The fall and rise of the global economy

John Quiggin

ALTHOUGH there are many different concepts and theories of globalisation, the rapid growth of international financial markets plays a central role in nearly all of them. Most commonly, it is argued that this growth has resulted from the technological progress which permits transfers of large sums of money between countries, thereby rendering national boundaries irrelevant. Hence, most supporters of globalisation (and many opponents) see the globalisation debate as a struggle between nostalgic attachments to the obsolescent nation-state and the technological forces which are creating 'one world, ready or not'.

The central argument of this chapter is that this description is misleading. Technological changes are of little importance in explaining financial globalisation. Rather, the growth of international financial markets is the result of the policy decisions (or, sometimes, non-decisions) that led to the 'deregulation' of global capital flows. The removal of government controls entailed a range of changes in policy designed to create an environment that would be viewed favourably by the owners of globally mobile capital, including anti-strike laws, favoured tax treatment for capital, and so on. In other words, the 'deregulation' package as a whole can be just as validly described as the 're-regulation' of the economy in the interests of global capital.

According to this view, the processes referred to as 'globalisation' are the result of choices made by societies and governments. In macroeconomic terms, they are the result of the particular choices made by national governments within the longstanding policy context known as the 'impossible trinity': a government cannot simultaneously pursue an independent macroeconomic policy, maintain a fixed currency exchange rate, and allow free international capital movements. Over the last two centuries, governments have responded to this dilemma in very different ways. The economy of the 19th century, like that of the late 20th century, was one of unrestricted capital movements and tight constraints on macroeconomic policies. By contrast, during the long postwar boom - the so-called 'Keynesian' era - governments restricted capital movements in order to give themselves the macroeconomic policy independence that was required to maintain full employment.

It follows that the main issues at stake in the globalisation debate are neither technology nor a question of nationalism or internationalism. Rather, the fundamental question is whether the world economy will be controlled by the individual and collective actions of governments, as it was during the postwar boom, or by capital markets, as it was in the 19th century. Framed in this way, the debate over globalisation is simply an extension, to the international stage, of the debate between the defenders of the social-democratic welfare state associated with John Maynard Keynes and the advocates of free markets. Indeed, the arguments for and against allowing free movement of international capital are much the same as those for and against the deregulation of domestic markets.

To illustrate the issues, this chapter begins with an account of the way in which the free market economy of the 19th century failed and was replaced by the social-democratic welfare state during the long postwar boom, which was, in turn, challenged by the processes now commonly referred to as globalisation. We will then discuss the relationship between globalisation, technology, internationalism and free market reforms. The chapter concludes with an assessment of the constraints facing governments in the world of free capital flows and the options that are available to reimpose some degree of social control.

The fall and rise of the global economy

Much of the discussion of globalisation, particularly from the mouths of right-wing advocates of globalisation, is based on the assumption that we are dealing with a wholly new phenomenon, to which the old responses of the social-democratic welfare state are simply inappropriate. In his book, Civilising Global Capital: New Thinking for Australian Labor, Mark Latham, for example, contrasts the task of the 19th century labour movement, which, he argued was to civilise national capital, with his proposed 'Third Way', which, he argued, is to civilise global capital.1 The problem with this analysis is that the 19th century was also an era of global capitalism. The progressive social reforms that aimed to 'civilise capital' during the 20th century rested on an assertion of state control over the economy, including over previously unrestricted global capital movements. Conversely, the resurgence of global capital has, since the 1970s, been closely entwined with the retreat of the social-democratic welfare state.

There is little value in disputes over whether the economy of today is more or less globalised than that of the 1890s, since different measures give different results. On many measures, the world economy was more integrated before 1914 than it is today. There were few restrictions on the movement of goods, labour or capital. In particular, 19th century colonies such as those in Australia and the newly independent nations of Latin America, were more reliant on overseas investment than developing countries are today, and the free international movement of labour was an outstanding feature of the late 19th century. Surprisingly, few advocates of globalisation favour a return to unrestricted migration. On the other hand, the global integration of manufacturing was less advanced in the 19th century than it is today. But these are differences of degree. The important point is that before 1914, national economies were, as they are now, significantly constrained by the demands of global markets, albeit in different ways. What is crucial to realise, though, is that the process of globalisation went into reverse for most of the 20th century. To understand why, we must examine the global economic institutions of the 19th century and the way in which they broke down.

