Price fixing

His transfer price set a record

Queen Elizabeth sent her first email long before you did. I got that from one of those sites giving details of this day in history, according to which she sent it on March 26th 1976 from the Royal Signals and Radar Establishment. (The Ministry of War used real names in those days, whereas now RSRE is part of something that calls itself QinetiQ.) Anyway, I was looking to find some great OECD-related anniversary that I could write about (the first lip reading tournament held in America?) to justify not reporting on the Annual International Meeting on Transfer Pricing under the auspices of the Tax Treaty and Transfer Pricing Global Forum being held here today and tomorrow.

Transfer pricing is important and interesting, it’s just that, as Brian Atwood, chair of the OECD Development Assistance Committee noted in this post the other day, it’s one of those subjects that’s “founded on concepts that are both technically demanding and arduous to understand and implement”. In fact, delegates to the meeting will be working on how to simplify and streamline the process, since even the experts admit that the rules are complex.

So what is transfer pricing and why does it matter?

Around 60% of world trade actually takes place within multinational enterprises, for example the headquarters in the US paying a subsidiary in India to carry out research or manufacture components. This payment is a transfer price. Transfer prices are used to calculate how profits should be allocated among the different parts of the company in different countries, and are used to decide how much tax the MNE pays and to which tax administration.

They’re also useful to the company itself first, because they can avoid being taxed twice if the various countries they are active in have signed agreements with each other on how to tax MNEs. In most cases, these are based on the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations.

In many cases, they’re calculated using a technique with the deceptively simple name of “the arm’s-length principle”, although some countries, notably Brazil, use other methods.  The ALP states that operations should be priced by comparing them with similar operations carried out on a commercial basis at market prices, as if both parties were independent entities – at arm’s length from one another.

In practice, this can be extremely difficult, particularly in developing countries. For instance, the developing country subsidiary may be the only firm in its particular line of business, so there’s nobody to compare with. Likewise, transactions involving high value-added services or intangible assets like intellectual property may be unique. And in many countries, publicly available information that the tax authorities can use is limited.

Given that there is no simple method for calculating a transfer price, the final value is the result of a negotiation between the company and the tax authority. In an ideal world, this would be based on equal access to information, a shared objective and a “zero sum game” where being taxed in one jurisdiction is offset by an exemption in another.

Of course it doesn’t work like that. Companies want to pay as little tax as possible and governments need tax revenue. There’s a whole international business whose goal is to help companies “manage the level of taxes paid on a global basis at a competitive level” as PwC put it in their prospectus. These international consultancies have more people working on transfer pricing than any national tax authority. Writing in The Guardian, Prem Sikka of Essex Business School, co-author of a paper on The Dark Side of Transfer Pricing, claims that “Ernst & Young alone employs over 900 professionals to sell transfer pricing schemes. The US tax authorities employ about 500 full-time inspectors to pursue transfer pricing issues and Kenya can only afford between three and five tax investigators for the whole country.”

The meeting at the OECD coincides with an initiative from The International Tax Review to ask tax practitioners to vote for who they think are the leading forces in global transfer pricing development. Apart from PwC, there are NGOs like ActionAid, MNEs like GlaxoSmithKline, and multilateral agencies and international organisations, including the OECD. You can vote here.

Useful links

OECD work on transfer pricing

The OECD Observer has good articles explaining transfer pricing in more detail:

Transfer pricing: keeping it at arm’s length

Transfer pricing: a challenge for developing countries

Trade for growth

G7 and BRICS Merchandise trade in US$ billion (Customs data)

Today’s post is from Ian Wood, the UK’s Deputy Permanent Representative to the OECD 

The OECD’s latest merchandise trade statistics provide further proof of tough times in the world economy, showing falls of 0.2% in imports to, and of 1.2% in exports from, G7 and BRIC countries in the fourth quarter of 2011.

