Lesson VIII Domestic Economy and External Transactions - revisited

Transcription

1 Lesson VIII Domestic Economy and External Transactions - revisited Domestic economy revisited Non-residents ownership of land and other natural resources Branch of multi-nationals & multi-territory institutional units SPEs Holding companies Head office External Transactions revisited Merchanting and Goods for processing Global Manufacturing Types of producers At this point, we will break away, for the time being, from our discussion on sequence of accounts and turn to certain issues relating to cross-border flow of goods & services and primary income that have emerged with the process of globalization in the recent years. The definitions and concepts relating to domestic economy and external transactions were introduced in the basic level course as well as reviewed in Lesson I of the present course. In this lesson, we will take up the key issues of external transactions relating to the changes made in the 2008 SNA. We will discuss the issues relating to cross-boarder flow of goods and services in some detail in this lesson and those relating to flow of income and transfers in latter lessons. With globalization, several types of cross-border production and distribution arrangements, have evolved that drew special attention of the experts while putting together the 2008 SNA. These include: (i) outsourcing production-related operations wholly or partly to affiliates or to unrelated entities in different countries. Often these arrangements are referred to as global manufacturing; (ii) re-exports, which can be very significant in economies that are international centers for trading, (iii) transshipment, and processing that does not change the physical form of the goods (such as packing and labeling). (iv) goods under merchanting, and (v) manufacturing services on physical inputs owned by others.

2 In this lesson, we will discuss these cross-border transactions in goods and services and examine the implications of the related recommendations of the 2008 SNA on compilation of NAS. First, we will take a closer look at what constitutes a domestic economy and its institutional sector, particularly in the context of growing presence of multi-national corporations in domestic economies. Domestic economy revisited Recall the definition of an economy. It states that a domestic economy is constituted of all the resident institutional units of the economic territory and the residents are those who have their centre of predominant economic interest in the economic territory. Centre of predominant economic interest in an economic territory means that the institutional unit should have some location, dwelling, premises within the economic territory an intention to continue indefinitely or over a long period of time (operational definition - one year or more) for carrying out economic activities and transactions on a significant scale. The 2008 SNA clarifies that (i) owners of land, buildings & immovable structures and (ii) extractors of sub-soil resources are always deemed to have a centre of economic interest in the country where they are located. Immediate question that arises is what if a non-resident owns immovable property in the economic territory of the domestic economy? Non-residents ownership of land and other natural resources For national accounts, a notional resident unit is identified when the (immovable) assets of the following kind are owned by a non-resident in the domestic territory: land, buildings, structures and other improvements on that land, leases of land for long periods, and ownership of natural resources other than land. This notional resident unit is treated as a kind of quasi-corporation. This treatment becomes necessary, since all land and other natural resources are always treated as the assets of the economy in which they are located. Thus, the notional unit is assumed to have the ownership rights on the immovable assets with an equity liability, same as the value of these assets to the legal non-resident owner. For example, when a person residing in a country B, owns a farm house in country A (which has a value of say 200,000, and fetches rent & rental of 20,000 per annum), a notional institutional unit is created in country A. The notional resident unit in country A owns the asset; receives the rent and rentals of 20,000 per annum, accruing to the house; and holds a long-term lease to use house. The legal owner in country B owns the equity worth 200,000 in the notional resident unit and receives a property income of 20,000 per annum from the notional resident unit. Intermediate-Level 2 Reading material

