This article was downloaded by: [North Dakota State University]On: 08 October 2014, At: 06:29Publisher: RoutledgeInforma Ltd Registered in England and Wales Registered Number: 1072954 Registeredoffice: Mortimer House, 37-41 Mortimer Street, London W1T 3JH, UK

Journal of Balkan and Near EasternStudiesPublication details, including instructions for authors andsubscription information:http://www.tandfonline.com/loi/cjsb20

Foreign Direct Investment and ProfitTransfers: The Turkish CaseV. Necla Geyikdaği & Filiz KaramanPublished online: 06 Nov 2013.

To cite this article: V. Necla Geyikdaği & Filiz Karaman (2013) Foreign Direct Investment andProfit Transfers: The Turkish Case, Journal of Balkan and Near Eastern Studies, 15:4, 383-395, DOI:10.1080/19448953.2013.844589

To link to this article: http://dx.doi.org/10.1080/19448953.2013.844589

PLEASE SCROLL DOWN FOR ARTICLE

Taylor & Francis makes every effort to ensure the accuracy of all the information (the“Content”) contained in the publications on our platform. However, Taylor & Francis,our agents, and our licensors make no representations or warranties whatsoever as tothe accuracy, completeness, or suitability for any purpose of the Content. Any opinionsand views expressed in this publication are the opinions and views of the authors,and are not the views of or endorsed by Taylor & Francis. The accuracy of the Contentshould not be relied upon and should be independently verified with primary sourcesof information. Taylor and Francis shall not be liable for any losses, actions, claims,proceedings, demands, costs, expenses, damages, and other liabilities whatsoeveror howsoever caused arising directly or indirectly in connection with, in relation to orarising out of the use of the Content.

This article may be used for research, teaching, and private study purposes. Anysubstantial or systematic reproduction, redistribution, reselling, loan, sub-licensing,systematic supply, or distribution in any form to anyone is expressly forbidden. Terms &Conditions of access and use can be found at http://www.tandfonline.com/page/terms-and-conditions

Foreign Direct Investment and ProfitTransfers: The Turkish CaseV. Necla Geyikdagi and Filiz Karaman

Turkish businessmen, politicians and most academicians tend to see foreign directinvestment (FDI) as a remedy for the chronic lack of capital accumulation in Turkey. The

meagre FDI inflows which followed the Customs Union Agreement with the EuropeanUnion, in 1995, created a deep disappointment among these people. Efforts to attractforeign capital have intensified since 2005 and inflows have soared. However, the greater

part of the increase is the result of the Turkish government’s privatization programme ofpublicly owned companies, and the acquisition of private firms by large multinational

companies, rather than greenfield investments. This research investigates FDI inflows toTurkey and tries to estimate the transfer of profits.

Introduction

Turkey, lacking sufficient savings to carry out investments necessary for her

development, looks abroad to attract foreign direct investment (FDI). The existing

literature generally focuses on the overall evaluation of FDI in the country, or location

advantages and other determinants that would lure FDI to Turkey. In general, there

was a tendency to emphasize the positive aspects of FDI, while the negative ones such

as the cost of incentives, the cultural, social and environmental impacts, as well as the

lowering or elimination of the shares of domestic firms were played down or ignored.

The growth effects of FDI have been extensively studied, and the contribution of FDI

on economic growth has been well publicized. Western-oriented international

economic institutions recommend the liberalization of trade and financial markets to

developing countries in order to facilitate FDI inflows. Foreign as well as Turkish

authors had expected that the 1995 Customs Union Agreement with the European

Union (EU) would encourage FDI in Turkey both from Europe and other countries.

It was surmised that this agreement would reduce the risk of investing in Turkey and

give firms outside Europe access to EU markets if they produced and exported from

Turkey.1 The meagre FDI inflows during the initial years of the Customs Union

Agreement created quite a bit of disappointment since some researchers had expected

soaring FDI inflows similar to the Spanish and Portuguese experiences soon after

their accession to the EU. At that time, the proponents of Turkey’s EU accession had

judged that the EU accession process would ‘encourage more rapid and consistent

q 2013 Taylor & Francis

Journal of Balkan and Near Eastern Studies, 2013

Vol. 15, No. 4, 383–395, http://dx.doi.org/10.1080/19448953.2013.844589

Dow

nloa

ded

by [

Nor

th D

akot

a St

ate

Uni

vers

ity]

at 0

6:29

08

Oct

ober

201

4

implementation of the rules and regulations that ensure a level playing field for all

companies, which, in turn, would enable Turkey to take full advantage of investment-related benefits’.2 However, neither the liberal policies of the 1980s nor the CustomsUnion Agreement with the EU were able to influence FDI inflows positively. It was

only the Turkish government’s privatization programme and the influences of themore recent liberalization in services trade and the financial markets which were

responsible for the rapid increases in FDI inflows after 2004.3

On the other hand, in recent years, there have been an increasing number of studies

reporting evidence that the positive spillovers for host economies were not always aslarge as expected, and the incentives given to FDI were not always warranted.4

