What’s changed in the international financial system and its institutions, what hasn’t and what needs to

Executive Summary
Back in 1995, the G7 met in Halifax during a “time of change and opportunity.” The meeting took place in a context of mounting deficits and debt crises in countries in the South; in the wake of economic collapse in Mexico; and amid strong global criticism from civil society, the media and governments about the World Bank and International Monetary Fund’s (IMF) austere neo-liberal structural adjustment policies.

A lot has changed since then, partly in response to the Halifax G7 Summit and subsequent G7 and G8 meetings. Too many of these improvements, however, exist only on paper. Beyond the surface, the neo-liberal, market-oriented bias that guides the Bank and Fund’s agenda and thinking has not altered.

The 2010 G8 Summit in Toronto in 2010 takes place during another “time of change and opportunity.” The financial crisis has spurred many civil society organizations (CSOs) to insist on far-reaching changes to the global financial system and its institutions. Clearly, as this publication will illustrate, 15 years of refusing to deal with the manifest shortcomings of the global economic system is enough.

This publication looks at several interrelated issues:

• The place of the dollar in the global economy, and the move towards a new global reserve system;
• The challenge to conditionality in the context of policy prescriptions that exacerbate the impact of the crisis;
• Truly sustainable responses to debt, in the context of a looming debt crisis; and
•  Tax justice in development, in the wake of a growing global movement challenging tax havens.

The need for transformation
Chapter 1 by Fraser Reilly-King sets the broader context for the publication by looking at the issue of global governance, as well as new and innovative sources of financing for development and climate change.

The G20 remains an exclusive club that does not represent the interests of low-income countries and that lacks mechanisms to ensure transparency and accountability. To achieve the broader goal of democratic governance, a global leaders’ forum must include the effective participation of low-income countries. It must respect democratic principles, providing avenues for citizens’ voices. In the medium term, such a forum cannot replace the need for a democratic and global leaders’ summit process within the framework of the United Nations.

Despite their minor role in causing the global financial crisis, developing countries have been deeply affected by it. Not surprisingly, the economic crisis is threatening to undo progress towards achieving the Millennium Development Goals (MDGs). Additional emergency funding is needed urgently to address their massive funding shortfalls. The chapter argues that low-income countries could benefit from targeted allocations of Special Drawing Rights (SDRs) — the “currency” set aside by the International Monetary Fund in an international reserve. In addition, a global tax should be imposed on all financial transactions with at least half of the generated funds allocated to developing countries to help achieve the MDGs and for climate change mitigation and adaptation.

Towards a new global reserve system
Financial crises have been a recurring characteristic of the international financial system over the past two centuries, but have become more pronounced and far-reaching with the advent of financial and capital account liberalization. The gold standard and the Bretton Woods system had ushered in two decades of relative global prosperity and monetary stability, but their collapse in the early 1970s triggered what economist Robert Triffin has called a “non system… anchored primarily on a national, paper reserve currency, that is, the dollar.”

In the absence of more far-reaching reforms, countries that have survived previous crises have pursued their own ad hoc measures, building up substantial hard currency reserves to buffer themselves against future crises and speculative attacks. For example, in 2000, the 10 countries of the Association of South East Nations (ASEAN) plus China, Japan and South Korea launched the Chiang Mai Initiative. This initiative is now a $120 billion multilateral “currency swap” arrangement to offset sudden outflows of foreign currency in order to avoid abrupt destabilization of national economies.

But building up vast currency reserves has an opportunity cost: it diverts resources that could otherwise be used for productive investments in the real economy, exerts deflationary pressures on economies and generates monetary instability. This may be a price that countries are willing to pay, opting for regional initiatives in the absence of more systemic global solutions that work for them. As the past three decades have demonstrated, however, crises are intrinsic to a globalized economy, not exceptions to be treated on an ad hoc basis.

At the heart of the problem is the US dollar-dominated international currency reserve-system. The accumulation of extensive foreign exchange reserves by some emerging market economies (China in particular) and excessive consumption by others (the United States in particular) are responsible for large and unsustainable global imbalances.

This unbalanced situation has intensified recent calls for a new global reserve system. Chapter 2 by Arnaud Zacharie with Soren Ambrose looks at the need for a new system that would accomplish two goals: reducing the reliance of the global economy on a single currency — the US dollar; and addressing the inequitable nature of the current reserve system that places the burden of adjustment solely on deficit countries instead of mitigating the difficulties caused by asymmetrical adjustments.

A new reserve currency and system would bring greater stability to the financial system, avoid the build up or global imbalances and preclude the need for countries to dedicate much-needed resources towards massive national hard currency reserves. The chapter considers the feasibility of creating a new global reserve system and some proposals for doing so.

Challenging conditionality
At the G20 summit in London in April 2009, world leaders committed an additional US$1.1 trillion in emergency financing — with US$750 billion pledged (although not yet fully committed) to the IMF. Some US$250 billion has already been issued to all IMF member countries (although not yet converted) in the form of SDRs, the IMF’s reserve asset. For the remainder, industrialized and reserve-rich governments are lending the IMF up to $500 billion for loans at market interest rates to countries in need.

Of the $1.1 trillion committed, only US$240 billion is expected to go to developing countries and $50 billion to low-income countries. This is a paltry amount relative to what G20 countries have dedicated to boost their own economies, and woefully inadequate given the shortfalls in financing that both the IMF and World Bank anticipate. Furthermore, many of these loans are attached to new conditions and to countries without recent IMF programs, such as Ghana and Ethiopia.

