Feb 10, 1998

 

FINANCE: GROWING CHORUS FOR REFORM OF SYSTEM

 

Washington 7 Feb (Martin Khor) -- There is a growing chorus of influential voices calling for reforms to the global financial system in light of the East Asian economic crisis.  

When the crisis broke out in the second half of last year, almost all the Western policy makers and most establishment economists and media blamed the Asian countries for wrong policies or structural faults such as "cronyism" and weak banking regulations.  

They ridiculed proposals made by some leaders in the affected Asian countries to regulate the global currency trade and the cross- border flows of short-term capital.  

The Western establishment was adamant that the financial markets should be left alone, without oversight by governments or by agencies such as the International Monetary Fund.  

Members of the establishment insisted that any reforms should instead be confined to the national level, where developing countries were urged to further liberalise their financial system, to strengthen supervision of banks and to remove favouritism and corruption in business dealings.  

Now the tide is turning. With the Asian crisis dragging on and its effects having ramifications on more countries (including in Latin America as well as on the rich economies), it has become more obvious that the crisis is a product of the global financial system and not simply the result of wrong national policies.

At the World Economic Forum, the annual elite gathering of business and political leaders, held at Davos last week, the Asian crisis was in the spotlight.  

Thai deputy premier Supachai Panitchpakdi highlighted the region's concern that urgent action is needed: "If there is no global arrangement, no concerted international action, this crisis will reappear. We can't wait."

The U.S. undersecretary of state, Stuart Eizenstat, admitted "we are in unchartered waters, there is no ready solution." His colleague, deputy Treasury Secretary, Lawrence Summers, hinted that the US was looking at some global measures when he commented that free markets will only work in a proper legal framework and in a framework of transparency, and that he hoped the US would respond to these challenges.  

A few days earlier, his chief, Treasury Secretary Robert Rubin had said the Asian crisis demonstrates that markets cannot be trusted to correct their own excesses. He called on governments to step in and "modernise the architecture of international finance."  

The US has announced that it would initiate the organising of a conference on the global financial situation, with leading finance officials from the Group of 7 and other key countries. However, there has been no further information on the topics, or the criteria for inviting the other, non G7, countries.  

Presumably such a meeting would have initial discussions on the current deficiencies in the international system, and what would be required to improve the situation. If, however, the conference is confined mainly to the rich countries, with a handful of "mature" developing nations, the interests of ordinary and poor developing countries may not be adequately taken into account of when the "architecture" is designed.  

>From the market, there are also sporadic calls for quick action, with the world's leading financial speculator, George Soros, lending his weight to the need for global reform.

Soros' hedge fund had been identified by Malaysian premier Dr Mahathir Mohamad as playing a lead role during the initial stages of the speculative attacks on Southeast Asian currencies. Soros in turn had attacked Dr Mahathir's proposals to control the global currency trade.

Since then, Soros has himself vociferously warned about the damaging effects of currency volatility, called for curbs to be put on financial speculation, and for the creation of a new credit institution to provide insurance up to a certain limit on the foreign loans of financial institutions.  

At the Davos meeting, Soros was reported as describing the world financial system as worse than a casino because at least a casino has a fixed set of rules.  

A key problem requiring global solutions is the recent rapid globalisation of financial systems, forcing developing countries to be exposed to great volatility and unpredictability of movements of foreign funds, before their officials were ready to cope with the effects of liberalisation.  

Asian countries, for example, experienced sudden and large capital inflows in the past few years. But even more suddenly did these funds flow out, as much (or more) due to sentiment and "herd instinct" as to economic reasons.

Reporting last week on the Davos conference, the Wall Street Journal said: "The world's big brains still don't agree on the causes or how to prevent a more serious repeat performance. But they agree that globalisation has outpaced the financial world's ability to manage it and has unleashed forces that the world must come to terms with quickly before a larger crisis strikes."  

And on the same day, the International Herald Tribune commented: "The waters are not only uncharted, they are turbulent and deep. The world's financial institutions are no match for the enormous blocks of fast-moving capital that have swept through Asian financial markets and then abruptly deserted them, officials now say."

The Economist (24 Jan) reported there has been a significant change in economists' thinking about the desirability of free capital flows across countries.  

"In particular, the abrupt reversals in economies that were hitherto deemed miraculous have challenged the conventional wisdom that it is a good thing to let capital move freely across borders," said the Economist article, entitled "Keeping the hot money out."  

"Popular sentiment in much of East Asia blames the present crisis on the sudden and destabilising withdrawal of foreign capital. Perhaps, it is suggested, things would have been calmer if less capital had been allowed to enter in the first place."  

The article also noted that for years, it has been dinned into governments of developing countries that financial liberalisation is essential for prosperity. "Instead of discouraging foreign investors and crafting rules to stop local capital from fleeing abroad, they were advised to open up.  

"When Mexico and South Korea sought to join the OECD, the group of rich countries, they were pushed to open up their capital markets further."  

The article concludes that financial liberalisation is "risky, and it therefore makes sense for economies with dodgy financial systems to open up to foreign capital more cautiously. China is now likely to learn from its neighbour's experience and proceed more slowly in opening up its own financial system and making its currency fully convertible."

Also recently, the Washington Post (30 Jan) published a report entitled "On the Table: Reform of the Global Finance System."  

The article quotes several leading personalities, including Soros and Rubin, as having concluded that "the system is broke and needs fixing."  

With Americans increasingly skeptical about the benefits of free markets and wary of taxpayer bailouts, says the article, it is unlikely the extra funding being requested for the IMF will be approved by the US Congress "without restructuring the IMF and rewriting the rules of global capitalism."  

The Post went on to describe four ideas that were being most talked about in a reform process: loan insurance for banks giving foreign loans; the "Tobin tax", or a global tax on currency transactions; another tax imposed on short-term foreign funds entering a country; and establishing international bankruptcy mechanisms so that foreign creditors can be paid back at least part of their loans in an orderly and predictable way.  

The above survey of views of influential people and reports from the establishment media show that opinion on the need for global financial reforms is gaining ground.

This is important, especially for countries in the region, for a solution to their present crisis (and prevention of future crises) will depend on both national policies and a reform that includes monitoring and regulation of international financial markets. For the latter to happen, it is not enough for Asian developing countries to make requests. The developed countries themselves have to be convinced that for the sake of stability and fairness in international finance, reforms have to be urgently worked on.