Capital Movements, Tobin Tax and Permanent Fire Prevention:
A Critical Note.
Massimo De Angelis
The last twenty years have been characterized by a tremendous increase in the amount of money capital floating around global financial markets. Also, the guardians of neoliberalism such as the IMF and WB have placed enormous pressure on the countries of the South to liberalize their financial markets and promote local stock markets and capital inflow. In 1995, while world exports of goods and services totaled about $6.1 trillion, the daily foreign exchange market turnover amounted to about $1.2 trillion, that is, about 50 times as much annually. The flow of foreign portfolio investment has been staggering, even in relation to foreign direct investment flows.
For major industrial countries, gross flows of foreign direct investment has gone from $75.94 billion in 1985 to $448.32 billion in 1997, while portfolio investment has increased in the same period from $233.44 billion to $1,040.19 billion. Furthermore, non-residents' holding of public debt has increased significantly. In the case of the US, in 1983 14.9 per cent of public debt was held by foreigners compared to 40.1 per cent in 1997. Apart from Japan, all other industrialized countries have experienced the same growth. Furthermore, while in 1975, cross-border transactions in bonds and equities were a negligible percentage of GDP (ranging from 1 per cent in the case of Italy to 5 percent in the case of Germany, and 4 per cent in the case of the US), in 1997 these have reached phenomenal levels: in the case of Italy, more than six times greater than GDP, for the US 213 and for Germany 253 per cent of GDP respectively.(1)
All these data are clear indications of the degree of financial integration reached and therefore of the full exposure of national economies to the whims of financial markets and to security owners with no particular "national allegiance". No government can afford to upset speculators with policies that are not compatible with the priorities set by international capital.
In terms of economic policy, the result, it is known, has been the handicapping of monetary policy and its inability to manage interest rates for internal purposes without affecting exchange rates. For example, in case of a mild deflation of the economy, the Central Bank could boost the economy by reducing the rate of discount. But in an open and well-integrated financial market in which capitals are free to come and go as easily as the pressing of a key, a reduction in interest rates would be followed by a capital outflow and consequent fall in the exchange rate. Not only would the increase in the cost of imports perhaps counteract the fall in interest rates and therefore contribute to rendering the Central Bank policy ineffective (this of course depends on the elasticity of import), but an obvious element of instability would also be introduced into the system. How much capital is withdrawn following the central bank policy? How much "trust" in the country is foregone, with an unpredictable impact for the future? All this is really a matter of "speculation".(2)
Speculative capital flows also play a role in controlling and disciplining government's fiscal policy. In particular, the neoliberal dogma requires that governments put public expenditures under control, especially current expenditures, and engage in structural reforms such as the privatization of services and industries. Also, the neoliberal era has witnessed a systematic attack on a series of entitlements that were central to the rise of the Keynesian era. Welfare state pillars, such as state pensions, education, health provisions, various forms of unemployment benefits and income support, have all been undermined. Movements of speculative capital also threaten any government that, under particular pressure from some interest group in civil society, would be willing to concede increases in social spending along the lines of the post-war period of Keynesianism. Thus, a return to systematic Keynesian policies depends on the regulation of capital movements, in such a way as to give more space to national governments to pursue expansionary policies.
The question of how to curtail capital movements seems therefore to be a central question to be addressed by all those concerned with restoring some degree of autonomy to economic policy. This autonomy would of course be associated with the necessary flexibility that governments require in order to pursue public goals that today are at risk because of the rigidity imposed by financial markets over public spending.
Unfortunately, the two main proposals that address the problem of limiting capital mobility suffer from major shortcomings, as I will be discussing in this paper. The first of these proposals is a mild tax on capital movements, and the second, a radical redesign of the international financial system.
