3.5.5 Restructuring Global Financial Governance

(This is a current page, from the Patterns of Power Edition 3 book contents.  An archived copy of this page is held at http://www.patternsofpower.org/edition03/355.htm)

The purpose of global financial governance might be defined as the maintenance of stability and the creation of optimum conditions for the global economy to grow.  Its performance has been patchy.  There has been huge economic growth since the Second World War, but there have also been many crises and there is much unfulfilled potential in poorer countries.

A financial system is essential to the creation of wealth (3.2.7).  Nowadays many financial institutions are global and funds can be rapidly transferred from one country to another, so the financial system is largely a global structure even though a lot of its governance is organised nationally.  Dani Rodrik’s article, The great globalisation lie, argued that unrestricted flows of money are a source of instability:

“there is a strong empirical association between financial globalisation and financial crises over time”.

He concluded that countries would be wise to exercise some control over “foreign money”.

Regulators, shareholders, banks and ratings agencies all failed to exert governance over the financial markets prior to the 2007-8 financial crisis (3.3.4.3).  Agreed standards and collaborative regulation are needed – to protect but not to control.  As Hayek wrote:

“The need is for an international political authority which, without power to direct the different people what they must do, must be able to restrain them from action which would damage others.” [1]

As noted previously, there is a strong argument for not making global financial regulation too rigid; countries should have some latitude for protecting themselves from damage (3.4.1.4).

Following the 2008 crisis much effort has been directed towards financial regulation.   In September 2011 the European Commission suggested two substantial changes: to increase the independence of auditing companies and to introduce a tax on financial transactions (often referred to as a Tobin tax).[2]  There has been significant opposition to the Tobin tax, mainly on the grounds that it would be ineffective unless it were possible to implement it everywhere and close the obvious loopholes,[3] but there are also arguments for it: in support of its possible role in increasing stability,[4] and in its probable impact in improving corporate governance (as described later: 3.5.6.3).

There are also arguments for and against the prohibition of some of the more complex financial instruments, including derivatives, as a way of reducing risk.[5]  Despite the efforts and suggestions there had been little progress in setting up an appropriate framework of regulation by the end of 2011, partly due to genuine disagreements about economics but partly because politicians are placing national interests first and are reluctant to empower collective institutions – as discussed later (6.6.4.2).

None of the existing global economic institutions is without its problems.  The International Monetary Fund (IMF) was created to ensure stability in the global financial system, by being able to lend money to governments that are overstretched, but it applies policies that are unhelpful to the borrowers.  Joseph Stiglitz argued that it needs comprehensive reform to enable it to avoid doing damage to countries it lends to; he quotes Russia as having experienced a 40% reduction in GDP which was largely attributable to IMF policies that he describes as pre-Keynesian,[6] making the same mistakes which were made in the 1930s: applying policies which reduce growth at precisely the time when recovery is needed.  At least part of the reason for this is that the representation on the IMF board is very unbalanced, reflecting the balance of power in the world immediately after the Second World War.  For it to have more legitimacy and to be better able to do its job it needs some representation from the borrowers, for example African countries; America’s blocking vote is now looking increasingly inappropriate.

Stiglitz, writing in 2006 – before the economic crisis of 2007-8 and the Eurozone crisis of 2010 – also argued that the global financial system is unstable:

“Many of the problems in meeting debt payments arise not from mistakes on the part of developing countries but from the instabilities of the global economic and financial system.  The need for better mechanisms for sharing risk and for resolving debt problems will continue to be great so long as the international financial markets continue to be marked by such instability.” [7]

This was remarkably prescient, given that both these crises were directly related to financial instability on a scale that had not been predicted in the risk models used by ratings agencies and others.  He also argued that the global reserve system is a potential source of instability because the American dollar’s status as a reserve currency has enabled America to run up huge debts to other countries – notably China.  Any instability in the value of the dollar would spread quickly to the rest of the world.

No country can act in isolation in financial matters, because business would simply shift to the least regulated centre.  Designing a more stable system, as Stiglitz suggests,[8] would require the kind of international cooperation that has previously only taken place to solve crises which have already happened – like the Second World War, which precipitated the formation of the United Nations (UN), the World Bank and the IMF.  It would be more prudent, rather than waiting for the next comparable crisis, to cooperate now to find stabilising mechanisms.

Back

Next

[1] Hayek’s view of the need for international regulation appeared in his book The Road to Serfdom, p.232.

[2] The Economist reported on the European Commission’s proposals on financial regulation, in an article entitled The blizzard from Brussels, which appeared on 1 December 2012 and was available in June 2018 at http://www.economist.com/node/21531008.  The article commented positively on proposals for making audit more independent but questioned the practicalities of a Tobin tax (named after the economist who suggested it).

[3] The Economist provided detailed arguments against a Tobin tax, in an article entitled The EU’s Budget: Stuck on Tobin again, which was published on 30 June 2011 and was available in June 2018 at https://www.economist.com/free-exchange/2011/06/30/stuck-on-tobin-again.

[4] Ha-Joon Chang, in Thing 22: Financial markets need to become less, not more, efficient in his book 23 Things You Didn’t Know about Capitalism, referred to the Tobin tax as a possible mechanism to slow down financial transactions and thereby increase financial stability.

[5] Ha-Joon Chang also argued for the prohibition of some of the more complex financial instruments, including derivatives, as a mechanism for reducing risk (ibid, Thing 22), though The Economist questioned the practicalities of such a policy, in an article entitled Where angels fear to trade, which was published on 12 May 2011 and was still available in June 2018 at http://www.economist.com/node/18654598.

[6] Joseph Stiglitz, in his book Making Globalisation Work, quoted examples of IMF contractionary policies in Iraq and Russia

“At the time, prospects for shock therapy working in Iraq appeared to be even bleaker than in Russia, where the IMF had imposed the same recipe and produced a 40 percent decline in GDP.”  (p.  234)

[7] He described the instability of the global financial system; Ibid., p.  244.

[8] Stiglitz’s analysis of why restructuring the global reserve system is needed, and how it might be achieved, are the subject of chapter 9; Ibid., pp.  245-268.