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Illicit Financial Flows and the Three Ts of the G8 Agenda – Alex Cobham
00:22:46
The day before we recorded this Wonkcast news broke of an agreement between the United Kingdom, France, Germany, Italy, and Spain to pilot “multilateral automatic tax information exchange.” My guest, research fellow Alex Cobham, explains...
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- [00:10]
A
Welcome to the Global Prosperity walkcast. I'm Lawrence MacDonald and I'm pleased to have me in the studio today. Visiting from London, Alex Cobham. He's a research fellow, newly affiliated with the center for Global Development and he's leading a new area of work for us on illicit financial flows, effective taxation for development and inequality. Alex, welcome to the show.
- [00:31]
B
Thanks a lot. It's great to be here.
- [00:32]
A
It's been a real treat for me to have you here because I've been, you know, we've spoken by phone and I've seen some of your work from afar. But to have you here at a time when the topics that you work on are suddenly much more in the news has been really exciting. And I'm hoping that in our chat today we can unpack some of them for I should say that you know what's in the news internationally or at least in the UK with David Cameron saying that the G8 is going to focus on the three T's, tax, trade and transparency. I gather people noticed that in the uk. I can't say that there was a whole lot of attention to that here in Washington.
- [01:11]
B
Well, give it time. This is coming, right? You know, this is an agenda that's been growing in development. I've been working on this for about 10 years. It's never been more live than it is now, but that's partly because it's becoming more and more of a live political issue in OECD countries, countries like the US as well.
- [01:27]
A
Can you give me an example of why this might matter for a developing country?
- [01:32]
B
Yeah. So a bit of work I did for a World bank report last year was looking at Zambia. Now, Zambia is a country that's just graduating to middle income status. Something like 80% of people probably still living on less than $2 a day. Zambia relies on copper as its main export, most of its economic activity. If in 2008 Zambia had received the price for its copper that Switzerland declared on exporting exactly the same copper, unprocessed, then Zambia's GDP would have nearly doubled. So the economic impact, if we're able to sort out trade prices and the implied pattern of tax, is potentially enormous.
- [02:20]
A
Wait a minute. Switzerland exports Zambian raw copper? It can't make sense to ship raw copper from Zambia to Zurich and then ship it out again.
- [02:30]
B
Indeed, Switzerland is a commodities hub, but it's also landlocked and an extremely expensive country to get anything to or from. So in fact, most of this stuff and certainly almost the entirety of the Zambian copper that allegedly goes to Switzerland, never, in fact, goes anywhere near Switzerland. It's just recorded in that way. What that means is it's even harder for anybody in Zambia to hold the companies, or indeed their government, to account for whether the right price is being paid, whether Zambia is getting the benefit that it should do from its own resources.
- [03:01]
A
So the copper is initially sold, what, by a parastatal or a private company? Doesn't matter, by whoever produces it. They sell it to a company in Switzerland at a price that is about half of the world price, and then that company turns around and sells it again without ever having laid its hands on it or done anything to it.
- [03:19]
B
Well, in a great many cases, in fact, in Zambia's case, it's actually Zambian subsidiaries of Swiss companies, so that it's trade that's happening between subsidiaries of the same Swiss company, which again adds another layer of opacity. But look, since the new government came in, in Zambia, they've actually required that prices declared at customs can't vary a great deal from the world price, which is great. And yet they're still not getting an enormous amount of, in particular, corporate tax revenue. That's because out of all of the mine companies operating in Zambia, I think only two have declared a profit in the last two years. This is at a time of copper prices being absolutely booming, you know, the highest they've ever been. If those companies aren't making a profit now, there is simply no reason for them to exist, to be in Zambia at all. So something is still not right here. We're still seeing manipulations that are costing Zambia revenue.
- [04:20]
A
So help me out here. It seems like there might be two problems here. One, if you're only getting half of the real price, is a loss of foreign exchange earnings to the country, and the other is the loss of taxes on those earnings. Those are separate problems, Is that right?
- [04:37]
B
That's right, that's right. No, and what you find is that there's, you know, two issues here that kind of underlie those. One is about the way that multinational companies are able to more or less choose where they're going to allocate their profits and therefore where they'll pay tax. And the other is with less reputable companies where they're able to use a lack of transparency, particularly anonymity of company ownership, to do even more abusive things, more corrupt practices.
