Global Trends by Martin Khor

Monday 7 Sept 2009

Financial reforms taking a back seat?

One year after the Lehman Brothers’ collapse sparked a global financial crisis and the urge to overhaul the global system, the Western countries seem less interested in reform as the crisis recedes.  This is a big mistake.

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There is a flurry of activity on the global economic policy because there will be a G20 summit meeting on 24 September in Pittsburg to be chaired by United States’ President Barrack Obama.

But despite an increase in activity, the winds pushing for reform of the international financial system seem to have subsided.

The 20’s finance ministers met last weekend in London to prepare for the summit. Much of their discussion seemed to have focused on whether the developed countries should continue their boost to government spending to counter the recession.

Some, like the United Kingdom, which is still mired in recession with no recovery in sight, want the option of continuing the “fiscal stimulus”.  But other European countries, which are seeing green shoots of recovery, are more worried that expanded government spending will lead to a inflation and new price bubbles. 

They are more concerned about the need for “exit strategies”, which is a short form for moving out of extra government spending and starting to close the budget deficits.

There was also discussion on disciplining the bonuses and high pay of bankers.  The financial institutions are identified with speculative practices that led to the crisis, which has cost the world many trillions of dollars of lost income, trillions more in bail-outs and millions of jobs.

Yet many banks, including some of those who received bail-outs, seem to have gone “business as usual”, paying their top executives and traders gigantic bonuses.  This has caused a public uproar in Europe and the United States.

But while France and Germany want the G20 to agree to a coordinated limiting of bank bonuses, some others especially Britain do not, and the London meeting was inconclusive.         

The United Kingdom seems to want to revive its role as the premier financial centre and wants to be able to attract clever brains to remain in the financial sector. 

In fact there is a big debate whether the UK or for that matter any country should continue to put such high priority on its financial sector.  The UK’s chief financial regulator recently said it was a mistake to want to place so much importance on his country being a global financial centre. 

Adair Turner, head of the Financial Services Authority, suggested that the UK introduce a “Tobin tax,” or a tax on financial transactions, aimed at curbing financial speculation activities.  Speculators would find it a disincentive to pay even a tax of a fraction of one per cent on their many sale and purchase moves.

Turner is the highest ranking financial official in the Western world to suggest such a tax, which has long been advocated by many economists and NGOs seeking to curb financial speculation.

It should be remembered that in 1998 Malaysia’s then premier Tun Mahathir Mohamed  called for a ban on speculation in the global currency trade, which he identified as causing the Asian crisis.  

He was then laughed at by the Western leaders and the financial media, and the speculation continued and increased, until the bubble burst, leaving the world in economic crisis.

Turner’s article should thus have marked a milestone on the road to reform.  But he was instead immediately criticized by many bankers and some politicians.  They are clinging to the old model of finance leading the economy, rather than finance being a servant of the economy.

There are many in the finance world that want to pick up the pieces from the crisis, as if nothing major happened, and continue with business as usual, including restoring speculation and leverage as the basis for profits.

There is thus great resistance being put up against financial reform.  This is also reflected in the G20 process.  The Western leaders’ fervour for reforming the international financial architecture seems to have waned.

This is because the world today seems much less on the brink of financial catastrophe than a year ago when the collapse of Lehman Brothers threatened to infect many other giant institutions and to bring down the whole system like a house of cards.

The trillion dollar bail-outs and the trillion dollar boosts to government spending have prevented a financial catastrophe and a Great Depression.  Since the policy steroids have patched up the system for the time-being, the Western political leaders are no longer seized with the need to overhaul the system and instead are yielding to the temptation of letting the old ways return.

Thus the critical reform issues are receding into the background, and there is a danger they will be forgotten, until a new and bigger crisis emerges.

These issues include:

·        Curbing financial speculation at national and global level,

·        Curbing or banning certain types of financial institutions and practices,

·        Drastically reducing leverage (or the amount of loans an institution or bank can obtain or make),

·        Regulating the cross-border flows of capital, especially capital that is not linked to economic activity such as trade and direct investment.

·        Reforming the International Monetary Fund’s governance and policies,

·        Reforming the system of international reserve currency (currently the US dollar),

·        New ways of providing enough liquidity to developing countries suffering from the crisis, and

·        An international system for debt arbitration and work-out to help developing countries avoid a new debt crisis.

The developing countries have even more at stake in having such reforms as they suffer the collateral damage from wrong policies in developed countries.

The G20 was created during the Asian crisis because the Western countries, especially the United States, were worried that it would spill over into a global crisis, and they wanted a forum to initiate reforms to overcome financial instability.

When the Asian crisis blew over, the G20 became inactive.   It took another ten years and a bigger crisis to get the G20 to re-start its engine.

Now that the global crisis seems to be receding, so too is the incentive for reform.  If the Western leaders have lost their urge, the leaders of developing countries should push for the reform, for the developing countries have more to lose if the dysfunctional and imbalanced global system continues in its old way.