Am I oversimplifying things by using the concept of risk / return tradeoff to explain this? Investment in the US is typically considered to have lower systematic risk associated with it (and therefore lower returns) while investing in non-US markets (which includes a lot of riskier emerging markets) has a higher risk / return profile.

The problem it seems with this sort of theory is the consistency of outperformance by US investment overseas. Higher risk portfolios may average higher returns over time but over a long period, underperformance by the riskier portfolio in a given year is to be expected.

Maybe "we" are just smarter?

The long answer is several books long but the short answer is Bretton Woods II and petrodollars. As long as the dollar is the world's reserve currency, expect all sorts of weirdness to happen.

Im sure George Soros has the answer. And it involves the doom of the US somehow.

Brad Setser makes the claim that a large portion of this is because of tax arbitrage, that its profitable for multinationals to declare profits abroad than in the US.

It might be useful to separate foriegn corporate investments from central bank investments too -- the latter are likely to be very conservative, and the dollars' status guarantees those will continue. Huge liquidity for treasuries is another factor.

Political stability is certainly a factor for Middle East countries and some Third World countries investing in the US -- they're willing to take lower yields for safety.

Finally, as a wealthier country, the US may just be more willing to spend on riskier instruments.To illustrate -- a poor American may put what savings they have into safe but lower yielding FDIC accounts, wealthier Americans will go for the stock market, the wealthiest for real exotic investments.

Dan -- As erg noted, I argue that the anecdotal evidence points to corporate tax arbitrage as a key explanation. But if you come across the definative b-school explanation, do let me know. So ask Bill Gates, or the big pharma CEOs with big profits in Ireland for the answer, not old George Soros.

I'll set aside my argument that investing in US dollar denominated assets is actually very risky for a foreign investors looking to maintain their real wealth in local currencies terms. The big current account deficit and all. Not everyone agrees with it.

But I don't think the US just is good at borrowing at low cost to buy high yielding assets argument works that well. For a couple of reasons. First, US returns abroad really aren't that good. The shocking thing is that reported foreign returns on their FDI are really bad -- less than they would have gotten holding long-term Treasuries generally. It isn't US skill, at least not skill at anything other than taking foreign direct investors for a ride that shows up in the data (now if FDI in the US doesn't want to show profits in the US for tax reasons, the story changes ... ). Second, most US FDI is just not in risky markets, nor are most US debt securities claims on risky places. Most US FDI is in the UK. lots more is in Switzerland. Throw in Japan, Canada and the Eurozone and you have a decent mental image of US assets abroad. Read the CBO report on this topic. Or look at the data the IMF has assembled on the sources of FDI in China (hint -- it ain't mostly coming from the US). US investors also own foreign bonds -- but they are mostly the securities issued in well developed markets that are almost as liquid as our own. UK, Japan, Canada, eurozone and the like.

We have lent tons of money to the Caymans too; I bet the Caymans also invests a lot in the US .... hhmmm? Maybe some b-school prof can help us out there. Or tax attorney.

This is a shot in the dark, but is it possible that the ROR is dependent on both the production in the host country and factors in the home country? Thus if US firms are making large profits at home (say Intel) and they invest in a production facility abroad shouldn't we expect that they have a higher ROR? They reason they investment is because they have some firm specific asset that gives them a comparative advantage over local firms.

Thus the same reasons why the U.S. economy has grown more quickly than the economies of the other FDI source countries could be the same reason why US investment abroad earn higher returns than foreign firms investing in the US.

This is just a late night shot in the dark, but I do think we want to consider the determinants of FDI to solve this mystery.

Great post on an important and unanswered question.

Try removing the Japanese from the equation and then run the numbers again. They seem to have a genius for direct investing in the US at the very peak of the market (cf Rockefeller Center bought ca 1989, sold at a loss to Goldman just as the manhattan RE mkt was emerging from the bottom a few years later...). Probably true for the French (cf Vivendi) and the Germans (Bertelsmann, Daimler etc) as well.

It would be interesting to break out the data for M&A activity between giant firms, which tends to produce poor returns, vs minority stakes taken by giant investors or investment funds in small local firms. The latter seem more characteristic of US investment abroad, esp since far more of the US investment comes from very savvy private equity investors whereas most of the European and Japanese FDI in the US is done by less-nimble mega-firms buying up or "merging" with large US firms (Daimler and Chrysler, Vivendi and Universal).

Perhaps another problem here for non-Americans is that FDI requires not just operating expertise but also a culture of management and financial performance measurement that is easily exportable. The US companies that focus heavily on FDI (P&G, GE, Citigroup) tend to be extremely disciplined, ruthlessly focused on pleasing customers and winning market share-- winning attributes in any market-- while the European and Japanese companies tend to invest in the US partly for political/market access reasons (Japanese auto manufacturers) or internal reasons that have more to do with the personality of the chairman (Jean-Marie Messier at Vivendi) or a sudden wish by the board (perhaps after listening to some McKinsey consultants) to get global, fast. A tough change for family-owned, read-aim-aim again European firms especially. Far more difficult for them to come in with their management style and culture and turn around or grow a US company than v-v.

the answer lies with international finance economists. And there's a book out that covers it in very good detail:

http://www.amazon.com/gp/product/1840640871/sr=1-5/qid=1137219488/ref=sr_1_5/002-3647293-3912827?%5Fencoding=UTF8

From a lawyer, not an economist, my observation is that the US Treasury bond market is the largest, most liquid, fairest market in the world. The expansion of our National Debt has produced good beyond even Hamilton's wildest dreams. Think about it: a company in Shanghai that has invested in textile mills in China knows that if they decide to sell their assets in China or take some profits out, for whatever reason, they have (1) a safe place to park funds; (2) as or more importantly, a market determined "safe rate" of return to measure other opportunities against. Thsu, they can make a decision about their investment in China without having an immediate decision to make about where to put the money longer term.

This is more than the dollar being a reserve currency. The Treasury bond market is so huge and so liquid, there has never been another market comparable to it in the world. It is the world's liquidity. Of course foreigners over invest in it, but what choice do they have?

"Of course foreigners over invest in it, but what choice do they have?"

That's precisely it. There is little to no choice. So long as the enormous capital inflow keeps coming (and it will), Americans "will be better at FDI" (whatever that means). If you have more capital than anyone else for use and exchange value, you will be the best at getting a return in industry and the forex market. Not to mention, you also hold enough power to unilaterally devalue the dollar (which 60-70% of the worlds asset are denominated in).

The corporate culture argument is worthless. Look at the flows! And the size of financial flows!

How about the other side of this...what kind of returns do non-US-based companies see on their FDI in the U.S.? I would bet that the ROI of a BMW Toyota assembly plant is pretty high.

Although it's important to emphasize that ROI of any entity below the level of the total corporation is highly dependent on cost allocation / transfer pricing.

There is nothing to worry about. When the time comes when foreigners want all their money back (although I think it is unlikely to happen), we print more dollars to pay them. Certainly the consequence is sharp devaluation and no one will be willing to lend us anymore after that. But don’t worry, America will not become a poor country overnight. Suppose this happens in 2050, at that time GDP per capita is 100,000 USD, and American economy crash (because pull-out of foreign investment from America) and let’s say the economy lose 90% of production capacity, eh, we are still not a poor country and we won’t be starving anyway!

It could also in part be explained black market money flows.

BTW it might be noted that black market money is not interested so much in ROI as in money laundering.

Thus explaining the lower return on American investments.