Key challenges facing modern finance: making the financial sector serve society

The second example of banks' rent-seeking is their benefiting from the power of issuing money, sometimes called “seigniorage”. It's a major source of profits and it rests on the trust in government and its ability to build up banks in trouble. The question is: How can we get the government to appropriate these rents for public purpose?

One way of doing that is auctioning off the right to issue credit. It could be easily implemented through a system of digital currency, and this is particularly true, as some countries, for example, Sweden, have gone to an almost totally digital system of payments. But I should emphasise that there's been a lot of discussions recently about cryptocurrencies -- in particular, Libra that Facebook has been trying to promote -- that I think should not be allowed [25]. The last thing we need is a new vehicle for nurturing illicit activities and laundering the proceeds, which another cryptocurrency would almost certainly turn out to be.

The entire thrust of the regulation of the financial sector is to promote transparency. Transparency is essential for a well-functioning competitive market, for preventing nefarious activities and for macroeconomic regulation. And the idea that you could have a cryptocurrency (which means `secret' or `anonymous') that is transparent is obviously an oxymoron. So, that is not the answer; the real answer is the approach that India has taken.

There are a couple of references here [26, 27], of recent works that have tried to highlight the ability to use digital currencies as an alternative, if we can break the monopoly power of the banks.

Taxation

Another negative role that the financial sector has performed in recent years is tax avoidance. A modern society needs a strong tax base for a wide range of public expenditures, from basic research and technologies to the other elements that I mentioned before -- infrastructure, education, health, and social protection.

But the corporate tax base has been eroded, and the financial sector has played a considerable role.

They have figured out how to take advantage of globalisation to avoid taxation. Apple is an example; it uses the same cleverness that is also used to produce the telephones that so many of you enjoy; it uses that same cleverness to avoid paying taxes. They use the same tricks that allow some of the world's largest companies to pay minuscule taxes, in some cases far less than 5 per cent of their profits, giving them an unfair advantage over small local businesses. And in Ireland, they got their tax rate down to something like point two or lower per cent of their profits. And they took all of their profits out of the rest of Europe and moved to Ireland. And when that got questioned, they moved it to Jersey. So, they are dedicated to not paying the fair share of taxes, and they work very hard on it.

But Apple is not alone. Many of the major corporations (among others, Google, Facebook, Microsoft, Amazon, Caterpillar) have used globalisation to avoid paying taxes. Some of you may know that there is a considerable effort by the OECD/G20 project to limit the extent of tax avoidance, but it has only scratched the surface. It is called “The Base Erosion and Profit Shifting” (BEPS) Project, where the corporations shift their profits around to a low-tax jurisdiction. The project aims to mitigate tax-code loopholes and country- to-country inconsistencies. So corporations cannot shift profits from a country with a high corporate tax rate to countries with a low tax rate See also Financial Secrecy Index, 2018.

Capital income should be taxed. We will review certain theoretical results -- in particular, those of Atkinson and Stiglitz [28], Chamley [29], and Judd [30] -- implying no capital income taxes and argue that these findings are not robust enough to be policyrelevant. The taxation of very high earners is a central aspect of the tax policy debate not only for equity reasons but also for state revenue raising.

But the fundamental problem is they also transfer a price system that has been employed now for almost 100 years, and what is needed is far more fundamental reform. The problem is that tax competition has resulted in a race to the bottom, which has been especially damaging to developing countries. There is a widespread misunderstanding of the incidence of corporate income tax and its effect, and that was evident in the discussion of the corporate tax cuts in the United States in 2017.

After the brief sugar high of the stimulus of the growth, the growth is already under 2 per cent (1,9 per cent), and it is expected to slow with negligible effects on wages, a small impact on investment, and it is actually predicted that GDP within a few years will be lower than it would have been without the tax cut.

