Does France Have an “Exorbitant Privilege”?

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By Joseph Joyce. Originally published at Angry Bear

The U.S. has long been accused of using the international role of the dollar to exercise an “exorbitant privilege.” The term, first used by French finance minister Valéry Giscard d’Estaing, refers to the ability of the U.S. to finance its current account deficits and acquire foreign assets by issuing dollars as a reserve currency. While flexible exchange rates have lowered the need for reserve currencies, the use of the dollar in international trade and finance ensures that there is a continuing need for dollar-denominated assets. The status of the dollar contributes to the surplus in U.S. international investment income despite its negative net international investment position (NIIP). But France also has a surplus in international investment income and a negative NIIP. Does it possess its own privilege?

The U.S. surplus reflects the composition of its external balance sheet as well as the return on its assets and liabilities. The U.S. has a positive balance on equity, and in particular, FDI, which is offset by the negative balance on portfolio securities, such as bonds. U.S. Treasury bonds are the universal “safe asset,” held by private foreign investors as well as central banks. The return on the equity assets exceeds that paid on the debt liabilities, thus yielding a positive investment income balance. This is the return that the U.S. receives for playing the role of the “world’s venture capitalist,” according to Pierre-Olivier Gourinchas of UC-Berkeley and Hélène Rey of the London Business School. In addition, the U.S. receives a higher return on its FDI assets than it pays out on its FDI liabilities.

France also has a negative NIIP but a positive net international investment income balance. In 2018, for example, it received $35.6 billion in investment income. Moreover, the Banque de France pointed out in the 2015 Annual Report on the French Balance of Payments and International Investment Position that while the ratio of outward direct investment stocks to liabilities was 2 to 1, the ratio of FDI receipts to payments was 3 to 1. The French surplus, like that of the U.S., therefore can be attributed to both a “composition” effect reflecting the difference in the types of assets and liabilities it possesses, but also a “returns” effect due to the relatively higher return on its direct investment assets vis-à-vis its liabilities.

Vincent Vicard of CEPII (Centre d’Etudes Prospectives et d’Informations Internationales) has examined this return in a CEPII working paper, “The Exorbitant Privilege of High Tax Countries.” He finds that French firms earn higher returns on their foreign operations in low tax countries and tax havens, evidence of using the reporting of profits to increase returns. Profit shifting by the French multinationals account for two percentage points of the difference in returns on French assets and liabilities. Four European countries account for much of this activity: Luxembourg, Netherlands, Switzerland and the United Kingdom.

These results are consistent with those reported for other countries, particularly the U.S. Kim Clausing of Reed College, for example, examined the impact of differentials in tax rates on the profits of U.S affiliates in “Multinational Firm Tax Avoidance and Tax Policy” in the National Tax Journal in 2009.  More recently, Thomas Tørsløv and Ludvig Wier, both of the University of Copehhagen, and Gabriel Zucman of UC-Berkeley investigated the profit-shifting of multinationals in a range of countries in a NBER Working Paper, “The Missing Profits of Nations.” They estimate that close to 40% of multinational profits are shifted to tax havens globally each year. The non-haven European Union countries appear to be the main losers from this maneuvering.

But it would be too simple to dismiss the foreign earnings of French or U.S. firms as a purely accounting artifact. Multinationals have used information and communications technology to form global supply chains that allow them to source operations in low-cost countries and assemble the components elsewhere before shipment to the final market. France has its share of multinationals, including firms such as BNP Paribus, Carrefour and Peugeot. Moreover, foreign economic expansion by French firms and investors predates modern tax codes. Thomas Piketty of the School for Advanced Studies in the Social Sciences and the Paris School of Economics  pointed out in Capital in the Twenty-First Century that the income earned from foreign holdings were sufficient to finance trade deficits and capital outflows in Great Britain and France during the late nineteenth and early twentieth centuries.

The U.S. and other governments have lowered corporate tax rates in part to lure multinationals back to their home countries, and the members of the Organization for Economic Cooperation and Development intend to limit profit shifting by multinationals. Whether or not this strategy will be successful is not clear. Chris Jones and Yama Temouri of the Aston Business School have pointed out in “The Determinants of Tax Haven FDI” in the Journal of World Business that tax havens have advantages for multinationals besides lower tax rates, including few regulations and restricted openness. But President Trump has also made clear that he wants U.S. firms to operate domestically, and is willing to limit access to U.S. markets by foreign firms. France’s “privilege,” exorbitant or not, will be affected by these restrictions.

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  1. FKorning

    In short, yes. The aristos are alive in France. They still wear their chevalières, go to the best schools, attend ralies, and hold key positions in politics, banking, and industry, but French is truly a meritocratic state and those positions are well deserved. (The nuance with the UK is that the French national education system is excellent to the degree it empowers any hardworker to mobility – not always the case throughout Great Britain).

    What is not deserved, is sitting on vast hoards of Capital accumulated tax-free and spiritited away in opaquely held property, shares, trusts, fine art, etc. To me the yellow vest trigger was not so much about Macron’s regressive fuel-tax, but that at the same time Macron was blatantly rewriting the “Impôt sur la Fortune” wealth-tax and flouting it with contempt.

