http://www.customs.gov.cn/publish/portal0/tab1/info161535.htm

in terms of the mechanics, I suppose you’re right, it could be done that way.

Though I do wonder if MNCs really do it the way you describe (i.e. run up huge accounting profits in mainland China, and then use their mainland China subsidiaries as a source for formal outwards investments).

I do understand that transfer pricing is and has been a tricky issue. But it’s new to me that MNCs formally use their mainland China profits for outwards investments.

Though I suppose they could use the domestic profits to finance domestic expansion of their factories. So instead of showing low value-added and low profits in China, and having to bring fresh money in to finance expansion, they create artificial profits in China and use them for local reinvestment.

So if what you say is correct, a change in transfer pricing would mean: Lower export figures, and at the same time higher foreign direct investments in China (unless domestic expansion is slowed down due to the crisis, in which case export numbers simply go down with no corresponding increase in foreign direct investments).

I have no idea what the magnitude of this could be, though. I find it a bit hard to imagine that it could account for more than 1-2 % of China’s current account surplus (in % of China’s GDP).

But in any case, it’s an interesting point to ponder.

Pardon my bluntness, but I have not said that exports have never been important to China. They were vital initially, when the country needed to get its economy started. But recently, not so much.

Well, as I have said, you may prefer a different split than 5 / 90.

Thomas wrote: “it seems to me that such practices would automatically be captured in China current account surplus.”

Not necessarily. Let’s continue the Nike example, where a $5 shoe made in China is imported into the U.S. for an arbitrary transfer price of $90. China gets the $90, and this the amount by which the export total and the current account grows. Fine so far?

Now suppose Nike takes its $85 profit in China (ignoring tax), which is the difference between its real costs and its fake transfer price, and “invests” it outside the country. Is the investment a transaction in China’s current account or capital account? I would say the latter.

Incidentally, the taxation dodge I have outlined might not last much longer: transfer pricing audits are to start next month in China. Whether they will actually happen is a good question; as you might imagine, the uproar from the tax dodgers (practically every multinational) has been deafening. But if the authorities stay the course, and China’s exports suddenly drop in value, you will know why!

In the early years, they imported so much raw materials and semi-finished products that they did not have a trade surplus. But they did have a trade suplus with the U.S.

Exports to the U.S. provided the final sales that fueled the entire process.

It is a given that all the parties are trying to game the system.

The facts remain that China’s exports went mostly to the U.S. in the important period of 2000 to 2005. China’s economy has been growing at a fantastic rate compared to other countries. Investment in plant and equipment is crucial for an extremely rapid growth rate. China controls who invests in China and on what terms. Despite the controls, multinational firms are intensely interested in setting up factories in China.
The combination of controlled foreign investment and redirection of profits earned from exports to domestic investment provide the funds to pay for machines and factories. Ability to ship goods made in China to the U.S. was crucial to these developments. The investment and GDP growth depended heavily on exports.

Exports are important to China, not to feed their people, but to provide the dollars used to fuel the growth of their economy.

Pardon my bluntness, but to try to discount the importance of exports to the growth of the Chinese economy is stupid.

you make an interesting point. While I accept that what you describe does exist, I doubt that the magnitude is anything close to what you assign to it, and in addition, it seems to me that such practices would automatically be captured in China’s current account surplus.

My reasoning goes as follows:

If a large proportion of China’s export earnings is simply shifting of profits to a low-tax-location (in this case, China’s SEZs), then presumably the companies benefitting from this shift would subsequently transfer the money out (e.g. to Bermuda/Cayman as mentioned in your post). In terms of balance-of-payment accounting, that would be classified as “profit on direct investments made by foreigners”, and would reduce China’s current account surplus.

Or are you suggesting that these companies find a way of channeling money out of China that isn’t accounted for anywhere?