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| Indira Rajaraman: Lessons for the G20 | | The first and the most robust lesson is that no single institutional support system is guaranteed to work everywhere |
| Indira Rajaraman / Jul 03, 2010, 00:02 IST |
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There is a dreaded spectre among the G20 today. It is the letter W. Not pronounced Dubya, it stands for double-dip recession. The reach of this fear has shaped the kinder, gentler treatment given to BP for what has to be one of the greatest environmental crimes of all time.
At a conference held in Ottawa at the North-South Institute a few weeks before the G20 summit, an attempt was made to gather together lessons from individual country experiences, in terms of regulatory strengths that lend resilience and reduce vulnerability to negative external shocks.
The first and the most robust lesson of the deliberations was that no single institutional support system is guaranteed to work everywhere. Just a week after the conference, the new government in the UK fulfilled a campaign promise and restored the task of overseeing the regulation of banks, building societies and insurance companies to the Bank of England. The FSA, the independent unified financial services regulator created 13 years ago, was excoriated as an experiment responsible for “the most spectacular regulatory failure”.
In complete contrast to the UK experience, Canada ascribes its own remarkable resilience to the Office of the Superintendent of Financial Institutions (OSFI), an independent and unified regulator. Although OSFI in its present unified form dates back only to 1987, the much longer history in Canada of independent regulation of banks and other financial entities might have been what made the difference. Paradoxically, the move towards independent bank regulation was the result of bank failures in the 1920s, and again in the 1980s. The prudential norms of OSFI as the home country regulator are among the reasons why Canadian banks, despite being heavily internationalised, remained relatively immune to practices in risky host countries like the US. In a globalised world, a country goes blindly with global fashions only at its own peril. This is an uncomfortable lesson for some market-thumping fundamentalists, but it needs to be driven home.
The second robust lesson is that asset market regulation matters critically. The Canadian market for asset-based securities was so comprehensively regulated that there was no scope for the kind of toxic build-up in the US. The governor of the Bank of England now chairs a new financial policy committee with a broad mandate to stop the “dangerous build-up of credit or asset bubbles”. Quite a change from the days when central banks were advised to keep to their knitting, and not look at asset markets.
An asset build-up in India was expertly steered away by the Reserve Bank (RBI) in the years just before the great crash, at a time when it was still deeply unfashionable for central banks to meddle in asset markets. The document Guidelines on Securitisation of Standard Assets, issued by RBI on February 1, 2006, has become rightly renowned in central banking circles for its definitional clarity with respect to the various types of securitisation exposures for originating banks, and the prudential capital required in respect of each. The Indian asset bubble was thus contained at an early stage.
In terms of developments currently under way, there is a discernible move to appropriate rents for the exchequer to fend off “W” while still rolling back some of the fiscal loosening of the past two years. The leader is Australia, which unveiled a draft for a Resource Super Profits Tax (RSPT) on May 2, a surprise move in a country which was actually relatively unscathed by the crisis. A tax on economic rent, defined as the excess of total sale value over the sum of the supply prices of all inputs going into that sale, does not distort production or investment decisions and, therefore, enjoys the support of economists on efficiency grounds, quite independently of distributional considerations. Clearly, the RSPT will encounter fierce opposition from mining interests, but as world growth gets under way, the price pressure on resources will increase, as will the pressure to appropriate those profits for the state exchequer.
In most countries, minerals are owned by the state, which issues a licence for their extraction. The state is thus fully justified in appropriating the rent from the activity. At the same time, rent extraction for the exchequer must not be so predatory as to deny to the mine developer a fair return on exploration and development of the mine (what Alfred Marshall termed quasi-rent).
The detail and technical design of the RSPT are yet to be developed through consultation over the months to come before July 1, 2012, the date set for its introduction. The new levy will accompany a phased reduction in the corporate tax rate to 28 per cent, along with a promise of infrastructure development by the state in the resources sector. The skeleton parameters suggested for the RSPT in the May draft are a 40 per cent tax on super profits from all mineral resource extraction, defined as post-tax returns in excess of the yield on 10-year government bonds.
The search is on for levies on other unearned economic rents. The British one-time windfall levy of 50 per cent on bank bonuses in excess of £25,000 enjoyed wide public support and earned the exchequer £2.5 billion. However, the bank levy imposed by the new government on June 22 is not on windfalls. It is more designed to discourage short-term risky borrowing by banks, relative to customer deposits or longer-term debt. Levies of this kind, if successful in the behavioural change targeted, will not yield much revenue.
There remains a need for big non-distortionary revenues that will close the fiscal gap while still staving off “W”. It now appears likely that a financial transactions tax, at a small rate on currency transactions estimated at $3.5 trillion a day, will actually be implemented. First proposed by James Tobin in 1972, its revenue-generating and volatility-dampening properties now appear likely to win the day.
The author is honorary visiting professor, Indian Statistical Institute, Delhi
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