2. The Tobin Tax.
One of the most debated proposals to limit the movement of speculative capital flow is the so-called Tobin tax. This is a tax levied on foreign exchange transactions and takes its name from James Tobin, who proposed it (Tobin 1974, 1978 and Eichengreen, Tobin, and Wyplosz 1995, among others). It has been pointed out that there are three main rationales for the Tobin tax (Arestis & Sawyer 1997: 753-755). In the first place, this tax would be essentially a small transaction tax that would penalize short-term round-trip movements of speculative capital, thus helping to "put grains of sand in the wheels of international finance" (Eichengreen, Tobin, and Wyplosz 1995). In this way, the Tobin tax would reduce the profitability of short-term speculation and allow exchange rates to better reflect long-term factors in the real economy rather than short-term speculative flows. The second rationale is based on the greater autonomy this tax would give governments in pursuing economic policies, by being shielded from financial market discipline on domestic fiscal and monetary policy. Finally, the third rationale for such a tax is its revenue-raising potential. According to a United Nations study, a Tobin tax of merely 0.05 % could raise $150 billion a year (United Nations 1994: 9).
What interests us here is of course the first rationale, that is, the capability of this transaction tax to serve as a restraint on international capital flows. This is indeed the main reason for discussing a Tobin-type tax. The second rationale is nothing but a consequence of the first, and the third one is an incidental result. The Tobin tax could certainly be welcomed on the ground that it serves to find resources that could be used for more honorable and ethically sounder activities than international speculation. But for this purpose a Tobin tax would merely be one among many possible ways to tax high and capital income.
The real question is whether the Tobin tax could restrain short-term capital mobility. Perhaps the most poignant critical contribution to this debate was provided by Paul Davidson (1997) who focused not on the practicality of the tax, but rather on its theoretical foundations. According to Davidson, the Tobin tax will not make it possible to reduce international speculation, but at most arbitrage. He convincingly argues that as the Tobin tax is a transaction cost, it is "independent of the round-trip time interval" (Davidson 1997: 675). This goes against the impression given by the proponents of the tax that a small tax rate (Tobin proposed 0.05%, this being the "small grain of sand" in the wheels of international finance) would convert to larger rates in direct proportion to the frequency of speculative trips. According to its proponents, the tax would discourage short-term capital movements and encourage long-term investment, as the total tax levied would increase with the number of trips within a certain time interval. However, in order for the tax to operate as a disincentive to capital movements, the speculators' expected change in assets price should be lower than the very low Tobin tax. Thus Davidson concludes that
the imposition of a Tobin tax per se will not significantly stifle even very short-run speculation if there is any whiff of a weak currency in the market. In fact, any Tobin tax significantly less than 100% of the expected capital gain (on a round trip) is unlikely to stop the sloshing around of hot money. (Davidson 1997: 678)
Thus, taking for example the case of the fall of the Mexican peso during the crisis of 1994-95, in which the peso fell by about 60%, a Tobin tax of about 23% would have been required to stop speculative run on the peso.(3)
3. Permanent fire prevention in global finance.
Paul Davidson himself (Davidson 1992, 1992-93, 1997) provides a more radical proposal for the regulation of international finance.(4) Following the idea behind Keynes' original plan during the Bretton Woods negotiations, the central theme inspiring Davidson's proposal is the "need for a permanent currency fire prevention institution rather than merely relying on either fire-fighting intervention such as the suggested Emergency Fund financed by contributions of the G7 nations and managed by the IMF, or a laissez-faire policy on international capital markets that can produce currency fires to burn the free world's real economies." (Davidson 1997: 679-680)
The proposal is built upon two pillars. First, a unit of account and ultimate reserve asset for international liquidity called the International Money Clearing Unit (IMCU). No other liquid assets would be allowed to be used as reserves for international financial transactions. Second, a mechanism that puts the burden of adjustment in international finance on countries experiencing surplus in their trade balance rather than, as it is currently the case, on countries in deficit. Individual countries' central banks would be the sole holders of IMCUs, and they alone would be able to sell it among themselves or the International Clearing Agency. This implies that there cannot be any draining of reserves from the system, since all major private transactions are cleared between central banks in the books of the International Clearing Agency. Thus, no country could be exposed to a liquidity crunch due to short-term speculative movements of financial capital. A system of fixed exchange rates would be put in place and international contracts would be denominated in the national currency. Any adjustment of the nominal exchange rates would be allowed only to reflect changes in the real costs of production, that is, the relation between productivity and wages in each country. Thus, competitive advantage could not be pursued by competitive devaluation, but by real factors in the economy.
