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solution to our payments problems must be reached cooperatively with other countries or it will be frustrated at an early stage. More effective demand management in the United States is both necessary and achievable. Hardships that may be experienced by particular sectors of the population as a result of exposure to healthy competition from abroad can and should be dealt with in ways that do not interfere with the maintenance of a domestic economy.

CAPITAL RESTRAINT PROGRAMS

By Samuel Pisar

I. INTRODUCTION. II. RESTRAINTS ON BANKS AND FINANCIAL IN-
STITUTIONS. III. RESTRAINTS ON DIRECT INVESTMENTS. IV.
OTHER ASPECTS OF DIRECT INVESTMENTS. V. RESTRAINTS ARE
NOT EXCHANGE CONTROLS. VI. RESTRAINTS AND THE OVERALL
BALANCE OF PAYMENTS. VII. SUMMARY. VIII. APPENDIX: CHARTS
AND TABLES.

I. INTRODUCTION

The principal focus of these remarks will be on the economic effects of the various restraints the United States has placed on the outflow of certain types of U.S. private capital. Beyond that, in order to provide an appropriate background for such an assessment-particularly concerning direct foreign investments-I would like to give some observations on the more general question of the economic and balance-of-payments effects of such private investments. There are many other economic, social, and political aspects of the multinational corporation that are very significant, but which I presume will be covered by others. Similarly, I do not propose to discuss the details of the operations of the control programs except to the extent necessary to assess their effects.

The system of restraints on private capital outflows began in 1963 with the Interest Equalization Tax (IET), was broadened in 1965 to cover-on a voluntary basis-foreign lending by U.S. banks and direct foreign investments, and was intensified on January 1, 1968, by making the direct investment restraints mandatory. There have been minor adjustments, largely tending toward relaxation, but the restraints have not been significantly changed in their basic essentials since early in 1968. This sequence of events is well known-but perhaps the environment and rationale underlying these steps could be explored very briefly without undue repetition.

In the early 1960's when the first measure, the IET, was proposed, the balance of payments was making good progress in the balance of trade in goods and services (this was a period of some slack in the economy

Samuel Pizer is Associate Advisor in the Division of International Finance at the Federal Reserve Board. The views expressed in this statement are his own; they do not represent an official position of the Federal Reserve Board.

and little or no increase in prices) but over-all deficits remained uncomfortably large. One conspicuous adverse factor was the rise in the outflow of U.S. private capital, and specifically the rising amount of new foreign bonds issued in the U.S. market by developed countries. As shown in Table 1, such issues reached over $2 billion in 1963, not including Canadian issues. About one-fifth of that total was purchased in the U.S. market by foreign investors-pointing to the growing foreign interest in such investments. Introduction of the IET was essentially a reaction to the fact that other industrial countries had failed to develop their own markets for foreign issues—although it was believed they were not lacking in the ability to absorb such issues-so that a disproportionate share of long-term financing was falling on the well-developed, and readily accessible U.S. market.

Foreign markets for international issues blossomed extraordinarily after 1963; sales in the European market rose from $0.6 billion in 1963 to $5.9 billion in 1968. Presumably part of the growth would have occurred in any case, but the impulse of the IET in 1964, and the intensifying efforts to have U.S. companies borrow abroad to finance direct investments in 1965, and especially in 1968, can be seen rather clearly in the data. At the same time the U.S. market continued to absorb large amounts of bonds of Canada and other countries or institutions that were exempt from the IET, while issues of other developed countries here were virtually eliminated by the tax. It would seem that the IET came at an opportune time, in that rather than causing a cutback in the plans of would-be borrowers it forced a long-overdue reorganization and deepening of the pool of capital available in markets worldwide.

The effect on the U.S. balance of payments has been clearly beneficial, since there is no evidence that when borrowers obtain funds-usually U.S. dollars-in foreign markets they are induced to distribute their expenditures any differently than when they borrow an equivalent amount in the United States. The extent of the relief provided by the IET can not be directly estimated, partly because it also underpins the other forms of restraint, or capital outflows and partly because the deterrent effect of the tax varies with market conditions.

Up to now the rate of IET imposed on purchases of securities of countries not exempted (and also on U.S. purchases of securities offered by the financing affiliates of U.S. companies that were organized to meet the requirements of the direct investment controls) has been high enough to amount to a prohibitive tariff.1 The rate of tax has been irrelevant as a deterrent at times when market rates in the United States

'The tax rate varies with the maturity of the securities or loans being purchasedin the present discussion we are concerned primarily with the rate applicable to longterm debt or equity securities. Under the present legislation the President has authority to vary that rate between 0 and 11⁄2 percent, and to establish a differential rate for new issues. The rate has been set at 4 percent since 1969. Major exemptions from the tax are new Canadian issues, issues of the international organizations of which the United States is a member, and issues of less developed countries.

were so high relative to foreign market rates that foreign issues would not have been sold in the U.S. market in any case. As shown in the attached charts, the cost of borrowing in the United States was relatively low until the latter part of 1968. Normally-in the absence of a taxthe volume of bond issues placed here by borrowers in developed countries would have risen from the $2 billion level of 1963, rather than diminishing as it did. By 1969, borrowing costs in the United States were rising steeply compared to those abroad, and it may be that the tightening of credit markets would in itself have kept the volume of foreign issues placed in the United States relatively low.

In 1970, the situation in international capital markets is tending again in the other direction-U.S. rates are lower though still at high levels, and they may decline significantly if inflationary exceptions are overcome; foreign rates are also easing somewhat but are likely to remain relatively firm as monetary authorities abroad combat demand pressures. Consequently, in the period ahead the IET may once again become a very significant wedge between U.S. and foreign capital markets, serving to divert some pressure on the U.S. balance of payments and allowing U.S. monetary policy to operate with somewhat more freedom.

Another effect of the IET has been to inhibit U.S. purchases of foreign corporate stocks. Net outflows to purchase such securities averaged $225 million per year in 1958-62, shifted to a net inflow of nearly $200 million per year in 1963-66, primarily because of the IET, and then reverted to net outflows which, although of some size, were mainly directed to specialized issues such as those of gold mining and Japanese enterprises. At first the IET did not apply to bank lending to foreigners, but this lending began to mount in 1963 and the net outflow of bank-reported claims, both long-term and short-term, reached a peak of $2.5 billion in 1964. In early 1965 the IET was expanded to cover bank loans of over-one-year maturity, with certain exemptions for export loans and credits to certain countries. Direct investment outflows were also rising in 1964, and other corporate outflows shot up to a record amount. Consequently, the aggregate net outflow of U.S. private capital reached a peak of $6.6 billion in 1964-compared to an annual average of about $4 billion in 1960-63-offsetting the gains being made in the trade and services accounts. It was against this background that the 1965 voluntary restraint programs were initiated.

II. RESTRAINTS ON BANKS AND FINANCIAL INSTITUTIONS

The Voluntary Foreign Credit Restraint Program (VFCR) for banks and other financial institutions, administered by the Federal Reserve System, took the form of establishing a base level for foreign assets and limiting the amount of increase over that historical level. Since 1965 the guidelines have been modified, mainly to provide more flexibility for institutions-primarily smaller banks-that would have had a very

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