An Analysis of United Kingdom Inflows and Outflows of Direct Foreign Investment

An Analysis of United Kingdom Inflows and Outflows of Direct Foreign InvestmentAuthor(s): B. D. Boatwright and G. A. RentonSource: The Review of Economics and Statistics, Vol. 57, No. 4 (Nov., 1975), pp. 478-486Published by: The MIT PressStable URL: http://www.jstor.org/stable/1935908 .

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AN ANALYSIS OF UNITED KINGDOM INFLOWS AND OUTFLOWS OF DIRECT FOREIGN INVESTMENT

B. D. Boatwright and G. A. Renton*

I. Introduction

A substantial portion of the United Kingdom's .11.international transactions in long-term capital is comprised of inflows and outflows of direct investment in foreign subsidiaries and branches, whether by acquisition of share and loan capital, retention of profits, changes in branch indebtedness, or by changes in intercompany accounts. These transactions have historically been very large. On average, since 1961 U. K. firms have invested abroad in direct investments about 11.5%o as much as they have invested at home. On a per capita basis, the U. K. is one of the world's largest foreign investors. These flows are of considerable importance for the balance of payments. The quarterly value of the deficit on direct investment account has averaged ?28 million since 1961, compared with an average surplus on current account of ?34 million, and the variance of the balance on direct investment is about 1 1% of the variance of the balance on current account.

Section II describes a model of direct investment flows. This model is tested in section III. The final section assesses some of the implications of the estimated model.

II. The Model Specification

The flows of foreign direct investment into the U. K. and of U. K. direct investment abroad are both explained on the basis of the neoclassical theory of optimal capital accumulation ad- vanced by Jorgenson.' Investment is viewed as being a process of adjustment by firms to changes in their desired stocks of capital. The analysis therefore has two stages: first, the desired or optimal stock of foreign capital is determined on the assumption that firms aim to maximise profits, taking account of an im-

plicit rental price of capital services and their aggregate production function; and second, the nature of the adjustment of the actual stock of capital to the desired stock is specified.

U. K. foreign subsidiaries2 often raise finance locally and therefore are often not wholly owned by their parent companies.3 Consequently, the optimal stock of British direct investment abroad is determined in two stages: first, a behavioural relationship between the outstand- ing net worth abroad owned by British direct investors and the total stock of U. K. subsidiaries' direct investment is specified; second, the overall desired level of capital stock of the foreign subsidiary or associated company is determined.

It seems plausible to suppose that parent firms regard it as essential to maintain a cer- tain minimum equity stake in their subsidiaries if they are to maintain control. Beyond this point, however, it is likely that the extent to which parent companies encourage foreign holdings depends upon the relative marginal cost of subscriptions from Britain and from overseas. These considerations suggest that

Kd_ (rd y O < a < 1

K ,a+p ) 0 > l (1) K ~~~rf 0 < Py

where Kd and K denote the stocks of British claims in overseas subsidiaries and the latter's total stock of capital respectively, and rd and rf denote the marginal costs of British and foreign capital to subsidiaries respectively. The marginal costs of borrowing are assumed to be reasonably well-approximated by market rates of interest, since data on the former are not available.

This relationship implies that the sensitivity

Received for publication May 28, 1974. Revision accepted for publication October 22, 1974.

* This paper is a part of the quarterly econometric model of the U. K. economy being constructed at the London Business School.

I See Jorgenson (1965) and (1967).

2 The discussion is conducted in terms of U. K. companies. However, throughout, similar remarks apply to foreign subsidiaries in the U. K.

3 For the period 1955-1964, in manufacturing industry an expansion of ?100 in British subsidiaries' net operating assets overseas appears to have involved only about ?60 worth of additions to the U. K. stake and ?40 of addi- tional finance raised locally. See Reddaway et al. (1968).

