Rethinking Global Financial Governance Reform

By Daniel D. Bradlow

The limited success over the past few years in reforming global financial governance means that there is a need to reassess the current strategy and tactics for achieving global governance reform.

Following the first G20 summit in November 2008, the prospects for global financial governance reform seemed promising. The G20 leaders, in the Declaration and accompanying Action Plan issued at the end of that summit, called for reforms in the governance of the key global financial institutions like the International Monetary Fund (IMF); the World Bank, and the Financial Stability Forum. These reforms included changes in the allocation of quotas and votes in the IMF, changes in the composition of the Boards of Directors of the IMF and the World Bank, changes in the services provided by these institutions, and reforms in the selection procedures for their chief executive officers. They also agreed to expand the membership of the Financial Stability Forum (eventually reconstituted as the Financial Stability Board) to include all G20 member states and to enhance its status and its role in the global financial governance architecture. It seemed that, at last, the G7 countries would agree to reforming the governance of the global financial system to make it more reflective of the actual power relations in the system, more inclusive, and more responsive to the needs of all the stakeholders in the system.

The promises made in 2008 were repeated at other G20 summits and in other international forums. However, the promised reforms have only been partially implemented and they have resulted in limited changes in global financial governance. The result, as events in 2011 demonstrate, is that the G7 countries still dominate global financial governance. When the Japanese government was looking for coordinated international action to counteract the rapid appreciation of the Yen, they turned first to the G7 and not their fellow G20 members or even their fellow participants in the Chiang Mai initiative. Similarly, when the Eurozone countries were looking for support in dealing with their sovereign debt and banking crises, they turned first to fellow G7 members and not to the G20. While the Europeans have utilized the services of the IMF in dealing with their problems, their key G7 allies, like the United States, have been reluctant to support an expansion in the general resources of the IMF because this might result in increased influence in the IMF for the most powerful new members of the G20. Finally, despite their promises to end the “gentlemen’s agreement” that ensured that the IMF is always led by a European, the European countries, this year, concluded that, they “needed” another European IMF Managing Director. Thus, the new IMF Managing Director, like all her predecessors, is a European and her first Deputy, like all his predecessors, is an American.

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In short, 2011 demonstrated that both the scope and the pace of the reforms in the global financial governance arrangements have not kept up with the pressures created by the rapidly growing role of the emerging economies in the international financial and economic systems. There are several reasons for this failure. First, the balance of power in the world has not yet shifted enough to force a meaningful and stable change in global governance arrangements. While the financial and economic indicators clearly show that the balance of power is shifting away from the G7 countries, and that they can no longer managed the global system on their own, the G7countries have not yet lost control of the global financial and economic governance agenda. Their concerns dominated the agenda in 2011 and no decisions were made on these issues without their consent. In other words the shift in global power has only been enough to force the G7 to concede seats at the decision-making table to the new rising powers but it has not forced them to surrender control over the agenda for discussion at the decision-making table or over effective decision making on issues of most interest to them.

Second, it suggests that the rising powers and their non-G20 developing country allies are not yet sufficiently organized to stop the G7 from enforcingtheir will on international economic matters of most interest to them. This is not surprising given that these countries currently lack mechanisms for quickly reaching and implementing agreements on global financial governance matters. Consequently, they tend to enter into the G20 discussion on these matters without a coordinated approach and often with unresolved tensions between their respective positions.

Third, the current situation highlights the weakness of civil society in global financial governance debates. It shows that, despite their progress in building influence and global networks, international civil society has still not even achieved sufficient influence to make their governments, particularly in the case of the G7, live up to their commitments about IFI governance reform.

While the events of 2011 have revealed the current limited potential for substantial global governance reform, they have also underscored, once again, the critical need for such reform. The limited success over the past few years suggests that there is a need to reassess the current strategy and tactics for achieving global governance reform and to develop a new approach. This article offers some suggestions to guide this reassessment.

 

The process of power realignment is not yet complete and both the extent and speed of global financial governance reform is likely to be shaped by the course of events and the way in which both old and new powers and their allies respond to these events.

The Current Prospects of Substantial Governance Reform

Two lessons can be drawn from the experience of the past three years. First, the process of power realignment is not yet complete and both the extent and speed of global financial governance reform is likely to be shaped by the course of events and the way in which both old and new powers and their allies respond to these events. Given this dynamic, and the fact that the G7 are only likely to surrender their governance prerogatives when forced to do so, the best hope for achieving meaningful reforms in the short run depends on the rising powers forming tactical alliances that can pressure the G7 countries to accept necessary reforms. These realities suggest that there is scope for a tactical bargain between the rising G20 member state, non-G20 developing countries, and international civil society.