- [05:07]
A
So this is Zambia, you know, it is, after all, an African country. One expects a certain amount of skullduggery if one believes in stereotypes. Is this an exception or is this an example of something that is widespread all around the world.
- [05:20]
B
Well, that's what we're seeing now. And that's why this will be, I think, rising up the media agenda in the United States as it is across Europe. Increasingly the same problems, problems of tax haven secrecy, of anonymous company ownership are being seen to really be exacerbating the fiscal pressures that are facing rich countries. And that's why we're starting to see greater interest in this. It's not just a development issue, it's an issue for all of us. And I think we're going to see real progress over the next year or so.
- [05:53]
A
We're going to take our first break. When we come back, I'm going to ask you if it's possible to put a number on the size of this problem. This is the Global Prosperity Wonkast from the center for Global development. I'm Lawrence McDonald speaking with Alex Coban, research fellow here at CGD, based in our Europe office in London. We'll be back in a bit.
- [06:21]
C
Hi, I'm Alex Gordon and I produce CGD's weekly Wantcast. Did you know CGD sends out 10 different E newsletters? To sign up for our weekly development update or topic specific newsletters, just visit cgdev.org and click on subscribe.
- [06:43]
A
Welcome back to the Global Prosperity Wonkast. Alex, when we initiated this area of work, in fact when we set out to recruit you, our colleague Owen Barter said there's a huge amount of advocacy around this. There's lots of concern and attention. There's clearly a problem, but there's very little solid research. To the extent that there is solid research, I suspect that you've done quite a lot of it and probably read the rest of it. Is there any credible number around this in terms of share of global GDP or billions or trillions of dollars? What are we talking about here?
- [07:18]
B
Well, it's a difficult area because by definition you are trying to estimate the size of something which is deliberately hidden. So all estimates need to be treated with a certain amount of caution. But I think there is a broad consensus now that for developing countries, the illicit hidden outflows are something in the range of 8 to $10 for every $1 of aid money that's received. So purely thinking about scale, this is very large. What we then need to think about is the impacts of that in terms of economic growth, of governance, standards and corruption and so on. And that's where it really starts to look like a major obstacle to development.
- [07:57]
A
Eight to ten dollars of illicit of Basically lost benefits for every dollar of eight, if one, then maybe to draw this as a pretty simple caricature, a lot of these transactions are facilitated by places like Switzerland and various offshore island havens that are under the direct jurisdiction of countries like the United States and the uk. So we're facilitating this pillaging of the developing world to the tune of eight to ten dollars for every meager dollar of aid we provide back. So have I oversimplified? Is that a reasonable way to describe this?
- [08:33]
B
No, I think that's a pretty good characterization of the situation, really. You know, if you look back 30, 40, 50 years, you see the UK in particular thinking that these small islands are potentially going to be a drag on UK revenues, and that by giving them this tax haven path of development, they have some way forward where they're going to become financially independent and also channel a bit of money through the City of London, which is thought to be a good thing.
- [09:02]
A
A bit of money. It turns out it's billions and trillions of dollars, probably.
- [09:05]
B
And that's part of the problem here. It turns out, actually it's a very large amount of money. The City of London, in some ways is quite dependent now on those flows. So for the UK to start pushing for greater transparency, perhaps putting some of those flows at risk is potentially a little bit worrying for the uk. You can see something similar with India and Mauritius, where a situation has arisen. An enormous amount of investment comes into India through Mauritius, or in China's case, through the British Virgin Islands. If they were to shut that down, the risk is that they'd see a collapse in, for example, in their stock markets, even though most of that money is coming actually from India or from China, and so would, eventually, you'd expect, be invested there.
- [09:48]
A
Anyway, this brings me to the question I asked you yesterday. You said that David Cameron is reluctantly leading this, and having watched the real difficulties here, I would say pretty much total failure following the financial crisis of Congress to bring Wall street to heel. These are massively powerful interests. If you set out to discipline the financial sector and you're a reluct, and the financial sector is a fierce fighter for its interests, it seems like it's pretty clear who's going to win. You can't win against these interests if you're reluctant to take them on, or even, indeed if you're determined to take them on.
