James Tobin: a Nobel prize-winning economist
A free market economy, combined with income redistribution and a responsive welfare state, remains a successful and attractive model. Indeed, it has the best record in history for combining economic growth with poverty alleviation. Add a careful bias by government towards the working poor and the socially excluded, and such a model gives western economies a fighting chance of tackling their common challenges: how to accelerate social mobility, fund an aging population and maintain international competitiveness.
Most of the imminent market reforms will be useful. Capital ratios for financial companies will be stronger, some speculative trading curbed, asset transparency clearer, and financial oversight strengthened. Protectionist measures that risk damaging the economy's ability to self-generate should, with a little political will, be seen off.
But the biggest market failure may not be addressed: that the profits of the last boom had been banked by the private sector before the bust arrived—leaving the public sector with the bill. A redesign of capitalism is needed—one that funds the cost of the whole economic cycle, including the inevitability of a future bust, from the capital transfers and profits generated in the next upturn. But to claim this prize policymakers must act swiftly, whilst laissez faire fundamentalism is weak.
How can we slow down volatility and irrational exuberance during the next upturn, whilst also providing for the cost of future bailouts from private profits, rather than public subsidy? The world has had a model for such a pay-as-you-go system for exactly 30 years—it's called the Tobin tax.
In 1978, James Tobin, a Nobel prize-winning economist, first proposed the idea of a levy on capital transfers that would be applied uniformly by all major economies. A tiny amount (say less than 0.5 per cent) would be clipped from all foreign currency exchange transactions to deter speculation and fund public goods. The rate would be low enough not to damage long-term investment (where yields over time are expected to be higher), but would deter speculators moving large amounts of currency around the globe as they seek to profit from minute differences in currency fluctuations.
As well as slowing volatility in fragile economies, the tax would yield enormous sums. But in a classic example of the law of large numbers, the cost would be absorbed by the international currency market. Only around 5 per cent of the $2 trillion traded each day is related to trade and other real economic transactions—the rest is simply financial speculation which often plays havoc with national budgets and allocation of resources.
So let's assume an effective tax base of $75 trillion annually—which takes at face value the claims of Tobin tax critics that currency trade would decline from current levels, and that some trade would circumvent the tax. Now apply a rate of, say, 0.2 per cent: an annual yield of $150bn in receipts then becomes available. If the next boom lasts for five years, then $750bn—the size of the current US bailout—has been generated at a neutral cost to the taxpayer.
Any reforms to capitalism that emerge in the next few months must accept the reality of boom and bust during an economic cycle, and should seek to smooth the future impact of both. A pay-as-you-go system modelled on the Tobin tax can aid stability by slowing down the speed with which market traders react to changes in prices of currencies. They will have to pause to calculate the need for their profits to exceed the tax. This deliberate throwing of "grit" in the system could smooth fluctuations while the tax receipts fund the correction of future imbalances.
The Tobin tax was designed for currency markets but the same pay-as-you-go principle could be adapted to other large-scale capital flows such as credit and derivative markets. The concept is as simple as insurance—collecting a tiny premium from every movement in large markets, to insure the stability of the system as a whole.
Critics of the Tobin tax have focused mainly on the formidable implementation challenges: international agreements, collection, tax avoidance, and the question of which national or international body will control the receipts. But the real barrier has always been political. And that's why policymakers should now give it urgent and fresh attention—while vested interests are weakest, and the case for a more resilient system is strongest.
Politicians have never felt more powerless than when dealing with the financial crisis of recent months. But in reality they have never had more power to change things, with resistance from the financial lobby so weak. A dynamic reform agenda, which starts with a positive affirmation of free markets but seeks to insure them over the economic cycle, has a better chance today than ever before. Moreover, once the basic stability costs have been covered, income from a Tobin tax could be earmarked for meeting global challenges such as international development and climate change, especially in poor countries. Presented in populist language as a small daily transfer from Wall Street to Main Street, and with substantial national sovereignty retained over the collection and distribution of tax revenues, it's a platform that I hope proves irresistible to political leaders.