Second, in such an unpredictable environment, it is not possible to build new and stable global governance arrangements. Whatever reforms are adopted are likely to be partial responses to the underlying problems that are shaped by the dynamics of that particular moment in the power realignment process. They will inevitably come under strain as the realignment process evolves. These partial responses can, nevertheless, contribute to the gradual development of a more sustainable and legitimate global governance architecture. They will only make this contribution, however, if their governmental and non-governmental supporters base their efforts on an acknowledgement of their limitations and on a realistic assessment of their ability to contribute to the ultimate goal of achieving sustainable, legitimate, and effective global financial governance. They can only make this assessment if they base both their strategy on a long term strategic vision of global financial governance and their actions on exploiting whatever potential for reform may actually exist or arise in the short term.

This long term vision should be based on the following five factors.

 

A Holistic Vision of Development

All states are developing states in the sense that they are striving to create better lives for their citizens. While states may differ in defining this task, they all acknowledge that development is a comprehensive and holistic process in which the economic, social, political, environmental and cultural aspects are integrated into one dynamic process. The ability of global financial governance institutions to help all states achieve their developmental objectives depends on how effectively they incorporate this holistic vision of development into their operations.

 

The governance arrangements must be based on the principle of subsidiarity, which holds that all decisions should be taken at the lowest level in the system compatible with effective decision making.

Comprehensive Coverage

Comprehensive coverage means that the mechanisms and institutions of international financial governance should be applicable to and serve the interests of all stakeholders in the international economy. Three important corollaries follow from this principle. First, the mechanisms of international financial governance must meet the needs of all stakeholders which include states, financial institutions, consumers of financial services, and those poor citizens and business enterprises in all countries who are excluded from these services.

Second, international financial governance arrangements must ensure that the international community receives all the services it requires from a well-functioning global financial system. These services include monetary and financial stability, a lender of last resort, monetary regulation, development finance; regulation of trade and investment in financial services; regulation of the cross border activity of financial institutions; coordination of national financial regulation; appropriate incentives for financial actors; coordinated taxation of financial transactions; incorporation of alternative financial systems, such as Islamic banking into the governance arrangements, arrangements for dealing with sovereign debt problems and complex cross border bankruptcies; and regulation of international money laundering.

Third, the governance arrangements must be based on the principle of subsidiarity, which holds that, all decisions should be taken at the lowest level in the system compatible with effective decision making. This principle can facilitate the creation of governance arrangements that are flexible, efficient, and not unduly centralised. It is difficult to implement because it must apply both in standard operating conditions and in crisis situations, which may require that decisions are made at a different level than is the case during standard conditions.

 

Respect for Applicable International Law

The institutional arrangements for international economic governance should comply with applicable international legal principles. There are at least four sets of such principles.

The first is respect for national sovereignty. While it is inevitable that in an integrated global system states forego some autonomy, the principle of national sovereignty helps them preserve as much independence and policy space as is consistent with effective global financial governance. This principle offers states a principled basis on which to limit the ability of international organizations, other states, and private creditors to influence their domestic policies and to ensure that even the smallest and weakest states have some capacity to participate in global financial governance. It should be noted that the principle of sovereignty must be balanced against the demands of the other principles of international law applicable in this context.

Developing country governments and international civil society should work together for changes in global governance that are consistent with their long term vision.

The second is non-discrimination, which ensures both that all similarly-situated states and individuals are treated in the same way and that differently situated states and individuals receive disparate treatment. In the case of states, this requires adapting the principle of special and differential treatment to international financial governance. This principle, well known in international trade and environmental law, is based on the view that different states have different capacities to respond to particular events or legal requirements and may also be differently affected by these events or requirements. Consequently, it is reasonable for international law to allow these states to assume differing responsibilities based on their specific circumstances. This may require, for example, the creation of special consultation and accountability mechanism that enable weak and poor states to enjoy a meaningful level of participation in international financial decision making structures and
institutions.

In the case of non-state stakeholders, the relevant principles should be derived from documents like the Universal Declaration of Human Rights, which many now consider to be applicable to all states as part of customary international law. In addition to these obligations, all states are signatories to at least some international human rights conventions and have specific obligations under these conventions. This suggests that while the sovereignty of states needs to be respected and protected it is not absolute and must be counter-balanced by the state responsibility to respect, protect, and fulfil the human rights of their citizens.

The third set of international legal principles is based on the general principles of state responsibility for treatment of foreigners located in the sovereign’s home territory. This means, in regard to foreign investors and service providers that they should receive treatment that conforms to certain minimum standards, a term not clearly defined in international law, but that at a minimum should be fair and equitable treatment and, most likely, must be at least comparable to the treatment of similarly situated domestic institutions. This principle has particular relevance to a globalized financial system, in which both direct and portfolio foreign investors play an important role.

The fourth set of principles is derived from international environmental law. At a minimum this requires all international governance institutions to fully understand the environmental and social impacts of their operations and practices. It may also require states to accept the responsibility for the pollution that they cause, under the well-recognized polluter pays principle.