Contrary to the predominant belief that FDI generates economic growth, empiricalevidence fails to support this in developing countries.5 In addition, the profittransfers may become a real burden if the host country cannot achieve development

and accumulate sufficient capital while continuing to look abroad for capital.A major purpose of this study is to examine the impact of profit repatriation by

multinational enterprises (MNEs) on future outflows from Turkey. It investigates FDIinflows to Turkey and tries to evaluate the transfer of profits the FDI earns in this

country. In the next section, recent trends of FDI inflows will be examined whilekeeping in mind the potential contributions of the investment type. Then, the trends

in FDI inflows as well as the relationships between liberalization, FDI and economicgrowth will be examined. The repatriation of FDI returns will be studied by a

regression (autoregressive process) analysis by using the official balance of paymentsdata. Because of the high transfer pricing manipulations of MNEs, such officialreports do not reflect all of the profit repatriation, but only a part of it. Still the

estimation of even a part of the profit transfers and its determinants will be helpful inevaluating the trends of future outflows from the country.

FDI Inflows to Turkey

FDI is usually defined as any investment on physical assets in foreign countries bytransnational firms. The creation of new productive assets, such as plant, machineryand inventory, is called a greenfield investment. A greenfield investor firm usually

creates its creative assets from scratch by building a factory, installing machinery andhiring employees in a foreign country. Therefore, it creates additional employment

and income in the host economy. However, the purchase of stocks in an existing firmby foreigners with the purpose of controlling the firm is simply an acquisition

without job- and income-creating characteristics. The purchase of small non-controlling shares is only a portfolio investment. When the shares are tightly held, a

51 per cent ownership is necessary to have control of a company. On the other hand,if the ownership is widely dispersed, a foreign investor may gain the managerial

control of an enterprise by acquiring even less than 10 per cent of the equity, inextreme cases.

As seen in Table 1, FDI inflows have displayed a large increase since 2004. However,

the global economic crisis of 2008 showed its negative impact with a decrease of 23per cent in 2008, and 69 per cent in 2009 with respect to 2007.6 It seems that profit

384 V. Necla Geyikdagi and Filiz Karaman

Dow

nloa

ded

by [

Nor

th D

akot

a St

ate

Uni

vers

ity]

at 0

6:29

08

Oct

ober

201

4

repatriations show a more steadily increasing trend than the FDI inflows whichdisplay wide fluctuations especially in recent years.7 Table 1 also shows the FDI stock

accumulated over the years as well as a ratio of profit transfers for each year out of theFDI stock.

When the FDI entries into Turkey are analysed, one can see that a very large part ofthese investments consists of the acquisition of Turkish firms by foreign investors.

The Turkish government’s privatization programme of publicly owned companiesconstitutes a part of these purchases. Private companies were also sold to foreigninvestors under the latest wave of liberalization. Table 2 gives a list of the major

mergers and acquisitions (M&A) between 2005 and 2011 inclusive. Since many of theagreed deal values are not disclosed by the parties, this table does not give a complete

picture of the M&A activities. An examination of the publicly available figures showsthat acquisitions constituted more than 60 per cent of the total FDI inflows from 2005

to 2011.8 The sales of public enterprises made their highest contribution in 2005,2006 and 2008 to the FDI inflows, but the sales of private companies to foreigners had

the lion’s share during the whole period.9

Capital Market Liberalization and Economic Growth

Since the early 1980s, the Turkish authorities responsible for the economy believedthat the total liberalization of financial markets was absolutely necessary forattracting FDI into the country. However, high growth Asian economies and a few

Latin American countries were successfully controlling the flow of capital in and outof their countries, and allowing only productive capital. As Peter Gowan aptly

Table 1 FDI Inflows and Profit Transfers from Turkey (Million US Dollars)

FDI inflows Profit transfers (PT) FDI stock PT/FDI stock

1995 934 312 10,557 0.0291996 914 207 11,471 0.0181997 852 203 12,323 0.0161998 953 328 13,263 0.0241999 813 313 14,076 0.0222000 1707 279 15,783 0.0182001 3374 309 19,157 0.0162002 571 401 19,728 0.0202003 696 643 20,424 0.0312004 1190 1043 21,614 0.0482005 8535 1051 30,149 0.0352006 17,639 1182 47,788 0.0252007 19,137 2208 66,925 0.0332008 14,733 2937 81,658 0.0362009 6002 2444 87,660 0.0282010 6520 3044 95,871 0.0322011 15,703 2999 111,570 0.027

Source: Central Bank of the Republic of Turkey, ‘Balance of payments statistics’, http://www.tcmb.gov.tr/yeni/eng/; UNCTAD, ‘Inward and outward foreign direct investment stock’, http://unctadstat.unctad.org/TableViewer/tableView.aspx

Foreign Direct Investment and Profit Transfers 385

Dow

nloa

ded

by [

Nor

th D

akot

a St

ate

Uni

vers

ity]

at 0

6:29

08

Oct

ober

201

4

explained, ‘very large flows of funds into productive investment do not pass through

the so-called “capital markets” at all’. The notion that a great expansion of the size of

‘capital markets’ is a symptom of positive trends in capital production is false.10

We can see from Tables 1 and 2 that during the 2000s, large increases in capital flows

to Turkey are for M&A purposes, and also in the form of portfolio investment.