But the evidence shows that boosting trade is one of the surest drivers of sustainable growth around. Trade allows firms to expand and – through competition – accelerate innovation and productivity growth.

That’s why the UK published its Trade and Investment White Paper in February 2011. One year on, as Trade Minister Stephen Green has underlined, we’re working hard to realise its goals, including through the OECD and its committees. 

Trade facilitation – rules to simplify import and export procedures – is one area where we should seek to make early progress.  WTO Director-General Pascal Lamy reminded OECD Council that some 50 per cent of potential gains from the Doha Round were to be found in this area. 

We are also optimistic about the work-streams launched following the revision of the Government Procurement Agreement in December of last year at the WTO in Geneva – governments are after all among the biggest consumers of products and services.

Free Trade Areas provide another opportunity, with the EU-South Korea deal alone set to increase UK GDP by £500m, and other agreements are in the pipeline. The OECD is doing valuable work in exploring the potential to take provisions from such regional deals and make them global.

Services is another key area.  Within the EU we are pushing hard for a genuine digital and services single market. We look forward to the OECD’s Internet Economy Outlook and the Economic Survey of the EU in the next few months, as well as the upcoming Services Trade Restrictiveness Index, which will all help reinforce the case for rapid progress.

We want trade to take place in fair conditions. The OECD’s Investment Round Table and Working Group on Bribery are both important in this regard. The UK is committed to ensuring that British firms abide by the rules of our new, state of the art bribery legislation.  We expect others to commit to equally vigorous enforcement.

At the same time, we want to make sure regulation is not burdensome, and are working hard with the OECD’s Regulatory Policy Committee on this. In all of these areas, we look forward to future OECD work, and the contribution it can make to strengthening the case for trade.

Trade and investment should work for developing countries as well as for developed ones. The UK is committed to the African Free Trade initiative, and we look forward to seeing a Continental Free Trade Agreement by 2017. And drawing on the lessons of the OECD’s excellent Aid for Trade work, we invest around £1bn a year in helping developing countries help themselves, including by providing assistance in preparations for key trade negotiations.

So, while figures are pointing down for this quarter, there’s plenty of potential to turn this around.  We’re proud to be working with the OECD to achieve this.

Useful links

OECD work on trade

International trade and balance of payment statistics from the OECD

OECD Insights: International Trade

How slow will China go?

Enjoy it while it lasts

Regular Insights blogger Brian Keeley is in Beijing, from where he sends this post.

You can sum up the hottest question on China’s economic future in just four words: Hard or soft landing.

At the moment, most people seem to think China’s economy isn’t about to hit a brick wall. Yes, the phenomenal growth rate since the 1990s is slowing, but it’s still at a level most mature economies would envy. After a decade in which GDP rose by at least 9% a year, it slipped back to “only” a bit above 8% by the end of last year, according to the OECD. For the next decade, the OECD forecasts annual growth will hover at around 7%.

To some extent, such a slowdown is inevitable as any economy matures – after all, you can only build so many roads, bridges and airports. But some fear it could be a sign of worse things to come – in other words, the much-feared hard landing. As China is now in many ways the engine of the world economy, that would be bad news not just for Beijing but for the rest of us too.

These questions on the mind of speakers at last weekend’s China Development Forum in Beijing, not least that of Dr. Nouriel Roubini – the economist whose all-too accurate forecasts in the run up to the financial crisis earned him the nickname “Dr. Doom”. Given his track record, it probably wasn’t surprising that he saw a hard landing as “possible” but, he insisted, “not inevitable”. To guard against it, he argued, China must undertake economic reforms, most notably to encourage Chinese to spend more and save less.

Dr. Roubini pointed out that China was the only major exporter to avoid a recession in the wake of the financial crisis. That was due in large part to massive programme of investment in things like infrastructure and property development. But, he warned, that’s not sustainable. Indeed, to some extent, the chickens from this spending are already coming home to roost, most notably in falling property prices and signs of a credit crunch as a result of loose lending.