 

Co-ordinated Specialisation

The principle of co-ordinated specialisation acknowledges that, even though development is holistic and all aspects of international governance are inter-connected, effective international economic governance requires institutions to have limited and specialised mandates. The principle of co-ordinated specialisation has two requirements, in regard to the institutions of global financial governance. First, their mandates must be clearly defined and limited to their areas of expertise. Second, they cannot ignore the fact that there are other international organizations that have expertise in and responsibility for the other aspects of development. Consequently, in order to ensure that together all these organizations help their member states implement a holistic vision of development, there is a need to ensure some form of coordination between the institutions of global financial governance and other international organizations. An effective coordination mechanism needs to be transparent and predictable and should provide a means for resolving jurisdictional disputes between the various institutions.

 

Good Administrative Practice

The arrangements for global governance should be guided by the same principles–transparency, predictability, participation, reasoned and timely decision making, and accountability–as are applicable to any public institution. This means that they must conduct their operations pursuant to transparent procedures that result in decisions and actions that are predictable and understandable to all stakeholders. They must also offer these stakeholders some meaningful way of raising their concerns and having them addressed by the institutions. Finally, the stakeholders should be able to hold the institutions accountable for their decisions and actions.

 

Some Short Term Opportunities for Reform

Clearly there is neither general agreement among the various stakeholders in the global financial system on the details of this long term vision nor on how to implement it. Moreover, given the current geo-political dispensation, it is not realistic to expect to create a global governance architecture that fully implements such a vision in either the short or medium term. Given these conditions, the most stakeholders most interested in reform– developing country governments and international civil society– should concentrate on building their relations with each other and on working for changes in global governance that can result in immediate real gains for their countries and their citizens and can open up further reform opportunities that are consistent with their long term vision. In this regard there are two potentially fruitful areas for reform.

The first issue on which the two groups can cooperate is raising the importance of financial inclusion on the financial regulatory reform agenda. They should advocate for regulations that encourage financial institutions to develop products and services for the currently unbanked and small businesses. In this regard, they should remind their counterparts of Paul Volcker’s contention that the most important recent financial innovation was not a fancy derivative but the ATM because it enhanced access to financial services. Africa could also point out that the next such innovation could be cell phone banking, in which Africa is a leader. They can also advocate for creative approaches to enhancing financial flows to poor countries, the unbanked and small businesses. One way to do this is to promote regulations requiring international financial institutions to recycle at least a stipulated proportion of the capital flight that they attract from developing countries back into these countries. Another way would be to advocate for the creation of an international trust, backed by socially responsible businesses and wealthy individuals. This trust would issue retail bonds—solidarity bonds—that individuals and corporate entities can buy. The proceeds of the bonds would be invested in revenue-generating, and job-creating development projects in developing countries.

Second, they can prioritise specific and achievable reforms of the institutions of global financial governance. This means that they should focus on reforms that do not require treaty amendments and that are possible within the existing legal frameworks. One such reform is increasing the IMF’s public accountability. Unlike the other IFIs, it does not have an independent accountability mechanism that allows non-state actors to have their claims that they have been harmed by the failure of these IFIs to comply with their own policies and procedures investigated. Such a mechanism, adapted to the IMF’s operations, could both enhance the IMF’s responsiveness to its stakeholders and enable it to obtain more detailed empirical knowledge about the impact of its policies and operations on people’s lives, thereby contributing to improved IMF performance.

Another potential governance reform is increased transparency in and accountability of the Financial Stability Board and such international standard setting authorities as the Basel Committee on Banking Supervision; the International Organization of Securities Commissions; and the International Association of Insurance Supervisors. These reforms should increase the likelihood that these bodies will promote standards and decision-making procedures that are responsive to the needs of all their stakeholders, perhaps event thereby helping to incentivize financial institutions to address such global problems as poverty, inequality, and environmental degradation.

 

Conclusion

In the short run, it is not feasible to substantially reform the institutions of global financial governance. The best that the developing countries and international civil society can hope for is to capitalize on opportunities for partial reform as they arise and to use these opportunities to slowly build towards a sustainable, legitimate, and effective global financial governance architecture. In order to do this, these stakeholders should use the principles discussed in this article to both shape their long term vision of international financial governance and to identify the opportunities that they can exploit in working towards their long term vision for global financial governance.

 

About the author

Daniel D. Bradlow is the SARCHI Professor of International Development Law
and African Economic Relations at the University of Pretoria and professor of law at American University Washington College of Law. He is also chair, Independent Review Mechanism, African Development Bank; and is a member of Board of Directors, New Rules for Global Finance; and was a member, High Level Panel on Governance of the Financial Stability Board (FSB). His scholarship focuses on global financial governance, and legal aspects of sustainable development. Recent publications include IFIs and International Law (co-edited with David Hunter, 2009); and Law, Justice and Development (co-edited with H.Cisse, and B. Kingsbury, 2011).

Email: [email protected]

 

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