Gaps and holes (crosspost from Crooked Timber)

Press coverage massive leak of papers from hitherto unheard of (by me, at any rate) Panama law firm Mossack Fonseca has, unsurprisingly, focused on the world leaders, celebrities and fixers whose financial affairs have been revealed in an unflattering light. As regards the financial system as a whole, the New York Times draws a fairly typical conclusion

Above all, the Panama Papers reveal an industry that flourishes in the gaps and holes of international finance.

Really? This description suggests that those involved are obscure minor players in the system, of the sort who might be expected to deal with dodgy law firms in tax havens. The real business of global finance is undertaking by upstanding financial institutions with transparent practices.

But writing this down is enough to see that it is silly. As usual in such cases, we find familiar names: HSBC, UBS, Credit Suisse,and RBS and so on. And of course this is just one firm in one tax haven. The absence of major American banks reflects, in large measure, the fact that they prefer tax havens other than Panama, where there is a high degree of US state countrol.

Again as usual, the line is that this is all in the past, and that the banks have cleaned up their act. But the criminal charges keep on coming. This is scarcely surprising when no major bank has been shut down, even for the most egregious wrongdoing, and where only a handful of bank employees have faced jail time over frauds that total well into the hundreds of billions.

As I’ve argued in the past, activities like tax avoidance/evasion and regulatory arbitrage aren’t peripheral flaws in a financial system primarily concerned with the efficient global allocation of capital. They are the core business, without which the profits of the global financial sector would be a tiny fraction of the $1 trillion or so now reaped annually. The burden of supporting this financial sector is a major factor in the secular stagnation now evident in most developed economies.[^1]

The financial globalization that began in the 1970s has not produced an efficient global financial market with a few gaps and holes. The gaps and holes are the market.

[^1]:Since it’s bound to be raised, the costs of financial globalisation to the developed world can’t be offset by considering rapid growth in China and India. These countries have, until recently, maintained tightly regulated financial systems, and have had plenty of criticism for it. Of course, that has resulted in plenty of corruption and misallocation of capital, but the sector simply hasn’t been enough to produce a large drag on growth. That’s clearly changed, in China at least, so it will be interesting to watch the consequences.

31 thoughts on “Gaps and holes (crosspost from Crooked Timber)

  1. A few days before the Panama Papers leaks hit the headlines, the smh in conjunction with the Haffington Post published information on Unaoil, a Monaco based company, which ‘facilitates’ direct investment. This material was leaked to investigative journalists at the smh.

    Today the smh published something on links discovered between Unaoil and Mossack Fonseca, and, of course, donations to political parties, real estate ownership, private jets, etc.

    No matter which article I read, in the English as well as German (Sueddeutsche) press, the authors are at pains to point out that it is not illegal per se to establish a company in a low or no tax juristictions (tax havens).

    Well yes, I can think of enterprises that supply goods or buy goods and even some services (eg insurance) to have a subsidiary in the ‘tax havens’. All these activities would be trade related multinationals [1]. However, I can’t think of one ‘legitimate’ subsidiary that physically fits into a post office box.

    Michael West, smh, who works with Prof Knapp, UNSW, has written reports on specific companies which, when I translate the information into a physical context and take it to the logical limit, amounts to saying that the balance sheets of multinationals are split such that Accounts Receivables are ‘located’ in country A while Accounts Payables are ‘located in country B with a finance subsidiary located somewhere, say C, which has the role of balancing the books in both locations.

    More regulation is easier said than done if effectiveness is an objective.

    [1] In contrast to a lot of international trade theory, in reality international trade involves ‘producers’ – firms, companies, corporations, or at least a contract between 1 person in ‘country A’ and 1 person in ‘country B’ and an enterprise (producer) to shift stuff from A to B. Electronic transfers not excluded. The role of a ‘producer’ is easily seen if one takes the definition of a commodity in Arrow-Debreu seriously. International trade is therefore motivated by profits and constrained, if at all, by asymmetric information among producers and legislation. It is not governed by ‘comparative advantage’ as portrayed in textbooks. One arrives at a model of partially segmented economy with multinational producers by taking another bit of real life into account, namely that consumers (including shareholders) also have bounded rationality regarding the ‘global set’ of commodities. The welfare outcomes are different from international trade models if one allows for at least 3 ‘countries’. Even under ‘competitive’ conditions, wealth transfers among segments of ‘consumers’ are not only possible but difficult to exclude. These are the elements of my theoretical model of a partially segmented economy with multinational corporations (PhD, published in 1988). Of course the described structure is also possible within one geo-politically defined Country. The difference is that governments within a Country can redistribute wealth, while this cannot be done by one country in the international context.

  2. Major nations (USA and UK for example) must want tax havens to continue. If they didn’t then they would invade them tomorrow and blow up all the local infrastructure supporting tax haven operations and kill any people they felt like killing along the way. This would not be the most cost effective or moral method of course but when has that stopped this method of international relations? Alternatively, they could cut all cable and data communications to such countries. Finally, they could ensure the hitting of a few electronic switches in SWIFT and other international payment networks to shut down the whole off-shore haven network.

    The fact that none of these expedients are used indicates that they have not the least interest in stopping the phenomenon. It clearly serves the purposes of the global elites (distributed and connected as they are through corporations and governments ).

  3. Hungary is an interesting example in the sense that the Panama Papers reveal one socialist politician and one extreme right wing politician. [Source, Sueddeutsche Zeitung]

    As at present, Putin does not seem to be in a hurry to pull the plug on electronic transfers of documents, including those with monetary values in them.

    Hidden monetary values are ultimately of no use. The question of how much of these numbers are converted into real estate, housing as well as shopping centres, retirement homes, private-public partnership infrastructure projects, etc. and political party donations in countries considered politically stable is one that will or could keep many people busy for a long time when trying to get answers.

    In the meantime first home buyers and renters are facing a hard time in London, Sydney, and, of late, even in Berlin.

  4. Commensurate pain means a proportionate response. I do not advocate anything disproportionate. Forms of proportionate response can be transmitted by peaceful protests and peaceful non-compliance.

    Come on Ikon! What is a proportionate response to a system that callously causes homelessness? I would think logically it would be the, how to say this nicely, the rapid removal of the dwellings of those driving the policies that cause homelessness. A match and an accelerant should do the job.

    Not, of course, that I recommend such things. I’m just looking logically at what would be a proportionate response – not necessarily recommending such a response.

  5. @John Brookes

    You have given the answer in a sense: “a system that callously causes homelessness”. I don’t like blaming individuals for systemic issues. To some extent, that principle must goes upwards as well as downwards… but not all the way upwards.

  6. Not to worry – the Banking and Finance Oath has only been in a few years and it already has a few hundred takers ( in a sector of a few hundred thousand). One of the 10 dot points of the B&F is : “I will speak out against wrongdoing and support others who do the same”. But it is still the case that only would be martyrs whistle blow.
    As one famously said ” If you are thinking of blowing the whistle, you might find it easier to just go outside and shoot yourself.”

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