3 When individuals change their economy of residence, there are changes to the status of the assets they own and liabilities they owe. While a notional unit is created that is deemed to own immovable assets legally owned by the individuals, the financial assets & liabilities move with the individuals from country of origin to the destination country. These changes are recorded as reclassifications through the other changes in volume account. Because of the treatment of having a notional resident unit for ownership of land by non-residents, new notional units may be identified as a result of changes in residence of the owners. [Refer 2008 SNA, 4.49 & 4.50]. Box 8.1 Intra-corporate Transactions of the MNEs There are aspects of MNEs operations that give rise to measurement problems for national accountants relate to internal accounting procedures of the MNEs. Driven by objectives of profit maximization, they arrange their operations to minimize taxes and thus maximize their company-wide global after-tax profits, and not their profits in each of the countries in which they operate. They allocate resources, price intra-company transactions, and bill transactions in a manner that is designed to reduce their global tax burden. For this purpose they indulge in Offshoring of royalties and licenses: by establishing foreign affiliates (called royalty and license company) and transferring IPPs to them to minimize tax payments. Outsourcing and offshoring of intermediate services Misleading transfer prices Supplier substitution. As a result, national accounts measures based on MNEs business records may not accurately reflect the underlying behaviour of the real economy in the countries where they operate. These practices affect estimates of GDP, but perhaps not the GNI. For example, consider the case where a software company located in country A develops a product and establishes a wholly-owned subsidiary company in country B from where the product is marketed. This would lead to understating GDP of country A and overstating it in that for country B. However, since reinvested earnings are included in income, the GNIs of countries A and B would remain unaffected. [For further reading on these issues, refer to Chapter 2 of The Impact of Globalisation on National Accounts, UNECE, 2011.] Intermediate-Level 3 Reading material

4 Branch of multi-nationals & multi-territory institutional units When a non-resident unit (of country A) has substantial operations over a significant period in country B, but no separate legal entity, a branch is identified in B as an institutional unit. The branch is treated as a resident quasi-corporation of B. It is owned by the non-resident unit (of country A), known as the parent. For the multinational enterprises (MNEs), often it becomes difficult to distinguish between main office and branches. Operations of MNEs extend seamlessly across national boundaries, which present special measurement challenges for national accounts. Such enterprises are typically involved in cross-border activities and include shipping lines, airlines, hydroelectric schemes on border rivers, pipelines, bridges, tunnels and undersea cables. The 2008 SNA recommends that, in case it is not possible to identify a parent or separate branches, the total operations of a multi-territory enterprise may be prorated by the individual economic territories in which it operates. Often, the MNEs create legal entities called special purpose entities (SPEs) in countries other than where the parent company is located to gain fiscal advantage and protect themselves from financial risks. Special Purpose Enterprises (SPEs) SPEs 1 are also known as special purpose vehicles, shell companies, special financial institutions, brass plate companies, mailbox companies or international business companies (and sometimes by yet other names). The 2008 SNA calls them special purpose entities.. SPEs are created by the enterprises for different reasons. Though there is no common definition of an SPE but some of its characteristics are that it is a legal unit formally registered with a national authority and are subject fiscal and other legal obligations, it has little physical presence, with none or a few employees, is always related to another corporation, often as a subsidiary, and it is often resident in a territory other than the territory of residence of its parent Such a unit is treated as an institutional unit and allocated to sector and industry according to its principal activity with some exceptions. [Refer 2008 SNA, 4.56] Broadly the SPEs can be classified into the three following categories: a. Captive financial institutions, b. Artificial subsidiaries of corporations, c. Special purpose units of general government. 1 For further reading on these issues, refer Chapter 4 of The Impact of Globalisation on National Accounts, UNECE, Intermediate-Level 4 Reading material