The central institution of the 19th century global financial system was the gold standard. Currencies were freely convertible into gold at fixed rates, and the exchange rate between any two currencies was simply the ratio of their values in gold. Gold was, in effect, a global currency, and exchange rates were fixed. There were no central banks in the modern sense, although the (private) Bank of England played a crucial, and quasi-official, role in the British market, which was at the core of the system, and similar banks played a central role in other countries. The interest rate policy of the Bank of England and of major banks in other countries was the main mechanism by which the system adjusted.

The adjustment mechanism worked as follows. If a country's income fell because exports declined or investors wished to withdraw their capital, gold stocks would run down. Banks would then raise interest rates until they could attract sufficient deposits of gold to meet the demand. The increase in interest rates would depress economic activity and lead to deflation; that is, a reduction in the general level of prices and wages. With fixed exchange rates, deflation made exporting progressively more attractive and importing less attractive, until the initial shock was counterbalanced and equilibrium was restored at a new, lower price level.2

Although this 'specie flow mechanism' sustained the system of fixed exchange rates, it did not work particularly well. Deflation is generally a painful process, involving long periods of high unemployment. Fixed exchange rates and free movements of capital (in the form of gold) were achieved at the cost of cycles of booms and busts, about which governments could do nothing. This is an example of the 'impossible trinity'. It is impossible to have fixed currency exchange rates, free capital movement and independent domestic macroeconomic policies. But by sacrificing any one element of the trinity, it is possible to have the other two.3 Another critical feature of the gold standard economy was the central role of business confidence. Because of the economic and social costs of responding to an outflow of capital, governments had to do their best to ensure they did not occur, which meant doing nothing that could be seen to threaten the interests of the owners of capital. The system offered few intermediate positions between complete conformity with the policy program that was regarded as 'sound' by financial markets, and the extreme alternative of repudiating debt.

The integrated gold based world economy was broken up by the Great War. After the war, a number of countries - notably the United Kingdom - made strenuous attempts to re-establish the system with prewar parities, but the resulting deflation caused high levels of unemployment throughout the 1920s. The gold standard was finally abandoned during the Great Depression, a decision accompanied by greatly increased tariff barriers. By the end of the Second World War, international movements of capital and goods were rigidly controlled.

After the war, the victorious allies interpreted the Depression as a major factor in the rise of Hitler, and sought to establish an international financial system under which it could not recur. Meeting in 1944 at Bretton Woods (in New Hampshire, United States), the Allies agreed to establish a new international financial system. The object was to control capital flows in a way which would allow for both fixed exchange rates and sufficient domestic economic policy freedom to permit the maintenance of full employment. The idea was to expand trade in goods while also ensuring that fluctuations in exchange markets did not create the kind of massive instability that had occurred in the Great Depression. Tariff barriers were reduced, but tight restrictions on capital movement were retained. The Bretton Woods meetings established two international institutions which, it was hoped, would provide a framework for international capital flows that could capture the benefits to be gained from borrowing and lending, but avoid the instability associated with uncontrolled financial markets: the International Monetary Fund (IMF) and the International Bank for Reconstruction and Development (now the World Bank). The IMF was to provide short-term assistance to countries experiencing balance-of-payments problems. The World Bank was to provide long-term finance for development projects.

The Bretton Woods system was an instance of 'internationalisation', as opposed to 'globalisation'. The 'beggar thy neighbour' tariff policies of the interwar era - a failed response to the breakdown of the uncontrolled global economy - were replaced with a set of policies and institutions designed to foster co-operation between nations. The US dollar played a central role in the system, being convertible into gold at a fixed rate of $35 per ounce. As long as other countries maintained fixed exchange rates with the US dollar, their currencies were effectively pegged to gold. From 1945 to the end of the 1960s, the Bretton Woods system functioned effectively in most developed countries, in association with Keynesian macroeconomic policies. The period from 1945 to 1970 was unparalleled in the history of capitalism in terms of achieving full employment and rapid economic growth in the developed countries.