According toCostas Lapavitsas, the 2000s have been a period of accelerated integration

of developing countries in global trade and finance, though with significant

variations.11 While some developing countries registered large current account

surpluses through rising commodity prices and manufacturing exports, Turkey

experienced large current account deficits, increasing the vulnerability of the economy.

Aybar and Lapavitsas give an analysis of the 2001 Turkish crisis and find the roots of the

Table 2 Major Mergers and Acquisitions of Turkish Firms by Foreign Investors

Company Acquirer Inflow (US$ million)

2005Garanti Bankasi GE Consumer Finance (USA) 1806Turkcell Alfa Group (Russia) 1593Turk Telekom Oger Telekom (Lebanon–UAE) 1500Dis Bank Fortis Bank (Belgium) 1062Yapi-Kredi Bank Unicredito (Italy) 6022006Telsim Vodafone (UK) 4690Denizbank Dexia Bank (Belgium) 3221Finansbank National Bank of Greece 2774Turk Telekom Oger Telekom (Lebanon–UAE) 1500Petrol Ofisi OMV Power 10542007Akbank Citibank (Hong Kong) 3100Oyakbank ING Bank (Holland) 2700Finansbank National Bank of Greece 2300Turkiye Finans Katilim Bank National Com. Bank (Saudi Arabia) 10802008Petkim Socar-Turkas (Azerbaijan) 2040Migros BC Partners–Dea Capital (UK) 1917TEKEL Sigara BA Tobacco (UK) 1720Baskent Elek. Dag. Verbund AG (Austria) 2040Eregli Demir-Celik ArcelorMittal (India) 959Finansbank National Bank of Greece 6972009Borasco Electrik OMV (Austria) 10002010Garanti Bank Banko Bilbao 5838Petrol Ofisi OMV (Austria) 13972011Genel Enerji Vallares (UK) 2100Mey Icki Diageo (USA) 2096Acibadem Saglık Hiz. Integrated Healthcare (Malaysia) 1206

Source: Prime Ministry Undersecretariat of Treasury, Foreign Direct Investments in Turkey (2002–10); Central Bank of the Republic of Turkey, Balance of Payments Report (2005-III to 2010-I); Ernst& Young Turkiye, Birlesme ve satinalma Raporu (2006); Deloitte, Annual Turkish M&A Review(2008, 2009, 2010, 2011).

386 V. Necla Geyikdagi and Filiz Karaman

Dow

nloa

ded

by [

Nor

th D

akot

a St

ate

Uni

vers

ity]

at 0

6:29

08

Oct

ober

201

4

fragility of the Turkish financial system within the ‘nature of capitalist development

followed by Turkey after the adoption of liberalization in 1980’. The adoption of theWashington Consensus views led to the belief that liberalized markets would lead notonly to economic prosperity but also to a ‘less corrupt economy andmore democratic

society’.12 They also emphasized that the flow of international capital has led to theabolition of capital controls, thus facilitating the operations of MNEs.

It seems that the Turkish economy would have been less vulnerable had the countryadopted some capital controls rather than liberalizing its financial flows completely.

Gerald Epstein maintains that capital account liberalization and economicintegration do not appear to increase economic growth and investment. Instead,

they contribute to financial crises that can have devastating short-term effects as wellas costly long-term influences on output.13 However, if the capital receiving countries

regulate capital flows with an appropriate framework of economic management, theywould be able to reduce different types of risk associated with international capital. It

seems that capital management techniques for inflow controls can promote desirabletypes of investments and financing strategies by rewarding investors and borrowerswho engage in them. Fearing that foreign capital owners will be discouraged to

bring their capital, the Turkish government made no plans for capital controls.On the contrary, even the speculative (portfolio) inflows, which do not contribute

to economic growth, are encouraged in order to finance the large current accountdeficit.

Economists (and the Washington Consensus strategists) have raised arguments infavour of minimal government restrictions on international capital flows because of

their belief in the efficiency of the market and the inefficiency and/or inefficacy ofgovernment regulation. Since financial markets serve as an intermediary between

savers and investors, and allocate credit to its most productive uses, they have to befree from government regulation. Therefore, free capital mobility, relative to moreregulations and control over capital flows, leads to higher levels of investment and

output, and more productivity growth and economic growth overall by allocatingfinancial resources away from those who need them less to those who need them

more at lower risk. Yet, there is little or no evidence that the free movement of capitaldelivers the benefits suggested by its advocates.14

During the 1980s, neo-liberal policies took the form of ‘Reaganism’ in the USA and‘Thatcherism’ in the UK, and were adopted by most of the developed economies of

the West. Under the influence of these countries and the Washington Consensus,many developing countries all around the world also adopted structural adjustment

programmes along the same lines. The global growth rate fell to 1.1 per cent in the1990s from 1.4 per cent in the 1980s, while it had been 3.5 per cent in the 1960s and

2.4 per cent in the 1970s.15 The liberalization of markets led to a situation which wasthe opposite of what its proponents had advocated.

