Prizes for Everyone [1]

The motor vehicle industry is playing an interesting game. General Motors produces in Europe under various names (Opel, Vauxhall) [2], produces as Holden in Australia, and has plants scattered elsewhere across the globe as well. As the economic downturn forces rationalization of the global capacity glut in motor vehicles, this places GM in a position to play off local governments against each other. GM announced plans to reduce production in Thailand, [3,4] while holding this as an example in extracting subsidies from the Australian government. GM is not the only one playing this game. Indeed, U.S. automakers (GM and Ford), together with Toyota, have already extracted 4.3 billion US dollars in subsidies (to be stretched out over the next decade) [4], even as they lobby Washington for more assistance. [5] In the U.S., we have the same mix of players lobbying against each other rather than cooperating, as Japanese MNEs (multinational enterprises) in the Southern United States try to block assistance to their U.S. based competitors. Not surprisingly, this is also shaping up as an inter-state game within the Federal system to support various local producers across the United States.

There have been worries surfacing in the policy research community about the death of the Doha Round, and the risk of rising protectionism. Narrowly read, the dominant risk is not really old fashioned protectionism -- higher import tariffs (see my VoxEU column on this. [6] ) Yes, we are seeing some of this (so far at the margins). Far more interseting is tax competition, seen through a lens darkly. There has been an emerging literature on competition between jurisdications to attract MNEs. [7,8,10,11,13,14] Emphasis is on new plants, and the tendency for firms to extract extra tax payer largesse by locating in multiple locations. Much of this literature is theoretical, though the empirical evidence already shows that global firms make local taxation difficult. We are learning much more as the current economic crisis causes a game of industrial musical chairs. Everyone is circling, and when the music stops, not all motor vehicle MNEs will be sitting comfortably. [2,3] As some go, some local jurisdictions will see their factories close as well. This reveals more elements to the tax competition game. Multiple plants mean more degrees of flexibility for extracting rents (i.e. Blackmailing) local tax payers. In addition, the game can be run in reverse. Open plants (creating a local constituency of suppliers and labor and government), threaten to close some, and demand compensation. In such a game, it may even make sense to build far too much capacity, if the losses from excess plants are covered by an increased expected taxpayer financed subsidy.

There is another important element to this game as well. In the U.S. for example, the rhetoric has become predictably nationalistic.[5] U.S. firms vs. European firms vs. Japanese firms. Yet, if we look closely at the set of automakers, where they operate, and who owns them, the national labels make less and less sense. European pension funds own American firms, Japanese firms are listed on the American stock exchanges, and American firms lobby in Europe as European producers and ask Australia for R&D subsidies. Capital markets are global, ownership of the corporate world is global, and the challenges posed are therefore global as well. U.S. subsidies to GM will be a subsidy for European pension funds, and the Australians are hoping the American taxpayer will subsidize their industry as well.

The European Union has taken steps to limit tax competition [9] -- hence the intervention the the European Commission against the GM subsidy game in Europe. The OECD has also flagged this as a problem issue. It may be time to take this global. [12] In a world with global firms and local tax authorities, WTO discussions limiting public assistance would help level the paying field for local taxpayers against blackmail by global firms.

References

[1] Lewis Carroll (1865), Alice in Wonderland, "Everybody has won, and all must have prizes," in CHAPTER III: A Caucus-Race and a Long Tale

[2] "EU warns against car subsidy race," BBC 21 November 2008.

[3] "Isuzu aims to avoid Thai layoffs," Bankok Post, 18 December 2008.

[4] "Car sales crash in Australia," The Earth Times, Thu, 04 Dec 2008.

[5] "Tax Fairness for U.S. Auto Makers," editorial letter, Wall Street Journal, 16 December 2008. (from Stephen Collins, President, Automotive Trade Policy Council Washington.

[6] "The economic crisis, Doha completion, and protectionist pressure," 17 December 2008 VoxEU column.

[7] Baldwin, R.E. and P. Krugman (2004), "Agglomeration, integration and tax harmonisation," European Economic Review, Volume 48, Issue 1, February 2004, Pages 1-23.

[8] Davies, R.B. (2005), "State tax competition for foreign direct investment: a winnable war?," Journal of International Economics, Elsevier, vol. 67(2), pages 498-512, December.

[9] European Commission, "Harmful tax competition," Europe website.

[10] Hauflera, A. and I. Wooton (1999), "Country size and tax competition for foreign direct investment, Journal of Public Economics," Volume 71, Issue 1, 1 January 1999, Pages 121-139.

[11] King,I., R.P. McAfee & L. Welling, (1993), "Industrial Blackmail: Dynamic Tax Competition and Public Investment," Canadian Journal of Economics, Canadian Economics Association, vol. 26(3), pages 590-608, August.

[12] OECD, "Harmful Tax Competition: An Emerging Global Issue," 1998.

[13] Ottavianoa, G.I.P and T. van Ypersel (2005) "Market size and tax competition," Journal of International Economics, Volume 67, Issue 1, September: Pages 25-46.

[14] Winner, H. (2005) "Has Tax Competition Emerged in OECD Countries? Evidence from Panel Data," International Tax and Public Finance, Volume 12, Number 5/September.