The Loop Hole

Firms become multinational corporations in an effort to find the cheapest way to make a profit. Author Richard E. Caves summarizes this idea as the “transaction-cost” approach, where dispersed plants fall under common ownership and control, rather than trade with each other because it is more cost efficient for the firm to own plants in different locations. This approach is used in horizontal integration (producing the same products in different countries), vertical integration (making inputs in one location to go into another plant’s outputs), and offshore procurement by firms, which involves carrying out labor-intensive stages of production at foreign locations with low labor costs. Firms are flexible and are able to move across boundaries in the long run because all costs are variable costs. For example, if a firm believes it can make a greater profit by seeking a lower tax rate in country A over country B then the firm will most likely move to country A. This type of a scenario where incentives are involved for firms; whether it is low taxes, low labor standards, or low environment standards, create market failures where firms have no incentive to provide the social equilibrium quantity rather only the profit maximizing quantity. This forces citizens to subsidize private firm operations by paying for any clean-up costs associated with pollution as well as any deductions that corporations are receiving by writing off their assets in another country.

This is where government regulation must be used to align private incentives with social benefits and costs. One country which is trying to do his part to make sure multinational corporations are paying their fair share of taxes is Canada. (ARTICLE) The Canadians have recently issued a Anti-Tax Haven Initiative to make sure that a fair burden of taxes is assessed to the multinational corporations. Canada’s current tax rules allow multinational corporations to avoid paying taxes by getting a double deduction for a single expense relating to a foreign investment. Furthermore the additional tax revenue generated through the Anti-Tax-Haven Initiative will be used to further reduce business taxes in Canada; and will be used to appoint an advisory panel of experts in the near future to look for ways to further improve the fairness and competitiveness of Canada’s international tax system.

The idea of competition limiting abuses by multinational corporations is something Stiglitz examines in his chapter. He notes that corporations threatened to move elsewhere when countries try to impose stricter tax or environmental regulations. However if a perfectly competitive market is present then barriers to entry are removed and a company’s decision to move does not effect the national economy as another company takes its place. When there is a lack of competition, the potential for abuses by multinational corporations grows much worse. Furthermore Stiglitz desires reforms, such as the Canadian reform, that focuses on laws governing corporations. Although this is a great idea it will be almost impossible to implement and enforce. It is hard enough to get two countries to agree on trade policy, let alone get hundreds of countries to agree on global laws for a global economy. What is more likely to curb the influence of multinational corporations is to find away to align private interests with the social interest. By providing companies incentives to invest in a developing nation, or produce less pollution, one is able to reach the social equilibrium of goods produced and sold without forcing the firm to incur greater costs.