Global finance needs new framework for global economic governance

Financial crises and surges in private capital markets can disrupt the global economy far more quickly and to far greater effect than any trade phenomena, argues Professor G K Helleiner. It is therefore critically important to establish a new framework for effective global economic governance and for development.

THE past half-century has seen tumultuous change, much of it the product of 'spontaneous' influences, in the world economy. In no sphere has this change been greater, particularly in the last quarter-century, than in international finance. In very large part, the emergence of globalised financial markets was the product of technical change in information processing, telecommunications and transport. But conscious governmental actions - in the general direction of market liberalisation - have also played some role.

Whatever the cause, private capital now dominates the total net (long-term) financial flows to the developing world - as much as 85% of the total in 1996 - compared with around 45% in 1990 and much less in the 1950s and 1960s. Portfolio flows make up over 40% of current private flows to the developing world. Pension funds, mutual funds and life insurance companies, investing in bonds and equities, are now considerably more significant sources of development finance than banks - whose activities peaked, to disastrous effect, in the late 1970s and early 1980s. Foreign direct investment is also rapidly rising again - now accounting for about 45% of total private flows compared to 55% in 1990 and much larger percentages in the 1950s and 1960s. At the same time the world has been experiencing the so-called 'crisis of aid': official flows are stagnant or declining except from a small number of donor countries (the Nordics and the Dutch).

Unfortunately, the private flows are highly concentrated in a relatively few countries - with 95% going in 1996 to just 26 countries, while 140 countries shared the remaining 5%. Worse still, private capital has proven highly fickle and volatile in its behaviour: portfolio managers have proven just as nervous in the 1990s as banks were in the 1970s and 1980s. And TNCs managing their own portfolios have emerged as major movers of short-term funds. It is not necessary to demonise George Soros or other money managers, who are merely trying to protect their shareholders' interests in a highly uncertain world. It is simply in the nature of financial markets that they are susceptible to panics, crises and volatility.

The role of national governments

Governments can and do play some role both in the evolution of the global financial system and in the determination of its effects upon development in individual countries. At the national level, all governments have a particular responsibility for the stability and security of the domestic monetary, banking and financial systems - critically important to the functioning of any economy.

The vulnerability of banking and financial systems to crises, instability and market failure has virtually everywhere produced central banks and regulatory authorities to protect the social interest and, usually, to mediate national interactions with global financial markets. Effective functioning and stability of the monetary and financial system is now universally seen as a fundamental requisite for development, and it can only be achieved through effective state action. The ultimate responsibility for national-level development policy - including macroeconomic management, the encouragement and effective deployment of savings and investment, and modes of interaction with the global economy - always rests with national governments.

But who plays the role of the development-oriented state in the global economy? Effective global macroeconomic and financial management is far more important to overall output, employment, and development than any individual national-level actions or, for that matter, any changes in the trade regime. Exchange rate changes and misalignments can and do easily swamp trade policies in the short- to medium-run. Financial crises and surges in private capital markets can disrupt the global economy far more quickly and to far greater effect than any trade phenomena.

It is therefore critically important to get the central macroeconomic financial institutions for the newly globalised economy broadly right.

Today's global financial world, the world in which governmental policymakers seek to promote development, at both the national and international levels is utterly different from that facing the original architects of the Bretton Woods system in 1944, a time when international financial markets had, in effect, been closed down.

The central governmental institutions in today's global economy are those of the major industrial powers and, inter-governmentally, the meetings of the G-7, realistically the G-3, (Finance Ministers or Heads of State), the IMF, the World Bank, and the Bank for International Settlements (BIS), and all of their committees. All have been attempting to come to terms with some of the monumental changes in the global financial system of the past couple of decades. Finance ministers and central bankers, in pursuit of safety and stability (not development per se), have been trying valiantly to develop appropriate governance arrangements to 'catch up' with global financial market forces.

Unfortunately, the process through which the current international monetary and financial system is attempting to respond to the challenges thrown up by the new global economy is severely flawed. It is tortuously slow, insufficiently participatory, overly influenced by powerful lobbies from the financial sector, and constrained by jurisdictional ambiguities and turf struggles. It is difficult at present to be very sanguine about the early prospects for appropriate changes - particularly those likely to assist processes of development in the developing world - that emanate from the current efforts of such bodies as the G-7, the BIS, the IMF, the World Bank, the various regional development banks, or, for that matter, the WTO, the OECD or such non-governmental organisations as the International Chamber of Commerce.

