The Reinvestment of Multinationals as a Capital Flow : Crises, Imbalances and the Cash-Based Current Account

On average, foreign corporations save a third of their local profits in the host country. While this is recorded as "Retained Earnings Foreign Direct Investment" (REFDI), macroeconomics has so far overlooked its particularities. This paper explores the aggregate economic properties of REFDI. It also introduces cash-based measures of saving and current account, which correct for REFDI. Using international capital flows (1980-2014), we show REFDI behaves like national saving in its cyclicality. Moreover REFDI deepens the saving-to-investment correlation (Feldstein-Horioka puzzle), unlike the rest of FDI. Importantly, adjusting for REFDI has real effects. In particular the cash-based Sudden Stops – which partial out the REFDI - are tougher than the traditional accrual-based sudden stops. They have slower GDP recovery. Also, we show REFDI lowers the probability of macroeconomic crises, both as flow and as stock. Overall, REFDI is stronger in countries receiving more FDI, and also during the recent commodity boom. Our results have policy implications for macro monitoring of external imbalances. Among others, repatriation tax holidays may trigger sudden outflows of accumulated REFDI