Peter Mandelson’s plane had barely left the Hong Kong tarmac after World Trade Organization negotiations in December 2005 before US and European trade warriors were back at it, threatening retaliation for each other’s transgressions. Transatlantic squabbles about farm supports, aircraft subsidies, bananas, beef or steel certainly capture media attention. But trade tensions represent a miniscule amount – only 1-2% – of overall transatlantic economic activity.

The UK is the number one destination for US foreign direct investment

Inordinate focus on trade disputes distorts the real nature of the transatlantic economy and distracts from the real headline: the transatlantic economic relationship remains the strongest, most interdependent economic partnership in the world – and these ties that bind have become stronger since the end of the Cold War, and especially during the first half of this decade.
Moreover, just a little bit of digging leads to a second big headline: despite all the hype about “big emerging markets”, British-American commercial ties are far and away the strongest and deepest bilateral economic relationship in the world.

America’s orientation towards the UK and Europe runs counter to all the hype and angst associated with outsourcing to such low-cost locales like China, India or Mexico, and the common, but erroneous, belief that low-cost destinations of East Asia have attracted the bulk of US investment. In fact, Europe remains by far the top destination of US foreign direct investment, accounting for about 56% of the global total during the first five years of this decade. The UK ranks as the number one nation for US foreign direct investment. US investment flows to the UK ($23bn) in 2004 accounted for roughly 25% of total US investments in the EU as
a whole.

Moreover, this transatlantic story is not an exclusive Anglo-Saxon affair: despite diplomatic ill-will between Washington and Paris, US investment flows to France soared to a record $6.8bn in 2004, some 45% larger than US investments to China that year. Despite transatlantic tensions over Iraq, corporate America ploughed nearly $100bn into the European Union in 2003 and another $93bn in 2004.

Corporate Europe also remains a key source of foreign capital for the US, accounting for 75% of total foreign direct investment inflows into the US over the 2000-2004 time frame. During this period, the UK accounted for 19.8% of total global investment flows into the US. There is as much UK investment in Texas alone as all US investment in Japan and China put together.

Why such a disparity between US investment in slow-growth Europe versus turbo-charged China and emergent India? At the end of the day, the motivations of multinationals to invest overseas are not only about cheap labour, but equally about access to wealthy markets, skilled labour and the innovative capabilities of host nations. The premium placed on such assets today goes a long way in explaining why the US and Europe are each other’s most important foreign investors, and why investment – a “deep” form of integration – is more important transatlantically than trade – a relatively “shallow” form of integration.

VIEWING THE BRITISH-AMERICAN ECONOMIC RELATIONSHIP IN 8-D
We get a clearer picture of the deep integrating forces that make the US-UK commercial relationship the strongest in the world by viewing the relationship through eight dimensions of economic activity.

GROSS PRODUCT OF FOREIGN AFFILIATES
The total output of US foreign affiliates in the UK is sizable – $117.5bn in 2003, accounting for more than 6% of total UK output. British affiliates are also major economic producers in the US – their output totalled more than $95bn in 2003.

OVERSEAS ASSETS OF FOREIGN AFFILIATES
The total foreign assets of corporate America amounted to roughly $8.2tn in 2003. Roughly 60% were located in Europe, with the largest share in the UK ($1.8tn), followed by the Netherlands and Germany. America’s corporate assets in the UK alone exceed total US assets in the entire Asia/Pacific region. European firms held some 3.9% in US assets in 2003, roughly 76% of total foreign assets in the US. Europe’s investment in the US is distributed widely across industrial sectors and geographic regions. European companies were the top foreign investors in 43 states, and ranked second in the remaining seven states in 2003. The UK was the top foreign investor in 16 US states in 2003.

