The nef blog

Ho Ho Ho. It’s Christmas time. A time of eating, drinking and spending time with those who are loosely genetically related to us.  But, for most of us, it isn’t all happy families. There are some family members who are generally hard work.

Imagine that to try and stimulate the Christmas cheer, your mum paid you to spend more time with the more challenging members of your family. How would you respond? Would this make you listen with more vigour to Auntie Emerald telling you about her difficult divorce, or more inclined to pop in to Grandpa and hear about the war?  Would you do it next year too, even if you didn’t get the reward? Or would you leave the whole business to your brother as he needs the money more than you.

This is an attempt at a festive analogy of payment by results. Broadly speaking this means that organisations that deliver public services get paid for performance. The rewards will be higher for the more difficult cases. For an example see the payment structure for the DWP’s new work programme.  Reading between the lines, it means you take a provider which might be a profit maximising company whose raison d'être is to maximise returns to shareholders. You then make solving the most entrenched social problems profitable. Everyone is a winner.

What could possibly go wrong - people respond to incentives don’t they? Well, yes they do, but in a very complicated way. They often don’t respond to payments received in the form of bonuses for performance. There are a number of explanations for this – the bonus may signal that the task is undesirable, crowd out intrinsic motivations, or distract attention away from the main point of the activity to the actual reward itself.

People are also often motivated by other factors. Heckman et al looked at the behaviour of frontline staff who were given discretion about who to accept onto a job training programme. They found that, contrary to expectations to ‘cream skim’ the best candidates, they were much more likely to accept people from more disadvantaged backgrounds. They had an intrinsic motivation to help those who were most in need.

This doesn’t mean that people shouldn’t get paid. Or that incentives never work. At nef we encourage local authorities to use incentives in the delivery of their services, including timebanking and local currencies. But incentives can be financial and non-financial and lessons from behavioural economics are important.  In a time where there is less public sector funding to go round commissioners need to build on and enhance peoples motivations to do a good job and to make a difference. Not crowd them out.

Yesterday, the European Commission’s call for evidence on country-by-country financial reporting drew to a close. The Commission is investigating whether the EU should require multinational companies to disclose, on a country-by-country basis, sales, costs, profits, assets, number of employees, total employee remuneration, and taxes paid. If these new standards are adopted, this would be an important step towards combating international accounting fraud, tax evasion and tax avoidance.

Christian Aid has estimated that approximately $160 billion of potential tax revenue in developing counties is lost each year as a result of “transfer pricing” abuse. Given the global nature of production and business, there is ample opportunity for different subsidiaries of a company to trade with one another. For example, a company could have a marketing team based in the UK, intellectual property rights or trademarks based in Switzerland, and production facilities based in China. Multinationals can manipulate transfer prices by mispricing the products traded between subsidiaries, which thus facilitates the flow of capital between countries. For example, a company may overstate the price of a product being sold from a subsidiary in a high-tax country to a subsidiary in a low-tax country. This is particularly prevalent when dealing with hard-to-value intangible assets, such as trademarks, which can be assigned any geographical location. “Management fees” to individuals and entities domiciled in tax havens are also commonly deployed, and the rates at which different subsidiaries lend to each other also often differ.  In 2009, even Forbes admitted that “intra-company pricing crosses the line from tax avoidance into outright tax evasion”.

For example, research by Sikka & Willmott in 2010 noted that within WorldCom: “The paying subsidiaries treated royalty charges as an expense that qualified for tax relief whilst the income in the hands of the receiving company attracted tax at a low rate. This transfer pricing arrangement may have saved the company between US$100 million and US$350 million in taxes.” Many big-name global corporations, such as GlaxoSmithKline and Shell, have also been criticized by tax authorities and have had to make settlement payments.

It is very expensive for regulators to investigate transfer mispricing, and developing countries, in particular, do not have the resources or expertise to probe and thus curb abuse. Consequently, such fraud currently rarely comes to light because, in today’s world of opaque accountancy, we are reliant on whistleblowers, undercover reporters, or someone taking legal action against a firm (as was the case with WorldCom).  Furthermore, this practice means that corporations do not need to incur the cost of relocating to a tax haven. Instead they simply set up a small idle subsidiary (a “shell company”) in a tax haven and subsequently abuse intra-firm trade. To add insult to injury, many accounting firms openly advertise their expertise in such maneuvers. For example, Ernst & Young boast of “creative and practical solutions for . . . transfer pricing needs”.

