Tax and transparency are the other two subjects about which G8 ministers will waffle meaninglessly next week. It’s a pity, because progress in these areas would be among the best ways of helping the developing world.
Tax havens are wrong for three reasons: they drain the tax base of developed countries, making it harder for them to maintain aid and social spending; they suck ill-gotten spoils from developing countries; and they destabilise the global economy.
Tax avoidance in rich countries is currently in the headlines. Using techniques with names almost too exotic to mention — anyone for a “Dutch Sandwich”? How about a “Double Irish”? – Google funneled payments to tax havens via low-tax countries like Holland and Ireland to minimise tax on its £11.5 billion in UK revenues between 2006 and 2011, paying only £10 million to the UK Treasury. Some have worked out that Google’s overseas tax rate is 2.4%, compared with the 28% it should be paying in Britain.
Apple, Marks and Spencer, Boots, Tesco, HSBC, Lloyds Halifax, Amazon, Starbucks, Vodafone — of course they’re going to minimise their costs. They’re profit-making enterprises. It’s no good berating them about their naughtiness; the only way to tackle these companies is to close down the havens where they hide their earnings. But no single rich country can address the problem alone because if Bermuda closes for business a company will just send its money to the Cayman islands. Action has to be taken in concert, which is why a multi-country group like the G8 is one of the only hopes for progress.
Developing country governments have had it even worse — having been denied billions of dollars in sorely-needed revenues as money is syphoned overseas. Liberia is an example of a poor nation that’s been ravaged by the iniquities of global tax-dodging, as a succession of kleptocrats stashed diamond wealth in hidden Swiss accounts. Switzerland’s at fault, not Liberians, who have a fragile democracy and a history of nasty dictators.
Nicholas Shaxson in his brilliant book Treasure Islands suggests that Transparency International‘s corruption perceptions index has things the wrong way round: we should rank countries on banking secrecy, not graft. The real economic issue is that nations harbour the spoils of corruption, not that Charles Taylor foists himself on Liberia.
Shaxson points out that tax havens, or what he calls secrecy jurisdictions, have played a starring and hitherto misunderstood role in the untrammelled economic liberalisation of the last few decades, in effect allowing cash to skitter freely around the planet. The market in shares, currencies and bonds is international and therefore difficult to tax — but the profits must eventually end up somewhere. Secrecy juridictions were purposefully set up as places for traders to hide their loot.
Most people ignored the euromarket for years after its birth in the mid-1950s, partly in the hope that it’d go away and partly because the UK and American authorities didn’t want to draw attention to the vast acreages of cash being made by their financial elites.
By the time we’d noticed, it was too late. Banks were among the prime users of tax havens, which played a key role in the credit boom of the 1990s and 2000s. Michael Lewis in The Big Short even argues that the creation of the financial weapons of mass destruction that caused the crisis wouldn’t have been possible without the likes of Cayman and Bermuda.
Some have argued that some of the low-income secrecy jurisdictions benefit so much from their offshore status that it’d be wrong to dismantle them. I worked for two years in Vanuatu, one of Britain’s former colonial havens in the South Pacific. London’s intention when the country gained independence in 1979 was to establish a tax haven which opened for business toward the end of the working day in Hong Kong, four hours west.
All kinds of nefarious activity found its way to Vanuatu. An Indian businessman convinced the government to accept a fake
diamond ruby as security for a loan (the last time I saw it, the ‘diamond’ ruby, actually a lump of rock, was acting as a toilet-paper holder in the Department of Customs bathroom). The director of a local bank was jailed in the US for his involvement in an international lottery scam. A tax cheat was arrested on Vanuatu soil by the Australian Federal Police and last year jailed for eight years over a A$5 million fraud. I remember him telling me he was a big fan of free trade. Little did I realise at the time quite what he meant.
The damage to Vanuatu’s reputation is huge. Foreigners often think of the country as a bit mickey-mouse, and as a result serious investment is severely curtailed. The absence of income tax creates appalling inequalities. Vanuatu has a Gini coefficient of 58, placing it among the 10 most unequal countries in the world. None of this is worth the 10% that the financial industry is estimated to contribute to GDP.
