Yet drawing from Roger Y W Tang's *Intrafirm Trade and Global Transfer Pricing Regulations*, Mehrene Laurdee and Tim Koechlin have argued in the latest Journal of Economic Issues vol 33, no 2 that in order to reduce its tax bills, MNE's often shift profits from one country to another, typically by over invoicing imported inputs and under invoicing exported output. Tang notes why MNEs shift profits out of China
1. To recover the cost of investment quickly, to avoid political and currency exchange risks 2. To shift profits to the parent firms before sharing them with joint venture partners in the host country 3. To inflate the cost of tech and equipment transferred to the MNE affiliate to obtain a greater share of equity investment and to increase the costs of fixed and intangible assets for tax purposes [Gabriel Kolko has noted the same practice in Vietnam--rb] 4. To reduce tax liabilities by shifting profits to low tax jurisdications.
Such transfer pricing is also encouraged by the US tariff code as tariffs are only levied on the value added abroad.
They then ask:
"is the size of such underreporting large enough to worry about? The available data suggest that it is, at least for some countries. For example, in 1991, as part of this effort, the Chinese tax authorities investigated the extent of transfer pricing for 15000 commodities and concluded that the transfer of funds out of China through false invoicing added up to $2.7bn, or at the time 27.1% of the total gross value of imports plus exports. (Tang) This implies that the distortion as a percentage of true value added was quite likely greater than 27%."
They also note: "Maquilardoras normally sell their finished products for cost plus a small profit (between 1 to 5% of total costs) In other words, typically a subsidiary of a US MNE would export its product back to its parent firm, reporting value added at just over cost; and the bulk of the cost is typically labor cost. In effect, such pricing practices would guarantee that reported MNE productivity would closely track MNE wages, while true MNE productivity would be much higher. Thus, host and source country ULCs might be reported as equal, but the MNE's true Unit Labor Costs could be substantially lower. FDI would then flow even where average ULC's were reportedly equal."
On the basis of taking this flow of FDI seriously, James Galbraith has constructed a most illuminating theoretical dynamics: "Uneven Development and the Destabilisation of the North: A Keynesian View" in *The Relevance of Keynesian Economic Policy Today*, ed. Phil Arestis, St Martins 1997.
I recommend it highly as a supplement to his book.
rnb