Global Policy Forum

By Dr. Jonathan Michie

This is the final part of the Third Perdana Lecture by Sainsbury Professor, Dr. Jonathan Michie of Management, Birkbeck College, University of London. The lecture, under this year's Program Pertukaran Fellowship Perdana Menteri Malaysia, was delivered at Putra World Trade Centre in Kuala Lumpur on April 2 and was entitled: Currency speculation: the case for reform and the need for a global response.

Globalisation

The need to reform the global financial system needs to take account of the huge increase in all sorts of international economic relations, from trade to investment, to the activities of multinational corporations, as well as the explosion of speculative financial flows. These developments have been variously characterised as marking a globalisation of international economic activity, the widening and deepening of international economic interactions. This globalisation is sometimes depicted as being driven by technological developments--the fax, satellite communications, the Internet, the World Wide Web.

I don't intend to talk on this aspect, which has been dealt with extensively elsewhere, but it is important to counter four ideas that have emerged in various ways. Firstly, the global operation of companies has not in most cases led to them abandoning their home bases or becoming in any sense non-national. Secondly, the globalisation of technology has not broken down differences between national markets--if anything differentiation and specialisation have increased. Thirdly, the globalisation of technology has not replaced National Systems of Innovation nor made the action of national governments any less important. And fourthly, although the technology has made currency speculation easier, that same technology can also be used to monitor and regulate such activities. It is quite wrong to adopt some sort of technologically determinist view of the globalisation of economic activities.

It would thus be a mistake to see globalisation as synonymous with economic liberalisation. Deregulation and liberalisation are simply the form that such globalisation is currently taking, given the current global neo-liberal regime. Thus, many of the problems that appear to stem from globalisation are due rather to the neo-liberal regime of deregulation and laissez faire within which these developments are occurring.

In considering the need for a global response to currency speculation and financial instability, we must of course start from an examination of the current state of the globalised economy. Indeed, as Datuk Seri Dr Mahathir Mohamad argued in the first Perdana lecture, this globalisation is very much part of the problem. For both international and domestic reasons, then, it is therefore necessary to work on two levels--strengthening national control over capital flows on the one hand, while at the same time working towards an alternative set of international structures on the other.

It is in this context that in this final part of my lecture, I set out the case for reform. We might begin by asking: Why is currency speculation and trading so untouchable? So sacrosanct? Why are currency traders and speculators so "hallowed," above the law? Why must they be subjected to no interference whatsoever?

The answers to these questions lie partly in what has already been said. There are powerful forces and interests who benefit from such speculation--not least the speculators themselves. There are also powerful interests who benefit not so much from the speculation itself, but from the freedom that deregulated international financial markets provides, not least the US. But is it really true that currency speculation is a problem about which nothing can be done? Is it something that we just have to learn to live with?

The answer must be an emphatic no. There is nothing inevitable or natural about current international financial arrangements. Indeed, financial speculation introduces "systemic" risk which is the duty of governments and others to tackle. The term systemic risk is sometimes used simply to indicate that the scale of the speculation is such as to threaten the whole system, should the speculation be unsuccessful and the speculator goes bankrupt. But there is an additional problem. Individual speculators (or financial institutions) will calculate the costs and benefits to themselves from the various speculative choices they face.

They will not factor in the wider costs to society, to the system as a whole, of their activities. These costs to the system as a whole include the resulting exchange rate instability and the periodic financial crises, with all the real economic hardship that inevitably follows in the wake of such financial crises. Where the private costs and benefits facing the individual economic actors differ from the social costs and benefits of their actions, it is the duty of public authorities to, in the jargon of economics, internalise such negative externalities through taxation, or through controls or both.

Few activities have proved more anti-social than international currency speculation. If ever there was an activity crying out for taxation and control, this is it. Indeed, it is bordering on the bizarre that when such a high proportion of goods and services, and of economic activity generally, is taxed, currency speculation remains one of the few activities to demand, and get, total exemption from taxation and control. Instead of wringing our hands at the loss of power of national governments, we should therefore be setting in place new controls and new regional and global structures to give us the ability to control our economic environment.

Turning to what specific steps might be taken to manage these problems, there are a variety of things that can and should be done, at the national, regional and global levels. Each will tackle a different aspect of the problem. They should therefore be pursued together. They are complements rather than alternatives. Each would help reinforce the others. The three main categories, all of which should be pursued together, are firstly a tax on speculation, secondly, exchange controls and thirdly, reforming the international institutions, particularly the IMF.

A tax on foreign exchange dealings would make a positive contribution. James Tobin proposed the taxation of foreign exchange transactions and such taxation is hence often labelled the Tobin tax. A proposal for the adoption of such a tax internationally was published last December by a network of European Economists, of which I am a member. We called for a tax on all foreign exchange transactions to deter short-term capital flows gambling on small exchange rate changes.

The aim of such a tax would be to reduce the volume of speculative currency movements. However, a side effect would be to raise revenues that could be put to good use for global economic development. Even if the tax was set at a low level and even if the tax succeeded in halving the volume of such transactions, revenues would still be around US$75bil a year. If this US_75bil were earmarked for development projects, the tax could have a doubly beneficial effect in damping down speculation and at the same time promoting economic development. The US_75bil a year would be significant in relation to total official development finance (foreign aid) to developing countries which stood at just US$56bil in 1990 and by 1997 had actually fallen to only US$44bil.

