Is trade policy affected by the activity of multinational companies?

Policy attention is increasingly focused on understanding how global production networks are reshaping the world trading system, and what this means for trade policy. Baldwin (2012, 2014) makes a compelling argument that global supply chain interests underlie “21st Century Regionalism,” the recent shift away from WTO negotiations in favour of mega-regional trade deals like the Trans-Pacific Partnership and the Transatlantic Trade and Investment Partnership. Gawande et al. (2014) suggest that similar forces may help explain the moderated policy response to the 2008 economic crisis. Protectionism is less appealing when global supply chains span national borders.

The underlying insight is simple but powerful. Today’s trade policy is less and less about “made-here-sold-there” products, but is increasingly tied to how – and by whom – goods are made in the world.  The WTO even recently launched the “Made in the World” initiative to better understand and measure this global production phenomenon.

Research has begun to map out the policy implications of this fundamental shift in the nature of international trade, but empirical evidence is scarce.  In principle, foreign investment, multinational firms’ activities, and production fragmentation could dramatically reshape governments’ trade policy objectives (e.g. Blanchard 2007, 2010, Baldwin 2010, and Antras and Staiger 2012). But how important are these mechanisms in practice?

In our recent paper, Blanchard and Matschke (forthcoming), we broach this question by examining whether offshoring activity by US multinational enterprises induces more generous US trade preferences for the exporting countries and industries that host such firms.

Multinational firms recast the traditional trade policy narrative

Our empirical prediction builds on the logic of the well-known “terms-of-trade argument”, which holds that large countries benefit from levying tariffs at the expense of foreign exporters.  Intuitively, imposing tariffs depresses the world price of a country’s imports, which increases domestic purchasing power in world markets. Foreign exporters bear the burden, since lower world prices translate into lower profits.  This terms-of-trade externality is a well-established determinant of trade policy in practice (Broda et al. 2008; Bown and Crowley 2013; Ludema and Mayda 2013) and forms the foundational logic for reciprocal tariff liberalisation (Bagwell and Staiger 1999).

Multinational firms recast this narrative. Offshore investments can cause a large importing country to internalise the terms-of-trade externality and thus reduce its unilaterally optimal tariffs. When part of the foreign export sector is made up by affiliates of domestically-headquartered multinational firms, the importing country has a direct interest in foreign exporters’ profits. Thus, a large importing country like the US will have an incentive to offer preferentially lower tariffs against countries and industries where it has a greater stake in the foreign export sector through its multinationals’ offshoring activities. This effect only grows stronger if the multinationals are influential in the political process because of lobbying or other political activities.

Our analysis tests this prediction using detailed data on US trade policy and multinational firm activities for 80 industries and 184 trading partners over a 10-year horizon (1997 to 2006).  We ask specifically whether US trade preferences are granted disproportionately to countries and industries where foreign affiliates of US multinationals are producing goods for sale to US consumers.

Discretion in US tariff preferences

Our analysis focuses on the various bilateral duty-free preference programs that the US offers to certain trading partners. Free trade agreements (FTAs) offer preferential market access at the bilateral level and include differential carve-outs and phase-in periods at the product level, which introduce the potential for discretionary application of preferences across goods and countries. Similarly, the Generalised System of Preferences (GSP), meant to allow countries to offer preferential market access to developing countries, introduces additional scope for discretion at the country-product level. In the US, GSP eligibility is reviewed annually through an open petition process.  So-called `competitive need limitations’ waivers and exemptions, differentially binding rules of origin, and product-level application of country penalties lead to substantial variation in applied preferences at the country-product-year level.

It is no secret that multiantionals actively seek to exploit this discretion in trade preferences. Multinational firms publicly petition for GSP eligibility of certain products from certain countries by openly citing their investment interests. For example, during a 2005-2006 US Trade Representative review of country-level GSP eligibility, Alcoa, a US aluminium producer, petitioned for continued GSP eligibility for Brazil, Russia, and Venezuela, arguing that loss of GSP access would “cause significant disruption to [its] supply chain” and could cause “the imposition of over 3 million in additional costs.”  It went on to add, “If Brazil, Russia, and Venezuela have their eligibility restricted in some way, we request that the following products not be removed,” before listing the relevant product codes for its imports from those countries.¹ This is one of many examples from our sample period that suggests the political means by which US-based multinationals may petition for, and ultimately even achieve, more generous trade preferences.

