TWN Info Service on WTO and Trade (July10/08)
17 July 2010
Third World Network

Global finance and trade systems need major overhaul
Published in SUNS #6964 dated 13 July 2010

Geneva, 12 Jul (Chakravarthi Raghavan*) -- A major overhaul and significant reforms of the international rules and systems of money, finance and trade to overcome the serious weaknesses exposed by the global economic crisis, have been advocated by the United Nations in a report issued last month.

Getting the world economy "back on track" and putting it on a more sustainable path of development will require significant reforms and new thinking, and the ongoing financial crisis provides an opportunity to re-examine and reform the system of global governance so that economic interdependence can be harnessed to overcome poverty instead of being the source of instability and greater inequalities, says the UN.

In its World Economic and Social Survey (WESS 2010), issued last month under the title "Retooling Global Development", the UN has said that the major crises (food, fuel and financial) that have afflicted the world over the last few years owe their origins to major systemic failures in the global economy and weaknesses in the mechanisms for global governance.

The report calls for a major overhaul of the existing systems of trade, aid and finance, so as to ensure that governments have the needed policy space to experiment with solutions appropriate to the local situation.

Among other things, the report calls for a new multilateral agency to enforce rules to be established for better and more comprehensive international financial regulation and supervision, and with governing systems that provide for sufficient representation of all sections of the world community.

"Existing institutions, such as the Basel Committee on Banking Supervision and the Financial Stability Board," the report points out, "are too limited in terms of the scope of their functions and instruments and they lack sufficient representation."

A new multilateral financial authority, the UN says, would also need to ensure coherence between the global financial regulatory framework and multilateral trade rules.

The international trading system, the UN survey notes, is now effectively skewed against small economies, and the system needs to both expand and restrict the scope of the World Trade Organization (WTO) rules.

There is also need for much closer coordination across the trading system, the new regime for international financial regulation, the global reserve system and the mechanisms for mobilizing and channeling development finance and climate funding, the survey adds.

In calling for "coherence in global governance", the WESS says, the financial crisis has highlighted the pressing need for better international financial regulation and better instruments for countries' management of capital flows.

These regulatory needs, it says, create tensions with the General Agreement on Trade in Services (GATS), which aims at easing cross-border financial services flows (Modes 1 and 2). Such inconsistencies can be avoided by defining multilateral rules on trade in financial services as part of a reformed international financial regulatory framework looked after by a specialized body.

Similarly, the complexity of regulatory needs regarding cross-border movements of people could justify the consideration of a separate multilateral framework for consular practices and immigration laws so as to create a transparent and non-discriminatory system of migration for people who wish to move, temporarily or permanently, across borders.

The report argues that the "... trading regime will have to deal with other frameworks for global governance and economic cooperation in key instances of incoherence, including between itself and the plethora of regional and bilateral free trading agreements, between multilateral trading rules and multilateral environmental agreements (especially those on climate change) and between rules on trade in services and international regulatory reforms and international tax cooperation.

"One may question whether, in the latter two areas, the World Trade Organization should be a prime mover or whether, instead, the main competency should lie eventually with specialized environment frameworks and an international financial authority."

This is a truly breathtaking, if idealist, vision for a new order.

There is much to be said in favour of the general thrust of the analysis in the UN survey in relation to the financial crisis and its impacts on the real economy and development.

Its critical look at the global trading rules and systems, with fault lines accentuated by the way the trade organization is led and administered to serve the interests of corporations and the major advanced industrial economies, and the call for overhaul is one that needs to be endorsed and supported.

However, in relation to the WTO and its rules, and in particular the GATS and the commitments by Members under it in "Trade in Financial Services" (which can take place not only via Modes 1 and 2, but also Mode 3 - commercial presence - that the survey has not pinpointed), the WESS has made some suggestions that may be problematic, and could be used to detract from the other important aspects of the UN survey.

The problem is that some of the suggestions for reforms relating to GATS and its Financial Services Trade could result in rules and governance structures of a new authority that would be even more skewed against the large numbers of developing countries, than the WTO, based as it is now on consensus decision-making, with every Member having equal voice, at least in theory. Some suggestions - like that for the cross-border movement of people - are non-starters in the current state of world polity.

For, whatever the rationale and reasoning for any system of rules, the framework of rules and the governance in fact reflect, nationally or in relations among nations, power equations - a reality that cannot be wished away.

"Coherence in global governance", the WESS says, may require rethinking the scope of World Trade Organization disciplines (page xix, Overview).

The subject of "coherence" was brought into and became part of the agenda of track one (the trade in goods) of the Uruguay Round negotiations, launched at Punta del Este in September 1986; it was a sub-item of the negotiating agenda, "Functioning of the GATT system" (of trade in goods) - Part I-E of the Punta del Este Declaration.

That sub-item (iii) called for negotiations "to increase the contribution of the GATT to achieving greater coherence in global economic policy-making through strengthening its relationship with other international organizations responsible for monetary and financial matters."

The GATT Contracting Parties, both in the preparatory process (1982-86) and at Punta del Este itself (September 1986), paid very little attention to the item. It was seen as non-controversial, and more a procedural one. None of the Contracting Parties at Punta del Este or subsequently, had put forward any specific proposals.

