Kevin P. Gallagher published the following op-ed in the Financial Times based on the recent Pardee Center report from the Task Force on Regulating Global Capital Flows for Long-Run Development, which he co-chairs.
Negotiators will meet in Singapore this week for yet another round of talks on a Trans-Pacific Partnership – it is the 16th time in just a few years. A TPP would bring together key Pacific-rim countries into a trading bloc that the US hopes would counter China’s growing influence in the region.
Among other sticking points, talks remain stalled because the US insists that its TPP trading partners dismantle regulations for cross-border finance. Many TPP nations will have nothing of it, and for good reason. The US stance stands on the wrong side of country experience, economic theory and guidelines issued by the International Monetary Fund.
TPP nations such as Chile and Malaysia successfully regulated cross-border finance to prevent and mitigate severe financial crises in those countries in the 1990s. In the wake of 2008, there has been a global rethink regarding the extent to which cross-border financial flows should be regulated. Many nations such as Brazil and South Korea have built on the example of Chile and Malaysia and reregulated cross border finance through taxes on short-term debt and foreign exchange derivative regulations. After 2008, emerging markets and developing nations want as many tools as possible to prevent and mitigate crises.
New research in economic theory justifies this. Anton Korinek and Olivier Jeanne have demonstrated how externalities are generated by cross border financial flows because investors and borrowers do not know (or ignore) what the effects of their financial decisions will be in terms of financial stability in a particular nation. Foreign investors may well tip a nation into financial difficulties, and even a crisis.
The authors argue that regulating cross border finance will correct for the market failure and make markets work more efficiently.
Such thinking has in part triggered an about face at the IMF on capital flows. Last December, the IMF endorsed an “institutional view” on capital account liberalization and the management of capital flows. The IMF now recognises that capital flows bring risk, particularly in the form of capital inflow surges and sudden stops, which can cause a great deal of financial instability. Under such conditions, the IMF will now recommend the use of cross-border financial regulations to avoid such instability.
I led a task force that held a compatibility review examining the extent to which the regulation of cross-border finance was compatible with many of the trade and investment treaties across the globe. It consisted of former and current Central Bank officials, IMF and WTO staff, members of the Chinese Academy of Social Sciences, as well as scholars and members of civil society. In areport published this week, we find that US trade and investment treaties were the most incompatible with new thinking and policy on regulating global finance.
Not only do US treaties mandate that all forms of finance move across borders freely and without delay, but deals such as the TPP would allow private investors to directly file claims against governments that regulate them, as opposed to a WTO-like system where nation states (ie the regulators) decide whether claims are brought. Therefore, under investor-state dispute settlement a few financial firms would have the power to externalise the costs of financial instability to the broader public, while profiting from awards in private tribunals.
Such provisions fly in the face of recommendations on investment from a group of more than 250 US and globally renowned economists. The 2012 IMF decision echoes these sentiments when it says “these agreements in many cases do not provide appropriate safeguards or proper sequencing of liberalization, and could thus benefit from reform to include these protections”.
Members of our task force recommend that emerging market and developing countries refrain from taking on new trade and investment commitments unless they properly safeguard for the use of cross-border financial regulations. Leaked text of the TPP reveals that Chile and other nations have proposed language that could provide such safeguards. The US should work with those nations to devise an approach that gives all nations the tools they need to prevent and mitigate financial crises.
Copyright Financial Times 2013 (first time visitors to the FT page will have to sign in but opinion articles at the FT are free)
Kevin P. Gallagher is co-chair of the Task Force on Regulating Global Capital Flows for Long-Run Development and co-editor of the task force’s latest report, “Capital Account Regulations and the Trading System: A Compatibility Review”.