Money retained by multinationals through strategic transfer pricing is lost tax revenue that should be going towards, for example, the fight against poverty. It is also fundamentally unjust that small and medium sized businesses, which are too small to have overseas subsidiaries, pay their full tax bill, whilst large corporations dodge their social obligations. Many of the multinationals that engage in transfer mispricing simultaneously claim to be firm believers in corporate social responsibility. This hypocrisy should not be borne; big business must be forced to stop manipulating taxes at the expense of the vulnerable.

Naturally, implementing country-by-country reporting would impose a burden on multinational corporations, due to increased auditing fees.  However, the benefits to the wider community far exceed this limited private cost. The new information would help draw attention to companies evading or avoiding taxes. It would also help quantify the impact of tax havens. As many tax havens are extremely reluctant to disclose information to foreign tax authorities, countries currently have limited knowledge of how tax havens precisely impact on tax revenues. Country-by-country reporting would also benefit investors. As many multinational companies operate across the globe under differently named subsidiaries, it is currently often difficult for investors to determine all the locations in which a company operates. This means that many investors are unaware of the geopolitical risks to their investments. Country-by-country reporting would also help ethical investors make informed decisions when deciding which companies they wish to invest in.

Crucially, these new rules would help increase transparency in developing countries, where corruption is rife. For example, citizens would be able to see how much their governments make exporting natural resources to the West. These numbers could then be directly compared to public spending figures. This would shine a light on the large sums of money that go directly into officials’ pockets. It would also help ethical investors avoid companies that collaborate in this practice. In May, the Hong Kong Stock Exchange acknowledged that the extractive industry is facilitating corruption, and mandated that all extractive industry companies applying to be listed must disclose “payments made to host country governments in respect of tax, royalties and other significant payments on a country by country basis.” The Dodd-Frank act has introduced a similar measure in the US. The EU must follow suit.

Let us hope that the European Commission’s consultation heralds a new era of transparent accountancy. Let us also hope that the major accountancy firms support this move and live up to what used to be the watchwords of the profession: “true and fair”.

Featuring interviews with Dr Rajendra Pachauri, chair of the Intergovernmental Panel on Climate Change; Adair Turner, chair of the Financial Services Authority; Professor Richard Wilkinson, co-author of The Spirit Level; Larry Elliott, Economics Editor at the Guardian. (If you can't see a Windows Media Player box below, click here to download the mp3)

This programme was originally created for the BBC's World Tonight.

It is nearly twenty years now since the former nef director Ed Mayo sat me down and asked me to write a short pamphlet called What is New Economics? It sold out in a week or so (it only cost £1.50).  But what I remember most from it was the list of new economics heroes, ideas in practice, at the end of each section.

They defined the new economics in more ways than one.  Seikatsu Club of Tokyo, the Green Belt in Kenya, Mondragon in Spain, they provided a frame by which we understood the new economics in those days. 

But the practical projects were also what distinguished us from so much of what had gone before. The Distributists in the 1920s had tended towards melancholia; it wasn’t clear that any other way was possible, however they might yearn for one.  Even Small is Beautiful was a bit sparse when it came to practical examples.

But of all the practical examples, micro-credit – and the extraordinary story of the Grameen Bank – were the strongest and most inspiring.  “Your bank just roared past in a cloud of dust,” said the original article in Christian Science Monitor.  We read it with huge enthusiasm.

But two decades later, we have reached something of a watershed.  Grameen inventor Muhammad Yunus in under huge personal pressure, and the micro-credit schemes of India – the creation of Hilary Clinton and George Soros and their championing of micro-credit in the 1990s – are now in crisis.

The Indian micro-credit industry is now worth about $4 billion, ploughed into it by the Indian banks.  But these are now in doubt.

In Andhra Pradesh, politicians have regulated how companies can lend and collect money and are encouraging people not to pay back their loans.

This matters because a third of India’s microfinance customers live in that state, only ten per cent of borrowers are continuing with their payments, and there are fears for some of the banks involved.

