As I reviewed in my first post , the sectoral balance equation for one country is typically written as
One problem with this equation is the definition of (M-X), otherwise known as the external balance. In the world of MultiNational Corporations, is this balance really meaningful? For example the output that corporations transfer between subsidiaries is subject to what is called transfer pricing. It is quite famous that if someone wants to smuggle financial assets out of a company one way is to find a willing partner in another country and who overcharges you while you undercharge him. The output is then sold at market prices and something close to the difference between the “true balance” and the actual transaction values is set aside for the other party. This is of course enormously easier when both parties are in reality the same corporation. As if that wasn’t complicated enough, corporations also transfer intellectual property and financial assets between subsidiaries.
Why would entities systematically charge inaccurate prices to transfer funds out of a country? The primary reasons are capital controls and, in our modern world the most important one, tax avoidance and evasion. It is precisely these sorts of strategies that have made domiciling in another country profitable. This causes some difficulties in doing sectoral balances analysis, particularly in regards to the behavior of the corporation. They also make us systematically misunderstand balance of payments dynamics. It makes an enormous difference whether we are truly running a trade deficit with the rest of the world or whether export and import prices (as well as transfer payments disguised within property, investment good or financial purchases) are being systematically manipulated to hide foreign investment. After all, definitionally a lower current account deficit means a smaller capital account surplus . In recent literature debating the United States Net International Investment Position (the culmination of current account deficits and the revaluation of foreign owned domestic assets and domestic owned foreign assets), this has been referred to as a “black hole”. If the strong form of the “black hole thesis is true”, that the U.S. is actually running something close to trade balance, foreign holdings of treasuries and other low return assets are essentially permitting the continuation of foreign investment. Thus our NIIP may be systematically underestimated. This would help to explain why despite the supposedly large negative NIIP, foreign return on U.S. assets is systematically and greatly lower than domestic return on foreign assets.
Mona Ali, New School Graduate and Assistant Professor at SUNY New Paltz, has two very interesting recent papers on this issue titled respectively "Dark matter, black holes and old-fashioned exploitation: transnational corporations and the US economy." and "Global imbalances and asymmetric returns to US foreign assets: fitting the missing pieces of the US balance of payments puzzle”. She covers many important issues in balance of payments (so please go read both those papers). However, what I want to focus on is her commentary on “systematic” mismeasurement of u.s. trade deficits because of multinational activity:
“These new and rapidly growing types of off-shoring activities may artificially inflate the US deficit. In fact, a declining trade balance might very well be consistent with higher profitability for US multinationals (Milberg 2006; Milberg and Schmitz 2011). Thus, to view the current account balance simply as the ‘passive outcome’ of movements in the capital account – as does a sizable swathe of the contemporary global imbalances literature – is misleading. Godley (1995) debunks financially motivated explanations of the trade deficit because of their disengagement from the disaggregated firm-level decisions that influence the trade balance. However, Godley-type structuralist trade models where a country’s trade deficit reflects a loss of competitiveness also fail to account for international outsourcing.”
This is of course a simplification. There are a great many corporations with a variety of percentages are owned by foreign sectors and vice versa. Ownership of a company’s debt can also involve influence over managerial decisions. Nonetheless there is no satisfactory “shades of gray” definition so here I will be treating plurality or greater ownership of equity shares as a “domestically owned” corporation. If we have to choose between not analyzing domestic ownership of foreign corporations and analyzing them with perhaps an overestimation of the U.S.’s NIIP so be it. Unfortunately, national statistics in a multinational world are always going to be not quite suited to the task at hand.
Nonetheless, there are strong advantages in accuracy this kind of approach provides. First of all, intra-company transfers disappear in this approach. Thus we don’t have to deal with the headaches of trying to figure out the true market value of Disney and Apple’s intellectual property transferred between subsidiaries. Nor do we have to deal with complicated intracompany insurance schemes or, god forbid, financial derivatives. These are still important, however they can no longer affect (at least directly) the financial surpluses or deficits of individual sectors. This also provides a clear why of understanding balance of payments issues. The result of such an analysis for the United States might reveal that
This sort of analysis actually has a long pedigree in post Keynesian economics. In a paper from the 1970s entitled "Financial Interrelations, the balance of payments and our crisis" cites and discusses Victoria Chick’s paper "Transnational enterprises and the evolution of the international monetary system" (this paper appears to have never been published). The strongest statement on this issue comes from foundational Post Keynesian economist Paul Davidson (who also cites Victoria Chick). In a chapter of the first edition of “International money and the real world” entitled "Multinational Corporations and International Transactions." he says:
”In other words, the existence of multinational corporations (MNCs) who maintain production and trading activities in many nations, can affect, via decisions which are internal to the firm, the accounting magnitudes which measure the balance of trade of any nation during any period. These decisions involve accounting transfer pricing transactions among subsidiaries which are chartered in various nations. These transfer prices need not have any equivalent value magnitude in real world markets. Hence, extreme caution must be exercised before interpreting any balance of trade statistics as symptomatic of a fundamental national disequilibrium, rather than an accounting imbalance due, in large part, to decisions of MNCs' comptrollers to take advantage of different regulations or tax laws in various national jurisdictions...National balances of payments have therefore become, in some significant measure, an appendage of MNC decisions on income distribution and liquidity needs within the MNCs”
It is very difficult tell what these modifications to the sectoral balances approach would mean for measurements of balance of payments deficits, surpluses and Net International Investment Positions. This essentially “GNP” conception of balance of payments would certainly reduce the United States NIIP, but by how much is very debatable and is subject to how accurate data on MultiNational corporate activities. It may even be possible, with adequate data, that such a measure would mean a balanced balance of payments. I haven’t yet dug into the data issues so I don’t know how close to such a measure we could get. Michael Hudson’s “Financial Payments Flow Analysis” is a masterful approach to producing a flow of funds balance of payments measure that shares a similarity to what I’m discussing. However, his work shows just how much careful effort needs to be put in such a project and my impression is it has only gotten more difficult since the late 1960s. At the very least, I hope readers keep the complications of MultiNational corporations involved when doing sectoral balances analysis.