In their case studies, analysing the capital management techniques employed

during the 1990s in Malaysia, India and China, Epstein, Grabel and Jomo foundstrong evidence that these countries had many positive impacts on these three

economies, including helping to insulate them from the worst effects of the 1997Asian crisis. In their opinion, capital management techniques can not only foster

Foreign Direct Investment and Profit Transfers 387

Dow

nloa

ded

by [

Nor

th D

akot

a St

ate

Uni

vers

ity]

at 0

6:29

08

Oct

ober

201

4

financial stability, but also, promote desirable types of investment and financing

arrangements. These techniques can even enhance the autonomy of economic policy,creating space for the government (or the central bank) to use policies that promotegrowth or control inflation by neutralizing the threat of capital flight. Hence, capital

management can enhance democracy by reducing the potential for speculators andexternal actors to wield undue influence over domestic decision-making directly or

indirectly.16

Joseph Stiglitz maintains that if the privatization revenues are even partially spent

on consumption following the acquisition of publicly owned enterprises (consideredas FDI inflows), then the country’s wealth (as a whole) diminishes and the country

becomes poorer. ‘Moreover, foreign firms may engage in bribery to obtain the naturalresources at a “discount” (or even in the case of manufactured goods, may use briberyto obtain protection or monopoly positions).’17

There are also important social consequences of economic integration. Accordingto Dani Rodrik, there is a very serious danger, even more serious than a protectionist

backlash, that globalization will contribute to social disintegration as nations splitalong lines of economic status, mobility, region or social norms.18 Since economic

integration reduces the willingness of internationally mobile groups to cooperatewith others in resolving disagreements and conflicts, it exacerbates tensions among

different segments of society. Although all societies can be afflicted with thesedevelopments, many developing countries are perhaps, even more exposed than the

advanced industrial countries. Rodrik maintains that ‘markets are a socialinstitution, and their continued existence is predicated on the perception that theirprocesses and outcomes are legitimate’. As it has been known for a long time, the

international market is not regulated by any political authority. ‘Consequently,transactions undertaken in the international marketplace carry the least inherent

legitimacy.’ This also exerts pressure on social groups, and the problem becomesmuch worse when segments of society are perceived as having separated from their

local communities.19

Analysis and Results

The most important determinant of profit transfers from a host country is consideredto be the amount of accumulated capital inflows to the country. As the capital stock

grows, we expect the repatriation of profits will grow as well. Since the FDI stockaccumulated over the years does not take into account the inflation effect, and thevalues of more recent years look unrealistically higher than the earlier investments,

the use of such data creates problems in many analyses. However, in the present study,this property of the stock would not create a serious problem since it is regressed on

profit data corresponding to the same period. Other factors such as the overallperformance of the economy and specific factors that may affect certain sectors at

certain times may also influence profit transfers. After trying several models, it wasfound that the following one gave the best fit to our data:

Rt ¼ aþ b1It21 þ b2Gt þ b3D1 þ b4D2 þ vt

388 V. Necla Geyikdagi and Filiz Karaman

Dow

nloa

ded

by [

Nor

th D

akot

a St

ate

Uni

vers

ity]

at 0

6:29

08

Oct

ober

201

4

where Rt is the return on FDI paid to foreigners (profit transfers) in period t, It21 isthe FDI stock up to the previous period, Gt is the growth rate of the Turkish economyand D1 and D2 are dummy variables, and vt is the error term as vt ¼ uvt21. One

assumes that foreign firms, like the domestic ones, earn higher profits in boom years,with the likelihood of transferring higher amounts of profits as compared to recession

periods. Thus, one must look for a positive relationship between the growth rate andprofit transfers. The period from the second half of 2005 to the first half of 2008 has

witnessed the largest privatization of the state-owned enterprises coupled withintense M&A activities. Since 2003, new amendments were frequently enacted

providing major incentives to foreign investors, resulting in an unusual increase inFDI inflows during this period. D1 was included in the model to see the impact of

such occurrences. To increase the number of observations, this study used bi-annualdata which persistently showed higher profit transfers during the first half of the year.D2 was employed to measure the effect of this seasonal change in the data. It is also

assumed that the official balance of payments statistics reflect a large part of the realprofits of the MNEs.

As is the case in many time series analyses, there is a certain amount ofautocorrelation in the FDI stock series. Consequently, the autoregressive procedure has

given the most appropriate results. As seen in Table 3, the maximum likelihoodestimators show quite satisfactory results with a very high R 2 indicating significant

explanatory power. The estimated coefficients have the expected signs and arestatistically significant (with p-values smaller than 0.001 for each independent variable).

