Making a world fit for inclusive development

Development Policy01 Jul 2013David Woodward

As I hope I demonstrated in my previous blog in this series, it is quite possible to envisage a set of policies and structures in developing countries which could allow the prospect of poverty eradication in a meaningful sense within a generation. But no country, least of all the poorest, where the need for inclusive development is greatest has complete autonomy in economic policy. Following such a path therefore requires changes at the global level as well as (and to a great extent as a precondition for) changes at the national level, to establish a global economic system which permits, fosters and promotes inclusive and sustainable rather than obstructing it.

There are many aspects to this – ensuring the policy space to allow appropriate policies free from the inhibitions of aid conditionality and trade agreements; favourable access to international markets for exports and financing for productive investment; stability of the international financial system and mechanisms to avoid or limit adverse effects of debt and financial crises; access to technologies necessary to development, etc, etc. But clearly a comprehensive blueprint for a development-friendly global economy is beyond the scope of a 700-word blog. This article therefore focuses on the issue highlighted at the end of my previous blog – that of ensuring sufficient resources for public expenditure.

The serious shortcomings of the international tax system (or rather the absence of one) have finally made their way onto the official agenda, and even the latest G8 communiqué, largely thanks to the sterling work of the Tax Justice Network. But the issues go far beyond the questions of transparency and banking secrecy acknowledged by the G8. Of critical importance is transfer price manipulation: different parts of the same company selling each other goods and services at artificially high or low prices so that profits appear to accrue in the country with the most favourable tax regime (often, though not necessarily, a tax haven). Mechanisms to ensure that prices in such trade (which is estimated to account for around 40% of all world trade) reflect the actual value of goods are thus essential.

The global mobility of capital also limits the tax rates that countries can impose on financial savings – and this is made worse by the existence of tax havens offering near-zero tax rates. Since most financial wealth is by definition held by the rich, while the main assets of the poor – labour (and to a lesser extent land) – are much less mobile, the result is to shift the burden of taxation onto those least able to pay, while also limiting public revenues. The only ways of dealing with this problem would seem to be more effective controls on capital movements and/or establishing a global minimum for tax rates on financial assets. (The former would have the added advantage of inhibiting large-scale corruption, by making it more difficult to conceal the proceeds. There is also some evidence that capital controls limited the impact of the 1997 Asian financial crisis and its aftermath in countries such as Malaysia, China and Chile.)

Competition for foreign direct investment has a similar effect. Increasing reliance on such investment (and arguably an unrealistic optimism about its developmental benefits) has led many developing country governments to offer preferential tax rates or tax holidays, and direct or indirect subsidies (eg provision of infrastructure primarily benefiting the investor) in order to attract transnational companies to locate operations in their country rather than elsewhere. The result is to bid away a major part of the potential developmental benefits.

This problem might be less serious in a development model which relied more on domestic than on foreign investment; but again some degree of coordination, including clear rules against preferential tax treatment or direct or indirect subsidies, could be very beneficial. Given the importance of foreign investment in extractive industries in many low-income countries, and of royalties from such investment as a source of public revenue, greater coordination – or ideally some form of collective bargaining – on contracts could also provide substantial benefits.

However, most low-income countries will continue to be heavily dependent on aid for the foreseeable future. Not only are aid budgets critically dependent on political sentiment and financial conditions in donor countries, but the aid provided to particular countries is often highly variable and unpredictable, subject to direct or indirect conditionality, may be tied to procurement from the donor country, and (for some donors more than others) is oriented more towards the financial, commercial and geopolitical interests of the donor than to the actual needs of the recipient.

There would thus be a strong case for moving away from a system in which the amounts and uses of aid are entirely at the discretion of the donor towards a multilateral system in which North-South transfers are made automatically from funds generated by taxes raised at the global level (for example on financial transactions, international travel, carbon emissions, etc), and mediated by an international body. However, it would be essential that such a body was governed by democratic principles (and not “economically-weighted” voting systems such as those of the IMF and World Bank), operated with full transparency, and was fully accountable (ideally to Parliaments rather than governments).

A particularly beneficial use of the resources so raised (in terms of the development model outlined in my previous blog) would be to fund the development and application of renewable energy technologies in rural areas in developing countries. By turning the enormous potential demand for rural electrification into effective demand (backed by financial resources) for micro-renewable technologies, it would be possible both to accelerate the product cycle, rapidly lowering costs through learning effects and economies of scale, while also promoting the development of technologies better suited to local conditions by shifting the focus of demand from North to South.

Clearly, this is an ambitious global agenda – and also tackling the other issues mentioned above would make it more so. But without changes on this scale, we will have little hope of attaining the global goals proposed by the UN High-Level Panel on the Post-2015 Development Agenda. Without real democratic reform of the whole system of global economic governance, we will have little prospect of achieving either.