Global financial governance: whose ownership?

Business Economics, April, 2004 by Hossein Askari

Over the past two decades, many changes that have taken place in international financial markets have had an important impact on developing countries. Because of increased global integration, what happens to developing countries is increasingly important to business in all countries. This paper discusses the role of the International Monetary Fund and the World Bank in dealing with the consequences of these changes and attempting to make new rules for the governance of the international financial system. It also discusses the current role of developing countries in the governance structure of the international financial system and the need for their stronger participation. In the end, the IMF and the World Bank will not be credible if they preach good governance and transparency to developing country members while shunning the same advice for themselves. Industrial countries' private sector financial institutions in particular, and their internationally focused firms in general, have an important stake in good governance of the IMF and the World Bank. Their own rapidly growing international activities will prosper only if the governance of these two international institutions is sound, equitable, and thus engages all member countries, including those from the developing world.

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Narrowly defined, globalization is global economic and financial integration. More broadly, globalization is the process by which countries become more like one country. In its humane dimension, globalization is the removal of all barriers and the integration of mankind. In this latter depiction, economic and financial integration can only be seen as a step in a long process. Because the most recent impetus for globalization began in industrial countries through rapid progress in financial innovation and information technology, there are concerns among developing countries that the advanced countries will reap the benefits of globalization while they will bear the costs.

The process of economic and financial integration has been historically reversible, as witnessed most recently after World War I. This often-forgotten fact has lulled some observers into believing that the process of global financial integration is irreversible and that the hegemony of industrial countries over the process is a necessary or a sufficient condition for its continuation. None of this is inevitable. It is also not inevitable that developing countries will have to bear all costs of financial integration, provided they play a major role in the design and implementation of the necessary changes in global economic and financial governance. At the center of this governance structure are the two major international financial institutions, the International Monetary Fund (IMF) and the World Bank Group (World Bank). (1) It is the contention of this paper that the role of developing countries in these institutions, and thus in global financial governance, must be enhanced considerably. If it is not, the changes taking place in the "architecture" of the international financial system are likely to lead to unequal sharing of costs and benefits and the developing countries' withdrawal from the globalization process altogether. If this happens, the negative effects on international finance and business will be widespread and significantly negative. This makes international financial governance a matter of interest to business as well as governments.

In this paper I will briefly discuss the rapid changes that have taken place in the international financial system and their impact on developing countries, the role of the IMF and the World Bank in dealing with the consequences of these changes through new rules for the governance of the international financial system, and the need for stronger participation by developing countries in the governance of that system.

Changes in Financial Markets and Developing Countries

The problems of today's developing economies are poverty, financial instability, debt, and institutional deficiencies of monumental proportions. To reduce poverty and improve standards of living, these economies need to grow at a faster rate, on a sustained basis and in a stable economic environment. This requires access to international export markets and investment financed in part from external financial flows, which in turn require liberalization of the external capital account.

Over the past two decades, the increasing internationalization of production, the growth of international trade, massive changes in financial markets, and the revolution in communication and information technology have created opportunities as well as challenges. The changes include significant increases in the magnitude of and composition of cross-border financial flows, innovations in financial engineering that have expanded the menu of new financial instruments, dizzying speeds at which these flows move across national borders in response to shifting perceptions of rewards and risks, growing capacity for leveraging financial exposure in the international system, revolutionary changes in risk management practices that can accelerate outflows from developing country markets in times of stress, and exponential increases in short-term capital flows, largely consisting of portfolio flows channeled through institutional investors by means of derivatives.