The Rich Know How to Sidestep Responsibilities

The Paradise Papers show how the wealthy and powerful use tax havens—some do it legitimately, others for re-routing illegal wealth—to avoid or evade tax liabilities

Three developments over the past few weeks provide pointers to how the rich, whether individuals or nations, behave when it comes to meeting obligations.

The Paradise Papers have revealed how wealthy and powerful individuals use tax havens—some do it legitimately and some for re-routing illegal wealth—to either avoid or evade tax liabilities. The examples also highlight how this corrosive affliction equally infects industrialists and politicians.

The second example relates to the behaviour of rich nations, which have unabashedly deployed evasive tactics at Bonn, host to the 2017 UN Climate Change Conference to implement the Paris Agreement signed in 2015. The rich countries have been trying every trick to avoid meeting commitments on reducing greenhouse gas emissions, arresting climate change and funding developing and poor countries to help counter the effects of climate change. The US, European Union and some other rich countries—including Australia, Canada and Japan—have blocked efforts by developing nations to review the developed world’s performance vis-à-vis commitments.

Developing nations have been blaming the rich for sidestepping commitments made under the Kyoto Protocol, which placed mandatory emission reduction targets to be achieved during 2012-15. Later, through what is known as the Doha Amendments, the target date was extended to 2020. Developing countries have been arguing that to finalize the rule-book for the Paris Agreement, as the successor to the Kyoto Protocol, it is necessary to understand the achievements so far.

For instance, as part of the Copenhagen Accord of 2009, the developed countries pledged to provide developing nations with $30 billion during 2010-12 and $100 billion every year till 2020 to help mitigate climate change effects. The understanding was that since the industrialized nations were historically responsible for greenhouse gas emissions and the consequent global warming, they have a moral obligation to help poor countries, especially island nations, offset the adverse effects of climate change. But, as data shows, the rich are not only in breach but have been dissembling: Apart from reneging on their promise, they have also been padding funding data.

The third example crosses the Atlantic Ocean to Washington, DC, where the annual meetings of the World Bank and International Monetary Fund were held a month ago. Among other things, the agenda included the Bank’s pivot towards a new financing mode, for which it has been laying the ground over the past few months. The new strategy is called the “cascade approach”, under which Bank president Jim Yong Kim proposes to convert “billions into trillions”, essentially by leveraging the Bank’s financing and crowding in private investment.

The Bank released a document in September titled “Maximising Finance For Development: Leveraging The Private Sector For Growth And Sustainable Development”. This builds on a preceding March 2017 document called “Forward Look—A Vision For The World Bank Group In 2030, Progress And Challenges”. This document defines the scope: “... The Cascade first seeks to mobilize commercial finance, enabled by upstream reforms where necessary to address market failures and other constraints to private sector investment at the country and sector level. Where risks remain high, the priority will be to apply guarantees and risk-sharing instruments. Only where market solutions are not possible through sector reform and risk mitigation would official and public resources be applied.” Currently focused on infrastructure, the approach will be later extended to financial services, healthcare, education and agribusiness.

On the surface, it sounds like a logical progression of the Bank’s strategy and, at a theoretical level, the right thing to do. The Bank, in some senses, seems to be heeding conservative economists who have for long contended that the Bank crowds out the private sector and, therefore, must step back and facilitate private sector project funding. But there’s no avoiding the tricky questions: How do you manage the political economy of reforms, who will bear the risks, how will risk be eliminated, what will be the role of user charges, what is the private sector’s exact role, and, what happens in countries with minimal private sector presence? There are also concerns about involving the private sector in healthcare and education, especially because private and public interests are rarely aligned. Many of these concerns have already played out in India.

To be fair, the Bank’s hands are tied because the rich countries, especially the US, have refused to provide additional capital. India’s finance minister Arun Jaitley was forced to comment at the annual meeting: “The possibility of generating sufficient resources through the management levers has had only a marginal impact given the scale of capital requirement, and hence, early capital infusion into WBG (World Bank Group) is an imperative... The excessive emphasis on the ‘Cascade Approach’ to determine suitability of the financing source and mechanism does not have potential to make a big difference. Applying cascade approach to every project posed to the World Bank will lead to considerable delay. We should be careful in applying this approach especially to social sector projects.”

What is worrying is that the lessons of 2007 and earlier crises are being forgotten as soon as the first signs of economic growth are visible in the Western economies.

