TWN Info Service on WTO and Trade Issues (Sept09/11)
18 September 2009
Third World Network

Financial markets, capital flows and impact of the Doha Round
Published in SUNS #6771 dated 14 September 2009

Geneva, 9 Sep (Chakravarthi Raghavan*) - As the world economy appears to be showing signs of recovery from its worst economic crisis since the Great Depression, with jobless growth though, developing countries need to assess their particular situations, and take precautionary regulatory and other steps to insulate their national economies and financial markets from renewed bouts of financial crisis that could be transmitted through the trading system, and in particular, commitments they have or may undertake on "Trade in Financial Services" and GATS disciplines in the current Doha Round.

The world economy is passing through critical times, and has just managed to escape the ravages of the Great Depression. However, despite the talk of the end of the recession, and green shoots, the world economy may not really be out of the crisis, and will have to go through a long period of jobless growth. In any event, it may take some years for the effects to be over. In the meantime, if lessons are not learnt from the crisis and remedial measures, including on socially useless financial speculation, are not taken before long, the world economy and developing countries may be enveloped in another financial crisis.

Since the outbreak of the crisis in 1997, and more so since 2007, there has been much writing and attention paid to the financial system and its governance and regulation, and the reforms that need to be undertaken. Some attention has been paid to the effects of the crisis, and the freezing of credit and trade-finance on trade.

However, there has been little or no focus on the systemic linkages between the global Financial and Trade systems, and their feedbacks in loops. This is in contrast with the vision of the designers and architects of the post-war systems, who had a clear vision and perspective on the overarching UN and its political, security, economic and social systems, the Bretton Woods system, and an envisaged Havana Charter and its multilateral trading system.

A working paper for the Group of 24 by this writer, "Financial Services, the WTO and Initiatives for Global Financial Reform", has focussed on these systemic inter-linkages.

Currently, in the wake of the financial systemic crisis, and the massive tax-payer-financed bailout of major financial institutions in the centres, various processes have been set in motion. These so-called Bretton Woods II processes under way - for reform of national and global regimes for governance, stronger regulations and their enforcement - will however be incomplete and may even be unsuccessful if parallel efforts are not made at the WTO and its ongoing Doha Round, in particular, on "trade in financial services".

There are attempts in these negotiations to liberalise "trade in financial services" on the basis of faith and failed theory - due in part to an absence of statistical data, and even more, due to a misunderstanding of the trade and money and finance systemic linkages.

Soon after President Barack Obama took office in the United States, the main centre where the crisis originated, and until about April this year, for a brief moment, it looked as if the view of the former Federal Reserve Chairman, Paul Volcker, would prevail in the US administration, and that forces for fundamental reforms will prevail in the main centre of the financial disorder. This is no longer so, and it is not even certain that any financial and regulatory reforms being mooted or under way will be more than window-dressing or a band-aid approach to an arterial hemorrhage.

In terms of the developing countries, if the fundamental regulatory reforms of the global financial system and architecture do not take place, it would mean that the financial crisis will come back with a vengeance. Key developing countries and their experts and negotiators, both at the Bretton Woods institutions (like the Group of 24), and their counterparts and colleagues in the trading systems, need to concert and coordinate and ensure that they are not enveloped in the next crisis.

In the current crisis, developing countries by and large escaped direct embroilment in the financial crisis - simply because they have not yet been "integrated" into the global financial system and the global capital and financial markets. However, they are still paying the costs in the form of the economic crisis that ensued. Next time, if they do not take actions both on the financial and trade fronts, they may get sucked into the financial crisis too.

Looking at it purely from the perspective of "mainstream economics", in a New York Times Sunday magazine article on 6 September, Nobel Laureate Paul Krugman has analysed (1) the failure (with some exceptions) of mainstream economists to predict this crisis and the collapse of the financial markets, and said: "In short, the belief in efficient financial markets blinded many if not most economists to the emergence of the biggest financial bubble in history. And efficient-market theory also played a significant role in inflating that bubble in the first place."

Also, earlier in September, the chair of the UK Financial Services Authority, Lord Turner, has questioned the social value of much of the activities of financial trades, and has called for remedial measures, inviting the wrath of the financial services industries and trades.