5 Captive financial institutions: Institutions providing financial services (other than insurance) where most of their either assets or liabilities are not transacted in open market. There three categories: i. Holding companies [discussed later] ii. Other captive financial institutions operating independently iii. Other captive financial institutions cannot act independently The first two are included in the financial corporation sector. The third is not treated as a separate institution, unless it is located in a different economy. Artificial subsidiaries: These are subsidiary corporations wholly owned by the parent corporation and created to provide services to the parent corporation, or other corporations in the same group, in order to avoid taxes, to minimize liabilities in the event of bankruptcy, or to secure other technical advantages under the tax or corporation legislation in force in a particular country. Ancillary corporations of the 1993 SNA are named as artificial subsidiaries in the 2008 SNA. These are not regarded as separate institutional unit unless resident in an economy different from that of its parent. Special purpose units of general government: General government may also set up special units, with the features of captive financial institutions or artificial subsidiaries. These units do not have the power to act independently. These are usually engaged in a restricted range of transactions and do not carry the risks and rewards of their assets and liabilities holdings.these are treated as an integral part of general government and not as separate units, if they are resident. If non-resident, they are treated as separate units. Holding Companies A holding company is a company that owns other companies' stocks. By owning shares of other companies, holding companies earn property income and that is their only earnings. As described in section K class 6420 of the ISIC Rev. 4, a holding company holds the assets of subsidiary corporations but does not undertake any management activities. Holds assets, in this context, means controlling level of equity (shares) of the subsidiary companies. Such a unit therefore, produces only the financial service. Thus, holding company is allocated to the financial corporations sector. In the 1993 SNA, the holding companies were recommended to be assigned to the institutional sector in which the main activity of the group of subsidiaries is concentrated. The calculation of GVO of holding company is done by cost approach, i.e. the sum of CE, IC, other production tax, CFC and net return to fixed capital. The entire GVO is allocated as IC of the companies whose stocks are held by the holding company. The GVO of holding companies may also be measured by the value of explicit fees, if any, paid by the enterprises in which the equity is held. Intermediate-Level 5 Reading material

6 Head office Producer unit undertaking purely ancillary activities are recognized as a separate establishment if: it is statistically observable, in that separate accounts for the production it undertakes are readily available, or it is located in a geographically different location from the establishments it serves. The ancillary establishment are classified according to its own principal activity. The value of output is derived on a sum of costs basis, including the costs of the capital used by the unit. The 1993 SNA treated a producer unit undertaking purely ancillary activities always as an integral part of the establishment it served. Head office exercises managerial control over its subsidiaries and is considered to be undertaking purely ancillary activities. Head office is allocated to the institutional sector preponderant to activity of its subsidiaries. The activities of a head office, as defined in section M class 7010 of the ISIC Rev. 4, includes overseeing and managing of other units of enterprise; undertaking the strategic or organizational planning and decision making role of the enterprise; exercising operational control and manage the day-to-day operations of their related units. Such a unit, therefore, produces the non-financial or financial services depending upon the nature of production of its subsidiaries. The 2008 SNA therefore, recommends that the head office should be allocated to the non-financial corporations sector unless all or most of its subsidiaries are financial corporations, in which case it is treated by convention as a financial auxiliary in the financial corporations sector. The 1993 SNA did not give explicit guidance for treatment of head offices. Points to note: All land and other natural resources are always treated as the assets of the economy in which they are located. For national accounts, a notional resident unit is identified when (immovable) assets are owned by a non-resident in the domestic territory. Holding companies are allocated to the financial corporations sector. The entire GVO of a holding company is allocated as IC of the companies whose stocks are held by the holding company. Intermediate-Level 6 Reading material

7 The ancillary establishment are classified according to its own principal activity. Its value of output is derived on a sum of costs basis, including the costs of the capital used by the unit. Head offices are considered to be undertaking purely ancillary activities and are thus allocated to the institutional sector preponderant to activity of its subsidiaries. Constituents of domestic economy: It consists of all resident institutional units, including constituents of local enterprise groups and resident enterprises of global enterprise groups resident special purpose entities (SPEs) of foreign companies / governments holding companies other captive financial institutions operating independently branches of non-resident enterprises resident artificial subsidiaries of a foreign government or non-resident enterprises notional resident units for land & other natural resources prorated part of multi-territory enterprises. Constituents of Non-financial corporate sector: all legally constituted corporations under taking production of goods and non-financial services, including branches of foreign non-financial companies, head offices of non-financial subsidiaries, and prorated part of multi-territorial enterprises captive financial institutions which are not independent of a parent in the nonfinancial sector public non-financial corporations NPIs serving non-financial corporations other non-financial quasi-corporate units. Constituents of Financial corporate sector: all financial corporations, including holding companies, head offices of financial companies public financial corporations artificial subsidiaries of non-resident corporations NPIs serving financial corporations independent captive financial institutions Intermediate-Level 7 Reading material

