For small countries to create an entire profitable industry by passing a few laws appears to be a cheap and effective road to economic development. It is estimated that the size of assets held in these tax havens is in excess of $21 trillion, and most of which is beyond the reach of tax collectors
My first law related job was with a large international bank in New York. I worked for the international trust department or as I called it: the ‘you got it, we hide it’ division. The purpose of our department was to take money from clients who were not citizens of the United States. We would then invest it in the US, but only through one of the bank’s off shore subsidiaries located in one of the Caribbean or European tax havens. Later, I practiced in the US city of Miami. Like my job in New York, I helped to structure in-bound investments by non resident aliens. So, when this week’s Economist published an excellent report on international tax havens (excuse me ‘offshore financial centres' or OFCs), I could not resist making comments.
The most interesting point of the article was of course the size of the tax havens. Presently in the world there are between 50 to 60 active tax havens. They exist in all parts of the world. Some of them are in surprising places. They also specialize. Some like Bermuda are the locations of international insurers. Other like Panama concentrates as flags of convenience.
The plethora of tax havens or OFCs and size of the business is hardly surprising. For small countries to create an entire profitable industry by passing a few laws appears to be a cheap and effective road to economic development. It is estimated that the size of assets held in OFCs is in excess of $21 trillion most of which is beyond the reach of tax collectors. They even have their own vocabulary. Structures to help individuals and businesses avoid tax go by monikers like a “Double Irish” or a “Dutch Sandwich”.
The location of these tax havens is also interesting. They usually fall into one of several categories. The first category is the older more established tax havens in Europe. These include Switzerland, Liechtenstein, Monaco, and Luxembourg which were started after the First World War. These countries profited by their proximity to larger economies. In an era of less international cooperation but nascent globalization, they were able to arbitrage different legal systems. After the war several British dependencies like the Channel Islands, Isle of Mann, the Caymans, British Virgin Islands and Bermuda were able to leverage their special colonial or historical status into financial industries. In the case of the Caymans, a very successful industry, they are now the 5th largest financial centre in the world after London, New York, Tokyo and Zurich.
It was not only the UK. The US also had relationships with a few islands like the Marshall Islands and Samoa. In fact, the US itself is also a tax haven of sorts. Laws making it difficult to determine the beneficial owners of corporations in Delaware and Nevada have made them popular with people with something to hide. Allegedly Miami, my old home town, is the centre for some of the dirtiest money in the US.
The rise of emerging markets has been coupled with the rise of specific tax havens catering to their needs. Much of the money that is exported from Russia goes through Cyprus. Money in and out of India is funnelled through Mauritius. Singapore is far more convenient than Switzerland for much of East Asia.
The real question about tax havens is why they exist at all? With the possible exception of Switzerland, these are tiny and very vulnerable states. Pressure from larger countries can and have forced them to become more transparent. Yet they continue to thrive. The inescapable conclusion is that they fulfil a very real and often protected economic niche which is becoming increasingly necessary in an era of globalization.
Promoters of OFCs like to argue that they provide both regulatory and tax neutrality for international transactions. A kaleidoscope of international laws, overlapping and contradictory regulations might make these transactions impossible. There are also, often, very real reasons for secrecy. Hostile governments often, have confiscatory policies against political enemies and safe havens for cash are a necessity.
Still the misuse of tax havens might outweigh many of their benefits. They are certainly a destination for all sorts of ill gotten gains. Accounts in the Caymans were subject to “massive misuse” by organized gangs from Mexico and elsewhere. It is estimated that elites from 139 low to middle income countries have parked up to $9.3 trillion in these havens. But it is not just small tax havens. Corporate secrecy in places like Delaware made them a favourite of the convicted arms smuggler Viktor Bout, also known as the “Merchant of Death”.
They are also handy in helping with international tax planning. Because under many tax systems subsidiaries are considered as separate entities, transactions between related corporations are taxed at different levels in different jurisdictions. This leads to enormous issues of transfer pricing or perhaps better described as transfer mispricing. For example, American corporate profits are at an all time high in proportion to GDP, but this record has not been matched by the amounts American corporations pay in taxes which are at an all time low.