In other words, in the view of two eminent market economists, there is nothing like perfect markets, and financial markets are inherently unstable and irrational, and regulatory reforms and their strict enforcement need to focus on them.

In any such regulatory reforms, it will be perilous to ignore the issues of "international trade in financial services" and their regulations - both existing regulatory and systemic gaps (including the complete absence of international bankruptcy regimes, brought to the fore in the collapse of Lehman Brothers) and how to insulate and safeguard national monetary and financial systems from the failures of the global financial system feeding into national systems via trade in financial services.

For example, it is acknowledged that in India, a financial crisis and meltdown was averted because of the wisdom of India's then Central Bank Governor, Mr. Yaga Venugopal Reddy, in not allowing himself to be carried away by theories of benefits of financial liberalisation and globalization, and imposing bans and severe restrictions on banks and financial sectors from: (a) lending money to buy land for development, and restricting or preventing sub-prime mortgages, and (b) and severely restricting banks from trading in derivatives, even banning some trades.

He was at that time accused of preventing innovation, but it has been later acknowledged that his actions saved the system. His actions would not have been possible or feasible, if for example, India had committed itself to liberalisation of its trade in financial services, and had undertaken "commitments" under the Financial Services Agreement, in accordance with the "Understanding on Commitments in Financial Services" (an additional modality proposed in the Uruguay Round and the Marrakesh Final Act), as the US, and most of the OECD/G10 countries had done. Apart from them, some of the Caribbean small island economies with offshore finance centres, and Nigeria undertook commitments in accordance with the Understanding. In the current Doha Round, major developing countries are being asked to undertake financial services liberalisation commitments in accordance with the Understanding.

For a proper focus on and attention to the intricacies of the trade in financial services, and its framework of the Financial Services Agreement (FSA), it is essential to bear in mind the nature of the overall Marrakesh Treaty (the WTO agreement), and its annexed agreements in the areas of Trade in Goods, Trade in Services, Trade-related Aspects of Intellectual Property Rights, and the integrated Dispute Settlement Understanding. The WTO and its agreements at Marrakesh became a Single Undertaking (with every member having to sign on to every agreement). In international law, when countries are parties to several agreements, they are expected to abide by all of them. And if there are conflicts, there are some well-known and accepted rules of interpretation - the later treaty overriding an earlier one, a particular treaty overriding a general one etc.

However, since Marrakesh, through the Dispute Settlement Process, the Appellate Body (AB) of the WTO, whose rulings are adopted and become binding through negative consensus, has made the clarification and interpretation of the rights and obligations of members under the various agreements a Single Undertaking, and has said the AB will so clarify and interpret the agreements that there will be no conflict - and this has given rise to complaints of the AB undertaking a rule-making role.

The intricacies and complications of these interlocking arrangements are explained in the Working Paper for the Group of 24, "Financial Services, the WTO and Initiatives for Global Financial Reform" (

The "international trade in financial services", under the WTO, is governed by the 1997 Financial Services Agreement (FSA-1997), and the individual market access commitments and obligations undertaken by countries and inscribed, with some specified limitations, in their country schedules on Services and Financial Services.

The scheme of the WTO, GATS and the DSU ensure that member countries not only have obligations in the trade on financial services arising out of their scheduled commitments (and any future ones they may undertake in the Doha Round or future multilateral negotiations), but also the other rules, disciplines and regulations, of the WTO agreement and the GATS.

An important element of these, in terms of translating any global financial and regulatory reforms, into parallel or equivalent reforms of "trade in finance", would require such reforms to be negotiated and agreement entered into at the WTO. In general, if care is not taken by member countries, this leaves enormous scope for forum games and regulatory captures to frustrate reforms.

And without parallel reforms in the rules relating to "trade in financial services", and any related rules of the GATS and the WTO, some of the financial sector and regulatory reforms that countries are undertaking can be challenged in WTO disputes.

For example, some of the regulatory actions, like bans on short-selling, or some of the assistance now extended to financial institutions - such as the TARP (Troubled Assets Relief Program) loans in the USA, or the government-guaranteed low-interest loans that financial institutions and firms are accessing, may be amenable to challenge through the WTO dispute settlement process.