In fact, however, it proved to be a hidden agenda of the GATT secretariat.

From its inception in 1947 and until the Marrakesh Treaty came into force in January 1995, the General Agreement on Tariffs and Trade (GATT) was only a provisional arrangement, brought into being under the Protocol of Provisional Application, to be in force pending the entry into force of the Havana Charter, which never came into being (since the US would not ratify it).

As a result, the GATT secretariat, legally, was only an adjunct of the UN with no personality of its own, only functioning as a servicing secretariat for the Contract and the Contracting Parties. In the Uruguay Round negotiations, the agenda item "Functioning of the GATT system" was used by the secretariat, almost towards the end, to push its own agenda for the establishment of an institution with an independent secretariat.

When the Uruguay Round negotiations ended at the official level in December 1993 (with agreements for a WTO, GATT 1994, GATS, TRIPS, the Dispute Settlement Understanding and the Trade Policy Review Mechanism - but with some bilateral tariff negotiations continuing beyond, almost till Marrakesh in
1994), as part of the preparations for the Ministerial meeting at Marrakesh, the exercise among contracting parties for drafting of various declarations began and the "Coherence" issue was one such.

The issue of "coherence in global governance" was seen by the Contracting Parties and their governments as of different aspects - one of them being that of economic policy-level coherence in global management of trade, finance and development. The intergovernmental institutions responsible for management of the three areas (trade, money and finance, and development) were seen as the WTO, the IMF and the World Bank.

With the package of Uruguay Round agreements envisaging the establishment of a World Trade Organization and its own institutional machinery, the GATT secretariat began pushing its idea of using "Coherence" to achieve its goal of becoming co-equal with the IMF and the World Bank, and functioning as a kind of trinity running the world economy.

As Mr. Balkrishan Zutshi, the then Indian ambassador to the GATT and a key negotiator and participant in the process, explains it in a communication to this writer, this was also seen in some quarters as an issue of coordination between the three institutions, at the policy formulation stage and in implementation.

The Ministerial Declaration adopted on this issue at Marrakesh (pp 442-443 of the Legal Texts) recognized that the primary responsibility for economic policy harmonization was that of governments at the national level.

The Declaration envisaged cooperation between the WTO, IMF and World Bank within their respective mandates and "avoiding the imposition on governments of cross-conditionality or additional conditions". The Declaration also directed the WTO to pursue and develop cooperation with international organizations responsible for monetary and financial matters which has since been done.

However, says Zutshi, two points need to be noted.

Firstly, that policy coherence at the national level in most if not in all cases is still a distant goal. Second, the advocates of coherence at the international level seem to believe that harmonization of regulations across countries will bring about such coherence. But this is to forget that one size cannot and does not fit all.

For example, one of the ideas on financial service regulations, namely, the imposition of a tax on banks across the globe, falls in the second category.

In a chapter, "Retooling global trade", the UN survey (page 71, chapter summary) says that "Coherence in global governance requires rethinking the scope of World Trade Organization disciplines. For instance, the needs for strengthening financial regulation in the aftermath of the global financial crisis create tensions with the General Agreement on Trade in Services which aims at easing cross-border financial services flows."

Such conflicts, it suggests, "can be averted by defining multilateral rules for trade in financial services as part of a reformed international financial regulatory framework."

In discussing the WTO and various trades in services, the authors of the WESS seem to have mixed up two issues - one relating to the GATS and its provisions, and the second arising out of individual country commitments incorporated in their schedules.

The WESS says that although the GATS "permits a considerable range of exemptions, since Governments can specify limitations on some of the commitments in particular sectors, such reservations must be signalled at the beginning, because it is difficult from a legal point of view for Governments to introduce them later. Because of the complexity of regulatory needs in many services, developing countries are at a disadvantage in identifying what limitations should be included in advance."

The footnote to this (Fn6, page 84), however cites the US (the world's super-developed, or mal-developed economy) as an example and says, the "United States could find itself subject to dispute should current proposals to re-regulate the financial sector become law."

This footnote adds that in the "additional protocol" under GATS, entitled "Understanding on Commitments in Financial Services" (the Understanding), which the United States signed with other countries, the US "carved out only trading in onion derivatives" under the "Trading of securities and derivative products and services related thereto", and thus subject to complaint on additional regulation on all derivatives except those related to onion futures. Moreover, says the footnote, the US signed on to a "standstill provision on regulatory changes" applicable to the WTO financial services list which is still in effect.

Factually, the Understanding is merely an alternative or supplemental modality or approach - to that envisaged in GATS Part III (Articles XVI, XVII, and XVIII) for entering into and making market access commitments - that WTO Members could use for scheduling commitments in financial services. (See Raghavan 2009, "Financial Services, the WTO, and Initiatives for Global Financial Reform", Group of 24, pp22-28).

Though promoted by the US during the Uruguay Round, the Understanding is not part of the Marrakesh "Legal texts", but merely a part of the Final Act of the Marrakesh Ministerial Conference. Under the Vienna Law of Treaties, the only obligations of the plenipotentiaries at Marrakesh was to carry it back home, for consideration of their governments (to accept, or reject, without jeopardising the Marrakesh Treaty.)

