Inappropriate regulations, macroeconomic imbalances and serious gaps in international economic governance helped amplify the financial crisis but will not be addressed adequately by the G-20.
Current regulations favour large, cross-border & multi-product financial institutions over smaller, simpler national rivals which were placed a competitive disadvantage having to hold higher capital. Moreover the multiple jurisdictions and product lines that large banks operate across allow them to game the system to further amplify their advantage. Lower capital and gaming regulation allowed these institutions to earn fat profit margins whilst posing more and more risk to the global economy and stifling competition.
The crisis driven mergers of banks and the now explicit guarantee of government bailouts has made finance even more dangerous and even less competitive. ‘Too large to fail’ financial institutions need to be broken up, by geography or by function into entities that no longer enjoy public guarantees and compete against each other to offer better service to the real economy.
We will not get that (yet) though new regulations which penalize financial institutions which pose a danger to the financial system through their size or inter-connectedness are likely to be agreed.
The harsh experience of the Asian crisis and punitive IMF policies associated with rescue packages drove Asian countries to self-insure by buying up (mostly) dollar assets (reserves) to serve as protection against volatile financial markets. They have indeed helped countries such as China to cope better with the crisis. However, having Asian and oil rich gulf countries always ready to buy US bonds (lend it money) might have encouraged profligate US consumption and irresponsible financial markets. Clearly it could not have gone on forever.
While it makes sense for each country to build up rainy day foreign exchange funds, it is clear that not everyone can do so at the same time. The current crisis is likely to spur other countries to try self-insure but it will be collectively self defeating. The only long term solution is the adoption of a new reserve currency as a UN commission and China have recently suggested and Keynes did more than 60 years back.
We will not get it though there is likely to be some agreement on issuing a modest amount of SDRs, the IMF’s reserve currency.
The fruits of the boom that preceded the crisis went mostly to the rich. Not content with this, several of the so called ‘high net worth individuals’, together with some corporations and many financial institutions actively used the combination of secrecy and low taxation provided by tax havens to escape paying their fair share of taxes. This has caused public outrage since bank bailout bills will need to be picked by ordinary tax payers for years to come. This and ballooning fiscal deficits have pushed tackling tax havens to the top of the public agenda.
With 192 countries, the world would need to be more than 18,000 of the kind of bilateral tax information exchange treaties being proposed to tackle tax havens. Moreover, these only allow tax inspectors very specific queries to the extent that they would need to know exactly what they are looking for before they even approach a tax haven. Moreover, while tax havens are likely to sign information exchange deals with large and/or rich economies, few have shown any interest in doing so with developing countries, especially those that are small. So tackling capital flight from poor countries will not be addressed.
While there will be some more transparency from some tax havens we will not get the multilateral agreement and automatic exchange of information needed to effectively tackle tax havens.
While there are miles and miles to go, it’s good that we are at least headed in the right direction!