[ 478 ]



INFLOWS AND OUTFLOWS OF FOREIGN INVESTMENT 479

of the share of parent equity in subsidiaries' total capital stock to relative interest rates varies directly with the size of parent claims, given a minimum "control" level of parent equity stake, and varies inversely with the "control" level of parent claims, given the stock of parent-owned capital, though it can- not exceed the value y. For from (1)

- y(I- (Kmi/Kd) ) (2)

where v is the elasticity of substitution between U. K. and total capital with respect to relative interest rates, and Kmin -_ aK denotes the ''minimum" level of British claims in foreign subsidiaries. These two implications seem a priori plausible.

Thus given British and foreign interest rates, the optimal stock of British-owned direct investments in foreign subsidiaries is assumed to be proportional to the latters' total capital stock. It remains, however, to specify this latter quantity. Assuming perfectly competitive product and factor markets and completely malleable capital, the hypothesis that firms aim to maximise net worth subject to a concave production function and a relationship between investment and the capital stock results in the following well-known marginal productivity conditions

_Q w 8L p (3) SQ q(r+8) c (4)

where Q is the quantity of output, L is the quantity of labour, K is the stock of capital, w is the average price of labour, p denotes the price of output, q is the price of capital goods, r is a discount rate, and 8 is the rate of depreciation of the capital stock. The numerator in (4), denoted by c, may be termed the implicit rental cost of capital services.

It remains to specify the form of the production function. On balance it seems preferable to postulate a function of the constant elasticity of substitution (CES) class,4 for it includes the Cobb-Douglas form as a special case. In this case

Q = (EK-P + (1 ) L-P)-v/P 0 ?uj E 1

(5)

so that

SK - ve Q(l +P/v) K- (l +P). (6)

Substitution of (1) and (4) into (6) gives the following expression for the value of the desired stock of British claims in foreign subsidiaries

qK*d =(a6EO) { qv6Q 10f+ (I+ cr)/vl (plc)0f1 ( 7) + (pea) {qvJQ[T+ (1-al)/]v (cp/c)(rdl/rf)Y}

where

1-F +p(8) and all other symbols have their previous mean- ings. This expression defines the optimal stock of British claims in U. K. subsidiaries abroad in terms of the price of investment goods, the expected volume of foreign output, the expected price of output relative to the rental cost of capital services, relative interest rates, a constant reflecting the extent of economies of scale in production, the elasticity of substitution between capital and labour, two constants par- tially determining the interest rate elasticity of substitution between U. K. and foreign equity, a scalar reflecting the minimum hold- ing of British companies in subsidiaries, and a distribution parameter determining the split of subsidiaries' output between capital and labour.

The demand for investment is viewed as being of two types, replacement demand, which is assumed to be proportional to the current capital stock,5 and net investment, which is assumed to be a function of changes in the optimal capital stock. However, since it takes time to initiate new capital projects and still more time to complete them, a given change in the desired stock of capital is likely to affect net investment expenditures for a considerable period of time. In general, then, gross investment may be written

00

I ,=wi ( (qK*d) _i (qK*d) -M-1)

+ 8(qKd)-1 (9) where wi denotes the proportion of investment projects completed after i periods.

Unfortunately, collinearities amongst the determinants of the desired capital stock prevent

4 See Arrow et al. (1961) and Eisner and Nadiri (1968).

5 Jorgenson (1965) shows this to be implied by renewal theory whatever the initial age distribution and replacement rates for different types of capital goods.



480 THE REVIEW OF ECONOMICS AND STATISTICS

the lag coefficients from being estimated directly from the data. Rather it is necessary to assume that the factors that cause delays in the adjustment of capital are constant over time, so that they can be represented by a fixed lag distribution. One plausible approach is to specify the lag distribution as a rational function of the lag operator,

P(E) I . A(qK*d) -i+8(qKd)_l (10)

0(E)

where P(E) and @(E) are polynomials in the lag operator E. The Pascal distribution is a special case of this specification.6 In this case equation (9) may be written

1(1 - XE1)8 - /3(1 _ X)8 A(qK*d)

