IPS Blog

The leaders of continental Europe's four biggest countries agreed at last week's euro zone summit on the principle that the European Union should move toward imposing a tax on financial transactions. Though it was hardly mentioned in the U.S. press, the agreement was big news in Europe. The leaders say they will raise funds equal to 1 percent of total euro zone gross domestic product through a financial transactions tax (FTT), though no details were forthcoming on just what would be taxed or at what rates.

That President François Hollande of France, Chancellor Angela Merkel of Germany, Prime Minister Mario Monte of Italy and Prime Minister Mariano Rajoy should all take time out from acute crisis talks to agree on any long-term policy position is remarkable. That they should agree on a new tax is more remarkable still. Nonetheless, Chancellor Merkel stated flatly that she was "pleased that all four here have committed to a financial transactions tax."

FFTs are nothing new. They used to be called "stamp duties" and all industrialized countries used to have them. Today, they survive mainly in real estate transfer taxes. Stamp duties on frequently traded financial instruments like stocks and bonds were eliminated in the twentieth century in most countries under pressure from the finance industry.

When the world went off the gold standard in 1971 and modern foreign currency markets came into existence, economist James Tobin recommended that a small transactions tax be applied to foreign exchange transactions as a way to prevent instability in these new markets. He argued that the hyper-efficiency of foreign exchange markets could lead to unwanted volatility that might harm countries' real economies and that a transactions tax would reduce these tendencies.

If Tobin was right for the foreign currency markets, he was even more right for stock markets. He couldn't anticipate in 1972 that by 2012 stocks would be traded electronically at such high speed that banks would move their computers physically closer to the exchanges so that their trading orders would be executed faster. Tobin taxes are probably more important today for damping down volatility in share markets than in currency markets.

The goal of a Tobin tax on financial transactions is not to take from the rich and give to the poor. It's to prevent the rich from destroying the economy for the rest of us. Tobin taxes are meant to slow down runaway markets, to let a little air out of inflating bubbles and in general to give people and governments just a little more time to respond to economic problems before they get out of hand. Tobin taxes give the real economy just a miniscule edge over the speculative economy. Usually, that's all that's needed to prevent the speculators from running roughshod over the rest of us.

What turns a Tobin tax into a Robin Hood tax is what you do with the money you collect. President Hollande et compagnie have made no mention of taking from the rich to give to the poor. Their plan, to the extent that they have one, seems to be to use the proceeds of a FFT to fund the European Union budget. At best, the money collected might go to the poor of Europe. There's certainly no talk of spending it on the poor of the world.

And, yet, the rich countries of the world - including the euro four and the United States - have all agreed to dedicate at least 0.7 percent of their national incomes to official development assistance (ODA) to poor countries. This foreign aid commitment has been in place in various forms since 1970, though it has been met by only a few (mainly Nordic) countries. Since the beginning of the global financial crisis, levels of ODA have actually declined for many countries.

United States ODA to poor countries is only 0.21 percent. The top three recipients are Afghanistan, Iraq and Pakistan, which hardly suggests that our aid money is independent of our foreign policy goals. France, Germany, Italy and Spain give 0.50 percent, 0.39 percent, 0.15 percent and 0.43 percent, respectively (2010 figures from the Organisation for Economic Co-operation and Development).

The numbers being mooted for the euro zone FTT are tantalizingly similar to the figures that developed countries have committed to spending on foreign aid. It is, however, highly unlikely that any money raised will be used for this purpose. A new tax imposed during an upturn might go to aid. A new tax imposed during a downturn will inevitably be spent at home.

The best solution might be a threshold split. The first 0.5 percent of gross domestic product raised by an FTT could be spent on national debt relief. Any remaining sum could then go to the aid budget. The advantage of such an arrangement would be to make the tax politically palatable now, but morally palatable later. It would also make the tax anti-cyclical: in a downturn the money raised would stay at home, while in an upturn it would go abroad. Wins all around.

But waiting in the wings is the sheriff of Nottingham. The UK's Chancellor of the Exchequer, George Osborne, staunchly opposes a European FFT that might cover British-based companies. Of course, if it doesn't include the UK, a European FTT would just drive business to London. The City of London is by far the world's largest offshore financial center, dwarfing other even shadier British territories like Bermuda, the Channel Islands, the Cayman Islands, the Isle of Man and the Turks and Caicos Islands.

To have any hope of helping the ordinary citizens of Europe and the poor people of the rest of the world, a European FTT would have to be coupled with European legislation to prohibit the trading of European financial instruments outside Europe. This is technically feasible, but it would require a higher level of commitment than European leaders have shown to date.