AFFILIATE EMPLOYMENT
Despite stories about companies decamping for cheap labour markets, most foreigners working for American companies abroad are European and most foreigners working for European companies outside Europe are American. US affiliates of British firms directly employed 995,000 American workers in 2003 – the largest numbers of workers employed by any foreign investor in America. British affiliates of US companies employed roughly 1,171,300 British workers in 2003 – also the single largest number of workers employed by US companies in any foreign country.

Moreover, these figures understate the employment effects of mutual investment flows, since these numbers are limited to direct employment, and do not account for indirect employment effects of nonequity arrangements such as strategic alliances, joint ventures and other deals. Moreover, affiliate employment figures do not include jobs supported by transatlantic trade.
In total, and adding in indirect employment, we estimate that the transatlantic workforce numbers some 12-14 million workers. Europe is by far the most important source of “insourced” jobs in America, and the US is by far the most important source of “insourced” jobs in Europe – with mutual employment in Britain and America leading the way.

RESEARCH AND DEVELOPMENT OF AFFILIATES
While R&D expenditures remain biased towards the home country, foreign affiliate R&D has become more prominent over the past decade as firms seek to share development costs, spread risks and tap into the intellectual talent of other nations. Accordingly, of the $22.3bn in global R&D expenditures of US foreign affiliates in 2003, roughly two-thirds was in Europe, with the UK ($4bn) leading the way, followed by Germany ($3.7bn).

INTRA-FIRM TRADE OF FOREIGN AFFILIATES
Foreign affiliate sales are the primary means by which goods and services are delivered across the Atlantic. Trade is secondary, although the two modes of delivery are more complements than substitutes, since foreign investment and affiliate sales increasingly drive trade flows. Indeed, a substantial share of US-UK trade is considered intra-firm trade or related party trade, which is cross-border trade that stays within the ambit of the company. It’s BP sending components to its affiliate in Texas, for instance, or 3M sending parts from St Paul to its affiliate in London.

Reflecting the tight linkages between UK parent companies and their US affiliates, roughly 59% of US imports from the UK consisted of related party trade in 2004. Meanwhile, 28% of US exports to the UK in 2004 represented related party trade. America’s widening trade gap with Europe, including the UK, has confused many on both sides of the Atlantic. Missing from most analysis is the simple fact that most US imports from the UK are parent-affiliate trade, which is less responsive to shifts in prices or exchange rates and more attuned to domestic demand. Accordingly, while in theory a strong pound would be associated with a decline in British competitiveness in the US, the fact that many British multinationals produce, market and distribute goods on both sides of the ocean gives firms a high degree of immunity to dramatic shifts in exchange rates.

Under this structure, trade flows are driven more by demand in the host nation. Since the US economy remains robust, sales of British affiliates have remained strong over the past few years, which in turn, have generated more demand (imports) from parent companies for parts and components irrespective of exchange rate movements. That is why US imports from the UK have remained so strong, and the trade deficit so persistent, despite the sizable appreciation of the pound against the dollar.

FOREIGN AFFILIATE SALES
US foreign affiliate sales hit a record $3.4tn in 2003, the last year of available data, well in excess of US exports in the same year. Europe accounted for half of total global sales. Sales of US affiliates in Europe totalled $1.8tn, more than double comparable figures for the Asia/Pacific region. Affiliate sales in the UK ($443bn) alone exceeded aggregate sales throughout Latin America.
US foreign affiliate sales in China have skyrocketed in recent years, but from a very low base. Sales of US affiliates in China in 2003 totalled just $57bn, lower than sales to Spain ($70bn) and less than one-seventh those in Britain ($443bn).
Foreign affiliate sales are the primary means by which US and British firms deliver goods and services to each other’s respective markets. British affiliate sales in the US, for example, were almost two-and-a-half times larger than US imports from the UK in 2003. In other words, trade tells part of the story of US-UK commercial ties, foreign affiliate sales tell another.