Not only are tax havens harmful to their own people, but allowing companies the freedom to shift their cash offshore makes no sense for the global economy. During an economic downturn governments can’t easily spend more to stimulate demand if they are being held to ransom by the financial industry. Central banks can’t easily cut interest rates if commercial banks immediately just shift their cash elsewhere in search of higher returns. Today’s angst about the cost of financing government debt, as seen in the financial travails of Portugal, Ireland, Italy, Greece and Spain, is exactly what the economist Keynes feared; it’s why he recommended controls on the movement of capital where necessary, and it’s why they were so prevalent until the 1970s. It’s also why he wanted a much stronger role for the International Monetary Fund and World Bank, which he hoped would help prohibit hot money flows and prevent a global race to the bottom in which countries tried to out-compete each other on tax.
The current financial system is constructed. It isn’t, as most theorists of globalisation suggest, the result of an inevitable and faceless century-long trend toward liberalisation. Britain built its network of secrecy jurisdictions on purpose, with the idea of putting London at the centre of global financial industry after the decline of the British empire. The United States leapt on to the wagon, and today a number of US states are in effect tax havens, notably Delaware, Nevada and Wyoming. These havens came into existence as part of a conscious strategy, not through an inexorable or uncontrollable process. The United States and Britain opposed a co-operative, controlled, post-war economic system because they stood to gain from financial deregulation.
Because the system was constructed in the first place, it can also be dismantled. The chances of this happening next week — or in the next few years — are limited because the world’s corporations and financial industries, literally, have so much invested in it. But it shouldn’t stop campaigners from bringing the issue to attention or enlightened politicians from discussing it at international talking shops. Tax havens make no economic sense, they helped cause the crash and they perpetuate inequality. They should be shut down.
Next week’s G8 summit in Northern Ireland will probably be dominated by discussions over a transpacific trade agreement and a proposed US-Europe deal. Both aim at boosting flagging growth in the world’s biggest economies. That would be good news for the whole world.
But don’t forget about the impact of trade deals on developing countries, argues Yurendra Basnett in a preview of the summit. Without careful design these two mega-treaties risk doing little for the developing world and could even make matters worse.
Trade taxes are already low, so the focus is likely to be on standards and trade facilitation. If the G8 agrees anything in these areas, Basnett argues, it should sign up to a principle of ‘do no harm’.
Take car production lines: common standards on both sides of the Atlantic would mean manufacturers no longer have to operate two separate production lines. A good idea in theory, but what about other countries? If EU–US trade standards damage Japan’s car industry, supplier countries like the Philippines and Samoa will suffer.
The UK has made a welcome proposal to help African countries reduce border crossing times and increase intra-regional trade. No-one can argue against making borders more efficient, but potentially unforeseen consequences may emerge: workers who earn their livelihood from delays at the borders must be ensured employment elsewhere.
Smoother borders will only lead to more trade when countries have the capacity to produce more and governments can effectively manage any improvements. It’s no use breaking down trade barriers if economies haven’t got anything to sell.
Efficient borders will provide value for money when they are facilitating more trade; efficient borders with no trade will be merely white elephants.
Basnett further argues that developing countries should have a role to play in new production networks and that countries should be helped to export better quality products.
A ‘do no harm’ principle aimed specifically at developing countries would be a major step forward.
G8 get-togethers are normally just talk-fests resulting in little more than a watered-down press release. Any progress on the two other ‘Ts’ to be discussed at the conference — tax and transparency — would do more for the developing world.
But with the World Trade Organisation Ministerial conference approaching in Bali next December, the group could at least show a statement of intent about trade that would be difficult for the WTO to ignore.
Here’s a video from the Overseas Development Institute highlighting the progress that’s been made in international development in recent years. To sum up: some worrying trends, but lots of good stuff.
Noah Smith, a very bright professor who blogs a lot about economics and who is unusually open to challenges from the economic wilderness, has an article in the Atlantic Monthly asking whether we should trust economists. Comparing them to 14th-century physicians who thought that either leeches or bleeding were the cause of illness, Smith concludes that mainstream economists are difficult to trust because their assumptions are wrong, they haven’t built a proper model of the economy and their data is bad. On top of all this, their models are dodgy because they’re just stories about how the world might work, not genuine explanations of hard data like in the natural sciences.
But we should probably make do with medieval quackery, Smith asserts, because economists are a humble bunch who are aware of their shortcomings. He quotes a couple of famous economists — Greg Mankiw (author of the textbook I used as an undergrad) and US Federal Reserve chairman Ben Bernanke — as saying that they don’t know everything about the future. Moreover, Smith continues, the quacks are better than the loonies outside the mainstream who peddle snake-oil and wizardry.
