The reinvestment by multinationals as a capital flow: Crises, imbalances, and the cash-based current account

When the affiliate of a foreign corporation saves a dollar of its profits, the host country records it as an inflow of retained earnings foreign direct investment (REFDI). If invested, this dollar arithmetically generates a current account deficit, even though cash does not cross borders. This study explores the empirical macroeconomic of REFDI, which globally comprises half of FDI inflows. Using international capital flows (1980–2018), we show that REFDI behaves like national saving in its procyclicality. Unpacking FDI in the analysis also makes a difference for the investment cycle. Moreover, we decompose the long run saving-to-investment correlation, finding a role for REFDI in the Feldstein-Horioka puzzle. Adjusting the current account for REFDI matters since REFDI lowers the probability of macroeconomic crises and sudden stops. Overall, REFDI is stronger in countries receiving more FDI and it was also strong during the recent commodity boom. We are not challenging that the balance of payments works on nationality and accrual bases. However, our results suggest that the external balance assessment of countries should adjust for REFDI because it tends to have a different propensity to be invested and to build-up vulnerabilities.