+ 8(1 - XE-1)8 (qKd)l. (11) The procedure is to estimate /3 and X for suc- cessive values of s, choosing that value which gives the lowest standard error of estimate. Of course, choosing s - 1 gives a simple geometric lag

00 I f( 1 -) X o At (qK*d) -i

+ 8(fKd) -l. ( 12 ) However, since the current capital stock is defined to be equal to the sum of all past net investments,

00 qKd 7i?,,o ( 1 a')y 1_j

00 A t o (1 A)i (qK*d) -ij (13)

equation (12) may be written as I - X(qK*d)- (X - 8) (qKd) -1-' (14)

A second general approach is to specify that the effects of a given change in the desired capital stock on net investment through time follow an interpolated polynomial distribution. In this case equation (10) may be written as

I Z a ,Zj + 8(qKd)-l (15) where the Zj are linear weighted combinations of current and past values of (qK*d), the weights being the appropriate Lagrangean in- terpolation polynomials.8

Finally the relationships may be made more dynamic by allowing firms to take future values

of output and the product price into account. It seems plausible to assume that firms attempt to maximise their expected net worth. Thus the current values of output and product price that enter qK*d in equation (7) are replaced by their expected values;9 these are hypothesised to be geometrically weighted averages of the current and past periods' levels. In this way past as well as current output and price levels are allowed to affect firms' planned capital stocks.

In early 1965 a number of measures were introduced by the U. K. authorities in an attempt to limit the outflow of direct investment from the U. K. The Overseas Trade Corpora- tion Scheme, which granted exemption from U. K. taxation to overseas trading corporations on retained profits earned from overseas branches, was withdrawn. Secondly, no official exchange was to be provided for direct investment outside the Sterling Area; such projects had to be financed out of retained earnings abroad, by borrowing abroad, or with "investment dollars" at a premium." Further, the supply of foreign investment currency was severely restricted by the authorities; various "leaks" into the pool (from legacies and gifts) were eliminated and a new regulation was introduced specifying that one-quarter of the proceeds of a sale of non-sterling securities could not be sold in the investment dollar market with the benefit of the premium but had to be surrendered to the authorities at the official rate of exchange. In addition, the introduction of the Corporation Tax may have discouraged direct investment abroad because companies were then able to offset their overseas tax lia- bilities only against Corporation Tax and not against the income tax payable on dividends paid to shareholders, presumably lessening the

6 See Solow (1960). 7 Writing I8 = 1 and substituting X for (1 - X) for

convenience. 8 See Almon (1965).

9 Experimentation with proxies for the expected levels of the other variables in the equation for net worth made little difference to the results.

10 Since 1962 British residents have been allowed to buy non-sterling securities only from other British residents or with the proceeds of sales of non-sterling securities by British residents. As a result of this regulation there developed a market in "investment currency" by which British residents who have sold non-sterling assets sell their foreign proceeds to investors wishing to invest outside the Sterling Area. The price of the investment dollar fluctuates freely in response to changes in supply and demand, and is expressed as a premium over the official rate of exchange. The premium has varied between 1.38% in the first quarter of 1962 and 33.24% in the first quarter of 1969.




rate of growth either of dividends to shareholders or of retained earnings abroad, though overseas taxes in excess of the U. K. tax liability may be carried forward as credits for future years. Finally, in May 1966 further restrictions were introduced. Direct investment projects outside the Sterling Area had needed Bank of England approval since 1958, but the rules ap- plied by the Bank when vetting projects were made more stringent. Also, investment in the "developed" Sterling Area (Australia, New Zealand, South Africa and Eire) was subject to a programme of "voluntary" restraint.

The specified relations, then, include two dummy variables in an attempt to identify the effects of the 1965 and 1966 policy measures upon the outflow of British investment abroad. Ideally, movements in the investment dollar premium should be allowed for via changes in the implicit cost of capital. Unfortunately, however, this is not possible, since the proportion of U. K. direct foreign investment that is financed out of the investment dollar pool is not known. Consequently the flow of direct investment abroad was related simply to changes in the premium as an approximation to the ideal.