So, this is a really good example of where badly designed tax bills, even tax cuts, can actually lead to lower GDP, lower economic growth. And the key flaw in the conventional analysis was the failure to recognise certain provisions of the Tax Code: the tax- deductibility of interests and depreciation allowance and write-off of investments. And the result of this is that with interest deductibility, the marginal cost of investments is reduced by the same amount as the marginal return on investments. So, there is actually no distortion in investment. The implication is the corporate income tax is close to a tax on pure profits and, in that sense, is not distortionary, but with positive distributive effects.

If we take it globally, there is no place for only piecemeal fixes. Indeed, the world is facing multiple crises -- including climate change, inequality, slowing growth, and decaying infrastructure -- none of which can be addressed without well-resourced governments. Unfortunately, the current proposals for reforming global taxation simply don't go far enough. And these are just some of the references that have discussed these points [31-34].

A direct, positive role for government

Most of the discussions about the role of “Government” are focused, firstly, on preventing bad behaviour through well-designed regulations effectively enforced and, secondly, on encouraging good behaviour on the part of the private sector. But the government has an important, and more direct, positive role. Of course, everybody recognises the role in monetary policy, where it is the lender of last resort. I have already mentioned the role in the development and in the rebuilding of infrastructure through development banks. There is a further role, what is sometimes called “the public option”, by providing more choice to consumers, increasing competition, innovation, lowering prices for financial services, growing returns on financial products. Now, obviously, for the government to perform these roles, it has to have good governance. It won't work in all countries, but in some countries, it has proven very effective.

For instance, one example is the student loan program in Australia -- income-contingent loans. All the students in Australia get a government-provided student loan that is income-contingent. So, what they repay depends on how well they do. If they do very well, they pay back a lot. If they don't do so well, they do not. But that means that they can still go to university, and if they want to choose to go into a low-income profession like being a professor, they can do that. But if they are going to go into a high- income profession like a banker, they can do that, but they have to pay back more. And that has had a very positive role in increasing opportunities for everybody in Australia without taking a hit on the government budget for good tuition.

Mortgages

It seemed remarkable to me that we waited so long to do anything about the foreclosure problem, which, in a sense, was at the root of the financial sector's problem. In many cases, we have on our hands a social and human tragedy. For example, as of August 2014, the foreclosure rate was 33.7 per cent, 1.7 per cent up from the last year. The rise in foreclosure activity has been most significant in New York and New Jersey, the two most densely populated areas in the USA.

The idea of a public option is now being discussed in the United States and concerns a number of different areas, particularly related to finance, and one these areas is mortgages. In my latest book, I also discuss the idea of a public mortgage financing system that could access an individual's I.R.S. (Internal Revenue Service) and Social Security data despite the current low-trust political environment. When you think about the mortgage, there are two pieces of critical information: income data and the value of the house. Both of these pieces of data are in the public domain, income tax data and housing transaction data.

An argument is that a conventional mortgage should be available, for instance, to anyone who has paid taxes regularly. There are economies of scope for the collection of the payments that can be done through the tax system. And this would mean that mortgages would be available to everybody at a much lower cost than they are today.

Retirement

Somewhere an argument's being made for a public option in retirement. Indeed, the Social Security Administration is far more efficient at disbursing retirement benefits than private pensions. The problem is that retirement products are very complex. Individuals, when they are 20, 30, 40 and when they are thinking about retirement -- 20, 30, 40 years from now -- they don't always fully understand what the world might look like. That gives an opportunity to those who would take advantage of individual vulnerabilities and take advantage of them.

President Obama proposed that those selling financial products (retirement products) have to satisfy a fiduciary standard of financial responsibility. In other words, you cannot have conflicts of interests. If you are selling a financial product, you have to put the buyer's interest first. But, remarkably, the financial sector said, “We cannot make profits if we do not have conflicts of interest if we are honest.” And they opposed this particular provision.

The public option could do well for those who want to have higher retirement benefits than are provided by the public program, to increase their contributions with benefits increased commensurately. And one could actually design a range of financial products with different risk profiles. And again, taking advantage of economies of scale and scope, and avoiding the potential for abuse.