While short-term imbalances between countries could be managed through an overdraft mechanism at the Clearing Agency, allowing unused resources to finance short-term credit, the real innovation would be the setting up of a mechanism that encourages surplus nations to spend money and generate demand for countries in deficit. Surplus countries could do this in three possible ways: a) by increasing the import demand of goods and services from deficit countries; b) by increasing the flow of foreign direct investment to countries in deficit; c) by providing unilateral transfers such as aid or grants to countries in deficit. A combination of these three is of course also possible. The key point is that under this provision "deficit countries would no longer have to deflate their real economy merely to adjust payment imbalances because others are over-saving. Instead, the system would seek to remedy the payment deficit by increasing opportunities for deficit nations to sell abroad and thereby earn their way out of the deficit" (Davidson 1997: 682).
Contrary to the dominant neoliberal efficient market theory, according to which the role of international capital markets is to ensure efficiency, Davidson's proposal stems from the thesis that the role of financial capital markets is to provide liquidity. His plan is thus aimed at ensuring that the global productive machine never runs out of oil, and that a crisis could never take the form of a liquidity crisis. There are however some major problems with this proposal.
In the first place, in the context of a competitive global economy geared towards production for profit, liquidity crunches have a systemic function in that they help ensure that standards of competitiveness or movements towards further global integration are enforced. Liquidity crises are always accompanied by negotiations about conditions between debtors on the one side and creditors and international institutions on the other. The latter are generally willing to either reschedule debt repayment or inject new liquidity in the forms of new loans only on the condition that structural reforms affecting both the openness of the country to global capital and the basic parameters of accumulation are implemented. But the implementation of these reforms leads of course to a confrontation with civil society, as the conditions always entail some form of reduction in the social wage, abolition of entitlements, and so on. It is for this reason that the ability of national governments to present this as a necessity posed by external objective factors (such as a liquidity crisis and its consequences) is of paramount importance for the legitimization of unpopular reforms. In other words, without liquidity crises, or the threatened risk of liquidity crises, governments and national capitals would be more vulnerable to those forces in society that do not have efficiency, competitiveness and global integration as their priority, but the simple protection of entitlements and rights. In a society riddled with contested terrains, liquidity crises provide disciplinary devices coherently linked to the priorities of market discipline, competitiveness and efficiency which form the guiding principles of capitalist accumulation.
A second weakness in Davidson's argument can be seen in the mechanism that puts the onus of adjustment on countries in surplus. As noted, this could take the form of a purchase of imports from countries in deficit, foreign direct investment or grants and aid. This principle is linked to the previous one, that is, the need to guarantee a well-oiled international economic system and avoid liquidity crises. Let us suppose the surplus countries aim at increasing imports from the deficit countries as per Davidson's proposal. A first problem can be seen by reflecting upon the reasons for the trade deficit. Within the framework of a competitive global economy, to the extent trade deficits are due to problems in the competitiveness of the traded goods of deficit countries, then it is contrary to any economic logic for surplus countries to increase their imports from deficit countries. In a context of falling wages and increasing consumers' and producers' indebtedness, why would consumers and producers in the surplus countries have to buy goods that are relatively more expensive and/or of poorer quality than, say, commodities that are domestically produced or supplied by another more competitive country? But perhaps surplus countries could increase the imports of those commodities that are not produced domestically. Again, this would require either first, that deficit countries were the sole international suppliers of that commodity, or second, that they were able to supply them on competitive terms. While failure to meet this second condition leads us back to the problem of economic logic mentioned before, the first condition would be a very unlikely case of absolute monopoly, which would allow the monopolist country to reap an economic rent. Alternatively, Davidson's proposal could imply the promotion of exports in commodities in which the country has a relative advantage. This case, however, is vulnerable to all the traditional criticisms stressing the socio-economic devastation and the vicious cycle of dependency linked to export promotion for countries with a limited range of internationally tradable goods.
