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Ottawa, April 14, 2000
2000-031
Statement by
The Honourable Paul Martin,
Minister of Finance for Canada,
to the Institute for International Economics
Washington, D.C.
April 14, 2000
Delivered text is official version.
The Institute for International Economics has a long and well-deserved reputation for insightful analysis of important public policy issues. I am delighted, therefore, to have this opportunity to speak to you about an issue that is critically important to global economic and social development – the reform of the international financial institutions (IFIs).
This issue, coupled with the greatest of all objectives – reducing poverty and improving the quality of life around the globe – will form an important backdrop to tomorrow's meeting of the Group of Seven (G-7) finance ministers and central bank governors. As well, it will frame the discussions of those attending the Spring Meetings of the Bretton Woods institutions that begin on Sunday.
Now much of the discussion to date has focused on the narrower issues of International Monetary Fund (IMF) lending facilities and charges. What I would like to do today is to situate the issue within the context of the broader debate of international financial architecture reform. In short, for IFI reform to be successful, we must recognize the greater debate that is taking place between sound global economic governance on the one hand, and the need to respect national sovereignty on the other, a debate in which both concepts are undergoing substantial redefinition.
There is broad agreement on the principle that financial stability is a "public good." Most would agree, as well, that this public good is not something that is provided naturally by markets, but is rather the hoped-for, though not always realized, consequence of the structures provided by governments – that is to say, central banks, securities regulation and banking supervision. Experience has demonstrated the need for these structures domestically – quite simply, markets work better with them. The issue we have to address is the role of the Bretton Woods institutions in ensuring this public good, that is to say, financial stability in global markets.
Looking back 50 years, it is clear that the Bretton Woods architects did not design their system for a world of massive private capital flows – the reality of today's economy. Working in the wake of the banking, exchange rate and debt crises of the 1930s, the Bretton Woods architects regarded private capital flows and exchange rate movements as sources of instability. It was because of this that exchange rates were fixed and capital controls were sanctioned by international agreement, an approach that worked well for almost 30 years.
By the late 1970s and 1980s, however, capital controls were no longer desirable. Indeed, they were no longer sustainable given the increasing sophistication of financial markets and the Organization of the Petroleum Exporting Countries (OPEC) price shocks. The progressive dismantling of capital controls that ensued partially coincided with growing international flows of private capital to the point that these flows now dominate global financial markets.
This, in itself, is not a problem. But as we know, sudden shifts in these flows can be. Whether these are motivated by deteriorating economic "fundamentals" or are based on fear and speculation, the outcome is the same – severe financial crises that disrupt the process of economic growth and social development throughout much of the world.
To date, the response to these capital account crises has been to provide very large financial packages, led by the IMF and supported by the Bank and bilateral funds, aimed at restoring confidence. In my opinion, in the case of recent crises in both Latin America and Asia, for example, this approach has avoided the worst sort of economic collapse.
But this does not mean that it is without problems. The fact is that the IFIs and national governments simply do not have the resources to forever provide assistance on this scale. However, even if the resources were available, there is a growing recognition that continuing to provide very large assistance packages as a matter of course is undesirable because of the distortion this causes to creditor behaviour and to expectations of risk and return.
The Meltzer Commission's response to this problem is to restrict the IMF's lending to 120 days with a one-time rollover and at penalty interest rates. This recommendation may be theoretically appealing, but in the context of the broader perspective we would address here, it suffers from a number of practical problems.
For instance, such a restriction would have meant pulling needed support from Thailand in the spring of 1998, just when the Indonesian situation was spinning out of control. This could well have set off another round of contagion.
Furthermore, domestic fiscal consolidation may be needed in crisis-hit countries to restore market confidence. However, restructuring government spending, while maintaining adequate protection for citizens, simply cannot be done in 120 days. The net result, therefore, would be unconscionable suffering.
Therefore, while I have no difficulty with the presumption that IMF lending should be as short-term as possible, given the reality of today's world, the Fund must retain the flexibility to go long where necessary.
As far as the World Bank is concerned, the Meltzer Commission would restrict its activities, and indeed those of regional development banks, to only the poorest nations on the grounds that middle-income emerging economies are able to borrow from private markets. Again, one must ask whether this solution recognizes the reality in which many emerging economies find themselves.
To be sure, emerging markets are now much more open to private capital flows than they were 10 or 20 years ago. Yet for most, the relationship with private lenders is tenuous, risky and intermittent. The fact is, there are hundreds of millions of poor in these middle-income countries who need the same basic health and educational services as those in the poorest countries – services that will not be funded by monies raised in financial markets.
In short, the distribution of income, and not just the average level of income, matters when we discuss the role of the IFIs in poverty alleviation. That means the Bank must retain the capacity to provide development assistance to middle-income emerging market economies, as well as the poorest.
Let me be clear: the point that I would make in questioning the two aforementioned suggestions for Fund and Bank reform is not to challenge the need for reform itself. Indeed, the Meltzer Commission has made a very helpful contribution to the debate. But I believe that to approach IFI reform only from the vantage point of the institutions themselves and their programs, without taking into account the need to proceed apace with the broader issue of architecture reform in all of its facets, is counterproductive. In short, reform of the IFIs is not an issue that should be discussed in isolation. It must be discussed in the context of the reforms needed to resolve the problems facing the international financial system as a whole.
There are four sets of players in this drama: first, the international institutions that promote global co-operation – not just the IFIs, but the full spectrum, including the United Nations system and the others; second, policy makers in national governments; third, private financial markets; and fourth, the world's population, which asks us to ensure that globalization works to everyone's advantage.
Let me now turn to each of these.
First, does it make sense to look to the reform of the IMF and the Bank without looking at their relationship with the other institutions for global co-operation – from the various agencies of the United Nations to the World Trade Organization? I think not. The way these institutions work together, or should work together, lies at the very heart of global governance.
