Too Global To Be National?

US multinationals fatten their bottom lines by arbitraging wages, taxes, and regulations across countries.

In its heyday, what was good for GM was claimed to be good for America. Today, in an era of multinational corporations, it is hard to claim what is good for US-based multinationals is good for America. Most of their growth in recent years has come from their foreign subsidiaries. Net sales of foreign affiliates of US multinationals increased from 20% to more than 25% of US GDP between 1995 and 2006, but the share of exports of all goods and services from the US stayed almost constant. The share of domestic output generated by US multinationals shrank from 21.8% of GDP in 2000 to 18.5% in 2005. In the same period, US multinationals increased employment overseas while cutting jobs at home by almost equal percentages (BW 3/10/2008).

To fatten their bottom lines, US multinationals have been actively engaged in global arbitrage in wages, taxes, and regulations. In other words, they outsourced production to where wages are low, parked profits where taxes are minimal and relocated where regulations are lax.

US multinationals are simply following the logic of a free market economy. Specifically, there cannot be more than one set of wages, taxes and regulations in an open global economy over and above the cost of overcoming some natural barriers. If the wages of one region or country is higher than those in another, jobs will flow to the lower-wage region until the gap is eliminated. But gaps in taxes and regulations are more resistant to change due to political inertia. So the most mobile factors can reap outsized reward from tax and regulation arbitrage for a long time. Because capital is the most mobile factor, arbitrage thus ends up inflating the share of profits.

Besides capital, intangible intellectual property such as copyrights and patents are also easily transferred to low-tax countries where taxes on income from copyrights and patents are close to zero. Since licensing fees make up about 3/4s of Microsoft’s annual revenues, transferring its licensing operations to low-tax countries such as Ireland could result in substantial tax savings. Indeed, Microsoft’s effective world-wide tax rate dropped to 26% in 2004 from 33% the year before because nearly half of the drop was due to “foreign earnings taxed at lower rates.” Other US multinationals whose products are heavily based on intellectual property such as technology and pharmaceutical firms have also set up units in low-tax countries to shield their profits from the punishing 35% US corporate profit taxes (WSJ 11/7/2005). US taxes on such profits parked overseas can be indefinitely deferred until they are repatriated home. But they can still be counted as earnings in the corporate balance sheet. So US and foreign shareholders can enjoy paper capital gains of their stocks at the expense of US Treasury tax revenues.

US multinationals still pay higher wages and employ more skilled workers than comparable domestic firms. And they still account for the bulk of private-sector R&D and a big chunk of corporate charitable contributors (BW 3/10/2008). But their footloose capabilities will severely moderate the effectiveness of domestic fiscal and monetary policies. And their corporate interests could no longer be assumed to align with that of the US economy.

In some sense, US multinationals dealing with mature products in saturated domestic markets may not have much choice but to cannibalize their own domestic markets and expand overseas markets. But the outsized gain of multinational corporate profits at the expense of wages may not be sustainable as the global asset bubbles are but a reflection of the difficulty of recycling dollar profits (See Bubble Economics and Dividing the Pie).