Combine this with weaker demand in China’s export markets, most notably in Europe, said Dr. Roubini, and it’s inevitable that “the model of growth has to change”. That makes reforms essential, he stated, and those reforms must aim to turn the Chinese consumer into a much more powerful driver of the country’s economy.

So, why do Chinese prefer to save rather than spend? There are many reasons, but one of the most important is the lack of an adequate social security net. Fall ill or lose your job in China, and you quickly realize the benefits of having a few yuan under the mattress. There’s a similar problem when it comes to pensions, a major concern for China’s ageing population; the one-child policy means many elderly parents and grandparents will have to rely on just one or two breadwinners for support.

Another factor is China’s currency, which is widely perceived as undervalued, although there’s debate over the scale of this. A relatively weak currency is good for China’s exports, but it makes imports more expensive than they should be, further weakening Chinese consumers’ spending power.

The valuation of the yuan is controversial, but in many respects much of what else Dr. Roubini had to say is not. Just last week, China’s outgoing Premier, Wen Jiabao, said the need for reforms was urgent, while China’s most recent five-year plan focuses a lot of attention on expanding the social security net and on reducing inequality.

Such concerns have been widely echoed in OECD work and were repeated again at the weekend in Beijing. Speaking at the forum, OECD chief Angel Gurría called for a bigger share of profits from state enterprises to go on social spending, and for more resources to go on education and training. Such measures would deliver both short and long-term benefits for workers and the economy, not least in the form of a more highly skilled workforce.

Encouragingly, there may already be some signs that China is beginning to rebalance its economy towards a greater dependency on domestic demand. An OECD report released at the forum pointed out that real household incomes rose by 10% in 2011 (and by more in the countryside), while the share of overall consumption in GDP increased for the first time in a decade, albeit only slightly. Nevertheless, there’s no question that the task ahead will be challenging. As Yang Weimin, a vice-minister for economic policymaking, stated at the forum, “these things cannot be achieved overnight”. 

Useful links

OECD work on China

The OECD’s Chinese-language site – 网站 (中文)

OECD Environmental Outlook to 2050: We’re all doomed

Click to see the book on OECD iLibrary

While we were launching the OECD Environmental Outlook to 2050, a German TV crew was heading for the zoo in Limbach-Oberfrohna to film an earless rabbit, announced as the Next Big Thing after Paul the Psychic Octopus and Knut the polar bear cub. But the poor bunny turned out to be luckless too, since the cameraman stood on it and killed it. We shouldn’t try to read too much into this, but we will since it sums up so neatly the message of the latest Outlook: humans are causing serious and in some cases irreversible harm to nature.

The Scottish poet Robert Burns was prompted to think about these things when he destroyed the nest of a field mouse with his plough. The most famous part of To a mouse is when he talks about what can happen to “the best laid schemes of mice and men”. But he also regrets that “man’s dominion/Has broken Nature’s social union” justifying the ill-opinion that other creatures have of us.

One rabbit or mouse more or less may be no big deal, but the Outlook paints a depressing picture of what’s happening to life on Earth under our dominion. Terrestrial biodiversity is projected to decrease by a further 10% by 2050, with significant losses in Asia, Europe and Southern Africa. Globally, mature forest areas are projected to shrink by 13%. About one-third of global freshwater biodiversity has already been lost, and further loss is projected to 2050.

Climate change will replace agriculture as the fastest growing driver of biodiversity loss to 2050. Without a significant change in policies, global greenhouse gas (GHG) emissions are projected to increase by 50%, primarily due to a 70% growth in energy-related CO2 emissions. Global average temperature is projected to be 3C to 6C above pre-industrial levels by the end of the century, exceeding the internationally agreed goal of limiting it to 2 degrees.

The GHG mitigation actions pledged by countries in the 2010 Cancún Agreements at the UN Climate Change Conference will not be enough to prevent the global average temperature from exceeding the 2C threshold, unless very rapid and costly emission reductions are realised after 2020.

