On Tuesday, June 29 the World Trade Organization’s Committee on Financial Services will hold its much anticipated session on the WTO and the financial crisis. Developing countries should follow this session with great scrutiny. The WTO has claimed that it played no negative role in the financial crisis. However, research by the IMF and the UN suggest otherwise.
Work by independent economists, the IMF, and the World Bank has shown that those nations that capital account liberalization is not associated with economic growth in developing countries. Indeed, developing nations need to cross a minimum threshold of institutional development before such liberalization can help spur growth.
In a February 2010 IMF report on the crisis, the IMF’s econometric analyses thus not surprisingly found that the liberalization of FDI in financial services industries was associated with worse growth outcomes than nations that did not liberalize previous to the crisis. To translate this into WTO language, that means that nations that committed to liberalizing “Mode 3” commitments (“commercial presence”) under the WTO’s General Agreement of Trade in Services (GATS) fared worse during the crisis.
That same February 2010 IMF report showed that those nations that deployed capital controls in the run up to the financial crisis were among the least hard hit during the financial crisis. Yet, nations that choose to liberalize “Mode 1” (“cross-border supply” of financial services) under the WTO implicitly have to liberalize their capital account. Thus, as I point out in a recent paper, the use of capital controls to prevent and mitigate financial crisis is actionable under the GATS and it is not clear at all whether any of the safeguards for prudential measures or balance of payments problems apply.
A responsible GATS session would urge developing countries not to make further Mode 3 commitments under the Doha Round and should address the need for a clear exception for those nations that have made previous Mode 1 commitments so they can use capital controls to prevent and mitigate crises.
A version of this post also appears on Politico.com, for which Gallagher is a regular contributor.