The one-year lagged FDI stock coefficient shows that as the stock remains positive,

profit transfers will be positive. While statistically very significant, the coefficient isquite small indicating a small impact on profit repatriation. The growth rate of the

economy (G) seems to be a very important determinant of profit transfers, indicatingthat profit transfers increase significantly in the high growth periods. The first

dummy variable (D1) shows that the privatization and a high level of M&A activitiesafter 2005, resulted in rapid increases in foreign capital stock and also led to high

profit transfers. D2 has the expected negative sign, capturing the fact that profittransfers declined in the second half of the year.

Transfer Pricing Manipulation

Our econometric test results, based on official balance of payments reports as

indicated earlier, show that profit transfers from Turkey have been highly dependent

Table 3 Test Results

Variable Estimated coefficient Standard error t-value pr . jt jIntercept 274.7816 49.7080 5.53 ,0.0001I 0.0199 0.00129 15.37 ,0.0001G 1325 358.0519 3.70 ,0.0009D1 289.6106 87.5015 3.31 ,0.0026D2 2495.3973 62.8637 27.88 ,0.0001

Foreign Direct Investment and Profit Transfers 389

Dow

nloa

ded

by [

Nor

th D

akot

a St

ate

Uni

vers

ity]

at 0

6:29

08

Oct

ober

201

4

on the performance of the economy. During the high growth years, profit transfers

have also grown significantly. Profit transfers have been highly related to theaccumulated FDI inflows, but the small coefficient for the FDI stock reveals a smallinfluence on transfers. As signified by the dummy variables, the privatization and

liberalization programmes of the Turkish government were also instrumental after2005.

It is widely known that MNEs try to reduce their tax base by showing their costshigh and profits low, and use transfer pricing to avoid, or evade, taxes they have to

pay in the host country. There are many examples of such practices, which createdacrimonious debates between companies and states as well as between states. Even in

China where the government continuously provides tax incentives and otherconcessions to attract FDI, MNEs have recourse to transfer pricing manipulations

and other methods to show low profits or losses in that country.20 When a very largenumber of MNEs, 54, 63 and 70 per cent of the total foreign enterprises in the years

1993, 1994 and 1995, respectively, reported operating losses while FDI inflows to thecountry was increasing to tens of billion of dollars, the Chinese tax authorities gotsuspicious and started tax audits.21 In 2004, the authorities claimed that the tax

evasion by MNEs cost them 30 billion yuan (3.6 billion US dollars) each year.22

Transfer pricing techniques are also used in Russia for sending funds abroad. One

study, based on official trade data, estimated that the capital flight from Russia to theUSA from January 1995 to December 1999 amounted to 8.92 billion dollars.23

In recent years, as foreign investments in developing countries increase, concernedauthorities and organizations try to address this issue and advise developing

countries to be alert to the cross-border transactions carried out by MNEs to avoidthe risk of losing out on tax revenues.24 Moving profits across borders without paying

taxes is so widespread that an American government report published in 2004 foundthat 61 per cent of American companies managed to pay no federal income taxesduring the boom years of 1996–2000 by simply ‘moving profits—rather than actual

business—to tax havens’.25

Problems created or enhanced by abusive transfer pricing practices are articulated

even by non-governmental organizations such as Christian Aid. The Christian AidReport of March 2009, very expressively titled ‘False Profits: Robbing the Poor to

Keep the Rich Tax-Free’, recounts the annual capital flow through ‘mispriced trade’ tothe EU countries and the USA as about 581.5 billion British pounds (1.1 trillion US

dollars) during 2005–2007.26 The capital flow from Turkey to the EU was calculatedto be 2.11 billion British pounds (about 4 billion US dollars) and the lost tax revenue

by Turkey was estimated to be 633 million pounds (1.2 billion dollars) for two years(2005–2006).27 Among the low-income countries, lost tax revenues were 502, 305,

251 and 186 million British pounds for Nigeria, Pakistan, Vietnam and Bangladesh,respectively, for the study period of three years. These lost taxes would have providedthe revenues needed for education, healthcare and infrastructure building, and

reduced dependency on overseas aid.By observing the lower than expected profits in the Turkish balance of payments

statistics, which were used in this study, one also suspects the existence of transferpricing practices by MNEs in this country. One major motivation for MNEs to

390 V. Necla Geyikdagi and Filiz Karaman

Dow

nloa

ded

by [

Nor

th D

akot

a St

ate

Uni

vers

ity]

at 0

6:29

08

Oct

ober

201

4

engage in transfer pricing manipulations is to reduce their tax base in a high tax

country. However, this is not the only motivation. Surveys of accounting firms havefound that MNEs use transfer prices for motivations internal to the firm, as a way tomotivate managers by manipulating subsidiary performance.28 In Turkey, the

corporate income tax is higher than those of some developing countries such asChina. Even in China, where MNEs receive tax breaks and face lower rates, capital

flight through abusive transfer prices has been determined. The higher corporate taxrate in Turkey, which was modestly reduced from 33 to 30 per cent in 2005, is

expected to motivate transfer pricing manipulations even more. As seen in Table 1,the ratio of reported profit transfers to the FDI stock has been calculated. We can see

that the ratio jumps to 3 per cent in 2003 and even to 4.8 per cent in 2004, thereafterstabilizing at around 3 per cent, while it consistently hovered around 2 per cent

between 1990 and 2002. This 1 per cent increase may be interpreted as resulting fromchanging environmental (or political) conditions after the election of a new

government which promised exceptionally favourable conditions and lower taxes forforeign companies. In that case, they may possibly choose to report higher profits. In2004, an Investment Advisory Council was established, chaired by the prime minister

and including the top-level executives of 20MNEs operating in Turkey.29 This councilhas held meetings each year, with the participation of the representatives of the

