TWN Info Service on Finance and Development (Nov08/04)
22 November 2008
Third World Network

Finance: Third "regime change" in global financial architecture
Published in SUNS #6588 Wednesday dated 12 November 2008

Geneva, 11 Nov (Chakravarthi Raghavan and Riaz K. Tayob) -- The present turmoil in global financial markets is an opportunity to broaden the range of possibilities for overhaul of the global finance architecture and a rethinking of the neoliberal "globalization model", according to Prof. Robert Wade, reputed academic and Professor of Political Economy at the London School of Economics.

A well-known economist, writer and critic of the dominant neoliberal paradigms, Prof. Wade has in effect called for complete rethinking and overhaul of global economic regimes and models, to allow for a diversity of rules and standards, rather than more uniformity and global standards.

Prof Wade's article comes at a juncture when the President Bush-hosted summit of the G-20 finance group of countries is due to meet in Washington this weekend over the financial crisis, with a number of participant developing countries and others, calling for regime changes and governance structures. Britain, some Europeans and many financial media are calling it a Bretton Woods II, but with the US itself, and those running the Bretton Woods institutions, digging in their heels to preserve their control.

And while several of the leading developing countries, some of whom are participating in the Washington meeting, have called for changes in the IMF voting power and on the Board, the IMF Managing Director, Dominique Strauss Khan, has been cited in the Financial Times as saying, while money from surplus countries (China, India, Gulf countries etc) to IMF funds would be welcome, he had no intention of reopening the question of member countries' votes at the IMF. Mr Strauss-Kahn, who in the final analysis is only a contracted employee of the membership, added: "The voting power is determined by a very complex formula. I don't propose at all to change this."

Several of the participants at this week's Washington meeting (like British Prime Minister Gordon Brown), and many economists and financial writers are calling it Bretton Woods II, after the original Bretton Woods agreement (negotiated by John Maynard Keynes and Dexter White) in 1942-44.

Wade in his article notes that the post-war Keynesian Bretton Woods system lasted from 1945 to about 1975. The second (after the breakdown of the Bretton Woods agreement, and the subsequent Jamaica agreement of 1976 amending the IMF articles for floating exchange rates) prevailed until the current (2007-2008) debt crisis of the developed world. This post-1976 regime (called variously as Washington consensus, neo-liberalism or more recently, the globalization consensus) has been on the paradigm of all governments "liberalizing" their economies, privatizing and deregulating. It was a regime associated with Reagan and Thatcher that moved back to the prewar laissez faire models. However, it sanctioned state intervention to supply a range of public goods, and competition rules against private monopolies.

Writing under the title "Financial Regime Change", Prof. Wade in his article of 7 October in the September/October edition of the New Left Review, has put forward a number of recommendations for the overhaul of international economic norms and a rethinking of the globalization model. Wade argues that if the present movement towards re-regulation lacks a consensus, it may albeit provide space for a wider array of standards and institutions - economic and financial alternatives to the global, systemwide neoliberal prescriptions.

The shocks of the past year indicate that the financial system is witnessing a wholesale loss of confidence in the Anglo-American model of transactions oriented capitalism and neo-liberal economics that legitimized it. Though some have been arguing that the current crisis is only a "blip", the events of September 2008, with financial market conditions having "sunk to their lowest levels since the banking shut-down of 1932," it is hard to avoid the conclusion that the world is entering a new phase.

The current crisis is more than just the housing market bubble which was only one part of a much wider run-up of debt. In the US, for example, the ratio of household debt to GDP more than doubled from 1980 to 2007 while that for finance had a fivefold increase.

The deeper causes lay in economic developments. In the US, for example, the rate of profit of non-financial corporations fell steeply between 1950-73 and 2000-06 - by roughly a quarter. As a result, firms invested increasingly in financial speculation, and the US government boosted military spending. Since the year 2000, foreign currency markets have persistently driven exchange rates in the wrong direction: economies with large external deficit experienced appreciation while surplus economies saw depreciation or no change.

The fire-fighting responses to the crisis have included setting aside competition rules. But the sheer monopoly power of the new financial conglomerates was likely to prompt a stronger regulatory response. As Warren Buffet has pointed out, the insurance and derivatives market have no central bank to prevent their toppling over.

The crises has raised the issue of the system's overall stability, with a furious debate over the impact of international finance standards on national systems - the debate on the "mark to market" international accounting standard. Critics, like the International Institute of Finance (the organization of international bankers), argues that it amplifies booms and busts.

Wade however warns that the critics of "mark to market" conflate the important distinction between accounting standards and prudential standards. Accounting standards are concerned with information provided to shareholders about the integrity of the market for investment decisions. Prudential standards focus on financial stability. Overhauling some prudential standards is important, Wade says.

A prudential standard ready for revision is bank's capital adequacy. The Basel II standard marked a shift from external regulation to self-regulation - making it an invitation to careless behaviour and "moral hazard", when banks are "more confident than ever" of a state bailout. Basel II requires banks to use agencies' ratings and their own internal risk-assessment models. Both are pro-cyclical and failed spectacularly in the run up to this crisis. Basel I and Basel II favour short term credit flows (the most dangerous kind) to developing countries from developed countries, and Basel II raises the cost of finance to developing countries.

Incremental revision of Basel II (now being undertaken by the Basel Committee on Banking Standards) will not address any of these issues and wholesale renegotiation will be required, according to Wade.

Central banks are responsible for the maintenance of monetary stability, which is keeping a tight lid on inflation. However, central banks ignored asset bubbles, since their mandate was inflation in consumer prices. The new regime that emerges ought to expand the mandate of central banks, so that they give more weight to asset prices. Also, since the interest rate is a very blunt instrument, central bankers and regulators will have to rely on "an expanded set of prudential measures."

Such measures include approval for new financial products to ensure that third parties can assess their riskiness, or (finance) organisations that can expect a public safety net submit to controls of its loan portfolio to reduce credit "overheating" sectors.

The fallout from the crisis may persuade many of the benefits of a small financial sector relative to the real one, perhaps including a "mixed economy" in finance where some firms "combine public and private purposes - operating more like utilities than profit maximizers."

The neo-liberal globalization model has emphasized capital accumulation or the supply side of the economy, to the detriment of the demand side. The stress on export-led growth implied that demand was unlimited. The failure of economies "catching up" stems from a lack of attention to domestic demand and marginalization of Keynesian-type approaches. This means greater efforts to achieve equality in distribution of income. It would also "necessitate strategic management of trade" to curb race-to-the-bottom effects of export-led growth and foster domestic industry and services for middle and working classes.

A key instrument in the demand-led process would be controls on cross-border flows of capital, to curb speculative surges, to give governments greater autonomy over exchange rate and in setting interest rates, states Wade.

Strengthened regional integration approaches should direct attention away from global standards and arrangements, which because of their maximal scope are "coarse-grained". Regional currencies like the Asian Currency Unit, could act as a benchmark independent of the US dollar, reducing vulnerability to market turbulence in Wall Street.

The global economic regime needs to be rethought to allow a diversity of rules and standards, instead of imposing ever more uniformity.