By Heikki Patomäki
Network Institute for Global Democratization2002
Whereas classical economics was the ideology of the British Empire, neoclassical economics is the ideology of the new empire of globalisation. Neo-classical economics is based on a set of relatively simple assumptions. All economic developments can be analysed in terms of supply and demand in markets. The standard axiom of the orthodox economics is that prices, which are freely determined in open markets, ensure optimally the reconciliation of supply and demand. The technical term to describe this reconciliation is "equilibrium", which is derived from Newtonian mechanics. The claim is that equilibrium in open, free markets also maximises economic efficiency and overall welfare of society, conceived simply as a sum of hedonistic individuals trying to maximise their utility and consumption.
OECD's study "Exchange market volatility and securities transaction taxes" is based on this theory and ideology. When applied to financial markets, neoclassical economics assumes that (i) that financial markets are determined by circumstances in non-financial markets (labour, production, consumption etc.), i.e. that markets for credit, stocks and currencies correctly reflect developments elsewhere; and (ii) that financial markets and other markets are in a simultaneous 'equilibrium', or are determined by an immanent equilibrium. However, in some contexts, "noise trading" can cause over-reactions and thereby "overshooting" of market prices. Although in general efficient and well functioning, financial markets may sometimes cause occasional disturbances as well.
The opening lines of the OECD study are: "Foreign exchange markets are essential to the functioning of the international economy. However, they sometimes appear to be excessively volatile and occasionally their movements have been disruptive." Particular consideration is given to the potential effects of the Tobin tax. However, all the subsequent points against the currency transactions tax are based on concepts and distinctions derived from neoclassical economics.
For instance, it is argued that a "Tobin tax" penalises high-frequency trading without discriminating between trades which "help to anchor markets by providing liquidity and information" and those that can be characterized as "de-stabilising noise-trading". How is this distinction made? The neo-classical idea is that liquidity trading is rational and will therefore enhance the efficiency of the markets, whereas some trading can be characterized as mere "noise" in the otherwise efficient markets (the term "noise" refers to the statistical sense of "arbitrary"). Critically, the distinction presupposes the notion of Pareto-efficient equilibrium, against which is measured whether trading is rational or just "noise". The notion of "effective equilibrium" is a purely theoretical notion, in fact imaginary. The equilibrium theorists themselves do not themselves know what "effective equilibrium" would designate in the real world (outside the fictitious models).
It is also a typical assumption of neo-classical economics that (the imaginary) "efficient equilibrium" between participants in a given market would enhance the efficiency of the economy as a whole. Thus the effects of the Tobin tax can be analysed merely in terms of cost-effects to the participants in the forex markets. In this regard, the OECD report claims, the evidence is mixed. "If a Tobin tax were to reduce volatility, the price of hedging instruments might decline significantly." On the other hand, "on the cost side, volatility could rise rather than fall, because of an indirect effect on liquidity, and the "Tobin tax" could hit particularly hard at those trades that enable low-cost hedging to take place". Again, the con-argument relies on the notion of "liquidity-trading", derived from the concept of "efficient equilibrium".
And so it goes, on and on. For instance, many of the subsequent arguments presuppose the neo-classical assumption that, in general, markets for credit, stocks and currencies correctly reflect developments elsewhere, i.e. they respond to changes in "economic fundamentals". The OECD study admits that "volatility in foreign exchange markets at monthly frequencies cannot easily be explained by looking at movements of what are thought to be underlying economic fundamentals". What is important, however, is how this problem is conceptualised. On the grounds that the available evidence is not "conclusive" (as if it ever could be!), a series of ad hoc hypotheses along orthodox lines are put forward. Most importantly, the OECD study suggests a distinction between public and private information as a potential explanation for the correlation between the volume of trading and volatility. "It appears that a sizeable part of volatility is associated with private information, but this does not necessarily imply that such information is not related to fundamental developments." The study does not argue that this "private information" would be related to economic fundamentals, but the quoted is sentence is meant to reassure the readers that it might as well be. As true believers in the orthodoxy, the standard readers of OECD studies might well be inclined to take the point seriously.
Do not believe in the economic orthodoxy. The whole edifice of neo-classical economics is - to paraphrase Immanuel Kant - like "Swift 's house, whose architect built it so perfectly in accordance with all the laws of equilibrium that as soon as a sparrow lit on it, it fell in". In fact, it has already fallen in many times over. Many economists have themselves shown that virtually every assumption of this construction is untenable. It would require critical social scientific studies to explain how and why the neo-classical economists have nonetheless been able to continue as if the critique had never been made.
Quite apart from the plausibility of the assumption that society consists of a sum of hedonistic individuals trying to maximise their utility and consumption, nothing in the theories of neo-classical economics really works. The standard representations of supply and demand curve are false and misleading. Consequently, prices set by "open free markets" do not maximise welfare. Also the assumptions behind the "efficient financial markets hypothesis" cannot possibly hold. Because financial actors are trading in open systems, they can't possibly have identical and accurate expectations of the future. Yet, this is precisely the assumption that grounds the notion of rational trading leading to an "efficient equilibrium".