International Monetary Fund and the World Bank. In the fourth council meeting in2007, a further reduction in the corporate tax rate, from 30 to 20 per cent, was

recommended by the members.30 So far, there has not been enough evidence toexplain the relationship between transfer pricing manipulation and decreased tax

rates and/or the betterment of the investment environment. In 2006, the Turkishauthorities formally adopted the transfer pricing rules set by the Organisation for

Economic Co-operation and Development (OECD) Transfer Pricing Guidelines,incorporating them under Article 13 of the Turkish Corporate Income Tax Law.

There have been no known tax audits of MNEs for transfer pricing practices to thisday. Therefore, we can only get some idea about the extent of transfer pricingmanipulation activities of foreign firms in Turkey through some special reports such

as Christian Aid’s or some individual studies. One such study, analysing the importprices of MNEs from the EU countries between 1995 and 2003, found a positive

relationship between tax rates and transfer price manipulation in the beverage, food,chemical, glass, paper and rubber sectors in Turkey. Although the study did not

establish a definite conclusion about the abuses of transfer prices, it certainly foundthat when tax rates increased transfer prices used by the MNEs in their intra-firm

trade rose and presented a high possibility of transfer pricing manipulation.31

Transfer pricing issues are generally discussed in the management accounting and

business ethics literature. They also occupy a dominant place in international taxlitigations. Although it is usually associated with large decentralized manufacturingMNEs, the service sector is not immune to such problems. It is also believed that

‘unethical’ transfer pricing activities are damaging to both companies and theeconomies of host governments. In addition to the arm’s length principle32 embodied

in the OECD Guidelines, a self-regulating code of conduct has been proposed toestablish personal responsibility for the MNEs’ senior management.33

Foreign Direct Investment and Profit Transfers 391

Dow

nloa

ded

by [

Nor

th D

akot

a St

ate

Uni

vers

ity]

at 0

6:29

08

Oct

ober

201

4

It seems that the Turkish balance of payments accounts do not reflect the totality of

the real profits that have been transferred. With the assumption of a reasonableamount of retained earnings by the MNE subsidiaries in the country, the profit ratiosin Table 1 look smaller than expected. This could, of course, create some bias in this

analysis. While there is no way of measuring the full extent of this practice in Turkey,one could still try to predict future developments and draw some meaningful

conclusions by looking at the estimations of the profit transfer abuses. According tothe Christian Aid Report, which is based on Simon Pak’s calculations for 2005–2006,

capital flows, because of transfer pricing manipulations, amounted to about 4 billionUS dollars. However, the official balance of payments accounts show a transfer of 2.2

billion dollars. This means that the unofficial transfers were about twice as much asthe official transfers, and for those two years the total outflow of capital was about 6.2billion dollars. Although we do not have enough evidence to make generalizations, we

can see that, during some years, capital flight through transfer pricing manipulationis much more than what the official statistics show. Even if, after a while, the country

stops receiving any FDI inflows, the profit transfers, whether hidden in transfer pricesor declared to the authorities, will naturally continue and negatively influence the

current account in the Turkish balance of payments.

Conclusions

This study had two purposes: finding the reasons for increased FDI inflows in recentyears and estimating the importance of profit repatriation on these investments. It is a

well-known fact that FDI inflows to Turkey have displayed very large increases inrecent years. However, when they are evaluated carefully, it is seen that more than 60

per cent of these inflows consist of private M&A undertakings or purchases ofprivatized public enterprises. Since such FDI inflows do not create new production

facilities, their contribution to the economy is limited at best. Clearly, the preferableform of FDI is greenfield investments that create new production facilities leading to

economic growth. As Stiglitz put it, ‘[i]n many cases, the foreigners may make thepurchase simply for purposes of asset stripping, not wealth creation; and the countrywill be poorer, not richer’.34

In conclusion, we can first say that FDI inflows to Turkey bring limited benefitsbecause of being mostly in the form of M&As. It seems that the advocates of capital

market liberalization were wrong. In Turkey, liberalization did not lead to newinvestments and growth, but to the transfer of ownership of the most profitable

domestic firms to foreigners. In the Turkish case, even trade liberalization, asrecommended by international institutions, as well as the Customs Union Agreement

with the EU did not encourage FDI inflows. As shown in a previous study, there is nocausal relationship between trade liberalization and FDI inflows.35 In many cases,

when foreign producers are able to sell and make a healthy profit in a liberalizedmarket by simply exporting, they are often unwilling to put their capital intounnecessary political and economic risks in a foreign environment.

Secondly, unless transfer pricing manipulation activities are eliminated, profittransfer estimations based on official figures will provide limited, if not moot, results.