A free market economy, combined with income redistribution and a responsive welfare state, remains a successful and attractive model. Indeed, it has the best record in history for combining economic growth with poverty alleviation. Add a careful bias by government towards the working poor and the socially excluded, and such a model gives western economies a fighting chance of tackling their common challenges: how to accelerate social mobility, fund an aging population and maintain international competitiveness.
Most of the imminent market reforms will be useful. Capital ratios for financial companies will be stronger, some speculative trading curbed, asset transparency clearer, and financial oversight strengthened. Protectionist measures that risk damaging the economy's ability to self-generate should, with a little political will, be seen off.
But the biggest market failure may not be addressed: that the profits of the last boom had been banked by the private sector before the bust arrived—leaving the public sector with the bill. A redesign of capitalism is needed—one that funds the cost of the whole economic cycle, including the inevitability of a future bust, from the capital transfers and profits generated in the next upturn. But to claim this prize policymakers must act swiftly, whilst laissez faire fundamentalism is weak.
How can we slow down volatility and irrational exuberance during the next upturn, whilst also providing for the cost of future bailouts from private profits, rather than public subsidy? The world has had a model for such a pay-as-you-go system for exactly 30 years—it's called the Tobin tax.
In 1978, James Tobin, a Nobel prize-winning economist, first proposed the idea of a levy on capital transfers that would be applied uniformly by all major economies. A tiny amount (say less than 0.5 per cent) would be clipped from all foreign currency exchange transactions to deter speculation and fund public goods. The rate would be low enough not to damage long-term investment (where yields over time are expected to be higher), but would deter speculators moving large amounts of currency around the globe as they seek to profit from minute differences in currency fluctuations.
As well as slowing volatility in fragile economies, the tax would yield enormous sums. But in a classic example of the law of large numbers, the cost would be absorbed by the international currency market. Only around 5 per cent of the $2 trillion traded each day is related to trade and other real economic transactions—the rest is simply financial speculation which often plays havoc with national budgets and allocation of resources.
So let's assume an effective tax base of $75 trillion annually—which takes at face value the claims of Tobin tax critics that currency trade would decline from current levels, and that some trade would circumvent the tax. Now apply a rate of, say, 0.2 per cent: an annual yield of $150bn in receipts then becomes available. If the next boom lasts for five years, then $750bn—the size of the current US bailout—has been generated at a neutral cost to the taxpayer.
Any reforms to capitalism that emerge in the next few months must accept the reality of boom and bust during an economic cycle, and should seek to smooth the future impact of both. A pay-as-you-go system modelled on the Tobin tax can aid stability by slowing down the speed with which market traders react to changes in prices of currencies. They will have to pause to calculate the need for their profits to exceed the tax. This deliberate throwing of "grit" in the system could smooth fluctuations while the tax receipts fund the correction of future imbalances.
The Tobin tax was designed for currency markets but the same pay-as-you-go principle could be adapted to other large-scale capital flows such as credit and derivative markets. The concept is as simple as insurance—collecting a tiny premium from every movement in large markets, to insure the stability of the system as a whole.
Critics of the Tobin tax have focused mainly on the formidable implementation challenges: international agreements, collection, tax avoidance, and the question of which national or international body will control the receipts. But the real barrier has always been political. And that's why policymakers should now give it urgent and fresh attention—while vested interests are weakest, and the case for a more resilient system is strongest.
Politicians have never felt more powerless than when dealing with the financial crisis of recent months. But in reality they have never had more power to change things, with resistance from the financial lobby so weak. A dynamic reform agenda, which starts with a positive affirmation of free markets but seeks to insure them over the economic cycle, has a better chance today than ever before. Moreover, once the basic stability costs have been covered, income from a Tobin tax could be earmarked for meeting global challenges such as international development and climate change, especially in poor countries. Presented in populist language as a small daily transfer from Wall Street to Main Street, and with substantial national sovereignty retained over the collection and distribution of tax revenues, it's a platform that I hope proves irresistible to political leaders.