Smith cites as example of this unpalatable wizardry the Austrian economists, ”who believe that we only need logic to understand how the economy works, and that data and evidence are useless.”
Smith is mostly right about the problems with economists. But as an example of wilful mischaracterisation this last statement is difficult to surpass. As Peter Klein (dismissed by Smith on Twitter as a troll) points out:
Certainly no Austrian economist has ever maintained that one can provide a detailed analysis of actual business cycles, or monetary policy, or any aspect of applied economics without careful, detailed, empirical study. It might surprise Smith to know that Mises wrote detailed empirical studies of prewar business cycles and European monetary policy, that Rothbard produced a 368-page treatise on the Great Depression, and that contemporary Austrians have written about the credit collapse, quantitative easing, and just about anything else in recent economic policy.
It’s not that i’m particularly keen on the Austrian school of economics. I am keen, however, on trying to understand different schools of thought. Dismissing them as “absurd”, as Smith does, is totally unhelpful, and typical of the mainstream of economics, which tends to ignore, misrepresent and drag opposing sets of ideas through the mud rather than accepting the possibility that they might have something to contribute, however small.
Mainstream economists are in fact far from humble. The implicit view of Bernanke and Mankiw is that they’re on the right track and that their brand of economics will, eventually, establish the truth. The 1994 textbook of Mankiw’s that I used says at the beginning: “Macroeconomists are the scientists who try to explain the workings of the economy as a whole… To be sure, macroeconomics is a young and imperfect science… we do know quite a lot about how the economy works.” He seems to think that the type of models used by mainstream economists aren’t quite up to the job yet, but eventually they should yield better answers.
The mainstream approach is so dominant that its practitioners are able to laugh about their own minor shortcomings. Haha, they exclaim. Look at our funny little foibles, but don’t bother taking any of the alternatives seriously.
Macroeconomists act from a position of power. It’s OK for Bernanke to affect modesty by saying that he doesn’t know much about the future. He sets monetary policy for the world. He knows that what he says goes, and that his sort of economics will anyway be force-fed to Americans and the rest of us because he influences how much money the Fed prints and how long it keeps interest rates at zero. For him to joke that economists don’t know much about the future is like a teacher joking to a pupil how boring his lesson is. They’re in charge, regardless.
Mainstream economists are part of a school of thought which posits some very specific things about human behaviour — many of which, in my view are complete rubbish — and which is backed by immense corporate power, as documented in the film Inside Job. Ideas about methodological individualism, rationality and equilibrium support the status quo. Neoclassical economists dominate the universities and in some cases even close down departments which think differently. From the 1980s economic methods infiltrated other social sciences in what came to be known — even by its proponents, led by Gary Becker – as the “imperialism of economics”. Far from being humble, this was a prolonged episode of extreme arrogance in which one individual had the temerity to write a decade ago that “economics is the premier social science.”
It is ludicrous naivety for Smith to suggest that “when you listen to economists, the key is to try to understand why they think what they think”. Most of the public don’t have a clue and never will have any idea about why economists think what they do. Economists, because of their close relation to power and because of the necessarily complex nature of what they do, are in a position of privilege, and it’s up to them to be realistic, to make it quite clear why they think what they think, and to be much more modest about their predictions.
Either that, or we prise their fingers off their privileged perch, one by one. Smith’s, and Mankiw’s and Bernanke’s method of economic science is mistaken. Most economists aren’t honing techniques to be able gradually to achieve better knowledge about the future. They’re never going to get better at predicting the future. The whole notion that we should spend our time building mathematical models using ridiculous assumptions like perfect foresight and rationality is flawed, and we ought to do away with it. One of Smith’s commentators rightly points out that these are “ghost” models, which produce results that are precisely wrong. Better to be somewhat right using intuition than precisely wrong using a formal model. If mainstream economics were any good as a school of thought, how come almost no mainstream economist was anywhere near predicting the 2008 crisis, after more than a century of economic ‘science’?
The leeching and bloodletting analogy is a good one, because it took a revolution in medical science to overcome these practices. When they were proved false, they were mostly consigned to the dustbin of history along with the physicians who practiced them. It was eventually discovered that bloodletting actually helped kill the patient. Leeching is now a rare technique used to reduce swelling on certain wounds during surgery. The 14th-century physicians were using the wrong methods, and would never arrive at the truth. I dislike that bastardised phrase ‘paradigm shift’, but a scientific revolution may be the only way of moving beyond the kind of 14th-century quackery that currently infects economics.