All variables are measured in sterling terms. This should account for the effects of the U. K. devaluation of November 1967 upon British investment financed by new capital outflows from the U. K. However, retained earnings abroad, the second major way of financing investment, are affected in sterling terms simply because they are entered in the U. K. accounts at a more favourable exchange rate. This effect is accounted for by including an index of the U. K. exchange rate relative to a weighted average of the exchange rates of those countries which have large stocks of British direct investment.

III. Empirical Results

This section reports the results obtained by fitting the above models to quarterly data run- ning from the fourth quarter of 1961 to the third quarter of 1972.11 Some of the more in- teresting regressions are shown in table 1.

For estimation purposes a range of values for

the parameters y, o- (the elasticity of substitution between labour and capital) and v (the degree of the production function) in the inter- vals [0, 2], [0, 4] and [0, 2], respectively, were substituted into the expression (7) for qK*d and those values accepted which gave the lowest standard error of estimate for the flows of direct investment. This also provided a test of the impact of relative prices on investment, for if the elasticity of substitution was zero relative prices would have no effect. Similarly, a value of zero for y implies that relative interest rates have no impact upon investment, save an indirect effect working through the expected rental cost of capital services. In any case, it seemed preferable to determine the values of o and v from the data rather than arbitrarily assign them a value of unity as is implied by the Cobb-Douglas production function.

Quarterly data on the size of the stock of capital abroad owned by British citizens do not exist. Consequently stock figures were calculated by adding the quarterly investment flows to a base year stock figure. An exponential depreciation pattern was chosen of the form

qK- I +(1-r)(qK)-1. (16)

Several capital stock series were calculated for different depreciation rates and that stock series accepted which yielded the lowest standard errors of estimate in the regression. This was because the specified functions were all under- identified in the parameters, so it was not possible to check if the estimated regression coefficient, 8, was significantly different from the assumed rate of depreciation, r.

Finally, since 1968 there has been an increasing number of large takeovers and mergers, sometimes sufficiently large to swamp the "normal" flows. Where extraneous information about the capital flows involved was available, the dependent variable was adjusted prior to estimation. In other cases, however, "special" takeovers were allowed for by dummy variables.

Generally, the assumption that the adjustment of actual capital stock to its desired level is well-approximated by a Pascal distribution was not confirmed by the regression results. Typically, the explanatory power of the relations was relatively poor, the coefficients were

11 The data for foreign direct investment in the U. K. begin in 19621.




TABLE 1.- SELECTED REGRESSION RESULTS FOR U. K. OUTFLOWS AND INFLOWS OF LONG-TERM DIRECT INVESTMENT

(The R2 shown relate to the unadjusted dependent variable)

(Al) FDIA = 269.75 + 1.909(qK*d,1)3 - 0.303(qK*d,2)-3 + 0.0029KDIA_1 - 1.965ADP-1 (127.03) (0.857) (0.284) (0.0153) (0.719) - 278.56ERDA + 34.65D1 - 28.83D2 + 14.44Qi + 12.81Q2 + 0.79Q3 R2 .821

(95.25) (15.11) (15.74) (6.61) (6.36) (6.34) D.W. = 1.21 S.E. - 13.93

J = 0.0 v-=1.25 8 = 0.01 /1u = 0.50 A2 = 0.25 y=2.0 6104 -7203

(A2) FDIA - 337.63 + 0.743(qK*d1)3 -0-107(qK*d2) 3 - 0.0260 KDIA 1 - 1.798 ADP 1- 288.60 ERDA (73.31) (0.122) (0.039) (0.0100) (0.523) (54.02)

+ 43.80 D1 - 26.19 D2 + 17.29 Q1 + 17.22 Q2 + 4.03 Q3 R2 = .930 (11.11) (11.42) (4.82) (4.67) (4.64) D.W. - 2.04

S.E. = 10.11 o- 1.75 v = 1.25 8 = 0.01 ,=0.50 p2=0.25 Y=2.0 6104 -7203

8 (A3) FDIA = 55.06 + i. 3W*(AqK*c 1)_j + 0.0217 KDIA_1- 1.832 ADP_1 - 125.63 ERDA

(98.13) (0.0049) (0.779) (72.31)

