WTO head "facilitating" financial services deal

The WTO head, Renato Ruggiero acting as a "facilitator" in the financial services talks is trying to persuade developing countries to liberalize their financial services sectors, resorting to prudential regulations to deal with problems. The Asian countries however, at the last round of WTO talks, were reluctant to heed the calls of the US and EU to liberalize these sectors.

by Chakravarthi Raghavan

GENEVA: The Director-General of the World Trade Organization, Mr. Renato Ruggiero, is trying to persuade the developing countries, particularly the Asians battered by the recent currency crisis, to go ahead still and liberalize their financial services, depending on prudential regulations to deal with problems.

The WTO press office on 19 September, announced that the WTO head, Mr. Renato Ruggiero, would act as a "facilitator" in the financial services talks, and be in Hong Kong in the last week of September (for the annual Fund/Bank meetings) where he would hold meetings with treasury officials of countries and hear their views and concerns.

The latest round of WTO talks ended on 18 September, with Asian countries reluctant to heed the "siren" calls from US and EU treasury officials and experts, and put in "improved" offers to open up their financial markets, or at least commit themselves now to phased-opening up (over a 3-5 year period).

The negotiations are working to a 12 December deadline, but it does not seem likely that the Asians, and particularly the battered ASEAN economies, would be more forthcoming, based on theoretical views of benefits of financial liberalization.

As the Thai negotiator (Piamsak Milintachinda) told the WTO financial services group on 18 September, "our house is on fire and we must put out the fire first."

Negotiators for the US and EC are telling the developing countries, particularly of Asia, that they would be realistic and flexible, meaning they would accept a longer phasing-in and ceilings for market openings.

The negotiations are all about liberalizing trade in financial services through allowing foreigners the right of establishment, the right to own assets, right to operate on an equal level with domestic banks, insurance companies or security firms, and protection of existing rights of foreign suppliers.

UNCTAD, which published this year's World Investment Report (in an unusual setting of an embargoed report launched at a press conference in Geneva by Secretary-General Ricupero, but linked by TV to Bangkok, and questions from there, not from journalists but from the president of a firm that advises European, American and Australian TNCs on how to get into the ASEAN markets), raised some questions about the impact of FDI, and short- to medium-term flows and TNC activities, on the development process.

WIR's view on global FDI

Nevertheless, the World Investment Report (WIR) sought to present an optimistic and robust picture of boom in global FDI, and shattering of records with developing countries receiving more and more FDI.

Ricupero referred to his launch earlier in the week of UNCTAD's Trade and Development Report 1997 - and its warnings about polarizing and rising inequality within and among countries, and the hollowing out of the middle classes, producing a backlash against globalization - and said the WIR brought out some encouraging signs in the world economy, namely continuing growth in the FDI flows.

Ms. Padma Mallampally, a senior economist in that division, said that while drawing on various sources, the data on capital flows are from the International Monetary Fund (IMF) and its BOP statistics.

However, IMF data show profits as outgoing on a country's current account and, when not remitted but retained in the country, as new investments.

UNCTAD, which has a large data-base on the activities of TNCs in these areas, had however, no data to show what portion of the FDI is "green-field" investments creating new productive units, and how much of the retained but not remitted profits, shown as new FDI, is really used by the TNC (affiliate or subsidiary) for new production or expansion, and how much for "investments" in local stock and other markets, thus adding to the speculative activities as had happened in Thailand.

Malampally said such data about the FDI were not available, nor could she say, about the effects on domestic savings and investments of developing countries, as a result of the spurt in FDI and portfolio investment flows, in the context of the liberalization of investments advocated in the WIR. She had been referred to some recent data showing a rise in consumption and fall in domestic savings ratios.

Ricupero said that FDI might frequently play a decisive strategic role in development, but has seldom played a central role in quantitative or qualitative terms on investment within a country. In Latin America, he noted, more than 90% of the domestic investment is from domestic sources. He cited the example of Chile which had been able to get successfully a large inflow of capital and has also maintained a domestic savings rate, as also the example of Singapore.

