Select Committee on Treasury Appendices to the Minutes of Evidence


Memorandum by War on Want



  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.


  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.[1] 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.


  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 GDP.

  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.[2] 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.


  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 pulled out.

  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 the poor.


  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.[3] 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.


  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.[4] 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.


  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.[5]

  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.[6]

  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.


  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.[7] 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 spending.


  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.[8] If it did happen, one response would be to tax transactions from non-taxing sites at a higher rate.


  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.[9] 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 same period.

  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.


  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.

Suggested questions

  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 crises?

  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 attack?

  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 transactions?

Supporting documents

  War on Want—Tobin Tax Q&A; War on Want—Tobin Tax Further Reading; Rodney Schmidt—A Feasible Foreign Exchange Transaction Tax?

January 2001

1   Human Development Report 1999, p 31. Back

2   Human Development Report 1999. Back

3   UNCTAD Trade and Development Report 1999, p vii. Back

4   Tobin J, 1978. A proposal for international monetary reform. Eastern Economic Journal, vol 4 (July-October). Back

5   Spahn P B, International financial flows and transactions taxes: surveys and options. International Monetary Fund, 1995. Back

6   Griffith-Jones S and Ocampo J A with Cailloux J 1999. The poorest countries and the emerging international financial architecture. EGDI:4, Ministry of Foreign Affairs, Sweden. Back

7   For example, Schmidt R, 1999. A feasible foreign exchange transactions tax. Mimeo, North-South Institute. Back

8   Schmidt R: 2000. Efficient capital controls. Mimeo, International Development Research Centre, Government of Canada. Back

9   Kaplinsky R, 1999. Is globalisation all it is cracked up to be? IDS Bulletin, 30,4, p 107. Back

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