The mechanism of adjustment could take the form of capital movements from surplus countries to deficit countries in the form of foreign direct investment. However, for these to take the form of planned long-term investments, the deficit countries need to be able to guarantee a stable economic and political environment suitable for increases in competitiveness, and thus profitability, which is the ultimate attractor of foreign investment. In principle, then, FDI cannot be the solution to a persistent trade deficit, but itself presupposes that structural reforms are implemented so as to attract FDI. These structural reforms are precisely the ones that follow a liquidity crisis and are embedded within the logic of financial deregulation, unless another institutional mechanism can be used.
The last of the instruments proposed is aid and grants from surplus to deficit countries. First, here we are entering the realm of discretionary policy, constrained by the amount of resources available to use as aid and grants and by the political and economic motivations of the economic agents (banks, multinational corporations, governments, etc.) that have surplus resources at their disposal. It is known that unilateral transfers of resources from surplus to deficit countries often come with "strings attached", which aim at subordinating the deficit countries' domestic social, political and economic priorities to those of the donor countries.(5) This is, of course, the basic condition for continuing the perpetual vicious cycle of dependency and poverty in which many countries of the South are caught. Furthermore, scholars studying the new aid agenda warns us that rather than pursuing the old developmentalist goal of `incorporation' of peripheral areas into the world system, today aid is instrumental for policies of management and containment of politically insecure territories on the edge of the global economy (Duffield 1996). The idea is that aid today is increasingly used to improve "governance" in the technocratic speak of World Bank and IMF, that is with the aim of providing a political and social environment suitable to neoliberal economic reforms. In this sense, unlike in the past in which the recipients of aid were national governments, today aid targets a plurality of actors, NGOs, businesses, communities and their grassroots organisations. The leverage exercised through aid (and the threat of its withdrawal) therefore directly meddles with national internal affairs. The general principle encompassing old and new aid agenda therefore is the following: to the extent there is a political economic rationale for aid, the resulting dependency is a tools in the hand of vested interests. Aid could serve to address the problem of international imbalances only to the extent that a mechanism of expropriation of financial resources from surplus to deficit countries is set in place. However, such a case would only be compatible with a framework of international political economy that is not geared toward competitive production and trade liberalization, which is the framework assumed by Davidson's analysis.
Whether capital mobility is targeted through a small tax or a redesign of international finance, it seems that what used to be called the contradictory nature of capitalist production is still the real barrier of reform. Both the Tobin Tax and Davidson's proposal are based on the recognition that capital movements endangers growth and accumulation, but overlook the fact that profit-led growth is a contradictory process. Both proposals seem to run up against the simple old adagio that capitalist growth is not only associated to prosperity, but to prosperity and poverty, development and underdevelopment, generation of wealth and of poverty. These contradictions are embedded not only in the financial system, but also in the priorities and driving forces of capitalist accumulation.
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1. Bank for International Settlements and Institute of International Finance (1998).
2. This problem could in principle be avoided if countries or central banks were to "coordinate" their policies, for example by simultaneously setting an interest rate reduction. However, as different countries are exposed to different pressure groups and their economies are situated in different phases of the cycle, coordination in the presence of capital mobility would risk either being ineffective or exacerbating the domestic problems faced by each country.
3. Davidson provides a simple formula. "All that is required to set off speculative flows is an expected change in the exchange rate that is greater than what would set off speculation regarding the exchange rate in the absence of the Tobin tax" (Davidson 1997: 678). "x" is the size of the Tobin tax rate.
4. Other proposals for the reforms of world's money include McKinnon (1988) and Williamson (1987, 1992-93). Both these proposals accept the neoclassical neutrality of money assumption. Davidson (1992-93) published a critical review of both theories.
5. For a recent critical review of the rationale and impact of IMF and World Bank policies, see Chossudovsky (1997).