There are many reasons to get angry about the financial crisis. One is that the people and countries with least responsibility are paying the highest price – as is also true of climate change. Another reason is that the G20 group of leading countries has already broken a key promise to the poorest. But European policymakers can play a crucial role in ensuring that the policy response to the crisis also addresses the fundamental obstacles to independent, sustainable development.
The crisis that began with banks and other financial institutions in the richest countries has spread through their economies and spilled into developing countries, undermining their sources of finance and extracting a direct human cost already. First, trade earnings have fallen sharply – with the World Bank estimating that low-income countries’ merchandise exports would have dropped by almost 15% in 2009, increasing their trade deficit from 6.3% to 9.2% of their GDP. Second, net private capital flows have fallen around 70% across all developing countries from around $1.2 trillion in 2007 to an estimated $363 billion in 2009 – a drop equivalent to around 5% of GDP. Third, remittances were estimated to have fallen in 2009 by 7.3%.
Of course the richest countries are also suffering economically. The difference is that shocks in many developing countries will have much harsher and potentially permanent impacts. An estimated 120 million extra people will be living on less than $2 a day by 2010. The ILO estimates that global unemployment will rise to 219-241 million people, the highest on record, with disproportionately damaging effects on women. The World Bank conservatively estimates that the crisis will cause an additional 30-50 thousand infant deaths in sub-Saharan Africa alone – to say nothing of the permanent effects on a generation that a peak in malnutrition is likely to have.
Don’t let these numbers make you angry, though - the real outrage is the underlying levels. More than a billion people going hungry every day, according to the FAO. It’s not the 11% growth that should shock us. A few more tens of thousands of unnecessary child deaths? It’s the eight or nine million a year that should shock us; should make us incandescent with rage.
This is why Christian Aid has long recognised that development efforts cannot only treat the symptoms of poverty, but must address the fundamental causes. You can learn more about this, and join our drive for Poverty Over at http://povertyover.christianaid.org.uk.
This is also why the crisis presents such a staggering opportunity for change that would benefit the world. The same lack of financial transparency that underpins the crisis also plays a major role in denying development, by facilitating the estimated one trillion dollars annually of illicit capital flows from developing countries due to corruption, money-laundering and above all tax evasion and avoidance. If international policymakers take the right measures, they can not only reduce the chances and likely severity of the next crisis, they can also kick away a major structural cause of poverty.
The crisis is the inevitable result of a classic financial liberalisation boom. As the experience of developing countries makes abundantly and painfully clear, every significant liberalisation of international financial flows has been followed by an economic boom, and then a subsequent bust. The boom periods involve rapid expansion of credit and are typically characterised by growth in consumption, bubbles in asset prices but little productive investment. The busts see a sharp contraction of credit, and – depending on the extent of countercyclical monetary and fiscal policy – often very sharp increases in unemployment and poverty.
The liberalisation that prompted the boom in this case is somewhat hidden from view, rather than being a clear policy decision. Effectively, financial integration among rich countries ran far ahead of the capacity of national regulators to maintain domestic credit restraint. By using structured investment vehicles in opaque and little-regulated jurisdictions, and other ways to exploit regulatory arbitrage, banks and other financial institutions were able to side step the key limits on their risk-taking.
Banks’ capital is regulated so that they cannot over-extend themselves and behave too riskily. The Basle Capital Accord mandates a safe level not exceeding $12.50 of (risk-adjusted) assets for each one dollar of equity or original capital. To take just one example, our partners the Tax Justice Network have shown that the Irish holding company of US investment bank Bear Stearns had almost $120 of assets for each dollar of underlying capital. Bear Stearns was subsequently bought out by JP Morgan, to avoid bankruptcy and at the behest of the Fed, for a price of around $10 a share – compared to a 52-week high of $133.20. Neither the US nor Irish regulators were apparently able to take a global view of the company’s risk, on-balance sheet or otherwise.
In this way competition among jurisdictions to provide ever-more attractive ‚Äòlight’ regulation, while other regulators failed to intervene, allowed banks and other financial institutions to avoid the key limits to their expanding credit. At the same time, financial market instruments of growing complexity were used to distribute the ultimate risks underpinning that credit expansion. Only when confidence eventually turned was it revealed that the ‚Äònew paradigm’ had been a shell game, with systemic risks ramped up rather than miraculously dispersed.
