The Future of Capital Mobility

When global trade barriers fell capital became free to flow around the world. In turn, it created a burst of jurisdictional competition that seems to have mostly run its course. But what happens as our economy goes digital, and assets of every type are able to by-pass national borders through the cloud?

Factor mobility refers to the ability of factors of production (like land, labor and capital) to move through space and across borders. Some factors are more mobile than others. Land is basically fixed, labor is somewhat sticky, and capital flows around the world like nobody’s business.

In the latter half of the 20th century, increased capital mobility meant firms could reduce tax and compliance burdens with relative ease by sending their capital to “off-shore financial centers” and other locales with special tax and regulatory treatment. This fueled significant jurisdictional competition, especially among smaller states with the most to gain from foreign investment. Corporate tax rates fell across the OECD not because of an international neoliberal conspiracy, but because choice and competition between national tax systems made multinational firms more sensitive to certain forms of taxation. Policy makers basically gave up fighting tax evasion.

From Worthwhile Canadian Initiative

The End of an Era?

The 1990s witnessed a wave of “cyber-utopianism” built on a radical extrapolation of these basic trends. The most buoyant futurists foresaw globalization paired with the information revolution as leading to a “twilight of sovereignty” that spelled “the end of the nation state” and “rebirth of individual liberty in a world-wide context.” Roughly twenty years on, these predictions were clearly overblown, or at least premature. It’s even an issue on which economist Tyler Cowen admits to have changed his mind:

In the 1990s, I thought information technology would be a definitely liberating, democratizing, and pro-liberty force. It seemed that more competition for resources, across borders, would improve economic policy around the entire world. Now this is far from clear.

What exactly changed? Well, rather than continuing forever, competition between jurisdictions induced governments to cooperate. Bilateral treaties and blocs like the European Union traded-off competitive federalism in favor of harmonization. The internet turned out to be a lot less regulation-proof than many expected, with Europe, the US and China all to some extent having started down the path to balkanization. Meanwhile, across the board, measures of globalization appear to be plateauing. Even capital controls seem to be making a mild intellectual comeback.

But what if this is admitting defeat too early? Futurists literate in social science are often surprisingly good at following through the implications of new technologies on the real world, but just bad at placing the sequential steps on a realistic time line. They come from the land of S-curves and exponential growth, while social systems lumber and backslide unpredictably. My instinct is to therefore view the optimism of ’90s cyber-utopians as having grasped some deeper structural truths which we now discount too steeply due to the temporary and aberrant regress at the forefront of our minds.

Let’s Turn Everything Into Capital and See What Happens

The failed promise of capital mobility driving pro-liberty and pro-market reforms is more fundamental than tax treaties or China’s Great Firewall. In essence, what we call “capital” did and does not yet encompass enough stuff.

Capital is a misunderstood concept in economics, metaphysically speaking. It usually refers to wealth like cash and other assets, including “physical capital” like buildings and machinery. But it can also refer to more nebulous things like organizational capital (the relationships and tacit knowledge inside a firm or social club) and human capital (the knowledge and skills one acquires through training or education).

Buildings are concrete and rebar. Labor is people. In contrast, physical and human capital are abstractions, metaphors really, that let us talk about “stocks” of knowledge in an individual or population in the same way, and with analogous economic models, as when we talk about any other capital input. Only instead of bricks, it’s years of education, wages instead of interest rates, and cognitive decline instead of depreciation.

In fact, anything that generates a rate of return and is accumulated in a production process (as opposed to being the final product for consumption) can be thought of as a type of capital. So it’s easy to see how more and more things can come to possess the properties of capital as information technology progresses: “Capital” at root represents an abstraction, and the internet and software at root represent making useful, electronic, globally mobile incarnations of abstractions.

The low mobility of labor (thanks to barriers to high skill immigration) hurts the mobility of human capital indirectly, abstractions be damned. Yet it doesn’t have to. As online tools for outsourcing knowledge intensive work improve, human capital mobility will increase despite the meat-space barriers to labor, just as communication technology and electronic banking let firms abstract their “capital” from the physical gold or banknotes in a vault. Today moving financial capital from a bank in London to a financial services company in the Cayman Islands is as easy as asking each to reconcile some 1s and 0s. Why can’t it be the same for human capital and more? And if it were the case, might we not then see similar jurisdictional competition over payroll and personal income taxes, say, rather than merely over the tax on capital gains?

Consistent with the premature futurism thesis, smart writers have been predicting large and looming social implications from telecommuting and remote work for decades, only to have their visions stymied by some unforeseen technical or psychological barrier. While hiring international freelancers has gotten a lot easier, for many jobs people just prefer face to face contact. Yet we seem to be finally reaching a critical point where video streaming, virtual reality, and collaboration tools are converging to make even the most complex team production viable across borders.

Importing embedded human capital this way can’t be stopped by regulation without significant collateral damage. That’s because the same tools that will soon let us have immersive collaborative experiences with creative workers in India are fundamentally the same tools you’ll use to connect with your Aunt in Peru.

The upshot? As software eats the world, all regulations become capital controls. And capital controls are notoriously hard to enforce.

Multinational as a Service

In order to exploit capital mobility and jurisdictional choice it still helps to be a multinational corporation with economies of scale and subsidiaries that remove residual frictions. Yet cloud storage and computing are changing that, too. The cloud decouples those advantages from traditional firm structures, democratizing regulatory arbitrage. In due course, international networks of data centers will be compelled by competition to sell jurisdictional choice to start-ups and individuals working in the digital economy.

Call it “Multinational as a Service.”

Combine global cloud platforms with software that significantly automates cross border compliance, and otherwise liaisons with regulators on a small firm’s behalf, and the mobility of digital capital falls dramatically. Imagine a software stack where every layer is potentially being routed through a different jurisdiction. The same forces that reward interoperability in software thus give way to interoperability in law.

Major players are investing in MaaS. The biggest, of course, is Amazon Web Services, whose global cloud infrastructure gives clients a choice of twelve different data center regions, taking full account of different local compliance standards. Even more radically, Google has been granted a patent for a mobile, marine-based server farm that would allow “users to conduct network activities that might otherwise be regulated heavily — or even prohibited — by the national laws of the country where a land-based server is located.”

Of course, legal constraints of all kinds are bound to crop up to mollify cloud-based regulatory arbitrage. Nonetheless, the cloud economy is growing orders of magnitude faster than its still-nascent jurisprudence. Already, in the context of cyber-crime, scholars have begun to refer to recovered digital assets (and evidence) as suffering from a “loss of location.” And while cyberspace has always been characterized by a high degree of extraterritoriality, the cloud is a leap forward in removing more latent geographical associations.

For smaller technology firms on the innovative (and regulatory) frontier, having the choice of computational habitat is not about obstructing justice or avoiding legal responsibilities. Instead, it’s about leveling the playing field against multinational incumbents and putting competitive pressure on the state to allow our intellectual capital to flow to its highest valued use.

As Walter B. Wriston wrote in his posthumous update to “The Twilight of Sovereignty,”