How globalization trips up the tax man

The free trade tax: The poor get poorer.

Published January 17, 2006 6:53PM (EST)

In theory, free trade is supposed to benefit everyone; this is a cornerstone of modern economics. But in practice, as Joseph Stiglitz and Andrew Charlton demonstrate in "Fair Trade for All: How Trade Can Promote Development," it doesn't always work out that way.

So-called trade liberalization is great for advanced economies, which can easily reallocate resources -- labor, capital, etc. -- to sectors of the economy where they might have an advantage. But in poor, undeveloped nations that are suffering from high unemployment, a lack of easy, cheap access to capital, and a host of other institutional problems, trade liberalization can often mean that previously protected industries take a hit, while nothing new emerges to replace them.

Some supporting evidence for this argument arrived today, via a New Economist link to an NBER research paper exploring the impact of globalization on the tax bases of developing countries.

Here, globalization is defined as "a process that induces countries to embrace greater trade and financial integration." But what happens as a result, write authors Joshua Aizenman and Yothin Jinjarak, is that the tax base moves from "easy to collect" taxes to "hard to collect" taxes.

Easy-to-collect taxes include such things as tariffs, and a somewhat ill-defined category called "financial repression." Hard-to-collect taxes include income, sales and value-added taxes (VAT).

Examining data from the last 20 years, the economists found that advanced and middle-range economies were able to make up what they lost in easy-to-collect taxes from the new hard-to-collect taxes. Exhibit A for the advantages of free trade. But the poorest, least-developed countries actually saw overall tax revenues decline by an average of 7 percent. The reason: Hard-to-collect taxes are, well, hard to collect. The poorest countries do not have the institutions in place to easily shift to new sources of revenue.

The research would appear to support a major gripe that leaders of developing nations often express with respect to the pressure for trade liberalization exerted by the U.S. and the European Union. So far, the evidence that the poorest will benefit from opening up wide is scant.

This doesn't mean that in the long run, freer trade won't make the world a more prosperous place. That's still most likely true. The point that Stiglitz and Charlton stress is that we'll only get to that future if the developed world does a lot more than it is currently doing to help those who are lagging behind make the transition.

By Andrew Leonard

Andrew Leonard is a staff writer at Salon. On Twitter, @koxinga21.

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Globalization How The World Works Taxes