Memorandum by War on Want
THE REGULATION AND TAXATION OF CAPITAL FLOWS
For the purposes of this submission we will
look at the role the IMF has in setting the agenda for much-needed
new financial architecture, with particular reference to currency
speculation, volatility and currency crises.
1. CAPITAL FLOWS
Systemic global financial instability has had
a disastrous effect on development, particularly in emerging market
economies. Of portfolio and other short-term flows to developing
and transition countries in 1996, almost all of it, 94 per cent,
went to only 20 countries.
However, financial crises have also had a knock-on effect on least
developing countries through their effect on commodity prices.
Moreover, as developing countries attempt to integrate their economies
into international capital markets, it is vitally important that
lessons are learned from the crises suffered by their predecessors.
The key is prevention and regulation, nationally and internationally.
2. THE ASIAN
The Asian crisis was a product of external and
domestic factors which globalisation aims to integrate. It is
not appropriate here to investigate the domestic factors. The
immediate cause of the crisis was a sharp reversal in capital
flows which had rocketed in the 1990s, reaching US$93 billion
in 1996 to Indonesia, South Korea, Thailand, Malaysia and the
Philippines. When investor confidence collapsed, despite the strength
of economic fundamentals, the outflow reached US$12 billion in
1997, which was a swing of 11 per cent in these countries' pre-crisis
The human impact was severe with more than 13
million people losing their jobs. Securing a livelihood is the
most important requisite for human development, as numerous studies
have shown. For those that kept their jobs, real wages fell sharply;
in Indonesia the fall was 40-60 per cent. The prices of essential
goods went up while people were less able to afford them.
Education and health budgets came under pressure as government
spending was cut back, usually under pressure from the IMF.
Although economic recovery is now in place in
the worst affected counties, human lives take longer to recover
and studies show that employment growth does not regain pre-crisis
levels for several years. In South Korea unemployment was still
double the pre-crisis level in April 2000.
3. THE ROLE
Domestic economic policy played a major role
in Brazil's crisis: high interest rates, an overvalued currency,
high internal debt. However, liberalisation meant Brazil was extremely
vulnerable to external factors in the form of global financial
volatility and from August 1998 to early January 1999 around US$50
billion left Brazil as first foreign and then local investors
Following its IMF agreement, Brazil cut the
land reform budget in March 1999 by 47.1 per cent from US$622
million to US$310 million. This cut has hit hard some of the most
marginalised people in Brazil where about 15 million people live
in extreme poverty (about £20 a month) according to the Brazilian
Ministry of Social Security. There is a strong case for making
land reform a high priority in strategies to improve equity and
growth, as the histories of South Korea and Taiwan make clear.
Among developing countries, there is a large and significant correlation
between more equitable land distribution and faster growth among
4. GLOBAL FINANCIAL
Governments are finding it increasingly difficult
to pursue independent policies that may be inconsistent with the
interests of global capital, as the case of Brazil shows. In this
context, it is useful to recall that developing countries are
not the only victims of speculative attacks on their currencies.
On what has come to be known as "Black Wednesday" in
1992, financier George Soros made an estimated US$2 billion out
of sterling and forced the devaluation of the pound. While it
may be arguable that the pound was overvalued, the fact is that
a democratically elected government with a popular mandate had
been forced into taking action by an individual acting for personal
profit, accountable to no-one. Alongside individual investors
such as Mr Soros, US and UK banks also make huge amounts out of
foreign exchange and particularly out of instability since their
profits depend on turnover.
Maintaining the momentum of growth has meant
an increasing reliance on attracting foreign capital of any kind
because liberalisation has meant greater volume of imports has
been sucked in than in the past. Attempts to close the payments
gap through increased exports to developed countries has not usually
been successful because of protectionism, declining markets and
adverse movements in terms of trade. Moreover, a growing proportion
of net private capital inflows is absorbed by activities that
add little to productive capacity and have a high rate of leakage.
In the 1990s for every dollar of short-term capital that was brought
into developing countries by non-residents, 56 cents were taken
out by residents for investment in short-term assets abroad.