Second, can one look at IFI reform without first looking at the role of national policy makers? Again, I think not.
Let's be candid. Part of the concern that many governments feel is based on the fact that we are asking developing countries to adopt overnight economic and social reform that the industrialized countries took decades to put in place. To ignore this reality will be to negate the legitimate concerns many feel about the pace and scale of change that is taking place globally. Therefore, we need to understand that the issues of timing, pacing, sequencing and transition are imperative, and this too is an essential component of the international architecture that is too often ignored when we talk of IFI reform. However, that being said, this does not mean we should not seek constantly to advance the yardsticks.
The most important bulwark against international financial instability has always been, and will continue to be, strong domestic leadership. This means sound macro- and micro-economic policy. The goal is to identify problems before they become crises so that corrective action by governments can be taken earlier, and so that markets are not taken by surprise. Thus, we have all advocated that national governments must provide transparent data that will help private investors make more informed investment decisions and allow markets to do a better job of identifying possible vulnerabilities.
What we have sometimes failed to recognize, however, is that the target for transparent data is one that is constantly moving and expanding. This is the case domestically. Why wouldn't it be the case internationally? For instance, national governments – rich and poor – must continuously review and improve financial sector supervision. We are all in this together and everyone must keep pace.
Indeed, with this in mind, over the last two years much has been accomplished. The Financial Stability Forum (FSF) has just completed its work on the role of hedge funds, offshore financial centres and capital flows. These are all relevant to the quest for a better understanding of the inherent risks and best practices required if we are to avoid problems in global capital markets.
The questions that follow, however, are: Once determined, how do we ensure that best practices are implemented? How do we monitor outcomes?
As far as the first point is concerned, best practices will not be implemented, and standards and codes will not be observed, if the countries that must adopt them have not had a "voice" in their development. Development economists have learned that lending will be ineffective if the borrowing country does not "own" the development agenda – that point is also valid when we discuss architecture reform.
This is why the Group of Twenty (G-20) is so relevant. It is made up of the G-7, emerging market economies from all regions of the globe, and representatives of the Bretton Woods institutions and the European Union. As such, it provides a forum representing more than 85 per cent of the world's population and 65 per cent of the world's gross domestic product. The G-20 is currently focused on exchange rate arrangements, financial sector regulation and supervision, and prudent liability management – all areas of architectural reform in which national governments working collectively have become increasingly prepared to take the steps required to reduce vulnerabilities to crises.
Assuming the success of both the FSF and the G-20, however, raises an important issue in the context of today's discussion, and that is: How does one monitor ongoing developments and ensure continued progress?
The answer I would suggest is that the Fund must be prepared to continuously redefine the scope of its surveillance function and the Bank should accelerate substantially its efforts in building institutional capacity in emerging markets and other economies. In other words, the reform of the Bank and the Fund cannot only look inward. It must take into account the progress that has been made by new "virtual" institutions, such as the FSF and the G-20.
The third players in our drama are private financial markets.
Canada believes that an effective framework for private sector involvement in crisis prevention and resolution is an essential prerequisite for IFI reform. The rationale is straightforward: to borrow a phrase from Barry Eichengreen, you can't have less crisis lending until you have more crisis prevention. And in our view, an effective framework for private sector involvement is an essential component of crisis prevention. Why? Because private capital flows now dominate the international financial system.
Therefore, let's get on with making collective action clauses in sovereign debt instruments a reality. Yesterday, Canada announced that it will adopt these clauses in our future foreign currency bond and note issues. We would hope that others will follow.
As importantly, Canada believes we should look long and hard at the introduction of standstills in the case of severe financial disruptions. Indeed, there is no better example than this of the need to complement reforms to the IFIs with action in other areas.
Think about the objective that the Meltzer Commission has advocated – programs restricted to at most 240 days. A necessary condition, if this objective is to be realistic, is to achieve the full involvement of private sector investors.
Yet this involvement is difficult, sometimes impossible, to obtain voluntarily during the "rush for the exits" that often characterizes international financial crises. Thus, it follows that advocates of shorter or smaller Fund programs should also support standstills; hence the need to pursue IFI reform in conjunction with the broader goals of overall architecture reform.
Finally, the fourth player I want to talk about is, in many ways, the most important, i.e., our domestic constituencies which collectively make up the world's population.
For most of their first 50 years of existence, the Bretton Woods institutions operated in relative obscurity. However, the last few years have brought a degree of scrutiny to the institutions as never before. This intense interest reflects the impact that the IMF and the World Bank have on the well-being of individuals and families worldwide, in a highly integrated global economy.
What we have to demonstrate is that architectural reform and its subset, IFI reform, are part of the solution, not the problem.
We must demonstrate that we understand that countries are made up of people and not economic indicators.
We need to address the skepticism as to what meetings such as this weekend's are all about.
Up until recently, the activities of finance ministers, development ministers and central bank governors at these meetings have been of interest primarily only to the participants and a few curious onlookers. I suspect that with this weekend, this will change. Whether it will change for the better or for the worse is up to us.
Our challenge is to demonstrate that not only are global markets essential to improved standards of living, but that national governments acting multilaterally through the great international institutions are the guarantors of that well-being.
Quite simply, global integration should represent the clearest and most direct path out of poverty for hundreds of millions of people.
Our task is to make this happen.
Our task is to see to it that the combination of new technologies and open markets translates into higher incomes, better opportunities and increased security for people in all parts of the world.
Whether that happens, I believe, depends on how successful we are in pursuing the overall goal of international financial reform.
I'm not sure that all of the protestors expected this weekend would agree, but if we succeed, their children will.
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| Last Updated: 2004-10-29 |
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