economic crisis. The Fed's aggressive suppression of interest rates has helped America recover faster than Europe. Although most large corporations have built up cash reserves, they are not hiring, making unemployment a concern. Across the globe, China and India continue to grow, and are likely to increase investment in the U.S. economy in the coming years.
The Federal Reserve has recently warned that economic recovery might take longer than previous estimates of one to two years, dampening the market mood. Considering the caution of the market and government, foreign investors may adopt a defensive strategy to combat uncertainties. Investors will likely consider less cyclical sectors for investment in the short term.
According to United Nations Conference for Trade and Development (UNCTAD), FDI inflows into the United States will decrease significantly, dropping it to the third place behind China and India as a destination for foreign investment from 2009 to 2010. UNCTAD's World Investment Prospects Survey 2008-2010 reports that the size of the local market, quality of skilled labor, and excellent infrastructure are the prime reasons for investing in America. Since economic conditions have not improved as expected, the next survey will likely show a lower level of confidence in the United States. In this survey of transnational corporations, the United States dropped to third place behind China and India as a destination for greenfield foreign investment from 2009 to 2010. However, if acquisition of assets and companies is considered, America will continue to be the largest recipient of FDI.
Even if the United States continues to be an attractive destination for foreign investment, there will be new risks associated with investing in this economic climate. In the last two years, the global economy has experienced an unprecedented slowdown triggered by the collapse of Wall Street investment banks. This has resulted in a consumer confidence decline and unemployment hovering near 10 percent. To stimulate the economy, reduce dependence on imported fossil fuels, and reduce global warming, the administration wants to institute green laws to encourage alternative energy and lower pollution. Cap and Trade is part of that equation. Although the U.S. dollar has been strong in 2009, as the American economy was perceived to be weathering the economic storm better than Europe and Japan, the ballooning U.S. deficit is beginning to drive its value down, which could concern parties investing in the United States. These economic factors need to be carefully evaluated by foreign investors and corporations to mitigate risk associated with business location.
Evaluating Risk and Opportunities
Unemployment in the manufacturing and service sectors has not been higher since the mid-1970s. Overall unemployment stubbornly remains at just below 10 percent. Foreign companies seeking to access the U.S. market will find that there is ample available labor in all areas of the talent spectrum. This might increase the number of location alternatives as more states offer job incentives to generate employment. This presents an opportunity for companies to attract and develop talented workers and retain them over the long term. The economic recovery might be slow, and the companies that attract the best talent in the short term will likely be placed advantageously compared to those who acquire workers when economic recovery is well on its way.
Trying to be early in skimming the best talent poses the risk of scaling up too soon, and it is expected that most companies will be conservative about scaling their operations. This is an opportunity for employers to negotiate salaries and introduce a mix of direct- and incentive-based wage systems.
On the other hand, rising unemployment affects consumer confidence negatively and results in lower sales of goods and services, which in turn has a negative impact on the bottom line of manufacturing and services companies. Investing companies will need to align their revenue potential with new talent access and development. New state job training grants might help cross-train existing employees to achieve greater efficiencies and nimbleness to be competitive in a tougher market.
Cap and Trade
The United States has recently moved towards a federal system for regulating carbon emissions. Several major corporations have broken with trade associations that oppose the cap-and-trade bill. The bill has moved a stage further towards becoming law. And, importantly, the Environmental Protection Agency (EPA) has stated that if Congress will not legislate to cut greenhouse gases, it will regulate regardless of a Congressional decision. Ultimately, Cap and Trade is likely to become a reality in the United States.
Under Cap and Trade, the government will set limits, or "caps," on the level of pollutants that can be emitted into the atmosphere from all industrial operations. Industries will hold permits or credits representing a level of pollutants emitted. The total number of permits in the market may not exceed the cap. Companies can sell unused credits to companies that wish to buy the right to pollute. This credit trading system intends to reward low polluters and penalize high polluters, thereby providing incentives to limit pollution.
