Download Trade-Fin Linkages- for NGLS-Final

Submission by International Working Group on Trade-Finance Linkages—Steering Committee
To: Commission of Experts of the President of the UN General Assembly on the Reforms of the
International Monetary and Financial System
Background and rationale of these proposals: Trade is the main channel by which the financial crisis is
making its impacts felt on the real economies of developing countries. No country can succeed in using
trade to develop or reduce poverty without supportive internal and external financial structures. The
fast dissemination of the crisis shows that the fate of developing countries in the trade system does not
lie so much in the achievement of enhanced market access as on meaningful reforms to the
international financial architecture in which context such trade is conducted. Therefore the trade
dimensions and impacts of financial reforms should be factored into any proposed reforms of the global
financial system.
Theme 1: Financial Regulation
The limited regulation and oversight of financial markets clearly favored the proliferation of highly
complicated financial instruments and the buildup of bubbles in the subprime mortgages, stock and
commodities markets. Once the first bubble blew up in the US housing markets, it was also limited
regulation that favored the rapid contagion to other financial centers and helped blow up the other
bubbles. The limited depth of developing country financial markets that reduced the penetration of new
instruments and exposure to rapid mobility of capital flows was a crucial factor that reduced or slowed
the damage in their economies. Those developing countries with more extensive financial sector
liberalization, including greater openness to foreign banks, are faring worse than the ones with more
closed financial sectors. Many countries have been forced to quickly introduce measures to restrict or
ban certain types of trading in financial markets.
These facts have important consequences for policy space for regulation of the financial sector in
developing countries. However, even as the crisis unfolds, we continue to hear calls for a rapid
conclusion to the Doha Development Round, which includes continued negotiations on liberalization of
trade in financial services.
In addition to global negotiations, the flexibility of many affected countries to introduce the capital
management techniques and regulations required by the crisis has been compromised already by
bilateral trade and investment agreements. Indeed, in the last few years, it has become common for
such agreements to include provisions that constrain the capacity of governments to manage the
financial sector, the capital account and sovereign debt. These provisions are contrary to the interests
of developing countries, as they forcefully expressed in categorically rejecting their inclusion in
multilateral trade negotiations in 2003.
Given the general consensus on the need to revamp and strengthen regulatory tools for finance, trade
and investment negotiations at all levels that affect them should be put on hold indefinitely and
negotiations on financial services separated from the 'single undertaking' of the Doha Round.
The pro-cyclicality of rules for banking supervision, embodied in Basel II, has also been recognized to
have negative impacts on trade flows, inter alia, through increased procyclicality of trade finance and
credit for production, without which trade is not possible. Banking supervision should be rebuilt on
different basis that accords more power to national supervisors to evaluate and regulate the capital
requirements of banks in ways that are counter-cyclical and subordinated to the desired profile of
production sought by a country.
The global financial crisis is leading to significant losses of jobs, as well as real wage and benefit
reductions. The implementation of pro-employment fiscal, monetary and banking policies, such as
exchange rate-targeting, is also compromised by the disciplines on capital management and respective
dispute settlement clauses contained in agreements on trade and investment.
In assessing the crisis, another generalized point of consensus relates to the role played by the
opaqueness and lack of transparency in financial markets. The negotiations on liberalization of trade in
financial services carry far-reaching consequences for the ability of governments to protect consumers,
workers and public policy objectives in the face of capital crises situations and, yet, are usually
exempted of public scrutiny. The recommendations should spell out what the Commission means in
terms of financial transparency and especially state how financial transparency is undermined by the
current practices for the negotiation on trade services liberalization.
The liberalization of trade in both services and goods has facilitated the growth of intra-company trade
worldwide limiting governments’ capacity for revenue-raising and leading to a substantial shift to
regressive, more labor-focused, taxation. These trends can only be tackled via a new global taxation
regime that among other things requires transnational corporations to shoulder their piece of the tax
burden.
Theme 2: Multilateral issues
We encourage the Commission to examine a significant distortion in the Bretton Woods system —
namely, the growing intervention of financial institutions in trade policy. Indeed, the Bretton Woods
System conception included three pillar institutions, one in charge of monetary policy (the IMF), one in
charge of development project lending (World Bank) and one for trade (ITO though only the GATT
protocol entered into force, later on replaced by the World Trade Organization). But over time, the
World Bank and the International Monetary Fund gained influence on trade policy since, ostensibly to
safeguard the debt servicing, the institutions required, as a condition of loans, that borrowing countries
commit to the implementation of economy-wide conditions. The more extensive loan conditions were
imposed on borrowers at about the same time that developed countries stopped being active
borrowers. The change also heralded an unquestioned belief in the virtues of trade and investment
liberalization by such institutions. Deregulation of financial flows and privatization of banking have had
as a consequence the globalization of self-regulated banking activities and a massive increase in
volatility.
