In a recent editorial the Financial Times said:
Every first-year economics student learns the conditions for an unregulated market, in theory, to function efficiently. The most important are full information, enforceable property rights and contracts, and the absence of “externalities” — effects of economic transactions on third parties.
When these conditions are absent, markets malfunction; the way they do so is one of the great topics of economic theory. It tells those who care to listen that when a market is too opaque, or when the effects of market transactions are too inter-dependent, the pursuit of self-interest can make everyone worse off, or unfairly land some with the losses caused by others, or — in extremis — make markets disappear altogether.
Anyone who believes that markets have a role in the economy (and I do) will find it difficult to argue with this. What it makes clear is that efficient markets are dependent upon the availability of information: the better the quality of the information and the more open the access to that information is then the better will be the efficiency of the allocation of resources by the market.
Tax haven activity is entirely dependent upon secrecy. That secrecy is an entirely deliberate and artificial market distortion. It is only available to some businesses and people and not others: a premium is placed upon access to this ability to hide one’s affairs.
One premium is imposed by cost: it is not cheap to set up offshore structures. As a result they are only available to larger businesses and wealthier individuals. As a result the wealth gap increases.
Another premium is imposed by age: those able to create structures before they are declared illegal are usually allowed to retain them after use by new market entrants is banned. This means older people, and most especially older companies have opportunities not available to new businesses that cannot legally access these centres. This has created a bias against new enterprise.
Thirdly, there is a premium imposed by legality. Some will choose to act illegally and take the risk of doing so. Others will not. If insufficient resource is allocated to tackling the illegality there will be a positive, and predictable return from that illegal behaviour which imposes a premium on those who choose to be law abiding.
Lastly there is a premium on those who work nationally: they cannot access offshore in a way those who work internationally can. They suffer as a result.
But in each and every case the answer is not to open the market to all: for a start that is not possible. Second, it would only make the problem worse: there would be even less data available to markets than now, and as the FT notes, the result might be no markets at all.
The answer is to create a level playing field. This is what efficient markets require. That means all should place their data on public record; all should have their data exchanged with their domestic tax authorities; all should provide it to those who need it to appraise the risk of trading with them if they are a limited liability entity.
Then we remove a market distortion. That market distortion does at present:
- support monopoly power,
- support the power of those already wealthy,
- support the power of the large company over the small company, and
- support the power of the existing market player over the new market entrant.
These all result in the misallocation of economic resources because
There is no benefit from this for society as a whole. Far from it. Wealth and resources are misallocated. Because of the secrecy implicit in offshore the cost of capital goes up (one reason why the bank bail out has been so expensive). Because of the activities of offshore agents a cost of tackling abuse is imposed on society at large.
None of these things need happen. Those who argue against tackling offshore argue for inefficient markets. Those who argue for tackling it argue for efficient markets where resources are as optimally allocated as possible, where risk is mitigated and capital has the lowest possible cost. Getting rid of tax havens would help achieve that.
Then we’d have proper globalisation for the benefit of all, not globalisation to reinforce monopoly profit which is the tax haven inspired variety that we have now.
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“Anyone who believes that markets have a role in the economy… will find it difficult to argue with this.”
I believe, as you do Richard, that markets have an important role to play… but in fact the FT and the first-year economics student have it completely wrong. Those efficiency conditions are only correct if ALL markets in the economy are perfectly efficient. If there are ANY market imperfections anywhere in the economy (which is extremely likely) – including externalities, natural monopolies, public goods, imperfect information etc. – then it is NOT the case that improving the efficiency of one market will increase economic welfare. It could, instead, decrease it.
This is the “theory of the second best”, which was discovered by Richard Lipsey and Kelvin Lancaster in the mid-1960s. It is well-known in the welfare economics literature but the implications are often ignored or pushed to one side – because it’s an ‘inconvenient truth’ that threatens to undermine most of the other economic theory that is taught these days.
I don’t disagree with your specific points on tax havens here – just to point out that the issue of overall economic efficiency (rather than the efficiency of one particular market) are a lot more complicated than the FT leader writers seem to think!
It is not expensive to establish offshore structures. Panama IBCs can be had for less than USD 500 p.a. Some Carribean IBCs go for even less. Use these IBC papers to open a bank account in Switzerland and tax evasion is feasiblefor every single customer.
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Mark
I stand corrected
How easy to open that Swiss bank account?
Why not London if not resident in the UK given what Jason Sharman says?
Richard
I’d like to reinforce Howard’s argument by referring to the dysfunctional land market without which we would never have a financial crisis. Lax credit creation always feeds into land values. There is a simple correction: collection of all land rent for public benefit. I am with the Austrian economist Silvio Gesell who contradicted Keynes that only the money market needed to be controlled. Gesell said that the land market too must be addressed (although his prescriptions for both markets are somewhat discredited – he was for land nationalisation).
[…] 3. Destabilise markets […]
[…] 3. Destabilise markets […]