Non-G7 members

Above all, the process is flawed because of its failure to take adequately into account another element of major change within the global economy and the global financial system, a change which has been of fundamental importance - and is much less remarked upon in the dominant financial institutions. That is the rapidly growing importance of non-G-7 members in the world economy, and therefore the growing importance of these economies to G-7 and global welfare. In purchasing power parity terms, developing countries alone already account for nearly half of world output. According to the World Bank, by the year 2010 they will account for 56% of global consumption and 57% of global capital formation. And developing countries as a group are still generally projected to grow at roughly double the rate of the industrial world during the coming decade.

We have recently been reminded, first in Mexico and now in South-East Asia, that there is another important dimension to increasing developing-country participation in the global economy and global financial markets. Developing countries' economic performance is subject to much greater volatility than that of the more industrialised countries. The closer integration of the developing and transition countries into the world economy and their greater importance to it pose increased risks - not only to themselves but also to the entire global system. There are bound to be many more Mexican-style and South-East Asian-style crises in the years to come. Developing countries have also recently proven more prone to disasters of climate, civil disturbance and war.

Apart from the fact that the G7 countries represent a small and declining proportion of the world's population, their own economic and political security now rests significantly and increasingly upon events in the rest of the world.

From these facts flows an inescapable conclusion: the world must find a way not only towards improved management of a newly globalised economic system - a difficult enough task - but also toward more politically and economically representative, and therefore more legitimate and more effective, means of global economic governance. And the search for such reformed arrangements must begin in the world of global finance, where the risks are highest and the potential gains from improved arrangements are greatest.

All of a single piece

The problems of the international financial system and its interaction with the agreed objective of global development are all of a single piece. It would be nonsensical to attempt to address the issues surrounding the future of the financing of development in isolation from the many influences upon the now dominant private flows of capital. Such influences include the macroeconomic policies of the major industrial countries, particularly as they affect interest rates, the provision of adequate liquidity and appropriate responses to periodic crises, the backstopping and supervisory roles of the major international financial institutions - not only the IMF and World Bank group but also the regional development banks, the BIS and related institutions. If there is to be a useful conference on the financing of development, it must therefore address the workings of the entire international monetary and financial system as it impacts upon development. A conference, if there is to be one, should be about 'the international monetary and financial system and development'. No less will do.

The developmental focus is essential, if only to discourage endless further debate on the appropriate exchange rate arrangements among the US dollar, the emerging Euro and the yen - the issue which, under Northern influences, ran away with far too much of the discussion on the occasion of the 50th anniversary of the Bretton Woods institutions.

Some urge the United Nations to stay out of monetary and financial affairs. One can certainly make a case that, in the interest of an efficient international division of labour, monetary and financial issues should be raised and addressed in the appropriate multilateral fora - presumably, at present, the IMF and the World Bank group. Most Finance Ministers and Central Banks do not regard the UN as an appropriate forum for discussion of these matters. Most probably do not know or, if they know, do not much care that the Second Committee is debating these issues in New York. From their standpoint, the only meetings that truly mattered were those in Hong Kong a month ago, meetings that they all attended.

The IMF and the World Bank group have done much of their work extremely well, better than quite a lot of the work undertaken by other specialised agencies of the UN, and one must never minimise the difficulty of achieving effective international governmental cooperation in any sphere, let alone in the complex world of international money and finance. We can and should celebrate the remarkable successes of the IMF, the World Bank Group, the regional development banks and the rest - and many of us have done so. But let us also be clear that they have done their work relatively well principally because they were financially supported to do it well. The administrative budgets of the IMF and World Bank - totalling roughly $2 billion per year - are considerably larger than the combined administrative budget of all of the rest of the UN system with all of its other responsibilities. The question of the cost-effectiveness of these expenditures in the Bretton Woods institutions, in support of multilateral economic and financial governance, is rarely raised.

To take a small current example, the World Bank's World Development Report is reliably estimated to have cost roughly $4 million, far more than the UN system spent upon its World Economic Survey, the (UNCTAD) Trade and Development Report and the (UNDP) Human Development Report.

The question is: are the current international financial institutions likely to be able to transform themselves, spontaneously and without prodding and in a reasonable time frame, into what will be required for the emerging world of the 21st century?

Whose priorities?