While the development of trade rules and agreements is typically subject to negotiations ruled by the
logic of parties carefully evaluating the value and impact of market access concessions being exchanged,
developing countries lose their bargaining power by implementing conditions attached to IFI lending
programs that unilaterally liberalize trade. The World Bank also exerts influence on trade policy via its
annual ratings of each country through an instrument called the “Country Policy and Institutional
Assessment” (CPIA). Among other things, the CPIA assesses the trade policies of each country in relation
to an ideal policy posited by the Bank as a “one size fits all” model for all countries regardless of their
level of development, particular circumstances, or the will of their citizens and elected representatives.
In recent years, the situation has worsened as donor countries increasingly align with these uniform
CPIA policies, as called for by the OECD Paris Declaration agenda.
It is worth noting that the international financial institutions’ involvement in trade is a disadvantage only
to developing countries. This is even the case with the IMF because, while all countries are subject to its
surveillance, there is no comparison between the impact such surveillance has on the capacity of
developed versus developing countries to access the external financing they need. At the same time, the
skewed governance system of the international financial institutions means that developed countries
are at a significant advantage in influencing the direction that the institutions take on trade matters.
In other words, developing countries have to make use of the space granted to them by the existing
trade rules, as well as negotiate new ones, at a substantial handicap. The imbalance due to the historical
impact on international financial institutions and the trading situation of developing countries should be
corrected.
These trends, in turn, are inscribed in a worrying context that has seen both the WTO and the
international financial institutions gain leverage on more aspects of economic, financial, social and
environmental policy, to the detriment of the UN. The composition and the principles embodied in the
charter of the United Nations give it the greatest comparative advantage in deliberation, consensusbuilding and design of multilateral policies and standards. However, the IFIs and leading governments
are successfully trying to refocus the full UN system in mere policy implementation, e.g., service delivery
around the MDGs, largely to the exclusion of a role in developing economic and social policies
increasingly dominated by the IFIs. Similarly, the WTO, which argues it is independent from the UN
system has crept into a growing web of legal rules that seem to move in parallel, even as they override
the legal regimes for human rights, environment and development that took years to develop within the
UN system. Worse than this, a growing number of financial standards and codes are developed
completely outside of any of these frameworks, in ad hoc bodies self-appointed by like-minded
countries, which then take advantage of institutional and extra-institutional channels to promote the
widespread adoption of such standards by countries that had no part in their design.
Many of these questions can only be addressed in a definitive manner in the context of a new
foundational conference, a-la-Bretton Woods, that should be convened by the General Assembly as the
major deliberative organ of the United Nations. Implementation of the results of such a conference
should go beyond a mere process whereby a minority of powerful countries seeks to impose its views
and have them paralleled by a larger number of countries.
Theme 3: Macroeconomic issues and addressing the crisis
From a macroeconomic perspective, the impacts of the crisis on developing countries can be attributed
to several macroeconomic difficulties stemming from movements in their current accounts. Reform
proposals that tackle macroeconomic policy-making should deliberately focus on generating an
environment more conducive to different patterns of trade, with more balanced domestic and external
market dynamics.
The source of woes for many developing countries is the implementation of a model of reforms that
gave centrality to a paradigm of export-led growth while not ensuring the financial gains derived from
exports ultimately accrue to them. This model of export-led reforms did not take into consideration the
importance of ensuring that trade became a means for the stable provision of development finance or
the need for its articulation with the domestic economy.
That the boom in developing countries for the five years before the crisis coincides with the surge of
commodity prices is more than a mere coincidence. What had been characterized as a boom actually
hid meager progress –or even retrogression -- in the export structures of developing countries. Very few
countries had been able to use the increased revenue from the boom in commodities to develop
diversified and value-added production systems. The application of a model based on productive
specialization on low –value added products led to a vicious circle of lower accumulation of capital in the
national economy, and lower public revenue. The countries that did manage to increase industrialization
are discovering the severe limitations imposed by the global supply-chain model within which such
industrialization was undertaken.
But macroeconomic difficulties related to trade are not confined to the current account. The patterns of
foreign capital inflows were also tied, in more or less direct ways, to the high rates of export growth.
Rather than generate income growth, they tended to reinforce unhealthy patterns of export-related
income growth. Now, at a time that the situation has reversed, with the prices of natural resources
falling, retreating investment is showing also its destabilizing face. This retreat should not be seen as a
withdrawal merely symmetrical to the increase in resources that were originally brought by foreign
investors. While investment in the good times was able to ride on a number of state guarantees and
subsidies, including regulatory and tax concessions, pro-investment reforms skewed the sharing of the
profits away from the national economy.
