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to the Brics countries also more than doubles for Australia, Denmark, Sweden, Switzerland and the US.


Larger equity positions in China Firms also issue equities through foreign affiliates. For example, as has been widely discussed, several US firms, such as Medtronic, have relocated their headquarters to Ireland for tax purposes, despite the bulk of their operations being located in the US. Our results suggest that US equity exposure to Ireland is five times larger in the US national statistics than it would be without such tax inversions. The largest equity reallocation


exposed in our work, however, involves China. Chinese law forbids foreign investments in strategic industries, such as certain internet and technology sectors. To circum- vent this restriction, prominent corporations, including Alibaba, Baidu, JD.com and Tencent, use what is known as a variable inter- est entity (VIE) structure. Through this, a firm owned by Chinese nationals can engage in a series of contracts with a wholly foreign- owned enterprise (WFOE). The WFOE is owned by a third company, typically a shell company in the Cayman Islands, that issues equity, and is entitled to receive operating profits and control rights without owning the operat- ing company outright. This means that when investors purchase stock in Alibaba, for example, they are purchasing equity claims on a holding company resident in the Cayman Islands. The ubiquity of the VIE structure


means that more than $500bn of US equity investments in the Cayman Islands are best thought of as carry- ing exposures to China. Including these investments, China grows from about 2% of the external equity portfolios of both the US and Europe, to 7% and 10%, respectively. When we include equity invest- ments in VIEs as investments in China, investment exposures to China surge for all developed coun- tries that we study.


Sales-based investment exposures For most economic analyses, it is helpful to ‘look through’ the shell companies located in tax havens and associate investments with the geog- raphy of the issuer’s ultimate


June/July 2021 www.fDiIntelligence.com


parent, as described above. For some purposes, it may be additionally useful to then take into account the full geography of that ultimate parent firm’s consolidated sales, potentially associating a given equity investment with multiple geographies. Doing so offers a differ- ent perspective on howthe patterns of global demand for goods and services affect investors. For example, it is well known


that investors disproportionately invest in domestic firms, which potentially suggests they are forgo- ing some benefits from diversifica- tion across foreign countries. Accounting for the foreign sales made by domestic firms attenuates this concern. Further, moving fromthe offi-


cial data to our measure that associ- ates tax haven affiliates with their ultimate parents, and then moving again from that measure to one that accounts for the global distri- bution of sales, markedly changes the view of portfolio exposures to China. Ray Dalio, the founder of Bridgewater Associates, recently wrote in an opinion piece for the Financial Times, “the world is underweight Chinese stocks and bonds. These currently account for 3% or less of foreign portfolio hold- ings; a neutral weight would be closer to 15%”. Figure 2 demonstrates that


Dalio’s “3% or less” is quite close to what is found in official statistics on China’s share of US foreign equity holdings during 2007–2017 (labelled ‘Residency’ in the figure). When we associate securities issued by Chinese affiliates in tax havens with China, we obtain a higher and grow- ing series that approaches 10% by 2017 (labelled ‘Nationality’). Finally, our calculation of US equity expo- sure to China, that takes into account the share of companies’ sales to China, reaches the 15% level postulated as neutral by Dalio by 2017 (labelled ‘Sales’).


Global capital allocation project The path from corporate and sover- eign borrowers to foreign lenders of capital has gotten more complex, and increasingly routes through tax havens. Our research initiative, the Global Capital Allocation Project, offers a variety of tools and results (including those summarised above) to help academics, policymakers, and


FIGURE 1: TAXHAVENNETWORK OF EUROZONEBONDINVESTMENT


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  


  


FIGURE 2: THE RISE OF CHINAINUS EXTERNAL EQUITY INVESTMENT





2007


2009 Residency


2011


2013 Nationality


2015 Sales


2017


practitioners see through these intermediaries and better under- stand the pattern of bilateral port- folio investment. As cross-border financial ties become deeper and more complex, it is more challeng- ing and even more essential to understand who owns what around the globe. ■


Antonio Coppola is a doctoral student in economics at Harvard University. Matteo Maggiori, Brent Neiman, and Jesse Schreger are professors at Stanford University, The University of Chicago, and Columbia University, respectively.


This article is based on: Coppola, Maggiori, Neiman & Schreger. Redrawing the map of global capital flows: the role of cross-border financing and tax havens. The Quarterly Journal of Economics 2021;qjab014. doi: 10.1093/qje/qjab014


85


0%


Share of External Investment 5%


10%


15%


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