Tobin Tax

The Tobin Tax -A Solution to the Problems of Globalization?

1. Introduction

Recently, there is a fierce academic and political discussion about chances and risks of globalization. Especially globalization of financial markets not only enhances the allocation of capital and support trade in goods and services through lower transaction costs and higher liquidity. Moreover, international asset diversification and hedging opportunities lower risks, and free international financial markets make it easier to reach foreign capital, especially for emerging economies. Therefore, international financial markets raise efficiency and profits due to international division of labour. Economic growth in emerging countries is not only enhanced by the availability of foreign capital but also by developing local financial centres that pave the way to international business. On the other hand, low transaction costs encourage speculation, which is said to destabilize markets, especially speculation on foreign exchange rates. High fluctuations of asset prices and exchange rates are a source of uncertainty for the real sector and cause misallocation. Hedging those risks is costly and in some cases not or only partly possible. Another crucial point against free financial markets is the loss of independence of economic policy. Under free convertibility of the currency and free capital markets, autonomous economic policy is only possible with free floating exchange rates but not with fixed ones. Therefore, if a country's objective is currency stability, it will have to give up the independence of its economic policy. Thus, governments lose their sovereignty over financial markets. Globalization of financial markets has been raising global foreign exchange transactions far faster than the growth of official reserves. In the 1980s, daily turnover was about 600 billion US-Dollar and exceeded 1,5 trillion US-Dollar before establishing the Euro. Today, daily transactions in the foreign exchange market are about 1.2 trillion US-Dollar (BIS (2001)) . Speculative runs can now rule out the financial resources that central banks can mobilize to counter such runs. The question arises whether it is not better to regulate or to restrict international financial markets. In December 1999, the German Parliament set up a commission with the task to examine chances and risks of globalization. It calls for regulations of international financial markets, since these markets bear some systematic risks due to huge volume of transactions and high capital mobility. The suggestion is to implement a transactions tax on all foreign exchange transactions - the so-called Tobin tax. The idea of taxing foreign exchange transactions goes back to the proposal of James Tobin in 1978, but it has come into mind not until the financial crises of some emerging countries such as Brazil or Mexico. The German Parliament is not the first one dealing with that issue. As the first country in Europe the French Parliament has introduced the Tobin tax in November 2001, but only on condition that all the other 14 European Union member nations agree to do the same. Canada passed a similar resolution in 1999, making its introduction conditional on widespread adoption.

This paper provides a critical view about the Tobin tax according to its concept as such, its efficacy and the feasibility.

2. The Tobin Tax

2.1 Introduction of the Tobin Tax

1978 James Tobin reintroduced the idea of John Maynard Keynes of the implementation of a tax on foreign exchange transactions in order to cope with several problems linked to short-term, speculative exchange transactions. The background for the reintroduction of Keynes' idea was the collapse of the international exchange rate system of Bretton Woods 1971 and, thus, the change of money currencies back to floating exchange rates. Simultaneously, a wide array of important industrial countries substituted their exchange controls and measures for a free convertibility of their currency . Free convertibility in the sense that everyone could trade freely with various currencies. In contrast to the system of fixed exchange rates, the price of a freely convertible currency is determined by supply and demand and is subject to ongoing volatility. The problem in this case is that not only exporters and importers who demand foreign currencies for their transactions determine the price . Moreover, the system of free convertibility also enables other market participants, especially interest arbitrageurs and exchange speculators to impact on the price of the currency, namely the exchange rate.

During the creation of exchange rates by supply and demand for the given currency through exports and imports, the 'potential' or productivity of an economy plays a vital role. The economic productivity is substantially driven by the country's economic policy. Thus, a stable and efficient tax policy with an effective inflation control mechanism leads to an increase in the relative competitiveness of national companies on a worldwide basis. This results in high exports which then result in an increase in jobs and economic growth, thus, in an increase in wealth. The high exports which are eventually paid by the importing countries' foreign currencies lead to an increase in the demand for the national currency and therefore to an increase in the exchange rate. Vice-versa, an inefficient economic and social policy causes a loss in competitiveness, lower exports and thus to redundancies and lower economic growth. Lower exports also mean that demand for the national currency decreases, because importers need less money to finance their imports - the exchange rate decreases.

Therefore,