However, other experts note, that Chile did not exactly stand by and play a hands-off role, but sequestered hot-money inflows (some 20-25%) in non-interest bearing deposits with the central bank. And Singapore's high savings rate has been through the public sector (provident fund and its use for housing).

The WTO secretariat has come out with a "new study" - "Special Studies: Opening Markets in Financial Services and the Role of GATS" - arguing that trade liberalization of financial services could have strong positive effects on income and growth, and that developing countries apprehensive of their effects on their domestic economies could put in prudential regulations and, if needed, take recourse to the GATS provisions enabling them to temporarily suspend their commitments for balance-of-payments and macro-economic considerations.

That prudential regulations of countries could take care of problems caused by speculative inflows and outflows of capital in liberalized financial markets is the view that the IMF, World Bank and WTO - institutions dominated by and run for the benefit of the major industrial nations and their corporations - have been putting forward.

But this is not a view that could be considered as a near- consensus. Rather, there is quite an impressive section of economic thought, among mainstream and neo-classical school of thought, that have more cautious, if not contrary views on these questions - on the real and financial economy and effects of speculation, an inherent part of stock and exchange markets.

A major problem in looking at impact of financial flows - short- and medium-term, portfolio investments and FDI - a paper prepared for the OECD last year, for the OECD drive for a multilateral agreement on investment, conceded that there was lack of adequate studies and research. In the absence of theories of effects of investment and investment liberalization, that study fell back on trade theories (most of which are in fact based on immobility of factors of production).

The WTO study

The WTO study also advances the neo-classical theories of efficiency through competition, but does not address the issue of how the efficiency and enhanced profits of the foreign suppliers add to domestic capital accumulation, domestic investment in the host country and thus public welfare.

The WTO study on financial services draws upon studies in the area of goods, about the positive correlation between "openness" and economic growth among developing countries, and the view that "liberalization" benefits most, the countries that undertake the reforms, and suggests the same would apply to services, and financial services in particular.

But if that be so, why are the major industrial nations that preach this view to the developing world, not liberalizing agriculture or textiles and clothing, and for that matter other factors of production? UNCTAD in its 1997 TDR has brought out the confusion caused in such discussions by using interchangeable concepts of "openness" and "outward orientation", and the proliferation of indicators and their reliability in deducing common aspects of trade policy for growth.

In successive studies, UNCTAD has in fact brought out the need for developing countries to adopt a step-by-step and calibrated approach for liberalizing and integrating into the world economy, with extreme caution in financial services because of the many side effects and negative impacts of too hasty a process in this sector.

The WTO study seeks to make a correlation between countries having a small banking sector and being less well-off.

But it could be equally said the other way around, namely, the less well-off have less money to spend, save or bank; neither proves any causal relationship nor provide a guideline for policy-makers.

And the only experience is of the poor countries of East Asia that have made good, but the literature on their experience is quite weighty that while they were outward oriented, their trade policies were not liberal nor did they (with the exception of Hong Kong) leave the pact or direction of investment to market forces.

Prudential regulations not sufficient

Except for Singapore and Hong Kong, two city-state economies in the region whose experiences are exceptional and can't be replicated by others, the WTO study is only able to draw on the benefits of liberalization of financial services and sectors in the industrial world - all of which did so after considerable economic development and for most of whom, the foreign presence on their equity, bond or exchange markets are relatively small in the 5 to 10% ranges.

The WTO study argues that volatility of financial markets does not rise with liberalization, and that exchange and stock markets are now less volatile in the industrial world.

UNCTAD's macro-economic expert and chief author of its Trade and Development Reports, Mr. Yilmaz Akyuz, argues however, that prudential regulations are not sufficient to deal with problems of speculative and other short-term inflows and outflows of capital.