+ 42.76 D1 - 29.37 D2 + 18.6 Qi + 15.2 Q2 -0.5 Q3 R2 = .831 (9.92) (11.31) (5.8) (4.7) (4.6) D.W. = 1.59

S.E. = 13.36 o, = 1.0 v = 1.0 8 = 0.01 ,U1 = 0.50 A2 = 0.25 6303 -7203

W3 = 0.917 W4 = 1.187 W5 = 1.320 w6 = 1.173 W7 = 0.825 w8 = 0.351

(A4) FDIL = 192.61 + 3.867(qK*f 1) 2 - 1.242(qK*f2)-2 - 0.0622KDIL_1 - 171.71ERDL + 194.32D3 (74.20) (2.107) (0.837) (0.0435) (64.50) (22.16)

- 21.44D4 + 3.17Q1 + 4.59Q2 - 3.04 Q3 R2 = .856 (8.51) (6.08) (6.03) (5.99) D.W. - 1.58

S.E. = 13.84 a=0.0 v= 1.25 8=0.01 Al=0.50 ,L2 =0.25 y=2.0 6102 -7203

(A5) FDIL = 214.85 + 1.022(qK*f1)-2 - 0.730(qK*f2)-2 - 0.0313KDIL1 - 219.49ERDL + 205.88D3

(69.39)+(0.280) (0.235) (0.0129) (62.57) (20.94) - 22.03 D4 + 3.11 Ql + 4.58 Q2 - 4.33 Q3 R2 = .875

(7.81) (5.55) (5.58) (5.41) D.W. = 1.81 S.E. = 12.78

c = 1.50 v = 1.25 8 = 0.01 ,u = 0.50 L2 = 0.25 y=2.0 6102 -7203

(A6) FDIL = 188.14 + W, (qK*f 1) .- - 0.046 KDIL_1 - 141.92 ERDL + 207.15 D3 - 27.32 D4

(76.08) (0.0098) (61.04) (26.76) (8.74)

+ 4.76 Q1 + 2.78 Q2 - 5.01 Q3 R2 - .839

(6.63) (6.54) (6.36) D.W. = 1.75 S.E. = 14.22

o- = 1.0 v-1.0 8 = 0.01 I, = 0.50 p.2=0.25 6202 -7203

W3 = 0.413 W4 = 1.368 w5 = 1.804 w6 = 1.721 W7 = 1.120

poorly determined, and the lag distribution implied by the roots of the lag polynomial was wiggly and implausible. It is probable that collinearities amongst the independent variables are responsible for these disappointing results. For these reasons no regression results based upon rational distributed lags are pre- sented here.

The estimates which made use of the Almon procedure for computing interpolated lag distributions were unimodal and fairly smooth

for both exports and imports, but were often not well-determined. Generally, the explanatory power of these relations was relatively poor. Equations (A3) and (A6) of table 1 are typical results in this respect. On balance, then, the most satisfactory results were based upon the assumption of a geometric lag in the adjustment of the actual to the desired capital stock.

It did not prove possible to estimate significantly the effects of the U. K. government's measures in 1965 and 1966 upon the outward




flow of direct investment, at any rate by the use of dummy variables. However this is not too surprising. The effects of the measures could in principle largely be offset by firms increasing the proportion of their foreign investment outlays that was financed out of retained earnings abroad and this seems to have hap- pened to some extent.12 Also, the 1965-1966 measures were to some extent reflected in movements in the investment dollar premium and these latter effects appear to have been significantly identified.

