International Accounting Practices (Getting the numbers right)

1. International Accounting Practices(Getting the numbers right) Chapter 2

2. Figure 2.1 Home firm decision tree Firm in Home serve foreign markets / source from abroad? no yes, source from abroad yes, serve foreign market Stay domestic Export or local production? Import or local production? export import local production local production Export Multinational activity: horizontal Multinational activity: vertical Import triggers intra-firm trade Two types of trade: intra-firm and inter-firm Consisting of trade in final goods, services, and intermediate goods Two types of multinational activity: horizontal and vertical Multinational = firm owning and controlling value adding activities in two or more countries

3. Fig. 2.2 Horizontal and vertical multinational activity Country B Country A Multinational (producer) Foreign subsidiary (producer) FDI Horizontal multinational (market seeking) Finished products Finished products Market A Market B Finished products Components Vertical multinational (efficiency seeking) FDI Foreign subsidiary (assembler) Multinational (producer, marketer) Finished products

4. Figure 2.3 US export shares in 2010 Source: US census Bureau, own calculations

7. Micro-level accounting: A firm’s annual report • Rules of double-entry bookkeeping • Complications • How should the firm account for foreign-currency transactions? • Cross-country financial management (exchange rate risk management, fiscal optimizations,...). • Diverging country-specific accounting regulations.

8. Macro-level accounting: A country’s balance of payments • Balance of payments: Records all economic transactions between the residents of the country and residents of the rest of the world. • Each transaction or exchange results in two opposite flows of value. • Double-entry bookkeeping. • A credit or positive item is the flow for which the country is paid—it is the item that the country gives up in the transaction, and it sets up a claim on the foreign resident, so that funds (or "money") flow into the country. • A debit or negative item is the flow that the country must pay for—it is the item that the country receives in the transaction, and it sets up a foreign claim on a resident of the country, so that funds (or "money") flow out of the country. • If we add up all items for the country's balance of payments, it must add up to zero

9. Figure 2.4 A country’s balance of payments Source: van Marrewijk (2012, p. 411)

10. Figure 2.5 Current account balance; % of GDP, 1980-2012 Source: based on data from World Development Indicators online (1980-2010) and The Economist, June 9, 2012, “Trade, exchange rates, budget balances, and interest rates” (2012 estimate).

12. FDI data and the capital account • US government’s definition of foreign direct investment (FDI): ‘Ownership or control of 10% or more of an enterprise’s voting securities, or equivalent interest in unincorporated business’ (2004, M5-6). • FDI and foreign portfolio investment (FPI) • World Investment Report (by UNCTAD - http://unctad.org/en/PublicationsLibrary/wir2014_en.pdf) is the most important source of information on FDI flows.

13. Figure 2.6 FDI flows, 2005-2011 Source: based on data from UNCTAD, World Investment Report 2012; developed = developed economies; developing = developing economies; transition = transition economies.

18. Some meanings of the current account balance • Current account (CA) equals the value of the country's net flow of foreign investments (both private and official). • CA equals the difference between national saving and domestic real investment (S  I). • CA is approximately equal to the difference (X  M) implies that CA is approximately equal to the difference between domestic production of goods and services and national expenditures on goods and services (Y  E). • Surplus current account <=> net capital (and financial) outflow

19. Official international reserves include financial assets denominated in readily accepted foreign currencies, the country's holdings of Special Drawing Rights (SDRs), the country's reserve position at the International Monetary Fund (IMF), and gold. • A line called "statistical discrepancy" is added to make the accounts on the BOP add to zero. It represents the net of many items that are measured incorrectly or missed (net errors and omissions).

20. Limitations of FDI data • Criticizing FDI data: See Box 2.3 • FDI data are still useful when comparing groups of countries (Table 2.7) • Significant observations about FDI flows: • FDI flows are to a large part from and to developed economies • FDI from developing countries (emerging economies) is on the rise

22. Sales and value added • Tax havens and FDI • Value added is the “best indicator of overall or sectoral economic significance of multinational activity” (John Dunning, 1993, p. 7) • World Input Output Database (http://www.wiod.org/new_site/home.htm) • Box 2.4: Transnationality index (UNCTAD) = (unweigthed average) of foreign assets/total assets + foreign sales/total sales + foreign employment/total employment • Table 2.9

25. Figure 2.7 Value added export (VAX) as a share of GDP; 1995 and 2008 (%) Source: based on World input output Database (WIOD), see wiod.org.

29. How is international capital mobility measured? • Current account balance as an indicator of the degree of international capital mobility • CA surplus (deficit)  net capital outflow (inflow) • Size of net capital flows (1870-2001): Table 2.12 and Figure 2.9

30. Figure 2.9 Global net capital flows; average for 15 countries, 1870-2010 Source: see Table 2.11; average includes countries listed in Table 2.11 plus Denmark, Finland, the Netherlands, Norway, Spain, and Sweden.

31. Degree of international capital mobility: Historical perspective • Main observations: • International capital mobility was already high during 1870-1914 and it is only recently that capital mobility started rising (after the significant decline that lasted until 1973) • There are considerable changes in the degree of international capital mobility over time which weakens the argument that ‘one of the key features of the present global economy is a high and rising degree of cross-border capital mobility.’

32. Figure 2.10 Capital outflows; selected countries (% of national savings Source: O’Rourke and Williamson (1999).

33. Figure 2.11 Evolution of British and American share in foreign assets Source: see Table 2.14

34. Figure 2.12 Net private financial flows to developing economies; $ bn, 1992-2009 Source: IMF, World Economic Outlook database; D Asia = Developing Asia; L Am = Latin America & Caribbean; C&E Eur = Central & Eastern Europe; CIS = Commonwealth of Independent States; SSA = Sub-Saharan Africa.

37. The importance of distinguishing between micro and macro • A micro-level investment (shown on the firm’s annual accounts) does not necessarily translate into a macro-level investments (in the country’s BOP). • M&As are firm-level investment but are neutral from a macro perspective. • A multinational’s sales cannot be compared with a country’s GDP

38. Box 2.7Why accounting is useful but it is not explaining. • C + M + S = I + X + C or • S – I = X – M This implies that the national saving surplus must be equal to the current account (CA) surplus. However, accounting cannot explain whether a trade deficit is good or bad or why we have trade deficit.