When capital flies, but corruption stays behind

March 28, 2013

One of the most important political and economic facts of this young century is that capital has been slipping the traces of the nation-state. Business is global; government is national. That mismatch is one of the big sources of tension in the world today: Whether it comes to taxes, bank regulation or immigration, the fact that money and politics no longer live in the same neighborhood makes consensus harder to achieve.

For Exhibit A, you could point to the flood of Russian rubles into Cypriot banks- and the dramatic consequences.

Global businesses have profited handsomely. Multinationals have legally lowered their tax bills by shifting their profits to low-tax countries: As a scandalized British public recently learned, for example, Starbucks paid 8.6 million pounds, or $13 million, in corporate taxes in Britain over the past 14 years.

For individual plutocrats, taking advantage of globalization is even easier: Move your legal residence – and your money – as the actor Gerard Depardieu or the Facebook co-founder Eduardo Saverin did.

But these lower tax bills come at a cost. As I was told by Kemal Dervis, former minister of economic affairs in Turkey and now vice president of the Brookings Institution, “Capital is seeking to avoid the burden-sharing which makes modern society possible.”

“If every country tries to race towards the lowest rate, then in the end nobody gains,” Dervis said. “If you believe there should be no government at all, then fine. But if you believe some government is good, then you cannot have a system that erodes the tax base in all major countries.”

The big losers, in Dervis’s view, are those who do not have the option of exiting the nation-state: the middle-class citizen and the medium-size business.

The Cypriot economy was an extreme product of the age of global business and a weakening nation-state. Cyprus used to live off a banking sector whose coffers were bloated chiefly by Russian money.

Part of the country’s appeal was the seduction of low taxes and light regulation. But for the Russians, whose home tax rates are low enough to attract Depardieu, that was not Cyprus’s only advantage.

Equally important was the fact that Cyprus allowed affluent Russians to escape the corruption of their home country and to trade it for the rule of law of the European Union. That was a shift with important political consequences.

One of the mysteries of modern Russia is why a country that is relatively rich and well educated is so tolerant of its authoritarian rulers and weak legal system. The political quiescence of the Russian middle class flies in the face of the theory that as the bourgeoisie gains economic power, it will demand a corresponding increase in political rights – a view that implicitly underpinned much of the West’s policy toward post-Soviet Russia.

But, partly thanks to globalization and the mass offshorizatsiya, as the Russians call it, that it has facilitated, that is not how things have turned out. In contrast to the rising middle classes of North America or Western Europe in earlier eras, rich Russians have not needed to fight for the rule of law at home to protect their capital. They have chosen the much simpler option of exporting their money and taking advantage of the rule of law in the West.

As Ivan Krastev, a Bulgarian political scientist, has argued, part of Vladimir V. Putin’s political genius is that he has not blocked the flight of his richest and smartest citizens. Unlike both the czars and the commissars, Putin has realized that letting these people and their rubles go actually makes his regime more stable, by exporting a potentially powerful source of dissent.

But the Cyprus crisis has shown that the Russian elite’s strategy of offshoring the rule of law, rather than building it at home, has its risks, too. When the wolf was at the door, Cypriot citizens had the political muscle in Nicosia and Brussels to defend their interests; Russian bank depositors did not.

The rule of law and a stable financial system are both part of the expensive infrastructure of modern society that Dervis worries is underfinanced. Russian elites found it easier and cheaper to buy these collective goods abroad. But even in this global age, citizenship has its perks, and one of them is that in a moment of crisis, your government might put you first in line.

Plutocrats worldwide have readily understood the advantages of evading the burdens of the nation-state. Cyprus is a reminder that government has benefits as well as costs and that if you opt out of paying the bill, you may find that you get what you pay for.


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You can create any sort of society you want just by the tax incentives and disincentives in force. But that axiom presumes that there is intelligence and thought to constantly keep incentives and disincentives so that they serve the wishes of “we, the people”.

In these United States, the electorate sticks it’s collective head in the sand, tends to vote “straight party tickets” in the mistaken belief that one or both major parties have “the answer” and THEIR interests at heart. Nothing could be further from the truth.

Look around! There is NO link today between “intelligence and thought” and our tax incentives and disincentives in force, nor is there likely to be in the foreseeable future.

Those elected again and again in both parties today have everything THEY want. The “other party” is the boogeyman that assures their reelection with a minimum of effort.

NEITHER political party has ANY intention of EVER actually reducing the size of government, increasing it’s efficiency, or pursuing consensus among the electorate. These things would reduce THEIR influence, so they ain’t gonna happen.

So America pays it’s underclass to sit on their butts and make more of themselves. Our government at every level pays endless benefits to illegal aliens who have easy access to fake green cards, drivers licenses, stolen identities, etc. with which they can receive Medicaid, Medicare, aid to dependent children, school lunch programs, the unearned income credit, food banks, etc.

There are people in their communities and in government offices that help them qualify for all these things; i.e.encourage FRAUD! The money shoveled out comes from the taxes paid by productive citizens or is just printed with NOTHING behind it. Uncle Sam has become the greatest counterfeiter the world has ever known!

To cap it all off, we have “our representatives” falling over themselves to actually LEGALIZE twelve to twenty MILLION fence jumpers with no money, no property, no education, little skill and NO intention of integrating into American society (we print everything in Spanish for them so they and their children don’t have to)! Any one who objects is “anti-immigrant” or racist.

But somehow these bozos aren’t concerned about hospital Emergency rooms overflowing with these people because the law required them “treated”. Some Emergency Rooms and Trauma Centers are closing because the economics of medicine in increasingly mathematically unworkable.