The primary concerns of the majority of the world's countries have repeatedly been raised within the existing multilateral monetary and financial institutions: in particular, the effective introduction of global considerations into G-7 macroeconomic management fora; the provision of liquidity in true accordance with global need; more effective response to sovereign bankruptcy, and debt and financial crises; the regularisation of development finance, more effective and representative governance in these institutions themselves; and developing country representation in financial supervisory and regulatory provisions for the global financial community.

Perhaps the developing (and transition) countries have not tried hard enough within the existing institutional machinery. Perhaps their spokesmen and women, and their representatives on the relevant boards, have been too junior in their levels, or too timid in their efforts. Perhaps developing-country Finance Ministers should assign higher priority than they now do to these multilateral economic governance issues (although their frequent inability and/or unwillingness to do so is perfectly understandable for smaller and poorer countries). Perhaps the G-24 could run its affairs much more effectively. All of these could be done. But would it, under current arrangements, make much difference? I suspect not much.

Consider some of the recent evidence. Recent efforts to amend the articles of the IMF centred on (i) an 'equity' allocation of SDRS, rather than an allocation to meet global needs as perceived by the majority of its members, and (ii) an expanded mandate to permit it to push the liberalisation of private international capital flows with greater vigour - hardly the top priority reform for the majority of IMF members either. Whose priorities were these? At the same time, the recent expansion of IMF quotas made virtually zero concession to the growing importance and needs of developing countries. The most that the Managing Director could do was to offer, in return for developing-country support for the much-needed current quota expansion, to look at these matters next time. These are not signs of an organisation able easily to recast itself in the interest of the majority of its members. They are, rather, stark reminders of who still really runs the principal global monetary institution.


Again, without casting any aspersions on the qualities of the current office-holders, it is worth asking - in the context of all of the current 'buzz' about governance in their institutions' boards - how the positions of President of the World Bank and Managing Director of the IMF, with all of their considerable attendant powers, are at present filled. What exactly are the transparent and participatory and rules-based procedures, which the World Bank recommends for all, through which these major multilateral leaders of the financial community are selected? The bizarre and hilarious manner in which the next-to-last President of the World Bank was appointed is recounted in the brilliant, newly-released history of the World Bank by Devesh Kapur, John Lewis and Richard Webb (The World Bank, the First Half-Century, Volume I. History, Brookings Institution, Washington DC, 1997, page 1199). Who can take seriously the World Bank's strictures on others' governance when its own governance is so severely flawed?

The reforms being pursued in the sphere of international banking supervision by the BIS and the regulation of international securities markets by IOSCO are, of course, welcome and overdue. But the BIS, a central bank for G-10 central bankers, is even less representative of global interests than the IMF, and IOSCO is even less so. Both deserve credit for recently consulting with developing countries. But is this enough? Incidentally, neither are answerable to elected representatives in their own countries.

Need to reconstitute IMF/World Bank governance

There is an overwhelming intellectual case for a strengthened multilateral framework both for the conduct of international/global finance and for sound global macroeconomic governance in the interest of both stability and development.

But one cannot, in good conscience, continue to recommend the strengthening of the roles of the IMF and World Bank in global macroeconomic management and the management of the international financial system (as I have myself done in the past) as long as their own governance has not been reconstituted so as to reflect more accurately and fairly their global membership. Much as they try to convey a more attractive image to the world, they still disproportionately reflect in their actions and policies the views and interests of a few major industrial countries.

Developed countries have utterly different voting powers and the provisions for special majorities for particular categories of decision vary enormously from one international economic organisation to another. Comparing the governance structures of a large number of multilateral organisations, the IMF and World Bank place last in their representativeness of the majority of the world's countries and peoples. Developed countries (as defined by the World Bank) account for 17% of overall votes in the Global Environmental Facility (the same as in the UN itself), 24% in the WTO, 34% in the IFAD, 48% in the IDB, 60% in the ADB, and 61-62% in the World Bank and IMF.

Financial strength should not grant the degree of across-the-board institutional and political power currently enjoyed in the international financial institutions by the G-7 governmental oligopoly. No doubt financial contributions bring some extra rights. They also bring extra responsibilities. Political democracy and the rule of law have been based, however, on quite different principles (granted that they have frequently been abused in practice).

Let me be more direct and extend the argument: brain power and technical insight have never been correlated strongly with the amount of money people bring to the table. Not the least of the changes in the global village of the past few decades has been the ascendancy of a whole new generation of Southern technocrats and academics with an interest in and capacity for sophisticated analysis of global issues, particularly as they affect development. There is simply no remaining rational basis for the continuing degree of reliance, on the part of the IMF and World Bank, upon North American and European scholars and consultants.

