Modern Economy, 2011, 2, 546-551
doi:10.4236/me.2011.24060 Published Online September 2011 (http://www.SciRP.org/journal/me)
Business Cycle and TPM of TNCs
Junrong Liu
School of Tourism and Management & Economics, Leshan Normal University, Leshan, China
Received June 23, 20 11; revised July 26, 2011; accepted August 5, 2011
Abstract
This article is devoted to analyses on effects of the four phases of business cycle on transfer pricing manipu-
lation (TPM) of transnational corporations (TNCs) and TNCs’ possible TMP practices through business cy-
cle. The researcher herein holds that business cycle arouses the fluctuation of economical indicators and pol-
icy changes, which subsequently affect TNCs’ production, financial situation, sales and their resource alloca-
tion globally. Acting as a reasoning business being, TNCs should take according strategies to manipulate
transfer pricing to harbor the possible benefit and escape from any risk ahead, by taking advantage of their
“Trans-nationality”.
Keywords: Business Cycle, Transfer Pricing, Manipulation, TNCs
1. Introduction
Economic cycle is an objective economic phenomenon,
which affects all economic activities and government
economic policies. Multinationals’ transfer pricing in
internal trade also be subjected to economic cycles. And
the impact of economic circular fluctuations on the mar-
ket and government policy changes directly influence
multinational transfer pricing strategies and the transfer-
ring direction, which, without the proper management,
would cause great waste of resources. In view of this,
this paper is sacrificed to that the exploring the impacts
of evolution of economic cycle four phases on the trans-
fer pricing manipulations (TPMs) of the multinationals’
intra-firm trade.
1.1. The Motivation of Internalization
Transnational companies in nature are the results of in-
ternationalized internalization of firms’ trade and the
economic organizations that are capable of harboring the
best resources in the world, to seeking for the maximum
market profits at the lowest cost. Unless the considera-
tion for long-term strategy, they always try to avoid all
negatives. Actually, the instinct advantages TNCs have
are not their vast resources and the advanced technology
and management techniques but their Trans-Nationality
as the core advantage. Multinational corporations, ac-
cording to the level of technology and specialization in
different countries, take the international specialized
production strategies and construct the network of senti-
nel production of specialized factories worldwide, and
spare parts’ manufacturing division and logistics leading
to the favorable locations, assembling bases and direct
marketing sub-cen ters. In orde r to face up the fierce mar-
ket competition, Transnational corporations have produ-
ction activities in different countries linked together th-
rough the production system, which covers investment
and trade activities, and convert a majority of their trade
into intra-firm trade among the parent company and sub -
sidiaries or among the affiliates. [1,2] The trans-nation-
ality of TNCs makes them enjoy the broad geographical
space, wide market and convenient finance, and thus
renders TNCs much mobility in dealing with various
risks.
1.2. The Functions of Transfer Pricing
Trade Internalization has made TNCs’ trans-nationality
effective and enables them to make up international op-
erating costs, harboring their competitive advantage. [3]
Internalization theories hold that because of external
market’s defects that raise market transaction costs, TNCs
prefer internal transactions to external market transac-
tions. Internal transfer pricing refers the pricing manipu-
lation on products, services, intangible assets and funds
so on, which are transacted within TNCs. Transfer Pric-
ing Manipulation (TPM) is a practice by TNCs in mak-
ing prices that would be higher or lower than the oppor-
tunity cost to avoid (not to evade illegally) national con-

J. R. LIU547
trol or take opportunity to exercise arbitrage strategies.
As the world market is not fully unified one, TNCs
can be the beneficiary of international operations. The
effective use of the global production and marketing
network makes the feasibility of transferring resources
within firms become the TNCs advantage which is ex-
clusive to any Non-TNCs.[4] TNCs’ transfer pricing
operations is the right practice in tak ing the advantage of
defects in the global market to achieve their business
goal. [5]
2. The Impact of the Economic Variables on
TNCs’ TPM
The economic variables herein are the macroeconomic
indicators which states business cycle, including ex-
change rates, tax rates, interest rates, GDP growth rates
and market consumption situation and so forth. Before
discussing the impacts of the economic cycle on TPM by
multinational corporations, we should come to the im-
pact of the economic variables on TNCs’ TPM.
