National accounts statistics, such as GDP, are designed to measure economic activity taking place in a country. Multinational corporations, on the other hand, operate across many countries. In pursuing global profits, the affiliates of these multinationals often engage in transactions intended to reduce the multinational’s overall tax burden, and some of those transactions arguably distort national economic statistics.
One of the most important methods of tax avoidance is locating intellectual property in low-tax countries. For example, a multinational corporation may conduct research in the United States that results in a promising patent. The multinational then transfers the intellectual property to its affiliate in a low-tax country such as Ireland. Because it is difficult to value intellectual property, the multinational is generally able to report an artificially low value for the transfer. Subsequently, the Irish affiliate is able to collect the royalties or license fees associated with the patent, paying corporate income taxes at the lower Irish rate.
With the growth of the digital economy, intangible knowledge products have become relatively important. The international standard for national accounting, the System of National Accounts 2008, recognizes as assets the intangible knowledge products that result from research and development, software development, or creation of artistic originals, and recognizes the payment of the associated royalties and license fees as sales of the services of intellectual property. These assets differ from traditional tangible capital in that they don’t need to be legally located where they are used in production. While this separation of legal ownership from use in production reflects an underlying legal reality, the result is that output from the use of intellectual property may be geographically divorced from other aspects of production, such as job creation. Thus, these conventions arguably distort the GDP statistics by boosting GDP in low-tax countries without necessarily using it in ways that provide jobs and income to the residents of that country.
A prominent example of this was reported last July in the Irish national accounts, when the Central Statistical Office of Ireland revised up the 2015 annual growth rate of GDP to an astonishing 26.3 percent. The Central Statistical Office explained that a small number of large multinational corporations had relocated their intellectual property assets in Ireland. The revision led some Irish observers to question the reliability and usefulness of the official GDP figures.
Some national accounting experts, such as Silke Stapel-Weber and John Verrinder of Eurostat, have argued that the fundamental conceptual framework is sound, but statistical agencies need to provide more details to allow users to distinguish purely domestic activities from the activities of multinational corporations. On the other hand, Dylan Rassier, my former colleague at BEA, has developed some alternative conceptual treatments using either a method of formulary apportionment, which requires the income to be spread across tax jurisdictions, or by refining the concept of residence to focus less on legal and tax rules and more on meaningful economic activity.
Intellectual property is only one of a number of globalization issues affecting GDP and the national accounts. A long-standing measurement problem is transfer pricing, which occurs when a subsidiary or affiliate of a multinational corporation in one country sells parts or partially fabricated goods to an affiliate in another country. They will need to declare their value for the import and export statistics, but if these parts are only produced for use within the multinational, the corporation has quite a bit of discretion to set the price for the transaction in a way that shifts profits to the lower tax country. This strategy also tends to artificially boost the GDP of the low tax country and suppress the GDP of the high tax country.
Other globalization measurement issues are related to the currently hot topic of bilateral trade balances. Economists have long recognized that bilateral balances may provide a distorted picture of the impact of trade on the two countries. One reason is that a country’s exports may not accurately reflect its value added (or GDP) in producing the product if the goods are built using inputs from other countries. Researchers have been using input-output techniques to try to better analyze the location of long global supply chains.
In 2018, the Conference for Research in Income and Wealth plans to hold a conference on issues related to globalization and the measurement of national accounts. I’m a co-organizer of this conference, along with David Richardson, Peter van de Ven, and Nadim Ahmad. The call for papers is still open; it closes on March 1. We’re looking for papers that make suggestions for how to better organize and analyze statistics to understand the impact of globalization on national economies. If you are doing research in this field or have ideas that you’d like to develop into a research paper, I encourage you to submit an abstract.
Dear Brent,
I cannot be more happy in readong this short promising text about this incredible Irish case. I am preparing a presentation for a conference in Seoul, in mid-March, in which I will propose, in the line of Dylan Rassier (whom I respect and appreciate very much), another solution avoiding to bias GDP. In my view, the concept of GDP remains, even in globalization, perfectly sound. Simply, we need to adopt conventions for classifying the transactions of MNEs that are based on economical facts and not on legal arrangements. I will send you my Power Point when it will be ready. We need to mobilize statisticians to reflect on this. I hope your conference will help in this auto-reflection.
François, Thanks. I agree and wish you the best with your Seoul presentation.
One of the things I’ve wondered about is the international transfers of services.
Goods have to go through customs so we have good data on exports and imports.
But what about services that arrive via the internet in your office without every passing through customs. How do we know that data collectors have a handle on such international transactions >
In the United States, BEA is responsible for estimating international transactions in services. In order to prepare these estimates, they conduct surveys of the companies that are engaged in selling services internationally (see BEA International Economic Accounts). These data are difficult to collect and there will undoubtedly be some data gaps.
Information on transfers of intellectual property among affiliates of multinational corporations are probably even more difficult to collect, and statisticians are generally forced to rely on what’s recorded in the corporation’s financial accounts, which tend to underestimate the value of these transfers.