The Bretton Woods system came under increasing strain from two main sources. The first was the rise of inflation rates in most developed countries. Sustained inflation undermined both the international role of the US dollar as a reserve currency pegged to gold and the Keynesian system of domestic economic management. The second source of strain was the gradual relaxation of the tight restrictions on international capital movements in many countries. Moreover, acting from a variety of motives, governments acquiesced in the development of a 'Eurodollar' market: that is, trading in financial instruments denominated in US dollars, but operating in European centres outside the control of the US Federal Reserve. The inflationary surge associated with the financing of the Vietnam War would have eventually forced the convertibility of the US dollar into gold to be abandoned. The process was accelerated, however, by the increased capacity of participants in international financial markets to speculate against currencies which were seen as being overvalued.

In 1971, gold convertibility was abandoned. The result was the rapid deregulation of international capital markets, which enhanced pressure for the deregulation of domestic capital markets and the consequent re-regulation of all forms of government activity to meet the demands of national and international capital. With the inflationary boom and slump of the early 1970s, the Bretton Woods system of fixed exchange rates was completely abandoned. This episode is often referred to as the 'OPEC oil shock'. Yet an inflationary surge leading to a boom in commodity prices was well under way by the time the Organisation of Petroleum Exporting Countries (OPEC) raised oil prices in October 1973. The oil shock was a consequence, not a cause, of the breakdown of the Bretton Woods system.

The move to floating exchange rates was associated with a reaction against Keynesianism. The standard Keynesian framework offered no prescription for a combination of inflation and unemployment. The briefly fashionable monetarist approach, advocated most effectively by Milton Friedman, appeared to offer a solution which could work well in the context of floating exchange rates. In terms of the 'impossible trinity', Friedman argued that the exchange rate could be left to the market, which would eliminate any unsustainable deficits or surpluses by bidding exchange rates up or down. Hence, governments could allow free flows of capital and still pursue independent macroeconomic policies. Friedman favoured a policy of fixing the growth of the money supply at a level consistent with moderate inflation. In the event, these policies never worked well and they were quickly abandoned, but their passing popularity dislodged Keynesianism, and it never regained its former dominant position. Most countries have now moved to a system that may be referred to as 'monetary activism', a system where interest rates are adjusted by central banks to stabilise the economy, with a heavy emphasis on controlling inflation and only modest use of fiscal (taxation and spending) policy.

The breakdown of the Bretton Woods system and the abandonment of Keynesian macroeconomic policy contributed to a more general turn toward free market policies. Belief in the effectiveness of government intervention per se was generally undermined by the mid-70s macroeconomic failures, and support for free market policies grew. Moreover, rising unemployment and declining rates of economic growth produced what has been called 'the fiscal crisis of the state'. This refers to the incapacity of governments to meet the obligations associated with expanding the provision of health, education and welfare services (see Chapters 11,12 and 13) without raising taxes beyond a level that individual taxpayers and, more seriously, owners of global capital are willing to accept.

Technology, internationalism and free market reform

The rate of growth in world trade declined after 1970. Unfortunately, the rate of growth in world output declined even more. As a result, trade in goods and services continued to grow faster than world output as a whole. This fact, along with the rise of manufacturing industry in East and South-East Asia, is commonly cited as evidence of increasing globalisation. The recent popularity of the term 'globalisation', however, primarily reflects the growth of international capital markets. We will now measure the growth in capital markets, assess the role of technological change, and consider globalisation's relationship to internationalism and free market reforms.

The aggregate value of internationally traded financial instruments is now 100 times the value of imports and exports, and the ratio is growing. The massive growth is predominantly due to growth in short-term transactions, which have been facilitated by improvements in computing and communication technologies and the development of new financial instruments, generically described as 'derivatives'. On the other hand, the volume of long-term international capital flows is still smaller compared to world output than it was at the turn of the century. Thus the main difference between the globalised economy of today and that of the 19th century is the greatly increased volume of short-term financial transactions relative to the 'real' flows of goods, services and long-term investment. According to the Bank of International Settlements, in the United States, for example, the ratio of cross-border financial transactions to real GDP rose from 9 per cent in 1980 to 135 per cent in 1995.4

The great increase in both the number and value of transactions is commonly claimed to be the inevitable result of technological change and, in particular, the striking innovations in computing and telecommunications since the 1970s. Claims of this kind are often connected with a more general argument that the technologies are associated with the development of a flexible 'New Economy', which will be characterised by rapid growth and the end of the 'boom-bust' business cycle. For a more balanced perspective, it is important to make two observations.

