Increasingly, the knowledge that is the basis of these competencies is created by and held within a firm; it moves freely within the firm—wherever the firm operates.2 Thus, allowing firms to invest across borders is part of allowing knowledge to move across borders.
Undermining the Rule of Law
Trump has forcefully illustrated the dangers of poorly thought through government interventions affecting cross-border investment. Should American firms be compelled to invest in the United States? There is, of course, the manner in which he attempts to do so—at the threat of an unfavorable tweet or the loss of government contracts. This is deeply disturbing, for it represents an abrogation of the rule of law, which, as I’ve just noted, is part of the foundation of our democracy and is critical to economic growth and well-being.
When a government believes that what individuals or firms are doing is imposing harms on others—when it wants firms or individuals to do something different—it creates incentives, for instance through the tax system, to do what is wanted and not to do what is unwanted; regulations are passed that proscribe antisocial behavior. But to pick on individual firms is the way of despots and demagogues.
Spillovers
An argument can be made that the country benefits from those who invest in the country. In a well-functioning market economy, it is the pursuit of profits that is supposed to incentivize firms to do this, and the private and social returns to investing are supposed to coincide. That this is so is the basic insight of Adam Smith and his “invisible hand theorem,” the idea that firms, in the pursuit of their own self-interest, are led to do what is in the interests of society as if by an invisible hand.
Over the past third of a century, though, we have learned that Smith was often wrong, though many conservatives seem to still be back in the eighteenth century when Smith wrote.3 When firms pollute, for instance, private profits exceed social returns. When there is a high level of unemployment—evidence by itself that markets are not working in the way they should—social returns to job-creating investments exceed private returns. At such times, government should further incentivize investment, through for instance an investment tax credit—an effective reduction in tax liabilities for those firms who engage in job creation. (This is markedly different from an across-the-board tax cut.)4 When unemployment is especially high in a particular region, it may be desirable to provide such incentives targeted to the afflicted locations.
In general, though, it doesn’t make a difference whether the investor is American or foreign—so long as they pay the taxes they should on the profits generated in America. Indeed, to try to force American companies to invest in the United States provides them with an incentive to locate their headquarters abroad; it gives foreign firms, not constrained by the threat of a tweet, an advantage over American firms.
Reciprocity
Trump’s “new protectionist” view of investment, like that of trade, doesn’t ever ask what would happen if others behaved in a way similar to how we do, that is, if they too discouraged their firms from investing abroad. America has a lot of inward investment—some $373 billion in new foreign direct investments in 2016.5 Foreign firms produce in the United States for a variety of reasons; for instance, by producing close to their customers, they reduce transportation costs. If these foreign governments discouraged their firms from investing in America, job creation would slow. In short, just as New Protectionist trade policies lower standards of living, but will not deliver on their promised job creation, so too for New Protectionist investment policies.
Making American Goods Less Competitive
Of course, what Trump is really concerned about is outsourcing, when American firms choose to produce abroad because it’s cheaper to do so. But that means that if American firms were not allowed to outsource, their prices would have to increase; they would be put at a competitive disadvantage. To offset this within the United States, Trump could raise tariffs—violating WTO rules, and subjecting America to costly penalties. But only by providing subsidies could he offset the disadvantages the firms would have in export markets—still another violation of international trade rules. In short, were Trump and other New Protectionists to think through the full consequences of what they are demanding, they would realize that the net result would be exactly the opposite of what they want.6
Short-Term Capital
There is a big difference between the real investment that I’ve just described, and the short-term financial flows that can go in and out of a country in a nanosecond. The free mobility of short-term capital, so loved by American banks, was indeed a source of profits for them; but it was a source of problems for the rest of the world. When money flowed into a country, the country’s exchange rate appreciated, its export businesses found it impossible to compete, and many businesses struggled to compete against cheaper imports. Furthermore, firms couldn’t build factories on the basis of money that was here today but gone tomorrow. And inevitably, that tomorrow came, and as the money flowed out, exchange rates plummeted, countries were thrown into crisis, and economic havoc ensued. Jobs were destroyed as money flowed in; jobs were destroyed as money flowed out. Rather than the win-win situation that the advocates of financial globalization claimed, it was a situation in which the recipients of the short-term flows were almost guaranteed to be worse off.
The East Asia crisis of 1997–98 (see chapter 8), caused by a sudden change in sentiment, a loss of confidence in East Asia, illustrated the dangers. Money had flowed into these countries when it was allowed to do so, in the years before the crisis. But the irrational exuberance turned to fear beginning in May 1997, and capital flowed out. And Korea, Malaysia, Thailand, and Indonesia went into deep crises.
