Regulation lags behind change in our global village

 

The Occupy Wall Street (OWS) movement has been an inchoate cry in the wilderness that the economic system, especially in the US but also in much of the west, has not performed as promised in creating prosperity for all. Capitalism’s raison d’être was that it worked more efficiently than communism, while producing more prosperity for the poorest among society. One simply had to accept its inequality as something ordained by nature. By pursuing economic efficiency, rather than distributive justice, the system did create more wealth. John Rawls, an eminent philosopher, proposed a significant test for justifying inequality. Rawls proposed inequality could be justified when the last person in an unequal system is better off than the average in an equal system. It is not clear if modern capitalism has failed the Rawls test. But what can no longer be denied is that capitalism must fix the problems it has created over the last two decades to retain its primacy as the preferred economic doctrine.
OWS is perhaps right to focus on the immediate problem of inequality. Modern capitalism cannot work without a functioning democracy as a necessary check on its excesses. However, over the last three or four decades, the discourse on economic systems was so captured by capital via sponsored think tanks that it left no space for criticism. This is unfortunate because capitalism’s case for self-renewal depends critically on its tolerance for innovation and creativity. To shut out the emerging problems is to deny reality. And the ugly reality is that the very regulatory mechanisms that guarantee a free market within its domain of validity were captured by ideologues. Alan Greenspan is a prime example of a committed high priest set atop a prime regulatory body. He let the banking system go haywire to the point of fraud and beyond in the name of free, self-regulating markets as dogmatically as any commissar. The price of his dogma is what we are faced with. The fact is, as the financial markets have evolved with globalisation of production, the regulatory mechanism to hold them to rules that ensure free competition and fair ethical practices has woefully lagged. Lack of effective regulation is at the heart of our crisis, which the OWS movement needs to focus on.
Nothing brings home the stark reality of globalisation better than the Greek announcement of a referendum to decide if the European Union (EU) imposed austerity measures were acceptable for a bailout package. The Greek resort to a referendum is unexceptionable. On the other hand, Germany and France cried foul. This ludicrous situation comes about because the burden of Greece’s default would eventually fall on the German and French taxpayers who have no vote in the Greek referendum! The fact is that markets for goods, services, jobs and indeed politics are still largely contained within nation-states, and regulated nationally. But capital is now more or less fully international and increasingly footloose. Athens itself has more houses with swimming pools than registered taxpayers, a fact that the authorities in Greece could verify using Google Earth. A clutch of top 10 Greek billionaires can repay the entire Greek national debt by writing a cheque! And yet you have most of the civilised world in a tizzy over the Greek referendum while the most obvious question remains unasked. Why do the billionaires not pay taxes?
Greece can be dismissed as too small a peg to hang capitalism on. So let us turn to the US. Bank after major bank has paid fines totalling a few billion after being sued by the regulators for wrongful practices in the mortgage and other security markets. What were they doing? One of the biggest scams run by most major investment banks was to originate pools of toxic mortgages, package them, and sell them to one set of investors as near A-grade securities while going ‘short on them’ on their proprietary accounts in conjunction with a few favoured hedge funds. Hedge fund investors are usually the super-rich. In the subsequent crash, hundreds of billions dollars were lost by banks investing in such toxic mortgages while the hedge funds laughed all the way to their bank. Ethical and legal questions apart, one is not questioning the right of knowledgeable hedge funds going short. That is as it should be in free markets. The question is: where did the profits go? Were any taxes paid on such profits?
Capital gains made on investing savings by taxpayers are spared a second round of taxes on such gains. This is only fair, as savings should not be taxed, a fact Central Bankers forget promptly when they need to make real interest rates negative. However, are hedge funds a mere pool of savings put together by the taxpayers or just joint stock companies that actively trade markets? Legal quibbles apart, if the only business you are in is trading stocks or securities, and a significant portion of your profits derive from such trading, then such profits should be taxed as normal business income. Is that so in the US? If not, why not? The Bush era Republican capture of Congress in fact widened this loophole to exempt dividend income as well. Most hedge funds in the US through legerdemain of playing around with tax jurisdictions, capital gains, profit sharing contracts and the like end up paying no taxes. Famously, Warren Buffet himself quotes his own example where, despite being a billionaire, he pays no taxes while his humble secretary does so. The fact is, if you went by the hedge fund flows after 2007, most of the money made from the froth in the markets in the US went to Chinese commodity markets without paying any taxes! So who pays for all that the governments do for society? Does capitalism meet the fairness test?
We cannot run a globalised economy by ignoring capital flows any longer. These are valuable pools of capital. Their availability is what made the Chinese miracle possible. And it is their pursuit of profits that will help lift the rest of the developing world out of poverty. Nevertheless, it takes huge amounts of investment in a variety of ways to enable this pool of international capital to obtain its profits for which service it pays nothing in taxes. The challenge before a globalised economy is to identify such capital pools, and find a way to tax these fairly with respect to where the profits originate as also where they are ultimately destined [actual investors]. The IMF has examined taxing international bank transactions that on the face of it appears unfair as it targets everybody and not just those who escape taxes.
In a way, the present legal system that regulates international capital flows was designed to let the super-rich get away without paying taxes. This worked as long as the capital escaping taxes was deployed largely within the developed world. It has become a problem precisely because the pool is now deployed in the less developed world that leads to hollowing out of the economies in the developed world. If you combine the labour force of China and the US as one, labour has done exceedingly well under capitalism! That is the ultimate irony!

The writer is a trader. She can be reached at sonali.ranade@hotmail.com or @SonaliRanade on Twitter