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TWN Briefings for WSSD No.11

Comments on the Treatment of the International Financial Architecture in WSSD Action Plan

By Goh Chien Yen

The treatment of global financial instability within the WSSD’s Plan of Action is remarkably timid in recognizing the depth and extent of the problem, inadequate in substance in terms of its recommendations, places the bulk of the burden on developing countries despite the imbalance between international debtors and creditors, and generally makes light of the severe consequences suffered by the crisis-stricken developing countries and the poor.

Inadequacy of proposed measures

The increased frequency and virulence of international currency and financial crises clearly demonstrates that instability has become global and systemic. Yet acknowledgement of this predicament does not even constitute a paragraph of its own and is obliquely captured in only para 45(alt). Even then this is in contention, which means that the WSSD text will not recognize the problem of international financial instability.

Para 45(alt)...There is further fear of increasing instability in the international economic and financial system,...[1]

Generally, the WSSD text has not addressed the establishment of a multilateral system for international finance based on a few core principles and rules, preferring instead to focus on strengthening of the domestic financial systems of debtor countries in crisis prevention. Thus the text (still not agreed) reads as follows:

‘(k) [Encourage national efforts to adopt better and more transparent forms of financial market regulation, including through, inter alia, the implementation of the Monterrey Consensus;] / [Delete subparagraph since it is contained in section IX;]

(l) [Strengthen the capacities of developing countries by increasing assistance from multilateral and regional financial institutions, inter alia, for public/private initiatives that improve access, accuracy, timeliness and coverage of information on countries and financial markets;] / [Encourage public/private initiatives that enhance the ease of access, accuracy, timeliness and coverage of information on countries and financial markets, which strengthen capacities for risk assessment. Multilateral financial institutions could provide further assistance for these .’

The approach here is focused on lowering the risk of financial distress and contagion by strengthening the domestic financial systems in debtor countries. It has also emphasized the provision of timely and adequate information regarding the activities of the public sector and financial markets in debtor countries in order to allow international lenders and creditors to make better decisions, thereby theoretically reducing market failures.

While their application should be generally beneficial, they will not necessarily contribute to financial stability. Considered from the standpoint of systemic reform, the suggested initiatives contain many omissions and reflect a lopsided view of different parties’ responsibilities for the changes required. It does not address the concerns of developing countries over the usually supply driven nature of volatile capital flows, which are strongly influenced by monetary conditions in the major industrial countries, particularly the US and the herd behaviour of lenders and investors in those countries. The obligations contained in the WSSD text seem to reflect the view that the main flaws in the system for capital movements are to be found in recipient countries, which should bear the main burden of the main adjustments needed to prevent or contain financial crises. By contrast, there are no measures at all in the text to reduce volatile capital flows at the source or to increase the transparency of currently largely unregulated cross border financial operations.

Between the two possible formulations in sub-para (l), the latter which places slightly greater emphasis on the roles of the private sector and multilateral institutions, is the relatively more balanced approach.  Nonetheless, paras (k) and (l) on their own are wholly inadequate.

Reform of BWIs

‘78. Make full and effective use of existing [non-financial and] financial mechanisms and institutions, including through actions at all levels to:

(a)  [Strengthen the efforts of the Bretton Woods institutions and make the existing international financial architecture more transparent, equitable, and inclusive, and provide for full and effective participation of developing countries in international economic decision-making processes and institutions with the objective of supporting their efforts to achieve sustainable development;]

(a.alt) [Encourage efforts by the Bretton Woods institutions to [make]/[strengthen] the existing international financial architecture more transparent, equitable, [rules-based] and inclusive, and [able to] provide for [and encourage] full and effective participation of developing countries in meeting the challenges and seizing the opportunities of globalization in international economic decision-making processes and institutions with the objective of supporting their efforts to achieve sustainable development;]’

Even a rules-based system raises concerns for developing countries: under the current distribution of power and governance of global institutions, such a system would be likely to reflect the interests of larger and richer countries rather than to address the imbalances between international debtors and creditors.

Calls for more transparent, accountable and participatory governance are not new and have consistently fallen upon unsympathetic ears, with the basic modalities and procedures for taking decisions largely unchanged. Hence more imploring language is necessary even though it is unclear how this can actually lead to real change, especially when developed countries jealously guard their dominance over the BWIs.

It is paramount that the BWIs should give greater weight to the views of developing economies, since the raison d’etre of these institutions is now to be found mainly in their mandates and operations which take them further and further into influencing the domestic policy choices of developing countries.

If reforms to the existing financial structures are to be credible they must provide for greater collective influence from developing countries and embody a genuine spirit of cooperation among all countries, facing many different problems but sharing a common desire to see a more stable international financial and monetary system. No less than a fundamental reform of the governance of multilateral institutions is therefore necessary.

Reform of International financial system

‘78 (b) [Provide a more predictable and secure international financial environment, that can contribute to the sustainable development of developing countries, by inter alia, measures to mitigate the impact of excessive volatility of short-term capital flows.]’

Arguably this is the only sentence in the entire text that captures some of the concerns of developing countries. In order to establish a more secure global financial system the international community should be calling for greater transparency in the way the financial markets operate. Specifically, there should be more disclosure of the players and deals in the various markets, including trade in currencies. In particular, the funds available to and the operations of highly leveraged institutions such as hedge funds should be made public and subject to regulation.

At the global level, there should be a system of monitoring of short term capital flows, tracing the activities of the major players and institutions, so that the sources and movements of speculative capital can be publicly know.

There should be greater regulation of the behaviour and operations of financial institutions. A distinction should be made between legitimate forms of investment that lead to genuine development, and unethical methods of speculation and market manipulation. Regulatory measures should be taken to prevent, prohibit or control the latter.

Unsurprisingly not only is this sub-paragraph in bold; it is also square bracketed. Some developed countries are particularly insistent that the reference to short-term capital flows be dropped altogether.  This runs counter both to the acceptance that short term flows are debilitating and the traumatic experiences suffered by developing countries as a result of sharp and rapid inflows and outflows of massive amounts of capital.

What is therefore urgently needed is an international policy environment which can be enunciated at the WSSD that treats the use of capital controls as a normal part of national financial policy with the aims of shielding a country from the turbulence of potential volatile flows of funds and of having greater stability in the exchange rate. With a more sympathetic international environment, developing countries can then feel comfortable with using the option of selectively maintaining capital controls to regulate inflow and outflow of funds.

Uncertainty surrounds whether there will be any adequate reforms to the international financial system and developing countries continue to be subjected to volatile capital flows. It is thus imperative that developing countries be encouraged and allowed to establish a national policy framework to deal with international capital flows, if sustainable development is to take root.

Conclusion

The WSSD text on the international financial system currently runs the risk of keeping out the much-needed reform agenda and many issues of immediate concern to developing countries. Objectives commonly shared by developing countries include: more balanced and symmetrical treatment of debtors and creditors regarding codes and standards, transparency, regulation and crisis management; more stable exchange rates among the major industrial countries, especially with respect to their effects on capital flows, exchange rates and trade flows of developing countries; less intrusive conditionality; and above all, more democratic and participatory multilateral institutions and processes.

Reference

[1]   Text in bold means that it is in contention and is subject to change. When it is square bracketed, it means that some countries are adverse not only to the language but the concept as well and want it deleted accordingly.

 


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