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Nicolas Meisel ( meiseln@afd.fr ) 2 April 2014

The International Tax and Financial Architecture and its impact on Economic and Political Development in Africa. Nicolas Meisel ( meiseln@afd.fr ) 2 April 2014 Mo Ibrahim Governance School on Governance for Development in Africa. Outline.

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Nicolas Meisel ( meiseln@afd.fr ) 2 April 2014

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  1. The International Tax and Financial Architecture and its impact on Economic and PoliticalDevelopment in Africa Nicolas Meisel (meiseln@afd.fr) 2 April 2014 Mo Ibrahim GovernanceSchool on Governance for Development in Africa

  2. Outline • Introduction: provide a few analyticaltoolsto understandkey mechanismsand insertion of SSA in FG. • Framework: Capitalism and financial globalisation (FG) • Assessing the impact of FG on economic and politicaldevelopment: theory & evidence • Concerningfeatures of FG: taxcompetition, capital flight and taxhavens • Conclusion: Wayforward • Bibliography • Discussion

  3. Capitalism & Financial Globalisation (1) • Capitalismisbased on marketeconomy but came muchlater and is more thanmarketeconomy • Marketeconomyparadigm = exchange amongequals. Price signals S=D. Marketsself regulating in competitiveequil. Engines of growth=Division of labour ; economies of scale ; technologicalprogress. Main policyrecommendation:separateecononomicspherefrompolitics. • Capitalism = force of accumulation. Because money = power & No limit to desire of power, capitalismis not self regulating. Not converging to anyideal model. Inequalityisits essence (social well-being not an obj). Separation of econ and pol impossible  objective = effective regulation.

  4. Capitalism & Financial Globalisation (2) • Developmenttrajectorydetermined by interaction between organisations (firms, states, etc) and institutions (formal = rules of the econ & polgame;informal = representations & beliefs) at all scales. • Capitalistgrowthisglobal in itslogic of accumulation AND enshrined in local structures. Possible to have accelerationin one part of the world AND decelerationin another • A historicalprocessfed by itsown contradictions (expansion, crises, innovation…). • Instabilityis the rule, stability the exception. • Finance = central mediation of capitalisthistory, must resort to it to borrow, invest, employ labour, expand K; dominant financial centres capture value (power shiftingbetweenVenice, Antwerp, Amsterdam, London, New York, Hong Kong…). Financial markets = money making money. Pb: greed has no bound. Self regulationcannotexist.

  5. Capitalism & Financial Globalisation (3) • 1944: BrettonWoodsmonetary system. Obj = stability. Fixedparities +USD-gold convertibility. Finance under state controls in segmented national financialsystems. Control of key prices= wages (w), goods, interest rates (i), x-rates. • 1960s: increasing tensions due to end of reconstruction + accumulation of USD outside US • 1971: Start of FG with the exit of BW by Nixon (end of dollar-Gold convertibility)  floating exchange rates & full K mobility • 1970s: recycling of petro-dollarsoverlending to 1st & 3rd world (public and privateloans). Race between p, w & i in Western World  stagflation. • 1980: Dramaticrise in US i to curb p and definitelytransfer power fromborrowers to lendersDebtcrisis structural adjustment plans: macro ‘stabilisation’ ; liberalisation of K account; and privatisationof public util.

  6. Rationale& theoreticalbenefits of FG • Standard justification for FG: if free to circulate, K flowsfrom S-rich-low-growth to S-poor-high-growth countries. • LICs need foreign K to grow because S-constrained (same fundamental justification since the 1950s!) • Financial opening will • Raise S, reduce financing costs (better risk allocation and increased liquidity reduces cost of K) • Develop domestic financial market (entry of foreign banks, increased competition, better credit allocation) • Smooth output and consumption volatility • Introduce market discipline in all macro policies: spur fiscal discipline, monetary policy, and institutional reforms • Attract FDI (intl markets confidence & business climate) • Raise domestic investment and growth

  7. Evidence (1): Saving and investment rates have actuallydeclinedwithfinancialintegration in SSA (source: WDI) Gross S and I in LA (% of GDP) Gross S and I in SSA (% of GDP)

  8. But not in ASIA Gross S and I in East Asia (% of GDP) Gross S and I in South Asia (% of GDP)

  9. Evidence (2): No relationship between growth and FG Rodrik and Subramanian (2009) find no correlation between long-run growth and intensity of cross-border capital flows, neither in level …

  10. … nor in growth Confirming (Prasad et alii, 2007 ; Gourinchas and Jeanne, 2007) : Countries that have grownmostrapidly are thosethatrelyless, not more, on foreign K! « For anygivenlevel of I, the more thatisfinanced by domesticsavings, the greater the long-rungrowth » Rodrik (2009)

