Stop preaching ---- The G7 has stopped blaming the victims for the global financial crisis. Jeffrey Sachs argues that now it must give them a bigger say in reform.
When the global financial crisis broke out last year, the Group of Seven largest rich nations was quick to seize on Asian misdeeds as the source of the crisis. This "blame-the-victim" approach was not only erroneous but extremely harmful. The G7's rhetoric against "Asian crony capitalism", backed by the International Monetary Fund's demands for abrupt bank closures, swingeing budget cuts, and sky-high interest rates in the Asian countries, convinced the G7's own capitalists to cut and run, helping to launch a worldwide panic.
Last week, the G7 finance ministers adopted a far more constructive approach. True, the proposals reflect many continuing flaws, especially a tendency to preach to developing countries. But if followed up by real negotiations between creditor and debtor countries, the initiative will lay the groundwork for a much improved international financial system.
The declaration makes advances in four areas:
* First, it calls for heightened supervision of creditor financial institutions, including investment banks, hedge funds and offshore institutions. There is surely a serious problem here. The international banks had lent just five Asian countries - Indonesia, South Korea, Malaysia, the Philippines, and Thailand - no less than $175bn (£104bn) in short-term loans by mid-1997, perhaps twice the level of liquid foreign exchange reserves in those countries. It was the flight of those loans, accelerated by the short positions of hedge funds and investment banks, that brought down the Asian economies. At the same time, the bail-out of Long-Term Capital Management, the US hedge fund, exposed the G7's own variants of crony capitalism, as well as serious gaps in financial market supervision in the advanced economies. Faulty risk management practices in the international banks and weak banking supervision surely contributed to the debacle.
* Second, the G7 has come down firmly against the IMF tradition of secrecy. Recognising that it could no longer preach transparency to debtor countries without exercising transparency itself, the G7 now calls for a presumption "in favour of the release of information". Equally importantly, it calls for formal mechanisms for external review of IMF operations. A good start would be for the IMF executive board to hold open sessions to take testimony from outside experts. I am sure I would not be alone in warning the executive board of the deep flaws inherent in any Brazil bail-out package in the context of an over-valued currency and little large-scale private involvement.
* Third, the G7 is more nuanced and realistic than previously about capital market liberalisation. Such liberalisation, it acknowledges, "must be carried out in a careful and well-sequenced manner if countries are to benefit from closer integration into the global economy". There is a lot of crucial detail left out of the declaration. Will the G7 support, as it should, strong prudential limits on cross-border flows of short-term loans? Will the Chilean approach of taxing short-term inflows win international approval for the first time?
* Fourth, the G7 recognises, albeit in muted terms, the failings of recent IMF bail-out loans, in which private-sector creditors walked away with the IMF money, while debtor countries in effect nationalised the private-sector debts. The early days of the Korean and Russian bail-outs were particularly egregious. The IMF money went out to foreign creditors as fast as it arrived to the debtor governments. The Korean debacle ended only when Korea ran out of IMF money, forcing the inter-national bank creditors to agree to roll over the debts owed by Korean banks. (Scandalously, the IMF stood by as the Korean government was cajoled into guaranteeing the repayment on the rolled-over bank debts).
In response to these abuses, the G7 declaration calls on the private sector to play a larger role in crisis management and resolution, aiming at "orderly work-out arrangements" in which the private creditors, rather than the official lenders, provide emergency financing. I have favoured this approach for years, pointing out that US bankruptcy courts get working capital to municipalities and corporations in financial distress not by the courts making loans themselves, but by courts approving standstills on repayments of old debts and granting priority on new market borrowing by the bankrupt entity. The G7 has taken an important step in this direction, though gingerly, as the international law in this area will have to be built from scratch.
On the down side, the G7 completely ducks some of the most important issues, especially international policies on exchange rate regimes. A close reading of the emerging markets crises in recent years leaves little doubt that pegged exchange rates have played a pivotal role in the onset of crisis. The logic is roughly as follows. Countries undertaking macroeconomic stabilisation (as in Latin America) or financial liberalisation (as in east Asia) pegged their exchange rates to the dollar as a confidence-building measure. Initially, capital flowed in, tending to push up domestic prices in the midst of an internal boom. As the boom peaked, the squeeze on exporters from the pegged rate became clear. Investors therefore began to withdraw funds in anticipation of a devaluation. Eventually, the central bank ran out of reserves in hapless defence of the exchange rate. The sudden market recognition that reserves were depleted set the stage for a full-blooded financial panic.
While the G7 makes important advances in financial market regulation, IMF openness, capital market liberalisation, and orderly work-out arrangements, the headline grabber was the proposal for a new contingency finance mechanism. This proposal can be either creative, or a further waste of time and money.
If such contingency financing comes in the context of flexible exchange rates, prudential limits on "hot money" flows, and orderly work-out arrangements which put the onus of emergency financing on the private sector, the new facility can be a constructive part of the solution. If instead the IMF continues to be the lender of first resort, aimlessly defending overvalued exchange rates while allowing private creditors to make off with public funds, the new facility will add to global instability. Brazil will be an early test of which of those visions applies.
Let me make a categorical prediction. Until the poor are brought into the international financial system with real power, the global economy cannot be stable for long. The G7 countries, plus the rest of the European Union represent a mere 14 per cent of the world's population. Yet these countries have 56 per cent of the votes in the IMF executive board. Even after a miserable year, the G7 declaration, for all its advances, still reflects a haughty disregard for the rest of the world. There is no talk about negotiation with the poorer countries, no talk about finding a fairer voice for those countries in the new international system. The rest of the world is called on to support the G7 declarations, not to meet for joint problem-solving.
It would be much better to build on tentative moves towards a true global dialogue such as the US's initiative to set up the Group of 22 "systemically significant economies" and the UN secretary general's call for a United Nations role in global financial reform. The aim would be to ensure that a real community of nations works to solve global problems. The G7 declaration looks forward to its next summit in Cologne in 1999. For the good of the world, that summit should be a dialogue of rich and poor together, not just a communion of the rich pretending to speak for the world.
The author is the director of the Harvard Institute for International Development
|