Yunus himself is in the middle of allegations from the Norwegian government that grants they made in 1996 were used by the wrong part of the Grameen operation, and for aid not loans (shock, horror).

It is far from clear what is really going on, except that one of the foremost practical new economics ideas in the world is facing the inevitable test of going mainstream.  David Roodman from the US Centre for Global Development’s said: “As an outsider, I only half-understand the extraordinarily complex situation.”  So don’t let’s assume that we yet have the full truth.

Part of the problem is when major profit-making institutions try to coerce micro-finance, rather as they did subprime loans in the USA.  SKS Microfinance, the biggest for-profit micro-lender in the India has just reduced its interest rate to a whopping 24 percent. There are also fearsome tales of the methods used for collection and of suicides for those hideously in debt.

On the other hand, the government of Andrha Pradesh has its own micro rival micro-finance schemes known as Self-Help Groups, so they may not be unbiased.

Politicians in Nicaragua also persuaded people to stop paying back loans, leading to the collapse of the local bankers and the return of the money-lenders.  Similarly in Latin America, Pakistan and North Africa.  After all, some politicians are not that keen to have ‘their’ poor made more independent. 

It may be that the main lesson here is that new economics solutions, however imaginative, are never foolproof.  Once that crucial embedding in the local population, which is what Yunus did with Grameen, gets abandoned, then there are bound to be abuses and destructive politics.

A critical, but unremarked, aspect of the new economics is that creative and imaginative solutions can’t usually be delivered in the old industrial way.  Perhaps that is the most important message of all.

As Felix Salmon puts it in the Columbia Journalism Review:

Much better that full-service banks grow organically out of local communities than monoline micro-lenders parachute in, flush with venture-capital funds, make a huge splash, and then implode.

In the UK, we are continually presented with the idea that foreign nations stand in the way of global financial stability. For example, we allegedly can’t properly regulative hedge funds, lest they flee overseas.  But before we rush to condemn others, perhaps it is time to consider what role the UK plays in dragging down global standards?

The UK is a global centre for commodities derivatives trading. These markets allow agricultural and energy producers and consumers to pass-on price risk to those who are willing to bear it. This should theoretically result in lower food and energy prices for the general public. Manipulative behaviour, however, can disrupt this important function, and the role these markets play in price-discovery (futures are also used as a benchmark for pricing in the physical market). Despite an urgent global need for efficient commodity derivatives markets, non-competitive behaviour occurs in London, as a result of comparatively lax regulation. 

For example, during this past summer there was a shortage of cocoa in the physical market. Clearly noting these underlying conditions, an individual market participant started buying July-contract cocoa futures, and built up an enormous holding which effectively dominated the market for this contract (cocoa futures promise delivery of a given amount of cocoa, on a given day, at a given price). But due to shortages in the physical market, not all of the July futures contracts in existence could be settled with the physical delivery of cocoa. Consequently, many of the market participants who had sold these contracts had to settle their obligations in cash.  But as one participant had bought most of the contracts, they were able to “squeeze” the settlement price to extract excessive profits.

This is a form of market manipulation that could not occur in US commodities markets, where position limits for speculators are in place. It also illustrates the lack of transparency in London commodities markets. How could such behaviour go unnoticed until it was too late? In the US, Commitment of Trader reports are published on a weekly basis. These disclose the number of contracts that have been bought and sold by the various types of participants, as well as the net positions held by each of the largest market players. Why is such information not available in the UK? The UK also discloses less information on European commodity inventories than is disclosed by the US on American inventories. Moreover, the UK allows self-regulation. This is clearly imprudent, as exchanges profit from increased trading volumes, and, thus, have an incentive to limit regulatory barriers. The US recognises this danger, and has an independent regulator: the Commodities Futures Trading Commission (CFTC). The UK desperately needs such a supervisor.

The United States is traditionally thought to be the epicentre of neoliberalism. But the US is actively intervening to help facilitate smooth-running commodities markets, whilst the UK is shirking this important duty. Why do we allow substandard commodities regulation in London? The financial sector is undeniably a significant contributor towards UK GDP and tax revenues, but does this mean we must cave to its every demand? Should the UK really be profiting from inefficient agricultural markets? Before we condemn overseas havens, we should fully acknowledge the extent to which the UK exploits global demand for lax governance. It is time the UK shakes off this shame, and stops dragging down global regulatory standards.