The negotiations on financial services under the GATS continued beyond Marrakesh, and was finally completed in 1997. This provided for the Financial Services Agreement (FSA 1997) and the schedules of individual country commitments in financial services (replacing or modifying their earlier schedules of commitments in this area) to be incorporated into the WTO-GATS through the Fifth protocol. Save for two, all developing countries who signed on to the FSA and the Fifth Protocol, did not use the "Understanding" (a negative list approach), but entered into commitments and scheduled them in terms of GATS Part III.

Only about 34 WTO Members - the US, EU, Switzerland, Canada and other developed countries, and two developing countries (Nigeria and Sri Lanka) - used the Understanding in scheduling their commitments. The US, by a headnote reference, incorporated the Understanding as part of its schedule - but listing a few specified limitations and reservations. This was done by the US Clinton administration (US Trade Representative Charlene Barshevsky and at the Treasury, by Rubin-Summers-Geithner) in order to force the hands of the Congress to enact the changes being promoted by the administration, including the ending of the vestiges of the Glass-Steagall Act.

The GATS scheme and provisions on regulations generally enable existing regulations to be changed and new ones introduced in all sectors provided these do not violate the provisions of the agreement or "nullify market access commitments."

In the Financial Services sector, governed by GATS and the Financial Services Annex, there is further provision for regulatory freedom to address prudential and systemic issues in the sector (Para 2 of the Financial Services Annex), generally referred to as the "Prudential Carveout". This enables for prudential reasons regulations, changes to them, or new ones - which may be in violation of the agreement and even the market access commitments, provided "regulations under this provision are not used as a means of avoiding a commitment." This is an essential and normal anti-circumvention provision in any trade accord. There can be no "prudential carveout" without an anti-circumvention provision.

While many civil society groups, particularly from the US and Europe, view this as blocking regulatory changes, there is the view of several experts and past negotiators who do not see this as an obstacle to the ongoing regulatory process; and some who think that the entire range of regulatory issues being considered presently, within different jurisdictions and multilaterally, can be accommodated within the prudential carveout.

However, there has been no WTO case law on this - arising from a dispute and rulings by a panel and Appellate Body, and this creates some uncertainty. But a way out could be an agreed interpretation by the WTO Ministerial Conference or General Council.

Be that as it may, even any regulatory changes contrary to scheduled commitments, can be done by acting under Art. XXI of GATS for modification of schedules. This of course involves "renegotiation" with Members who may have an interest in trade under that commitment. In fact, however, such renegotiations under Art. XXI of GATS is much easier than under the corresponding provisions for GATT (on trade in goods).

This is because in the absence of services trade statistics (something for which not only the WTO, but the UN and its statisticians and bodies share some responsibility), negotiating rights between parties in GATS could not be determined and recorded.

This gives a Member seeking renegotiations for changing or modifying its schedule of commitments much greater degree of freedom in regard to compensatory commitments. In the absence of reaching an agreement with affected Members, any affected Member can seek arbitration. And in such an arbitration, it is mandatory for others seeking compensatory concessions to participate in the arbitral proceedings and abide by the outcome.

Zutshi, who coordinated the positions of developing countries during the GATS negotiations in the Uruguay Round, in a communication to this writer, points out that the idea of taking out the Financial Services sector from the coverage under GATS is not new. It was raised by the US with support from some others, like Switzerland, who wanted a "stand alone" agreement, or at least exemption from the application of the MFN clause.

The US move was not accepted, Zutshi says, for the simple reason that a single sector agreement would not provide benefits to Members who were not competitive in that sector and would deny a large number of developing countries any possibility of developing their own financial services sector.

[Even at the final stage of official level negotiations, Mr. Larry Summers, Treasury Undersecretary in the Clinton administration, came to Geneva and threw his weight around in making this attempt at the Uruguay Round Group of Negotiations in Services. But he gave up when it became clear that the US was isolated and that none of the negotiators from the other countries were impressed or influenced.

[The other negotiators made clear that any attempt to change the draft GATS framework would mean de novo negotiations for a services accord. Negotiators of most other countries made clear that for lack of time, the Services issue would then have to be dropped from the Uruguay Round agenda, and it was a choice to be made by the US, as the demandeur in Services as a trade issue - reports in SUNS #3190, #3192 and #3195 of November-December 1993.]

The Services agreement, Zutshi underlines, was premised on the basis of the possibility of cross-sector exchange of concessions. It would be a grave mistake on the part of the developing countries even to contemplate the possibility of a stand alone Financial Services agreement. As for giving a super regulator the possibility of a role in trade issues, it would violate the sanctity and the integrity of the WTO system itself, he says.

This, he views as part of the attempt to change the character of the multilateral trading system through such means as PPMs (process product measures in goods) and giving environmental agencies a say in trade matters, as advocated in the WESS report.

"It is similar to efforts at changing the rules of the game when the competitive edge is lost so as to come up with new rules that perpetuates dominance."

(* Chakravarthi Raghavan, Editor Emeritus of the SUNS, contributed this review article and commentary.) +