Everyone now recognises the need to reform the international economic regime. But the idea should not simply be to fix a system that is obviously broken: we need to exchange it for a better model. That is because the current financial architecture has failed in some very important ways.
Most importantly, the international financial system has failed to meet two obvious requirements: of preventing instability and crises, and of transferring resources from richer to poorer economies. Not only have we experienced much greater volatility and propensity to financial meltdown across emerging markets and now even industrial countries, but even the periods of economic expansion have been based on the global poor subsidising the rich.
These global failures are so immense that they constitute enough reason to abandon this system. But there are other associated failures in terms of what the regime has implied within national economies: it has encouraged pro-cyclicality; it has rendered national financial systems opaque and impossible to regulate; it has encouraged bubbles and speculative fervour rather than real productive investment for future growth; it has allowed for the proliferation of parallel transactions through tax havens and looser domestic controls; it has reduced the crucial developmental role of directed credit.
So we clearly need a new system, even if the goals remain the same as that of the original Bretton Woods: to ensure currency stabilisation through international monetary co-operation; to encourage the expansion of international trade in a stable way; and to promote development by facilitating productive investment.
To achieve this in the current context, four elements are crucial. First, the belief that self-regulation supported with external risk assessment by rating agencies is an adequate way to run a financial system has been blow sky-high. There is no alternative, therefore, to systematic state regulation of finance.
Second, since private players will inevitably attempt to circumvent regulation, the core of the financial system – banking – must be protected, and this is only possible through social ownership. Therefore, some degree of the socialisation of banking (and not just socialisation of the risks inherent in finance) is also inevitable. In developing countries it is also important because it enables public control over the direction of credit, without which no country has industrialised.
Third, to cope with the adverse real economy effects of the current crisis, fiscal stimulation is essential in both developed and developing countries. Enhanced public expenditure is required to prevent economic activity and employment from falling, to manage the effects of climate change and promote greener technologies, and to advance the development project in the South.
Fourth, we need an international economic framework that supports this, which in turns means that capital flows must be controlled and regulated so that they do not destabilise any of these strategies.
It may be argued that such an international system based on state regulation will reduce the possibility of developing countries to access much-needed capital for their own economic expansion. But this perception is wrong, because in fact the current liberalised system did not provide for a net transfer of resources to the developing world. In the past six years, there has been a net flow of financial resources from every developing region to the North, primarily the US, even as global income disparities have increased. And within countries, the idea that deregulated finance could put more resources in the hands of the poor (as in sub-prime lending) has proved to be unsustainable.
So greater state involvement in economic activity is now both necessary and desirable. The time for arguing about whether to have it or not is over. Instead, we should be thinking of how to make such involvement more democratic and accountable, within our countries and internationally.
(This article has appeared in the The Guardian, 24 October 2008)