On the Role of the International Financial Markets in Globalisation, Public Finance and Financing Development
by Peter Wahl
Berlin, April 2008
Summary
The liberalisation and deregulation of the financial markets since 1973 was the economic trigger for the present wave of globalisation. The free floating of exchange rates, and the subsequent liberalisation as well as the deregulation of the financial markets played a decisive role for the formation of the present day financial markets.
The original role of the financial markets previously consisted in providing services to the real economy. In the meantime, this subordinate function has been reversed so that the financial sector now dominates the rest of the economy.
This has lead to a dramatic growth in financial transfers – up to 3 billion USD per trading day in 2007 - which is increasingly detached from the real economy. However, this separation is relative. If a crisis develops, this hits the real economy and thus also affects jobs and society.
The worldwide speculation business and arbitrage with foreign currencies, interest rates and share prices became an independent source of profit. Extreme short-termism now dominates all portfolio investment strategies.
Short-termism
A basically new process is securitisation. Loans are converted into securities and then traded on the market. In this way, the financial market interferes with the traditional relationship between bank and borrower. Large companies no longer seek finance from their bank but obtain it from the financial markets.
At the same time, new financial products, derivatives, became available. Whereas they serve to cushion risks that arise from the increasing instability of the financial sector at the micro level, they accentuate systemic instability at the macro level.
The institutional investor is an innovation which has attained particular importance over the last decade. This represents the institutionalisation and professionalisation of the proprietor function. The sole interest of the institutional investor is the maximisation of profit for the proprietor, the shareholder. This shareholder orientation is being increasingly transferred to the real economy. Other business objectives are neglected.
Little investment in the real economy
The emergence of transnational financial markets has developed new and superior sources of high profit. Today, a 25% return on investment is the norm for leading financial market actors. This is the reason why capital holders prefer to invest their money in the new financial market business. The result is a structural weakness for investment in the real economy with negative consequences on economic growth and jobs.
At the same time, the financial sector's instability and vulnerability to crises has increased considerably. Financial crises occur more frequently. The latest proof is the 2007/08 crisis which started as a subprime mortgage crisis in the USA and turned into an international bank and credit crisis with considerable effects on the real economy. It is the most serious financial crisis since the Second World War. Essential characteristics of this instability are exchange rate volatility, short-termism, high risk funds, offshore centres, derivatives, pro-cyclic behaviour ("herd behaviour") and the risk of being infected by the crisis. The vulnerable developing and emerging market economies are particularly affected from the effects of the crisis on real economy.
Altogether, these new developments have in the meantime lead to a new wealth accumulation regime which is extremely focussed on property and capital. Structurally, it affects national economies and the world economy.
The multilateral financial and economic institutions such as the IMF, World Bank, WTO, the Bank for International Settlements, etc., participate with a leading role in establishing this new regime.
Radical change of historic dimensions
We are dealing with a radical change of historic dimensions, a system change comparable to the revolution of Fordism and Taylorism. It is not only an economic process but also affects everyday life. It amounts to a structural and functional change from the nation-state to the competitive state. The classic welfare state is dismantled. It aggravates the polarisation of society and increases precarity. The cake is growing, but the piece which the financial markets cut out for themselves gets bigger and bigger, and what is left for others becomes smaller.
The capacities for democratic policies within the nation-state are being limited. The transnationalisation of the economy leads to the erosion of democracy.
Public finances are under pressure from two sides: On the one hand, the public spending ratio and public expenditure is reduced, and on the other hand, the public revenue is under pressure because of the erosion of the tax base. The result is a restriction of the political leeway for political institutions. Social disintegration and a growing risk of political destabilisation are the consequences.
Civil society must deal with the role of financial markets in globalisation more systematically. A democratic, socially just and ecologically sustainable form of globalisation will not be possible without fundamental reforms of the financial markets.
Ways out?
Numerous suggestions are presented in this text. Taxation of foreign currency transactions, capital transfer controls and – in the medium term - the creation of regional currency unions - are introduced to cushion exchange rate problems.
The short term orientation of the financial markets must be repulsed. Instruments for this are capital controls and taxation with a corresponding governance function.
Institutional investors, especially hedge funds, private equity funds and REITS must be subjected to political regulation. A restriction of leverage is especially necessary to mitigate the risk of taking up highly leveraged credit. Additionally, long-term investors should be given extended voting rights and employee participation must be developed. Important public services, such as social welfare, as well as important infrastructure areas such as transport and energy should be withdrawn from the shareholder dynamic and be publicly controlled. Institutional investors who operate from offshore centres and tax paradises should be banned from operations.
Debt relief
The economic functions of offshore centres and tax havens are to be neutralised through international political pressure and instruments such as taxes on banking secrecy. Unconditional and complete debt relief is necessary for the Highly Indebted Poor Countries (HIPCs), together with an international insolvency law.
The rating system must be public and organized within the context of financial supervision. Financial supervision in general has to be strengthened and internationalised. The central banks must be subject to democratic control.
Reforms of the multilateral finance institutions to support these measures are suggested in this text. Firstly, these include democratization of the IMF and the World Bank, restricting the IMF to its original mandate as lender of last resort and the abolition of neo-liberal structural adjustment policies. The regionalization of development financing should be promoted, including efforts which are independent of Bretton Woods institutions. The role of the UNCTAD should be reinforced and in the long term, the ECOSOC should increasingly be upgraded as the central institution of economic regulation.
Innovative instruments have to be developed to enable the financing of global public goods such as development and environment. An important role is assigned to international taxation.
The prerequisites for reforms are good at present. The increasing legitimacy crisis of the neo-liberal model strengthens the chances of emancipatory alternatives.