392 V. Necla Geyikdagi and Filiz Karaman

Dow

nloa

ded

by [

Nor

th D

akot

a St

ate

Uni

vers

ity]

at 0

6:29

08

Oct

ober

201

4

This latter conclusion is valid not only for Turkey, but also for other countries as long

as international transfer pricing manipulations exist. In order to prevent undesirable

capital outflows, Turkey should, perhaps, adopt some of the recommendations

proposed by international experts working in this area. A ‘price filter matrix’, as

proposed by Simon Pak, may be constructed in detecting abnormally priced import

and export transactions in intra-firm trade.36 Such a price matrix shows median

price, upper and lower quartile prices, mean and standard deviation for each

harmonized commodity code by country, using the most detailed import and export

database collected and maintained in Turkey.A good topic for further research would be the changing contributions of FDI to

the host country as the MNEs’ form of entry changes and becomes mostly M&As. In

this case, they would cease to create new production facilities and jobs, and pay no

additional taxes to the government. Then, of course, outflows (profit transfers) could

exceed inflows (new investments).

Notes

[1] Glen W. Harrison, Thomas F. Rutherford and David G. Tarr, ‘Economic implications for

Turkey of a Customs Union with the European Union’, Policy Research Paper 1599, TheWorld Bank, Washington, DC, 1996.

[2] Mark Dutz, Melek Us and Kamil Yilmaz, ‘Turkey’s foreign direct investment challenges:

competition, the rule of law and EU accession’, in B. M. Hoekman and S. Togan (eds), TurkeyEconomic Reform and Accession to the European Union, The World Bank and the Center forEconomic Policy Research, Washington, DC, 2005, pp. 261–293.

[3] V. Necla Geyikdagi, ‘The economic views of a nineteenth century Ottoman intellectual: therelationship between international trade and foreign direct investment’, Middle EasternStudies, 47(3), 2011, pp. 529–542.

[4] Gordon H. Hanson, ‘Should countries promote foreign direct investment?’, UNCTAD G-24Discussion Paper Series No. 9, Center for International Development, Harvard University,Cambridge, MA, 2000.

[5] L. Alfaro, A. Chanda, S. Kalemli-Ozcan and S. Sayek, ‘Does foreign direct investment promotegrowth? Exploring the role of financial markets on linkages’, Journal of DevelopmentEconomics, 91, 2010, pp. 242–256.

[6] R. T. Prime Ministry Undersecretariat of Treasury, Reports on Foreign Direct Investment inTurkey, various issues.

[7] Central Bank of the Republic of Turkey, ‘Balance of payments statistics’, 2012 ,http://www.

tcmb.gov.tr/yeni,/eng. (accessed 3 March 2012).

[8] Deloitte, Turkish M&A Resistant to Credit Crunch in the First Half, 2008; Deloitte, Annual

Turkish M&A Review 2009, 2010; and Deloitte, Annual Turkish M&A Review 2010, 2012.[9] R. T. Prime Ministry Undersecretariat of Treasury, Reports on Foreign Direct Investment

in Turkey, 2011; Cevat Karatas and Metin Ercan, ‘The privatization experience in Turkeyand Argentina: a comparative study, 1986–2007’, METU Studies in Development, 35, 2008,pp. 1–47.

[10] Peter Gowan, The Global Gamble: Washington’s Faustian Bid for World Dominance, Verso,

London, 1999, p. 9.[11] Costas Lapavitsas, ‘Financialisation embroils developing countries’, Papeles de Europa, 19,

2009, pp. 108–139.

[12] Sedat Aybar and Costas Lapavitsas, ‘The recent Turkish crisis: another step toward free market

authoritarianism’, Historical Materialism, 8, 2001, pp. 297–308.

Foreign Direct Investment and Profit Transfers 393

Dow

nloa

ded

by [

Nor

th D

akot

a St

ate

Uni

vers

ity]

at 0

6:29

08

Oct

ober

201

4

[13] Gerald Epstein, ‘Should financial flows be regulated? Yes’, in Jomo Kwame Sundaram (ed.),

Reforming the International Financial System for Development, Columbia University Press,New York, 2010, pp. 194–217.

[14] Ibid., p. 199.

[15] Vassilis K. Fouskas and Bulent Gokay, The Fall of the US Empire: Global Fault-Lines and the

Shifting Imperial Order, Pluto Press, London, 2012, p. 83.

[16] Gerald Epstein, Ilene Grabel and K. S. Jomo, ‘Capital management techniques in developing

countries: managing capital flows in Malaysia, India, and China’, in J. A. Ocampo and J. E.Stiglitz (eds), Capital Market Liberalization and Development, Oxford University Press,Oxford, 2008, pp. 139–169.

[17] Joseph E. Stiglitz, ‘Capital market liberalization, globalization, and the IMF’, in J. A. Ocampo

and J. E. Stiglitz (eds), Capital Market Liberalization and Development, Oxford UniversityPress, Oxford, 2008, pp. 76–100.

