Chairman and friends,
I am thankful to the organizers for giving me this honour to share my thoughts on a new complex question. The organisers include non governmental organizations and research on money and finance groups of University of London. I must compliment the Ford Foundation and the European Union for providing financial assistance to the event. The initiative provides me a unique opportunity to ask what I believe to be some right questions for which answers are difficult but, the questions must be asked.
What does the global crisis indicate in terms of balance between national and global factors on the one hand and finance and non-finance elements of economy on the other?
First, the current global financial crisis is perhaps indicative of the fact that globalisation of finance took place prematurely and excessively, relative to the globalisation of regulation of financial sector. This conclusion is inevitable from the ongoing efforts towards improving global financial architecture and enhancing global coordination in financial regulation.
Second, the globalization of trade has brought about some benefits and arguably serious costs. But, the benefits of globalization of finance are suspect in view of the fact that it resulted in financial resources flowing from poorer nations to richer nations for financing the consumption of the latter. It is also noteworthy that those countries which were cautious in integrating their economies with global finance, such as China and India, are performing well, on all accounts, both in pre-crisis and during current crisis.
Third, the sources of the current crisis are mainly international financial centres while economies with a significant domestic bias in finance and emphasis on retail banking,, such as perhaps Canada and Australia, are less affected by the crisis.
Fourth, almost all actions to manage the crisis have been at national level, as part of fire-fighting operations while the stimulus was coordinated the exit so far, however, is characterised by some countries, like Australia and India, initiating the process and not the others so far.
Fifth, there have been many initiatives for revamping regulatory structures polices and approaches in several countries, especially in US, UK and Europe, but there are legitimate differences within each of them to agree on the appropriate framework for the future. No doubt, there has been some progress in financial stability board on some general aspects of regulations, to be adopted voluntarily in all jurisdictions. An interesting issue is the scope for and limits to agreements on a global framework for financial regulation at a time when fundamental differences persist on such a framework at national levels in jurisdiction of major global players.
With these broad observations, it is useful to proceed to some specific aspects of financial regulation and pursue the serious business of asking the right questions, keeping in view the crisis and the current debates on the future environment of global finance and global financial regulation.
What should be objectives of regulation?
Some doubts are raised as to whether exclusive attention to price stability, especially through inflation targeting is appropriate. There is greater consensus on the need to make financial stability as an objective in addition to price stability with appropriate attention to output and employment.
In developing economies, with little or no hedge against inflation and financial instability for vast majority who may be poor, the weight given to stability has to be more than in others. The autonomy in monetary policy needed for the purpose is critical for developing countries in taking a view on benefits as well as costs the extent of globalised finance and of regulation.
How to prevent regulatory and tax arbitrage?
Financial activity is foot loose in the sense that it requires essentially a computer, an address and professionals to work together and hence it has a tendency to move towards jurisdictions which have softer regulation. This partly explains why international financial centres like US and UK preferred a process of increasing deregulation in recent past to attract such activity. The objective of globally agreed framework of financial regulation and agreed regulation of cross border activities is precisely to reduce the scope for such regulatory arbitrage.
However, there still remains the issue of tax-arbitrage. In other words, financial activity can move smoothly to jurisdictions which have significantly lower taxes. This partly explains focus given to tax-heavens in the recent past by G-20. However, the basic issue remains to be one of tax arbitrage and it can be mitigated only with globally agreed tax burdens and tax structures. But, the core issue of exercise of national sovereignty and carrying out the obligation of national governments warrants exercise of taxing powers by the national governments. The issue is whether countries would be willing to give up, in any significant manner, such powers in order to facilitate globalisation of finance. Special, concessional and uniform treatment for financial sector by all countries will disseminate against real or non-financial sector, aggravating excesses in financial sector. It is important to note that huge increase in public-debt that may be accumulated to fight the crisis now, has to be reversed by the national governments and that would warrant exercise of taxing powers as appropriate to each country.
There is a more important problem of what may be termed as significant non-reversibility in deregulation of financial sector. It is not easy to devise for financial sector measures such as quotas, anti- dumping duties, limits on movement of persons etc that are possible for real sector.
How competitive is global financial market?
A basic argument in favour of globalization of finance and regulation is that benefits accrue from global competition in finance and that it is possible to avoid downside risks of such global competition by appropriate regulation at global level. It is therefore necessary to explore how competitive the global financial market really is. There are two rating agencies which account for a large chunk of global rating business. There are only two news agencies who provide financial news services at the global level. There are a few large financial conglomerates which account for a major part of the cross-border financial business. More important, some of them are currently very heavily funded by governments through bailout schemes, and it is not clear how these would be unwound to give a level playing field in global finance.
