Adair Turner, chairman of the Financial Services Authority, the UK’s financial sector regulator, has proposed the possible use of Tobin taxes to curb destabilising financial transactions. The late James Tobin, winner of the 1981 Nobel prize in Economics, argued that a very small tax (between 0.1 and 1 per cent) should be imposed on foreign exchange transactions to dampen destabilising foreign currency speculation and thereby reduce exchange rate fluctuations. Lord Turner’s proposal would apply to a whole range of financial transactions, putting some friction in these very volatile and often highly leveraged markets. Such a tax would discourage some of the riskier and more exotic transactions on which many of the bonuses of bankers have been based.
Not surprisingly, his proposals have been met with derision by many in the banking sector. Many politicians too have been critical, arguing that the taxes will divert financial business away from London to other financial centres around the world. And yet, at the G20 summit in Pittsburgh on 24/25 September, both the German chancellor, Angela Merkel, and the French president, Nicolas Sarkozy, argued in favour of such taxes. The result was that the IMF was asked to investigate the practicality of using Tobin taxes on financial transactions as a way of reining in more risky behaviour. A week later the IMF, while ruling out a simple Tobin tax, came out in favour of taxes on the global financial sector designed to reduce speculation.
So who is right? The following articles look at the issues.
FSA chairman Lord Turner says City too big Times Online (27/8/09)
Financial Services Authority chairman backs tax on ‘socially useless’ banks Guardian (27/8/09)
Cutting finance back down to size Financial Times (27/8/09)
Support for tax to curb bonuses BBC News (27/8/09)
FSA boss gets tough on bonuses (video 1) (Video 2) (Video 3) BBC News (27/8/09)
City tells FSA to stick to day job Reuters (27/8/09)
Charities applaud FSA’s support for new bank tax Guardian (27/8/09)
The time is ripe for a Tobin tax Guardian (27/8/09)
Ça fait malus: France gets tough on bankers’ pay The Economist (27/8/09)
Sarkozy chides bankers for bonuses, calls for tougher regulation (video) France 24 (18/8/09)
Politicians Clamp Down on Bankers’ Bonuses BusinessWeek (26/8/09)
Treasury would be crazy not to listen to Turner Guardian (27/8/09)
Three cheers for Turner and tax on easy money Guardian (27/8/09)
What is the City good for, again? Guardian (27/8/09)
Will Transaction Taxes Reduce Leverage? The Atlantic (27/8/09)
FSA backs global tax on transactions Financial Times (27/8/09)
The Tobin tax explained Financial Times (27/8/09)
Could ‘Tobin tax’ reshape financial sector DNA? Financial Times (27/8/09)
Postscript
Turner defends bank tax comments BBC News (30/8/09)
Turner stands firm after Tobin tax backlash Financial Times (1/9/09)
Brown calls for bank bonus reform BBC News (1/9/09)
Brown pledges bonus clampdown Financial Times (1/9/09)
Cut the banks (and bonuses) down to size Financial Times (31/8/09)
Postscript 2
Sarkozy to press for ‘Tobin Tax’ BBC News (19/9/09)
The wrong tool for the job The Economist (17/9/09)
Dani Rodrik: The Tobin tax lives again Business Standard (19/9/09)
Postscript 3
IMF presses for tax on banks’ risky behaviour Guardian (3/10/09)
IMF’s Strauss-Kahn puts bank tax on the agenda Times Online (3/10/09)
Banks and traders threatened by new international tax plan drawn up by IMF Telegraph (3/10/09)
Questions
- Explain how a Tobin tax could be used to reduce destabilising speculation without preventing markets movement to longer-term equilibria.
- How might the use of a Tobin tax on financial transactions help to curb some of the ‘excessive rewards’ made from financial dealing.
- How do Lord Turner’s proposals differ from those of President Sarkozy?
- Examine the advantages and disadvantages of using a Tobin tax on financial transactions. How might the disadvantages be reduced?
- Explain what Lord Turner means by “the financial services industry can grow to be larger than is socially optimal”. How would you define ‘socially optimal’ in this context?
The leaders of the G20 countries gathered in Pittsburgh on 24 and 25 September 2009 to discuss a range of economic issues. These included co-ordinated action to ensure the world economy maintained its fragile recovery; reforming the IMF; agreeing action on bank regulation and the limiting of bankers’ bonuses.