Firstly, while the developments in computer technology are impressive, the productivity improvements they have generated have proved disappointingly hard to measure, and they must be set against a slowdown in technological progress for the economy as a whole. For a long time, researchers have insisted that the gains must be there, but were unable to find them. More recently there has been increasing scepticism, although the Internet boom led to a renewed general suspension of disbelief in the United States; this is likely to be sustained as stock prices fall. In the context of the globalisation debate, the slowdown in technical progress in transportation is particularly noteworthy. Although incremental improvements have continued in all transport areas, there have been no fundamental innovations in the last few decades (also see Chapter 3).

Secondly, the recent improvements in communications are merely a continuation of a long-term trend (see Chapter 4). For most of the 20th century, the cost of telecommunications services declined at a real rate of 4-5 per cent per year. For long-distance services, the decline was even more rapid - around 10 per cent per year. Over a period of 100 years, the compound effect of these declines yields a reduction in costs by a factor of one million or more.5 Yet, as far as long-term financial transactions are concerned, the innovations of the 20th century are not particularly important. An order to buy or sell assets worth billions of dollars can be transmitted just as effectively in a 15-word telegram as in a 15-minute telephone conversation, even though the bandwidth requirements differ by a factor of one million. Instantaneous communication within and between developed countries has been available since the 19th century (see Chapters 4 and 5). Computers and telecommunications have permitted an increase in the complexity of financial transactions, but they have not fundamentally changed the situation. The increase in financial 'churning', as measured by the ratio of the volume of financial transactions to the volume of real transactions, has been widely noted with respect to international markets. It is important to observe, however, that a similarly massive increase in churning has taken place in domestic financial markets, such as stock markets.

As with technologically driven explanations, the frequent depiction of globalisation as a debate between nostalgic advocates of nationalism and progressive supporters of internationalism is also a misleading view. Most supporters of globalisation do not want an end to national boundaries by increasing international co-operation. Rather, they want to keep governments and trade unions confined within national boundaries, while allowing capital to move freely around the world. They are opposed to international co-operation, except where it takes the form of governments agreeing not to interfere with the market, as in the General Agreement on Trade and Tariffs (GATT), which is administered by the World Trade Organisation (WTO), or the now aborted Multilateral Agreement on Investment (MAI).

The complexities of the relationship between globalisation and internationalism may be illustrated by the development of the European Community and, particularly, the recent move to the European Monetary Union. Superficially, the integration of the European economies appears to be a prime example of globalisation, in the sense that national boundaries are vanishing. Growth in trade among European countries is a major component of the growth in world trade, which is often referred to as evidence that globalisation is occurring. But since trade between Europe and the rest of the world has grown more slowly than European output, an analysis of world trade which excluded intra-European trade would yield only weak evidence of globalisation. Be this as it may, many advocates of globalisation have been lukewarm at best in their attitude to the European Community. Most notably, British Conservatives like Margaret Thatcher have been openly hostile to European economic integration, even though in other contexts they have relied on arguments about globalisation to prove the need for free market reforms. On the other hand, British unions, which have traditionally been portrayed as narrow-minded and parochial, have supported closer links with Europe. With little prospect of assistance from either Conservatives or New Labour, they have looked to the European Social Charter as the best hope for protecting workers' rights.

These contrasts are even sharper in relation to the European Monetary Union, the process by which a single currency called the 'euro' has replaced most national currencies, with the notable exception of the British Pound.. At one level, the disappearance of national currencies may be seen as an extension of globalisation, with further weakening of national governments. Again, this is an oversimplified view. European Monetary Union has been accompanied by the creation of supranational governing bodies, most notably the European Central Bank. Moreover, by definition, the abolition of currencies implies the abolition of currency traders (one source of British resistance to participation in European Monetary Union). Most importantly, in the absence of variable exchange rates and given a relatively slow movement of labour between different regions of Europe, macroeconomic stabilisation will require active fiscal policies and further harmonising of tax and welfare policies. Implementing these policies will require either the creation of new European institutions or, more probable, an enhancement of the role of existing institutions such as the European Commission and the European Parliament.

