The importance of pricing: a microeconomic theory of multinational behaviour under trade barriers
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This thesis develops a theoretical model of a multinational enterprise (MNE) consisting of two horizontally integrated firms, both monopolists in their own markets. The MNE is assumed to maximize total profits; hire labor and capital in competitive markets; own a scarce factor on which monopoly rents can be earned through trade; and price discriminate between countries. When cost and revenue differentials exist between firms profit maximization requires intrafirm trade, the direction and volume of trade reflecting these differentials. The value of trade depends upon the transfer price. The thesis discusses the effects of various transfer prices (average cost, marginal cost, fair market value) on factor and product markets; the welfare and efficiency gains from trade; the division of gains among producers, factors, consumers and governments; and the National Incomes and Balance of Payments of the host end home countries. The MNE's behaviour is studied under 1) free trade, 2) a tariff, 3) a profits tax by the home government, 4) taxation of MNE profits by both governments, 5) both taxes and tariffs. Chapter VII broadens the analysis to include vertically integrated multinationals and compares results. The main conclusion is that the theory of intrafirm trade differs from standard trade due to transfer pricing and joint profit maximization . As a result free trade may not maximize world welfare nor bring unambiguous gains to all parties. Tariffs can cause trade expansion and injure the import-competing industry with certain transfer prices. Corporate tax differentials are as much a barrier to free trade for the MNE as tariffs. A pure profits tax on a multinational monopolist is generally nonneutral since international tax neutrality requires equal actual tax rates or a special transfer pricing policy based on marginal export cost under free trade. The most neutral form of tax relief at present is the tax credit although internation equity can be affected even if tax neutrality is achieved. Tax policy is not impotent in a world of taxes and tariffs. Fair market value pricing may cause more distortions than marginal cost pricing. In short, transfer pricing and multinational intrafirm trade have important implications for governments, consumers, factors and producers that are only just being understood. This dissertation is one such attempt.