2.1. Exchange Rates
Exchange rate is the monetary value ratios between the
two nations’ currencies. The appreciation or depreciation
of one nation’s currency would create arbitrage opportu-
nity between two counties in a short time, which, for
TNCs with a huge amount of fund, is an excellent profit
opportunity. Such arbitrage should be necessarily re-
flected in the internal trad e pricing, and th e popular prac-
tices are over-pricing or under-pricing the assets to be
internationally internally tran sacted so as to achieve their
financial returns with the changes of exchange rate.
2.2. Tax Rates
Changes in tax rates also exert obvious influence on
transferring pricing of TNCs. Some scholars even be-
lieve that TNCs manipulate transfer pricing primarily for
tax avoidance or evasion. [7] TNCs generally achieve tax
avoidance in two ways through transfer pricing: First
way is the over-pricing of transfer-in to drive up cost for
tax reduction, and the other is to shift profits to the
branches in low tax countries. [6,8,9]The two methods
can be applied by the companies who are in the cou ntries
of high tax rate. When the host countries’ tax rate is low,
the more effective method for tax avoidance should be
the choice; Of course, compared with other countries, the
host country’s tax rate is very low or even free (say, that
in FTZ), low-priced transfer-out and high-priced transfer in
seem to be the best policy.
2.3. Interest Rates
A question worthy of further exploration is the impor-
tance of interest rate changes to TNCs. transfer pricing
issues. Any fluctuation in interest rates in host country
would change the financing cost of TNCs costs in the
country. In the case of low interest rates, TNCs can eas-
ily harbor financial resource at low cost, and they decline
in this time directly to transferring the low-cost capital to
their brunches in the nations of high interest rates. If
there is limitation over the tran sf er (th e policy co nstr ain ts
mainly), these funds may be transferred in disguise of
production equipment or management aids to the high-
interest rate countries through the intra-trade channels;
Additionally, TNCs also transfer their financial assets to
parent company or foreign branches, thus saving fund,
lower costs and improving return on assets. Largely,
these behaviors of TNCs are arbitrage practices over the
gap of international interest rates. The transfer prices can
be determined with TNCs’ cons idering the exchang e rate
and tax rates. Given their economic variables are con-
stant, low interest rates would lead to in-transferring at
high prices and out-transferring at low prices and vice
versa.
2.4. GDP Growth Rate
GDP growth rate is the basic indicator of economic con-
ditions and the main measurement of business cycle.
Higher growth rate of GDP indicates that the economy is
in booming phase, when firms enjoy a f avorab le busin ess
climate for development and need more tangible assets
and equipment for production and operation, and have
accumulated many new technologies since the previous
phases. In the case of slow GDP growth, corporate suffer
sluggish sales and underproduction and enlarging inven-
tory, TNCs then generally move their idle equipment to
the booming economies where their branches or parent
company are. According general economic theories and
practice, in the four phases of economic cycle, govern-
ments usually adopt an “anti cycle methodology” to re-
gulate their national economies. In the period of eco-
nomic expansion, government monetary and fiscal poli-
cies are always featured with high tax rate and high in-
terest rate; while in a recession, the governments largely
adopt a low tax rates and low interest rate. The changes
in GDP form the immediate impact on people's income
and consumption power, thereby affecting the prices of
products and marketing of TNCs.
In addition, GDP growth and exchange rate have a
close relationship. Therefore, changes in GDP would im-
mediately influence the transfer pricing manipulation
(TPM) of TNCs mainly with changes in the economic

J. R. LIU 548
development and the relevant adaptation of government
policies concerning tax rates, interest rates, exchange
rates etc. Largely speaking, when GDP grows rapidly,
TNCs will exercise high priced transfer-out of physical
assets for the production in other locations and low-
priced transfer-in of intangibles such as technology for
product upgrading and innovation. While the GDP growth
rate is high, TNCs then employ the manipulation of
high-priced transfer-out and low-priced transfer-in, and
the former transferred are mainly invisible assets such as
technologies while the latter intra-transacted are the phy-
sical assets concerning production.
