India should insist that the discussion at the summit be restricted to the design of multilateral reforms and exclude desirable reforms of individual country institutions.
Prime Minster Manmohan Singh will attend the G-20 summit in Washington, DC on November 15, 2008 that will discuss the reform of global financial architecture. The Finance Minister has already met with a group of economists to discuss what reforms India should propose. A paper by the Finance Ministry is expected soon on the issue. Certainly the spreading global financial crisis calls for a quick and appropriate response. It is also possible that a crisis of the magnitude b eing experienced will make it easier to adopt far-reaching reforms that will be very difficult, if not impossible, to adopt in more tranquil times. However, it is essential that, first, any short-term responses to the crisis do not unwittingly increase the possibility of a repetition of the crisis in the future and also foreclose future freedom of action. Second, any fundamental reform of the architecture of interstate economic institutions such as the International Monetary Fund, World Bank and World Trade Organisation has to recognise that the global trade and financial system have changed drastically since some of these institutions were founded more than half-a-century ago. In particular, the financial system is no longer dominated by commercial banks and publicly regulated entities. The range of financial products offered in the market along with their risk-return characteristics have been expanding at ever more rapid rates. Yet the capacity of individual market participants and of regulatory frameworks to understand their idiosyncratic and systemic risks has been lagging. This has generated an increasing potential for opportunistic and fraudulent behaviour that can and has imposed significant social costs.
Proposals for long-term systemic reform borne out of a major crisis have to start from a reasonably complete understanding of the origins of the crisis and the systemic failures as well as fraud and opportunism that were causally responsible for the crisis. Although the blame-game for the crisis is in full swing, no one claims that the full extent of the crisis and its proximate contributions is as yet known. In particular, an accounting in full of the contingent liabilities to the state associated with its massive interventions since the onset of the crisis is not available. Clearly a causal analysis of the crisis and developing reform proposals are impossible without these basic facts. However, the opportunity of the Washington Summit could still be used to consider those general reforms which could pave the way for reforms that are deemed necessary once the facts of the crisis and a causal analysis based on them became available. The desirable general reforms should be prioritised. For example, the reform of procedures for the selection of leadership of the IMF/World Bank, the quotas of members that determine the weights for the voting decisions of its executive board, though eminently desirable, is not of high priority. India should resist from pushing them at the summit.
India should insist that the discussion at the summit be restricted to the design of multilateral reforms and exclude desirable reforms of individual country institutions to better insulate their vulnerable population from the adverse consequences to them of external and domestic financial shocks. An international forum, such as the summit, is inappropriate to discuss such domestic reforms that necessarily involve issues of domestic political economy. Suggestions from some European countries that the summit should consider grandiose ideas of the reform of the capitalist system are a waste of precious time. India should have little to do with such an ill-defined and futile enterprise.
The most important reforms in my view would be first to restrict the mandate by the IMF to maintaining the stability of the global financial system with the definition of the financial broadened to include the fiscal, monetary and exchange policies as well as global markets for trading financial claims. The involvement of the IMF in the largely domestic policies of its developing country members which have no cross-border externalities through its insistence of the Poverty Reduction Strategy Papers from those seeking its assistance should be stopped forthwith. India should strongly advocate both these reforms.
The expanded definition of the financial system and the assignment of its stability as the sole mandate have two basic implications. First, the IMF has to be provided with adequate resources not only to assist those seeking assistance but also for intervening if appropriate in global markets to the extent needed to have an impact. Given the enormous volume of transactions in global markets, the resources required would be substantial even if the IMF interventions are coordinate with those of its members. Second, to be able to provide policy advice to members and also to determine whether and how it should intervene in markets the IMF has to have a significant analytical capacity. India should insist on ensuring that the IMF has the resources, financial and analytical, commensurate with its mandate.
Proposals to give any form of representation, even as observers, to non-state actors in the IMF should not be entertained at the summit. The notion that such representation would augment the legitimacy of the IMF has no basis. Its legitimacy depends largely on it being seen as the source of technically sound and politically unbiased policy advice to its members. With an adequate analytical capacity as well as transparency and quality of the discussions in its decision making Executive Board (even under its current weighted voting system), the IMF would gain legitimacy through its advising role provided the longstanding asymmetry, in which the IMF advice is binding as conditionalities on members (basically developing countries) who have unsustainable current account deficits and seek its financial assistance and not on others who run persistent current account surpluses and do not need its assistance (basically developed countries), is eliminated. This should be done by an ex ante and credible commitment by all members to abide by IMF advice that is finalised after mutual consultations along with a suitable mechanism for ensuring the accountability of each member to its ex ante commitment. Needless to say that reforms that result in improvements in transparency of all financial transactions within and between member-states are necessary conditions for the IMF to be able to advise appropriately. India should support such reforms.
It is likely that the summiteers may not be able to resist pressures to discuss regulatory reform and, in particular, the boundary between regulation and markets. Such a discussion can be meaningful only after we have an adequate analysis and understanding of the relative contribution of failures of each to the current crisis. In its absence, I would urge India not to take an ideological posture on the issue but to simply emphasise that it would be counterproductive to suggest a “one size fits all approach.” Instead, the search should be for a solution that leaves adequate and appropriate room for markets and regulation. Another reform issue that should be postponed for a later occasion is the reform of the World Bank. It certainly is in need of a significant downsizing and restriction of its engagement through its lending and free policy advice only to those countries for which external resource and policy making capacity are serious constraints on development. There is no rationale any longer for the Bank to be lending, for example, to Brazil, China or India. All three should be charged a fee for the Bank’s advice if they seek it.
(T.N. Srinivasan is Samuel C. Park Jr. Professor of Economics, Yale University.)
6 months ago