8 External Transactions revisited Recall that external transactions or transactions between residents and non-residents consist of the following: External trade exports (X) and imports (M) Income from and to the RoW (flows of factor services in exchange of CE, investment income and rent of natural resources) Current transfers (including income & wealth tax) from and to the RoW Capital transfers from and to the RoW Acquisition from and disposal to the RoW of valuables and non-produced assets Net acquisition and net incurrence of financial assets and liabilities. External trade, i.e. transactions is goods & services between residents and non-residents, includes all cross-border merchandise trade as well as trade in (non-factor) services between them. [Note that transactions in factor services are exchanges of factor compensations for the services provided by factors of production, i.e. primary income]. It also includes: Resident-nonresident transactions of transport, insurance and other services, Service charges for goods received from abroad for processing [discussed below] Merchanting of goods [discussed below] expenditure on goods and services made in an economy by resident of another economy (tourists for example). Merchanting Merchanting can be simply defined as the trading activity undertaken by a merchant residing in country X, who purchases goods in economy Y and sells them to economy Z, without letting the goods pass through the economic territories of its own country. The goods legally change ownership once changing to the merchant and next from the merchant - but do not physically enter the economy X. Following the principle of economic ownership: country Y exports goods, country Z imports the goods and merchanting services provided by country X, and country X exports merchanting services. By convention, the acquisition of the goods intended for resale is shown as negative exports (of country X) and disposal as exports. Thus, when the operation is completed, the difference of the sale and purchase values (analogous to the trading margin of the domestic trading) gets included in the exports of X. Intermediate-Level 8 Reading material

9 Goods for processing Recall the discussion on goods for processing manufacturing services in the previous lesson. Here, we will discuss the implications of this activity when carried out across the boundaries of economies. In accordance to the principle of economic ownership, the flows of goods between the country owning the goods and the country providing the processing services should not be recorded as imports and exports of goods. For the goods sent abroad for processing, imports and exports should be measured as the processing fee instead of by the full value of the processed goods. The fee paid to the processing unit should be recorded as an import of processing services by the country owning the goods and an export of processing services by the country providing it. Global Manufacturing 2 The term global manufacturing refers to activities of the MNEs in which the processing and procurement of materials is distributed over different countries and are carried out with the help of affiliates (or unrelated non-affiliates) abroad. Global manufacturing can be carried out under various arrangements. We can also see these as different combinations of merchanting and goods for processing arrangements. Where a parent MNE resident in country A acquires ownership of finished product from a manufacturing affiliate (or an unrelated enterprise) in country B and sells the product to an affiliate (or unrelated enterprise) in country C, we say the parent MNE is engaged in merchanting. But, if the parent MNE acquires ownership of the physical inputs or semi-manufactured goods while being processed by the affiliate in country B, then we say it is an arrangement of goods for processing with the affiliate in country B. The entire process of manufacturing the product to sale of product in country C than can be seen as a combination of merchanting and goods for processing arrangements. Here the parent MNE is buying a processing service from the manufacturing affiliate or unrelated enterprise in country B and at same time providing services of merchanting to countries B and C. Take a case in which the following transactions are carried out by the principal (parent) of an MNE, who is resident in country A: a. parent MNE buys raw materials in country B b. parent MNE arranges to ship the raw materials to country C c. raw materials are used to manufacture goods by an affiliate in country C d. the parent MNE then arranges the sale of the finished product to country D. 2 For further reading on global manufacturing, refer Chapter 4 of The Impact of Globalisation on National Accounts, UNECE, Intermediate-Level 9 Reading material

