TWN Info Service on Finance and Development (Apr09/02)
1 April 2009
Third World Network

Stiglitz panel for sweeping reforms of financial system
Published in SUNS #6668 dated 26 March 2009

Geneva, 25 Mar (Kanaga Raja) -- A high-level commission of experts headed by Prof. Joseph Stiglitz has proposed wide-ranging reforms to the global financial system including establishing an alternative forum to the G20, improved coordination of global economic policies, a new global reserve system to replace the dollar-based one, reforms in the governance of the World Bank and IMF, as well as comprehensive financial market regulation.

A key recommendation is for a globally representative forum - in the form of a Global Economic Council - to be created as an alternative to the G20 to address areas of concern in the functioning of the global economic system in a comprehensive way. At a level equivalent with the General Assembly and the Security Council, such a Global Economic Council should meet annually at the Heads of State and Government level to assess developments and provide leadership in economic, social and ecological issues.

The Commission of Experts of the President of the General Assembly on Reforms of the International Monetary and Financial System is chaired by Nobel Laureate Prof. Joseph Stiglitz and is comprised of notable economists, policymakers, academics and central bank officials drawn from Japan, Western Europe, Africa, Latin America, South and East Asia. The Commission was established by Assembly President Father Miguel D'Escoto Brockmann of Nicaragua.

The aim of the Commission is to review the workings of the global financial system and to explore ways and means to secure a more sustainable and just global economic order.

The wide-ranging recommendations of the Commission are contained in a draft document that is expected to feature in an interactive thematic dialogue convened by the Assembly President on "The World Financial and Economic Crisis and its Impact on Development" at the United Nations Headquarters in New York on 25-27 March.

It is part of the UN General Assembly discussion on an agenda item, "Follow-up to and implementation of the outcome of the 2002 International Conference on Financing for Development and the preparation of the 2008 Review Conference."

The draft document comes just as the G20 process involving some twenty leading developed and developing economies will be holding a leaders' summit in London next week to discuss the global financial system. The recommendations in the draft document are expected to be raised at the G20 summit.

The draft document said that the Global Economic Council would promote development, secure consistency and coherence in the policy goals of the major international organisations and support consensus building among governments on efficient and effective solutions for issues of global economic governance.

"Such a Council could also promote accountability of all international economic organizations, identify gaps that need to be filled to ensure the efficient operation of the global economic and financial system, and help set the agenda for global economic and financial reforms."

Representation would be based on the constituency system, and designed to ensure that all continents and all major economies are represented. At the same time, its size should be guided by the fact that the council must remain small enough for effective discussion and decision making. All important global institutions, such as the World Bank, IMF, WTO, ILO and members of the UN Secretariat dealing with economic and social issues would provide supporting information and participate in the Council.

"It could thus provide a democratically representative alternative to the G-20."

The draft document said that the rapid spread of financial crisis from a small number of developed countries to engulf the global economy provides tangible evidence that the international trade and financial system needs to be profoundly reformed to meet the needs and changed conditions of the 21st century. Past economic crises have had a disproportionate adverse impact on the poor, who are least able to bear these costs and that can have consequences long after the crisis is over.

While it is important to deal with the structural changes to adapt the international system to prevent future crisis, this cannot be achieved without significant measures to promote recovery from the current crisis whose impact may be even worse than in the past. Short term measures to stabilize the current situation must ensure the protection of the world's poor, while long term measures to make another recurrence less likely must ensure sustainable financing to strengthen the policy response of developing countries.

"Some 200 million people, mostly in developing countries, could be pushed into poverty if rapid action is not taken to counter the impact of the crisis on developing countries," said the draft document. "Even in some advanced industrial countries, millions of households are faced with the threat of losing their homes and access to health care, while economic insecurity and anxiety is increasing among the elderly as they lose their life-time savings in the collapse of asset prices."

Without a truly inclusive response, recognizing the importance of all countries in the reform process, global economic stability cannot be restored, and economic growth, as well as poverty reduction worldwide will be threatened.

"This inclusive global response will require the participation of the entire international community; it must encompass more than the G-7 or G-8 or G-20, but the representatives of the entire planet, from the G-192."

The draft document highlighted a series of immediate measures essential for global recovery as well as an agenda for deeper systemic reforms to the international system, which it said should begin now, if recovery is to be sustainable.