The boom period also encouraged high spending levels, and exerted upwards pressure on foreign
borrowing. Lending and borrowing sprees for public-private partnerships in infrastructure projects
utilizing contracts that provided (off-budget) public funding guarantees, were often promoted by
multilateral financial institutions. For example, in many public-private partnership contracts, it is
common practice to attach provisions that guarantee a certain level of demand and, therefore, revenue
to the provider. If the economic activity then does not sustain such demand, the government becomes
liable for the difference. The exchange rate risk may also be built into demand guarantees.
Export-oriented infrastructure projects which seemed viable in the times of a boom represent a liability
in bust times and there are usually no clauses safeguarding the country’s position in the contract in case
the expected returns from exports do not materialize. Neither are there provisions to ensure the
country captures a greater share of the revenue when projects yield higher-than-expected returns.
Rather than reviewing the viability of the projects in the light of actual export prospects of the
borrowing countries, or encourage fairer clauses for sharing of losses with private sector providers, the
response of multilateral financial institutions is to increase the deployment of lines of credit to keep high
levels of public spending. In turn, this encourages a culture of borrowing without safeguards,
environmental or otherwise, and without mechanisms for local accountability that could prevent the
worst cases of unproductive loans.
The increased debt only puts pressure on the country to boost exports, without the means to do so, and
at the expense of domestic market needs. In this context, indeed, labor-intensive products and
industries that could create much-needed jobs, unless they are to serve the foreign market, run against
disincentives.
As critical aspects of generating a more resilient macroeconomic policy frameworks in developing
countries the Commission should emphasize the importance of measures to diversify trade profiles
(both products and markets), manage investment, rebalance profit- and loss-sharing in infrastructure
lending, extract a fair share of export-related income and encourage investment in the development of
local processing infrastructure in the area of origin of natural resources.
Theme 4: Reforming the Global Financial Architecture
The original Bretton Woods system was conceived as a complement to the multilateral trade system,
which in order to properly function required a certain degree of exchange rate stability. The IMF was
originally created to perform such function but, since the fall of the par value Bretton Woods system in
the 1970s, instability and misalignments of currency exchange rates have become the norm. Increased
levels of exchange rate volatility have a strong impact on trade performance through channels such as
the levels of domestic investment, the variations of relative prices of export products (which, in turn,
affect competitiveness of the economies), the price of access to finance for production. The value of
market access concessions and price-based trade liberalization measures that receive so much attention
in trade negotiations, has been at times dramatically reduced or become uncertain due to the exchange
rate fluctuations. These changes, it is worth noting, do not affect all countries equally, having
asymmetric impacts on the trade performance of developing countries, as compared to developed ones.
Not only has the IMF lost this function with the fall of the Bretton Wood System in the 1970s, but we are
of the view it is in no position to regain capacity to perform such function in the future. There is more
than enough evidence of this in failed attempts of the last 10 years, first through the “spillover”
assessment in Art. IV consultations, later through the “multilateral consultations on surveillance.”
There is an urgent need to establish alternative credible mechanisms for the multilateral management
of exchange rates. Establishing an institution concerned with orderly coordination among hard currency
issuers is a desirable goal but the issues above are likely to remain as long as the domestic currency of a
country continues to be used widely as main international trading and reserve currency. So steps should
be taken to move towards a system that relies on a multilateral currency for trading and reserve
purposes.
Strengthened regional and sub-regional schemes for monetary cooperation hold the key to lower
dependence on the currencies of a few dominant countries. Ultimately, a more balanced and
development friendly system for multilateral management of exchange rates will be one that builds on,
and seeks to gradually coordinate, South-South regional currencies and currency units.
Indeed, multilateral exchange rate coordination is more feasible, as a first step, at the regional or subregional level, and it would lead, by supporting intra-regional trade, to diversifying trade products and
markets, thereby deepening the resilience of developing country economies to external shocks like the
current one.
All these reforms, however, are likely to take a long time. Some degree of currency exchange rate
instability will presumably continue to exist, leaving non-reserve currency countries to
disproportionately bear its impacts, so a regular and predictable mechanism to ensure that developing
countries can opt-out of their trade obligations to the extent required to compensate for such impacts
on their economies should also be set in place. By the same token, while global institutions to manage
exchange rates of trend-makers are missing, it is all the more necessary that trend-takers (mostly poor
and undiversified economies) can enjoy the necessary space to manage their exchange rates.
While reducing exchange rate fluctuations is an important factor, a long term vision of the global
financial system that supports fairer trade should also pay regard to curbing the speculative movements
of capital that generate or exacerbate the fluctuations of export-related incomes in developing
countries. These magnify Dutch-disease dynamics and entrench an international division of labor that
condemns a large number of countries to specialize on a decreasing number of low value-added exports.