But even advanced countries like the United States and those in Europe are not immune from suffering the vagaries of capital flows. The exchange rate between the dollar and the euro has fluctuated between 1.60 and 1.04 between 2008 and 2016. These fluctuations are not due to sudden changes in differences in inflation or productivity rates; they are due to fickle changes in sentiment in financial markets that lead to changes in financial flows, and those financial flows change the demand for dollars relative to euros—and thus the exchange rate. The pro-globalization mantra is that the market should set the exchange rate. But put yourself in the position of a small firm in Indiana making optical equipment that it exports to Europe. Assume it sets its price in dollars. The price in Europe could go up some 50 percent as a result of this fluctuation in the exchange rate. It would be hard for that small firm to retain its customers, and there is no way it could increase its productivity enough to offset the effect of the exchange rate change.
The speculators and financiers who move massive amounts of money across borders aren’t thinking about this firm and the effects of their actions (via the exchange rate) on it and its workers. They’re only thinking about the short-term profits they make from these speculative moves. These effects are another example of “externalities”—just as, when chasing profits, firms might pollute the air or water and bankers pollute global capital markets with their toxic mortgages, firms that engage in these speculative cross-border activities impose large costs on others, which they don’t take into account.7 And the presence of these large externalities is one of the major costs of unfettered globalization, and provides a rationale for the kinds of intervention I will describe.
Short-Term Capital Encourages Short-Termism and Shortchanges Long-Term Needs
There is another fundamental concern with short-term capital: it encourages short-term thinking, a malady sometimes referred to as short-termism. The managers of most firms, given their short-term tenure (usually around five years), are naturally focused on the performance of the firm over the term in which they hold office. This too gives rise to short-term thinking. “Incentive” compensation schemes have made matters worse. Managers are increasingly rewarded based on how the firm’s stock performs now, and they have learned how shortsighted investors ar
e. An increase in dividends and stock buybacks drives up prices—even if those payments come at the expense of investments in people, technology, and machinery that would have increased long-run profits. And so they ruthlessly pursue the short-run—part of the explanation for the slowing down of economic growth since around 1980.8
At the global level, this short-termism has some major consequences: in the developing world, there is an enormous need for long-term investments. Around the world, there is a large supply of long-term savings by individuals and institutions (such as sovereign wealth funds and pension funds) focusing not on tomorrow, but on the world decades into the future. Yet sitting between the two, supposedly “intermediating,” that is, matching suppliers of funds with demanders, are short-term financial markets. No wonder the global economy is not functioning as well as it should.9
Rewriting the Rules of the Market Economy through Investment Agreements
Accompanying the increase in cross-border investment and capital flows has been a growth in investment agreements, agreements between countries about how investors from abroad are to be treated. Investment agreements were “sold” based on the idea that they were just protecting against the nationalization of assets—and such protection was a win-win: the investor gained, but the increased investor confidence that ensued meant that the developing country also gained.10 Such claims, like so many others, were at best deceptive—and more accurately, just lies, not even the kind of white lies that were used to push trade globalization.11 Furthermore, these agreements weren’t even necessary—if expropriation was really what they were about: the World Bank and most governments provide insurance to investors against the risk of expropriation.12
The defenders of investment agreements respond by suggesting another justification: the agreements prevent discrimination against foreign investors. But if that were the case, the agreements could simply say that foreign investors would get “national treatment,” which means being treated neither better nor worse than domestic firms. Instead, most investment agreements go much further than that; they give foreign firms the right to sue the government if the government passes a regulation that has an adverse effect on the profits of the firm—no matter how justified the regulation. Foreign firms are treated more favorably than domestic firms!
Thus, in a famous case, Philip Morris, the cigarette manufacturer, sued Uruguay in 2010 because the country passed a regulation which required the company to disclose possible harmful effects of cigarettes on health.13 The regulation had the effect that the government desired—smoking was reduced. But this meant Philip Morris’s profits decreased, and it responded by suing—in private arbitration where it appointed one of the three judges (and the judge it appointed had a crucial role in the appointment of a second judge). The arbitration is biased toward corporations. And it is very expensive. In the Uruguay case, the judges themselves got paid hundreds of thousands of dollars, and the costs to Uruguay were $7 million.14 Uruguay eventually won the case and those costs were eventually paid by Philip Morris, as part of the judgment. But the South American country might not have been able to prevail without outside financial help during the arbitration: New York City mayor Michael Bloomberg and other wealthy Americans helped the country defend itself.
Canada has lost multiple such investor-state suits and settled others under NAFTA, mostly over the environment. Other countries have been sued under a variety of investment agreements with similar provisions over matters ranging from the minimum wage to restricting toxic waste dumps to affirmative action statutes attempting to attain racial and social justice.
