This document discusses how retained earnings attributed to foreign portfolio investors are currently not accounted for in balance of payments statistics, which can distort measurements of current accounts and gross national income. It presents two stylized facts: an increase in retained corporate profits and an increase in foreign ownership of domestic firms. The paper then proposes a method to correct for this by attributing a share of retained earnings to portfolio investors based on their ownership share. Applying this method significantly redistributes recorded income between highly globalized economies.

1. Retained Earnings & Global Imbalances
C´ıan Allen
Trinity College Dublin
IAOS-OECD. 2018
1 / 21

2. Introduction
Motivation
Understanding current account imbalances is high on the
academic and policy agenda
Globalization can significantly cloud its interpretation
Key Balance of Payments (BoP) Principle: Retained earnings
(profits not distributed via dividends) are attributed to direct
investors and not portfolio investors
Direct investors (”DI”) > 10% ownership stake
Portfolio investors(”PI”) < 10% ownership stake
Here, we focus on distortions due to retained earnings on
foreign portfolio equity
2 / 21

3. Introduction
Motivation
The past few decades have seen a considerable rise in
retained corporate profit in advanced economies
At the same time, global firms and global investors have
accumulated a growing share of the ownership of domestic
firms
⇒ Given the current Balance of Payments (BoP) methodology, this
creates growing distortions
We follow the basic principle in Lane (2017):
The recording of income should be independent of the timing
of distribution of profits
Insures better measurement of the underlying resources
available to countries
3 / 21

4. Introduction
Potential Distortions Arising from BoP Principle
Case 1: Consider a country hosting MNEs headquarters:
MNE have direct investment subsidiaries ⇒ FDIRE
Credit
MNE are owned by foreign portfolio investors ⇒ No flow
⇒ Leads to overvaluation of Current Account (CA)
Case 2: Consider a Firm in country A that makes profit and
retains it
Held 50% by direct investors in country B ⇒ FDIRE
Credit
Held 50% by portfolio investors in country C ⇒ No flow
⇒ Leads to inequality between country B and C in measured
net income
4 / 21

5. Introduction
Contribution & Findings
This paper documents:
Stylized Fact 1: An increase in (retained) profits
Stylized Fact 2: An increase in foreign (portfolio investment)
ownership
It offers a correction of CA by attributing share of retained
earnings to Portfolio Investors
Significant redistribution of (recorded) income between highly
globalized economies
Depends on level of Gross Saving and Net Portfolio Equity
position (NPEQ)
Relatively small correction for large economies
5 / 21

6. Introduction
Related Literature
Difficulties in measurement due to globalization
Lane (2017), Guvenen et al. (2017), Damgaard and Elkjaer
(2017), Avdjiev et al. (2018), and Bruner et al. (2018)
Parallel work on retained earnings correction but using
stock market data
IMF’s External Sector Report (2018) and Fischer et al. (2018)
Implications for global imbalances?
Gourinchas and Rey (2007), Hausmann and Sturzenegger
(2007)
6 / 21

7. Outline
National Account identities
Stylized Fact 1: Increase in Profits
Stylized Fact 2: Increase in Foreign Ownership
Method & Results
Concluding Remarks
7 / 21

8. National Account identities
Retained earnings or gross saving (GS) is after-tax profit less
dividends paid to shareholders
GS = π −Div (1)
The current account is the trade balance plus net income
(NINC)
CA = (X −M)+NINC (2)
The net equity income for FDI and Portfolio investment:
NINCFDIEQ
= NDIVFDIEQ
+NREFDIEQ
NINCPIEQ
= NDIVPIEQ
(3)
8 / 21

9. Stylized Fact 1: Increase in Profits
Both Retained and Distributed Profits
51015202530
1995 2000 2005 2010 2015
75th Percentile/25th Percentile Dividends
Retained Earnings Profits
Note: Median values in percent of GDP. Selected advanced economies
9 / 21

10. Stylized Fact 2: Increase in Foreign Ownership
For Both Direct and Portfolio Investors
01020304050
1995 2000 2005 2010 2015
75th Percentile/25th Percentile PI Share
DI Share Foreign Share
Note: Median values in percent of GDP. Selected advanced economies
10 / 21

11. (3) Correction Method
Step 1: Calculate the imputed retained earnings attributed to
foreign portfolio investors (λit ) as the share of portfolio equity
liabilities (PEQL) in the total outstanding stock of domestic
equities liabilities (EQ) times gross saving (GS)
For country A:
λA
it =
PEQLA
it−1
EQA
it−1
×GSA
it (4)
Step 2: Reapportion λit on the debit side and credit side,
using country weights from IMF’s CPIS database
ωA
B =
PEQLA
B
PEQLA
(5)
with ωA
B the share of foreign portfolio equity liabilities of
country A vis-a-vis country B relative to all foreign liabilities of
country A
11 / 21

12. Net Correction of Retained Earnings for Portfolio
Investors
λNET = λCREDIT - λDEBIT
-3 -2 -1 0 1 2 3 4 5
Japan
Korea, Republic of
Ireland
Switzerland
Spain
Greece
Poland
Germany
Finland
Portugal
Italy
Hungary
Romania
Czech Republic
Latvia
United Kingdom
Austria
Lithuania
Bulgaria
Slovenia
Slovak Republic
France
Denmark
Estonia
United States
Belgium
Cyprus
Sweden
Canada
Netherlands
Norway
Note: Average values for 2012-2015. In percent of GDP.
12 / 21