And another example. When I was the chairman of the Council of Economic Advisors (under President Clinton), we proposed a product called inflation- indexed bonds, that would help people face inflation. However, the US Treasury and Wall Street opposed it. At first, I was surprised because our analysis said that not only would it make people have a more secure retirement, it would also actually reduce borrowing costs for the government. It was a win-win situation. But they opposed it because they discovered that if people have these products that protect them against inflation, they buy them and hold them until their retirement. They do not trade, and Wall Street does not make money by transaction costs from these trades.

RESTORING TRUST

Remember, at the beginning of this talk I said the way we responded to the financial crisis led not only to mistrust of the financial system but to mistrust of institutions more generally. Well, not a surprise, the bankers behaved in a morally reprehensible way, they took advantage of others and their positions of trust. Many of these bankers, when they were students of mine, seemed just like other people. And the question is -- what happened? What turned these people who seemed to be ethical and nice into people who behaved so badly?

Well, this illustrates some of the dangers of the standard economic model. It assumes that individuals are rational and selfish; there is no room for altruism. However, much of modern behavioural economics, including behavioural finances, explains that humans are less rational than that model assumes. They are also less selfish. Based on these standard models, the IMF and U. S. Treasury promoted the diversification of risks. It would spread the risk widely, and that would make the system more stable. As a matter of fact, the risk was not distributed and spread, but it was propagated and amplified. There was not a diminution of risk through diversification, but rather an amplification through contagion. Like the domino effect, diversification simply turned what could have been contained cases of financial failure into a global pandemic.

A number of studies revealed two things: The longer people study economics, the more they become like the economic model assumes they would be. That is to say, the longer people study economics, the more selfish they become. And also, those who are more like the economic model assumed are more attracted to economics and finance, but bankers maybe even more than economists in general.

I am going to illustrate this by some recent research [35, 36] that was done in experimental behavioural economics. When bankers were reminded that they were bankers, they were more dishonest.

So, the experiment was a very simple one, done in Switzerland. I cannot tell you whether it would apply here or in the United States, but I think the suggestion is that it is actually more general. They went into a room, and they tossed a coin. And you tossed the coin ten times, and you reported how many heads or how many tails you got. And it was totally in secret; your pay-offs were related to the outcome of the tosses.

Now we know, on the basis of probability, what they should report. We know how many should report “1 heads-9 tails”, “2 heads-8 tails” and so forth. So, we know what the probability distribution should look like; we also know what they would look like if they were totally dishonest because they would report the answer that gave them the highest returns.

The interesting thing about most people is they are not quite as honest, they are not fully honest, but they are not fully dishonest either. They don't take as much money as they could, but they are not fully honest. We can test how honest they are, we can contrast what the probability distribution should be with what they report. And the interesting thing is if we contrast what probability distribution should be with what they report when you remind bankers that they are bankers, they turned out to be more dishonest.

So, the question is -- why did the bankers' behaviour change?

The argument in experimental behavioural economics is that the norms of the industry may permit or encourage dishonesty. A behaviour shift may have happened even outside the bankers' awareness. When you reminded the banker who he was, what is called “cueing the banker's identity,” it increased this dishonest behaviour, even in the novel setting of the experiment, since the priming question unconsciously calls up these perspectives and habits associated with the banking `compartment' of the individual's life. In another experiment, with non-banker participants, it was shown that cues to banking have no influence on dishonest behaviour.

This is a kind of experiment that has been done over and over again and is replicable.

There are some broader insights from modern economic theory about how the pursuit of profits leads to societal well-being only when social and private costs and benefits are perfectly aligned. Whenever information is imperfect and asymmetric, they are not well-aligned, which is why the market economy is not in general Pareto efficient.

One of the most important ideas in economics is called “Adam Smith's invisible hand”. An idea was that the pursuit of self-interest and profits leads the economy, as if by an invisible hand, to the well-being of society. And what my colleague Bruce Greenwald and I showed is that the reason the invisible hand often seems invisible is that it is not there. That is to say that when information is imperfect, risk markings are incomplete, competition is imperfect -- all these conditions, which are true all the time, -- markets are not in general efficient.

