In case you’ve managed to miss it (which is possible, considering the vulgar paucity of coverage it has received in the US), the biggest global news story in a long time broke less than two days ago. How big is it, you might ask? So big that at least one head of government has already stepped down because of it, and many more names, including Vladimir Putin and Xi Jinping, are on the naughty list. What happened was that documents were leaked that revealed that many of the world’s most important political leaders, sports officials, and financial institutions were involved in a shell company scheme in Panama. The documents that revealed this scandal were so numerous and in so many different languages that media outlets around the world took over a year to collaboratively decode them before releasing them simultaneously this past weekend, and the process of engineering that collaboration will probably get the Spotlight treatment itself in a few years.
So what exactly is a shell company? I wasn’t entirely certain either, but in a gem of wit, Reddit user DanGliesack explains here on the “Explain Like I’m 5” subreddit:
When you get a quarter you put it in the piggy bank. The piggy bank is on a shelf in your closet. Your mom knows this and she checks on it every once in a while, so she knows when you put more money in or spend it.
Now one day, you might decide “I don’t want mom to look at my money.” So you go over to Johnny’s house with an extra piggy bank that you’re going to keep in his room. You write your name on it and put it in his closet. Johnny’s mom is always very busy, so she never has time to check on his piggy bank. So you can keep yours there and it will stay a secret.
Now all the kids in the neighborhood think this is a good idea, and everyone goes to Johnny’s house with extra piggy banks. Now Johnny’s closet is full of piggy banks from everyone in the neighborhood.
One day, Johnny’s mom comes home and sees all the piggy banks. She gets very mad and calls everyone’s parents to let them know.
Now not everyone did this for a bad reason. Eric’s older brother always steals from his piggy bank, so he just wanted a better hiding spot. Timmy wanted to save up to buy his mom a birthday present without her knowing. Sammy just did it because he thought it was fun. But many kids did do it for a bad reason. Jacob was stealing people’s lunch money and didn’t want his parents to figure it out. Michael was stealing money from his mom’s purse. Fat Bobby’s parents put him on a diet, and didn’t want them to figure out when he was buying candy.
Now in real life, many very important people were just caught hiding their piggy banks at Johnny’s house in Panama. Today their moms all found out. Pretty soon, we’ll know more about which of these important people were doing it for bad reasons and which were doing it for good reasons. But almost everyone is in trouble regardless, because it’s against the rules to keep secrets no matter what.
In slightly more grown-up terms, many countries charge different tax rates depending on what you do with your money – investments often get taxed less highly than money deposited in a bank since, supposedly, they’re doing productive work in the economy. So a shell company is essentially a bank that poses as a company taking investments, so that “investors” can simply store their money safely in a bank while getting the tax discount as if they were investing. Got it? Good.
This entire scandal raises far more questions than it answers.
First of this non-exhaustive list, how did this scheme stay secret for so long, especially since reporters around the world knew the gist for a year before going public?
Second, why are there so few Americans on the list?
Third, what does this scandal say about the nature of globalization and inequality?
I can’t begin to answer the first one. To the second, I recently learned that the United States – or, more specifically, Reno, Nevada – has become a financial safe haven that is rivaling or eclipsing Switzerland, the Caymans, etc. The reason for this is that the United States in recent years has become a sort of financial watchdog for international capital flows of Americans, attempting to crack down on tax avoidance by increasing reporting requirements from offshore or Swiss bank accounts. However, one country on which the United States has not been particularly harsh during this crusade is the United States, meaning that many Americans may have chosen to find less risky domestic methods of tax evasion rather than doing so abroad.
The third question is more to the meat of economic philosophy. The traditional factors of production – the things you have to acquire in order to make economies work and that can shift between countries and industries over time – are land, labor, and capital. That trifecta had emerged by the 19th century, and perhaps it is fitting to add new factors like “energy” and “bandwidth” or “data” into some modern calculations. But the critical thing to grasp is that individuals and entities all possess at least one of these factors, and trade them for the use of, or product of, other such factors, and that forms the basis of a market or an economy.
Now, if you notice, the fluidity with which some of these factors of production move across borders or between industries is not equal. Land pretty much stays where it is, barring military conquest or switching between industries (e.g. turning a cattle ranch into a solar array). Capital was once extremely immobile (e.g. in the ancient world wherein you would have to tote a bag of gold around wherever you went) but as banking networks began to spread in the late middle ages capital has been increasingly liberated every century, and with digitization it now moves at the speed of light or at the regulated speed limit of financial transactions. Labor, the third in the traditional trifecta, can vary immensely. Slaves, serfs and the like have little labor mobility; residents of nation-states can move much more easily within their own countries than if they try to cross borders; and in modern post-national institutions like the European Union people can move around from country to country as long as they can handle the changes in language, culture, and institutions. Factors such as access to transportation or cultural tendencies to migrate also play an important role.
Now, generally speaking, these factors of production all have ways of working themselves out. An economy that is rich in land but poor in capital and labor may attract settlers and investors willing to seek their fortunes, like in the settlement of the American West; a trade metropolis that grows rich in capital may develop inflation, be willing to pay higher wages, and attract denizens of the hinterland seeking their fortune in the big city; an overpopulated region, or one that has just experiences a loss of jobs, may see an exodus of workers like the Rust Belt-Sun Belt migrations in the US, or see an influx of capital investors seeking cheap labor, such as with outsourcing today.
As some perceive, however (my opinion on the matter is far from settled), global agreements in the post-WWII era have “unfairly” liberated the flow of capital far more than they have liberated the flow of labor. NAFTA, for instance, allows the owners of capital in the US and Canada to build factories in Mexico; however, Mexico, which is relatively richer in labor than in capital, cannot send its labor to the capital-rich US with nearly the same ease, and can only, in this scenario, reap benefits from the exchange on the terms of the owners of the capital in that they can decide if and when to invest in Mexico.
This general dynamic brings us back to the main point of this rambling post: an unemployed American, say, in Oklahoma, especially a middle-aged one who has spent his life working on oil rigs, or a West Virginia Coal Miner, cannot up and move to Manhattan or Silicon Valley and hope to take advantage of the relative abundance of capital, much less can they move to globally capital-rich countries like Oman, Norway, or Monaco. On the other hand, a wealthy Icelander or Russian can invest their [yes, I am intentionally using a singular ‘they’!] capital wherever they want around the world with relative ease, investing in an Oklahoma oil company or West Virginia coal company if they so choose, but also investing in a New York hedge fund or Silicon Valley Startup if they so choose.
One of the several ways in which this system can work for the benefit of those unemployed oil patch workers or coal miners is if governments tax the money international investors make from those international investments, putting it back into the educational system or social welfare system.
When international investors hide that money away, however, in international tax havens, or place their savings in shell companies to avoid negative interest rates, for example, that money is not taxed, and those individuals who make their livings by renting out their labor instead of renting out their capital get a decidedly worse part of the deal.
Now, there are plenty of other ways in which the system does provide different benefits for them, but that’s another post entirely.