  11. Evidence (3): doubts on benefits of FG • Facilitated external borrowing may actually relax, not increase, macro discipline and fiscal constraint for longer periods than possible otherwise;↑ future adjustment costs • Y, C and income volatility ↑ with FG (Kose et al, 2007) • Insufficient absorption capacity  Risk of overborrowing through domestic financial institutions  Poor I perf + Speculative asset bubbles → priv & public debt → boost C  inflation + CA deficit  ↑ risk of K flow reversal (sudden stops) and financial crises (Mex 1994, Thai 1997, Arg2001) • Classic answer: “inappropriate regulatory, prudential, supervisory structures” • Pb: endless list; unfeasible; not strategic : ignores trade-offs & resource constraints (other reforms may be more urgent) ; historically unjustified (post-45 Europe, Korea, China).

  12. Real riskswith capital inflows (2) • Appreciation of the real exchange rate (overvaluation) hampering diversification in tradables • Increase of real x-rate  loss of profitability and competitiveness of tradable goods sector which is the key sector to foster endogenous growth  Disincentive to invest in non traditional tradable sectors  I demand for tradables diminishes and productive capital accumulation actually recedes

  13. Net privateflows (loans, FDI, portfolio) and overvaluation 1970-2004. Source: Rodrik (2009) Undervaluation of the real exchange rate and growth (panel of 5-year averages 1980-84 & 2000-04)

  14. Decomposition of growth into‘within sectors’and structural change betweensectors, 1990-2005 SSA: Growth-reducing structural change - Constrast with Asia • Economic development requires systematic reallocation of factors of production from low-productivity, low skill & technology, decreasing returns sectors to higher-productivity, increasing returns sectors. Disindustrialisation in SSA: Manufacturing Value Added (% du GDP)

  15. FG hampering industrialisation: trickle down effects • Impact on cost of capital: Atrophy of tradablesectorsmayworsencurrentaccountdeficits and trigger a lasting dependence on foreign K to coverthem, hencereinforcingperceivedvulnerabilities and increasingcost of K. • Impact on labour and demand for democracy: Historically industrialisation has promotedwageearners, formalisation and taxation of labour incomes, & contributed to developwelfare state • If desindustrialisation slows down middle class formation, it may well suppress an essential historical constituency behind the D for democracy

  16. Conclusion on impact of FG • Increased instability • Overliquidity, esp. since 2000s (see graphe) • Boost in consumption ; • Appreciation of real x-rate even in countries with large CA deficits! contrary to Mundell Fleming std model • Reduction of domestic I in tradables (decreasing returns on domestic I)  Impact on growth = O • Sounds familiar? Variation of real exchange rate horizontally and current account vertically for 30 emerging countries (2003-2007). Source: WEO, IBS.

  17. Net Capital Flowstowards 30 emerging Countries (USD 2010) Source : Institute of international finance (2010)

  18. Explanation: LICs suffer more from investment constraints than from saving constraints • If an economy suffers from a lack of I demand, financial opening is not likely to impact domestic I positively because I is not responding to market conditions (decreasing function of r) • Low demand for domestic I in tradables may be due to: • Low social return of K bec. human K, skills, infrasand social welfare limited by inadequate gov capacities • Poor I appropriabilitydue to weak institutions (eg property rights) or enforcement capacities of the state • Tradable sectors suffer the most from weak institutions & learning externalities (implicit tax, on top of x-rate appreciation)  Putting the emphasis on I rather than on S as a main constraint entails completely different prescription = invest in public infras, public goods and public services

  19. Harmfulfeature of FG: Taxcompetition • Tax rebates ; 5-year holiday... schemes encouraged by WB (DB) to attract FDI • Esp & ironically recommended “because you do not provide investors with key public infras” so they won’t come unless offered tax breaks • Individual ad hoc treatments that increase fiscal policy complexity (IMF opposition) • Race to the bottom in corporate income tax (no limit to the process) • Pb: Not part of integrated fiscal, employment, skill devt, and industrial strategy.

  20. Harmfulfeature of FG: Capital flight (1) • FG reduces returns on domestic I in tradablesbut ↑ incentives for K flight (returns on foreign I ↑) • Certain skills imported with FG = fin., legal, fiscal and private banking. • Much easier to send money abroad than invest in risky industrial venture for export markets. • Much safer to protect assets abroad from predation, taxation, expropriation, competitors, etc. • NB: origin of funds may be licit or illicit : proceeds from privatisations; kickbacks on gov loans; procurement contracts; transfers from public accounts… • Csq: tax evasion by elites (reduced fiscal space) and inequality

