Restructuring the International Financial Architecture
by Kavaljit Singh
For many years, a number of progressive intellectuals and activists have been advocating a complete restructuring of the unregulated international financial system. However, their concerns and alternative proposals towards building a more transparent and accountable global financial system were, quite often, dismissed by proponents of free capital movement as ideologically driven, biased, and non-pragmatic. The proponents further argued that there are no policy mechanisms to regulate global capital flows, and the task should be left to the markets to control themselves on the principle of self-discipline. The case against any attempt to regulate the financial flows was built on the assumption that the market is the best tool for determining how money should be invested; if capital is allowed to move freely, markets will reward countries that pursue sound economic policies and pressure the rest to do the same. Since capital account liberalization was much in fashion in the late 1980s and early 1 990s, any controls on capital movements were strongly opposed.
However, it seems that certain recent events, particularly the Southeast Asian currency crisis and the near collapse of a multi-billion hedge fund, the Long-Term Capital Management, have turned the tide against the free-market financial system. Increasingly, it is admitted that if the international financial system is not regulated, we will continue to witness financial crises. Even the champions of the free-market economic policies, particularly the IMF, World Bank and G-7 countries, are now acknowledging the need and effectiveness of capital controls and state intervention.
In fact, restructuring the global financial architecture has become the key theme in the ongoing international debates, as witnessed during the just concluded annual meeting of the World Bank-IMF. Leading the debate, at the political level, is Tony Blair, Prime Minister of Britain and currently chairperson of G-7 nations. In his speech at New York Stock Exchange on September 21, 1998, Blair not only demanded greater openness and accountability of the World Bank and the IMF, he also put forward a five-point agenda including building a new Bretton Woods for the next millennium. Critics had never anticipated that the tide against free-market financial system would turn so quickly.
Still, there is no consensus on what kind of restructuring is needed to solve the problems associated with global finance capital. In any case, the restructuring of global financial system is not an easy task. As the main obstacles to regulate the global financial flows are political (not technical), no meaningful restructuring is possible without the strong political support. Perhaps, more political will is expected from the G-7 countries which account for majority of transborder financial flows.
To illustrate this point, let us take the case of Tobin tax (a 1/4 percent tax on currency transactions) which could substantially slow down short-term speculative capital flows, as they will be taxed every time they cross the borders. Critics of Tobin tax often argue that it is impossible to get all countries to agree ~n a common tax. But a beginning can be made with a few countries coming together if it is not possible in the near future to enlist the support of al] countries. A small Tobin tax could be instituted by agreement among the seven major centers of currency trading, namely, the U.K., U.S., Japan, Singapore, Germany, Switzerland, and France, where more than three-fourths of all currency transactions takes place. The threat of relocation of funds to offshore centers and island heavens, because of Tobin tax, is without any strong basis as such centers are mere booking addresses that function because the mainland authorities have tolerated such evasive tactics.
Besides Tobin tax, there are various policy alternatives to regulate capital flows. However, no single country or institution alone can address the issues as the financial markets are globally interlinked. Thus, a return to the types of regulations that existed in the 1960s and 1970s may not adequately address the problems which are arising because of deregulation and globalization of financial markets in the 1980s and 1990s.
At the national level, controls on the financial inflows (e.g. in Chile, Colombia and Malaysia) can help in cooling down the "hot money" flows in recipient countries. Similarly, tax measures such as capital gains tax could be helpful in keeping off speculative money. Controls in the recipient countries are likely to remain ineffective in the absence of complementary regulatory mechanisms in source countries, from where these flows originate. For instance, certain types of financial instruments (e.g. hedge funds) are highly unregulated in their source countries. This became very visible in the recent collapse of Long-Term Capital Management.
Furthermore, by putting effective regulatory mechanisms, source countries will not just protect their domestic investors but also avoid the creation of a crisis-like situation in those recipient countries, which do not discourage volatile capital flows. As the ongoing Southeast Asian currency crisis shows that the contagion effects of the crisis can also affect the economies of source countries, it makes more sense to have regulatory mechanisms at source level.
(This article was published in The Economic Times, October 24,1998.)
(Kavaljit Singh is the coordinator of Public Interest Research Group. He is author of A Citizen's Guide to the Globalization of Finance (Madhyam Books- Delhi, Zed Books- London, DAGA Press- HK 1998).