Projections like these are probably familiar to most people interested in environmental issues, but other figures in the book may prove more of a shock, notably concerning health. We may be damaging the environment, but it’s killing us. Today, unsafe water kills more people than all forms of violence, but air pollution is set to become the world’s top environmental cause of premature mortality, overtaking dirty water and lack of sanitation. The number of premature deaths from exposure to particulate matter (which leads to respiratory failures) is projected to triple from just over 1 million today to nearly 3.6 million per year in 2050, with most deaths occurring in China and India.

The absolute number of premature deaths from exposure to ground-level ozone will more than double worldwide (from 385,000 to nearly 800,000). More than 40% of the world’s ozone-linked premature deaths in 2050 are expected to occur in China and India. However, OECD countries with their ageing and urbanised populations are likely to have one of the highest rates of premature death from ground-level ozone, second only to India when the figures are adjusted for population size.

The subtitle of the Outlook is “The Consequences of Inaction”, but the authors show that actions to protect the environment make economic sense too. For instance, global carbon pricing sufficient to lower GHG emissions by nearly 70% in 2050 compared to the Baseline scenario and limit GHG concentrations to 450 ppm (the level that keeps warming below 2 degrees) would slow economic growth by only 0.2 percentage points per year on average. The potential cost of inaction on climate change could be as high as 14% of average world consumption per capita.

As the international media noted, the data and trends the report sets out are grim. But the Outlook also proposes policies, and strategies for coordinating them, across all the domains it covers. The question is whether we will take the actions required. Too often we give the impression that we’re like skydivers whose only plan is to jump from the plane and hope they’ll find a parachute somewhere on the way down.

Useful links

OECD Environment Ministerial Meeting 29 March to 30 March 2012

OECD Environment Ministers will meet in Paris under the theme of Making Green Growth Deliver. They will discuss future priorities for action based on the OECD Environmental Outlook to 2050, which makes a strong case for green growth policies.

Sell the farm: agriculture and poverty reduction

Click to see the book on OECD iLibrary

In 1972, French film maker Louis Malle spent several days interviewing people he met in a large square in Paris. The resulting documentary, Place de la République, provides a snapshot of a country undergoing profound changes as a result of the postwar boom. Then, as now, a significant number of Parisians were not born in the city but “came up” from the provinces.

One of them was a road mender. Malle asks him what it’s like to do such a tiring, dirty, dangerous job. He agrees that it’s hard, but, he points out, it’s much better than working on a farm. He describes his life as a farmboy back in Normandy in the 1940s – the endless chores, the poverty, the lack of opportunity. He left as soon as he could, and never regretted it.

Across the world, millions would do the same in the search for a better life, and the process is continuing. It can be surprising to see how keen people are to quit farming and life in the country for the city. Author Fred Pearce interviewed women working in sweatshops in Bangladesh. Like Louis Malle’s road mender, they had no illusions about their present jobs, but they still preferred having some money and better prospects for their children than the alternative in rural villages. Nazma Akter, a campaigner for garment workers’ rights told Pearce that, poor as they were, “women are becoming an economic force here. This is the first time they have had jobs. They are independent now. They can come and go; nobody stops them. Don’t take that away from them.”

Today, it may be more difficult for unskilled farm labour in poor agriculture-dependent economies to be absorbed by other sectors than it was for, say, European farmers to move into industrial jobs a century earlier. But once the change starts – and, crucially, once people have the relevant skills – the pace is invariably more rapid than in the past. In Korea, agriculture’s share of employment fell from 40% to 16% in just 14 years – a transition which took 53 years in the US and 68 years in the UK.

One way of looking at this process and what governments can do to help is outlined in a new OECD publication  Agricultural Policies for Poverty Reduction, edited by Jonathan Brooks. Change can be seen as a four-phase process for the agricultural sector.

