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Financing sustainability: where has all the money gone?
Ladislau Dowbor
7 December 2015
“The job of ensuring that the financial system is fit for sustainable development
has just begun” – UNEP – Aligning the financial system with sustainable development
“There is no shortage of money waiting to be put to productive use. The problem is that the world’s financial markets, meant to intermediate efficiently between savings and investment opportunities, instead misallocate capital and create risk”. – Joseph Stiglitz, on the 2015 Addis Ababa Conference on Financing for Development
“Banks should return to doing what they were created to do in the first place: offer a safe environment for people’s savings and provide capital to business for development purposes”. – C. J. Polychroniou
The overall challenge we are facing is not difficult to define: on one hand, climate change, the destruction of wild life, overfishing in the oceans, the cutting down of rainforests and so many other slow motion catastrophes demand deep-pocket investments to save the planet; on the other hand, studies on inequality and social dramas are showing with very clear figures that the economic governance is out of control. In short, we are destroying the planet for the benefit of the few. This doesn’t work. And it is not getting fixed: the earth does not vote, nor do the poor or the next generations that will bear the disasters we are creating. It is a lopsided democracy.
Yet we have the necessary financial resources and the knowledge to face both the environmental and the social inclusion issues. The world presently produces 73 trillion dollars of goods and services for 7,2 billion inhabitants. In rough figures, this means over three thousand dollars per month for every four person family. Total in the accumulated personal wealth (houses, cars, savings etc.) and social capital (roads, dams etc.), and we see every human being could live a reasonably decent life. From this point of view, Brazil is situated exactly at the world average. But of course, some people are more average than others, and this goes for countries and cities.
Money is just paper. But those who have access to it in large figures, can buy a villa in Nice, fly a private jet, invest in a productive startup, or just buy other papers. Overall, the villa in Nice and the private jet won’t make a big difference. Productive investment does make a difference, because invested money becomes growth inducing capital: it creates goods and services, and generates jobs, which in turn will expand demand and markets for the created goods and services. The wheels will turn. These were the (relatively) good times. But nowadays buying other papers is the real thing where big money is made.
As we entered the 1980’s, investing in papers started to generate more profit than investing in production. Centuries after the Venice bankers, we rediscovered the golden path: pecunia pecuniam parit, money begets money. This is somewhat difficult for the English speaking world to grasp, since buying dollars or options in derivatives, gambling on what will go up or down, is called investment just like building a dam or creating a factory. In French the distinction is clear: investissements is one thing, placements financiers another. In Brazil, investimento and aplicações financeiras. The Economist, at a loss to properly address money clearly going into speculation, such as gambling on the variation of different financial papers without creating any new wealth, called themspeculative investments. But the basic issue is that getting rich and investing in production are now very much divorced. This is all that “world’s financial markets”, in Stiglitz’s words above, is about. Pecunia pecuniam parit.
The world is awash with information on what should be done. From Our Common Future to The Future we Want, from the Millenium Goals to the Sustainable Development Goals, and the Paris COP21 Summit, the road we must take has never been so clear. But in the present rules of the game, when putting money in the world’s financial markets earns big returns, while putting money in clean production or productive inclusion of the poor earns warm smiles, things will just not work. Not because people are evil, particularly at the top, but because an institutional investor managing a huge pension fund is bound to maximize returns or lose his job. And as it seeks maximum returns, it will not hesitate to squeeze the real-economics productive firm to the limit.
The engineers at Samarco know how to build a dam and understand risk evaluation, but Samarco is controlled by Vale and Billiton, which manage huge financial systems where financial returns are way above environment or social concerns in corporate governance. The huge disaster in Mariana, the worst in Brazilian history, is not very different, in terms on how decisions are made at the top, from the Volkswagen scandal on toxic emissions, or the already forgotten Enron scam, the irresponsible speculation frenzy at Lehman Brothers, or the Libor and other fraud involving practically every member of the top financial institutions club.
The basic challenge is how to build new rules of the game, so that the convergence between environmental, social and economic interests can be restored. In Brazil, private pension funds have roughly 200 billion dollars to work with. They seek a basic return of 5,5% a year to cover future pensions payments. This money could be invested in the small and medium enterprise to stimulate production and jobs, or in new less disruptive technology in agriculture and so forth. This would stimulate economic growth and better cover our needs in the future, as well as improve sustainability, income and social stability, the so-called triple bottom line. As it is, they can simply put the money in government bonds which in 2015 pay 14.25% a year, ensuring total liquidity, no risk, good earnings. The government pays this interest from the taxes it collects from the population. Thus the public pays for private pension funds with public money, and the wheel turns without any money going into what would be useful for society.