Multinationals influence FTAs and (especially) aid-through-trade programs

We define the dependent variable in our study as the share of imports by industry, country, and year that enter the US under any trade preference program.² Our measure of offshoring activity is defined as the total sales of goods to the US market by affiliates of US-based multinationals. (The confidential firm-level data are from the US Bureau of Economic Analysis, which we aggregate to the sector-country-year level for our analysis.  US trade preferences cannot, by law, discriminate at the firm level.)  We include a customary set of additional explanatory variables to control for other important determinants of US trade policy in the estimation and control for country, industry, and year fixed effects, thus mitigating potential concerns that secular trends or bilateral political relationships drive our results. Our empirical approach also explicitly recognises and corrects for the potential reverse causality in the data (the likelihood that more generous trade preferences will attract more offshoring activity by US MNEs) through an instrumental variables approach.

Our results indicate that the impact of offshoring on US trade preferences is large and robust. A 10% increase in US-bound sales by affiliates induces a 4 percentage point (roughly 20%) increase in the rate of preferential duty-free market access in the following year. Moreover, the estimated effect is nearly three times as large if we restrict attention to just GSP preferences afforded to potentially eligible developing countries. These results are robust to a wide set of alternative specifications, robustness, and falsification tests.

Summary and implications

Recent research finds evidence that offshoring activity by US multinational firms leads the US government to confer more generous market access to countries that host US affiliates. Within a given industry in a given country and year, a 10% increase in US-bound exports by US foreign affiliates leads to a 4-percentage point increase in the rate of duty-free market access. The impact is even stronger when attention is restricted to GSP preferences afforded to developing countries. This second finding is particularly surprising given that the ostensible goal of GSP is to offer aid-through-trade to developing countries, rather than, say, investors in US multinational firms.

Is it good or bad that trade policy is sensitive to multinationals’ activity? Unclear. For some trading partners, the nexus between investment and trade policy may lead to a virtuous cycle of improved market access and increased multinational investment, which would further both economic and political integration. At the same time, it stands to fear that the same mechanism could lead to substantial investment and trade diversion, which would increase integration among the “haves” – those countries that already have rich networks of investment and trade integration – at the expense of the “have-nots” – countries that are likely to be the most in need of economic development and linkages with the outside world. How these competing effects will ultimately play out remains an important question for both research and policy.

References

Antràs, P and R Staiger (2012) “Offshoring and the Role of Trade Agreements”, The American Economic Review 102 (7), 3140-83.

Bagwell, K and R Staiger (1999). “An Economic Theory of the GATT”, The American Economic Review 89, 215-48.

Baldwin, R (2014) “Multilateralising 21st century regionalism.” VoxEU.org, 1 January.

Baldwin, R (2012) “WTO 2.0: Global governance of supply-chain trade”, CEPR Policy Insight No. 64,  December.

Baldwin, R (2010) “Unilateral tariff liberalisation”, The International Economy, Journal of the Japan Society of International Economics, No.14, pp 10-43. 2010. Also NBER WP No. 16600, 2010.

Blanchard, E. J. (2010). “Reevaluating the Role of Trade Agreements: Does Investment Globalization Make the WTO Obsolete?”, Journal of International Economics 82(1), 63-72.

Blanchard, E. J. (2007). “Foreign Direct Investment, Endogenous Tariffs, and Preferential Trade Agreements”, B.E. Journal of Economic Analysis and Policy – Advances 7, Article 1.

Blanchard, E. and X. Matschke (forthcoming) “U.S. Multinationals and Preferential Market Access.” Forthcoming in Review of Economics and Statistics.

Bown, C. P. and M. A. Crowley (2013). “Self-Enforcing Trade Agreements: Evidence from Time-Varying Trade Policy.” American Economic Review 103 (2), 1071-90.

Broda C, N Limão, and D E Weinstein (2008), “Optimal tariffs and market power: The evidence”, The American Economic Review 98 (5), 2032-65.

Ludema, R D and A M Mayda (2013), “Do terms-of-trade effects matter for trade agreements? Theory and evidence from WTO countries”, Quarterly Journal of Economics 128 (4), 1837-1893.

Gawande K, B Hoekman and Y Cui (2011), “Determinants of trade-policy responses to the 2008 financial crisis”, VoxEU.org, 10 November.

Footnotes

1 2006 GSP Annual Review, written comment of Alcoa (USTR docket FR-0052)(2)

2 In robustness tests, we demonstrate the robustness of our findings to an alternative definition based on preference program eligibility, rather than use.

This article is published in collaboration with VoxEU. Publication does not imply endorsement of views by the World Economic Forum.

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Authors: Emily Blanchard is an assistant professor at the Tuck School of Business at Dartmouth College. Xenia Matschke is a Full Professor of Economics, Chair in International Economic Policy, at Trier University. 

Image: A container ship departs Burrard Inlet in Vancouver. REUTERS/Andy Clark.