Advanced economies of the world, G7 countries reached an agreement by signing a pact about multinational companies. The pact was signed to curb tax erosion by multinationals and implement source-based taxation rule on technology companies. The meeting agreed on a global minimum corporate tax rate of 15% which would deter countries who use their low tax system to attract MNCs. US treasury secretary Janet Yellen says that this agreement will end the 30-year race to the bottom. Digital monopolies do not have physical infrastructure in every country they do business in, they use this loophole to evade taxation and pay taxes only in those countries where they have a physical infrastructure. Countries like India levy digital service tax or equalisation levy to reduce tax erosion. Companies use a giant web of subsidiaries to shift profits to low tax regime countries to save money. This deal may take months or years to come into existence as rounds of negotiations on details within the G7 and with the rest of the world are remaining. This pact will create divide of haves and have nots, a global minimum tax made to curb tax erosion by corporates undermines countries whose major income depends on a low taxation regime.
Given the pandemic and failure of market, this G7 summit post-Donald Trump era is seen as the harbinger of change. With normalcy and an agenda to work on. Donald Trump disrupted the working of G7 and outrightly postponed G7 saying that it was not in sync with the reality of the world. He had a problem with representation saying that it was a group of outdated countries. (He may have a point about not in sync with reality).
How will the G7 pact change the relationship between states and the market?
The pact aims at three types of changes.
- First, it gives control to the states instead of market to decide key policies. It detests the idea of neoliberalism where states should step in only when necessary and leave the rest to Making market the boss lead to consequences like untameable big technology corporates and insecurity about future.
- Coronavirus has reminded us that public goods like healthcare, education and climate are far more important than money. Free-market deterred domestic players to focus on these areas because global harmony advised against it and market was supposed to do everything. The 2008 financial crisis showed that the government was only supposed to pick up pieces that were left by market.
- The third change is the will to commit towards the greater good- When India asked the US to put Pakistan on an international terrorism watchlist after 26/11 the US said that it’s India’s domestic After 9/11 the US wasted no time enlisting Pakistan on the watchlist. The talk of public goods picks up momentum only when advanced economies face problems like corona deaths in the US, Italy, UK et cetera.
The G7 proposal regarding minimum taxation is good in principle but according to the Tax Justice Network report United States, Netherlands and United Kingdom are most responsible for tax losses imposed on other countries. The US, Switzerland, Singapore and Hong Kong fare highest on financial secrecy index. These countries allow individuals to hide their financial records from other governments. Unless the advanced economies are in jeopardy no momentum takes place, this trust deficit will motivate China to disrupt negotiations in the upcoming G20 meet.
All eyes are set on further meetings with the G20 hoping that it will bring down the Washington consensus and replace it with a possible London/Cornwall consensus.
What is Washington consensus? Why does it need to go?
Economics is a dynamic subject that needs to change with the changing world. When laws of excessive supply and supply create their demand failed and brought perils, it was substituted by Keynesian economics. Washington consensus is a term used for 10 economic policy changes that were part of a reform package made for crisis wrecked developing countries in 1989. It was supported by the International Monitory Fund (IMF), the World Bank and of course United States of America.
The consensus asked for macroeconomic stabilisation, liberalisation that is opening up markets for investment and trade, excepting marginal rate of taxation, elimination of subsidies, privatisation etc. It believed in market fundamentalism and that market will figure everything out.
If all these measures are followed it jeopardises the domestic players of developing world and exposes them to competitive prices of developed world. This consensus in the name of helping developing world created a larger market for developed countries like the United States to feed on. It believed in the idea of trickle-down effect and surrendering to the market forces to determine important factors like interest rate, currency exchange rate, inflation etc. In 1991 India introduced the new economic policy or LPG policy where India agreed to open its markets against a loan from IMF and World Bank. There have been a lot of criticisms against the Washington consensus which circles the idea that developing world was forced to accept harsh conditions in the name of reform. The criticism is-
- Free trade is not always the best choice for developing world. Just like babies have to be supported until they can stand on their own 2 feet infant economies also deserve the same treatment like subsidies, import tariffs et cetera to provide long term growth. Free trade is like the law of the jungle where the strongest and weakest are equated. A lion and a rabbit are no match to each other hence competition between them is unfair.
- The Chinese interventionist model where firms invest in developing economies to create public sector infrastructure is also another way to go about it. They invested in markets of Latin America, Asia, Africa and proved that an interventionist approach can bring back money.
- Free-market leads to credit dysregulation and creates an artificial bubble of growth. When this bubble burst, its result was the 2008 financial crisis. But India due to its solid economic policy of did not suffer much.
- Washington Consensus is also blamed for causing Latin American crisis of increased inequality 1980s, South East Asian crisis and the Argentinian economic crisis of 1999.
What does India say about the new economic order?
As per the Washington consensus and the need for macroeconomic stability, India was following a budgetary fiscal deficit of 3% with the help of FRBM Act. India is now moving away from rigid fiscal consolidation, following the path laid down by economist Oliver Blanchard. Blanchard says, “if interest rate paid by the government is less than the growth rate, then the intertemporal budget constraint facing the government no longer binds“. Intertemporal constraint means cash outflows cannot be greater than cash inflows. The new budget pegs fiscal deficit at 9.5% of GDP for the financial year 2021 and 6.8% for financial year 2020. Spend like there’s no tomorrow is the motto. This sudden change is because of IMF and World Bank are now urging everyone to move away from the Washington consensus and increase the debt to GDP ratio. Before, ideal debt to GDP ratio would not cross 100% but now advanced economies are urged to spend more by increasing deficits. This need for increased spending is because of global stagnation due to pandemic. The Economic Survey of India reported that expansionary fiscal policy will cause low debt to GDP ratio because our growth rate has always been higher than our interest rate, India till 2030 need not worry about mounting debts.