This simple example shows that the issue is not with the lack of financial resources to face our challenges, but with what we can call the governance, or the decision process, concerning their management. The financial flows have been cornered to serve financial intermediaries, instead of serving sustainable development. If we do not face this challenge, no amount of discussions will help. It is not a question of sequestering the villa in Nice, but of generating rules of the game where the staggering amount of unproductive money is put back to work for society, and for the earth, and for the future generations. In this paper, we shall concentrate on the concrete example of how financial intermediaries in Brazil have stalled 20 years of progress, and thrown the country into recession.
The international dimension
But first we must have a look at the overall situation in this area of finance. No country is an island in these days, and this is particularly true for money, which has been reduced to bits, travelling in fractions of seconds and huge amounts on the waves. Dematerialized money flows in the global space, while regulation is fragmented into roughly 195 countries with different governments and a diversity of regulations. Global finance flows in unregulated space, notwithstanding the strong declarations during successive G20 meetings. No global regulation means no government regulation, since if a central bank decides to regulate big money, it will simply flow somewhere else. The huge title on the IMF publication Finance&Development cover, “Who’s in charge?”says it all. Nobody is in charge. Actually, the financial corporations are in charge.
One of the few positive results of the 2008 ongoing crisis is that for the first time we have some solid numbers concerning the financial world. The Swiss Federal Institute of Technology (ETH) presents the first figures on how the global network of corporate control works. Basically, in the corporate world, 737 groups control 80% of the system, while a nucleus of 147 corporations controls 40% of the system. Of these, 75% are financial intermediation groups. These are staggering figures, and the research is generating ample debate. With such a degree of concentration of economic power, we need no conspiracy theory. And the degree of concentration also generates systemic risk, because of the huge volatility and the amounts of resources involved. The sheer size of the groups involved in worldwide different activities makes rational management impossible, and the political power they wield makes democratic process a fiction.
Example of a few international financial connections. In red the European groups; in blue the North American ones; other countries in green. The dominance of the two first is evident, and coincides with the map of the present financial crisis. Only a small part of the links is shown here. Source: Vitali, Glattfelder e Fattiston,
The crisis has also highlighted the importance of tax havens and illegal money in general. James Henry, former McKinsey chief economist, estimates the overall value at between 21 and 32 trillion dollars, roughly between one third and one half of world GDP. In a special report The Economist settled on the probable figure of 20 trillion. Most importantly, it shows that the illegal money is not stacked in some paradisiac islands, but basically in Delaware, Miami and London, and managed by the same big banks which rig the Libor and Euribor figures, engage in money laundering and so forth. Basically the same financial groups presented in the ETH study.
The international dimension, since the 2008 crisis, if not better regulated, is now at least better documented. The crisis and the evident chaotic behavior of the financial system stimulated a collection of basic data on international finance, which interestingly, always eluded the International Financial Statistics of the IMF. In other studies we presented the detail of each of the new research carried out, with only the main results summarized here:
Research by the ICIJ (International Consortium of Investigative Journalists) has identified many names of companies and owners of fortunes, with details of instructions and transactions progressively released as they work with the immense files received. In November 2014, they published the massive tax evasion scheme of multinationals, using the tax haven that Luxembourg has become. The amounts of evasion by Itaú and Bradesco are presented in detail. ( ICIJ, 2014) (Fernando Rodrigues, 2014)
The study by Joshua Schneyer, systematizing Reuters data shows that 16 international business groups control the bulk of intermediation of planetary commodities (grain, energy, minerals), mostly based in tax havens (Geneva in particular), creating the current framework for financial-commercial speculation on products that make up the blood of the world economy. Derivatives of this speculative economy (outstanding derivatives) surpass 600 trillion, for a world GDP of 73 trillion. (BIS, 2013) (Schneyer, 2013)
The Credit Suisse discloses the analysis of the large world fortunes showing the concentration of ownership of 223 trillion dollars accrued (accumulated assets, not the annual income), that is to say, basically 1% of the wealthiest own about 50% of the wealth accumulated on the planet. The most commented figure in the 2015 Davos economic forum was that 80 persons have more wealth than the bottom half of the world population. (Oxfam, 2015)
The drain on productive activities, on the side of consumption as well as investment, is planetary. It is part of an international machine that since the liberalization of financial regulation, by the Reagan and Thatcher governments in the early 1980s, until the settlement of the main regulatory system, the Glass-Steagall Act, by Clinton in 1999, generated an international free-for-all.