And as said, the notion of equilibrium itself is unreal. It does not refer to anything in the real world. Even as a theoretical construction, it is deeply flawed. Even if there was a unique Pareto-optimal equilibrium in a given market, neoclassical models would have nothing to say about how to get there. Besides, if an acceptable specification of a market allows for one specification, it typically allows of many. Even if the specification of the market was based on realistic assumptions, any of these equilibria was Pareto-optimal, and there was a clearly specified way of getting there (none of these conditions is usually fulfilled, and perhaps cannot be fulfilled), the models would say nothing about whether "efficiency" in this narrow sense in the financial markets would actually enhance the efficiency of the economy as a whole.
Since Veblen and Keynes, heterodox economists have claimed that credit and secondary financial markets are partially autonomous and in no way synchronised with other markets. Moreover, if left to develop freely, finance can assume power over the way the capitalist market economy works and develops. Indeed, it seems that the world economy has been, again since the 1970s, increasingly dominated by 'mighty finance', haute finance, which is co-determining its own values and also has the power to shape many other processes as well. We should ask: what kinds of mechanisms or causal complexes are producing financial (in)stability and occasional crises? Do financial instability and crises have real causal consequences to the way capitalist market economies work? We should follow this up by asking: what is the power of financial actors to transform socio-economic worlds, also to their own benefit? What is the structural power of finance over, say, states ' economic policies? Moreover, what are potential feedback loops to the reproduction and transformation of those structures that tend to produce instability and crises?
These are among the questions that neo-classical economics cannot even raise. Yet these should be among the key questions in any adequate assessment of the desirability of measures such as the currency transactions tax. Following Keynes, Tobin originally argued that over-liquid and "efficient" finance is tantamount to short-termism and thus irrational investments. This leads to the lack of states' autonomy in determining economic policy and to general misallocation of resources. Thus the need to "throw sand in the wheels of finance". However, the argument against the power of short-term financial flows can be generalised, to cover also the transformative capacity of global finance more generally. Because of global interdependencies, financial fluctuations have far-reaching consequences to the lives of those who neither benefit from financial activities nor have any say on the decisions and developments suddenly hampering their lives. In other words, the millions bearing the consequences of recurring financial crises seem to get a punishment without committing a crime. Many (or even most) of those few causally responsible are rescued or bailed out, that is, they do not seem to get a punishment even when they fail. To the contrary, they can continue to enjoy their privileges. The principle of "individual profits, socialised risks" is not fair in the sense of equal treatment. From this perspective, a tax would weaken these dependencies and reduce the risks of crises. Moreover, incomes could be transferred from the "speculators" to improving the conditions of those actually or potentially afflicted by the global casino.
A more general argument from justice would start from the claim that global financial markets are co-responsible for widening global disparities. This is as unnecessary as it is unjustified. On the basis of real and causally efficacious (inter)dependencies, it is also possible to posit generalised - even if contested - guidelines of distributive justice on a global scale. There must be also a commitment to transform the characters and powers of agents, and the structure of institutions, in order to reduce powerlessness and vulnerability. From this perspective, the Tobin tax is an important step towards more just practices of global governance. The Tobin tax would yield revenues from the financial actors operating in the forex markets and generate public funds, which can be used to benefit also the less well-off.
Alternatively, an argument for the Tobin tax may also start from the shared ideal of democracy. In fact, some of the above arguments can be easily translated into an argument for democracy. For instance, Tobin' s defence of the autonomy of national economic policies is an argument for democratic self-determination of economic policies (within the confines of a nation-state). Similarly, if the main worry is that those whose lives are transformed by the consequences of financial outcomes do not have a say on financial developments, the argument is really about democratic self-determination of citizens in an interdependent world. Democratisation also concerns empowerment of the powerless, to realise equal, practically effective - although not necessarily actualised - rights of every person to take part in collective self-determination. Attempts to tackle global power relations give rise to novel questions about democracy. Whether acknowledged or not, the Tobin tax seems to open up a discussion about global democracy, too.
Perhaps most generally, the case for the Tobin tax can also be made in terms of human emancipation. The doctrines claiming that current institutional arrangements in global finance are natural and "optimally efficient" are false. Yet these misconceptions are necessary for the reproduction of the financial practices and related power relations. Because of their false underpinnings, these practices and relations should be changed. Although not a panacea to all ills caused by the global financial markets, the Tobin tax would bring about some of the desired or needed outcomes. Hence, the Tobin tax can be said to constitute a step of emancipation in the sense of "the transition from an unwanted, unnecessary and oppressive situation to a wanted and/or needed and empowering or more flourishing situation".
In sum, the problem with the OECD's study "Exchange market volatility and securities transaction taxes" is not only that many if not most of its arguments presuppose false theoretical constructions. Equally importantly, the problem is that it conceptualises the currency transactions tax as an issue of economic efficiency only. Many other very important values are at stake, including relations of power, autonomy, democracy, justice and human emancipation.
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