In the early stages of development, agriculture dominates output and employment, and the priority is to “get agriculture moving”.

The subsequent generation of a surplus within agriculture leads to a second period in which agriculture makes a key contribution to growth both directly and via a variety of linkages to other sectors. These linkages range from small-scale local arrangements such as farm households having another source of income off the farm, to participation in global value chains through selling produce to international food processors.

In the third phase, agriculture’s share of national income declines and agricultural incomes fall behind those in other sectors, so the priority lies in helping the adjustment to succeed.

The fourth and final phase is one in which the agricultural sector, including agricultural labour markets, is integrated into the rest of the economy.

Policy requirements vary at each stage, and many of the policies required to improve farmers’ opportunities are not agricultural. Education and health for example may be better investments for rural populations than spending on agriculture.

A number of poor countries, mostly in Africa, are at the first two stages of this development process, and agriculture can account for up to half of GDP and 80% of employment. The book argues that while there may be plausible reasons for governments to intervene in agricultural markets in poorer economies, any short-term benefits from these expenditures should be balanced against those from investments to support long-term agricultural development.

If this development is successful, it will lead to many farmers quitting the sector, so a strategy for strengthening rural incomes should emphasise three development pathways for farm households: improving competitiveness within agriculture; diversifying income sources among farm household members; and, finally, leaving the sector for a better paid job.

This approach is relevant for countries at all stages of development, even if the opportunities vary. Smallholder farming dominates agriculture in most poor countries, and while some smallholders will be able to establish commercially viable operations, others won’t. Every country that has made the transition to a modern economy has seen agriculture’s share of GDP and employment shrink, not because agriculture has become poorer (on the contrary, farmers have become richer), but because other sectors offer far greater prospects. Agriculture can contribute to development and the fight against poverty, but there is no evidence that it can win on its own.

There may be a price to pay in terms of traditional lifestyles and culture, but not all aspects of these traditions are positive. This is one reason why the experience of Louis Malle’s road mender in France or the garment workers in Bangladesh suggests that given the chance, many people living in poor rural areas will leave the farm.

Useful links

OECD work on agriculture

OECD work on poverty reduction

For the people…

Bad governance comes at a cost

Today’s post is from  Brian Atwood, chair of the OECD Development Assistance Committee.

At this year’s Global Forum on Development, I was invited to contribute some remarks on “governance”, a convenient shorthand for referring to the mechanics by which our societies are run, our institutions function, and our public administrations exercise fairness.

In today’s complex and globalized societies, governing implies understanding and applying a multiplicity of complex  rules, standards and agreements. Often these are quite technical, and even incomprehensible for non-experts who are unfamiliar, for instance, with the vocabulary of genetics databanks or nuclear energy. Others hide extremely difficult tasks of interpretation and application behind expressions we’re all familiar with, such as due diligence or bribery. And then there are those, such as transfer pricing, that are founded on concepts that are both technically demanding and arduous to understand and implement.

This is why we need bureaucracies: we need people trained to understand and apply the complex sets of rules that allow our ever-more diversified yet interconnected societies to function. Critics often point out that the great empires of Greece, Rome, China, Persia, or Britain managed to govern vast territories with fewer pen pushers than an average government department today. That may be true, but life is much simpler for an administrator who makes the rules, decides how (and if) to apply them, and can exile, imprison or execute anyone who disagrees. Fortunately today, it is the rule rather than the exception for legislation to hold governments and their administrations to account for how things are done.

At a meeting like the Global Forum, we are all constantly checking our smart-phones for emails or appointments, but we couldn’t have done this without a whole set of international rules and agreements covering everything from access to radio frequencies to taxes on calls from abroad.

Administering such matters is a vital task, like so many that our bureaucrats carry out. A quarter of a century before he published his Inquiry into the Nature and Causes of the Wealth of Nations in 1776, Adam Smith said: “Little else is required to carry a state to the highest degree of affluence from the lowest barbarism but peace, easy taxes, and a tolerable administration of justice; all the rest being brought about by the natural course of things.” Such a view might appeal to members of America’s Tea Party, but it doesn’t work in a world of complexities.

