Sven Giegold (MEP for the German Greens) has an interesting comment piece in Handelsblatt: while focusing on Portugal, it is illustrative of much that is wrong with economic policymaking in Europe. He reports that 17 of the 20 largest Portuguese listed companies organise at least part of their activities in the form of holding companies based in a single tax haven. Cyprus? The Cayman Islands?
No. The Netherlands.
The reason is Dutch tax laws that allow large companies to organise their revenues in a – to use the jargon – “tax-efficient” way. The upshot is that holding companies registered there pay little or no tax on even large profits and, more specifically, they do not pay it in the countries in which they actually earn the profits.
Sven Giegold points out that this means that the burden of fiscal consolidation, bank-bailouts etc. falls disproportionately on the immobile: workers and small companies. This is an important issue, but in the current context a related, but somewhat different matter deserves emphasis.
The rescue – if that is the right word – of Cyprus was a frightfully incompetent blunder. Huge economic risks have been taken, not to mention the misery imposed on largely innocent Cypriots, for the sake of what is, in the context of EMU as a whole, small change. The justification offered for this policy choice was, in a word, “moral hazard”: Cyprus, so the argument runs, had a “business model” based on low taxes and slack regulation. This brought in foreign money from which, for a while, the Cypriots lived very nicely thank-you, but it also engorged the financial sector. When such an inherently unsustainable business model collapses, why should those countries with a sustainable one foot the bill? It is unfair and will merely encourage irresponsibility in future.
On the face of it this is not an unreasonable question. I pointed out a number of counter-arguments, the most important of which is the pragmatic one that it is in practice impossible to punish the guilty and spare the innocent in such cases, while the risks incurred by ham-fisted attempts to do so are much too high. In response one of the commentators baldly stated the moral hazard argument:
This bailout circus simply cannot go on forever. It may not sound nice, but is very realistic: there is a limit to solidarity between countries when it comes to shoveling money out of one’s own country.
The commentator’s “own country” is the Netherlands. Sven Giegold’s piece is thus important in reminding us of the danger of such a line of argument: hypocrisy. The commentator might have had a valid point except that, as we see, EU member states are all engaged in an unseemly and damaging, and largely clandestine battle to attract mobile sources of tax revenue. And the bail-out-fatigued Netherlands is, shall we say, not exactly a reticent player in this game.
A slightly different shade of hypocrisy regarding national business models can be seen in another country increasingly tired of being the “paymaster of Europe”, Germany. It substantially liberalised the financial sector in the 2000s with the explicit goal of “catching up” with supposedly nimbler English-speaking countries. Largely as a result it was heavily exposed to toxic products Made in the USA and to property and bond markets in the euro area periphery. Several banks had to be rescued. And although it is true that the Germans did not ask, say, the Cypriots, to help fund their bank bail-outs, it should not be forgotten that the European rescue packages and central bank interventions, to which all member states contributed, had the prime aim of saving the necks of those financial institutions that had most recklessly overlent to the crisis countries: German financial institutions were first and foremost amongst them. (Another issue is whether a product specialisation with a prime role for high-performance, high-consumption automobiles and advanced weapons systems can be called “sustainable”, but let us not pursue that here.)
The euro area crisis shows that increased European solidarity is necessary, but the moral hazard point is not entirely without merit. The mistake, however, is to turn this into a fight between countries and their real or supposed “business models”. This is entirely the wrong issue: national specialisation within a monetary union is not only legitimate, it is inevitable and, in principle, also desirable. What is key is not to pit country against country, but to recognise that Europe is a place where the wealthy and the mobile profit at the expense of the poor and middle-income groups with few options to move their assets or their income streams around the globe or the continent. And the reason the former can do so is Europe’s still fragmented politics and governance. So greater European solidarity must go hand in hand with sensible rules about the sort of economic activities that countries can specialise in, the basis on which they do so and the economic (financial, regulatory, tax) policies that are legitimate to promote them.
A basic principle underlying the rules should be that national economic policies must be constrained wherever they have the potential to impose costs (externalities) on other member states or free ride off them. This will also prevent mobile production factors picking and choosing jurisdictions, blackmailing policymakers and unleashing a race to the bottom. These rules need to be agreed on a long-term basis between member states and not, during a crisis, suddenly forced down the throat of some countries by others who find themselves in a position of relative strength. The legal basis for such an approach already exists given the treaty requirement for member states to consider economic policy as a matter of common interest and to coordinate activities in the council. Unfortunately, what passes for economic policy coordination consists largely of a number of ill-conceived European rules (Stability and Growth Pact, to a lesser extent the macroeconomic imbalance procedure) mixed with opportunism, and strong-arming by competing nation-states – and a large dose of hypocrisy.
Europe must do better. One positive development in this context is recent media reports about the scale of tax evasion by political and economic elites in Europe and indeed world-wide. (Yes, it is ultimately a global, not just a European, problem but you have to start somewhere.) This may unleash a popular pressure for the necessary political changes and enable Europe to move beyond the distraction that is the North-South divide and the frustrations of national politics.