From 2005 to 2008, the number of multinational corporations supporting Cap and Trade grew from 23 to 150. But many corporations do not favor Cap and Trade, and instead promote a carbon tax that could lower other taxes and make overall taxation revenue neutral. Cap and Trade will force manufacturers to innovate, and will increase the initial cost of operations. Some investing corporations might balk at this prospect, but those manufacturers who have lower emissions might find this advantageous. Cap and Trade assumes international cooperation, otherwise carbon leakage from non-signatory countries could negate some of its gains of emission control. Companies that try to locate in countries that don't comply with Cap and Trade might find their goods being slapped with import tariffs at the U.S. border. Conversely, goods produced in the United States under Cap and Trade might be more expensive initially, considering the cost of retooling and buying credits, but will eventually become competitive with economies of scale.
Although Cap and Trade is federally mandated, state programs target certain sectors, such as the Regional Greenhouse Gas Initiative (RGGI) for power utilities in the Northeast and Mid-Atlantic, that may try to augment Cap and Trade with even lower limits on emissions. A similar program, the Western Climate Initiative (WCI), includes seven western states and four Canadian provinces. It has established a regional target to reduce heat-trapping emissions by 15 percent by 2020. Companies planning to invest in the United States will need to do their due diligence to locate in states that make this process the least onerous. If there is widespread international cooperation, risks of locating in a Cap and Trade regime are minimized. But if there is opposition from many countries, it could fuel a detrimental, global tariff war.
Devaluation of the U.S. Dollar
According to the IMF, the U.S. dollar fell to a 15-year low in August 2010. Most of this devaluation is based on risk aversion. The value of the dollar is usually inversely related to risky assets such as stocks. The U.S. stock market has seen a strong rally since March 2009, and in the same period, the U.S. dollar has generally declined steadily. There has been a long-standing case made against the current U.S. deficit as the cause of the devaluation. The 2010 budget proposes significant debt increases, and projects that the debt could rise to 100 percent of the GDP by 2020. Continuing large trade deficits and a high level of debt are raising concerns about inflation and currency devaluation. This fact is not lost on investors who are now diversifying their risk by holding a variety of currencies. A lower demand for dollar will negatively affect its value. But confidence in the U.S. dollar continues to be strong as European governments struggle with their economic woes.
Last year, the world needed U.S. dollars to manage liquidity, and demand for the dollar was high, pushing its value up. Since 2009, the Federal Reserve has been buying debt under the Quantitative Easing program, resulting in a surplus of dollars in the market, driving down its value. Some economists say that due to the ballooning deficit, the dollar's value must decline in the long term. Investors usually borrow in a low-yielding currency and invest in a high-yielding one, but since confidence in the U.S. dollar remains high, investors are still treating it as a funding currency.
If the U.S. dollar devalues further, it will make U.S. exports more competitive and foreign imports more expensive. Coupled with some Buy American provisions, this might spur manufacturers to expand manufacturing to the United States to access its market. If imports cost more and the buying power of Americans decreases, only products manufactured with American resources will be affordable or attractive to American buyers. This will present an opportunity for foreign investors to manufacture at a lower cost for the North American markets, but it would become less attractive to repatriate wealth to their home countries. The level of risk will depend on how much the dollar devalues and if the global perception of the U.S. dollar as a trading currency changes.
The devalued dollar will also create opportunities for foreign investors, as their currency will buy more in the United States. This is already creating a resurgence in U.S. R&D activity funded by overseas corporations. The United States has historically led in startup activity, with startups accounting for 3 percent of the job growth in the last decade. According to The Huffington Post, startup activity has declined 24 percent in the last two years because of a lack of venture funding, but more people are starting businesses with investment from friends and family. This has created an enormous opportunity for overseas angel funds to invest with favorable exchange rates in promising businesses in the United States.
The United States continues to attract investment because of its large market, pro-business environment, good infrastructure, and skilled work force. Recent developments and regulations in the wake of the economic downturn have introduced some risk factors that are not insurmountable, but have to be considered by foreign companies investing in the United States.
New risk factors and state measures to attract business mean that there will be regulations, but there will also be economic incentives to gain. This makes due diligence during site selection critical. Simultaneously, foreign investors planning greenfield operations in the United States should plan carefully for incentive negotiations to benefit from state and local funding to create jobs. Fiscally-challenged states and regional target industries evaluated for FDI will receive a stronger reception. For projects that create significant economic impact, states could still be aggressive with incentives in the United States.
Robert Hess and Rajeev Thakur head Newmark Knight Frank's Location Strategy and Optimization practice area.