It may seem incongruous that actions taken by a country to save a bank or its financial system, could be challenged at the WTO, through the dispute settlement process. However, this is the nature of the WTO animal, and hence the need for very careful assessments.

Each WTO member, who has undertaken commitments in services and in particular, in financial services, has obligations arising from: (a) the WTO treaty and its various annexed agreements, including the DSU; (b) the various provisions of the GATS; ( c) the provisions of the Financial Services Agreement of 1997; and their schedules on market access commitments in services filed at Marrakesh, and subsequently modified by schedules of market access commitments in financial services - the sectors or sub-sectors or specific services within them on which they have undertaken commitments, limitations for these in terms of market access, any exceptions in terms of national treatment and/or additional commitments.

At the WTO, while for financial services, there is a prudential carve-out set out in para 2 (a) of the Financial Services Annex to GATS, and the first sentence of that para gives an over-riding right to take prudential measures ("Notwithstanding any other provisions of this Agreement etc"), the second sentence qualifies this by saying that "where such prudential measures do not conform with the provisions of this agreement, they shall not be used as a means of avoiding the Member's commitments or obligations under this Agreement". This makes it a subjective judgement of a panel on a dispute raised before it. And while GATS is yet to formulate the mandated disciplines on subsidies, in the absence of a specific exception to national treatment on this listed in a country's schedule, a Member's action in going to the rescue of a bank or insurance enterprise by giving loans at concessional rates etc can be challenged.

The US, in a further complication, has incorporated by reference, in its head-notes on financial services schedule, the "Understanding on Commitments in Financial Services". In its services schedule filed at Marrakesh, it has entered a general horizontal national limitation on subsidies. But in its financial services schedule, where it has head-notes and incorporated the Understanding, there is no such national treatment limitation. This makes it a fruitful field for trade lawyers. And it is doubtful whether TARP loans, or the FDIC (Federal Deposit Insurance Corporation) guarantees that enable some big banks to raise money at cheaper interest rates, are covered even by the general horizontal national treatment exception on subsidies in the 1994 schedule.

Perhaps one of the elements inhibiting such challenges now is the cost of the DSU litigation, estimated by Canada recently as involving some C$12 million and a 3-year time period - showing that the DSU is of benefit only for the rich. Another is that despite the attempts to present the DSU - with its panels and Appellate Body - as a kind of independent, judicial process, it is not so, as cited in the Working Paper, and in some of the academic writings on this issue. All this introduces at the least an element of uncertainty into the regulatory stability and predictability of a country's financial system and its actions. It is worth noting that there is no time-bar for raising disputes, nor does the Anglo-Saxon legal principle of "stare decis" apply in international law or WTO disputes.

And when one talks of "financial services" in WTO terms, the definition covers a very wide range of activities, and not merely the 16 items mentioned in the illustrative list of financial services in the financial services annex of the GATS. A financial service, according to Paragraph 5 (a ) of the Financial Services Annex, is "any service of a financial nature offered by a financial service supplier of a Member". And GATS does not define what is a "service", or what is a "financial nature".

For example, very recently, the United States and European Communities took up with China as a dispute the issue of Chinese regulations and restrictions on three international news services - Reuters, Bloomberg and AP Dow Jones over their rights for the collection and distribution of "financial news and services" in China. It was taken up as a dispute bilaterally (prior to raising it at the WTO), and as a violation by China of the GATS and market access obligations it undertook. And the dispute was settled on that basis - though the terms of that settlement are yet to be notified at the WTO and made public.

In much of the current discussions, the successful conclusion of the Doha Round is being promoted more or less as a panacea for the economic crisis and problems: over the last 2-3 years, it has been presented by WTO Director-General Pascal Lamy as a solution for the food crisis and prices, as a solution to the financial crisis, and most recently, also as a solution for the Climate Change issues.

In fact, it appears to have acquired in international discourse the role that "mother love and apple pie" once had in the US political discourse - something one could not disagree with. In the US now, with the obesity problem threatening to be a major health issue of pandemic proportions, and the "culture wars" over gay rights and same sex marriages, perhaps it easier to oppose "mother love and apple pie"; but the successful conclusion of the Doha Round as a panacea for problems is not challenged - excepting in a growing section of civil society.