- [10:29]
B
Well, I think that's why this is an exciting moment in history. You know, I think there's an alignment of interest that for the first time, actually makes it possible that we'll see real progress. You know, we've always heard two arguments about why you can't do the kind of things that we'd like to see happen in terms of greater transparency. The first is that if you act unilaterally, you risk your own competitive position. The second is that it's simply impossible to get everyone to work together. What we're seeing now, a combination of it being very well recognized in developing countries that this is a problem and rich countries increasingly feeling fiscal pressure themselves. You're seeing a combination of interest there that actually does, for the first time, have the potential to overcome all of the interest on the other side of this.
- [11:19]
A
We'll take our second break. When we come back, I'm going to share with you my pessimistic outlook on the US version of this and ask you to venture into that territory and try and persuade me I'm wrong. This is the Global Prosperity Wonkcast from the center for Global Development. I'm speaking with Alex Cobham about tax transparency and trade, the 3T agenda of David Cameron in the G8 and whether or not it can lead to real change. We'll be back in a bit.
- [11:57]
C
Hi.
- [11:57]
A
Hi.
- [11:57]
C
I'm Alex Gordon, based in Washington and interested in development policy. If you don't already receive invitations to our lively events, you'll want to sign up@cgdev.org.
- [12:11]
A
Welcome back to the Global Prosperity Wellcast. Alex, you know way more about this than I ever will and indeed more than I think you know the vast majority of people who've even thought about it. So I'm pleased that you're feeling optimistic. But when I look at the US context here, it's hard to see how we could get a political consensus to strengthen taxation on anything.
- [12:34]
B
Well, there's a couple of reasons, even within the US context, I think, to be quite optimistic. One of them is about the US role at the G8 later this year, and perhaps we could talk about that in a minute. But the other is what the US has already done in this area. Now, even if we think there isn't political support to address this as a development issue, and in addition, there isn't political support to address this as an issue beyond the impact it has for US revenues, there has already been significant progress made purely for that last reason. Because of the fiscal pressure, the US has pursued the Foreign Accounts Tax Compliance Act, a unilateral measure which some people thought was pretty unhelpful that they weren't taking part in a multilateral process. But what that's done for the first time is use the US power to force even big secrecy jurisdictions like Switzerland to have to agree a certain amount of automatic exchange of tax information. And it's the automatic nature of the exchange that really makes a difference. We've had exchange on request, as the OECD says, for many years, which in practice has meant very little exchange, if any. What this will now do is force not only Switzerland, but a lot of the UK territories like Jersey and Guernsey to exchange information automatically with the US and then it becomes extremely difficult, and we're already seeing this, for those same jurisdictions to say no to exchanging the same kind of information with the UK with other European countries. So we've seen yesterday the uk, France, Germany, Italy and Spain agree to pilot between them effectively a multilateral factor. And the question is how quickly and how far that can be expanded. It will certainly cover some of the difficult jurisdictions in Europe. Whether we can help it to expand to developing countries is the real question. And that's what we need to be focusing on.
- [14:37]
A
This seems like it touches, and I should mention you've done two terrific blog post. You've really hit the ground running. One, Render unto Caesar, which is essentially about the taxation issue that we've been discussing. The other with the wonderful short title Horse or Beef. And I should say the rest, why we should know who owns companies and what the G8 can do. Seems like that gets into the question you just discussed of this automatic exchange of information. In a highly globalized world, it becomes increasingly difficult to say that Google generated this profit here and that profit there and to tax them separately. So I guess the solution is something that's called unitary taxation. You figure out how much Google earned globally and then the jurisdictions squabble over how to divide it up. Is that the new vision of global taxation?
- [15:23]
B
I mean, that's very much the direction that I think we're going in. And the OECD has been charged by the G8 to do a bit of work on that. Looking at why the current rules around transfer pricing, which is the means of effectively pricing trade between subsidiaries of the same multinational company, which has a big impact on where the profit ends up being declared. So they're looking at that again to see if it makes sense. And actually, you know, this is in the context of really public outrage, I think it's fair to say, over the way that Google, Amazon, Starbucks, other major companies with a very high public profile are being seen to have paid very little tax in countries like the uk where they do an enormous amount of business. And this applies to the US too. So for US based multinational companies, nearly half of their total profit ends up being declared in five jurisdictions only, including Bermuda and Switzerland. So there is again a real interest for rich countries as well as developing countries in looking at these rules and getting something a bit more sensible that just says we will divide the global profit according to where you actually did your economic activity.