The intent of these investment agreements is clearly not to prevent discrimination against foreign corporations. They are really an attempt by corporations to write the rules of the economic game in their favor through trade agreements negotiated behind closed doors, with corporate interests at the table, in ways that would not pass muster in an ordinary legislative process. In particular, their intent is to discourage governments from taking actions like passing regulations that would hurt corporate profits, period.15 There is no weighing of costs and benefits—the costs to society, for instance, of asbestos or smoking. It is a totally one-sided calculus. These provisions have profound consequences. In the absence of these provisions, if a company, like the manufacturer of asbestos or cigarettes, sells a product that imposes damages on others, it can be sued. There is, for instance, in the area of the environment the principle of “polluters pay”—polluters have to pay for the damage they inflict on the environment. These investment agreements reverse this: with these provisions, if government passes a new regulation because there has been a discovery that a product causes harm to health or the environment, the firm sues the government to recover its lost profits. Such agreements embrace a principle that profits are as important as lives, and even if the regulation saves lives, the firm must be compensated for its lost profits.16 (Well, one might ask, why do countries agree to these deals? The agreements are typically negotiated in secret, so ordinary citizens don’t have a chance to express their views as the agreements get developed—and then they’re confronted with a take-it-or-leave-it proposition. The United States threatens loss of assistance or other retaliatory measures if the agreement is not signed. And ever-hopeful citizens center their attention on promises of jobs and investment—typically never even noting detailed provisions such as those under discussion here.)
And the investment agreements may have played a role in compounding the problems of workers. One of the big advantages of locating firms in the United States and Europe had been their “rule of law”—the protection they give to property rights—but these new trade agreements, in their investment provisions, effectively encourage corporations to invest abroad, because they have more rights there than they enjoy at home.
Thus, while the investment agreements seem like they just affect developing countries where the rule of law is weak, they affect those in the developed countries and feed into the New Discontents. They are an essential part of the framework encouraging outsourcing of jobs, and of the corporate global race to the bottom—low wages, low taxes, and low regulations—all in the objective of higher corporate profits. Sometimes the effects are obvious—as Canada has already learned. Sometimes, as in the United States, the effects are more subtle, and will be fully realized only gradually over time.
FISCAL PARADISES AND TAX COMPETITION: STEALING YOUR TAX DOLLARS
There are other aspects of globalization in which the costs are even more apparent—and the benefits less so. Globalization has made it possible for corporations to avoid the taxes that they should pay—and corporations have induced competition among jurisdictions around the world to lower taxes, in a destructive race to the bottom. Corporations enjoy the benefit of a trained labor force, good infrastructure, and a rule of law that a country provides—but they want a free ride. They assume an air of corporate responsibility, even as they use all the ingenuity at their disposal to avoid paying taxes—but the first responsibility of any corporation should be to pay its fair share of taxes.
“Fiscal paradises”—places where individuals and corporations can avoid or evade taxes—have cropped up around the world, from Macau and Singapore to Panama, the Cayman Islands, Luxembourg, Ireland, and the Channel Islands. We often think of these as “offshore financial centers,” but some jurisdictions in the United States (Nevada, Delaware) and the City of London, the hub of the UK’s financial market, have also flourished on the basis of these nefarious activities. We might not have known about the full range of activities of these fiscal paradises—given their success in maintaining secrecy—had it not been for some huge leaks and some impressive investigative reporting. This included the LuxLeaks, which showed the role of Ireland and Luxembourg in tax evasion and avoidance in Europe, and the Panama papers, which showed the global pervasiveness of not only tax evasion and avoidance, but also other antisocial activities, the profits from which were laundered in these fiscal paradises.17 The pr
ime minister of Iceland and the president of Russia were among those implicated by the Panama Papers. (Iceland’s prime minister was forced to resign.)
A congressional hearing in 2013 alerted European officials to one of the most egregious cases of using globalization for tax avoidance: Apple, perhaps the world’s most profitable company, had made secret deals with Ireland to get its tax rate down to 0.005 percent.18
It was obvious that globalization expanded opportunities for tax avoidance and even made tax evasion easier.19 Companies could more easily locate production in a low-taxed jurisdiction and sell their goods anywhere in the world. A company could locate its intellectual property in a low-taxed jurisdiction, and claim that most of its profits were attributable to its intellectual property; then, not even the country where the goods were being produced would get much tax revenue. With so much freedom to locate production and to decide where the locus of profits would be, tax competition and the race to the bottom became even worse.
None of this was inevitable. It would have been possible to negotiate as part of trade and investment agreements tax provisions ensuring that corporations paid their fair share of taxes overall, and that there was a fair allocation of taxes among the signatories. But just about the only tax agreements that have been made are to avoid double taxation (which occurs when two jurisdictions attempt to tax the same income)—which in practice often result in no taxation. That this is so says something about globalization: as I have repeatedly noted, it has been a corporate-driven agenda; and corporations were interested in keeping opportunities for tax avoidance open. And they liked the race to the bottom, which lowered their overall tax rates.
Globalization and Its Discontents Revisited Page 9