Who bears lender of last resort responsibility in a world of securitized finance? Are the political and social priorities of governments too strongly influenced by the new financial environment? These are examples of issues that must be more widely understood and debated if, as expected, the leaders who gather for the G-7 Summit in Halifax address the question of international capital flows.
It has been suggested that the summit's host, Prime Minister Jean Chretien, is especially concerned with the volatility of international capital flows and the apparent constraints they impose on domestic policy and sovereignty. Hence, he is interested in exploring the possibility and feasibility of either regulating or overseeing international capital flows or of reinforcing international institutions such as the International Monetary Fund. Easier said than done.
The surge in capital flows that has characterized the 1990s reflects proposed transformations in the world economy and may not be responsive to policy approaches now being considered. Capital has been attracted to certain countries, notably developing countries, which have undertaken economic liberalization and privatization. Technology, innovation and securitization in international markets as well as globalization of production by international firms have also triggered more capital mobility. Interest-rate differentials and variations in stock market performance have also contributed to the increased volume and changed composition of capital flows.
In contrast to large-scale government intervention that was associated with capital inflows in the 1970s and to the bank lending that characterized the 1980s, foreign direct investment and portfolio flows now dominate capital movements with private-sector borrowing accounting for a large share of new financial flows. Not only has the level of financial integration between G-7 economies and developing economies changed, we are encountering a very different form of financial interdependence.
By definition, portfolio flows especially are more volatile, more vulnerable to fad and fashion and more sensitive to ''push factors'' such as differences in returns in stock markets or interest rates. The issue of whether capital flows are primarily driven by sound domestic policies and market-oriented reforms - ''pull factors'' - or external or ''push factors'' remains contentious.
It is assumed that flows responding to pull factors would be less volatile which argues for sound macro-policies, continued structural reform, liberalization and productivity-enhancing measures. Nevertheless, it is also widely recognized that securitized capital flows are much more responsive to adverse news events and bandwagon effects than are commercial bank lending and foreign investment. This explains, in part, the sudden interest in practices that attempt to control capital inflows, more specifically measures such as those imposed in Chile that tax short-term capital inflows.
Malaysia and other Asian countries have adopted other measures to limit capital inflows. Controls on inflows surely helped these countries weather the storm of the Mexican crisis but perhaps, more importantly, most of these countries also differed from Mexico in a very important respect: success in raising their domestic savings. Unless proponents of measures to stem capital inflows address this very issue of domestic savings and, by extension, investment needs, they will have overlooked a crucial aspect of today's economic challenges both in the developing and industrialized world. The U.S. and Canada, for example, should be looking at ways to boost domestic savings.
Quick-fix measures that focus on augmenting the resources of the IMF hold more appeal for governments who are reluctant to put order in their own houses. Even an expanded surveillance role for the IMF raises eyebrows. Can the IMF really operate as an international rating agency? Should it? And finally, the very point raised at the outset - the lack of clarity about lender of last resort responsibility in a world of securitized finance.
The best option is for countries to insure themselves through sound fiscal and monetary policies - measures that enhance productivity, savings and investment - and political reform that engenders more democracy, transparency and accountability. There may be bumps along the way but such is the price of change and transition.
DNOTE (Ed. note) Marie-Josee DRouin is a fellow of the Hudson Institute Inc.
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Revised: June 3, 1995
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