And this, of course, is a major change in thinking from the world that Adam Smith (presented) in the first welfare theorem. I began by emphasising the problems of corporate governance. The typical incentive pay systems are neither efficient nor effective. Those in the financial sector were actually counterproductive, leading to short-termism and excessive risk-taking. In a way, academic economists should be very sensitive to this point: non-material incentives, professional standards, are often far more effective. Most of us are not motivated most of the time by just material incentives. It is professional standards that really drive us.

Societies and economies in which norms are taken into account, as well as the impact on other externalities, perform better; likewise, societies and economies where there is less inequality also perform better. Inequality gives rise to negative externalities.

Concluding remarks

The rules of the game matter. In the decades after 1980, the US and much of Europe changed the rules of the game in ways which led to a less wellperforming financial sector, with more inequality, more instability and lower growth. Only the financial sector seemed to gain.

Societal norms and trust all matter. A change in norms of finance towards a more exploitative behaviour, far different from what it was 60 years ago, has helped undermine trust in the institutions. And the social contract has been broken. Bankers were given `privileges' -- limited liability, rights to create credit by government, control over the means of payments --and they abuse those privileges to serve themselves rather than society more generally, at great cost to our economy, our society and our democracy.

Underlining all this is a significant disparity between social and private returns and deregulation that gave them the ability to pursue the private returns at the expense of the rest of society. That is why, returning to the remarks I gave in the very beginning, in spite of the growth of the financial system in the last 40 years, economic performance deteriorated, growth slowed and inequality increased, and the world eventually faced the worst crisis since the Great Depression. The financial sector played a large role in these failures, both because of what it did and what it failed to do.

There are reforms in the economic and financial system that can make the financial sector perform better -- better serve the roles that it needs to play. And what I have tried to do is outline some of the major reforms and to show how research in economics over the past 30 years has helped us understand both the limitations -- the failures of other financial systems -- and what we can do to make it work better.

Most importantly, restoring trust in the financial system is essential if it is going to perform the role that it should play in the economy and society. And that will require changes in laws, in regulations, governing setting standards, and in norms.

banks financial rent taxation

References

1. Stiglitz J.E. The current economic crisis and lessons for economic theory. Eastern Economic Journal. 2009;35(3):281-296.

2. Stiglitz J.E. Ten years later: Keynote address. Roosevelt Institute Working Paper. September 2018.

3. Greenwald B., Stiglitz J.E. Towards a new paradigm in monetary economics. Cambridge, New York: Cambridge University Press; 2003. 328 p.

4. Stiglitz J.E. Moving beyond market fundamentalism to a more balanced economy. Annals of Public and Cooperative Economics. 2009;80:3:345-360.

5. Stiglitz J.E. The price of inequality: How today's divided society endangers our future. New York: W.W. Norton & Co.; 2012. 560 p.

6. Battiston S., Delli Gatti D., Gallegati M., Greenwald B., Stiglitz J. E. Credit chains and bankruptcy propagation in production networks. Journal of Economic Dynamics and Control. 2007;31(6):2061-2084.

7. Delli Gatti D., Gallegati M., Greenwald B., Russo A., Stiglitz J.E. Business fluctuations and bankruptcy avalanches in an evolving network economy. Journal of Economic Interaction and Coordination. 2009;4(2):195-212.

8. Gallegati M., Richiardi M.G., Greenwald B., Stiglitz J.E. The asymmetric effect of diffusion processes: Risk sharing and contagion. Global Economy Journal. 2008;8(3). DOI: 10.2202/1524-5861.1365

9. Miller M.H., Modigliani F. The cost of capital, corporation finance and the theory of investment. The American Economic Review. 1958;48(3):261-297.

