3.5.5 Restructuring Global Financial Governance

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 several 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 Friedrich Hayek pointed out, in chapter 15 of The Road to Serfdom, some regulation is essential:

“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.” [p. 172]

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 and in September 2011 the European Commission suggested substantial changes.  An Economist article, The blizzard from Brussels, commented positively on some proposals for making audit more independent but questioned the practicalities of a financial transaction tax.

There has been significant opposition to such a tax (named the Tobin tax, after the economist who suggested it), mainly on the grounds that it would be ineffective unless it were possible to implement it everywhere and close obvious loopholes – as argued in an Economist article, The EU’s Budget: Stuck on Tobin again.

There are also arguments for it.  Ha-Joon Chang referred to the Tobin tax as a possible mechanism to slow down financial transactions, and thereby increase financial stability, and in its probable impact in improving corporate governance.[1]

Ha-Joon Chang also argued for the prohibition of some of the more complex financial instruments, including derivatives, as a way of reducing risk – although the practicality of that suggestion was questioned in an Economist article: Where angels fear to trade.

Despite the efforts and suggestions there has been insufficient progress in setting up an appropriate framework of regulation, 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 has applied policies that are unhelpful to the borrowers.  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]

He described the IMF policies as pre-Keynesian: making the same mistakes which were made in the 1930s – applying policies which reduce growth at precisely the time when recovery is needed.

One of the IMF’s problems is that the representation on its 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 also argued, in chapter 9, 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, would require the kind of international co-operation that has previously only taken place to solve crises which have already happened – as, for example, the United Nations, the World Bank and the IMF were formed after the Second World War.  It would be prudent to co-operate now to find stabilising mechanisms, before the next comparable crisis.

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[1] Ha-Joon Chang, in his book 23 Things You Didn’t Know about Capitalism, described the possible effects of a Tobin tax in Thing 22: Financial markets need to become less, not more, efficient.

This is a current page, from the Patterns of Power Edition 3a book, © PatternsofPower.org, 2020.  An archived copy of it is held at https://www.patternsofpower.org/edition03/355a.htm