The complexity of the debate over European Monetary Union illustrates the point that the discussion of globalisation in terms of the supposed irrelevance of national boundaries misses the point. Throughout the 20th century, the national and international aspects of economic activity have been closely inter-related. The primary issue is not the balance between national and international economic activity, but the balance of power between governments and financial markets at both the national and international levels. In large measure, this simply boils down to an extension of the debate between the defenders of the Keynesian or social-democratic welfare state and the advocates of free market reform. The arguments for allowing free global movement of capital are much the same as the arguments for deregulation of the domestic economy.

The growth of unregulated international capital markets is closely entwined with the shift to free market domestic policies, including privatisation, capital market deregulation and the abandonment of Keynesian macroeconomic management. This is true in two senses. Firstly, the two policy processes have taken place in parallel and have reinforced one another. The Australian Hawke-Keating Labor government's deregulation of international capital flows in 1983, for example, rendered the existing system of domestic financial regulation unsustainable, and facilitated the government's decision to deregulate interest rates and bank lending policies. The need to please international financial markets also encouraged the privatisation of public assets. Privatisation yielded direct income to the financial institutions that managed the public floats and trade sales, and it was interpreted by financial markets as a sign of fiscal rectitude. Secondly, it soon became evident that the prices that could be realised by selling enterprises such as electricity, water and telecommunications services to transnational companies in the same line of business were far higher than under the initially popular method of public floats limited to Australian residents. Hence, even when privatisation was undertaken primarily for domestic reasons, it reinforced financial globalisation. The interaction between financial globalisation and free market reform may be seen as a vicious or virtuous circle, depending on one's political viewpoint. But there can be no doubting that the global mobility of capital has weakened public control over the domestic economy and intensified pressure for free market 'reforms'. These 'reforms' have increased the power of financial markets, which has encouraged the removal of barriers both to capital flows and to the control of economic activity by private transnational corporations (see Chapter 6).

More fundamentally, the claim that globalisation is inevitable and desirable is based on the same arguments which imply that government intervention in the domestic economy is unsustainable and undesirable, even in the absence of that economy's substantial exposure to trade and capital flows. The point may be made most clearly in relation to Keynesian macroeconomic stabilisation policies. Free market critics of Keynesian policy have long argued that stabilisation policies can, at best, produce a short-run improvement in economic outcomes at the cost of a long-run acceleration in inflation. These criticisms are based on the central assumption of neoclassical economics; that is, unregulated markets, including capital markets, are self-stabilising and self-correcting, at least in the long-run. The case for unregulated global flows of goods and capital stands or falls on precisely the same assumption. Consistent advocates of free market policies have always recognised this, arguing that global capital markets merely force governments to face the consequences of their actions. A particularly influential instance of this argument is the claim that the floating of the Australian dollar represented a 'fiscal and monetary discipline' on governments.6

Until recently, the advocates of free market policies have found it convenient to focus on the international dimension of the debate. In the absence of any convincing evidence that their policies have produced tangible benefits, it has been convenient to claim that globalisation is a technologically determined process which makes the triumph of the free market inevitable, a claim summed up by Mrs Thatcher's famous dictum: 'There is no alternative'. The supporters of global financial deregulation claim that 'the market' represent a powerful force confining inherently irresponsible governments to 'sound' financial policies. As the 1997 Asian crisis demonstrated, though, the 'discipline' imposed by international financial markets is, at best, erratic. For most of the 1990s, the 'tiger economies' of Asia could do no wrong. The practice of doing business on the basis of networks of personal connections was hailed as a new and superior form of capitalism. Financial institutions fell over themselves in the rush to capture a share of Asian business. When Thailand's economy ran into difficulties in 1997, the sentiments of financial markets changed dramatically. The Asian way of doing things became 'crony capitalism'. This pattern is becoming more and more widespread. Within months, countries such as Mexico, Indonesia and Brazil went from being seen as shining examples of the benefits of globalisation to being seen as basket cases. Retrospectively, defenders of free capital movements have argued that the crises were all the fault of the governments concerned. Some governments have been blamed for being too attached, or not attached enough, to fixed exchange rates. Others are said to have over regulated their domestic financial systems, or failed to introduce necessary prudential controls.

