Economic Review
Third Quarter 2006 

Going Global: The Changing Pattern of U.S. Investment Abroad - (PDF 216K)
By Marcela Meirelles Aurelio

Investors typically allocate only a small share of their portfolios to foreign assets. This pattern of investment behavior, known as “home bias,” is puzzling because it causes investors to miss opportunities to diversify risks. During downturns in the U.S. economy, many domestic assets perform poorly, precisely when asset returns are most valuable. By purchasing foreign assets that are only partly affected by the U.S. business cycle, however, investors are able to hedge against adverse fluctuations in domestic income.

Recent evidence suggests that home bias might actually be declining. Over the past decade, U.S. holdings of foreign financial assets—stocks and bonds—have grown remarkably. At the same time, foreign physical assets, such as foreign direct investment in production plants, have also become far more common. Overall, the share of U.S. investments allocated to foreign assets swelled from 40 percent of GDP in 1990 to 89 percent in 2005.

Meirelles Aurélio investigates the recent behavior of U.S. foreign investment and the factors driving the change in its fastest growing category—namely, international equity investment. Home bias in U.S. equity investment has indeed declined during the last decade. However, the propensity to invest abroad has varied significantly across assets from different foreign economies. Specifically, U.S. investors tend to prefer investing in other industrial countries rather than in emerging markets. This pattern has likely developed because the assets of industrial countries provide a better hedge during downturns in the U.S. business cycle.

Migration in the Tenth District: Long-Term Trends and Current Developments - (PDF 226K)
By William R. Keeton and Geoffrey B. Newton

The movement of people into and out of a state can have important implications for the state’s economy. The total net inflow of people to a state matters because it affects the overall supply of workers in the state. Economists predict that growth in the national labor force will slow in coming decades as a result of such factors as the aging of the baby boomers and the decline in the fertility rate. As this happens, the availability of workers is likely to become an increasingly more important factor in the location decisions of firms.

Migration matters not only for the size of a state’s workforce but also for the composition of the workforce. The spread of computers and advances in information technology have increased the demand for highly educated workers over the last two decades. Most economists expect the demand for such workers to continue growing in response to further advances in technology. But there will also continue to be a need for unskilled workers to perform jobs at the bottom of the job distribution. In deciding where to locate, firms are likely to pay careful attention to the educational composition of a state’s workforce in addition to the size. The most important determinant of the educational composition of the workforce is the quality of the state’s educational institutions. But also important is whether the state is retaining and attracting the kinds of workers in demand by businesses—for example, whether the state is suffering a net gain or net loss of college graduates to the rest of the nation, and whether the state is receiving too large or too small an influx of less educated immigrants from abroad.

Focusing on the last half century, Keeton and Newton examine overall patterns in total migration and migration by level of education in Tenth District states. They show that the net inflow of people from other states has been consistently positive in only one state, Colorado, but has gradually improved in most other states. In addition, immigration increased greatly in most district states but ended up more important than in the nation only in Colorado. They also show that many district states have experienced both a net loss of college graduates to the rest of the nation and a net gain of people without high school degrees from abroad. The effects of these migration flows on the mix of workers have been greatly outweighed up till now by increases in education in the population at large. Finally, the authors show that in the current decade migration flows have taken a turn for the worse in several states, but this shift was due to temporary changes in relative economic conditions.


Interchange Fees in Australia, the UK, and the United States: Matching Theory and Practice - (PDF 173K)
By Fumiko Hayaski and Stuart E. Weiner

Interchange fees are an integral part of the pricing structure of credit and debit card industries. While in recent years the theoretical literature on interchange fees, and payment cards in general, has grown rapidly, the empirical literature has not. There are several reasons for this. First, comprehensive data are hard to obtain. Second, the industries are very complicated, and empirical models need to incorporate many industry-specific features, such as payment-card network rules and government regulations. And third, empirical studies may require a generalized empirical model since, typically, only a few payment card networks exist in a given country. However, because of the first and second reasons, generalizing empirical models may prove problematic.

Hayashi and Weiner seek to provide a bridge between the theoretical and empirical literatures on interchange fees. Specifically, they confront theory with practice by asking, to what extent do existing models of interchange fees match up with actual interchange fee practices in various countries? For each of three key countries—Australia, the United Kingdom, and the United States—models that “best” fit the competitive and institutional features of that country’s payment card market are identified, and the implications of those models are compared to actual practices. Along what competitive dimensions is there alignment? Along what competitive dimensions is there not alignment? What country-specific factors appear to be important in explaining deviations from theoretical predictions? The results suggest that a theory applicable in one country may not be applicable in another and that similar interchange fee arrangements and regulations may well have different implications in different countries.

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