Wednesday, September 10, 2014

Changing international trade patterns

MR nudged me into reading the work on the changing nature of international trade. This paper by Pol Antras and Stephen Yeaple captures the change starkly,
In 2000, for instance, the top 1% U.S. exporters accounted for 81% of U.S. exports. The involvement of these large firms in the world economy goes well beyond the mere act of selling domestically produced goods to foreign consumers. According to 2009 data from the U.S. Bureau of Economic Analysis, the sales of domestically produced goods to foreign customers account for only 25% of the sales of large American firms.The remaining 75% (nearly U.S. $5 trillion) is accounted for by the sales of foreign affiliates of American multinationals. Furthermore, data from the U.S. Census Bureau indicates that roughly 90% of U.S. exports and imports flow through multinational firms, with close to one-half of U.S. imports transacted within the boundaries of multinational firms rather than across unaffiliated parties. 
The out-sized role of multi-national corporations in international trade is highlighted by the table. Foreign affiliates of multi-national firms take up a large share of the sales, R&D expenditures, and exports of the host country.
As Antras writes, these trends hold for the US too,
The first thing that one notices when using U.S. related party trade data is how pre-dominant intra-firm transactions are in US trade. In 2011, intra…-firm imports of goods totaled $1056.2 billion and constituted a remarkable 48.3 percent of total U.S. imports of goods ($2,186.9 billion)... On the export side, related-party exports are also pervasive, with their share in total US exports ranging from 28 to 31 percent in recent years... (in 2011) the share of intra-firm trade reached a record 89.6 percent for U.S. imports from Western Sahara... the share of intra-firm trade still varies significantly across countries, ranging from a mere 2.4 percent for Bangladesh to an astonishing 88.5 percent for Ireland.
Clearly, the case for placing MNCs at the center in any analysis of international trade is now compelling. If 92.3% of Ireland's exports come from MNCs, with a few firms constituting the dominant share, then it stands to reason that the Irish government be able to closely monitor their activities. In particular, the monitoring of transfer pricing, or the accounting allocation of firm profits across the different geographical jurisdictions where the firm operates, assumes great significance.

Consider the incentives. While notionally, the parent firm and its affiliates are supposed to conduct arms-length transactions, the tax accountants of the parent firm have the exclusive mandate of minimizing the entire corporate group's tax outflows. In other words, its job is allocate profits across the different entities, consistent with prevailing rules, in a manner than minimizes the tax liability in each jurisdiction. Typically, they end up working accounts to transfer profits from high tax jurisdictions to low tax ones. See this, this, and this.

In the absence of effective regulation, the acrimony and controversies that arise from practices like under-pricing of imports and under-pricing of exports, 'Double Irish and Dutch Sandwich', and 'tax inversion' are only likely to worsen. Even more importantly, it is estimated to cost developing countries around $160 bn in annual taxes evaded. India's sharply rising trade volumes means that its transfer pricing losses are likely to be substantial. For those in India campaigning to recover black money stashed abroad, plugging the far bigger annual leakage from transfer pricing may be a more effective and realistic objective.

Unfortunately, no country, on its own, including the US, is in a position to crackdown on such practices. Unilateral actions are unsustainable not only because such actions require international co-operation, but also because MNCs have the advantage of exiting such countries. But, in the prevailing international environment, the consensus required to achieve an agreement on this issue look remote. A more realistic campaign, one which a country like India could assume leadership, would be to increase transparency through greater disclosure of intra-firm pricing and profit allocation across jurisdictions.   

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