Stepping back, it is increasingly apparent that free capital movement is part of the problem, not the solution. From the Keynesian viewpoint, there is nothing surprising in this. Working in the largely closed economy of the 1930s, Keynes identified the instability of domestic investment as the main source of boom and bust cycles. It is easy enough to see that in a world of free capital movement, fluctuations in the 'animal spirits' of speculative investors and currency traders will have a similar effect. The experience of the recent damage caused to the world's economy by unrestricted capital movement strongly supports the Keynesian view that a market economy must be stabilised by government intervention, whether this takes place at a national or a supranational level. A more specific problem arises from the fact that, without restrictions, capital will naturally flow where it can secure the highest post-tax returns. Hence, governments are likely to have increasing difficulty levying tax on income from capital. Indeed, they are facing increasing economic and political pressure to compete for global capital flows - pressures that have been reinforced by the examples of some countries, such as Ireland, experiencing considerable success in attracting investments after lowering company tax rates.

Responses to globalisation: Tobin taxes and public capital

Although the capacity of governments to tax income from capital has clearly declined, the difficulties are not as great as some commentators have suggested. Particularly in Europe, moves are now being made to harmonise the rates of tax on income from capital to prevent the competitive bidding down of rates. Moreover, governments still retain the option of taxing the capital income of residents, whether this income is derived from foreign or domestic assets. More broadly, a variety of measures have been proposed, and in some cases implemented, to reduce the volume and volatility of short-term capital flows. Australia's Whitlam government (1972-75) adopted a deposit requirement, under which a proportion of capital inflows had to be lodged with the Reserve Bank for several months. A similar scheme has been in operation in Chile since speculative flows brought about the collapse of its financial system in 1979.

We will now examine a more systematic approach, the proposal by the US Nobel laureate, James Tobin, for a small tax on all financial transactions, a proposal commonly referred to as the 'Tobin tax'. Most proposals for a Tobin tax have been based on the assumption that an international agreement could be reached to levy a tax on financial transactions wherever they take place, and that the resulting revenue could be divided among national governments or paid to the United Nations. Although the prospect of an agreement like this may appear remote, many of the issues that are raised by considering an idealised Tobin tax are relevant in evaluating more limited and practical policy options for controlling financial flows. Initially, however, we will briefly examine the different motives for considering a Tobin tax, which may broadly be classed as macroeconomic, microeconomic and revenue motives.

The main macroeconomic motive for a Tobin tax is the belief that the operations of financial markets unduly constrain macroeconomic policy and represent a source of macroeconomic instability. By reducing the volume of international financial flows, it is hoped that a Tobin tax will reduce two of the adverse influences of financial markets on macroeconomic policy. Firstly, markets place excessive weight on inflation as a policy objective. With the major exception of stocks and instruments based on stock prices, the profitability of the majority of financial instruments depends either on the actual rate of inflation, or on the rate of inflation relative to other countries. To the extent that financial markets are able to direct government policy, they are therefore likely to impose a deflationary bias. A second concern is that the short-term power of financial markets can result in financial crises, even in countries with economic policies that are sustainable in the long term; a decrease in the volume of financial flows would, as a corollary, reduce this power.

The microeconomic reasons for considering a Tobin tax include, firstly, the concern that financial markets appear to increase the risks faced by firms and individuals engaged in economic activity by, for example, increasing the volatility of exchange rates. Secondly, it is widely perceived that the resources consumed in financial markets represent a loss to the economy, and that the rewards earned by market participants are excessive compared with the economic benefits they generate. Thirdly, there is a concern that prudential regulation may be undermined by the availability of risky, large-scale and hard-to-monitor financial instruments. This concern has been heightened by a number of recent financial collapses involving derivatives. A more general concern is that the control exercised by markets over macroeconomic policy may be extended to microeconomic and social policy, 'punishing' governments that pursue, for example, redistributive taxation and welfare policies. In all these cases, it is hoped that a Tobin tax would reduce the damage associated with excessive financial speculation by reducing the volume of financial transactions, and confining the financial sector to a supporting role in facilitating trade and long-term investment.