13. Correction Depends on Portfolio Equity Holdings (NPEQ)
& Gross Saving (GS)
Positive Correction NPEQ GS λNet
Norway 116.5 17.8 5.1
Netherlands 20.8 20.0 1.9
Canada 29.6 12.5 1.8
Sweden 25.7 15.0 1.4
Cyprus 5.7 12.1 1.0
Negative Correction NPEQ GS λNet
Japan -5.5 23.4 -2.9
Korea, Republic of -16.7 20.5 -2.9
Ireland -568.5 25.7 -2.6
Switzerland -69.8 14.3 -2.1
Spain -8.3 18.7 -1.6
Note: Top 5 average values for 2012-2015. In percent of GDP. λNet is the net
correction for retained earnings for portfolio investment.
13 / 21

14. Correcting the Current Account Balance
CA*= CA + λNET
Net Positive Correction CA CA* ∆
Norway 10.00 15.10 5.09
Netherlands 9.29 11.20 1.92
Canada -3.03 -1.23 1.79
Sweden 4.97 6.36 1.39
Cyprus -3.65 -2.69 0.96
Net Negative Correction CA CA* ∆
Japan 1.66 -1.27 -2.93
Korea, Republic of 6.63 3.75 -2.88
Ireland 6.67 4.07 -2.60
Switzerland 10.60 8.51 -2.12
Spain 1.24 -0.31 -1.56
Note: Top 5 average values for 2012-2015. In percent of GDP. CA* is the CA
corrected for retained earnings for portfolio investment.
14 / 21

15. Correcting Gross National Income Growth
GNI*= GNI + λNET
Net Positive Correction GNI GNI* ∆
Switzerland 4.53 4.79 .259
Korea, Republic of 3.43 3.55 .121
Norway .316 .399 .083
Net Negative Correction GNI GNI* ∆
Ireland 13.8 9.94 -3.91
Netherlands 1.49 1.1 -.392
Denmark 3.66 3.34 -.325
Note: Top 3 average values for 2012-2015. In percent of GDP. GNI* is GNI
corrected for retained earnings for portfolio investment.
15 / 21

16. Total Valuation Changes in Portfolio Equity Holdings
(SFA) can be a lot Larger
∆ NPEQ= Flows + SFA
-8 -6 -4 -2 0 2 4 6
Japan
Korea, Republic of
Switzerland
Spain
Greece
Poland
Germany
Finland
Portugal
Italy
Hungary
Romania
Czech Republic
Latvia
United Kingdom
Austria
Lithuania
Bulgaria
Slovenia
Slovak Republic
France
Denmark
Estonia
United States
Belgium
Cyprus
Sweden
Canada
Netherlands
Norway
Net Correction SFA PEQ
Note: Average values for 2012-2015. In percent of GDP. SFA is the total valuation
change in net portfolio equity holdings.
16 / 21

17. Concluding Remarks
Treating retained earnings for portfolio and direct investors in
a consistent manner leads to a significant redistribution of
(recorded) income between highly globalized economies
Modifies the Current Account balance and Gross National
Income
Other valuation changes on portfolio equity holdings are still
important
Given recent increase in retained earnings and portfolio
holdings, caution is need in interpretation of key macro
statistics
BoP methodology needs to adapt to globalization for key
macro measures to capture the underlying net resources
available to countries
17 / 21

18. Extra Slide: Haven Adjustment
-8 -6 -4 -2 0 2 4 6
Ireland
Japan
Korea, Republic of
Switzerland
Greece
Spain
Poland
Germany
Finland
Portugal
Italy
Hungary
Romania
Latvia
Czech Republic
Denmark
United Kingdom
Austria
France
Slovenia
Slovak Republic
Bulgaria
Lithuania
Belgium
United States
Estonia
Netherlands
Sweden
Cyprus
Canada
Norway
Net Correction Haven Adjustement
Note: Values for 2015. In percent of GDP. Adjustment for Cayman
Islands’ holdings
18 / 21

19. Extra Slide: CPIS Coverage
Country CPIS Country CPIS Country CPIS
United States 79.2 Canada 91 Cyprus 54.1
United Kingdom 79.9 Japan 91.5 Korea, Republic of 86.5
Austria 95.5 Finland 95.1 Bulgaria 99.5
Belgium 97.8 Greece 99.7 China, P.R.: Mainland 72.6
Denmark 91.4 Iceland 97 Czech Republic 97.1
France 95.2 Ireland 88.9 Slovak Republic 99.8
Germany 97.3 Malta 1.39 Estonia 97.8
Italy 99 Portugal 93.4 Latvia 96.6
Luxembourg 86.8 Spain 96.4 Hungary 95.8
Netherlands 88.9 Turkey 93.8 Lithuania 99.2
Norway 88.5 Mexico 98.3 Slovenia 93
Sweden 93.5 Bermuda 89.5 Poland 70.8
Switzerland 91.8 Cayman Islands 90.2 Romania 96.6
Note: Share of foreign portfolio equity holdings covered by the CPIS relative to
total portfolio equity holdings.
19 / 21

20. Extra Slide: IMF Results
Note: IMF’s ESR (2018)
20 / 21

21. Extra Slide: Credit and Debit
Positive Net Correction λA
λL
λNet
Norway 7.35 1.52 5.83
Canada 2.68 .7 1.98
Cyprus 1.75 .3 1.45
Sweden 2.95 1.53 1.41
Netherlands 4.1 2.81 1.29
Negative Net Correction λA
λL
λNet
Ireland 13.86 19.4 -5.54
Japan .69 3.86 -3.17
Korea, Republic of .42 3.07 -2.65
Switzerland 2.47 4.39 -1.92
Greece .05 1.8 -1.74
Values for 2015. In percent of GDP. λNet is the net correction for retained
earnings for portfolio investment. It is the difference between assets and liabilities.
21 / 21