On balance, equations (A2) and (A5), which assume a geometric lag in the adjustment of capital, a more than unitary elasticity of substitution between capital and labour, and increasing returns to scale, seem preferable. Further experimentation confirmed the rejec- tion of a Cobb-Douglas production function. Tables 2 and 3 show standard errors of esti-

mate from equations for inflows and outflows for various values of o- and v. For both U. K. investment overseas and foreign investment in the U. K., the standard error of estimate tended to be at a minimum at an elasticity of substitution of about 112, for all values of v tested. Imposing diminishing returns to scale gave noticeably inferior results to constant or increasing returns to scale. However the assumption of constant returns to scale would not appear to be very damaging, as the changes in the standard error of estimate as v was

raised above unity, with constant o, were very small.

These experiments also provide a measure of the importance of relative prices in explaining the observed capital flows. Typically, setting the elasticity of substitution equal to zero, so that relative prices were omitted from the relation, lessened the explanatory power of the relations by a sizeable amount, though this is less true for inflows than for outflows (see equations (Al) and (A4) for example). It seems that a simple accelerator-type theory of investment behaviour is not as compatible with observed behaviour as the neoclassical model.

The impact and steady-state multipliers which may be calculated do not provide any information about the time-path of response of investment to changes in an exogenous variable. Dynamic multipliers were calculated by solving each equation for 60 periods ahead, first on the basis of a set of assumptions about the course of the exogenous variables, giving "control" solutions, and then with a different assumption about the exogenous variables, giving "disturbed" solutions, and finally taking the differences between the control and disturbed values of investment divided by the change in the exogenous variable as a set of multiplier values.

Unit changes in the exogenous variables were taken to be: a cut of '2 of 1 percentage point in the U. K. and foreign rates of interest, an increase of 5% in the U. K. and foreign indices of production, and a devaluation of sterling by 10%o against the U. S. dollar. The exogenous variables were assumed to remain at their end 1971 values for the "control" solutions. Of course, the calculated multipliers are not invariant either to the particular initial conditions or to the particular sequence assumed for the exogenous variables. Nor do the

TABLE 2. - STANDARD ERRORS OF ESTIMATE FOR U. K. INFLOWSa

v '/2 1 '4

2 13.578 12.834 12.801 13/4 13.299 12.816 12.784 1 /2 13.087 12.809 12.778 1 12.885 12.885 12.895 X2 12.954 13.109 13.164 0 13.274 13.665 13.842

a y = 2.0

TABLE 3. -STANDARD ERRORS OF ESTIMATE FOR U. K. OUTFLOWSa

V

Y2 1 14

2 12.906 10.345 10.136 13,4 11.867 10.211 10.112 1Y2 10.895 10.248 10.235 1 11.157 11.157 11.157 Y2 12.991 12.744 12.718 0 13.924 13.871 13.931

a y = 2.0

12 The share of unremitted profits of foreign subsidiaries in total U. K. direct investment rose from about one- half in the period 1962-1965 to two-thirds in succeeding years; the proportion of direct investment financed by net acquisition of share and loan capital fell from one-quarter to only one-sixth over the same period; and the flows of investment in the form of changes in branch indebtedness and in intercompany accounts changed very little over the period.




multipliers bear a fixed relationship to the sizes of the changes in the exogenous variables. Also, the calculations use the point estimates of the parameters and the error terms are set at their expected value, though the multipliers are really probabilistic.

Table 4 shows the calculated elasticities of U. K. investment abroad and of foreign investment in the U. K. with respect to the selected instruments, using the parameter estimates of equations (A2) and (A5). Changes in the U. K. and foreign interest rate appear to have proportionately greatest effect upon outflows and inflows of direct investment respectively. A fall of '2 of 1 percentage in the U. K. domes- tic interest rate appears to worsen the U. K.'s net balance by only about ?5.5 million in the short-run and ?2 million in the long-run, but a cut of the same amount in foreign yields is calculated to improve the U. K.'s balance by about ?9.5 million within a year and ?3 million in the long-run. Direct investment inflows are more sensitive in the short-run to variations in U. K. output than are outflows to changes in the volume of activity abroad. However, in the long-run the increments of gross capital asso-

ciated with unit changes in output are very similar for both U. K. investment abroad and foreign investment in the U. K. As might be expected, the effects of a change in the exchange rate for sterling are proportionately very much greater for outflows than for inflows, except for the first 3 quarters.