2.5. Consumption Power
The consumption power is another key indicator which
reflects market size that possibly taken by TNCs. In gen-
eral, the low consumption means the small demand on
the market and vice versa. In fact, market conditions
faced by TNCs hardly affects directly their transfer pri-
ces, but given combined with other factors, it would
make big difference.
Based on the above analyses, the economic cycle will
cause changes in exchange rates, tax rates, interest rates,
GDP growth rates, market conditions and even political
stability and consumption changes, which drives TNCs
to take different transfer pricing strategies. For conven-
ience, we exhibit the relationship between TNCs’ TPM
and Changes in economic variables in the table below.
3. The Business cycle and the TNCs’ TPM
3.1. The Impact of the Evolution of Business Cycle
Phases on TNCs
Briefly speaking, the impacts of economic cycle on
TNCs can be generalized as follows: first, the change in
consumption leads to fluctuation in the sales’ of TNCs.
Usually, the economic downturn is accompanied with the
decline in national income and weak investment, which
lead to deep reduction of consumption, and thereby make
TNCs suffer the enlarging product backlog or underpro-
duction, resulting in high business opportunity cost and
low capital efficiency. Second, the governmental adjust-
ment over the policies has great implications to TNCs’
operation. Faced with cyclical economic fluctuation, the
local governments will make macro-control policies to
deal with the adverse changes in the economy, which
would conflict with TNCs’ established strategic and
plans and influence firms’ operations negatively. Third,
the economic circular fluctuation sometimes jeopardizes
TNCs’ assets. Large fluctuations in the economy may be
accompanied by political events and even wars, and di-
Table 1. The Relationship between TNCs’ TPM and Changes
in Economic Variables.
VariablesChange Transfer price
(outward) Transfer price (inward)
up HP LP
Ex-rate down LP HP
low HP LP
Tax rate high LP HP
low HP LP
Int-rate high LP HP
low HP
(intangibles) LP (physicals)
Growth
-rate high LP
(physicals) HP (intangible )
down LP
(intangibles) HP (physicals)
Consum.
power up HP
(physicals) LP (intangibles)
rectly endanger the security of the assets of transnational
companies, and the possible dangers would be destruc-
tion, expropriation and confiscation and prohibition of
profit repatriat ion and so on.
For transnational corporations, the economic risks of
cyclical fluctuations are frequent, and one of the effec-
tive means TNCs take to avoid these risks is to take ad-
vantage of their existing global operation network to
reallocate their resources through internal transfer of
both tangible and intangible assets. This transfer must
involve pricing the goods to be transferred. For the
transfer of assets within the enterprise makes no differ-
ence on ownership, transfer pricing thus seems unimpor-
tant. However, due to the trans-nationality of the intra-
firm transfer of TNCs’ assets, which involves differences
in international tax, currency exchange rates [10], na-
tional economic sovereignty, and TNCs’ benefit internal-
distribution, TNCs’ transfer pricing becomes necessary.
Actually, internal transfer pricing allows the TNCs’
cross-boarder transfer of assets the legitimacy of export-
ing, which enables TNCs to evade tax legally and avoid
some possible high political risks from their consid erable
arbitrage pr ofi ts.
The economic cyclical fluctuations have their own dif-
ferent characteristics in each phase of business cycle,
thus TNCs’ transfer pricing face variable economic poli-
cies, which drives firms to adjust their business objec-
tives and transfer pricing manipulatio n. In this paper, we
employ the methodology of John. R. Mayer and Daniel.
H. Weinberg, who held that a complete economic cycle
consists of the four phases: recession, recovery, demand-
pull inflation and prosperity. And, we maintain that the
evolution of business cycle has significant implication
for TNCs, and would bring about changes which power-
fully influence TNCs’ performance, such as national tax

J. R. LIU549
policy change, the changes in exchange rates and interest
rates, the changes in, and as an unusual situation, the
risks over ownership of TNCs’ asset from political risks.
