Global Policy Forum

Fair Exchange Could Help Poor Countries Grow


A currency tax could be the best way to raise billions for the UN development goals

By Larry Elliott

February 27, 2006

Something important will happen in Paris tomorrow. Led by France, up to 10 countries will agree to impose a tax on air travel, with the money used to increase spending on overseas aid. Every passenger departing French territory will pay an airline ticket levy (ATL) of between €1 and €40 depending on the destination of the flight and the class of ticket. The amount of money raised will be modest, at least initially. At the best, the levy might raise £600m a year, but that's not really the point. Jacques Chirac believes that if the idea proves workable, a further 20 countries could sign up, making the levy a far more lucrative source of funds.

Chirac's ATL is one of a number of ideas that will float at the two-day innovative financing conference, with Gordon Brown's international finance facility (IFF) also on the table. The disadvantage of the French plan is that the amounts it will raise - even with 30 countries signed up - will be modest in comparison to the sums said to be necessary to meet the United Nation development goals. The G8 is talking about boosting aid spending by just shy of $50bn (£28bn) a year by 2010; the most optimistic estimate of the revenue to be generated by the ATL puts the sum at $5bn annually. On the up side, the ATL has the virtue of simplicity and is a source of genuinely new money.

That may help explain why it has found more international support than the IFF, which is essentially a live-now, pay-later scheme. Brown's idea is that rich country governments float bonds on the financial markets and thereby increase the cash available for overseas development over the next 10 years, when the pressure is on to meet the millennium development goals set by the UN. Britain's idea is to front-load aid spending in the hope that this will provide the springboard for more rapid economic growth. The bonds will have to be repaid out of future aid budgets, but the chancellor believes that by the time the repayments fall due, poor countries will be better able to stand on their own feet.


The refusal of the United States to have anything to do with an IFF means there is no hope of Brown reaching his original goal of $50bn through an IFF, but if Britain and France went ahead it might raise $5bn-plus a year. There is no reason why the ATL and the IFF need to compete. One possibility being canvassed by the Treasury is that the relatively small amounts of cash from the ATL could be used to leverage bigger sums through a bond flotation under IFF. Another form of synergy would be to earmark funds from the ATL to pay back investors in the IFF when the bonds fall due for repayment in 10 or 15 years. This would remove one of the more important objections to the IFF plan - namely that there may still be a need for substantial development assistance after 2015 when aid budgets would have to be spent repaying bondholders.

Ultimately, though, neither the IFF nor the ATL can compete with a third idea - a tax on foreign exchange transactions. This has two big things going for it. The first is that it raises pots of money, even when levied at very low rates. Estimates made by the Stamp Out Poverty campaign group suggest that a 0.005% tax on the world's most traded currencies could generate between $35bn and $40bn a year without really making a dent in banking sector profits.

The second advantage is that, in the post 9/11 world, a tax on forex dealings would be virtually impossible to evade. Such is the paranoia about terrorist financing that the authorities now use the most sophisticated electronic technology to keep tabs on flows of money. Avinash Persaud, chairman of Intelligence Capital, a specialist advisory practice for financial institutions, says that whatever validity the old argument about avoidance of a currency tax used to have, it no longer does.

"Today, concern over settlement risk, money laundering and terrorist financing means that the activities of the banks that represent 90% of foreign exchange turnover is highly regulated. Under existing domestic and international banking regulation, these banks would face enormous regulatory, credit and technology costs if they tried to opt out of the evolving global settlement systems that make this tax easy to collect. In the best tradition of banking, they will pass this cost on to their customers. Would you object to paying an extra penny for every £200 you exchanged at the bureau de change? Compare that with the £8 daily congestion charge in London?"

Persaud adds that the cost wouldn't really register with the big market players unless they were exchanging cash backwards and forwards 50 times a year - which he describes as the "volatility-boosting behaviour we would want to discourage". For the time being, supporters of a stamp duty on foreign currency dealing are keeping their powder dry. They want to show that international cooperation can work in a modest way with the ATL, and then extend the principle to a forex levy for international development. Only when that has been accepted will there be an attempt to use a transaction tax as a market-calming mechanism.


Such a proposal would, of course, be met with ferocious opposition from the global banking industry. Yet, events last week illustrate just how unstable financial markets can be. Iceland is a country that rarely makes the business pages; it has a population of fewer than 300,000 and an economy less than 1% the size of Britain. But when the ratings agency Fitch downgraded Iceland's debt, it sent ripples through the markets.

Hang on, dealers said, didn't the Asian financial crisis of 1997 start with a balance of payments problem in a country that previously had barely blipped on to the radar screen? The lesson of Thailand nine years ago was that the beating of a butterfly's wing can have powerful - and costly - consequences. As a result, traders took one look at what was happening in Iceland and dumped the currencies of other emerging markets - Hungary, Brazil, South Africa.

The caution was explicable and sensible. After all, it was the collapse of a bank in Austria that prompted the worldwide financial panic in 1931. What's less explicable and less sensible is the insouciance with which the financial fraternity shrugs off these scrapes as the necessary price that has to be paid for open global markets.

The technical term for what has been going on in Iceland - and other emerging markets - is a carry trade. Inflation and interest rates are low in the leading industrial nations, and their currencies have been moving in fairly tight ranges. Central bankers tend to like this state of affairs, because it suggests economic stability. Investors don't like it nearly so much, because it means returns are not as big as they would like. So, they have been filling their boots with money borrowed in dollars, yen, Swiss francs and euros (at suitably low rates of interest) and buying assets in countries where interest rates are much higher (including Iceland).

There is a potentially explosive mix here - bubble money and bubble think. Markets have been awash with liquidity and see nothing anomalous about their desire to have - at one and the same time - inflation rising by no more than 2% but the value of assets going up by 10% or more. In the same way that rising household debt in the US is acceptable provided bubble money is pushing up house prices by 15%, so Iceland is a oneoff from which there are no wider lessons to be learned. I bet someone said that about Credit-Anstalt in 1931.



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