- [16:35]
A
You know, it's interesting, you've mentioned Google, Starbucks and Amazon. And I'm putting myself in the shoes of a UK citizen and thinking these big bad American corporations, but if I put myself in the shoes of an American, it's like, well, these are household names and these are brands that were very proud of, you know, they astride the world like a colossus and they were invented right here at home and some of our friends work for them. So there's a sort of a nationalistic piece to this. I think if we were talking about maybe, you know, Honda and Mitsubishi and Samsung, maybe it would feel different.
- [17:11]
B
Yeah, no, I can see that. And you know, for the US based companies, it's long been an effective, although little stated, part of US policy to allow them what in effect is a tax subsidy. By operating largely through these offshore jurisdictions and not paying a lot of tax in the U.S. i think in this moment in time, when there's such a great fiscal pressure, there's a little more interest in wondering whether the US is really getting value for that. If this isn't in fact rather unpatriotic of these companies to be acting in this way at a time when the country clearly needs, needs revenue.
- [17:48]
A
I want to ask you to throw us forward. What are you going to be doing next? You've done so much since you arrived here. You've educated me and a lot of other people about this issue. You have both the research agenda and the sort of engagement, just basically reporting and analysis of this story that's unfolding very rapidly. What's next in your work?
- [18:09]
B
Look on the research side, I think, you know, this is a great time for CGD to be getting into this area. We need to look across the range of estimates that have been made, the kind of big numbers that are out there, and do a, you know, a slightly critical piece looking at them, saying, how good are these numbers? How much can we rely on these? Not with a view to producing our own big numbers, but starting to get more into the detail of those relationships, thinking about the bilateral relationships in particular between different types of developing countries and different types of secrecy jurisdictions. So one Question I'm really keen to look at. To give you an example, we know that continual attempts in research have failed to find systematic economic growth benefits for developing countries from foreign direct investment. And yet instinctively, I think a great many of us feel that those benefits must be there. So the question is somehow that we're not looking at the question, the issue in the right way. What I'm keen to look at is look bilaterally and say, is it the case that when foreign direct investment comes into a developing country through a more transparent jurisdiction that we can find growth benefits, but when it's coming through one of the most secretive jurisdictions, perhaps a Jersey or a Switzerland, then it's associated with so much secrecy, so much in the way of problems of governance, that it's actually not surprising we don't see growth benefits. And that would have, you know, an immediate policy agenda for developing countries to say this is the type of foreign investment that we should really be prioritizing because this we know, has benefits.
- [19:42]
A
Is there a piece of big data in this? There's a lot of excitement around the idea that we now have the ability to crunch these huge data sets, whether they be geospatial or consumer generated data. Does this apply to the financial data as well?
- [19:55]
B
It really does, and I'm delighted you asked that question. You know, this is an area in which there's a great deal of data on bilateral stocks and flows between different countries and yet a good part of that is not publicly available. In addition, there's an area of data which is not collected but could be collected. And if that was all made available, we'd be in a completely different position. So what we're thinking about is whether there's a way to get people who are concerned about this from the development side with the kind of people like central banks and financial regulators, you know, who have really seen the cost of not having that information as the crisis has developed. Trying to get those interests together to have some kind of initiative to get to a completely different level of transparency about exactly that sort of information.
- [20:43]
A
Well, Alex, it's been a real pleasure talking with you. I'm delighted to have you as a colleague. Welcome to the center for Global Development and I look forward to chatting with you about your work again on the Wonk Cast before long.
- [20:55]
B
Great, thanks.
- [20:56]
A
This has been the Global Prosperity Wonkast from the center for Global Development. My guest today, Alex Cobham and we've been talking about Transparency and Taxation, two of the three T's in David Cameron's Three T's Agenda for the G8. You can find the Wonk cast online on itunes and on Stitcher. Just search for wonkcast or CGD and subscribe to hear a new interview every week. Until next time, I'm Lawrence MacDonald. Thanks for listening.