IV. Concluding Remarks

The neoclassical model of investment behaviour appears to provide a reasonable explana- tion of direct investment inflows and outflows in aggregate. The economic implications of the estimated relations also seem plausible. On the other hand, the model has not been tested rig- orously against any other theory, but simply imposed upon the sample data. Hence the large number of a priori restrictions in estimation. But the results, though not conclusive, are en- couraging. And it is unlikely that the existing data are such as to permit fine discrimination between competing theories. At any rate, more rigorous tests must stand over for future in- vestigation, preferably when more accurate and disaggregated data have become available.

TABLE 4. - EFFECTS OF SELECTED EXOGENOUS VARIABLES UPON THE EXPORTS AND IMPORTS OF DIRECT INVESTMENT

Quarters

Exogenous variable 1 2 3 4 5 6 7 8 ..... 20 ..... 40 60

U. K. Direct Investment Abroad U. K. exchange 27.2 9.7 9.6 52.4 51.0 49.6 48.4 47.2 36.9 27.6 23.2 rate ($/?) 2.51 0.71 0.70 4.22 4.35 3.76 3.74 4.15 3.78 3.27 2.97

Weighted foreign - - 6.1 9.0 10.2 10.6 10.7 8.2 5.7 4.4 output - - 0.99 1.53 1.55 1.65 1.88 1.69 1.34 1.14

Yield on 22% - - - 7.5 7.3 7.1 6.9 6.7 5.0 3.4 2.7 consols - 1.05 1.07 0.92 0.91 1.01 0.88 0.70 0.60

Weighted yield on foreign long-term government - - 1.9 1.9 1.8 1.8 1.7 1.3 0.9 0.7 securities - 0.21 0.21 0.18 0.18 0.20 0.17 0.14 0.12

Foreign Direct Investment in U.K. U. K. exchange 19.7 19.1 18.5 17.9 17.4 16.9 16.4 15.9 11.5 7.7 6.0 rate ($/?) 3.17 2.76 2.35 2.59 2.40 2.27 2.20 2.49 2.18 1.77 1.53

U. K. output - 4.3 6.3 7.2 7.5 7.5 7.4 5.3 3.5 2.7 - - 1.10 1.83 1.98 2.01 2.01 2.31 2.02 1.59 1.35

Yield on 22% - - 1.9 1.8 1.8 1.7 1.7 1.6 1.1 0.8 0.6 consols - 0.41 0.45 0.42 0.40 0.38 0.43 0.37 0.30 0.25

Weighted yield on foreign long-term government - 11.8 11.5 11.1 10.8 10.5 10.1 7.2 4.7 3.7 securities - 1.70 1.89 1.75 1.65 1.60 1.80 1.56 1.24 1.06

Upper lines denote deviations from "control" (Lmillion); lower lines denote elasticities.




Variable Definitions

FDIA Flow of U. K. direct investment overseas, adjusted for special events these are +i25m in 1968III to account for the sale of one large subsidiary abroad, -i30m in 1968IV to account for the large transaction between Rio Tinto Zinc and Bethlehem Steel, and -?50m in 1970111 reflecting a share exchange between Plessey and Alloys Unlimited. ?m.

FDIL Flow of foreign direct investment into the U. K. adjusted for special events these are -?lOOm in 196811I for several large takeovers including Gallahers by American Tobacco and Godfrey Phillips by Philip Morris, +?45m in 19681V to account for the sale of U. S. General Telephone Company's stake in Thorn Electrical Industries Ltd., and -?100m in 19711 reflecting several large takeovers. ?m.

PROD - Index of industrial production, 1963 100, seasonally adjusted.