In at least two respects, if remedial actions are not taken, the conclusion of the Doha Round even on the basis of "what is on the table" may have negative effects for financial regulatory reforms.

Firstly, even prior to the launch of the Doha Round, in an era of euphoria about benefits of liberalisation of trade in services and financial globalisation, the GATS Council on Trade in Services has adopted (May 1997) in respect of "accountancy services", the Guidelines for Mutual Recognition Agreements or Arrangements in the Accountancy Sector; and following on that, in December 1998, by the Disciplines on Domestic Regulation in the Accountancy Sector. The Anderson accounting firm that was involved in the Enron scandals, and ceased operations as an audit and accounting service, played a large role in drawing up these rules. These rules and disciplines will become effective as part of the Doha single undertaking.

When that happens, countries may find it difficult to take strong regulatory measures against audit firms that combine consultancy with their audit functions or against rating agencies.

Second, on the agenda of the Doha Round, Services chapter, are draft GATS Domestic Regulation Disciplines (to be adopted under Art. VI:4 of GATS). These, as formulated in the GATS Services Negotiating Chair's text of July 2009, could prove problematic for regulatory provisions of several developing countries (See South Centre analytical study by Ellen Gould - SC/AN/TDP/SV/12).

Third, is the enormous "Gaps in Statistical Data on Trade in Services" highlighted on pp 29-35 of the working paper, and in the monograph (Raghavan, 2002, "Developing Countries and Services Trade: Chasing a black cat in a dark room, blindfolded", Third World Network, Penang). All currently cited data about trade in services (based on the IMF's BOP and EBOP) do not reflect the services trades of countries or sectors, as defined by GATS. At present, the only available data are those bandied about on the basis of the BOP and EBOP data; by definition, these data relate to transactions between "residents" and "non-residents". Most of the data cited are about benefits of conclusion of the Doha Round and its liberalisation of trade in services.

A recent Petersen Institute working paper estimates a $100 billion trade gain if there is equivalent of 10% reduction in services trade barriers! However, GATS definition of services in Mode 3 (currently, the main and major one on which there is focus in the Doha Round) is by commercial presence. Such trade is between the foreign service provider "resident" in the country and resident consumers. This cannot be reflected in BOP or EBOP data that are used to project benefits.

And the manual adopted with the imprimateur of the UN (Statistical Commission decision/recommendation, formulated on one page of a 28-page report of the Commission to ECOSOC and taken note of by ECOSOC, and in turn, by the UN General Assembly) has ignored the GATS definition and the mandate. And the latest is that the task of improving the quality of the manual has been "outsourced" by the UN Statistical Commission to the OECD!

Whatever use such data may produce, its use for GATS negotiations will be akin to Andrew Lang's definition of statistics ("He uses statistics as a drunken man uses lampposts - for support rather than illumination").

In this light, a question that needs to be seriously weighed in country capitals now, and more so in capitals of developing countries, is the real implications of GATS as an "agreement" of the WTO system. Within it, must be weighed the wisdom of further market access openings and concessions - more so in Mode 3, and to some extent, in Modes 1 and 2, in a wide range of financial services, without reaching a clearer understanding, and arriving at prior agreements to strengthen and enforce regulations rather than reducing them. Even the wisdom of financial globalization and its benefits would need to be re-assessed in capitals.

The Doha Round of negotiations are at an impasse - with major public attention for revival focused on agriculture and non-agricultural market access issues. Notwithstanding the efforts to shift the focus away from financial sector reforms to the trade front, it is probable that the trade negotiations may not reach a conclusion for a year or two. This gives developing countries time and opportunity to examine their own particular situations, think through their particular needs, and, if needed, revisit proposals and partial tentative accords in the trade negotiations, including on financial services and GATS rules.

In theory, WTO governance structures and consensus decision-making, with every member having the theoretical right to object, enables developing countries to have an equal voice. However, in practice, while developing countries and their groups have been able to prevent certain actions and policy courses, they have not been so successful in prevailing in a positive way.

Preserving the status quo will not be beneficial to the developing world.

(* Mr. Chakravarthi Raghavan is Editor Emeritus of the SUNS. The above is based on remarks made by him at the G-24 Technical Group meeting in Geneva on September 7, during a panel discussion on "Implications for Regulation of Financial Markets and Capital Flows".)