FOREIGN AFFILIATE INCOME
In terms of profits, Europe easily remains the most important region in the world for corporate America. Over the first half of this decade, for instance, Europe has accounted for 53% of US foreign affiliate income, a proxy for global earnings. Here again, the UK ranks as the most important market in the world for corporate America. In the first half of this decade the UK represented nearly 11% of global US affiliate income. US affiliates in the UK tallied record profits in 2004, with affiliate income totalling $19.7bn, more than five times US affiliate profits earned in China that year.
Similarly, the US is the most important market in the world in terms of earnings for many European multinationals. Profits of British affiliates in the US totalled $19.5bn in 2004.

FOREIGN AFFILIATE SALES OF SERVICES
Service activities are the sleeping giant of the transatlantic economy – an economic force that, if awoken and unbound, would further deepen transatlantic ties and enhance the global competitiveness of both shores of the Atlantic. The service economies of the US and Europe have never been as intertwined as they are today. Foreign affiliate sales of services on both sides of the Atlantic have exploded over the past decade. In fact, affiliate sales of services have not only become a viable second channel of delivery, they have become the overwhelming mode of delivery in a rather short period of time. Nothing better illustrates the ever-deepening integration of the transatlantic service economy.

Europe remains the most important region for corporate America

Europe is the most important market in the world for US foreign affiliate sales of services, just as it is the most important market for US foreign affiliate sales of goods. In 2003, Europe accounted for 53% of total US affiliate sales ($477bn), with Asia (with 23% share) and Latin America (13%), a distant second and third. US foreign affiliate service sales of $113bn in the UK alone in 2003 were greater than foreign affiliate service sales in all of Asia ($105bn) and Latin America ($56.4bn).
By country, the UK, whose various service sectors are most aligned with those of the US, accounted for the largest share of US affiliate sales not only in Europe but also the world.

Sales of services by US affiliates of European firms have also soared over the past decade, totalling $263bn in 2003 versus $86bn in 1994, a jump of 200%, well ahead of the 85% rise in US service imports from Europe over the same period. Leading the way were British service firms, whose US affiliate sales in services amounted to $75bn in 2003, or 28% of total European affiliate sales. In 2003, British affiliate sales of services in the US were nearly three times larger than service imports from the UK, highlighting the role of foreign investment and affiliates as the primary means by which UK and US firms deliver services to each other.

CREATING A FREE TRANSATLANTIC MARKET
The full potential of the transatlantic service economy, however, remains hampered by internal barriers in the US and particularly in Europe. Lack of services reform represents a significant “opportunity cost” to the US, the EU and the transatlantic economy.
All of these numbers add up to one simple conclusion: the European and American economies have become so intertwined that we are literally in each other’s business. Transatlantic markets are in many respects the cutting edge of globalisation. Instead of falsely portraying our commercial relationship as a zero-sum battle for global market share, leaders would do well to harness transatlantic potential to advance key shared interests.

During the Cold War, Americans and Europeans shared an interest in preventing our economic disputes from intruding on our core political-strategic partnership. Today, we share an interest in preventing our political disputes from intruding on our core economic relationship. We certainly share an interest in widening the circle of prosperity to others through multilateral trade liberalisation in the Doha Round. But we share an equal interest in the greater gains to our own economies that could come from deepening the transatlantic marketplace. The transatlantic economy is the freest in the world. But it is not free. A concerted effort to create a truly free transatlantic market could generate considerable dividends in terms of growth, jobs and consumer welfare on both sides of the Atlantic.

Daniel S. Hamilton directs the Center for Transatlantic Relations at the Paul H Nitze School of Advanced International Studies, Johns Hopkins University. Joseph P Quinlan is a Wall Street analyst and Fellow at the Center for Transatlantic Relations. They have written and edited a series of publications on globalisation and the transatlantic economy, including Deep Integration: How Transatlantic Markets are Leading Globalization, and Partners in Prosperity: The Changing Geography of the Transatlantic Economy. This article draws on their latest annual survey, The Transatlantic Economy 2005.