Future international development agencies will be cross-ministerial platforms for the coordination of aid rather than behemoths with their own projects, programmes and spending. These agencies will be staffed by politically astute people with good negotiation skills. So says says Andy Sumner in the Economist:
One might imagine smaller, cross-governmental administrative units with mandates to pursue ‘policy coherence’ on trade and other matters and with the technical capacity needed to build, say, tax systems in developing countries. Such new units would need to be staffed by people with ‘soft skills’, meaning with strong political sensitivity, rather than, as in the old days, people whose skill lay in evaluating and managing big projects.
What’s striking is the optimism of Sumner’s piece. Sumner accepts the possibility that extreme poverty — those who live on $1.25 a day or less — could be slashed to about 300 million by 2030. This is based on the idea that big countries like China, Brazil, Indonesia and India are developing so rapidly that they’re on the brink of becoming middle-income. Contrast this optimism with the negativity of a book like Dead Aid by Dambisa Moyo, which Bill Gates recently called “evil” (h/t Andrew Parker). Moyo presents a picture where vast oceans of aid are being squandered and stolen. In reality global aid is much smaller than she states (ridiculously, she counts only gross aid to Africa, not net — lenders receive large sums in interest payments on development loans) and it’s had a tremendous effect. Gates, for example, points out that it’s just immoral to deny children live-saving medicines and vaccines, and that health-related aid has saved countless lives — not to mention supported economic growth — over past decades.
Sumner is clear that this positive trajectory isn’t guaranteed. But it’s likely that in a few decades most poor people will live in middle-income countries, with the result that global poverty is increasingly found either in countries which don’t really need aid or in countries that can’t absorb aid easily and quickly.
This relatively small number of fragile states where a relatively high number of poor people live will still benefit from direct aid funding in the form of grants, budgetary support and so on. But overall, traditional aid will become less important, and donors will start thinking of more innovative ways of supporting the big, rapidly-growing countries using tools like better trade and migration policies and additional concessional lending. Handouts just might not cut it anymore. Attention will turn to questions like inequality, the environment and the inclusiveness of economic growth — and this will require a softly-softly approach from donors.
“It’s as though campus physics departments have been taken over by teams of frightfully useful engineers.”
Randomised controlled trials are increasingly trendy in social science and development economics. Based on clinical drug trials in medicine, RCTs randomly assign people to treatment and control groups. The treatment group might, for example, have access to savings accounts, while the control group doesn’t. The technique avoids selection bias: the economist might distort results by picking a group that really wants to take part or where he knows the chances of success are high.
I’m sceptical, as I wrote here. RCTs ignore the role of power in policy, imagining that researchers and policymakers are engaged in an objective and noble hunt for the truth rather than being swayed by convention and corporate interests. It’s no surprise that the State Bank of India, Standard Chartered and Citi all support microfinance. Microfinance gets so much attention — for good or ill — because it’s so prevalent in development policy.
RCTs are unambitious, tinkering only with what can be experimented with and tending to overlook bigger issues. Giving some of the 2.4 billion people who live on US$2 a day savings accounts just isn’t alone going to propel them toward acceptable living conditions.
Testing discrete policy ideas tends to focus on what’s been already done, shifting focus away from the search for radical or sweeping new ideas. Economists now seen as mainstream — like Smith and Hume — were at first considered heretics because they espoused off-the-wall theories would have been untestable.
I’m also wary when natural scientists start doing social science. People aren’t atoms, and because human society is changeable and unpredictable the results of experiments may work in one place for a short time but can’t really be taken as hard fact for ever in the same way as findings in natural science can. So most social-science findings are only provisional and context-dependent. Most natural scientists are aware of these differences, but some aren’t.
A great article in the Boston Review by Pranab Bardhan sums up the criticisms:
First, it is very hard to ensure true randomness in setting up treatment and control groups. So even within the domain of an RCT, impurities emanate from design, participation, and implementation problems.
Second, RCTs face serious challenges to their generalizability or “external validity.” Because an intervention is examined in a microcosm of a purposively selected population, and not usually in a randomly sampled population for any region, the results do not generalize beyond the boundaries of the study.