But like the elites, these corporations have power. Although it is possible to eliminate the problem of tax havens, doing so would have to overcome powerful entrenched interests around the world. Global competitiveness including tax and regulatory arbitrage reduce the prospect for the easiest way to get rid of tax havens: harmonization. If countries could agree on a simple and efficient way to tax their citizens and to regulate their businesses, then the need for tax havens would be sharply reduced. But most countries cannot even agree on the definition of a crime. What is a bribe in one place might be considered only the cost of doing business in another. As long as these divides exist, OFCs will have a bright future.
(William Gamble is president of Emerging Market Strategies. An international lawyer and economist, he developed his theories beginning with his first hand experience and business dealings in the Russia starting in 1993. Mr Gamble holds two graduate law degrees. He was educated at Institute D'Etudes Politique, Trinity College, University of Miami School of Law, and University of Virginia Darden Graduate School of Business Administration. He was a member of the bar in three states, over four different federal courts and has spoken four languages.)
According to the ratings agency, over the next 12 months, troubles for the Indian banking system are likely to increase due to slowdown in economic growth and sluggish fiscal reforms
Standard & Poor's (S&P) Ratings Services has said that the troubles for the Indian banking system are likely to increase over the next 12 months due to slow economic growth and sluggish fiscal reforms and the situation is likely to improve in the fiscal year ending March 2015.
According to the report, titled, "India Banking Outlook 2013: More Pain but Relief Might Be on the Way, performance of the Indian economy and corporate sector are likely to start improving in fiscal 2014.
S&P said, it assumes that the government will be able to carry forward its recent reform initiatives, which could improve operating conditions for the corporate sector and the benefits of these measures could also flow into the banking sector with a lag.
Talking about key factors that affects, the banking sector in India, the ratings agency said, while access to funding remains a strength for domestic banks, they are likely to need significant amounts of capital to meet Basel III norms.
While US, China, Israel and even smaller countries are busy in harnessing their youth to build something innovative, the Infosys, TCS, Wipro and others are just doing mundane tasks that the West thinks is not worth their time. That is fine, but are Indian IT companies then worthy of being entrusted with large and difficult domestic projects like Aadhaar and other government databases?
According to NASSCOM, the IT industry contributed about 7.5% of the GDP. For FY2012, the net revenues were $100 billion. It is also said to employ 2.8 million people directly and 8.9 million indirectly. Indian IT companies compete for deals along with global peers for outsourcing and our companies have the cost advantage. They would get the project executed in India and deliver the end product to the client. This is a win-win situation. The client can get the work done to his satisfaction for a low price. The IT companies earn profits by two means labour arbitrage and dollarrupee arbitrage. The software developer benefits by having a well paid cushy job with occasional overseas opportunities. This industry offers well paying jobs to a large number of young people. The career is also attractive as it provides overseas opportunities. All in all, this paints a very attractive picture. Our government is happy because it has got exports to cut the current account deficit and more jobs are being created. So everything should be all right with this industry. Right?
However, there is a different aspect to this glittering story – the core of which is what is being outsourced and how the country benefits. My issue is with how we have transformed outsourcing. Outsourcing is good as long as it is a level playing field for both the parties. Currently, outsourcing is being seen as doing the core work in-house and outsourcing the menial task to India. India is becoming a dumping ground for all the work that the West doesn’t want to do. The West thinks “I have developed this software but how do I test it?... Ok. Let’s outsource it to the offshore team”. “Calling our clients and reminding them of their mortgage? Let’s hand it over to the Indians.” When it comes to slightly value-added work, they say “We can’t trust the offshore team to do this task. They are not competent enough. Let’s get it done here and get the documentation done by them”
I feel that India shouldn’t be allowed to become a dumping ground. Yes, Indian labour is cheap. Pay them the market rate at India, no problem. But to say that Indian labour is incompetent and thus they should just do these sets of tasks is grossly wrong. Unfortunately, our IT companies are falling head over heels to grab more deals of this kind.