Too many are getting a “free ride”. America is already critically short of family practitioners, but we’re going to fill doctor’s waiting rooms with people now paid for by “Uncle Sugar”. Americans are going to be dying because they can’t get in to see THEIR doctor in less than a MONTH when they fall ill.

But OUR government tells us again and again that it can’t afford to protect AMERICAN CITIZENS’ purchasing power on Social Security…we’re supposed to meekly accept a Chained Index which reduces an index already short-changing seniors. I don’t hear much howling, so maybe we ARE stupid enough to let them get away with what they’re doing. If that’s true, we DESERVE what we get.

OUR government is NOT doing it’s JOB, and we need to FIRE it!

Posted by OneOfTheSheep | Report as abusive

Excerpt from the article: “Business is global; government is national. That mismatch is one of the big sources of tension in the world today…”

This is a profoundly astute observation with myriad global proofs and implications.

Posted by breezinthru | Report as abusive

Whilst there are are some very valid thoughts in this article, I’d like to comment on a couple of points that I believe need to be clarified.

First of all, it’s wrong to say that the flood of Russian rubles triggered or caused the financial sector crisis in Cyprus. What in fact caused it was the lack of prudent risk management both within the banks and Cypriot/European banking regulators, allowing Cypriot banks to invest heavily in Greek bonds and as a consequence incurring huge losses through Greek debt restructuring. In other words, the problem lies with banks’ assets (Greek bonds) rather than with liabilities (deposits of Russians). In fact, there’s much more Russian money in Swiss private banks than in Cypriot banks, but we have not heard of any problems this is causing for Swiss banking industry.

Second, it is wrong to assume that all or even majority of Russian deposits in Cyprus are those of plutocrats and tax evaders. Although I am not a supporter of Putin, there are definitely certain achievements he (or the then Finance Minister Kudrin) can be credited for. Among them the tax reform of early 2000s and liberalization of capital flows, welcomed by emerging middle class, small/medium businesses, and international community. So many Russians opened accounts in Cyprus in a perfectly legal way after paying 13% income tax in Russia. There were many reasons for opening an account in Cyprus – keep part of the money in a European bank (was ironically perceived more reliable than Russian banks in particular by those who had lost money in Russia’s 1998 crisis), buy holiday appartment in Cyprus and so on.

Posted by DimitriV | Report as abusive

Krastev makes an interesting point. Obviously part of the reason Putin kept a liberal stance on offshore money is that he and his inner circle are deeply involved. If there’s one he might provoke a revolution or putsch against himself, it would be to try to restore the strict capital controls of the Soviet era.

There’s something about the Russian money in Cyprus story that just doesn’t add up. The official data from the Cypriot central bank says there were €21b of deposits in Cypriot banks from outside the Eurozone as of the end of February, practically unchanged since last summer. Meanwhile deposits from the rest of the Eurozone have dropped quickly and were less than €4b. I’m having a hard time believing that Russians of all people complacently trusted that all would be okay as others (Greeks mainly I guess) got their money out. Maybe as the process continues something more will surface that will explain.

Posted by tom_the_bear | Report as abusive

I agree that capital needs to recognize the society that it sprang from, with all the attendant advantages that is obviously manifest in its success. Ms. Freeland, maybe we need to enlarge the discussion of capital movements? Back in the eighties, free trade began to eviscerate our auto industry. The Japanese had done it a decade earlier in steel and electronics. Yes, America provides a stable platform for foreign capital, unlike Cyprus. But what has it done to us? Is it corrupt to allow foreign capital to export wealth from us? I’m not advocating cessation of capital flows, but tariffs should be placed to avoid the disappearance of industries, and with them much needed tax revenue and meaningful jobs. If that’s protectionism, then so be it. And isn’t that rooted in the basis for a nation-state?

Posted by aeci | Report as abusive

Some good analysis, but this is hardly new. The French suffered significant outflows in the 20’s when they tried to tax their way to solvency after WW I. My copy of Quicksilver Capital is dated 1991, and it was comprehensive and empirical in its observations then.

For there to be change that can cope with this, some longstanding beliefs must die. I fully understand the marginal propensity aspects of the graduated income tax, but experience teaches that our legislatures are too corrupt, venal, and addicted to rewarding constituencies to make it viable anymore. Go with a modified flat tax, no exemptions, and apply it to all income, and for business, a direct tax on all revenue with all payments registered in the country of the customer.

Won’t happen, because the fact is there are too many constituencies that make a pretty good living off the status quo, including Reuters.

Posted by ARJTurgot2 | Report as abusive

@ ARJTurgot2. Your third paragraph states the issue very well. It also raises the secondary issue as to why these same politicians are motivated chip away at the rights afforded us under the Constitution. (See the comments from the White House regarding Conservative media, the proposed firearm legislation, and the expansion of eminent domain as examples).

By reducing or eliminating alternative opinions, while increasing the reliance on government for our personal security and welfare, and diminishing property rights, the politicians consolidate their power. Both inside the Beltway and in the state capitols. Power tends to corrupt, and absolute power corrupts absolutely.

Posted by COindependent | Report as abusive

What you have missed, Chrystia, is that statist democracies have become generators of sovereign debt, a mechanism for enriching bankers. Large corporations have simply been able to slip this noose. Taxation is armed robbery. Avoiding being robbed is cannot be considered a crime.

Posted by Myroslav | Report as abusive

One historical point explains why Russians have been so keen to bank outside their own country: the governments of Russia, be they Tsarist, Stalinist or Putinist have NEVER put their own citizens first. They have always been all to happy to eat their own. Examples are myriad. So it’s hardly surprising that Russians are not very willing to trust their governments with their interests. Alas, they should not have assumed that Cyprus could be trusted… and should have been paying attention to who Cyprus was investing in. If you have millions on the line, shouldn’t you?

Posted by LidiaW | Report as abusive