Nonetheless, we shouldn’t forget Max Weber’s warning issued over a century ago: bureaucracies, for all their benefits, can threaten democracy if they become an end in themselves rather than a means for the rest of us to carry out our business in the most practical, efficient way.

In Weber’s day bureaucracies were still essentially national, but even in his lifetime that began to change with the founding of the International Telecommunication Union in 1868, the Universal Postal Union in 1874, and the Intergovernmental Organization for International Carriage by Rail in 1893. When Weber died in 1920, there were 200 international diplomats and civil servants in Geneva; today there are some 40,000 and many more tens of thousands are to be found the world over, including in Paris where the OECD – one of the many organisations that oversees complex global standards – has its headquarters. These organisations exist because today we know that a modern society needs well-functioning public institutions to work well and fairly.

Yet if this is the case, why have our efforts to promote these lessons among developing states shown a low success rate? What is missing?

There is strong evidence that institutional reform, a core factor in development, has not succeeded when it is imposed from outside. In The Globalization Paradox, Dani Rodrik asks how young developing democracies can survive given all the obstacles built-in to global trade and financial regimes. He argues that when the social arrangements of democracies clash with the international demands of globalisation, as they inevitably must, national priorities should take precedence.

Yet our development agencies and international organisations, including OECD members, constantly fall short on an essential ingredient of the development recipe: local “ownership” by developing countries of their own processes and priorities, as well as of participation and accountability.

We invested in the transition from colonialism and were heavily engaged in the transition from communism, yet the wave of revolt that swept over the Middle East and North Africa saw us taking only baby steps. The arrest of NGO officials in Egypt threatens to scare us away. It should not. These organisations were in the country because Egyptians wanted them there. The National Democratic Institute, an organisation I once led, held seminars with 15,000 Egyptian participants, including the Muslim Brotherhood. They worked with Egyptians and it was Egyptians who ended up in court when the government cracked down, not the Americans who got all the media attention.

The December 2011 Busan Partnership for Effective Development emphasises that “promoting human rights, democracy and good governance are an integral part of development efforts.” This declaration was not just another agreement among governments. Civil society played a central role, with over 1700 CSOs represented at the High Level Forum that shaped the partnership, engaging fully in the agreements about how to make development more effective. They worked side by side with developing countries, parliamentarians, the private sector, foundations and non-OECD donors, all of whom today are helping to create a truly open, inclusive space for moving forward.

It wasn’t easy to get so many different groups to agree on shared principles; but debate is obligatory if we want to generate the broad commitment that is the foundation for building budget systems, tax systems and efficient public administrations under the control of democratic institutions with engaged citizens. This reflects one of the key aspects set out in the Framework for an OECD Strategy on Development adopted by OECD ministers in May 2011:  “Integrate, where appropriate, the diverse perspectives, views, and realities of developing countries in OECD analyses and policy advice to deepen shared understanding of the alternative impacts of different policy options”.

Timothy Besley and Torsten Persson’s Pillars of Prosperity: The Political Economics of Development Clusters suggests what this means in practice. They show that countries combine effective state institutions, absence of political violence, and high per-capita incomes when they have cohesive political institutions that promote common interests, guaranteeing the provision of public goods. The absence of common interests and cohesive political institutions can explain why fragile states are plagued by poverty, violence, and weak state capacity.

To become part of the solution, and not part of the problem, the OECD’s development strategy must embrace this self-evident truth. Only in this way can it prove Kafka wrong when he said to Gustav Janouch: “Every revolution evaporates and leaves behind only the slime of a new bureaucracy. The chains of tormented mankind are made out of red tape.”

I am confident that we can learn the lessons of both our successes and our failures.

Useful links

OECD work on governance and development

Key OECD publications and documents on capacity development