The following is a selection of podcasts and videos looking at various aspects of the summit and its outcomes. The first one, to set the scene, is a webcast from the IMF looking at the state of the world economy and the role of macroeconomic policy and banking regulation. There are also some articles looking at the achievements of the summit. (See here for G20 draft communiqué)
World Economic Outlook, September 2009 (video) IMF Webcast (22/9/09)
G20: Who will feel the pain and when? (video) BBC Newsnight (25/9/09)
G20 leaders meet in Pittsburgh BBC Today Programme (25/9/09)
‘Little change’ in bank regulation BBC Today Programme (25/9/09)
World Bank’s Zoellick on G20 Summit (video) CNBC News (25/9/09)
G20 ‘was a successful meeting’ BBC Today Programme (26/9/09)
Obama on G20 plans for financial reforms (video) BBC News (25/9/09)
Greater role for emerging powers BBC News, Amartya Sen (25/9/09)
Preventing Another Global Crisis (video) CBS News (25/9/09)
Obama hails progress at G20 (video) Reuters (26/9/09)
World map of deficits and stimulus spending
The cost of the financial meltdown: Deficits and spending BBC News
Articles:
G20: Banks to be forced to double capital levels Telegraph (25/9/09)
Will tough new G20 measures work? BBC News (26/9/09)
Analyst View: G20 ends reign of G7 in Pittsburgh Reuters (25/9/09)
Leaders bury differences over bonuses to agree standards FInancial Times (26/9/09)
Same tune, different fiscal instrument on bank bonuses Times Online (25/9/09)
G20: History and fudge Peston’s Picks, BBC News (25/9/09)
What the G20 said on bonuses (and why it didn’t say much at all) eFinancialCareers (27/9/09)
Hamish McRae: G20 communiqué signals transfer of power to the emerging world Independent on Sunday (27/9/09)
The G20 fantasy Guardian (27/9/09)
Questions
- Explain the issues faced by the G20 countries.
- To what extent is trying to reach international agreement on co-ordinated action a prisoner’s dilemma game? Is it, nevertheless, a positive sum game?
- What was agreed at Pittsburgh and to what extent will it lead to action as opposed to being mere rhetoric?
- The G8 is effectively dead, having being replaced by the G20, plus Spain, The Netherlands and various international bodies, such as the IMF. What are the advantages and disadvantages of this move?
The blame for the global economic crisis has been placed on many different people, but one area that has been severely criticised for the extent of the financial crisis is banking and financial regulation (or a lack thereof). One thing that has been repeated is that we must learn from our mistakes and therefore tighten financial regulation on a global scale. The Institute for Public Policy Research (IPPR) says the ‘rapid return to the City’s bonus culture shows that real reform has been “very limited”’. France in particular is arguing for tighter financial regulation, including curbing bankers’ bonuses to avoid a repeat of last year’s meltdown. However, it is meeting resistance from the UK and USA. Indeed, some banks appear to have extended their bonus culture.
As the banking sector slowly begins to recover, there is concern that few changes have been made to ensure that there is no repeat of the recent crisis. Banks have been warned that they should not resume taking risks, as they did before, as future bailouts by the government (and hence the taxpayer) will not keep happening. The European Union has now unveiled plans for new ‘super-regulators’, but only time will tell whether they will be a success.
EU unveils new ‘super-regulators’ BBC News (23/9/09)
EU proposes new Financial-Market supervision system The Wall Street Journal, Adam Cohen and Charles Forelle (24/9/09)
FSA head launches fresh attack on ‘swollen’ system ShareCast (24/9/09)
Bank crisis lessons ‘not learned’ BBC News (15/9/09)
US, UK resisting French drive for regulation AFP (22/9/09)
European System of Financial Supervisors (ESFS): Frequently Asked Questions Mondovisione (23/9/09)
Tighter grip on economy needed BBC News (13/9/09)
Turner warns against regulation overkill Money Marketing (23/9/09)
EU calls for European Banking, Securities Regulators Bloomberg (24/9/09)
EU financial watchdog to rely on moral authority The Associated Press (23/9/09)
Obama issues warning to bankers (including video) BBC News (14/9/09)
Questions
- What are the advantages and disadvantages of tighter regulation of the financial sector for (a) the UK and (b) the global economy? What forms should such regulation take?
- What are the arguments for and against imposing a statutory capital adequacy ratio on banks that is substantially higher than the ratios with which banks have been operating in recent years?
- In what ways was a lack of financial regulation responsible for the financial crisis?
