LSE Institute of Global Policy
Globalization Requires an Ambitious Reform of International Taxation
Philippe Martin
Full Professor, Department of Economics, Sciences Po

The multilateral trading system is now under attack by the country which has been its main inspirer, the United States. The current view of the US administration of trade as a zero sum game where some countries (with trade surpluses) gain at the expense of others (with trade deficits) marks a stark departure from previous administrations as well as from the consensus of economists. It is therefore important to have in mind the losses that a trade war would entail. A simulation of a trade war (see Jean, Martin and Sapir, 2018 and Vicard 2018) shows large permanent losses (around 3% to 4% of GDP for the EU, US and China and much larger for smaller countries) that are similar to the estimated permanent effect of the Great Recession. Benefits of trade (and losses of a trade war) should not be overestimated (there are also decreasing returns to trade liberalization) but they do exist.

This is not to say that benefits of trade liberalisation are evenly distributed. In fact, it has been known for a long time that international trade can not only increase inequalities but also create losers (be they individuals or regions inside countries).

The standard response of economists is that if trade generates aggregate gains but with winners and losers, it should always be possible to transfer some of the gains from the winners to compensate the losers or to use increased resources to improve (through retraining for example) the fate of those who lost their jobs. However, with the possible exception of the Scandinavian countries, industrialised countries have failed to redistribute the benefits of globalisation.
This may partly explain the striking contrast between economists support to trade and public opinion. 60% of French people have a negative opinion of globalisation and only 13% are favourable to a deeper trade openness. The French are more critical of trade integration than the Germans: 75% of the French and 57% of Germans are favourable to greater protection against foreign competition. Also, 68% of the French and 55% of Germans consider that globalisation increases social inequalities. Economists broadly share these concerns on inequality and point out that over the last thirty years increasing globalisation in trade has increased competition between markets, often at the expense of certain categories of workers in developed countries. This is in particular the case for the impact of Chinese imports, (see Author D.H., D. Dorn and G.H. Hanson (2013) for the US case and Malgouyres C. (2017) for the French case). Several empirical studies have assessed the impact of increased imports from emerging and developing countries (mainly China). The increase in inequalities and the effects on wages and employment in developed countries can be partly attributed to the increase in imports from emerging and developing countries. The studies found that the regional employment areas most exposed to competition from Chinese imports –intensive in unskilled work– are the ones that have experienced the greatest decline in manufacturing jobs.

The standard response of economists is that if trade generates aggregate gains but with winners and losers, it should always be possible to transfer some of the gains from the winners to compensate the losers or to use increased resources to improve (through retraining for example) the fate of those who lost their jobs. However, with the possible exception of the Scandinavian countries, industrialised countries have failed to redistribute the benefits of globalisation. This is true both in the US and in the EU. Instruments seeking to mitigate the negative consequences of trade liberalisation exist (for example the European globalisation adjustment fund), but the tasks and resources assigned to these instruments are manifestly insufficient. It may be that trade is a positive sum for countries as a whole but we have failed to make it a positive sum gain for all inside countries. Why? Political reasons exist but financial ones should also be mentioned. At the same time as trade globalization should have led to more redistribution from winners to losers to make it socially and politically sustainable, financial liberalization made it more difficult for governments to tax the winners. The mobility of capital, of production and of the taxable base indeed makes this redistribution more difficult because it means that the gains of globalization and of technology by individuals and multinational firms can more easily be shifted to low tax countries. In practice, along with competition and tax optimisation (or even tax evasion) it puts an unprecedented pressure on our redistribution systems. Trade integration also acts as an incentive to play the game of tax competition as it facilitates the relocation of production in response to tax advantages. Trade integration (in particular in services which is a key vector of profit shifting towards tax havens) and trade liberalization make it more difficult for countries to tax the winners (for example large multinationals) and redistribute efficiently to the losers. Moreover, profit shifting by multinationals reduces the willingness of ordinary citizens to pay taxes (a clear issue of fairness during the recent “gilets jaunes” crisis in France) which puts even more strain on public finances. Assessments of the magnitude of profit shifting are subject to uncertainty due to the lack of detailed and comprehensive information at the firm level and comparable data across countries. By comparing profit to wages ratios of multinational firms in tax havens and in high tax countries, it is still possible to identify the “abnormal” profits attributable to profit shifting. Globally, in 2015, recent work by economists (see Torslov, T., L. Wier et G. Zucman, 2018) estimates that 600 billion euros of profits were placed by multinational companies in tax havens, nearly 40% of their foreign profits, a large increase since the mid-1990s. Multinationals not only shift profits to tax havens, they also shift sales so as to further disconnect sales and production to avoid paying corporate taxes (see Laffitte and Toubal, 2019). This is amplified by digitalization of the economy but the international taxation problem is not limited to the digital sector.

Governments have been slow to react but the present G20-OECD project on Base Erosion and Profit shifting (BEPS) is a promising avenue. The international tax system is in a deep crisis and must indeed be urgently reformed. Reducing profit shifting not only would increase tax revenues for most countries, it would also reduce the global incentive to reduce taxes on corporate profits. The period where the sole objective of the international tax rules was to facilitate the development of international trade and investment through the elimination of double taxation is over. An equity objective (so that countries get their “fair” share of tax revenues but also that mobile factors pay their “fair” share) should now be at the core of the reform of the international tax system. Only if the perceived lack of fairness on the contribution of the winners of globalization and technological progress is addressed, will globalization itself be politically and socially sustainable.

International Taxation numbers on graph
Author D.H., D. Dorn and G.H. Hanson (2013): “The China Syndrome: Local Labor Market Effects of Import Competition in the United States”, American Economic Review,
vol. 103, no 6

Jean, Sébastien Philippe Martin and André Sapir, International Trade Under Attack: What Strategy for Europe? Les notes du conseil d’analyse économique, no 46, July 2018

Laffitte, S. et F. Toubal. (2019) : “A Fistful of Dollars? Foreign Sales Platforms and Profit Shifting in Tax Havens”, CEPII

Malgouyres C. (2017): “The Impact of Chinese Import Competition on the Local Structure of Employment and Wages: Evidence from France”, Journal of Regional Science, vol. 5, no 3, pp. 411-441.

Torslov, T., L. Wier et G. Zucman (2018): “The Missing Profits of Nations”, NBER working paper, n°24701

Vicard V. (2018): “Une estimation de l’impact des politiques commerciales sur le PIB par les nouveaux modèles quantitatifs de commerce”, Focus du CAE, no 22, July.

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