The need for developing countries to accumulate large amounts
of foreign exchange reserves as a safeguard against speculative
attacks on the currency and the reversal of capital flows has
been costly since reserves are borrowed at higher rates than they
can earn in international markets.
6. CAPITAL CONTROLS
The main objective of controls in a world of
integrated capital markets is to prevent the cumulative build-up
of foreign liabilities that can easily be reversed. As the experiences
of China and India showed during the Asian crisis, such measures
can serve to deter speculative flows without deterring capital
inflows for productive investment. Chile and Colombia have also
implemented effective capital controls, while Malaysia's measures
are credited with boosting its recovery, even if that did not
prevent its crisis. One such preventive policy tool is the Currency
Transaction Tax (Tobin Tax), a concept first outlined by Nobel-prize
winning economist, James Tobin in the 1970s.
A small tax of 0.25 per cent on foreign exchange, it is argued,
would have the effect of calming volatile markets and throwing
sand in the wheels of currency speculation. It would be levied
nationally which would therefore increase the autonomy of national
authorities in formulating policy.
7. EFFICACY OF
We do not argue that the Tobin Tax alone is
an adequate measure to prevent global financial instability. The
Tobin Tax is one of several policy instruments that could be deployed
to discourage speculative or unsustainable short-term capital
flows since it acts as a general disincentive to such flows. More
targeted instruments may be used nationally that are tailored
to specific circumstances, such as reserve requirements and/or
higher taxes. Clearly when a currency fluctuates by a significant
amount a minimal tax would not be a deterrent and Spahn has proposed
a variation on Tobin whereby the tax on forex transactions is
adjusted to far higher levels during crises.
It is interesting to look at the cases of Chile
and Colombia, which have implemented a kind of national Tobin
Tax. In 1991, Chile imposed a one-year reserve requirement of
20 per cent on capital inflows which later rose to 30 per cent
in response to capital surges. This avoided over-borrowing during
booms and induced a better private debt profile (it was short-term
debt problems that underlay the collapse of Thailand and Korea
during the Asian crisis). In Colombia, a similar but more complex
system was established in 1993, which was replaced in 1997 by
a 30 per cent flat reserve requirement for all loans. In both
countries reserve requirements can be substituted by a payment
to the bank of the opportunity cost of the requirement and this
is what makes their systems equivalent to a national Tobin Tax.
The equivalent tax level which reached 3 per cent in Chile and
10 per cent or more in Colombia is of course much higher than
that proposed for an international Tobin Tax.
Some studies have asserted that the efficacy
of the Tobin Tax depends on its universal application, but in
fact this is not so, as the cases of Chile and Colombia suggest.
It can be used by governments as a national policy instrument
without causing massive capital flight and deterring productive
investment. Other moves by individual countries to increase transaction
costs, such as the UK's stamp duty on securities transactions,
have not had the predicted negative effects either. The UK Treasury
garners a substantial yield from stamp duty which is a tax on
the transfer of share ownership.
8. EFFICACY OF
Again, we do not argue that the Tobin Tax alone,
even applied internationally, is an adequate measure to address
global financial instability, although global application is likely
to be more efficacious for the global problem. Even with global
application, it still seems most feasible for the tax to be levied
at a national level. This is because the most straightforward
point of collection is when each transaction is settled on a central
bank account in the interbank/wholesale market. Currently, 80
per cent of global forex transactions take place in seven cities
around the world: London, New York, Tokyo, Hong-Kong, Singapore,
Frankfurt and Berne. The City of London alone accounts for 32
per cent of the total. The other reason for advocating the use
of the Tobin Tax internationally is because of the potential it
has for raising revenue for global development and thereby for
a global redistribution of wealth.
Implementing an administrative framework for
a Tobin Tax is agreed by a number of studies to be relatively
easy since globalised automated processing and telecommunications
are already in use for foreign exchange transactions.
Administration would be further facilitated by the opening of
the Continuous Linked Settlements Bank planned for 2001 which
is a global settlement institution to process payments 24 hours
a day, with direct links to domestic payments systems. The CLS
Bank has been formed by a consortium of major foreign exchange
trading banks at the urging of the G10 central banks. It will
eliminate settlement risk by simultaneously making the two or
more payments of a foreign exchange transaction on its own accounts.