The success of Chile in Latin America in dealing with inflows of short-term capital, he notes, is often cited. But Chile tackled the problem by requiring deposit of 20-25% of the funds, in the form of non-interest bearing reserve requirements. Similarly, Colombia, another example often cited, also dealt with the problem of short-term speculative inflows of capital by applying non-interest bearing reserve requirements on funds brought in by the banking and non-banking sector.

"These are not prudential regulations; it used to be called in the old days as financial repression," Akyuz said.

Akyuz agrees that a country's fundamentals could be wrong and this could create a problem or even a crisis. He noted that in the case of South-East Asia, UNCTAD in its 1996 Trade and Development Report had pointed to some of the problems and weaknesses of these countries in their fundamentals.

The US stock and financial markets probably have one of the best prudential regulations and oversight. Yet there are daily or weekly gyrations on the stock and other markets of one percentage point or more, according to the International Herald Tribune (IHT).

[The report in the IHT has referred to the sharp day-to-day movements on Wall Street this year, with fluctuations of one percentage point or more becoming common-place - with the common US indicator, the Dow-Jones industrial average, having fluctuations of this type for almost three out of every 10 daily changes, more than four times that in 1995. The IHT report said that the much broader Standard and Poor's index has also shown the same volatility.]

Getting fundamentals right

Does it mean that the US fundamentals are undergoing such changes every day? Every week or every month? Are the markets right or are those praising the US economy and its fundamentals right?

The issue for the international monetary and financial system, and institutions overseeing it, is hence what is being done to get fundamentals right? And how this will be found and action taken, before the event?

Either there has to be an international institutional framework to deal with speculative flows (inwards or outwards) of capital, or developing countries need to maintain some amount of autonomy and ability to regulate and keep controls on inward and outward flows of capital, which it would be difficult to do by financial liberalization and tightened prudential regulations. It has to be achieved through measured liberalization or integration in the global market, taking account of each country's particular situation.

And this cannot be easily put into a time-frame for weaker economies in the process of development.

In the current situation of the globalized financial markets, where operators move money across national frontiers searching for arbitrages to make profits, the markets tend to act on a speculative basis, and may or may not have any relationships to the macro-economic "fundamentals" of a country.

In 1992-1993, in the Exchange Rate Mechanism (ERM) turmoil of Europe, the French fundamentals were good, and better than that of anyone else in Europe. And yet this did not prevent the attacks on the French currency.

It is important hence to realize that markets can be wrong too.

While governments must make sure their fundamentals are right, it is equally important to realize that markets too could be wrong. And it is time, that the international community begins to think that not only could governments be wrong, but the markets too, and what to do when markets can go wrong?

At a press conference on 15 September, to release this year's Trade and Development Report, UNCTAD Secretary-General, Rubens Ricupero (a former Brazilian Representative to the GATT, and then his country's finance minister) said that in the absence of a broad international consensus on measures to curb volatile capital movements, developing countries and transition economies have to maintain flexibility as a means to deal with inward and outward flows of capital.

But neither GATS, nor WTO's other accords provide for this. This is because, the Uruguay Round and its outcome was based on anti-Keynesian, monetarist economic theories (voiced in late 1960s and mid-1970s) which, as Prof. Paul Krugman puts it in his book "Peddling Prosperity", had ceased to command support of the academics by early 1980s, though these were "peddled" by some "policy entrepreneurs" in economics to politicians.

The WTO study points to the IMF efforts to deal with the capital account problems.

But the IMF, pushing for its role in the capital account, envisages developing countries being allowed to reimpose such controls (after liberalization), but with its consent - a suggestion opposed by developing countries, as well as the private banking institutions. (SUNS4058)

(Third World Economics No.170, 1-15 October 1997)

Chakravarthi Raghavan is the Chief Editor of the South-North Development Monitor (SUNS) from which the above artilce first appeared.