Some thoughts on improving global financial governance

Globalization has recently come under attack for having given rise to excessive nationalism and protectionism. Excessive nationalism and protectionism carry the potential to hamper global economic recovery. For this reason, the subject of global financial governance has acquired significant interest, particularly in China, in recent years.

Why has globalization come under attack? There is nothing wrong with globalization, per se. However, the way in which globalization has been implemented left some people better off, while many have been left behind. The concerns of those left behind about the fairness of globalization appear genuine. Empirical evidence in recent years has suggested that countries which participated in the process of globalization benefited enormously in sustaining higher economic growth and reducing poverty. China is a classic example of globalization’s success as it has pulled more than 700 million people out of poverty.

As such, the process of globalization is simply irreversible. There is no room for excessive nationalism and protectionism in the global economy today. What is, however, required is that we must make the process of economic globalization more fair, inclusive, broad-based and sustainable.

The root causes of the current discontentment with globalization appear to be connected with the unfair decision-making representation for emerging and developing countries in the institutions that are responsible for global financial governance. The 2008 global financial crisis has consistently reminded emerging and developing countries that they suffered immensely in terms of losses of income and human sufferings for which they were not responsible. These countries do not want to experience a similar catastrophe again. It is for this reason that they want fair representation in global financial governance.

The voice of emerging and developing countries is being raised in different international forums, particularly by the Chinese leadership. This may have unnerved some developed economies which currently command disproportionate amount of power in global financial governance. There is nothing to be unnerved about by giving fair representation to emerging and developing economies in the institutions of global financial governance.

As a matter of fact, there are at least three benefits from fair representation: First, emerging and developing economies would benefit by having a stronger voice. Second, institutions responsible for global financial governance would benefit from enhanced legitimacy – after all, they represent 85 percent of the global population as well as a significant proportion of the global GDP. Finally, greater participation by these countries in global financial governance would ensure greater commitment by them to further free and open their markets – an aim shared by G-20 economies. In short, a more diversified and fair global financial governance will minimize risks and promote financial stability for the entire world. It will have the potential to minimize the risk of the recurrence of a 2008-like global financial crisis.

Changing global economic landscape 

It is an undeniable fact that the landscape of global economy has changed altogether and so have the rules of engagement with global financial governance. The sooner we realize this, the better it is for global financial stability. Let me share some facts about the changing landscape of the global economy. According to Ms. Christine Lagarde, the Managing Director of the IMF, the emerging and developing countries are contributing about 80 percent towards global economic growth. Recent World Bank estimates suggest that China alone is going to contribute over 35 percent to the estimated global economic growth during 2017-2019 followed by the United States (17.9%), India (8.6%), Eurozone (7.9%) and so on.

Unfair representation 

The current representation of emerging and developing economies in global financial governance is not at all consistent with their contribution to global economic growth and prosperity. Global financial institutions have not yet embraced these new realities and therefore, the representation of emerging and developing economies continues to be highly inadequate and unfair. The bottom line is that global financial governance and the institutions responsible for managing financial governance are not fair, inclusive, broad-based and therefore cannot be sustainable.

There is an urgent need for a further round of IMF quota and governance reviews. Additional adjustment to quota representing the strength of the economies is urgently required. At the same time, the appointment of the Chief Executives of the IMF and the World Bank needs to be made on the basis of open competition so that the best candidates, irrespective of their nationalities, lead these two institutions. While conducting governance reviews, fairer representation be given to emerging and developing countries according to their contribution to global economic growth. Given the experience of the recent past, additional reforms are not likely to be undertaken and implemented anytime soon. What should then be the strategy for the emerging and developing countries?

Rise of China: two-pronged strategy 

The rise of China on the global economic scene is a blessing for emerging and developing countries. They are all looking towards China for its constructive role in improving global financial governance and hence providing global financial stability. China has also realized the current weaknesses of the global financial system and governance and has already started playing its role.

China appears to be pursuing a two-pronged strategy: First, China is making efforts to secure due roles in existing International Financial Institutions so as to play a constructive role from within to reform and improve global financial governance. Internationalization of Chinese currency is a classic example. China has succeeded in including RMB (Chinese currency) in SDRs “(Special Drawing Rights) to become one of the five reserve currencies in the world. China has entered into a currency swap Arrangement with 32 countries as of end- 2015 and today 22 percent of China’s trade is being settled in Chinese currency. This is a major step towards minimizing pressure on the US dollar. Still, some 45 percent of all cross-border transactions are denominated in US dollars. More than 60 percent of all Central Banks reserves are held in the US dollar. A global RMB would not only win more respect but it would also release pressure on the US dollar.

Second, China has created institutions to supplement and complement the work of existing international development financial institutions. The best example is the establishment of two development financial institutions, namely, the Asian Infrastructure Investment Bank (AIIB) and the New Development Bank (NDB). A recent Asian Development Bank (ADB) study has estimated that Asia alone would require $26 trillion investment in infrastructure by 2030 in order to bridge infrastructural the investment gap in Asia. The existing development financial institutions, namely the World Bank and the ADB would certainly not be in a position to finance such a huge investment.

Over the years, the IMF resources and its staff have been stretched thin which has adversely affected its performance. Asian economies were hit hard in 2008 by the global financial meltdown. As a result, these countries approached the IMF for balance-of-payments support. IMF provided assistance to the best of its ability. Given the current status of global financial governance, recurrence of 2008-like global financial crisis cannot be ruled out. In such an event, the IMF alone will not be in a position to provide such a large balance-of-payments support.

Need for new initiative 

Since the1950s, the size of the global GDP has increased 14 folds; world trade has grown by 135 times; world population has grown three times and the membership of the IMF has increased fourfold. The IMF alone cannot handle such developments. Their efforts must be supplemented and complemented by other regional initiatives. It is for this reason that the need for regional financial cooperation arrangements has never been so great. A regional financial architecture performing the role of lender of the last resort is the need of the hour. Today, over three-fourths of the IMF resources are consumed by three/four European Countries which have virtually transformed the institution into a European Monetary Fund (EMF). The best brains of the IMF have been deployed to the European desk while others are left at the mercy of junior and less experienced staff and interns that further compound the emerging and developing countries’ economic difficulties.

China has already taken initiatives by establishing the AIIB and NDB to supplement and complement the efforts of the World Bank and ADB. China may consider taking additional steps to supplement and complement the efforts of the IMF in maintaining global financial stability by establishing another institution to perform a role like the IMF for the Asian region. Let this institution be named the Asian Monetary Fund (AMF) or Asian Monetary Initiative (AMI) or Asian Monetary Support Fund (AMSF). Such an institution will be of great help to the IMF as this will reduce pressure on the Fund. In so doing, China will also be playing a constructive role in maintaining global financial stability and reducing global financial risk. This move will also be consistent with the ever-rising strength of the Chinese economy as well as with the Middle Kingdom’s emerging leadership role on the global economic scene.

(The writer is Principal and Dean at NUST School of Social Sciences and Humanities, Islamabad: Email ahkhan@s3h.nust.edu.pk)