Finally, a Tobin tax is attractive when considered simply as a potential source of revenue for governments and, possibly, international institutions such as the United Nations. Various estimates suggest that the volume of financial transactions is between 10 and 100 times that of real transactions. As a first approximation, this implies that a Tobin tax could raise between 0.4 and 4 per cent of GDP - in Australia, between $1.5 and $15 billion a year - as the financial sector currently has total resources equal to about 12 per cent of GDP. The latter estimate is almost certainly too high: 4 per cent is implausible in the context of our financial sector, much of which is part of the retail sector (banking, insurance and real estate services for households and small business). Moreover, the volume of financial transactions would shrink if the tax were imposed (this is, of course, a desired outcome). Realistically, it is reasonable to anticipate a revenue yield of between 0.2 and 1 per cent of GDP from the imposition of Tobin tax. For Australia, the corresponding revenue would be between $1 billion and $5 billion a year. A Tobin tax could, therefore, raise significant revenue. Note that this would not represent a solution to the problems associated with the difficulty of taxing mobile capital. The revenue a Tobin tax might yield is much less than the revenue currently raised by taxing capital income, and the existence of a small Tobin tax would not deter owners of capital from moving their capital to countries with low tax rates.

Decisions about the best way in which international financial transactions should be taxed will be influenced by the relative weight one attaches to macroeconomic, microeconomic and revenue objectives. Some advocates of restricting capital flows are primarily concerned with macroeconomic policy, particularly episodes such as the crisis of 1992-93, which led to the partial breakdown of the European Monetary System. They favour a deposit requirement over a transactions tax. A deposit requirement would impose a relatively high effective tax on a relatively narrow range of transactions (for example, it would almost certainly not apply to sales and purchases of shares), and it would bite most severely in periods when exchange rate alignments are under pressure, which results in large flows of short-term capital. By contrast, microeconomic and revenue concerns are best addressed by a broadly based transactions tax levied at relatively low rates, which would avoid the need to distinguish between domestic and international transactions.

The most obvious objection to a transactions tax is that the tax could be avoided or evaded, either by substituting exempt for taxable transactions or by shifting transactions to a financial centre that does not levy the tax. Unless a tax is imposed universally, it is argued, a shift in transactions to financial centres where the tax is not applied would nullify it. This claim appears premature, to say the least. After all, in principle it is already possible to completely avoid income tax by locating all income-generating contracts in jurisdictions that levy no income tax (tax havens). Although in practice considerable tax is already avoided in this fashion, countries nevertheless do succeed in levying income taxes on their residents at widely divergent rates. Moreover, prudential problems, such as those associated with the near collapse in 1997 of the US hedge fund, Long Term Capital Management, can only be managed by imposing a rigid separation between financial institutions that are regulated and protected by central banks and those that are not. Given that the standard objection to a Tobin tax is that it will simply drive speculators offshore, this separation would be an advantage in the context of an internationally supported system of prudential regulation. Countries could choose to operate outside the Tobin tax net and the system of prudential regulation, but only in the knowledge that they would not have access to the IMF if things went wrong. Financial institutions could choose to base themselves in countries operating outside the Tobin tax regime, but they would be unable to borrow from central banks or the institutions operating within their prudential control.7 On the other hand, arguments concerning the possibility of substituting exempt for taxable transactions appear well founded. It would appear that the only feasible approach is to tax all financial transactions, domestic and international, at a common rate. Many countries, including Australia, already tax a range of 'retail' financial transactions, such as bank debits and credits, often at rates higher than those envisaged for a tax on international transactions.

Yet, no matter how compelling the arguments in its favour, there seems little likelihood that a Tobin tax will be adopted in the near future. There is a need, therefore, to focus on other instruments that can be implemented unilaterally, like deposit requirements. Moreover, while instruments such as deposit requirements and Tobin taxes may reduce the magnitude and volatility of short-term capital flows, they can do little to control the long-run movement of capital in search of the highest possible after-tax return. One possible response to this problem is for governments to secure capital income directly through the public ownership of business enterprises. In the absence of effective methods of taxing income derived from private capital, it is necessary to reconsider the traditional case for public ownership, based on the need to redistribute the returns to capital.