The above article was originally published in Mint newspaper and can also be read here

Globalization: Much Needed, Yet So Treacherous

The unravelling of the quarter-century-old global economic order will have many effects, some unpredictable but mostly unavoidable

Developments in Germany have surprised those rejoicing defeats of Marine Le Pen and Geert Wilders. Alternative for Germany (AfD) has won 13% of votes and is Bundestag’s third largest party; significantly, it’s the first time since World War II that a far-right, nationalist party has done this well. AfD will surely want to add momentum to this regained arc of history by chipping away at the economic and social policies that we now take for granted. They are no longer at the gate; they are just one step away from the round table.

It’s not happening in Germany alone. The assault on the established order has begun even in the US and UK, with policies now resolutely inward-looking. The global right wants to fashion many changes, including the framework upon which the current idea of globalization is draped. Politician Shashi Tharoor writes in his Project Syndicate column that the backlash against globalization will be felt on both cultural and economic fronts. The unravelling of the quarter-century-old global economic order will have many effects, some unpredictable but mostly unavoidable.

India’s version of the new world order is still work-in-progress, though early signs indicate a somewhat dichotomous character. India’s social and diplomatic policies are making a departure from the past, including moving away from their pluralistic, cosmopolitan and multicultural moorings. The resistance to Rohingya migrants—including hapless children, women and the elderly—under the implausible and untenable pretext of pre-empting Islamic terrorism is an example.

But, conversely, the current administration’s economic policies endorse the late 20th century world order, which includes an openness to financial globalization and a dogged belief in an economic orthodoxy that has been discarded elsewhere. Ironically, financial globalization—especially portfolio flows—is like the two-faced Janus: much needed yet so treacherous.

McKinsey Global Institute’s report, “The New Dynamics Of Financial Globalization”, sees a return to a “more stable, more risk-sensitive era of financial globalization” though manifold risks remain. India has been a beneficiary of global capital flows. Since opening up to foreign portfolio flows in 1992-93, India has received net inflows of Rs12.6 trillion, of which 32% was invested in debt instruments. In the first five months of 2017-18 (till 15 October), while equities saw net outflows of Rs7,054 crore, debt instruments received Rs1.11 trillion. This could be the fabled chink.

The first warning comes from Mervyn King, a former Bank of England governor and vocal supporter of Aston Villa football club. Writing in The Wall Street Journal, King warns of a “bumpy decade ahead” because of over-borrowing and the spectre of rising interest rates in the developed economies leading to a rash of defaults. This doomsday prediction might resonate with India’s twin balance-sheet problem (over-leveraged companies and contaminated banks). The Reserve Bank of India (RBI) is under pressure to cut interest rates, not raise them. Assuming the RBI does slash rates, the slightest disruption in the global economy could still spell trouble, given Indian corporate and financial sector’s over-reliance on foreign capital.

The second alert comes from Deutsche Bank’s chillingly titled report, “The Next Financial Crisis”. It shows how the frequency of financial crises has increased after the Bretton Woods system broke down in the early 1970s, especially since it allowed nations to issue fiat currency without any disciplining restraint. The report lists 11 probable sources for the next crisis, which include central bank unwinding, escalation of global imbalances or Italy going bust. In short, the report states that the current global economy is “particularly prone to a cycle of booms, busts, heavy intervention, recovery and the cycle starting again...there will likely be another financial crisis/shock pretty soon with their frequency continuing to be high until we create a more stable global financial framework.”

Christine Lagarde, managing director of International Monetary Fund, provides the third cautionary note, saying that balance sheet unwinding by Western central banks, particularly the Fed, could lead to capital outflows from emerging economies and the ensuing volatility could even spill over into the domestic economy. She advocates gradualism and increased communication between central banks.

The fourth arrow comes from the bow of Jerome H. Powell, a member of Federal Reserve System’s board of governors. Like his predecessors, Powell reiterates that adverse consequences from central bank unwinding will be felt only by emerging economies with fundamental vulnerabilities, thus absolving Fed of fomenting global instability. While admitting that emerging economies are better placed this time to manage outcomes, he says significant risks remain. Powell cites research that puts emerging markets’, including the Indian, corporate sector debt at vulnerable levels; any interest rate increase, accompanied by earnings drop and exchange rate volatility can create “unpredictable and outsized” surprises.

So, while growth in the US and Europe is still gradual, Indian policy managers need to urgently put some risk mitigation measures in place. An obvious one is to immediately recapitalize public sector banks. The second is to actively catalyse investment: waiting for miracles to happen while drawing up a 10-point programme is so 42 years old.

The above article was originally published in Mint newspaper and can be read here