‚ÄòSecrecy jurisdictions’, the preferred term to tax havens - as it is not the low tax that havens levy that is the problem, but the secrecy they offer which allows abuses and corruption to thrive, are not only the small islands of popular imagination. In fact, a great deal of the global total of opacity in financial flows can be attributed to larger centres – not least the US and the UK, which both feature in the top 5 of the new Financial Secrecy Index that Christian Aid and the Tax Justice Network have just published.
The index, which can be found at http://www.financialsecrecyindex.com/, measures the opacity of each jurisdiction, and weights this by their share of the market in providing financial services to non-residents. The top twenty includes eight European countries: Luxembourg (2), Switzerland (3), UK (5), Ireland (6), Belgium (9), Austria (12), Netherlands (15) and Portugal (Madeira) (17).
For developing countries, the same mechanism and the same jurisdictions that contributed to the boom have caused even greater damage than the crisis itself: international financial integration without coordinated regulation. For the crisis, the key area of flaunted regulation was that of capital reserves to constrain credit expansion and risk. For developing countries, the major impacts are around tax evasion, tax avoidance and other corrupt or illicit flows.
Global Financial Integrity, based in Washington DC and headed by Raymond Baker, have produced the most comprehensive and respected study of illicit flows. The findings are that one trillion dollars of illicit capital flow out of developing countries every year. Raymond Baker previously estimated the corporate tax evasion component to account for around two thirds of this, and consistent with that is Christian Aid’s own estimate that the mispricing of trade in commodities (by multinational companies and others) results in a tax loss to developing countries of around $160 billion each year – more than one and a half times the total received in aid. We estimate that these funds, if spent according to current patterns, would save the lives of almost 1,000 children under five every day.
Tax revenues are lost by the abuse of trade prices to shift profits out of developing countries and into secrecy jurisdictions. One resource-rich sub-Saharan African country, for example, sends more than half of its exports - on paper at least - to Switzerland. When uncovered, the illicit funds of corrupt politicians are also typically found in secrecy jurisdictions – whether London or Geneva. Tax administrations and anti-corruption authorities in developing countries typically have neither the capacity nor the legal agreements to be able to access the necessary information to see if individuals or companies are cheating the state of much needed funds.
But the damage goes well beyond the revenues lost. Academic research has shown that the share of tax in funding governments’ expenditures is a key determinant of their responsiveness to citizens – taxation drives political representation, strengthening governance and combating corruption. What this means is that a lack of transparency in financial markets and international trade are not only costing developing countries the funds that are rightfully theirs, they are also undermining the extent to which states use those resources for the benefit of their citizens.
Christian Aid has two key demands, which would go a long way to breaking down the international obstacles to effective taxation for development. One concerns the secrecy jurisdictions, and this is to replace the largely ineffective bilateral Tax Information Exchange Agreements (TIEAs) with a multilateral agreement including secrecy jurisdictions and developing countries. Like the EU Savings Tax Directive, but unlike TIEAs, this would need to include an element of automatic information exchange. At present, TIEAs allow exchange ‚Äòon request’ and the burden of proof is so high that even powerful requesting jurisdictions like the USA are only able to meet it infrequently. Small, low-income countries would have little chance, even if they were able to negotiate TIEAs – which shows little sign of happening.
The second key proposal is for an international accounting standard to require multinational companies to report some basic data on their economic activity, including profits made and tax paid, on a country-by-country basis. Unlike the current system of global consolidated reporting only, country-by-country reporting would allow tax authorities a system to ‚Äòred flag’ the highest risks of abuse – where, for example, a company carries out 20% of its business there but only declares 2% of its profits, while the reverse proportions apply in a secrecy jurisdiction.
The G20 is considering both proposals, not least because of the lead that the UK government has taken, but so far the grouping has not kept its promise to present proposals by the end of 2009 to ensure that developing countries benefit from the new cooperative environment for tax information exchange.
The interests of rich and poor countries and people alike are, for once, unified in the need for greater international financial transparency. European policymakers can provide the critical momentum to ensure that the new context takes account of developing countries and truly delivers a silver lining to the crisis. The alternative is a return to business as usual – and no-one can afford that.
Alex Cobham is Chief Policy Adviser at Christian Aid
This article was originally published in Europe’s World. Reproduced with permission