CAMBRIDGE – Something happened in late August that I never thought I would see in my lifetime. A leading policymaker in the Anglo-American empire of finance actually came out in support of a Tobin tax – a global tax on financial transactions.

The official in question was Adair Turner, the head of the United Kingdom Financial Services Authority, the country’s chief financial regulator.

Turner, voicing his concerns about the size of the financial sector and its frequently obscene levels of compensation, said he thought a global tax on financial transactions might help curb both.

Such a statement would have been unthinkable in the years before the sub-prime mortgage meltdown. Now, however, it is an indication of how much things have changed.

The idea of such a tax was first floated in the 1970’s by James Tobin, the Nobel laureate economist, who famously called for "throwing some sand in the wheels of international finance.” Tobin was concerned about excessive fluctuations in exchange rates.

He argued that taxing short-term movements of money in and out of different currencies would curb speculation and create some maneuvering room for domestic macroeconomic management.

The idea has since become a cause-célèbre for a wide range of non-governmental organizations and advocacy groups that see in it the double virtue of cutting finance down to size and raising a big chunk of revenue for favored causes –foreign aid, vaccines, green technologies, you name it. It has also been endorsed by some French (predictably!) and other continental European leaders.

But, until Turner mentioned the idea, you would not have been able to identify a single major policymaker from the United States or the UK, the world’s two leading centers of global finance, with anything nice to say about it.

The beauty of a Tobin tax is that it would discourage short-term speculation without having much adverse effect on long-term international investment decisions.

Consider, for example, a tax of 0.25% applied to all cross-border financial transactions. Such a tax would instantaneously kill the intra-day trading that takes place in pursuit of profit margins much smaller than this, as well as the longer-term trades designed to exploit minute differentials across markets.

Economic activity of this kind is of doubtful social value, yet it eats up real resources in terms of human talent, computing power, and debt. So we should not mourn the demise of such trading practices. 

Meanwhile, investors with longer time horizons going after significant returns would not be much deterred by the tax.

So capital would still move in the right direction over the longer term. Nor would a Tobin tax stand in the way of financial markets punishing governments that grossly mismanage their economies.

Moreover, it is undeniable that such a tax would raise a great deal of money. Revenue estimates for a small tax on international currency transactions run into hundreds of billions of dollars per year.

The receipts would be even greater if the base is extended, as was implied by Turner, to all global financial transactions. Whatever the precise amount, it is safe to say that the numbers in question are huge – larger than, say, foreign-aid flows or any reasonable assessment of the gains from completing the Doha Round of trade negotiations.

Predictably, Turner came in for severe criticism from City of London bankers and the British Treasury. Much of that criticism misses the mark.

A Tobin tax would raise the cost of short-term finance, some argued, somehow missing the point that this is in fact the very purpose of a Tobin tax.

Others argued that such a tax fails to target the underlying incentive problems in financial markets, as if we had an effective, well-proven alternative to achieve that end.

It would threaten the role of London as a financial center, some complained, as if the proposal was meant to apply just in London and not globally.

It can easily be evaded by relying on offshore banking centers, some pointed out, as if not all financial regulations face that very same challenge.

In any case, as Dean Baker of the Center for Economic and Policy Research in Washington observed, there are many imaginative ways in which a Tobin tax could be made harder to dodge.

Suppose, he argues, that we give finance workers who turn in their cheating bosses 10% of the receipts that the government collects. That would be quite an incentive for self-monitoring.

What the Tobin tax does not do is help with longer-term misalignments in financial markets. Such a tax would not have prevented the US-China trade imbalance. Neither would it have stopped the global saving glut from turning into a ticking time bomb for the world economy.

It would not have protected European and other nations from becoming awash in toxic mortgage assets exported from the US. And it would not dissuade governments intent on pursuing unsustainable monetary and fiscal policies financed by external borrowing.

For all of these problems we will need other macroeconomic and financial remedies. But a Tobin tax is a good place to start if we want to send a strong message about the social value of the casino known as global finance.

Dani Rodrik, Professor of Political Economy at Harvard University’s John F. Kennedy School of Government, is the first recipient of the Social Science Research Council’s Albert O. Hirschman Prize.

His latest book is One Economics, Many Recipes: Globalization, Institutions, and Economic Growth.

Copyright: Project Syndicate, 2009.
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