Economic Integration and Agglomeration of Multinational Production with Transfer Pricing

64 Pages Posted: 22 Apr 2019 Last revised: 25 Jan 2021

Date Written: April 4, 2019

Abstract

Do low corporate taxes always favor multinational production in the course of economic integration? We propose a two-country model in which multinationals choose the locations of production plants and foreign distribution affiliates and shift profits between home plants and foreign affiliates by manipulating transfer prices in intra-firm trade. We show that when trade costs are high, plants are concentrated in the low-tax country, but surprisingly this location pattern reverses when they are low. Unlike existing models with single-plant firms, the impact of economic integration is non-monotonic, which we empirically confirm: a fall in trade costs first decreases and then increases the share of plants in the high-tax country. We also analyze tax competition and find that allowing for transfer pricing makes competition tougher, indicating a possibility of international coordination on transfer-pricing regulation making the world better off.

Keywords: Profit shifting; Multinational firms; Intra-firm trade; Trade costs; Foreign direct investment (FDI)

JEL Classification: F12; F23; H25; H26

Suggested Citation

Kato, Hayato and Okoshi, Hirofumi, Economic Integration and Agglomeration of Multinational Production with Transfer Pricing (April 4, 2019). Available at SSRN: https://ssrn.com/abstract=3365385 or http://dx.doi.org/10.2139/ssrn.3365385

Hayato Kato (Contact Author)

Osaka University ( email )

1-7 Machikaneyama
Toyonaka, Osaka 5600043
Japan

HOME PAGE: http://https://hayatokato.weebly.com/

Hirofumi Okoshi

Okayama University ( email )

1-1-1 Tsushimanaka, Kita Ward
Okayama, 700-0082
Japan
+81 86 251 7525 (Phone)

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