To be morally and politically palatable, a FFT should have a built-in threshold beyond which any funds collected would go straight to official development assistance. On the one hand, it is politically unrealistic to expect a European FTT to be devoted entirely to foreign aid. On the other hand, a narrowly targeted FTT designed only to respond to the current euro crisis might simply be repealed once the crisis passes. A well-designed FTT should serve both purposes.

Throughout this debate it must be remembered that a well-designed FTT will pay for itself. The original Tobin tax idea wasn't about feeding the poor. It was about improving economic performance by damping down the worst excesses of financial markets. Runaway markets can severely misallocate financial capital. We should all have learned that lesson in 2007, if not in 1929. If we can save the euro while improving the economy and at the same time divert part of the benefit to help the poorest people on Earth ... why not?

The sheriff might just have to accept a happy ending after all.

There was a big brouhaha at the G-20 summit this week over what they’re dryly calling “global trade imbalances.”

In the simplest terms, what this boils down to is this: Americans buy too much stuff from China. Chinese stuff is artificially cheap because of currency manipulation, but also because of labor repression that keeps wages down. And because wages are so low, Chinese people don’t buy very much stuff, so the money from exports piles up.

China is expected to have a trade surplus of $270 billion this year, while the United States is expected to have a trade deficit of $466 billion. Other countries have trade imbalances too, but these are the biggies.

The trade deficit hurts the U.S. economy because money spent on imports is money not spent on U.S. products that support jobs in this country. Also, to fund this deficit, the United States has to borrow money from abroad. And if the deficit keeps growing, the day may come when foreign investors are no longer willing to lend.

Last month, Treasury Secretary Timothy Geithner tried to get the other G-20 governments to agree to limit their trade imbalances to no more than 4 percent of GDP. How did he pick 4 percent as the target? Well, it’s probably no mere coincidence that China’s surplus is expected to exceed that mark this year (4.7 percent), while the U.S. deficit is expected to fall below it (3.2 percent). Geithner was basically told to take a hike.

So what’s a U.S. policymaker facing a nearly 10 percent unemployment rate to do? One option would be to reinvigorate U.S. manufacturing through targeted public investment. You could pay for it by increasing taxes on the ultra-rich or by taxing financial speculation. Sadly, the outcome of the mid-term election likely put the kibosh on that kind of stimulus spending, at least for the next two years.

Instead, the Fed, which doesn’t have to worry about Tea Party opposition, did what’s called “quantitative easing” — another unnecessarily abstract term that basically means they’re printing money, to the tune of $600 billion. The Fed's idea was that all this cash will lubricate the wheels of the American economy, get credit flowing again, and create jobs.

This is largely based on faith. As Brazilian Finance Minister Guido Mantega put it, “It doesn’t help things to be throwing dollars from a helicopter.” Brazil and other fast-growing emerging markets are worried that the Fed-created cash, instead of financing U.S. job creation, will slosh into their economies, where interest rates are higher. This would drive up the value of their currencies, making their exports less competitive. Wolfgang Schaeuble, the finance minister of Germany, which is a trade surplus country like China, declared the Fed’s action “clueless.”

Such tough jabs are unusual among finance ministers. What seemed to really get their blood boiling was the fact that the Fed announced the action without giving the other governments as much as a heads up. This week’s G-20 summit in Seoul, Korea concluded without any meaningful agreement, other than a timid pledge to “refrain from competitive devaluation of currencies.” So much for the G-20 fulfilling its self-declared status as the “premier forum for international economic cooperation.”

Meanwhile, to deal with the surge of short-term “hot” money that could drive up the value of their currencies, Brazil, Taiwan, and several other countries are imposing various forms of controls on capital inflows. However, this is not really an option for the 52 countries that have signed U.S. trade or investment treaties which severely restrict the use of this policy tool. If they violate these restrictions, they run the risk of facing expensive lawsuits from affected foreign investors.

Hopefully the Obama administration will now recognize that bans on capital controls are outmoded and work to revise them. As Dani Rodrik, of Harvard University puts it, “capital controls are now orthodox.”

While giving governments the authority to use policy tools at the national level to control capital flows is critical, this patchwork approach is not ideal. We need a new international monetary system that can help prevent the kind of “currency wars” we’re seeing today. That’s something French President Nicolas Sarkozy plans to put at the center of the G-20 agenda now that he has taken over the presidency of that body for the next year. Let’s hope he can get the other leaders to stop squabbling and take the challenge seriously.