    1. Ignacio

      Yes, I also believe that Macron’s tax cuts were important as a trigger. Piketty explained in his blog the maths of Macron’s tax cuts on wealth and every French could check it.

    1. Oh

      A foreign direct investment is an investment in the form of a controlling ownership in a business in one country by an entity based in another country. It is thus distinguished from a foreign portfolio investment by a notion of direct control.

  2. Susan the other`

    So, the EU has higher corporate income taxes than the US, the US has higher taxes than the UK, the UK has higher taxes than the tax havens? Why is this chain of avoidance allowed to exist? This isn’t accounting at all. Can’t follow the logic of Picketty on FR and the UK as late stage imperialists, early 20 C, “…earned foreign income was sufficient to finance trade deficits and capital outflows in the UK and France.” But doesn’t this leave us hanging, waiting for an explanation about the long term consequences of insanity? So extraction both from the foreign income source country by using offshore accounts and therefore from their own domestic income taxes (where did all that money go?) “Profit shifting” is a gross euphemism. It is fraud. And it gets agreed to because the internationals declare enough “income” (aka theft) to balance out domestic trade deficits. Wink wink. Which keeps the whole circus going. This ancient balancing act is pretty hard to follow, because it is entirely illogical. Begging the question, Why even bother? Because it is fed by the delusion that money, symbolic of gold, is valuable by association. It is no such thing.

    1. Sushi

      Tax arbitrage goes way beyond rates to include achievement of that nirvana of stateless income and increased levels of opacity, which isn’t very patriotic at all. King and country, or CEO and company, some Faustian bargain.

    2. RBHoughton

      “doesn’t this leave us hanging” …. Too true Susan.

      With a lawyer you get the facts followed by the opinion, two section in the one report. With accountants and economists we seem to get the facts, full stop.

  3. notabanktoadie

    U.S. Treasury bonds are the universal “safe asset,” held by private foreign investors as well as central banks.

    Being inherently risk-free*, U.S. Treasury bonds should return no more than zero percent – otherwise we have welfare proportional to account balance.

    And think what it could do for the US trade balance if foreigners no longer had the option of a risk-free return on their dollars but instead had to purchase US goods and services or at least honestly invest** here?

    * since the US is a monetary sovereign.
    ** but not as land owners since only US citizens should own US land and even then to only a limited degree, e.g. a homestead/farmstead.

      1. notabanktoadie

        Welfare is welfare even if it just means that one loses purchasing power at a slower rate than non-buyers of inherently risk-free sovereign debt do; i.e. the richer have no more right to be shielded from price inflation than the poorer.

        So the maximum NOMINAL interest rate or yield on the inherently risk-free debt of monetary sovereigns should be ZERO* percent.

        Btw, it’s nice to hear of some confirmation from the Market itself.

        *Unless one subtracts overhead costs in which case the maximum NOMINAL interest rate or yield should be at least slightly negative.

        1. notabanktoadie

          Correction: Make that *Unless one subtracts overhead costs in which case the maximum NOMINAL interest rate or yield should be at MOST slightly negative., please.

    1. run75441

      That did happen pre-2008 when Greenspan told foreign investors who were looking for safe haven investments such as treasuries, he was not likely to raise Fed Rates. Instead they flocked to the next safe investment . . . mortgages. We know the rest of the story.

  4. FKorning

    I’m not sure it’s accurate to talk about EU tax rates. There are different corporate tax rates for all 27 countries. Fiscal integration and harmonisation, or fear of it, is one of the key points of contention, and probably a driver of Brexit angst. But it has to be addressed. It’s structurally unsound to have a single currency in a customs union but with different tax regimes and different interetes rates. It just creates basis arbitrage and friction.

  5. David

    FDI = Foreign Direct Investment.
    I saw the original of this, by coincidence, the same day that Michelin announced that it was closing one of its factories in one of the poorest areas of France, as part of moving production overseas to take advantage of lower costs. French industry (when it’s not foreign owned) increasingly gets its profits from FDI initiatives.
    One effect of this is, indeed, a reinforcement of social stratification. Its always working-class and junior management jobs that go, whilst senior managers have seen their pay explode in recent years. And education is no longer any kind of guarantee of social ascension. Recruitment into the Grandes Écoles, from which the business, political and government elites come (and increasingly merge into each other) is now overwhelmingly from the professional upper-middle classes, and often from families where the parents themselves had the same education, beginning with exclusive private schools. The percentage of entrants from what the French call the “Classes populaires” – that is, ordinary people- has dropped to around 10%. For that reason, the masses are no longer worth educating: about 20% of French children are functionally illiterate at age 11, and the percentage among working-class and immigrant communities is much higher.

    1. eg

      What’s the long game, here? I mean, this “beggar thy labour” approach of offshoring production to cheap wage locales isn’t sustainable, is it? Ultimately who will be able to afford the production?

      1. David

        Ah, there isn’t a long game here. The game ends when the current crop of senior managers retire. Anyway, the Chinese are good for a few more years yet. Aren’t they?

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