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Globalization of the world economy
is proceeding at a rapid pace, particularly in the arena of international
finance. The presumed virtues of globalization, however, are a
long way from materializing and being fairly distributed among
nations.
The opening of domestic capital markets to foreign investment
is still a relevant component of the "Washington consensus",
although many experts argue that free mobility of private capital
in the 1990s was one of the major causes of the financial crises
in emerging markets.
Only theoretically
the liberalisation of the capital account brings
equal benefits to both developed and developing countries. In
practice it leads to increasing benefits for western investors
and banks expanding their opportunities for portfolio diversification
and the efficient allocation of global savings and investment.
In addition, it offers to creditor countries broader investment
and risk- diversification opportunities, particularly as their
ageing populations with growing pension funds seek higher returns
on their investments.
A country
can take advantage of greater capital mobility only when its domestic
financial market has a sufficiently developed structure. Therefore,
while an open capital account is a positive instrument for financially
developed countries, countries with emerging markets and transition
economies are constantly being undermined by uncontrolled and
unexpected capital flight and by sudden
and unsound deregulation and liberalisation policies.
As
a result, greater capital mobility brings high costs and limited
benefits to countries with emerging markets who lack sound, modern
national financial institutions and are vulnerable to the volatility
of financial flows.
The financial
crises in the 1990s showed that the liberalisation process is
disastrous when it is not properly managed. Liberalisation can
be extremely costly and highly dangerous in countries that do
not have proper bank regulatory and supervisory
structures, well-functioning legal and judicial systems, and adequate
safeguards against highly risky and unethical behaviour.
Unfortunately,
the above measures are far from being implemented in emerging
countries. Despite their importance, such measures are unlikely
to be implemented in the near term because of the complex processes
involved.
There
are temporary measures, however, that can be taken to protect
vulnerable national economies from financial instability before
strong financial structures are in place. Amongst others, these
include limits on loan-to-value ratios and consumer credit, maximum
repayment periods and minimum down-payment percentages. Additional
measures that reduce vulnerability of national financial systems
include restrictions on foreign-denominated debt and prudential
controls to limit capital inflows.
Chile's
experience with capital controls in the 1990s is a concrete example
of such a temporary measure. Chile introduced restrictions on
capital inflows in June 1991. Initially, all portfolio inflows
were subject to a 20% reserve deposit with no interest. For maturities
of less than one year, the deposits applied for the duration
of the inflow, while for longer maturities the reserve requirement
was for one year. In July 1992, the rate of the reserve requirement
was raised to 30%, and its holding period was set at one year,
independently of the length of the flow. The results achieved
by the authorities with this policy have been so far:
* a decrease
in the volume of short-term inflows and an increase of longer
maturities. (As shown in Table 1, the reduction in shorter-term
flows was fully compensated by equivalent increases in longer-term
capital inflows. Thus, aggregate capital inflows to Chile were
not decreased by capital controls!);
* a decrease
of the country's vulnerability to international financial instability;
the ability of the central bank to implement an independent monetary
policy (despite the presence of pegged exchange rates) and to
maintain a high differential between domestic and international
interest rates.
Table 1. Capital Inflows (gross) to Chile: USD Millions
Year Short-term flows Percentage
of total Long-term flows Percentage of total Total Deposits*
1988 916,564 96.3 34,838 3.7 951,402 /
1989 1,452,595 95.0 77,122 5.0 1,529,717 /
1990 1,683,149 90.3 181,419 9.7 1,864,568 /
1991 521,198 72.7 196,115 27.3 717,313 587
1992 225,197 28.9 554,072 71.1 779,269 11,424
1993 159,462 23.6 515,147 76.4 674,609 41,280
1994 161,575 16.5 819,699 83.5 981,274 87,039
1995 69,675 6.2 1,051,829 93.8 1,121,504 38,752
1996 67,254 3.2 2,042, 456 96.8 2,109,710 172,320
1997 81,131 2.8 2,805,882 97.2 2,887,013 331,572
* Deposits in the Banco Chile due to reserve requirements
Source:
Central Bank of Chile
This
example shows that temporary measures such as restrictions on
capital flows are useful instruments that safeguard financial
stability, prevent financial crises and encourage long-term capital
inflows. Thus, without a stable and sound international
financial system,
capital controls can be
considered as valid, safe and valuable policy options to promote
development.
