The power of global finance

The power of global finance

Simon Johnson ruffled a lot of feathers earlier this year, when he wrote a stinging article titled “The Quiet Coup" in The Atlantic, a monthly magazine, in which he said that a financial oligarchy had taken control of US financial policy and had led the world into the current crisis. Johnson is no angry populist waving his fists at the rich. He is a respected economist who was once chief economist of the International Monetary Fund, or IMF, and is now a professor at the Massachusetts Institute of Technology.

The new IMF Research Bulletin for December returns to this contentious subject by asking and answering seven questions about the political influence of the financial industry. The picture is not a pretty one. The financial industry in the US has been successful in regulatory capture, which led to consequences such as weaker lending norms, riskier loans and excess profits.

Financial regulation will continue to be a tricky subject in the coming year. There is rage against bankers in the West, not just for their role in the crisis but because they used bailout funds and zero interest rates—indirect subsidies to banks and trading firms—to pay themselves huge bonuses. The problem is that capital is mobile and hasty decisions to impose heavy taxes on bonuses, as the UK has recently done, will be undercut by the flight of some financing activities to competing financial centres.

Every modern economy needs finance and even financial innovation. But the political economy can be complex. Large Western financial firms have immense influence and are not above using it to prise open relatively closed markets such as India. This is one reason why financial sector reform should be done gradually rather than in sudden leaps, with the other reason being that a country needs sounds macroeconomic fundamentals before it opens its capital account or allows free entry to foreign banks.

There are no easy answers, unlike in trade reform where both theoretical and empirical evidence in favour of lower tariffs is very strong.

But, then, the evidence in financial sector reform is more cloudy. Any debate on such reform has to take into account both the politics and economics of such a move.

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