Thus we have a deformed planetary system, and Brazil is just playing its part in the global process of capital concentration through financial and commercial intermediaries. Information is far from complete in this shadowy area. However, two studies give us some orders of magnitude.
The mentioned study by the Tax Justice Network gives us some basic figures of capital amounts in tax havens by regions. In Brazil, the order of magnitude is of 519.5 billion dollars, which represents about a third of Brazilian GDP. (First line, sixth column of figures on table below).This is naturally the stock of Brazilian money in tax havens, not the yearly flow, but it represents a huge amount, and the government is fighting for its repatriation.
Source:
As such, Brazil is not isolated in this planetary system, nor is it particularly corrupt. But the whole set-up created is indeed heavily corrupted. Data for Brazil, 519.5 billion dollars in terms of offshore capital, are impressive, ranking fourth in the world. These resources should pay the taxes that would allow expanding public investment, and should be applied in fostering the economy where they were generated.
A second particularly interesting study is from the Global Financial Integrity, coordinated by Dev Kar, Brazil: capital flight, illicit flows and macro-economic crises, 1960-2012. This is a drain of resources by evasion estimated at 100 billion reais per year between 2010 and 2012 (over 2% of GDP). These are resources which in turn feed a good part of the 519,5 billion dollars in tax havens seen above. According to the report, "the [Brazilian] government should engage more efforts to combat both under-invoicing of exports and overpricing of imports, actively adopting additional deterrent measures rather than retroactive punishment." Here, multinational companies prevail. Kofi Annan believes that this mechanism drains about 38 billion dollars a year from the African economies. The mechanism is known as mispricing, or trade misinvoicing, and has been intensely debated in the January 2015 African Union meeting, with the yearly evasion estimated at 53 billion dollars. (GFI, 2014 and 2015)
First of all, it is important to understand the limits of government’s action. At international level, while the American and European elites will indeed continue to tolerate tax havens, including in the USA itself as in the case of the State of Delaware, and in Europe as in the case of Luxembourg and Switzerland, real control will be almost impossible. Tax evasion became too simple, and the ability to locate the illegal capital is remote. The order may, however, be significantly improved by controlling the outputs, transfer pricing and the like. The GFI report mentioned above, points out these possibilities and acknowledges strong advances by Brazil in recent years. On an international level, the BEPS (Base Erosion and Profit Shifting) endorsed by 40 countries representing 90% of world GDP, gives us some hope as to the onset of a reduction of the planetary system of tax evasion by transnational corporations. (OECD, 2014)
The numbers have to be put in perspective. The Rio+20 summit hoped to raise 30 billion dollars to fund sustainability worldwide, while Brazil alone has over 500 billion dollars in tax havens, and the overall tax haven money is more than 20 trillion dollars. The Paris COP21 summit on climate change is hoping to drum up 100 billion dollars until 2020. Our hopes are to depend on Bill Gates or Mark Zuckerberg? However generous or simply conscious some people can be, we need a social and political compact to build sustainable development, and the figures that are being discussed are ridiculous. To quote Siglitz again, “new geopolitical realities demand new forms of global governance”.
Sustainable development in Brazil
Brazil has come a long way. Ending the corporation-supported military dictatorship in 1985 brought us back to civilization, the 1988 Constitution generated basic civil rules of the game, the breakdown of hyperinflation in 1994 (it reached 80% a month!) brought us back to normal accounting and planning practices. And in 2003 the Lula government organized the first countrywide and long term integral problem to fight poverty and social exclusion. Bolsa Família is widely known, but the Ministry for Social Development coordinated 149 such programs, involving Luz para Todos which brought electricity to whole deprived regions, a more decent minimum wage law, large scale stimulation of formal jobs, social security for people in informal and rural activities and so forth.
The results can be seen in the large scale study by IBGE (the Brazilian institute of Statistics), IPEA (the national economic research institute), FJP (an academic research foundation) and UNDP. The results are impressive. In 1991, 85% of the 5570 municipalities in Brazil were listed in the lowest Human Development Indicators, the “”very low” class, under 0,500 HDI. In 2010, only 0,6% of the municipalities remained in this class. Life expectancy rose from 65 years in 1991 to 75 in 2014. Brazilians earned ten more years to complain. Child mortality fell from 30 to 15 per thousand. Overall 36 million people were pulled out of poverty, the Gini inequality indicator fell from 0,58 to 0,49, curiously approaching the Gini indicator in the US which reached 0,45 and climbing. In 1991 only 13% of 18-20 youths had completed secondary schooling, in 2010 the proportion reached 41%. In two decades, coming from very low, Brazil has been transformed. And yet, so much has yet to be built.