10. Stiglitz J.E. A re-examination of the Modigliani-Miller theorem. The American Economic Review. 1969;59(5):784-793.

11. Stiglitz J.E. On the irrelevance of corporate financial policy. The American Economic Review. 1974;64(6):851-866.

12. Grossman S.J., Stiglitz J.E. Information and competitive price systems. The American Economic Review. 1976;66(2):246-253.

13. Grossman S.J., Stiglitz J.E. On value maximization and alternative objectives of the firm information and competitive price systems. The Journal of Finance. 1977;32(2):389-402.

14. Grossman S.J., Stiglitz J.E. On the impossibility of informationally efficient markets. The American Economic Review. 1980;70(3):393-408.

15. Grossman S.J., Stiglitz J.E. Stockholder unanimity in making production and financial decisions. The Quarterly Journal of Economics. 1980;94(3):543-566.

16. Greenwald B., Stiglitz J. E. Pecuniary and market mediated externalities: Towards a general theory of the welfare economics of economies with imperfect information and incomplete markets. NBER Working Paper. 1984;(1304).

17. Allen F., Gale D. Financial contagion. Journal of Political Economy. 2000;108(1):1-33.

18. Allen F., Gale D. Understanding financial crises. Oxford, New York: Oxford University Press; 2007. 320 p.

19. Stiglitz J.E. Where modern macroeconomics went wrong. Oxford Review of Economic Policy. 2018;34(1- 2):70-106.

20. Benjamin B., Capponi A., Stiglitz J.E. Bail-ins and bail-outs: Incentives, connectivity, and systemic stability. NBER Working Paper. 2017;(23747).

21. Battiston S., Caldarelli G., May R.M, Roukny T., Stiglitz J. E. The price of complexity in financial networks. PNAS. Proceedings of the National Academy of Sciences of the United States of America. 2016;113(36):10031- 10036.

22. Roukny T., Battiston S., Stiglitz J. E. Interconnectedness as a source of uncertainty in systemic risk. Journal of Financial Stability. 2018;35:93-106.

23. Battiston S., Delli Gatti D., Gallegati M., Greenwald B., Stiglitz J. E. Liaisons dangereuses: Increasing connectivity, risk sharing, and systemic risk. Journal of Economic Dynamics and Control. 2012;36(8):1121- 1141.

24. Stiglitz J.E. Dйjа Voodoo. Project Syndicate. Oct. 4, 2017.

25. Stiglitz J.E. Thumbs down to Facebook's cryptocurrency. Project Syndicate. July 2, 2019.

26. Rogoff K. The curse of cash: How large-denomination bills aid crime and tax evasion and constrain monetary policy. Princeton, NJ, Woodstock: Princeton University Press; 2016. 296 p.

27. Stiglitz J. E. Macro-economic management in an electronic credit/financial system. NBER Working Paper. 2017;(23032).

28. Atkinson A. B., Stiglitz J. E. The design of tax structure: Direct versus indirect taxation. Journal of Public Economics. 1976;6(1-2):55-75.

29. Chamley C. Optimal taxation of capital income in general equilibrium with infinite lives. Econometrica. 1986;54(3):607-622.

30. Judd K. L. Redistributive taxation in a simple perfect foresight model. Journal of Public Economics. 1985;28(1):59-83.

31. Stiglitz J.E. Taxation, corporate financial policy, and the cost of capital. Journal of Public Economics. 1973;2(1):1-34.

32. Stiglitz J.E. The corporation tax. Journal of Public Economics. 1976;5(3-4):303-311.

33. Korinek A., Stiglitz J.E. Dividend taxation and intertemporal tax arbitrage. Journal of Public Economics. 2009;93(1-2):142-159.

34. Stiglitz J.E. No more half-measures on corporate taxes. Project Syndicate. Oct. 7, 2019.

35. Cohn A., Gesche T., Marйchal M. Honesty in the digital age. University of Zurich. Department of Economics. Working Paper. 2018;(280).

36. Cohn A., Fehr E., Marйchal M.A. Business culture and dishonesty in the banking industry. Nature. 2014;516:86-89.

Размещено на Allbest.ru