Multinational Enterprises: A Short Story of Globalization Engines
Di Francesco Laureti
Unbundling, offshoring, tax competition. An economic entity encompasses all of these concepts, and, though quite unbelievable, it is neither a State nor an international organisation. In fact, we are focusing on multinational enterprises and their global power. Whilst threatening Western middle class economic steadiness -or, rather, their conviction that developed countries are to benefit from globalisation, not to be harmed-, MNEs have experienced an impressive rise in economic power since the early 1980s. There is clear evidence that such prominent actors on the international stage have been strongly affecting the world’s trade market. To start with, for us to draw an outline of our analysis, we will point out some significant numbers.
First, $482 billion, that is Walmart’s annual revenue in 2016. Surprisingly huge, it outperforms the raising-revenue abilities of 181 countries out of 193 in the UN system. Second, the 2007 report from the research network European Firms and International Markets (EFIM) shows that in Europe the top one percent of exporters accounts for no less than 40 percent of aggregate exports. In other words, the so-called ‘superstar’ exporters drive aggregate exports in Europe. Finally, a meaningful indicator of this widespread phenomenon is the rise in number of MNEs relatively to States all over the world. In 1984, among the 100 biggest economic entities, 55 were States and 45 firms; in 2001, 29 were States and 71 firms; in 2015, the 100 biggest companies in terms of assets equalled US GDP. Now that we have shown a few facts about multinational enterprises, we can provide a deeper insight into the topic.
Offshoring is an inherent practice of multinational enterprises. Through offshoring, the production process is either partly or totally done outside the domestic operating base, still it may be kept into the firm. Therefore it implies the existence of a network of foreign affiliates. For instance, in the aerospace industry, some hugely fragmented companies are Airbus and Boing; in the automotive, European producers benefit from intermediate components imported from Eastern countries; with regard to electronics, Apple takes advantage of the cheap labor cost in China. Consequently, considering that we call Value Chain “the full range of activities that firms and workers do to bring a product from its conception to its end use and beyond” (Gereffi and Fernandez-Stark, 2011), we can observe that these activities turn out to be accomplished within the same firm or split among different firms. It is the so-called global value chain (GVC).
How to Deal with GVC mania
In recent years, economists have suffered from a serious GVC mania, meaning that, whilst the academic literature has been highlighting the role of MNEs in international trade and finance, only few researchers have tried to illustrate how multinational enterprises and global value chains are intertwined. Although the academic community as a whole might agree that MNEs boost the economic growth, foster employment by creating new jobs, promote foreign direct investments and open new pipelines for know-how transmission; empirical evidence is limited to a small number of countries and focused on the manufacturing sector. In a recent article, Koen De Backer et al. (2019) points out some remarkable advancements in this research field were provided by the Analytical AMNE Database. This “includes data on output, value-added, exports, and imports of intermediate inputs — which account for more than 50% of trade in the last decade — of foreign affiliates in host countries”. It is worth having a look at the main results.
- “MNEs and their foreign affiliates account for one third of the world’s output and GDP and two-thirds of the international trade”. Though having smaller shares in terms of inputs of intermediate inputs, MNE headquarters were responsible for 34% of global exports in 2016
- “Differences between foreign affiliates and domestic companies are due to differences in production technologies but also because of the specific roles of MNE affiliates”. While some affiliates aim to reduce transportation costs, others provide “goods and services that are used as inputs for production activities within the MNE network in other countries”. In fact, domestic companies are found to be smaller, less productive and invest less in R&D
- “Contrary to traditional wisdom, foreign affiliates have strong backward and forward linkages with domestic companies, including SMEs.” When looking at data, we can observe that more than a half of domestic intermediate consumption is provided by non-MNE’s. Nevertheless, foreign affiliates operate in host countries as consumers as well as suppliers. To this regard, “about two thirds of the production of foreign affiliates feed into domestic value chains”
- “MNEs are believed to be important drivers for the international fragmentation of production within GVCs.” We might go further and explain that offshoring of factories fosters know-how offshoring, meaning that GVCs operate like pipelines that allow knowledge to flow across borders (Baldwin, 2016)
In the end, the analysis raises several questions about policy implications. The current debate on the international stage focuses on taxation and profit shifting, thus putting on the table a real challenge in setting rules.
Tax Competition
The issue of a minimum tax rate to adopt through an international agreement has been addressed very recently. Since classical economic theories assume that there is no mobility of capital between countries (e.g. David Ricardo’s comparative advantages), academic research did not deal with tax competition for too long. As capital mobility has been increasing, governments tend to reduce tax rates to attract capital in their countries, whereas MNEs can benefit from their global organisation to arbitrate between tax rules. Therefore foreign profits are, most of the time, taxed at a lower rate than domestic profits. It’s nothing but a cost-benefit calculation. MNEs can easily draw their strategic plans thanks to transfer pricing or through domestic affiliates that borrow to the foreign, so that debt decreases domestic profit. Thus it’s worth having a deeper insight into this issue.
For us to understand what is at stake, we might take into account the several attempts to build up an effective European fiscal union. For instance, in accordance with EU legislation, the Irish tax treatment of Apple was judged to be illegal by the European Commission in 2016. There is clear evidence that, “between 1985 and 2018, the global average statutory tax rate fell by more than half, from 49% to 24%”, as Thomas Tørsløv et al. (2018) writes. While, along with standard explanations, globalisation encourages countries to engage in a hard competition for productive capital, the latest scientific research, through innovative methods combining pre-tax corporate profits and wages, provides interesting findings.
First of all, since “today’s largest multinational companies don’t seem to move much tangible capital to low-tax places, […] but avoid taxes by shifting accounting profits” — i. e. “Google Alphabet made 19.6 billion in revenue in Bermuda […], where it barely employs any worker nor owns any tangible assets” -, this method should lead to a better comprehension of how MNEs condition economic policy-making. When we look at these results, what clearly emerges is the huge gap in the ratio of pre-tax corporate profits to wages between local and foreign firms. If the ratio for local firms in tax heavens is around 30–40%, for foreign firms in the same tax heavens it reaches striking percentages, as an example 800% in Ireland. Then, focusing on the Eurozone, we observe that “tax avoidance by multinationals reduces EU corporate tax revenue by around 20%.” That is to say that the governments of the EU are experiencing a major loss in tax revenue owing to profit shifting. In short, there are good reasons for the incoming EU Commission Vice-President Margrethe Vestager to keep on struggling to catch the ‘missing profit of EU member states’. After all, it is a fight for justice and equity, thus for every single European citizen.
