Global economic governance

January 06, 2011
IDRC Communications
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As the global financial crisis has spilled over into local economies, triggering bankruptcies and unemployment, livelihoods everywhere are under threat. Developing countries are particularly alarmed. In fragile political and economic environments, financial systems already are prone to volatility. Even where these local systems are robust, they remain vulnerable to the more general collapse of confidence. Instability in one country can provoke instability in others, and when this happens, poor countries have few resources to fall back upon.

Meanwhile, policymakers have been inundated with suggestions for solutions. Clearly, some of the proposals being put forward are coloured by ideological bias or by special interests.What decision-makers need instead is hard empirical evidence, drawn from credible, independent research.

The mission of Canada’s International Development Research Centre (IDRC) is to support science in the service of poverty reduction. As part of this brief, IDRC pursues knowledge that will help developing countries join more effectively in the world economy. For two decades IDRC has invested in research on global finance. This work has posed fundamental questions about the very issues of economic governance that, some argue, lie at the root of the current crisis. The knowledge gained from these studies has helped poor countries reinforce their bargaining positions — and understand their choices — in the context of today’s emergency.

A VOICE FOR THE DISENFRANCHISED

When poor countries try to make their case in policy deliberations of institutions like the World Bank or the International Monetary Fund, they often have trouble getting their message across. Frequently, emerging economies lack the capacity to investigate and become familiar with complex financial issues.

To help address this problem, IDRC in 1988 began funding the research program of the Intergovernmental Group of Twenty-Four on International Monetary Affairs and Development (the G-24).

By way of over 100 technical studies and discussion papers, the research program has provided G-24 members with the sophisticated data and analyses that formerly were available only to richer nations. This expertise has helped countries such as Ethiopia, Trinidad and Tobago, and the Philippines strengthen their hand in high-level monetary negotiations. More broadly, the studies have highlighted the need to include a “development dimension” in any discussions of international finance and institutional reform. Because of the know-how and advocacy it provided, the research program became, in the view of its stakeholders, “the glue that held the G-24 together.”

Toward the same end, IDRC funds the studies carried out by the Global Economic Governance Programme at Oxford University. Directed by Ngaire Woods, this initiative convenes scholars and policymakers, and fosters research and debate into how global markets and institutions can better serve the needs of people in developing countries.

THE PROBLEM OF TOO MUCH MONEY

The Latin American debt crisis of the 1980s largely disengaged local economies from international capital markets and led to widespread hardship. Despite the severity of the “lost decade,” however, by the early 1990s external private capital had begun to flow back to the region.

This influx of money was welcomed because it boosted investment and alleviated the recession, but such inflows also had undesirable effects — on exchange rates, on the degree of national control over the money supply, and on future vulnerability to new external shocks. These aftereffects provided an opportunity for IDRC-funded researchers to throw light on global financial governance, in particular on the critical need for firm regulation.

In the past, economists commonly likened the free trade in goods to the free trade in financial assets, but instead these researchers contrasted the two. Cross-border trading in money is not identical to, for example, the cross-border exchange of wheat for textiles. While a transaction involving goods is “complete and instantaneous,” a transaction involving financial instruments “is inherently incomplete and of uncertain value because it is based on a promise to pay in the future.” This is one of the factors that make financial markets inherently unstable, and why — as much of the world is now learning so painfully — governments have a responsibility to regulate them.

FINDING FLEXIBILITY AND HARMONY

Could policymakers now toiling to restructure global financial institutions learn lessons from earlier reform efforts in developing countries? Conclusions from IDRC-supported research, coordinated by economist José María Fanelli and IDRC Vice-President and economist Rohinton Medhora, may have relevance today.

In 1998, the economists posed the question: How do you structure a financial system so that it contributes to development? By way of case studies of representative developing and emerging countries, contributors explored the institutional environments in which reform occurs and the integration of principles of finance with more macroeconomic approaches.

In 2002 — in the wake of the Asian financial crisis —Fanelli and Medhora explored the links between finance and trade competitiveness. They discovered that the nature of these links varies across sectors and countries, and so policymakers should beware of applying policies in a cookie-cutter fashion. Although conventional wisdom holds that every country should have stock markets, floating interest rates, and so on, the research shows that not all these instruments are equally important everywhere as engines of growth and stability.

Nonetheless, caution the authors, if a country is to successfully integrate globally, its domestic financial system — or “architecture” — needs to be congruent with the international financial architecture. Medhora believes that a fatal mismatch lies at the root of the current crisis: “Basically, the American financial architecture is not in line with the international one; this affects everybody.” The need for accord is especially important for more crisis-prone emerging economies.

In a more recent volume, a global team also led by Fanelli showed that policy responses to crises can have longer-lasting unintended effects than the crises themselves. International coordination and mechanisms to support reformers will therefore remain on the global agenda for a long time.

FINANCIAL STABILITY AS A PUBLIC GOOD

When foreign aid is increasingly directed toward goals that benefit both rich and poor countries — such as financial stability, limits on climate change, and biodiversity — traditional aid concerns in specific countries can be underfunded. Furthermore, when foreign aid in general is being reduced, even those “global public goods” can suffer neglect. One solution is for donor countries to two-track their aid budgets: one fund for worldwide concerns, another for domestic needs in developing countries.

This is an argument that poor countries need to push. IDRC has sought to improve their bargaining power by funding and supporting intellectually the research program on global public goods at the United Nations Development Programme.

In economic terms, a “public good” is a resource that everyone can enjoy. Examples include peace and security, law and order, efficient markets, clean air — even moonlight. A “global public good” is one with universal benefits stretching over countries, individuals, and generations, for example, international financial stability.

Recognition that financial stability is a global public good has profound implications for developing countries. Combining notions of universality, stability, and “good” in this way makes for strong rhetoric and an effective negotiating tactic, for it compellingly argues that we are all in this together. It means that rich and poor countries must find common ground — to better manage the global economy and to achieve sustained growth, poverty reduction, and real benefits for everyone.