An equitable development

Something important happened in Paris last week. Led by France, up to 10 countries agreed to impose a tax on air travel, with the money used to increase spending on overseas aid. Every passenger departing French territory will pay an airline ticket levy (ATL) of between €1 ($1.20) and €40, depending on the destination of the flight and the class of ticket. The amount of money raised will initially be modest. At best the levy might raise $1bn a year, but that is not really the point. The French president, Jacques Chirac, believes that if the idea proves workable, a further 20 countries could sign up, making the levy a far more lucrative source of funds.

Chirac's ATL is one of a number of ideas that were floated at the two-day innovative financing conference. Also on the table was Gordon Brown's international finance facility (IFF). Paris and London struck a deal in which France backed Brown in return for British support for the ATL. The two countries announced a working party to report back on the IFF before the annual meetings of the International Monetary Fund and the World Bank in September.

The disadvantage of the ATL is that the amounts it will raise, even with 30 countries signed up, will be modest compared with the sums said to be necessary to meet the UN development goals. The G8 is talking about boosting aid spending by nearly $50bn a year by 2010; the most optimistic estimate of the revenue to be generated by the ATL puts the sum at $5bn annually. On the up side the ATL has the virtue of simplicity and is a source of genuinely new money.

That may help explain why it has found more international support than the IFF, which is essentially a live-now, pay-later scheme. Brown's idea is that rich governments float bonds on the world's financial markets and thereby increase the cash available for overseas development over the next 10 years, when the pressure is on to meet the millennium development goals set by the UN. The idea is to "front-load" aid spending in the hope that this will provide the springboard for economic growth. The bonds will have to be repaid out of future aid budgets, but the British chancellor believes that by the time the repayments fall due, poor countries will be better able to stand on their own feet.

The refusal of the US to have anything to do with the idea means there is no hope of Brown reaching his original goal of $50bn through an IFF, but if Britain and France go ahead, it might raise $5bn-plus a year. There is no reason why the ATL and the IFF need to compete. One possibility being canvassed by London is that the relatively small amounts of cash from the ATL could be used to leverage bigger sums through a bond flotation under IFF. Another form of synergy would be to earmark funds from the levy to pay back investors in the IFF when the bonds fall due for repayment in 10 or 15 years. This would remove one of the more important objections to the plan - namely that there may still be a need for substantial development assistance after 2015, when aid budgets would have to be spent repaying bondholders.

Ultimately, though, neither the IFF nor the ATL can compete with a third idea - a tax on foreign exchange transactions. This has two big things going for it. The first is that it raises pots of money, even when levied at very low rates. Estimates by the Stamp Out Poverty campaign group suggest that a 0.005% tax on the world's most traded currencies could generate between $35bn and $40bn a year without really making a dent in banking sector profits.

The second advantage is that in the post-September 11 world, a tax on foreign exchange dealings would be almost impossible to evade. Such is the paranoia about terrorist financing that the authorities now use the most sophisticated electronic technology to keep tabs on flows of money. Avinash Persaud, chairman of Intelligence Capital, a specialist advisory practice for financial institutions, says that whatever validity the old argument about avoidance of a currency tax used to have, it no longer does.

"Today, concern over settlement risk, money laundering and terrorist financing means that the activities of the banks that represent 90% of foreign exchange turnover [are] highly regulated," he said. "Under existing domestic and international banking regulation these banks would face enormous regulatory, credit and technology costs if they tried to opt out of the evolving global settlement systems that make this tax easy to collect. In the best tradition of banking, they will pass this cost on to their customers. Would you object to paying an extra penny for every £200 [$350] you exchanged at the bureau de change?"

Persaud says the cost wouldn't really register with the big market players unless they were exchanging cash backwards and forwards 50 times a year - which he describes as the "volatility-boosting behaviour we would want to discourage". For the time being, supporters of a stamp duty on foreign currency dealing are keeping their powder dry. They want to show that international cooperation can work in a modest way with the ATL, and then extend the principle to a forex levy for international development. Only when that has been accepted will there be an attempt to use a transaction tax as a market-calming mechanism.

Such a proposal would, of course, meet ferocious opposition from the global banking industry. Yet events last month illustrate just how unstable financial markets can be. Iceland is a country that rarely makes the business pages; it has a population of fewer than 300,000 and an economy less than 1% the size of Britain's. But when the ratings agency Fitch downgraded Iceland's debt, it sent ripples through the markets.

Hang on, dealers said, didn't the Asian financial crisis of 1997 start with a balance-of-payments problem in a country that previously had barely blipped on to the radar screen? The lesson of Thailand nine years ago was that the beating of a butterfly's wing can have powerful and costly consequences. As a result, traders took one look at what was happening in Iceland and dumped the currencies of other emerging markets - Hungary, Brazil, South Africa.

The caution was explicable and sensible. After all, the collapse of a bank in Austria prompted the worldwide financial panic in 1931. What is less explicable and less sensible is the insouciance with which the financial fraternity shrugs off these scrapes as the necessary price that has to be paid for open global markets.

Inflation and interest rates are low in the leading industrial nations, and their currencies have been moving in fairly tight ranges. Central bankers tend to like this state of affairs, because it suggests economic stability. Investors don't like it nearly so much, because it means returns are not as big as they would like. So they have been filling their boots with money borrowed in dollars, yen, Swiss francs, euros at suitably low rates of interest and buying assets in countries where interest rates are much higher (including Iceland).

There is a potentially explosive mix here: bubble money and bubble think. Markets have been awash with liquidity and see nothing anomalous about their desire to have - at one and the same time - inflation rising by no more than 2% but the value of assets going up by 10% or more. In the same way that rising household debt in the US is acceptable provided bubble money is pushing up house prices by 15%, so Iceland is a one-off from which there are no wider lessons to be learned. I bet someone said that about Credit-Anstalt in 1931.