10 Note that while (a) and (d) are monetary transactions, (b) and (c) are not. Following the ownership principle, the activity (a) should be recorded as an import of raw materials from B to A. Activities (b) and (c) together represents an arrangement of goods for processing and thus should be recorded as an import of processing services from C to A. lastly, activity (d) should be recorded as an export from A to D. But, in the business accounts of the MNE, the only figures that might be obtained are the value of purchase of raw materials in transaction (a) and value of sale of finished products in transaction (d). Transactions (b) and (c) being non-monetary, obtaining the value of import of processing services may be difficult in practice. The 2008 SNA recommends that goods acquired by global manufactures, wholesalers and retailers should be recorded as negative exports on acquisition and positive exports on disposal. The difference between the two appears in exports of goods but appears as the production of a service in the merchant s economy, analogous to trade margins applied to domestically traded goods. The processing services in the arrangement of goods for processing should be treated as exports of the country providing the processing services. In the case where goods are acquired in one period and not disposed of until a subsequent period, they should appear in changes in inventories of the merchant or the global manufacturer even though these inventories are held abroad. The recommendations of the 2008 SNA relating to global manufacturing can be summarised as follows: If parent MNE owns the physical inputs or semi-manufactured goods which are sent to affiliate or unrelated enterprise abroad to produce the final product, the parent MNE is considered as buying a processing service from the manufacturing affiliate or unrelated enterprise abroad. If the parent MNE acquires ownership of goods from a manufacturing affiliate (or an unrelated enterprise) abroad and sells them on, the parent MNE engages in merchanting. Types of producers Recent recommendations by the Office of Management and Budget of US suggest three broad categories of producer, namely (a) integrated manufacturers, (b) manufacturing service providers, and (c) factoryless goods producers. Traditional or integrated manufacturer: an integrated manufacturer uses capital, labour, and energy to transform material inputs into a product to be sold. They own the rights to the intellectual property or design of the final manufactured product. the production facilities and input materials. the manufactured product, and sell it. An integrated manufacturer can fully account for input costs and output values. Intermediate-Level 10 Reading material

11 Manufacturing service provider (MSP): A MSP provides contract manufacturing services, transforming material inputs to contract specifications. The MSPs do not own or control the intellectual property or design of the final product manufactured. may or may not own input materials. own production facilities. do not own the manufactured products they are contracted to produce. do not sell the final product. MSP can provide information on the value of the contract work, the types of transformation activities performed, and the value of the labour, plant and equipment used. It cannot report the market value of the final product. Factoryless goods producer (FGP): A FGP outsources the manufacturing process, but undertakes all of the entrepreneurial steps and arranges the availability of the capital, labour, and material inputs required to make a good. The FGPs typically: own rights to the intellectual property or design (whether independently developed or otherwise acquired) of the final manufactured product; may or may not own the input materials; do not own production facilities; own the final product of their SP partner; and sell the final product. A FGP can provide data on the number of units produced and the market value of the final product, and information on the purchase of the manufacturing service (the cost of the contract), but would not necessarily have data on the production worker payroll or capital expenditures on plant and equipment. An Example of global manufacturing: An oil refinery plant (the processor) converts 100 of crude oil into petrol worth 150. The crude oil is owned by a foreign parent company purchased and shipped from abroad. The foreign parent sells the petrol abroad. The oil refinery plant receives processing fees from the parent company to cover its operating costs. Under the 1993 SNA, it is unclear what economic activity will show up in the accounts of the economy in which the parent is resident and required imputation of the value of goods shipped. Under 2008 SNA, the processor s output is based on the actual service provided. Measurement of transactions related to global manufacturing is challenging. In recording the activities of MNEs, it may be very difficult for statisticians to distinguish between these cases, particularly since the goods in neither case cross the border of the country in which the parent MNE is resident. Implementation of the 2008 SNA guidelines may be made difficult by international trade in goods statistics based on a cross-border registration principle. Additional information, if available, on Intermediate-Level 11 Reading material