[18] Dani Rodrik, Has Globalization Gone too Far?, Institute for International Economics,

Washington, DC, 1997.

[19] Ibid., p. 71.

[20] K. Hung Chan and Lynne Chow, ‘An empirical study of tax audits in China on international

transfer pricing’, Journal of Accounting & Economics, 23, 1997, pp. 83–112.

[21] D. H. K. Ho and P. T. Y. Lau, ‘A study of transfer pricing in China’, International Tax Journal,

28(4), 2002, pp. 62–78.

[22] Prem Sikka and Hugh Willmott, ‘The dark side of transfer pricing: its role in tax avoidance

and wealth retentiveness’, Critical Perspectives on Accounting, 21, 2010, pp. 342–356.

[23] Maria E. de Boyrie, Simon J. Pak and John S. Zdanowicz, ‘Estimating the magnitude of capital

flight due to abnormal pricing in international trade: the Russia–USA case’, AccountingForum, 29, 2005, pp. 249–270.

[24] C. Silberztein, ‘Transfer pricing: a challenge for developing countries’, OECD Observer, Nos.

276–277, December 2009–January 2010,,http://www.oecdobserver.org/news/fullstory.php/aid/3131/T. (accessed 12 March 2012).

[25] Economist, The, ‘Special Report: Offshore finance’, 2 February 2007.

[26] Christian Aid, ‘False profits: robbing the poor to keep the rich tax-free’, ,www.christianaid.

org.uk/images/false-profits.pdf. (accessed 3 January 2013). These numbers were estimatedby Professor Simon J. Pak (commissioned by Christian Aid) using the most detailed tradedata available from the EU and the USA which records bilateral trade in every commodity.

[27] Although the study period of Professor Pak is three years, there was an error in 2007 because

of erroneous reporting of the quantity of the exported goods from Turkey that causedunusually high export values. Therefore, we simply look at the two years of reliable tradefigures.

[28] Lorraine Eden, ‘Taxes, transfer pricing, and the multinational enterprise’, in A. M. Rugman

and T. L. Brewer (eds), Oxford Handbook of International Business, Oxford University Press,Oxford, 2003, pp. 591–619.

[29] R. T. Prime Ministry Undersecretariat of Treasury, Foreign Direct Investment Report 2004,

Ankara, March 2005.

[30] R. T. Prime Ministry Undersecretariat of Treasury, Foreign Direct Investments in Turkey 2007,

Ankara, June 2008.

[31] Murat Cak, Uluslararsi vergi rekabeti transfer fiyatlaması ve vergilendirme [International Tax

Competition, Transfer Pricing and Taxation ], Ministry of Finance, Ankara, 2008.

[32] The arm’s length principle states that intra-firm transactions should be priced as they were

taking place between unconnected parties in the open market. In other words, ‘related parties’within the same organization should try to emulate the market conditions as closely aspossible, thereby attaining what would be a fair price.

[33] MessaoudMehafdi, ‘The ethics of international transfer pricing’, Journal of Business Ethics, 28,

2000, pp. 365–381.

394 V. Necla Geyikdagi and Filiz Karaman

Dow

nloa

ded

by [

Nor

th D

akot

a St

ate

Uni

vers

ity]

at 0

6:29

08

Oct

ober

201

4

[34] Joseph E. Stiglitz, ‘Development policies in a world of globalization’, in Kevin P. Gallagher(ed.), Putting Development First: The Importance of Policy Space in the WTO and InternationalFinancial Institutions, St Martin’s Press, New York, 2005, pp. 1–47.

[35] Necla Geyikdagi, op. cit.[36] Simon J. Pak, ‘Capital flight and tax avoidance through abnormal pricing in international

trade—the issue and solution’, in R. Murphy (ed.), Closing the Floodgates: Collecting Tax to PayDevelopment, Tax Justice Network, London, 2007, pp. 118–123.

V. Necla Geyikdagi is Professor of International Economics at Yeditepe University,Department of Economics. Her research interests include foreign direct investment

and international trade flows. She has published books and articles in many journalsincluding Middle Eastern Studies, Business History, Transnational Corporations,Management International Review, RISEC, Enterprise and Society and the Journal of

Asia Pacific Business.

Address for correspondence: Faculty of Economics and Administrative Sciences,Yeditepe University, Kayisdagi Caddesi, 34755 Atasehir, Istanbul, Turkey.Email: geyikdagi@superonline.com

Filiz Karaman is Associate Professor of Statistics and Business in the Department ofStatistics, Yildiz Technical University, Istanbul. She has published in Journal of

Applied Sciences, Journal of Agricultural, Biological and Environmental Statistics andCommunications in Statistics—Simulation and Computation.

Address for correspondence: Department of Statistics, Yildiz Technical University,Davutpasa Caddesi, 34222 Esenler, Istanbul, Turkey.

Email: filiz_karaman@hotmail.com

Foreign Direct Investment and Profit Transfers 395

Dow

nloa

ded

by [

Nor

th D

akot

a St

ate

Uni

vers

ity]

at 0

6:29

08

Oct

ober

201

4