PW = Index of wholesale prices, 1963 - 1. RL - Yield on long-term government bonds,

per cent per annum/100. KDIA Stock of direct investment overseas,

?m, constructed. KDIL = Stock of foreign direct investment in

the U. K., ?-m, constructed. DP = U. K. investment dollar premium, per-

centage. ER - Index of official par exchange rate, ex-

pressed as local currency per U. S. $ except for U. K.; floating rates used when applicable; 1963 - 1.

PI = Price of investment goods, 1963 1.

Qi = Seasonal dummies, i 1, 2, 3. 1 af 7

K*d,l = [ _ Zt=- 1w ERuxk

r PW*VIERi ] a x PI*i (RLi + 8) -

X PROD*,ta+(l-a) Iv] RLuk l

K*d,2 =K*d,l: 73 w=1 wi RLi

ERDA ERuk i=1 wi ERi.

The weights are the proportions of the stock of U. K. direct investment in Canada, U. S.,

France, Germany, Australia, India and South Africa at the end of 1965, as given in "Survey of Book Values of Overseas Direct Invest- ments," Board of Trade Journal, Sept. 23, 1970.

POW*uka

_PIuk(RLUk + 6)

X (PROD*uk) [aY+ (1a) /v] 2

7,1 wjRLj K*f,2 ={ K*f,1l R|.

RLUK 2

ERDL - ER 1k w, ER-.

The weights are the proportions of the stock of direct investment by Canada and the U. S. in the U. K. at the end of 1965. These countries accounted for 77% of the total stock.

KDIA FDIA + (1 -8) KDIA1 ERukl \ ER1 . / ERukJ

?4210m at the end of 1965. KDIL FDIL + (1 -8) KDIL-1

?1995m at the end of 1965.

PROD* = 2 i=o (I- PROD(1- P o ?<KLi 1.

PW* = /L2 (1 -,2PW-

o < U 2 ?1.

PI* = /12 (1 - 2)WPL_ 0 <,U2 <1.

D, = Dummy variable to account for a number of small takeovers, taking the value unity in 1971I and 0 elsewhere.

D2= Dummy variable to account for a number of small takeovers, taking the value unity in 19701V and 0 elsewhere.

D3= Dummy variable to account for the unusually large inflow of import credit from foreign companies due to various tax changes and tight credit controls, taking the value 1/6 in 1969IV and 197011, 2/3 in 19701, and 0 elsewhere.

D4= Dummy variable to account for the weakness of sterling in anticipation of a possible devaluation, taking the values 1 in 19641V and 19651, -1 in 196511, and 0 elsewhere.

As data on investment goods prices in all 7 countries and data on the percentage of capital goods imported from the home country for for-




eign investment were not available, the price of investment goods in Canada was proxied by the U. S. price, and the investment goods prices in Australia, India and South Africa were proxied by the U. K. price.

REFERENCES Almon, S., "The Distributed Lag Between Capital Ap-

propriations and Expenditures," Econometrica (Jan. 1965).

Arrow, K. J., H. B. Chenery, B. S. Minhas, and R. M. Solow, "Capital-Labor Substitution and Economic Efficiency," this REVIEW (Aug. 1961).

Eisner, R., and M. I. Nadiri, "Investment Behavior and Neo-Classical Theory," this REVIEW (Aug. 1968).

Jorgenson, D. W., "Anticipations and Investment- Be- havior," in J. S. Duesenberry, G. Fromm, L. R. Klein, and E. Kuh (eds.), The Brookings Quarterly Econometric Model of the United States (Chicago: Rand McNally and Co., 1965).

, "The Theory of Investment Behavior," in R. Ferber (ed.), Determinants of Investment Be- havior (New York: Columbia University Press for the National Bureau of Economic Research, 1967).

Reddaway, W. B., S. J. Potter, and C. T. Taylor, The Effects of U. K. Direct Investment Overseas: Final Report (Cambridge: Cambridge University Press, 1968).

Solow, R., "On a Family of Lag Distributions," Econo- metrica (April 1960).



Documents

An Analysis of United Kingdom Inflows and Outflows of Direct Foreign Investment