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Rules liberalizing financial services, an obstacle to anti-crisis efforts (March 2009)

Rethinking Bretton Woods | Sun, Mar 29, 2009

By Aldo Caliari

In the last few months, more analysts have come to agree on the undoubtedly global reach of the financial crisis, and estimate it rivals the seriousness of the 1930s Great Depression. This article reviews a growing number of reports that are documenting the threat that financial services liberalization provisions in a number of treaties pose to the ability of countries to either counteract the crisis or even take the most minimal protecting measures to mitigate its effects.

Last year, at a time that the global financial crisis seemed to be still relatively contained, a large number of civil society organizations warned that "The proliferation of provisions that constrain the capacity of governments to manage the financial sector, the capital account and sovereign debt in a number of trade and investment agreements runs contrary to the interests of developing countries." The basis for this warning were that such constraints were not consistent with the flexibility needed to successfully implement pro-development fiscal, monetary and banking policies, such as employment- or exchange rate-targeting, where governments may deem them necessary. They also noted that painful financial crises were the product of exactly the type of policies that such provisions crystallized in legal rules and commitments. (See Benchmark Document, dated June 2008)
 
In the last few months, more analysts have come to agree on the undoubtedly global reach of the crisis, and estimate the crisis rivals the seriousness of the 1930s Great Depression. At the same time, a growing number of reports is documenting the threat that financial services liberalization provisions in a number of treaties pose to the ability of countries to either counteract the crisis or even take the most minimal protecting measures to mitigate its effects.
 
This evidence is all the more worrisome given the continued insistence by several high level officials of G20 countries in characterizing the trade elements on their agenda at the upcoming London Summit as one of generally "stopping protectionism" and "reviving the Doha Round at the WTO." Whenever these two items are mentioned, they often include-sometimes quite explicitly- a holding and continuation of financial services liberalization.
 
The issues raised by restrictions on capital controls are developed by Sarah Anderson, of the Institute of Policy Studies, in a study called "Policy Handcuffs in the Financial Crisis: How U.S. Trade and Investment Policies Limit Government Power to Control Capital Flows." [1]
 
The study quotes economist Joseph Stiglitz to argue that "the single most important factor leading to the troubles that several of the East Asian countries encountered in the late l990s-the East Asian crisis-was the rapid liberalization of financial and capital markets." Mr. Stiglitz is hardly alone on this, as demonstrated by a list of recognized economists quoted in the study that includes John Maynard Keynes, Robert Rubin and Jagdish Bhagwati among others.
 
Yet, the US government has, if anything, deepened its support for restrictions to capital controls being made binding in all trade and investment agreements it has signed since the East Asian crisis. The current global economic crisis has brought to the fore in a more dramatic way the damaging consequences for countries of signing away their ability to establish capital controls. Some countries have needed to maintain capital controls (e.g., China and Thailand), while others have needed to impose or tighten them (e.g., Iceland, Ukraine, and Argentina). In several countries, the crisis was expressed in severe episodes of capital flight and currency devaluations. Countries that do not have the option of using capital controls are left with few other tools they can use to respond to such outflows. They may be forced to take the weakening step of spending, sometimes in a matter of days, precious foreign exchange reserves built over years of hard economic sacrifice.
 
But capital controls are not the only tool necessary to mitigate impacts of the crisis that that governments may lose as they sign free trade deals. "Taking the Credit: How Financial Services Liberalization Fails the Poor"[2], a study by the World Development Movement, argues that foreign banks' entry and enhanced access in the financial markets of developing countries and the progressive elimination of controls on their activity vis a vis domestic providers has led to 1) Active selection or 'cherry-picking' of high value customers, 2) Benefits for high-value customers, but a
decline in the ability of the wider financial sector to reach low-value customers, 3) Less credit available to the local private sector (as opposed to public sector or large firms) 4) Less credit for productive activities; credit for personal consumption increases 5) Distorted behaviour by local banks because of increased competitive pressure and 6)  Overall loss of access to affordable and sustainable financial services for key groups and thus a decline in national welfare.
 
More importantly, WDM argues that the ongoing global recession will aggravate the threat of financial exclusion, but that this will get broader and deeper if proposed trade deals between the EU and various developing economies are left unchallenged.
 
In the face of the report's survey of lobbying interests that influence those trade negotiations, the shape of such and the negative distributional impacts that the treaties will carry are hard to attribute to mere inadvertence. There are many organisations which seek to influence international trade negotiations on behalf of the banking industry and it is clear that the European Union's "Global Europe" strategy has been actively developed with, and supported by, a range of lobbyists working on behalf of the finance sector: the European Services Forum, British Bankers' Association, European Banking Federation, International Financial Services Federation, all in addition to the lobbying directly undertaken by some banks.
 
A more detailed look into one ongoing negotiation that includes financial services, the EU-India FTA, can be found in "EU-India Free Trade Agreement, should India open up banking sector?", a report published by Madhyam and written by Kavaljit Singh.[3]
 
The report states that the crisis, far from stopping European banks from entering the Indian market, is increasing their aggressiveness. "As a counter weight to ailing domestic markets, the big EU-based banks would like to get out of recession by exploring newer markets, where the engines of economic growth are located.... At present, there are very few growth spots in the world and India is still counted among one of them."
 
But, is this good for India ? The report offers extensive documentation of the damage done by the entry of foreign banks in India: less bank branches in rural areas, greater financial exclusion, a rise in unbanked and underbanked regions, a sharp decline in agricultural credit, and a decline in bank lending to SMEs. In doing this, the report also compares those results with the results of a previous phase that involved nationalization of banks in India. Such period saw a dramatic expansion of bank branches in rural and unbanked areas, a growth that has no parallel in any developing country, and that directly owed to the licensing incentives provided under that regime. The credit and savings in rural areas also increased dramatically, lowering the traditional dependence that rural populations had on non-institutional moneylenders for the purpose of obtaining credit.
 
It is worth noting that as the financial turmoil gets worse, the concept of bank nationalization is no longer the taboo that it used to be. Several countries -both developed and developing --  are flirting with the concept of bank nationalization while others were forced to partially implement it. Yet, it is not at all clear that this newly-accepted concept would entail the same type of incentives and management measures that India, according to the report, implemented. Indeed, governments that talk about the likelihood of nationalizing banks often add the caveat that this would be done on a "temporary" basis, and the institutions would be quickly returned to the private sector once they have been "cleaned up" -presumably by a subsidy at the expense of taxpayers.
 
The multiple provisions in trade agreements that can increase the likelihood of a financial crisis and make it more difficult to take the necessary measures to deal with one once it occurs, are also the subject of a "Preliminary Note on Financial Crisis and Trade and Investment Treaties"[4], presented by Third World Network to the Commission of Experts on Financial and Monetary Reform set up by the President of the General Assembly.
 
In addition to the restrictions on capital controls, this report expands on how usual provisions in agreements on trade or investment at all levels, may hamper the ability of states to implement bailout packages, stimulus measures and the regulation of financial instruments. In the light of the evidence, it would be hard not to agree with the study's call for "a blanket review of relevant existing FTAs, BITs and WTO provisions to see which provisions of these rules are now inappropriate given the new understanding we now have on financial liberalisation."and a freezing of all current FTA negotiations including economic partnership agreements (EPAs), until a review of their appropriateness in light of the current crisis conditions takes place.
 
 

[1] Download full study.

[2] Download full study.  

[3] Download full study.  

[4] Download full study.