Hence, in the context of finance, the problems to be addressed are not only a global framework for regulation but also a policy and procedural framework to ensure adequate competition.
What are the issues in countercyclical policies?
There is currently a broad consensus on the need to have a regulatory framework in finance that would not be pro-cyclical and would aim to be countercyclical. The approach is to provide, among others, a capital cushion in the financial institutions at good times so that they can weather bad times.
It is necessary to recognise that monetary policy also needs to be countercyclical, as experience has shown. A loose monetary policy could act as a dampener on the effectiveness of countercyclical policy of financial regulation. Similarly, it is well recognised and recent experience has shown that fiscal policy has a legitimate role to play in the moderation of the cycles. There is therefore need for a harmonized policy response at the level of each nation to address the economic or trade cycles that occur in their jurisdictions. However, there are two possible scenarios in regard to such economic cycles at the global level.
In the first, the cycles among different countries are synchronised. In such an event, synchronization of national policies becomes easier, but the risks of both boom and bust get globalised. In other words, diversity in economic cycles in different countries could by itself be a stabilising force for the global economy. The process of synchronisation of national policies may not add to such diversification.
In the second scenario, the economic cycles of different countries being at different stages may be inevitable. In such an event, there is a need for autonomy and effectiveness of policy at national level; and globalised finance may reduce scope for autonomy in policy or induce excessive volatility at national level.
In other words, like bio-diversity being a desirable objective in the long run, there is a need to explore whether maintaining some diversity in ideology, institutions and economic policies in the global economy is desirable for the long run.
In brief, the countercyclical policies in financial regulation that aim at moderating booms and boosts may be enabled by some autonomy in public policy at national levels. Such autonomy in national policies may imply some limits on the trend towards globalization of finance.
What should be the way forward:
There is considerable agreement on need for regulation or redesigning financial regulation in many jurisdictions. This is indeed a welcome step. There are several unresolved issues on what appears to be an acceptable framework of such re-regulation at the national level. There is some progress on global standards for some elements of financial regulation. It is reasonable to expect that there would be significant strengthening of regulatory framework and the process would also involve improving accountability of regulators in financial sector to national governments. Broader public policy issue is the scope for reconciling strengthened financial regulation and countercyclical policy at the national level with increased globalisation of finance.
There is very interesting development which is indicative of new priorities, namely using the financial sector for its primary purpose of development and welfare; and directing the globalization of finance to meet that end. In October, representative ministers of twelve countries have decided to task an international committee of experts with producing a detailed report in may 2010 proposing operational recommendations to the task force and the leading group on how to finance economic development through financial transaction taxes. The task force on international financial transactions for development is working as per mandate of the leading group of twelve countries, namely Austria, Belgium, Brazil, Chile, France, Germany, Japan, Korea, Norway, Spain, Senegal and the United Kingdom.
The significance of this initiative lies in exploring the possibilities of moderating the unfettered freedom of global financial markets. Such an idea is not entirely new, but it is being revived now after giving it up in the context of enthusiasm for increasing globalization of finance.
With the experience of global financial crisis among leading economies that adopted free flexible exchange rate regimes and contrasting experience of China and India which had varying elements of government intervention, there may be a strong case for revisiting the ideas of managed exchange rates. Indeed, one needs to take a less dogmatic and more pragmatic view of managed exchange rates, within a band if need be, among the economies such as US, UK, Euro and Yen.
Conclusion: Towards Re-regulating financial sector and recalibrating global finance
To conclude, I submit that going forward, there should be three pronged attempt at reforms of the global economic and financial system.
First, and undoubtedly the current Brettonwoods Institutions need to be reformed significantly to strengthen their legitimacy, capacity and role. In parallel regional arrangements for cooperation should be encouraged, as part of countervailing force to the existing global institutions and also in the interests of diversity.
Second, the systems of regulation of financial sector need to be revisited and elements of re-regulation of financial sector introduced, with some elements of harmonisation at the global level, but with significant policy space at national level.
Third, and most important, moderating and where necessary rolling back, globalization of finance would be essential for both growth and stability in the global economy. Such limits to growth in globalised finance may happen partly due to the policies that will be adopted in future by several countries, including the developed countries, as part of near future as well as longer term response to the current global financial crisis.
Way forward, I believe that there may be both re-regulating of financial sector and recalibrating of globalization of finance.
Yaga Venugopal Reddy