The UK Government’s recent decision to cap both the number of non-EEA Tier 1 and 2 immigrants, and to limit student entry, has attracted a great deal of adverse comment. Such critiques have rightly pointed out that the Home Office claim that these policies will reduce net immigration to ‘tens of thousands’ is intrinsically incoherent. EU citizens have a right to move freely within the region, and the level of net migration is essentially dependent upon these flows, and also upon the number of emigrants from the UK, which is currently falling.

In any case, it is clear that measures aimed to reduce immigrant numbers are economically inefficient. All available figures indicate that migrants bring a net positive economic gain to Britain, and that local and sectional problems could be dealt with by redistribution of these additional resources to areas where specific funding is needed. Moreover, many sections of the economy have serious skills shortages, and are critically dependent on migrant labour. Such considerations are vital to the economic and social welfare of the country, and underline the fact that UK Government policy is based on little more than the perceived political advantage of bowing to a populist anti-immigrant sentiment among the electorate.

The decision to sacrifice the short-term interests of the country in the pursuit of political gain is bad enough, but in fact there are several much broader long-term factors in the equation that make such policies even more regrettable. In the first place, immigration is by its very nature an international issue. Global inequality is one of its main drivers, and poverty and lack of opportunity are among the main push factors that threaten to make future migratory flows a ‘problem’ for the rich countries of the world.  Three decades of coercive Northern-led policies have seen the liberalisation of movements of capital and goods and services, but there has been no parallel liberalisation of labour markets. This asymmetry has skewed global wealth distribution in favour of the industrialised countries, and together with other exploitative policies (including inappropriate pressure to increase commodity exports, aggressive lending creating debt dependency, and unfair trade rules) has vastly increased inequality between the developed and the developing world. Rich country incomes have soared (the per capita income in the UK is now £28,000) while over half the world’s population live on under $3 a day – the level below which life expectancy abruptly plummets.

In addition, climate change, driven by the environmental impact of our productive and consumptive system, is taking an appalling toll on poor countries, with drought, flood, hurricanes and increased salination damage from rising sea levels, causing acute and often intolerable resource stress.  Until global economic policies are focused on achieving environmental and social objectives for all, the pressure to migrate from the poorer developing countries will not be alleviated – and a rhetoric that shirks our responsibility for this situation is profoundly distasteful.

From a purely self-interested perspective it is also extremely unwise.  The global balance of economic power and demographics is altering remarkably fast, and with it the needs and patterns of behaviour within both industrialised and developing countries. As detailed in a recent nef report, research has consistently found an inverted u-shaped relationship between country development stage and emigration levels – that is, as a country develops, emigration initially takes off until the difference in wages and living standards between home and source countries significantly shrinks.  Although this may lead to increased immigration to the UK in the very short-term, expected international development transitions will in all likelihood cause a decline in the emigrant stock from its current source countries after 2030, and these changes will have many repercussions. Among them, since the peak coincides with a projected peak in the UK dependency ratio (the ratio of children and those of state pension age to those of working age),  it may become very difficult to care for an aging population by 2040. In short, a restrictive migration regime that discourages migrants in the short term, may compromise the UK’s ability to attract them at a time when it is going to need them most.

Above all, the world of the 21^st century is a world of interdependence, in which the idea of ‘fortress Britain’ is long past its sell-by date.  Not only is the UK reliant on other countries for food, oil, raw materials and manufactures, we cannot possibly tackle the big problems that beset us –  climate change, environmental degradation, global poverty, international crime, security issues, energy provision, or the spread of disease, for instance – without co-operation on a global scale.  And such co-operation is not made easier by nationalistic mentalities, draconian border controls, or xenophobia. Rather, we need to build and retain good relations with other nations, their governments and their populations, and a rich global interchange of people is an absolutely critical building block in such a process.  The international student body, for example, does not simply finance 13% of our universities’ income, vital though that contribution may be. It also plays a uniquely important role in forging long-term bonds of friendship and understanding between the various nations and cultures that make up our very troubled world.

 If we wish to move forward as 21^st century citizens, and provide a future for our children that is marked by good global relations rather than bad, we must view immigration as a long-term international issue of extreme importance, rather than using it as a tool to further short-term party political advantage at the polls.