Foreign Policy In Focus Special Report: Repairing the Global Financial Architecture

“In a world of free capital flows, this burden (economic losses from financial crises) tends to fall on those who are unable to escape. Loss distribution is a political matter.”
— Andrew Sheng, Bank Restructuring: Lessons from the 1980s
(Washington: World Bank, 1996), p. 181.

The World in Numbers
Repairing the Global Financial Architecture
   Countries with Per Capita GDP Growth Below 1960-71 Levels
   Annual Percentage Growth of the Volume of Exports, 1959-94
   Annual Percentage Growth of Gross Fixed Investment at Constant Prices, 1959-94
   Annual Percentage Productivity Growth of the OECD Business Sector, 1960-95
   Annual % Rates of Unemployment and Growth of real Wages and GDP
   Per Capita in the U.S. and the EU, 1960-95

The lifting of controls on international capital movements over the past quarter-century has been paralleled by a succession of international financial crises—the current one being the most extensive and virulent to date. “By any standard,” observes Gerald Corrigan of Goldman, Sachs and former president of the New York Federal Reserve Bank, “the frequency and consequences of these events are simply too great.” There is now, therefore, general consensus that something needs to be done to reduce the incidence of such crises. In the jargon of financial bureaucrats, the “global financial architecture” needs reforming.

Beyond that, consensus fragments. The reform agenda of the International Monetary Fund (IMF)—and of the central bankers and finance ministers of most of the major industrial powers who dominate the IMF—would extend free capital mobility while adapting developing countries to handle volatile capital flows more effectively. The alternative approach—restraining the freedom of financial capital to move globally in order to reduce its power to deter countries from pursuing autonomous economic policies—is not on that agenda. But this alternative approach is evoking support among academic economists in both developed and developing countries. More importantly, since political feasibility is an essential requisite, it is also gaining support at the grassroots level in both groups of countries and is infiltrating official circles.

Because each approach requires collective action restricting national sovereignty, there will be tradeoffs between different types of freedom. To induce free but more stable capital flows, proposals on the IMF agenda would standardize tighter bank regulations and require each country to enforce them. Other schemes would increase the power of the IMF to oversee the economic policies and performances of developing countries and ensure that these countries provide accurate data to international investors, eschew capital controls, and avoid defaulting on their foreign debts. Propositions under the alternative approach call for coordinated measures—international tax and/or regulatory agreements—to minimize evasion and policy discordance.

Proposals demanding a much greater surrender of national sovereignty have also been put forth: a global central bank, a uniform bankruptcy code enforced by international bankruptcy courts, and other ambitious institutional innovations of global reach. These ideas have didactic value by identifying distant possibilities, but they clearly lack a serious political constituency now, either among the power elite or the grassroots. This report does not address such long-range proposals. Nor does it review the full array of specific proposals associated with either the liberalizing or capital restraining approaches. These have reached a mind-numbing quantity that precludes item-by-item assessment within the scope of this brief paper.* This Special Report of the Foreign Policy In Focus project itself has two main tasks: 1) to assess the economic welfare and political feasibility arguments used to validate each of the two competing approaches to architectural reform, and 2) to draw from the two approaches specific proposals that in combination would improve global welfare and also have some chance of being adopted.

* Readers are referred instead to the recent survey volumes by Barry Eichengreen, Toward a New International Financial Architecture (Washington: Institute for International Economics, 1999), and Robert Blecker, Taming Global Finance (Washington, DC: Economic Policy Institute, 1999).

Repairing the Global Financial Architecture:
Painting over Cracks vs. Strengthening the Foundations

Assessing the Welfare Effects of International capital Mobility

On Architectural Reforms

Comparing the Macroeconomic Performance of Developing and Industrial Capitalist Economies During and After Bretton Woods

Post-Bretton Woods Financial Trends

An Alternative Package of Architectural Reforms: Bretton Woods Light

Reference Notes and Financial Flows Packet