As already described, the most straightforward point of collection
is the wholesale market where transactions have to be settled
on a central bank account. An important precedent is the supranational
VAT that funds the European Union's governmental structure. National
governments levy this tax and keep 10 per cent of it for national
The growth of the derivatives market has been
cited as an illustration of how avoidance of the Tobin Tax might
be a problem for efficacy. In fact, as foreign exchange derivative
instruments also require payments, they can therefore be taxed.
Even options, which may never be executed, are bought at a price
that reflects their value and therefore the payment made to buy
the option could be taxed.
Offshore financial centres, both virtual and
actual, have also been cited as a potential method to avoid a
tax on forex transactions. The first point to make is that payments
to settle wholesale forex transactions cannot be made on a significant
scale in the retail payment system. Even offshore wholesale payment
systems must maintain close links with the central bank, entailing
regulation and oversight. Secondly, the communications technology
involved would make it difficult and expensive to disguise or
hide forex payments on a large scale.
If it did happen, one response would be to tax transactions from
non-taxing sites at a higher rate.
11. GROWTH AND
Inter-country income distribution has worsened
as the extent of global openness has increased. Indeed, the only
group that appears to have gained relatively after 1970 was that
of high-income countries.
The redistribution of wealth is not only a prerequisite for increased
equality within countries but also between countries. The international
implementation of the Tobin Tax would mean raising large amounts
of funding which could be used for development. This is particularly
significant given the long-term decline on ODA which fell to US$48.3
billion in 1997 compared to US$52.9 billion in 1990. ODA to low
income countries saw a sharp decline of US$10 billion over the
Given the dominance of industrialised countries
in the global economy, it is particularly important that developing
countries have a genuine say in how proceeds from the tax are
distributed. Although the Bretton Woods institutions seem the
most likely candidates for the job, their historic role as the
promoter of OECD interests as well as the predominance of neoliberal
ideologues on their staff, mean that developing countries have
good reason to be suspicious of them. The World Bank has nearly
universal membership and expertise in dealing with international
and national financial markets. Its views are also influential
in developing countries. Other UN institutions, such as the UNDP
or UNCTAD, are also possible candidates for administering the
distribution of Tobin Tax proceeds. It may be more desirable,
however, for a separate new UN institution to be set up. Whatever
the solution, it is essential that the formula settled on for
the funds' distribution is agreed with full participation of the
poorest countries. National governments would make the ultimate
decision on how the tax was used.
12. THE "SPAHN"
The "Spahn Mechanism", basically a
two-tier Tobin Tax with a minimal tax rate on all transactions
(basic rate), and a higher rate (surcharge) which is only activated
in times of exchange rate turbulence, would help to prevent most
crises. The surcharge would only come into action when the level
of currency trading passes a certain threshold or safety margin.
Once trading enters or passes this margin, traders will be taxed
heavily, thus dissuading trading and dampening excessive currency
movements. Once the danger has passed, the rate will fall back
to the standard level.
Does the future potentially hold more speculation-led
or speculation-fuelled financial crises and if so what measures
is the IMF taking to guard against them?
Is the IMF exacerbating the likelihood of future
Could a Tobin Tax be part of the solution to
prevent financial crises?
Has the IMF considered the Tobin Tax proposal
as part of its review of financial architecture?
Could part of the funds from a Tobin Tax be
used as a "Global Intervention Fund" to boost currencies
under speculative attack?
How would the IMF react to the introduction
of the Tobin Tax by one state to protect itself from speculative
Does the Government accept that spiralling levels
of currency trading inevitably create instability and an environment
that brings too many risks for developing countries seeking to
join the global economy?
Looking at Chile or India or China, do you not
accept that unilateral currency controls imposed by developing
country governments can provide a very useful form of protection
against the ravages of speculation and allowing an emerging economy
to attract greater long-term investment?
Given that London is the location of more currency
exchange than any other country in the world do you not agree
that Britain should play an active role in building international
political support of the introduction of a small tax on currency
War on WantTobin Tax Q&A; War
on WantTobin Tax Further Reading; Rodney SchmidtA
Feasible Foreign Exchange Transaction Tax?
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