In
the United Nations Secretary General Report prepared in view
of the preparatory process of the High Level Conference "Financing
for Development" which will take place in Mexico in March
2002, capital controls are mentioned in article 21 as a temporary
measure to protect national stability. However, the wording underlines
that capital controls should not replace the implementation of
adequate reforms in the financial system. We support this argument,
although we remind that such reforms are far from being implemented
in most emerging markets. Meanwhile the international community
should recommend and allow immediate measures to protect national
financial stability.
Furthermore,
the policy dilemma of the "impossibility of the holy trinity"
- that is, achieving free capital mobility, a pegged exchange
rate and an independent monetary policy simultaneously - is false.
There is no valid argument or evidence to support the need for
full liberalisation of capital markets and flows at all cost.
On the contrary, ad hoc measures to control capital flows, specifically
designed and implemented for each individual country, should
be pursued by national governments and strongly encouraged by
international institutions.
An
additional argument in support of capital control measures is
the acknowledgement of the speculative nature of a relevant proportion
of financial inflows.
To
accomplish this goal it is essential to focus on the analysis
of the composition of financial flows and their ability to support
development. In the past two decades, the combination of liberalisation,
speculation and technology innovation has given rise to a system
of huge dimensions that functions more on rumour than on economic
fundamentals. The main players in this system, inter alia commercial
and investment banks, exchange USD1,862 billion daily in currency
transactions and Over The Counter Transactions (OTC). Moreover,
the currency market has grown. Table 2 shows that foreign exchange
transactions increased from USD18.3 billion/day in 1977 to USD1,500
billion in 1998. With derivative transactions added, this figure
is USD1,597 billion. Furthermore, from 1977 to 1998, the ratio
between annual currency value in foreign currency and foreign
export increased from 3.51 to 55.97, while the ratio of central
bank reserves to daily currency activities in foreign currency
decreased from 14.5 to a mere 1.
Table 2. Daily
average turnover in currency exchange markets in 1998,
by length of contract (in millions of US dollars)
Maturities 2 days 3-7 days 1 year >1 year Total %
1. Spot 577,737 577,737 40.1
2. Outright 65,892 58,680 5,099 129,671 9.0
3. Forward
4. Forex swaps 530,683 192,592 10,847 734,122 50.9
Total 577,737 596,575 251,272 15,946 1,441,530 100.0
% 40.1 41.4 17.4 1.1 100.0
Source: B.I.S. (1998)
Table
3 shows that 40.1% of contracts are two-day spot transactions,
41.7% are three to seven days, and only 1.1% are for more than
one year. It should be noted that contracts on currencies are
purely speculative. This market is beyond any public control
and totally disconnected from productive activities.
Table
3. Official
Reserves, foreign exchange trade and exports, 1977-98
Year Official Reserves
(Billions of USD) Reserves+ gold
(Billions of USD) Daily global turnover*
(Billions of USD) Reserves / Daily turnover
(1) (2) (3) (1)/(3) (2)/(3)
1998 1,636.1 1,972.0 1,500.0 1.0 1.3
1995 1,347.3 1,450.0 1,190.0 1.1 1.2
1992 910.8 1,022.5 820.0 1.1 1.2
1989 722.3 826.8 590.0 1.2 1.4
1986 456.0 23.0 270.0 1.7 2.0
1983 339.7 494.6 119.0 2.8 4.2
1980 386.6 468.9 82.5 4.7 5.7
1977 265.8 296.6 18.3 14.5 16.2
*excluded derivative contracts
Source:
B.I.S. (1998)
This
economic sector grew at an incredible rate compared to the international
trade of goods and services. The total amount of the goods traded
in 1998 was USD6,700 billion, registering a 14% growth rate from
1995. Financial activities involve 76 times more financial resources
than global trade in goods and services: for each dollar spent
on trade, USD75 are invested in financial assets. In the financial
markets monetary returns -together with risks- are much higher
than in the real economy, thus increasing resources are shifted
from productive and long-term investments into speculation. Capital
controls can, as the Chilean case showed, allow governments to
welcome long term investment, while discouraging short term ones
making them more costly.