In response to the crisis, the IMF changed a number of its conditions. It eliminated structural conditions in many programs; it created a new Flexible Credit Line (FCL) that provides liquidity for building up foreign reserves without attaching “any conditions;” and it is allowing countries to incur slightly higher deficits compared to historic IMF positions.

Despite these changes, structural benchmarks (which are not legally binding but that still force policy change in countries that accept IMF finance) will continue to be used, as well as traditional quantitative targets. As it stands, only “countries meeting pre-set qualification criteria” of “very strong fundamentals, policies, and track records of policy implementation” are eligible for the FCL. Consequently, only three countries — Mexico, Poland and Colombia —have benefited so far.

Such “fiscal loosening” is also only a temporary measure; the emphasis on social protection still sits firmly within a context of shrinking government budgets. Finally, research on the conditions attached to new crisis loans for Eastern Europe and many middle-income countries clearly underscores the IMF’s ongoing obsession with “tightening monetary and fiscal policy.” In other words, the conditions may have changed in name and form, but they are still alive and well.

As Chapter 3 by Bhumika Muchhala and Nuria Molina notes, these new conditions have forced governments to cut expenditures on key essential public services, such as health care, education, public transit, water, sanitation and access to fuel and electricity; to privatize many of these services; to cut subsidies; and to introduce user fees. Unnecessarily restrictive deficit-reduction and inflation-reduction targets prevent developing countries from growing their economies by expanding public spending.

These restrictions, in turn, have undermined the ability of country governments to meet their own human rights’ obligations. This chapter underscores the need for substantial (unconditional) resources to be dedicated to countries to enable them to pursue counter-cyclical policies during times of crisis; for policies that promote greater domestic resource mobilization; and for macroeconomic analysis and assessment that is more objective, flexible and country-driven —and independent of the IMF — that helps governments foster economic growth, as well as protect and promote the rights of their citizens.

Next steps on debt
The Heavily Indebted Poor Country (HIPC) Initiative in 1996, Enhanced HIPC in 1999, and the Multilateral Debt Relief Initiative (MDRI) in 2005 have all helped move debt cancellation forward. There is a danger, however, that new loans to developing countries, especially if disbursed at commercial rates, will lead to a new debt crisis in the South. The World Bank has already increased its lending activities by 54 percent over the previous year, reaching an unprecedented US$58 billion in fiscal year 2009. Meanwhile, the IMF has committed an additional US$170 billion since the crisis broke out.

This expansion in lending could create significant debt problems in the near future: the debt-to-GDP ratio of 28 countries is already above what the IMF considers a sustainable threshold at more than 60 percent. Similarly, in its 2009 Least Developed Country (LDC) Report, UNCTAD points to serious concerns over the unsustainably high debt burden of 49 LDCs. Therefore, it is important that appropriate measures mitigate the negative effects of the crisis on the indebtedness of developing countries and ensure that lending is sovereign, democratic and responsible, an issue currently under discussion at UNCTAD.

In Chapter 4, Lidy Nacpil and Gail Hurley describe a number of ideas currently under discussion internationally that could help avoid a new debt crisis. A two-year moratorium on all external debt service payments of developing countries, for example, would free up additional resources in the amount of US$30.5 billion annually for 64 of the world’s most indebted countries. This would be an effective way to release extra funds for critical social investment, while ensuring no additional debt would be incurred.

Much of the debt burden of developing countries has arisen through irresponsible lending practices. In the context of the current crisis, countries are in debt due to a crisis they didn’t cause — and there is an urgent need to assess and cancel these odious debts. Indeed, governments and civil society organizations are conducting audits to identify these debts. In the longer term, a renewed debt cancellation initiative should ensure future lending is responsible and transparent, and establish a fair, transparent and sovereign debt restructuring mechanism.

Promoting tax justice
Over $600 billion, or nearly three times the current levels of external debt of sub-Saharan Africa, has leaked from the continent in illicit financial flows since 1975.20 Global Financial Integrity estimates that globally US$500-800 billion of illicit flows exit developing and transitional economies every year. The Tax Justice Network has estimated that wealthy individuals hold $11.5 trillion offshore in secrecy jurisdictions. Furthermore, Christian Aid estimates that developing countries lose around $160 billion each year in tax revenue as a result of secrecy jurisdictions — more than 30 percent higher than the amount of aid given by northern donors in 2008.

While the G20 has begun to address the issue of tax havens, the UN Commission of Experts on the Financial and Monetary System has noted the G20’s approach through the Organization for Economic Co-operation and Development (OECD) has led to, “discriminatory targeting of small international financial centres in developing countries while a blind eye is turned to lax rules in developed economies.” In fact, the Commission notes that, “the principal sources of tax evasion, tax secrecy, money laundering, and regulatory arbitrage [are] located in developed countries’ on-shore banking systems….”, such as Delaware in the United States and the City of London.

Chapter 5 by David McNair, John Christensen and Dereje Alemayehu traces the ties between mobilizing domestic resources through taxes and pro-poor economic growth, good governance and stability. It considers how those who use secrecy jurisdictions to evade taxes undermine the “tax culture” in many countries. It then presents the mechanisms, scale and impact of capital flight and tax arbitrage; assesses the current approach by the G20 to addressing the issue of secrecy jurisdictions; and considers why and how this approach falls short of tackling the issue.

Finally, it summarizes a number of policy measures for international tax cooperation that address capital flight, including the following:

• adopting automatic information exchange procedures along the model adopted by the European Union;
• promoting country-by-country reporting on accounts by multinational companies;
• ensuring alternative sustainable development paths for jurisdictions that have become dependent on financial
• secrecy; and
• giving countries the space to set their own domestic fiscal policy and supporting stronger tax authorities in developing countries.