Among the immediate measures are that all developed countries should take strong, coordinated, and effective actions to stimulate their economies. National stimulus packages should thus include spending measures to be undertaken in developing countries to offset the impact of the decline in world trade and financial market dis-intermediation. Industrialised countries should thus dedicate
1.0% of their stimulus packages, in addition to traditional official development assistance commitments.

(An ILO study released on Tuesday examined current rescue efforts in 32 countries, including all members of the G20. It said that while the IMF had called for stimulus plans in the order of 2% of GDP in response to the crisis, stimulus plans stand on average at 1.7% - even less as a share of world GDP. Moreover, said the study, stimulus as a percentage of GDP for advanced economies is only 1.3% - less than half that allocated by developing and emerging economies.

(The study, entitled "The Financial and Economic Crisis: A Decent Work Response", also found that the stimulus packages lean heavily toward financial bailouts and tax cuts instead of job creation and social protection. In advanced economies, only 3% of total spending is on employment measures while developing and emerging economies are spending 0.2%. Social transfers to low-income households comprise a relatively small percentage for both groups - 10.8% in advanced economies and 6.8% in developing and emerging economies. The study also noted that on average, fiscal stimulus packages for the real economy are five times smaller than financial bailout packages.)

Developing countries need additional funding, said the draft document. More permanent and stable sources of funding for developing countries that could be activated quickly and are not subject to inappropriate conditionality are necessary. Indeed, additional funding would be required just to offset the imbalances and inequities created by the massive stimulus and bail-out measures introduced in advanced industrialised countries.

Such funding could be provided by an issuance of Special Drawing Rights approved by the IMF Board in September 1997 through the proposed Fourth Amendment of the Articles of Agreement to double cumulative SDR (special drawing rights) allocations to SDR 42.8 billion and through the issuance of additional SDRs through standard procedures.

The document also called for the creation of a new credit facility as a matter of urgency. If such a facility could be created in a timely way, it could be a major vehicle for the disbursement of the requisite additional funding. The new credit facility might be more quickly established under the umbrella of existing institutions, such as the World Bank, where efforts are underway to remedy existing inadequacies in governance and lending practices, or in Regional Development Banks, where developing countries have more equitable representation.

Stressing the need for more policy space for developing countries, the document said that there was lack of coherence between policies governing trade and finance and these must be rectified.

Policy space is circumscribed not only by lack of resources, but also by international agreements and the conditionalities often accompanying assistance. Many bilateral and multilateral trade agreements contain commitments that circumscribe the ability of countries to respond to current crisis with appropriate regulatory, structural, and macroeconomic reforms and rescue packages, and may have exposed them unnecessarily to the contagion from policy failures elsewhere in the global economic system.

"Developing countries especially need policy frameworks that can help protect them from regulatory and macro-economic failures in systemically significant countries," the document said. Developing countries have had imposed on them not only deregulatory policies akin to those that are now recognized as having played a role in the onset of the crisis, but have also faced restrictions on their ability to manage their capital account and financial systems, for example, as a result of financial and capital market liberalization policies; these policies are now exacting a heavy toll on many developing countries.

The crisis responses, the document said, must avoid protectionism. Overt protectionism, including tariffs and domestic restrictions on procurement, is contained in some stimulus packages. Seemingly "symmetric" complex provisions in international trade agreements (such as exceptions to application of provisions to countries covered by particular WTO or other agreements) can have markedly asymmetric effects.

Subsidies, implicit or explicit, can be just as distorting to open and fair trade. Banks receiving large amounts of government assistance have been pressured to focus on lending domestically. "Efforts need to be made to finance additional support to developing countries to mitigate the impact of the crisis as well as of both open and hidden subsidies."

There are asymmetries in global economic policies - counter-cyclical policies are pursued by developed countries, while most developing countries are encouraged or induced to pursue pro-cyclical policies. While this is partly due to the lack of resources to pursue counter-cyclical policies, it is also due to misguided policy recommendations from international financial institutions. Conditionality attached to official lending and support for international financial institutions has often required developing countries to adopt the kinds of monetary and regulatory policies which contributed to the current crisis.