  21. Stock of capital flight by country, 2008

  22. Harmfulfeature of FG: Capital flight (2) • KF figures by Ndikumana & Boyce 2011 > Henry 2012 • KF = BoP residual (K inflows – uses) + trade misinvoicing (underinvoice X– overinvoice M) + unrecorded remittances. • 2010: accumulated stock (39 African countries) since 1970 = $1700bn >> Debt = 280bn. Collier (2001): 40% of Africa’s private wealth is held abroad. • Nigeria, Algeria, Morocco, Egypt, Angola, Cote d’Ivoire… • Csq: Africa net creditor to the rest of the world • However important difference: public L but private A! • Negative impact of K flight on domestic I • Negative impact on growth = -2.4% (average) ; -0,8 (median) • On tax = 1700bn*3%=51bn (earnings per year)*30% (marginal income tax rate) = 15Bn per year of lost revenues

  23. Harmfulfeature of FG: Capital flight (3) • KF from SSA = equal to the sub-continent’s total GDP • Equal to 10 years of Africa’s infrastructure investment needs • Equal to the wealth of Africa’s 100,000 “High Net Worth Individuals” • Direct impact on inequality: rich do not pay tax ; real distribution of income and even more of wealth far more skewed than current inequality stats (underestimation of Gini) as very rich underreported in both HH surveys & tax accounts • Indirect impact on inequality and democracy : rich do not contribute to public infrastructure provision ; do not create local demand ; do not push for better institutions. • Elites’ incentives disconnected from ordinary citizens: do not have to account for their deeds and can increase their wealth independently of their people’s fate.

  24. Harmfulfeature of FG: Capital flight (4) • 60% of KF due to debt = debt fueled KF ; and debt fuels KF as well = KF and external overborrowing = twin problems • Zaire: ‘(…) In this office [the Presidency], no distinction is made between state expenditures and personal needs. (…) Impossibility of control of frauds means that there is not any – I repeat any – chance on the horizon that the numerous creditors of Zaire will recoup their funds.’ E. Blumenthal (1982), Zaire: Report on its international financial credibility. • FT, 12 May 1997: Senior banker quoted: ‘How Mobutu built up his $4bn fortune: Zaire Dictator plundered IMF loans’ • Mobutu: the first African president received by Bush Sr • WB loans to Nigeria 1984-94 = $4.6bn • Responsibility of lenders  “Odious debt” by odious gvt • Today: KF accelerating ; China’s 2004-2010 $14bn Resource backed non transparent loans + IMF optimistic projections

  25. Public foreignborrowingnowconditional to IMF Debtsustainabilityanalysis IMF stress tests of debtsustainability in poorindebted countries recognizinglenders’ responsibility to prevent new crises  green, yellow, red. Limits: onlyexternal public D, missingdonors; IMF position Growthhypotheses are a key parameter of debtdynamics : dt = bpt + dt-1 (1+i)/(1+g) ; and easy to control Annualaveragegrowth rate of GDP (historical, source WEO) and DSA hyp.

  26. Harmful dimension of FG: Taxhavens • Off-shore secrecyjurisdictions • About 80 such places • Withbetween USD 20 and 30.000 bn of accumulatedassetsfromdeveloping countries under management (thuswithhyp of 3% of return= 600-1000 Bnincomes) • Hyp = 30% Marginal incometax 180-300Bn annuallosttax revenue • 50% of banks cross border deposit and creditoperations ; 1/3 of FDI • Organised and controlled by 50 largestbanks

  27. The WayForward: Democracy and capitalism • Main effective governancescaleuntiltoday = national. Largelyineffective in front of today’s global challenges • «As long as the world economyremainspoliticallydividedamongdifferentsovereign and regulatoryauthorities, global finance iscondemned to sufferfromdeformations far worsethanthose of domestic finance » (Rodrik). • Incompatibility triangle: democ – econintegration (globalisation) - sovereign nation-states • Global financial capitalismrequires global regulation to protectitselffromitsexcesses. Regulatory institutions need to beprotectedfrommarketmechanisms. Politics must rule finance.  New formsof governancerequired and emerging: multi-scale, from national to global, to help democracy survive

  28. References • P. Gourinchas & O. Jeanne (2007), Capital Flows to Developing Countries: The Allocation Puzzle, NBER WorkingPaper. • E. Prasad, R. Rajan, A. Subramanian (2007), Foreign Capital and EconomicGrowth, Brookings papers on economicactivity • A. Kose, E. Prasad, M. Terrones (2007), Growth and Volatility in an Era of Globalisation, IMF Staff Papers • D. Rodrik & A. Subramanian (2009), Whydid Financial Globalisation Disappoint, IMF Staff Papers • J. Henry (2012), The Price of Offshore Revisited, Tax Justice Network • L. Ndikumana & J. Boyce (2011), Africa’sOdiousDebts: How foreignloans and capital flight bled a continent • N. Shaxson (2011), TreasureIslands: Taxhavens and the men whostole the world • R. Baker (2005), Capitalism’sAchille’sHeel: Dirty Money and How to Renew the Free Market System • T. Piketty (2014), Capital in the 21st Century

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