Question

Are Multinationals a Market Failure?

1. How do the following topics: profit shifting, offshore tax havens, and money laundering relate, in your opinion, to the development of multinationals?
2. Why haven’t employee wages increased in a manner similar to CEO salaries?
3. If monopoly was considered a market failure, requiring government intervention, is it possible that multinationals are in fact another form of market failure?
4. Some people argue that the problem is globalization, that if we were more isolationist, as some of President Trump’s trade policies (that we looked at the second week) seem to be trying to achieve, we would be better off, we, meaning Americans. Is globalization really the problem? Or have we just encountered another market failure? If so, who and how can we fix this? What do you think? Or do you not even see it as a problem? If not, explain why not.

Answer 1

Part A)

Multinational companies are those, which have their operations run in more than a single country i.e. they sell goods and manufacture them across the globe with a view of reducing costs and running up and above local demand. For example, companies such as Apple, design their products in the United States of America, produce the same in China and sell the goods and services across the globe.

We need to now look at the terms which have been raised in this question and analyze their impact on these companies and what most of these companies follow and increase their earnings.

Profit Shifting & Offshore Tax Heavens:-

Multinational Companies across the globe, use profit shifting which is a way of reducing tax liability and turning it into an expense. These companies have their operations running in both tax heavens as well as in countries where tax rates are extremely high. They use intellectual property sales mostly as a method to reduce their tax liability and earn better profits which has largely contributed to their profits and emerged as one of the key challenges for governments as it limits their tax collections.

For example, if a company happens to operate in both a high tax country as well as a low tax country, it can easily sell its intellectual property to a sub division of the company operating in a low tax country and charge royalty against the same.

In the high tax country the same would be shown as an expense and would allow for tax deductions while the income in the low tax country would allow them to reduce their liability. India is an example of a country that charges high tax rates, whereas Bermuda has extremely low tax rates. Operating in both countries allows companies to benefit from selling intellectual property within the firm but with different identities in both countries.

Money Laundering:-

Money laundering is the generation of illicit money through transactions which otherwise would not be legal. In the current scenario as explained above, if the intellectual property is rather fake in existence and is not utilized in real life, the transaction between the company and its subsidary can be considered to be money laundering of one for or another.

The rise of Multinationals has been attributed to the considerations explained above and the fact that they would go to any extent to reduce their cost of operations. Even though illicit transactions have been reduced over the years due to Multinational companies following stricter ethics and norms, it is yet a problem for many governments to deal with.

Part B)

It is well argued across the globe, that employees working in the private sector are highly underpaid while comparing their salaries to CEO's and people with other designations in the top management. The core reason for this is that companies expect CEO's to cut down costs or to bring in significant income into the company. On the contrary the lower and middle level managers are expected to only have control over day to day activities which they believe does not bring in significant revenue to the firm.

Companies believe that strategic planning has more importance than smaller jobs which do not have similar kinds of complexities. Also there is a significant gap in demand and supply of such labor. The supply of low skilled jobs is much higher than its demand. On the contrary the demand of CEO's is much higher than its supply thus the difference in wages exists.

Part C)

Monopolies were considered to be market failures, primarily because of the way in which they controlled the market place and were the only company which the consumers could reach out to if they required goods or services. This meant that with only one seller in the market place, the price of the goods would always go unchecked and the company would turn complacent towards its users.

Multinational Companies however today are rising in number and face tough competition within the industry, because of which the need to innovate and improvise on prices happens on a daily basis. For example, in the smartphone market, numerous players such as Apple, Samsung, Xiaomi etc exist and they sell their products with constant innovation and development. Thus these do not lead to inefficiency, but rather have caused healthy competition in the market. Yes, the entry and exit into such markets is tough because of the required levels of investment, yet monopolies do not exist and companies need to continuously improvise in order to maintain market share.

Part D)

Moving forward, when we look at the concept of globalization which is widely criticized by some sections of economists of being a reason towards having such societies, we need to understand the demerits of localization and the benefits that globalization has caused. When the Trump administration wants to follow protectionist measures, it is important to note that other countries would have similar tariffs on us which would lead to lack of demand and supply.

The overall demand in the United States is not sufficient for these companies to grow and make profits like they already are. For example if companies as big as Apple and Microsoft face high tariffs in other countries, they would be forced to operate in a less healthier economic environment and their profit margins would be significantly low which is bad for both the companies as well as the overall economy at large.

Thus, we can conclude by saying that protectionism and localization would limit firms operating in the United States to be able to sell their goods and services in other countries which is bad for the economy as a whole.

Please feel free to ask your doubts in the comments section.