The usual objection to such a tax is that it would be impossible to enforce, since the speculators would simply move offshore, out of reach of whichever national governments were attempting to impose it. It is certainly true that attempts should be made to adopt such a tax internationally. And if the European Union, the US and Japan all agreed, the chances are they could ensure its success.

But there are also other ways of preventing such a tax from being evaded. For example, any currency transaction not undertaken through regulated exchanges could be denied legal status. This would mean that any claims regarding unpaid debts could not be backed by the force of law. However, such matters are far from purely technical; two political obstacles would need to be overcome. Firstly, to achieve the degree of international co-ordination that would be required. And secondly, to overcome the political power of the financial sector which would most likely resist any restriction or tax on their activities.

My purpose in drawing attention to these political problems is not to imply that they cannot be overcome. Quite the contrary. They clearly can be. But only if they are recognised as such, and only if the necessary political work is done to overcome and defeat these vested interests.

On exchange controls, in our 1998 European Economists' Memorandum, we recognised that currency speculation of the more fundamental kind cannot be dealt with adequately by a transaction tax alone. We therefore called for collateral deposits to be required in the case of currency derivatives of all kinds. Such measures would still need to be backed up with a system of circuit breakers which interrupt trading when necessary, because in a moment of crisis no trading system is able to cope with the volume of selling. Such circuit breakers have been used in stock exchanges and there is no reason why they could not also be used in currency markets.

There are thus many useful controls that can be introduced. For example, Chile has successfully operated such controls for almost 10 years now. In 1991 they introduced a 12-month holding period. This requires almost all capital inflows to remain in the country for at least 12 months.

Another example would be the set of measures operated here in Malaysia which will be well known to the current audience. All I would say, therefore, is that the whole package of measures adopted by the Malaysian government appears to me to be eminently sensible.

Indeed, I suspect the sense of the government in contrast to the nonsense espoused by the IMF has probably had an unacknowledged effect on the IMF, reforming their policies somewhat to be less damaging than they would otherwise have been for example regarding the IMF conditions imposed on Thailand.

A third specific example is one that I am involved with. The European Economists' network mentioned before pointed out in our 1998 memorandum that: If speculative flows from third countries or capital flight to third countries are becoming dangerous to the functioning of the economic and monetary union, the EU can--according to Article 59--take all necessary measures to master the situation.

This implies administrative restrictions on capital imports or exports, albeit only for the limited period of six months (which can be repeated). The EU should make it unequivocally clear to the financial work that it is determined to apply strict capital controls if necessary.

It is worth emphasising that the EU has in its Treaty on Monetary Union reserved the right for all member states to introduce such exchange controls as and when necessary. This point has gone largely unnoticed.

What about the IMF and the international institutions generally? The peculiar genius of the IMF, according to American economist J.K. Galbraith, is to bail out those most responsible (for the crisis) and extend the greatest hardship to the workers who are not responsible. The IMF has become inseparable from Wall Street, the US financial establishment and the "Washington consensus." A good start would therefore be to move the IMF headquarters to another country.

It is worth remembering that the case for capital controls to be included in the Bretton Woods agreements was not only to prevent speculation--although that was certainly seen to be an important aim. It was also to assist policy action more generally, regarding interest rate management, promoting investment and so on.

Conclusion

Keynes warned long ago that without controls on capital movements, Loose funds may sweep round the world disorganising all steady business (Keynes, 1941). How right he was.

Short-term borrowing in foreign currencies and large scale speculative trading were major factors in the Asian crises of 1997 and 1998. Unless these problems are tackled soon, they are likely to lead to further, and possibly greater, upsets. What is required is a combined attack on exchange rate instability and speculative capital movements.

The problems witnessed in today's global economy are not just technical, economic ones. They are also political. Devising new structures of World Economic Governance requires, as a starting point, that this be recognised. This means that to be successful, any alternative needs to not only spell out appropriate policy and institutional developments, it also needs to win sufficient political support globablly to force through the necessary change of course.

In this context, ideological issues play a role. Today's complacent economic orthodoxy needs to be exposed. The fatalistic belief that globalisation rules out any change of course has to be challenged.

Globalisation has created problems that need to be tackled. It is not an excuse for inactivity. On the contrary, globalisation makes policy action at the national and international level more necessary and more urgent. And at the top of the list of priorities should be to put stop to international currency speculation, and to reform the international monetary system.

The fact that the world's economy is becoming increasingly internationalised does not dictate the form that this process has to take. The free market, laissez faire agenda is one being pursued by those who benefit from such a deregulated, winner-take-all environment. It is not the only choice. And for the majority of the world's population, it is an inappropriate one.

Keynes' judgement in 1926 was to be proved correct, most dramatically with the Wall Street crash of 1929 and subsequent economic recession--leading to the rise of fascism in Europe and ultimately the Second World War. It was also a judgement that was eventually acted on, with the Bretton Woods agreement. This helped underpin the most successful period in world economic history.

That era came to an end in the 1970s. Fixed exchange rates were abandoned. Exchange controls were scrapped in country after country through the 1970s and 80s. The result has been global instability and uncertainty.

It is high time for global reform.

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