We suffered a brain drain in the ‘80s and ‘90s. We are facing a different kind of problem now. Every year lakhs of engineering graduates join these IT companies. Little do these graduates realise the kind of work that they are going to do. Most of them don’t ever get to do real engineering. They are run through a crash course of few months and then allocated to projects. Not everyone is able to learn it all in the training. Some of them understand this and then move on to better companies, which allow them to do use their skills well. Also their low cost model can’t retain a skilled employee as he is likely to find greener pastures soon. Although no one has ever thought about it, can we imagine a day that when this current set of engineers retires what is that they have to their credit? Did they build something significant? What use did they put to their education they learnt in college? To develop software which would hardly see the light of the day or one which would silently die as it doesn’t serve the intended purpose?
In fact, thanks to intense competition, Indian IT companies will just grab any contract. They don’t care as to what is the nature of the project. They are ready to do tasks like infrastructure management, website management etc. Now that since the pools are drying in the West, they are looking for similar contracts in India. Does by any means handling passport application look like a contract to brag about? Even our government blindly trusts the so-called leaders of this industry.
One should look at US and China. US houses some of the best technology companies. Search engine, social networking, e-commerce, cloud computing and mobile are all that have been brought to the masses by companies based in US. Can our IT companies boast of building something world class? Isn’t our government doing a grave mistake by entrusting the monitoring of UIDAI database to companies which lack the credibility to maintain such a system?
Even China, whose internet regulations are very tight, has its own search engine and social network. While we Indians have always joked saying that China has not adopted outsourcing due to language barrier I feel that it is more a matter of pride for the Chinese to not compromise. The Chairman of a large IT company keeps bragging about what we need to learn from China whenever he goes to a college to deliver a lecture. I wonder what he has learnt from China. The Chairman and the cofounder of the company are from a prestigious college. However the same college doesn’t allow this company for its campus interview because the students of this college realise that they deserve much better. Doesn’t that send a message to them?
Even smaller countries like Israel and a host of Eastern European countries are miles ahead of us in terms of technology. While these countries are busy in harnessing its youth to build something innovative, we Indians are just doing mundane tasks just because the West thinks it is not worth their time and the IT company sees a big dollarrupee arbitrage and labour arbitrage in this. In fact now, we are in the league of countries like Vietnam and Philippines which are proving to be low cost outsourcing destinations. Our IT companies instead of learning a lesson from this and adopting new technologies will open a shop in Vietnam and Philippines.
Indian labour is well-skilled. They just don’t have the right exposure. There is a disconnect between what we learn at our colleges and what actually happens in the industry. Most of the graduates dream of working for big companies but lack innovative thinking. It has become a rat race of sort where every corporate house wants to have a slice of the pie.
If coal, telecom spectrum etc are natural resources, then a country’s human resources are the most valuable assets that it possesses. They drive its economy. Using these resources for such menial tasks should be labelled as a grave crime. NASSCOM the voice of the industry is not any better. It is more a lobby as is FICCI. They raise a hue and cry over a visa restriction but have nothing to say when a ground-breaking technology is released. NASSCOM will organise a string of events to cater to the IT industry but has very few events for startups and product development. This is why a group of companies, which is focused on product development, has parted its way to create a separate group called ISPIRT (www.ispirt.in). Their focus is on innovation and product development.
This sector has created a vicious circle. There are many dependent sectors on it. Housing sector on metros depends on workforce of this industry. The same goes for the auto and consumer goods industry. An entire army of security guards, support and infrastructure staff is deployed in the offices of these companies. A host of mutual funds and insurance companies have invested in these companies. If there is a problem in the West the whole system comes to a halt. Do we plan to build an economy around this?
Our country has a young population. We should harness it to good use. We need to encourage innovation, adoption of new technologies and product development. Among the IT exports only 20% is constituted by products. The young graduates and the adults alike have to be taught that working for a big company is not the ultimate achievement rather building something disruptive is.
Having said this I would also say there are companies which take the outsourcing route but do very good engineering projects. Likewise, not all product companies are good. There are companies which are product-oriented but their engineering doesn’t live up to the mark.
I would like to reiterate that outsourcing is not the problem. The problem here is the greed to earn profits at the cost of quality (of both the software and developer). Some MNCs have tried to copy the outsourcing model by setting up shops in India. Initially the staff was doing mundane tasks at India, however of late the MNCs are offloading some real work to India. This is a welcome step but we need more of this to happen.