12.4The damaging effects of international markets?

Towards the end of the twentieth century, attitudes appeared to harden over the effects

of the free mobility of international capital. Two issues came to the fore. Firstly, a

question initially stated in the late 1970s resurfaced – should an international tax be

placed on capital movements to slow them down? The tax proposal was originally

made by James Tobin, a Nobel Prize-winning American economist. Tobin (1982)

proposed a uniform tax on capital ows, levied by all countries, to make ‘hot money’

round trips unprotable and to remove the dominance of capital account move-

ments over exchange rates. Similar proposals were made later for different forms of

tax but the idea came to be referred to as the ‘Tobin tax’, although Tobin later dis-

owned it.

Tobin’s particular concern at the time was with the volatility of exchange rates

and with the loss of the ability of governments to choose their own macroeconomic

356

....

FINM_C12.qxd 1/18/07 1:28 PM Page 357

12.4 The damaging effects of international markets?

policies. The argument gained support, however, following the Asian nancial crisis,

the nancial problems in Russia and Brazil, and the near-collapse of the US hedge

fund, Long-Term Capital Management (see section 9.5), all of which occurred between

the middle of 1997 and early 1999 and which appeared to threaten the stability of

the world nancial system.

Naturally, Tobin’s proposal had many critics. It was argued that many capital

ows were desirable and that there would be a problem in discriminating between

speculative capital ows (bad) and those designed for long-term investment (good).

Others rejected it on the grounds that it would favour inertia and local asset bias in

portfolios and, like any tax, was bound to interfere with the efcient operation of

markets. A third argument, from the opposite point of view, was that the usual size

proposed for a Tobin tax would be a negligible deterrent to short-term speculation

and probably smaller than the deterrent to real trade ows and arbitrage activities,

and that something much stronger was needed. The simplest argument was that it

would be impracticable. It would be impossible to obtain international agreement

on a world-wide tax and, even if agreement were reached, the market would quickly

nd its way around the tax. Nonetheless, there has been some support for the tax

even at a governmental level. For example, a motion was passed in the Canadian

House of Commons in 1999 suggesting that the government ‘should enact a tax

on nancial transactions in concert with the international community’. Of course,

since there was no prospect of the international community acting in concert on

this issue, the motion did not commit the Canadian government to doing anything.

This was true also of Belgium where, in 2004, the Commission of Finance and Budget

in the Federal Parliament approved the Spahn tax(a version of the Tobin tax) which

Belgium will introduce if all countries of the eurozone pass a similar bill.

The second issue concerned the heavy indebtedness of the poorer developing

countries. It was argued that their large debt repayments (particularly large as a per-

centage of GDP) were at the expense of essential expenditure on health, education

and social welfare; that the need to earn foreign currency to meet the debt repay-

ments distorted their agriculture away from staples for the home population towards

producing luxury goods for the markets of the industrial countries; and, above all,

that the countries had no prospect of struggling their way out of poverty while

they remained burdened with the debt repayments. A campaign for debt forgive-

ness grew. G8* countries promised limited forms of debt relief but always linked to

the countries’ following the orthodox economic policies ordained by the IMF. This

took the form of the Heavily Indebted Poor Countries Initiative (HIPC) the aim of

which was to provide debt relief for the poorest countries while trying to ensure that

funds saved from not having to repay loans would be spent on poverty reduction.

Opponents of debt forgiveness have always argued that any nancial aid provided

by the industrial countries would go to corrupt governments rather than ltering

down to the poorest people.

* G8 the seven largest industrial countries (US, Japan, Germany, France, Italy, UK and Canada)

Russia.

357

....

FINM_C12.qxd 1/18/07 1:28 PM Page 358

Chapter 12 • Financial market failure and nancial crises

The HIPC initiative identied 38 countries, mainly in Sub-Saharan Africa, poten-

tially eligible to receive debt relief. At the G8 meeting in July 2005, the Multilateral

Debt Relief Initiative (MDRI) was agreed, offering full cancellation of the debts of

HIPC countries to the World Bank, the IMF and the African Development Bank.

In December 2005, the IMF granted preliminary approval to an initial debt relief

measure of US$3.3bn for nineteen of the world’s poorest countries and the World

Bank began to take action to cancel the debts of seventeen countries in the second

half of 2006. For example, at the end of August 2006, the IMF and the World Bank

jointly announced a US$2.9bn debt cancellation deal for Malawi, one of the world’s

poorest countries. The difference between the numbers of HIPC countries poten-

tially eligible to receive relief and those that actually receive help merely reects the

existence of conditions other than poverty that countries must meet.

Any help for the poor countries is welcome even if the amounts ultimately

received are almost invariably less than what seems to have been promised initially.

However, there is no evidence as yet that sufcient has been done or is likely to be

done even to slow down the widening of the gap between rich and poor countries.

Yet the rich countries clearly recognise that until this happens they will continue

to have problems with migration and ‘economic refugees’. This is certainly one

example where a nancial problem has strong real-life effects.