Towards a New Development Paradigm What does a responsible financial system look like?

1. Towards a New Development ParadigmWhat does a responsible financial system look like? AniketBhushan Researcher- Finance for Equitable Growth Korea University July 8, 2010

2. About The North-South Institute • Canada’s oldest research institute on international development (35yrs) • Research for a fairer world • Independent policy analysis & dialogue, emphasizing southern partners & perspectives • Thematic areas: • Finance for Equitable Growth • Trade, Natural Resources • Employment and Migration • Peacebuilding and conflict prevention • Governance and Effective Development

3. Introduction • Why should we be concerned about crisis, policy responses and the changing dynamics of global economic governance? • What failed and why? Story of three imbalances • A New Development Paradigm: what a responsible financial system looks like

4. Widest Engagement of Civil Society • Financial markets serve real economy (not other way round) • Markets without democratic oversight are inherently prone to exaggerations (bubbles & collapses): gains privatized, risks socialized • Finance & economics is ultimately political • Economic, political, social, environmental interconnectedness

5. E. Asia’s experience • This crisis goes back to last crises episode • Asian crisis experience (late 90s) enough to warrant high degree of attention to reform debates & G20 • But key differences: • Shift in balance of global economy from West to Asia • Emerging economies well prepared, vindicated • Asia’s leadership role & influence on global reform never more important • BUT: cannot be restricted to official/commercial interest. Informed civil society engagement critical

6. Rapid Shift in Balance of Global Economy

7. Self insurance & Policy Space

8. Interaction of Three Imbalances • Financial imbalances • Capital/assets (leverage) • Short/long-term (mismatches) • Pro-cyclical • Macroeconomic imbalances • Chronic deficits, savings surpluses • Incoherent monetary adjustment & currency system • Real, political economy imbalances • Widening income inequality, unprecedented debt levels (not since great depression) • Regulator/regulated (capture)

9. Finance and real economy

10. Finance serving finance

11. Too big for the real economy

12. Income inequality and consumer debt

13. Macroeconomic imbalances

14. Understanding the Development Model Banker and consumer of last-resort: US/W Europe Free-floating, capital-liberal interest rates target Emerging market: capital attractive Export competitive: China, E.A, Jap, Ger, Managed-float, managed cap opening; int rates + Informal pegs, cap ambiguous, wider policy tool-kit Aid, other transfer (remit, tourism), poor resource-rich Formal pegs, monetary unions;

15. Limits of Development Paradigm • Narrow market efficiency paradigm • Excessive reliance on overextended households in advanced economies to support global demand • Excessive reliance on USD as store of purchasing power and incoherent monetary system • Excessive reliance on unrestricted private capital flows to smooth imbalances • An international financial architecture (IFIs) that lacks credibility, democracy, influence over policies of major advanced countries

16. Why a “development” crisis and Towards a New Development Paradigm • Aid levels decline/stagnate in donor crises • Small revenue impact has big social impact • Food, fuel crisis received little attention: LIC no real voice in key global debates • LIC, LMIC more open than ever before: trade linkages • Capital flight makes poorest regions (SSA) net creditors Therefore: • Articulating the purpose of the financial system • Financial regulation • Macroeconomic adjustment and monetary system

17. What does a Responsible Financial System Look Like? • Basic retail function: turning savings into productive investment; turning short term into long-term; meeting liquidity needs of households, govts, businesses • Behavioural function: creating incentives to move change in direction of sustainable (environmentally and socially stable) growth. Shifting bias –short speculative to long-term productive investment • Balanced interconnectedness: different needs in different contexts. Poorest most affected. Meeting developmental commitments (MDG)

18. New Development Paradigm • Financial system must foster growth with equity: imbalanced growth breeds instability. Different countries will have diff balance of domestic/external orientation (pace, desire for liberalization). Investment in social safety, human capital, harnessing productive capacity in emerging/developing regions • Desirable financial innovation: in service of long-term change • Not just regulation: regulators must get the definition of ‘efficiency’ right; tools only good if used • Not institutions, but markets: no individual institution can be more imp than the underlying market • Clear state-role: stabilizing force in financial system; map the market genome; regulation vs. structuring (e.g. securitization) • Cross border regulation: weakest link; we do not have “global financial regulation” all we have is minimum standards

19. New Development Paradigm • Broader view of stability: cannot be limited to price stability. Containing asset bubbles, speculative volatility (graduated capital gains taxes, margins etc.). Pragmatism over dogmatism • More coherent monetary system: interconnected global economy needs to move beyond sys dominated by nationally based reserve/trade currencies (inherently unstable) • Building on Special Drawing Rights (SDR) • Financing facility for countries lacking fiscal space: going against the cycle • Protection vs. protectionism, recognizing importance of preserving systemic integrity: capital controls, curbs on asset bubbles, regional & multilateral swap arrangements • New revenue raising mechanisms to finance public goods: Currency Transaction Taxes