- Why is the continuation and possibly growth of the bonus culture a potentially dangerous issue for any future crisis?
- The articles talk about ‘lessons being learned’. What lessons are they referring to?
- The financial crisis has affected everyone in some way. What has been the impact on taxpayers?
Is the power supply industry a cartel? Are the energy companies exploiting a position of market dominance to increase profits at the expense of consumers? At first sight, it would certainly seem so. Despite falling wholesale prices for gas and electricity, the six main power suppliers have not reduced prices to their customers. The result has been a substantial rise in profits. Over the past three years, the average annual gross profit for supplying each dual-fuel customer has been £110. The figure has now risen to £170, a rise of 55%. This is likely to rise further in the short term with further reductions in wholesale energy prices over the next few weeks.
But despite this large increase in profits, the power companies are considering increasing prices this coming winter if wholesale energy prices start to rise again, even though the expected wholesale price rise would still leave them with a gross profit of £140 per dual-fuel customer.
Ofgem, the gas and electricity industry regulator, wrote to the six main companies asking them to explain their pricing position. You can read Ofgem’s report from the link below. In it, Ofgem argues that there is scope for the companies to cut their prices. But Ofgem no longer has the power to cap prices: in 2002 the RPI-X system of price cap regulation was abandoned, since it was felt that there was enough competition between suppliers not to warrant price regulation.The articles below consider the question of whether the companies are justified in their pricing policy or whether they are exploiting their market power to make excessive profits.
No energy cuts despite huge profits (video) Channel 4 News (18/9/09)
Energy bills may rise despite wholesale price drop Times Online (19/9/09)
Where is the will to power? Times Online (19/9/09)
Energy bills set to rise further, companies warn Guardian (18/9/09)
Energy bills ‘unlikely to fall’ BBC News (18/9/09)
Bills face a power surge (Douglas Fraser’s Ledger) BBC News (18/9/09)
An Electricity and Gas Price Cartel? Why Ofgem Can’t Tell iStockAnalyst (17/9/09)
Evidence from Ofgem:
Ofgem’s letter to the six main suppliers and their responses to Ofgem can be read here
Ofgem’s findings can be read in Quarterly Wholesale / Retail Price Report – August 2009
Ofgem Factsheet: Household energy bills explained
Questions
- Assess the justification by the power companies for not reducing the price of gas and electricity to their customers.
- Explain what is meant by ‘hedging’ in the context of the purchase of gas and electricity.
- The power suppliers are an oligopoly. If there is collusion between them, what form does it take? Why is it very hard to find evidence of collusion?
The large bonuses received by bankers, often amounting to more than a million pounds, have been contentious for many years. With the banking crisis and subsequent recession, and with both public and government outrage at the size of the bonuses, many thought that the days of such bonuses were over. But such is not the case. “There has been public disquiet that leading banks – which have been seen as a major cause of the financial crisis – have been receiving taxpayer funds, but are not prepared to change their traditional culture of awarding big bonuses to key staff.”
The following articles look at what has been happening to senior bankers’ remuneration in recent months. But what are the market conditions that allow such rewards to continue? Are they a reflection of the marginal productivity of bankers or of their market power, or what?
RBS to keep paying bonuses despite 1bn first-half loss Telegraph (7/8/09)
Lloyds chief plans bonuses for ‘spectacular job’ in making £4bn loss Telegraph (6/8/09)
CS toxic bonuses are up 17%, but gains can’t be realised for four years eFinancial Careers (7/8/09)
Banks: Look, don’t touch Guardian (8/8/09)
Analysis: The plan’s the thing Times Online (7/8/09)
Cutting our bonuses would hit the taxpayer, says RBS Citywire (7/8/09)
France targets bankers’ bonuses BBC News (7/8/09)
Sarkozy weighs into debate over banker bonuses after BNP Paribas compensation sparks anger Los Angeles Times (7/8/09)
Knotting the purse-strings The Economist (6/8/09)
Pay and politics The Economist (6/8/09)
Questions
- Explain why many senior bankers have continued to receive huge bonuses. To what extent is oligopoly theory relevant to your explanation?
- To what extent do the size of the bonuses reflect senior bankers’ contributions to (a) the productivity and (b) the profits of their bank?
- If bankers are to be paid bonuses, what is the best form for these bonuses to take? Consider the incentive effects in your answer.
- Should bankers’ bonuses be regulated and, if so, what criteria should regulators use for determining the acceptable size of bonuses?