Before The analysis over the impacts of the four
phases on TNCs’ transfer pricing, we first make the fol-
lowing assumptions: First, the governments act on the
theories of business cycles; Second, the enterprises re-
spond to the outside environmental change and the ad-
justment in economic policies in accordance with the
“rational economic man” approach; Third, all countries
(say country A and country B) be at different phases of
business cycles; Fourth, national economic activity are
independent from the political ideology; Fifth, other fac-
tors within enterprises are fixed. The purpose of these
assumptions is to simplify our analysis, and in fact, these
assumptions are consistent with economic theories and
the traditional practice of g eneral economic activity.
1) Economic recession. In recession phase of business
cycle, the particular country (say country A) adopts loose
monetary and fiscal policies of economic expansion, say
lower interest rates, low tax rate and high governmental
transfer and so on. In the economic downturn phase, the
Government welcomes the entry of foreign capital, while
the outflow of assets and funds are under strict control;
At this time, tax rate decreased significantly, while the
country's currency is expected to appreciate; And the
difficulties faced with by TNCs are baggy consumption,
sluggish sales, rising inventories and underemployment.
2) Economic recovery. In this period, the country
(country A) will continue to maintain accommodative
monetary and fiscal policy, and hold the welcoming atti-
tude to foreign investment, but policy efforts are to be
weakened, and the market conditions faced by transna-
tional corporations continue to improve, sales increase,
and excess inventory decreases.
3) Demand-driven inflation. Because people’s demand
and investment are increasing, the economy grows rap-
idly, but the signs of inflation become clear for faint,
while the economy is still being steadily improved.
Meanwhile, the government policies turn neutral and
hence the preferential policies offered by government to
TNCs have gone. However, at this time, TNCs enjoy
better business climate with increasing product sales,
boosting corporate income and a gradual expansion of
production and larger market share. The only drawback
is that the cost of TNCs expresses a significant upward
trend, which further encourages th e inflation in the coun-
try, and change in exchange rate will makes TNCs suffer
losses in profit repatri a t i o n and from export.
4) Economic booming. With the further development
of the economy, the country (country A) entered the
boom phase of business cycle, with rapid production
promotion, investment scale-up, credit expansion, the
price level rising and increasing employment. Meanwhile,
consumer demand is climbing up and the market is in its
expansion. At this stage, the macroeconomic contains
two forces, that is, the power driving economy to grow
and the strength forcing the economy down-turning. In
the boom phase, the country (country A) mainly takes
tight monetary policies and fiscal policies to deal with
the economic overheating, and thereby the bank interest
rates rise, and corporate tax increase. The government
would manage the expectation of investment revenue to
control the total investment, thus preventing the econ-
omy from reducing to be of recession from excessive
expansion. In this phase, the government in short run
restricts the entry of foreign capital, while depreciation
of the currency lies under strong expectation, which
brings some detriment on TNCs in prof it repatriation and
exporting. And in spite of increasing corporate sales, due
to the rise of costs, TNCs’ actual profit would drop from
that of the previous phase, making TNCs lack for moti-
vation for business exp a nsion.
3.2. The TPM Employed in Each Phase
With the environment faced by the four stages pictured
above, TNCs will employ transfer pricing strategy ac-
cordingly in order to achieve reasonable tax avoidance,
and thus optimize the global resource allocation, corner
greater arbitrage opportunities and ensure the efficiency
of asset proliferation.
1) The TPM in recession
At this stage, due to underemployment and glissading
sales, TNCs will ship resources in a branch in a particu-
lar country (country A) to its sister branch in another
country (country B)to ensure the effective use of total
corporate resources. Country A in recession should take
low-tax policies to stimulate economic development,
whereby TNCs would transfer out at high-price to enjoy
the advantages o f low taxation ; Add itionally, becau se the
currency of country A are to appreciate, TNCs can corner
arbitrage opportunities for exchange rate fluctuation. For
TNCs in any country in recession, they are witnessing
the market shuff le and product upgrading, so they would
transfer out tangible assets concerning production, op-
eration and management through intra-trade channel, and
move into technologies at low prices to equip the new
production for the future market. Besides the transfer of
capital, TNCs can also take advantage of the loose mo-
netary polices to financing in country A and then transfer
the fund to country B, reducing corporate costs and en-
hancing asset utilization, harbor tax relief and interna-
tional arbitrage opportunities.