For instance, in a recent conference on the future of the SDR, I counted only nine developing- or transition-country speakers out of a total of 36 on the programme. Of eight more participants listed in the subsequent publication as having participated in the general discussion, only one was from a developing country. These proportions are fairly typical.

There are now more staff-members from developing countries within these institutions than there once were. Staff-members of such organisations are always severely constrained, however, in their activities. In-house analyses and evaluations can rarely generate much self-criticism or results that stray seriously from the current 'policy line'. Bureaucratic incentives simply do not encourage such independence of mind. Change and fresh thinking is sometimes pushed 'from the top', as once again at present in the World Bank, but rarely to very much long-term effect.

'Fresh air'

Pressure for more significant change usually comes from elsewhere, from bad experience or - but this may be more difficult - from truly independent external assessments and recommendations, particularly when buttressed by some significant political or intellectual authority. Further bad experience will surely assist the process of change, but one can hardly recommend further financial crises. On the other hand, one can and should try to breathe more 'fresh air' into the currently somewhat inbred discussions of global money, finance, and development in the Bretton Woods institutions.

I hope I have made it clear that, because the needs of the entire global community are at stake, and because the existing international financial institutions are so unrepresentative and show so little sign of making necessary changes in the near future, I believe that the Second Committee of the United Nations General Assembly now has little alternative but to take a keen interest in the current state of multilateral governance in monetary and financial matters, particularly as they affect development.

But how can it move events forward? How do we all get from here to there? There are many possible options, only one of which is a global conference. There should certainly be no expectation that, as at Bretton Woods, one extended meeting can deal with all of the problems. One should instead be thinking in terms of a more effective process of change - change which is urgently needed but seems very slow in coming.

The aims are both to improve the final product and to speed the progress toward it. However one proceeds, a useful starting point - or a point quite early in a new process - would be a global conference. It could serve an important educative and galvanising purpose. It must not serve, as conferences sometimes do, as a de facto substitute for action.

What realistic options for an improved process might be considered? There are four - and they are not necessarily mutually exclusive.

  • The Secretary-General of the UN might appoint a panel of independent and representative experts to address the major questions, and to make recommendations. To do this, he would no doubt want to consult with the Bretton Woods institutions. But he must not be dependent upon them. Such commissions may not seem to change the world so much. But they can be important elements in a process of review, popularisation of important ideas, and change. In retrospect, the Pearson, Brandt and Brundtland Commissions were important signals of such change in the second half of the 20th century.

  • As earlier recommended by the Group of 24, one could seek to re-initiate an intergovernmental process like that of the Committee of Twenty (the 20 were equally divided between industrial and developing countries), created by the Bretton Woods institutions themselves in the 1970s, to reconsider their functioning in the new financial world of that decade.. In the absence of IMF/Bank response to this request, such a prospect would have to be initiated from elsewhere, and might be more difficult to launch. It might usefully be discussed in the Second Committee.

Separate reviews

Separate reviews might be initiated at the regional level, perhaps by the regional economic commissions of the United Nations (or perhaps by the regional development banks), and perhaps all under the Secretary-General's or ECOSOC's umbrella authority. Proposals from Japan and Australia for regional IMF-style funds and improved arrangements for increased regional monetary cooperation in Asia suggest that some such thinking is already under way, and it needs to be placed appropriately into a more global context.

  • Some developing countries and/or some industrial 'middle powers' might initiate their own independent or intergovernmental review with recommendations, as has previously been done in other dimensions of UN activity. These possibilities might be actively explored in the forthcoming Extraordinary Meeting of G-24 Ministers of Finance.

No doubt there are many other possibilities. I hope you will consider many such possible avenues for broader progress in the sphere of global economic governance as you debate the merits of the proposed conference on the financing of development. On behalf of all of those with a concern for effective global economic governance and for development, let me wish you every success in your deliberations. (Third World Resurgence No.87/88, Nov/Dec 1997)

G.K.Helleiner, Professor of Economics at Toronto University, Canada, is one of the world's outstanding developmental economists and directs the UNCTAD/G-24 technical support project on International Monetary and Financial Issues. The above is based on his presentation, on invitation, at the UN General Assembly's Second Committee on 15 October.