12 whether commodity imports or exports are subject to inward or outward industrial processing, may be used to remove commodity flows which are not subject to change of ownership from import and export data in the national accounts. This information will not always account for all aspects of global manufacturing, notably where the global manufacturer is engaged in merchanting type activity. Points to note: Acquisition of the goods under merchanting is shown as negative exports while disposal as exports. GVO of merchanting activity is defined as value of sale minus value of purchase of goods meant for merchanting. Under goods for processing, the fee paid to the processing unit should be recorded as an import by the country owning the goods and an export of processing services by the country providing it. Global manufacturers usually get goods under their ownership processed by affiliates or nonaffiliates located abroad. They also combine merchanting with the activity of getting goods processed by others. Intermediate-Level 12 Reading material

13 Lesson V: Production Account and Generation of Income Account Lesson Completion Test [Please note that this a fixed set of questions. You have to take the test on-line and may attempt as many times as you like. You will get access to the presentations of the next lesson, only after you secure 80% score in this test. All the questions carry equal marks.] Please mark one of the alternatives ([a], [b], [c] and [d]) to indicate your answer to a question. Note that for each question there is only one correct answer. 1. The receipt of rental of a dwelling owned by a non-resident is included in [a] GVO of the production account of the household sector of the domestic economy [b] GVO of the production account of the non-financial corporate sector of the domestic economy [c] GVO of the production account of the household sector of the non-resident s economy [d] GVO of the production account of the household sector of the non-resident s economy 2. A mobile phone enterprise owned by a company registered in country C provides communication services to countries A and B. It has a network of transmission centres spread over the countries A and B, employs workers from both the countries and has its head office in country A. The output of the enterprise is included [a] entirely in GVO of country A. [b] entirely in GVO of country C. [c] partly in GVO of A and partly in GVO of B [d] none of the above 3. In the production accounts based on business accounts of an MNE whose production unit is in country A (having high rate of corporate tax) and marketing unit in country B (with very low rate of corporate tax), the GVO is likely to be [a] only understated for country A [b] only overstated for country B [c] none of the above [d] both the above Intermediate-Level 13 Reading material

14 4. The GVO of a holding company is included in [a] IC of the companies whose shares are held by the holding company [b] GVO of the companies whose shares are held by the holding company [c] OS of the companies whose shares are held by the holding company [d] None of the above 5. A holding company with control-level shares of a mobile communications company, a trading company and a advertisement company is [a] is allocated to financial sector [b] is allocated to non-financial sector [c] treated as an NPI [d] none of the above 6. The GVO of an ancillary unit includes [a] IC, CFC and CE [b] other production (t-s) [c] net return to fixed capital [d] all the above 7. In the 2008 SNA, the head office of a company with manufacturing, trading and transportation units is [a] is allocated to financial sector [b] is allocated to non-financial sector [c] treated as a financial auxiliary [d] none of the above 8. Which one of the following does not belong to financial sector of an economy [a] a holding company [b] head office of a bank [c] artificial subsidiary of a resident manufacturer [d] none of the above Intermediate-Level 14 Reading material

15 9. When a merchant, resident of country A, purchases goods in country B and sells them in country C, then the imports of C includes [a] merchant s purchase value of the goods [b] value of sales & merchanting services [c] value of merchanting services [d] both [a] & [c] above 10. The value of goods sent for processing from country A to country B is included in [a] exports of country A [b] imports of country B [c] both [a] & [b] above [d] none of the above Indicate whether the following statements are TRUE or FALSE 11. If a parent MNE sends owned physical goods to an affiliate abroad to produce the final product, the parent MNE is considered as buying a processing service from the affiliate. True False 12. If a parent MNE acquires ownership of goods from an affiliate abroad and sells them to a third country, the parent MNE engages in merchanting. True False 13. A manufacturing service provider always sells the final product. True False 14. A factory less producer always sells the final product. True False 15. A traditional producer always owns the final finished product. True False Intermediate-Level 15 Reading material