The need to capture returns to capital for the benefit of the people as a whole is a central theme in traditional socialist thinking. During the postwar boom it appeared irrelevant, since taxes could be used in place of public ownership. One of the beneficial effects of the debate over public sector 'reform' in Australia after the past decade or so has been the recognition that government business enterprises can, and in general should, generate profits. Although government business enterprises should not pursue profit maximisation as their sole objective, there is no doubt that the profit objective was given insufficient weight in the past. Following Australia's widespread adoption of policies which require government business enterprises to pursue 'commercial' profits, it has been possible to generate returns to capital invested in public enterprises at rates considerably higher than the rate of interest paid on government debt. This implies that, on average, the public receives a greater return when tax revenue is invested in government business enterprises than when it is used to repay public debt. Free market advocates argue that the gap between the government bond rate and the average return to public enterprises reflects the cost to the public of the risk they bear as owners of government business enterprises. All attempts to explain the 'risk premium for equity' as the outcome of efficient capital markets in a neoclassical framework have failed, however.8 It is now widely agreed that the high 'risk premium for equity' is a reflection of the incapacity of private capital markets to spread risk effectively. By contrast, governments can spread risk through the tax system, and therefore we can reap the benefits of the low cost of capital that they enjoy.

The rise of global financial capital thus places the issue of public ownership firmly back on the agenda. It is not surprising that the privatisation of public enterprises is one of the central policies demanded by 'the markets' and their advocates. Conversely, a defence of public ownership should be a central element of any policy aimed at renovating and extending the welfare state. Australian governments are well placed to undertake an expansion of public investment because they have low levels of debt, both by comparison with other countries and relative to the levels that prevailed here for most of the postwar period. Australian tax rates are also low by international standards. Furthermore, because of stringent restrictions on public investment since the 1970s, there are many potentially beneficial investments available in infrastructure. In addition, it would both profitable and desirable to reverse some previous privatisation initiatives, such as the creation of private toll roads and the partial privatisation of Telstra (also see Chapter 4). The combination of a strong fiscal position and the availability of profitable investments means that governments can increase debt levels without facing any significant interest penalty, thus increasing public sector net worth.

Conclusion: Relearning the lesson

The term 'globalisation' obscures as much as it clarifies. This is particularly true when we attempt to understand the breakdown of controls over international capital movement since the end of the Bretton Woods system in the early 1970s. Financial globalisation is not an exogenous technical development which forces governments to adopt free market policies. Rather, it is the international manifestation of the general movement towards free market policies since 1970. It reinforces and is reinforced by domestic free market 'reforms'. The results are comparable with the globalised economy of the 19th century, which was characterised by chronic economic instability. This instability became even worse in the period between the two world wars. The Keynesian and social-democratic reforms that were introduced during and after the World War II reflected the lesson drawn by most observers at the time: namely, an unregulated economy in which investment is driven by private capital markets is inherently unstable, and therefore inefficient. We are relearning that lesson today.

John Quiggin is an Australian Research Council Senior Research Fellow, based at the Australian National University in Canberra and at the Queensland University of Technology.


1. Mark Latham, Civilising Global Capital: New Thinking for Australian Labor, Allen & Unwin, Sydney, 1998.

2. A return to a gold standard is most unlikely. A similar outcome would arise, however, if all countries used a common currency. The world money supply would then be determined by US government policy rather than by the vagaries of the gold mining industry. It is an open question whether this would be an improvement.

3. To say that a country with a floating exchange rate can control capital flows and maintain an independent domestic economic policy does not imply that it is insulated from international pressures. Such pressures are felt through fluctuations in the exchange rate and through shocks to export demand.

4. Bank of International Settlements 66th and 67th Annual Reports (Introduction, p. 10), in Dean Baker, Gerald Epstein and Robert Pollin (eds), Globalisation and Progressive Economic Policy, Cambridge University Press, Cambridge, 1998.

5. For the period since the 1970s, see Alex Arena, John Bahtsevanoglou and Suzanne Branton, "The importance of telecommunications reform", Austel, Occasional paper, Melbourne, 1992.

6. This was the argument used, for example, by the Howard government's Financial System Inquiry ("Wallis Inquiry"), Final Report, AGPS, Canberra, March 1997.

7. A number of perspectives on the Tobin tax are presented in Mahbub ul Haq, Inge Kaul and Isabelle Grunberg (eds), The Tobin Tax: Coping with Financial Volatility, OUP, Oxford, 1996.

8. Narayana Kocherlakota, "The equity premium: It's still a puzzle", Journal of Economic Literature, 34, (1), pp. 42-71.

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