Third, for many important policy issues, RCTs are not very useful. You cannot run experiments in order to decide where to put power plants or ports. You cannot do a controlled test on the advisability of tight money, fiscal austerity, or deregulation. Moreover, even if you can show convincingly that a policy intervention works in a small-scale trial, policymakers still have to worry about the economic and political spillover effects of a policy when it is implemented regionally or nationally. What will be its impact on other markets and the macro economy? And what happens when a policy once handled experimentally by a local NGO is taken up for large-scale implementation by a national bureaucracy, even a well-functioning one?
Fourth, RCTs show only the average impact: a policy intervention may be very helpful for some people and not at all for others, just as a clinical drug trial may show that a particular drug works well for the average person, but it may not work at all for you. One of the standard questions of political economy, however, concerns who gains and who loses from a given policy. RCTs cannot answer that distributional question.
Finally, even when an RCT shows quite cleanly that A causes B, we do not quite know the mechanism through which it works. In interpreting many experimental results, [authors] give plausible accounts of the processes that may be at work, but these are at best their informed guesses. They are usually not rigorous derivations from the experiments themselves. In understanding alternative mechanisms through which A may have caused B, theory has to play a more important role in empirical economics than the experimentalists have assigned to it.
“It’s as though campus physics departments have been taken over by teams of frightfully useful engineers,” writes Bardhan.
None of this means that social scientists shouldn’t do controlled trials or that policymakers shouldn’t pay any attention to RCTs, but it does mean their findings should be taken with a hefty pinch of salt and that they shouldn’t sideline other techniques.
Despite the breadth and quality of the Economist magazine’s international coverage, I often don’t bother reading stories on certain subjects because I already know what they’re going to say. Argentina is one topic which tends to bring out a particular strand of swivel-eyed lunacy.
“A Decade of Division” shouts the latest headline, above an article about ten years of rule by Nestor and Christina Fernández de Kirchner. The piece criticises the husband and wife pair for allegedly agreeing to take turns at the presidency, a plan which Nestor spoiled by inconveniently dying of a heart attack in 2010.
But before that he “pulled a subtler, counterintuitive power play: he stepped aside.” Stalinist! Clearly he must have thought that no Argentine voting in the 2007 election would have the gumption to vote for anyone other than his wife, who again won hands-down in 2011.
The article makes much of “rumours” “swirling” that Fernández might amend the constitution to seek a third term. “But she seemed to suggest otherwise when she spoke to supporters at her anniversary party on May 25th, stating: “I’m not eternal, nor do I want to be.” Ah. So she probably won’t seek a third term, then.
We just spent four months in the country travelling from north to south. We didn’t experience a country worthy of the mouth-frothing and negativity so prevalent in the English-language international media. Since Kirchner’s election in 2003 the economy has boomed, with a faster and more sustainable growth path than under the right-wing era of the 1990s. Domestic industry has flourished and the economy has avoided the dependence on the financial sector that artificially propped up many developed countries then sent them into slump. Poverty has fallen dramatically. As many as half of all families were poor at the height of the crisis, compared with around a tenth now. Unemployment is much lower now than in Europe. Until recently inflation has been manageable. Many Argentines actually still like Fernández, particularly because she has done something to tackle poverty.
This isn’t to suggest that everything is smiles — and nothing would excuse further concentration of power or the amendment of the constitution so as to support a third term for Fernández. Inflation is also clearly a big problem, as is the massaging of statistics. The black market dollar rate has diverged significantly from the official rate in the last few months, suggesting a worrying downturn in confidence. Calle Florida in Buenos Aires heaves with money changers. The middle class apparently take regular trips to Uruguay to get dollars.
But it does seem that publications like the Economist, and its readers, dislike Argentina’s alternative economic policy so much and want to punish it for its 2001 sovereign default, that they will concoct a negative story whatever the reality. Reading the comments under the Economist piece you’d think that the country’s economic performance in the 2000s didn’t outstrip either of the previous two decades or that the country has somehow been less politically stable. One poster says that the country used to be as wealthy as Australia and that somehow it’s the Kirchners’ fault. Er, maybe it was rich 100 years ago. The long-term decline in the country’s relative world economic standing might have something to do with the intervening century, during which it was ruled by dictators and quasi-fascists.
While in the country I began to wonder whether the Argentina that the Economist referred to was some other land, some fictional anti-Xanadu where journalists project their dystopias. The reality’s not that bad.