2) The TPM in recovery
In the economic recovery period, as TNCs face the
similar fiscal and monetary policy with that in economic
recession, their transfer pricing strategy is also roughly

J. R. LIU 550
the same. With minor policy changes, there are some
adjustments within TPM of TN Cs. At this time, with the
gradual economic recovery of country A and vigorous
market, TNCs gradually cater for the economic impro-
vement and start transferring in intangible assets (such as
Proprietary technology, trademarks, patents) at low price
to meet the increasing production in country A, when
transfer-out at high price is still dominant.
3) The TMP in demand-driven inflation
At this stage, the government policies of country A
become neutral and the nation is suffering the pressure of
the devaluation of its currency. The low tax policy ad-
vantages enjoyed by TNCs have disappeared, while the
demand-driven inflation in the country A makes the
value of international assets of TNCs shrinking. How-
ever, the current active market and greater profit margins
in this country provide TNCs a better business climate.
Considering the advantages and disadvantages syntheti-
cally, TNCs will transfer out mainly intangible assets at
low price, while transfer in the tangible assets concerning
production, operation and management from country B
to meet the production requirement and capital needs in
country A, thus they increases the carrying cost, and
thereby circumvent the tax in country A and the loss of
assets from currency depreciation, and access to arbi-
trage opportunities in country B. The period is the prime
season for TNCs’ business operation, and in this phase,
enterprises should consider not only the in-transferring
but the out-transferring for the local high tax rate and the
security of their assets.
4) The TMP in economic boom
In economic boom phase, the government usually ex-
ercise tight fiscal and monetary policies, that is, high tax
rate and high interest rates; And the country (country A)
suffers high inflation and currency devaluation; Besides,
market gets saturated and competition fierce; Fourth,
TNCs have large corporate sales, but profit margins are
narrow; Additionally, in this time, the factors economic
growth and recession coexist. To response to this adverse
environment, TNCs mainly forth-put the low price policy
in intra-trade transfer pricing, which aims to 1) avoid-
ance of tax, 2) preventing the devaluation of assets from
currency depreciation, 3) avoiding inefficient use of
corporate assets. Therefore, the usual TPMs are transfer-
ring out the resources at low price to the efficient pro-
duction location (say country B) for high capital revenue
and transferr ing in technologies and patents at high pr ice
to upgrade produ c ts for future competition.
3.3. Generalization
Based on the argument above, we generalized TNCs’
TPM in Table 2 and Figure 1 as follows:
Table 2. Business cycle, Economic variables and TPM.
Phases
of Business
cycle
Tax rate
and Ex-rateINT- rate
GDP
growth
rate
Consum-
ption
TPM
Inward
(price)
TPM
Outward
(price)
RecessionL L L L L H
RecoveryL L L L L H
InflationH H H H H L
Boom H H H H H L
Figure 1. Schematic diagram of business cycle & TPM.
4. Concluding Remarks
Business cycle affects all factors of economy, and the
factors directly affect the pricing products and services
transacted within TNCs. This paper merely theoretically
analyzes the impact of business cycle on TNCs transfer
pricing. Anyhow, th is study has its due some implication
for government administration and enterprise governance.
The findings of the paper show that within the four
stages of business cycle, TNCs take a different transfer
pricing strategies, and these strategies come out of TNCs
property of “rational economic being”, which would off-
set the local government “counter-cycle” policies, ag-
gravating economic overheating, exacerbating economic
recession and inflation. In addition, this study helps our
understanding TMP of TNCs in each phase of business
cycle, which provides the government with a perspective
to view of TNCs’ TPM and better their policy making.

J. R. LIU 551
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