The incredible
dimensions of the financial markets private flows have serious
consequences- as it is noted in the chart- also in terms of Central
Banks capability of reacting to speculative attacks. Global central
bank reserves merely reach the equivalent of the amount traded
in one day of currency transactions on financial markets, and
the more recent data from March 1999 show that this situation
is worsening. Two controversial issues in this field require immediate
reaction: the volume of short-term capital flows, in
particular massive inflows and outflows of speculative capital
(spot transactions), leads to substantial exchange rate instability;
the excessive liquidity of financial markets means that national
institutions such as central banks are unable to protect national
currencies from speculative attacks. Traditionally, a central
bank buys and sells its national currency on international markets
to keep the currency's value relatively stable. The bank buys
currency when a glut caused by an investor sell-off threatens
to reduce the currency's value. In the past, central banks had
reserves sufficient to offset any sell-off or attack. Currently,
speculators have larger pools of cash than all the world's central
banks together. This means that many central banks are unable to protect
their currencies, and when a country cannot defend the value of
its currency, it loses control of its monetary policy.
The
international community should address adequately this new situation
and design new rules and institutions capable to guarantee stability
and more equitable growth in the system. The United Nations Conference
on Financing for Development represents an historical event to
promote a constructive dialogue on these issues among the different
actors: Governments, UN Agencies, International Financial Institutions,
the World Trade Organization, civil society and the private sector.
The agenda of such a meeting contains most of the major current
challenges: domestic resources for development, private flows,
Trade, Official Development Assistance, debt, the international
financial architecture and many others.
In
the preparatory process and in the Conference itself civil society
will monitor that adequate decisions are made. Differently, another
precious opportunity will be lost. In the framework of this Conference
civil society has great expectations about a consistent discussion
on the implementation of a currency transactions tax (CTT). This
study was recommended by the UNGASS in Geneva in June 2000. As
a follow up, the UN Secretary General Kofi Annan set up an High
Level Panel chaired by the former Mexican President Zedillo.
This Panel will produce a Report in May 2001 that will hopefully
contain concrete and effective proposals.
Civil
society and academics from many countries have already produced
studies on the economic feasibility of currency transaction taxes.
Currency transaction taxes are uniform international taxes payable
on all spot transactions involving the conversion of one currency
into another, in both domestic security markets and foreign exchange
markets. They would discourage speculation by making currency
trading more costly. The volume of short-term capital flows would
decrease, leading to greater exchange rate stability.
Achieving
this stability through taxation would require high rates, however,
and this would seriously obstruct the workings of international
financial markets. A small charge on international financial
transactions would not create distortions, but it would also
not inhibit speculative behaviour in foreign exchange markets.
One possible compromise, suggested by Paul Bernd Spahn, Professor
at the University of Frankfurt, would be a two-tier structure:
a minimal rate transaction tax and an exchange surcharge that,
as an anti speculation devise, would be triggered only during
periods of exchange rate turbulence. The minimal rate transaction
tax would function on a continuing basis and raise substantial,
stable revenues without impairing the normal liquidity function
of world financial markets. It would also serve as a monitoring
and controlling device for the exchange surcharge, which would
be administered jointly with the transaction tax.
The exchange surcharge, which would be dormant as long as foreign
exchange markets operated normally, would not be used to raise
revenues, but would function as an automatic circuit-braker whenever
speculative attacks against currencies occurred. A minimal nominal
charge of, e.g., two basis points on foreign exchange transactions,
would raise the cost of capital insignificantly and would probably
have no effect on the volume of transactions involving currency
conversions. The exchange surcharge would avoid the negative
effects of other monetary policy measures that sacrifice valuable
international reserves or offer excessively generous interest
rates to combat speculative attacks. It would also eliminate
expectations of recurrent bailouts by central banks and reduce
unethical behaviour and the impacts of financial crises.
To summarise, the implementation of currency transaction taxes
could: reduce
short-term speculative currency and capital flows; enhance national
policy autonomy;
restore taxation capacity of individual countries eroded by the
globalisation of markets;
distribute tax pressures more equitably among different sectors
of the economy;
trace movements of capital to fight tax evasion and money laundering.
In
addition, currency transaction taxes could collect resources
for development purposes. The revenues generated should not,
however, replace the fulfilment of fundamental commitments, such
as the internationally agreed level of official development assistance
(ODA), adequate
debt reduction and cancellation initiatives, and a more equitable
trade agreement. All these crucial commitments will be discussed
in the Conference Financing for Development where civil society
will work to make it a concrete success.
*Published
in Social
Watch
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