As to the issue of deeper systemic reforms, the draft document pointed to the need for a new global reserve system. The global imbalances which played an important role in this crisis can only be addressed if there is a better way of dealing with international economic risks facing countries than the current system of accumulating international reserves.

Inappropriate responses by some international economic institutions in previous economic crises have contributed to the problem, making reforms of the kind described here all the more essential. To resolve this problem, a new Global Reserve System - what may be viewed as a greatly expanded SDR, with regular or cyclically adjusted emissions calibrated to the size of reserve accumulations - could contribute to global stability, economic strength, and global equity.

The draft document said that the dangers of a single-country reserve system have long been recognized, as the accumulation of debt undermines confidence and stability. But a two (or three) country reserve system, to which the world seems to be moving, may be equally unstable. The new Global Reserve System is feasible, non-inflationary, and could be easily implemented, including in ways which mitigate the difficulties caused by asymmetric adjustment between surplus and deficit countries.

(Media reports from Beijing on Tuesday cited China's central bank chief as calling for a new international reserve currency that would replace the dollar, the predominant foreign exchange reserve at the moment. China currently holds the world's largest foreign exchange reserves, which media reports have put at some $2 trillion. According to the media reports, the governor of the People's Bank of China has proposed in a paper that the IMF could control the new reserve currency system, which might prove to be more stable and equitable. A similar proposal was recently made by Russia.)

The draft document also called for reforms of the governance of the international financial institutions. It said that there is a growing international consensus in support of reform of the governance, accountability, and transparency in the Bretton Woods Institutions and other non-representative institutions that have come to play a role in the global financial system, such as the Bank for International Settlements, its various Committees, and the Financial Stability Forum.

"These deficiencies have impaired the ability of these institutions to take adequate actions to prevent and respond to the crisis, and have meant that some of the policies and standards that they have adopted or recommended disadvantage developing countries and emerging market economies."

On financial market policies, the draft document said that financial policies, including regulation, have as their objective not only ensuring the safety and soundness of financial institutions and stability of the financial system, but protection of bank depositors, consumers and investors and ensuring financial inclusion - such as access to all banking services including credit, and the provision of financial products which help individuals and families manage the risks they face and gain access to credit at reasonable terms.

The current crisis has made it apparent that there are large gaps and deficiencies in the regulatory structures in place in many systemically significant countries. It is also apparent that while effective regulatory system must be national, there must be some global regulatory framework to establish minimum national standards and also govern the global operations of systemically relevant global financial institutions.

On financial product safety, the draft document said that regulations should be based on what things are, not what they are called, i. e. insurance products should be regulated the same way, whether called insurance or not. Financial regulators should be mandated to ascertain the safety and appropriate use of various financial instruments and practices, including through the creation of a Financial Products Safety Commission.

Although the activities of private investment funds, equity funds and hedge funds did not trigger the financial crisis, their regulation is not globally uniform, creating the potential for regulatory arbitrage and the potential for gaps in regulation. Funds should be registered in the countries of their operations and provide appropriate information to regulatory authorities. In addition, banks must define limits for transactions with hedge funds.

The draft document also noted that the large-scale use of unregulated, unsupervised over-the-counter (OTC) derivatives has resulted in undue complexity, opacity, and mis-pricing of these instruments, and facilitated capital avoidance by financial institutions. "These practices have weakened our financial system significantly and made resolution of failing firms extremely difficult."

Where appropriate steps should be taken to develop regulated exchanges for trading standardized contracts of systemically significant derivative contracts, with the associated regulatory restrictions including limits on non-commercial traders. Regulations should insure that derivative instruments are held on balance sheets, valued at independently audited real transaction prices, with appropriate capital provisioning, and clarity of purpose. The use of OTC contracts by core institutions should, in general, be discouraged, but whenever used, there should be ample and adequate margin.

It is imperative that there is not only adequate oversight of large financial institutions but that efforts be made to limit their size and the extent of their interactions, to limit the scope of systemic risk. This will require more effective global cooperation in financial and competition regulation. Movement towards this goal might be enhanced by taking steps to lay the groundwork for a Global Financial Regulatory Authority and a Global Competition Authority.

On the trade front, the draft document said: "There is a need for a true development round, to create an international trade regime which truly promotes growth in the developing countries. It is essential, that in all trade negotiations, the long recognized principle of special and differential treatment of developing countries be preserved." +