TFR 37 – International Financial Integration: The Policy Challenges
Today the international economic system is dominated by financial factors. Thirty years ago, most foreign exchange transactions were closely related to the transfer of goods and services across national frontiers. Today only some five percent or less of foreign exchange transactions reflect world trade in goods and services.1 The globalization of financial markets extends beyond foreign exchange to securities of increasing varieties. The leading example among securities is the market for U.S. Treasury paper, which has become a global commodity (and even a medium of exchange). Barring catastrophe, the globalization of financial markets will continue. Trading around the clock and around the world will not only be an enduring feature of the intemational economic system but will become even more pervasive.
The decision-making processes and regulatory and legislative frameworks in Trilateral countries were created many years ago and are essentially the children of the nation-state. At best, they pay lip service to a marketplace of worldwide dimensions in which firms with different charters and national origins compete with each other continuously all over the world.
The globalization of markets is thus in tension with inherited arrangements for making decisions by national governments particularly with regard to taxation and regulation of financial activity, which have traditionally been considered quintessentialiy matters of domestic policy. The growing international mobility of financial capital will reduce the effectiveness of strictly national taxation and regulation, and may distort the international flows of capital away from their economically most useful roles, i.e., to direct surplus national savings to productive investments and to help spread risks.
National control of international capital movements is increasingly impractical. The channels for transferring funds from one center to another are numerous, and effective control would require a major move toward autarky in all international transactions, which would be prohibitively costly to economic well-being. To avoid loss of influence altogether, Trilateral countries must collaborate to reduce the differences in taxation and regulation of financial capital which would otherwise lead to extensive avoidance. Over time, the convergence in tax and regulatory policies will have to be extended to other countries as well.
Loss of national sovereignty is not at issue. Sovereignty remains unambiguously lodged with national governments, each with its own constitutional procedures. At issue rather is the ability of sovereign nations to influence their own destiny. That has always been subject to outside events, but in the economic arena the influence of outside events is increasing rapidly. Nations do not lose sovereignty by reaching agreement with other sovereign nations to reassert some measure of political control over the evolution of economic events.
The stakes are high. While international financial integration brings widespread benefits, these benefits are not automatically realized. International financial integration has not been accompanied by increased stability. Particularly since the early 1980s, both the volatility and misalignment of exchange rates have been pronounced, with deleterious effects on longer-term real economic performance. The higher degree of interdependence has quickened the worldwide transmission of changes in interest rates and securities prices, starkly evident in the stock market crash of October 1987. How is reasonable stability to be maintained in a world of growing financial integration? How can governments jointly reassert some measure of control over the evolution of exchange and financial markets?
The answers to these questions must be sought not only in exchange and financial markets. As long as the current account imbalances of major countries remain enormous, financial markets will remain uneasy and volatile. If stability is sought superficially without adequately addressing the fundamental causes of underlying imbalances, exchange and financial markets might react in a volatile manner. Volatility itself can be a warning to policymakers (and the public) against the misalignment of national economic policies, correction of which is a necessary part of the process of adjustment. We devote one section of our report to macroeconomic policies of the Trilateral countries. The importance of these policies can hardly be overemphasized.
A basic aim which should guide macroeconomic policy collaboration among our countries is, of course, the attainment of non-inflationary economic growth. In the short term, there may be some trade-off between growth and price stability, but in the longer term, confidence in price stability will contribute to steady economic growth. Another basic aim should be the maintenance and promotion of free movement of goods and services. This report will not focus on trade policy, but the successful outcome of the Uruguay Round of multilateral trade negotiations under the auspices of GATT is of great importance. The trade policies of Trilateral countries, even those adjusting large trade and current account imbalances, should be pursued in ways that impose as little strain as possible on other countries and on the international economic system.
After discussion of macroeconomic policies, the report describes the broad structural adjustments in Trilateral countries that are also essential in reducing imbalances and creating an environment more conducive over time to international financial stability.
Following a discussion of macroeconomic and structural adjustments, two sections address issues directly related to exchange and financial markets. They form the heart of this report. However important macroeconomic policies are in correcting the disequilibria that underlie exchange and financial market instability, they cannot substitute for direct attention to the functioning of these markets.
In the five-year perspective that has informed this report, longer-term proposals for the reform of international institutional arrangements such as creation of a common central bank for the industrial democracies are not practical. Several issues relating to existing international institutions are quite relevant, however, and we devote one section to them. It is important to strengthen the International Monetary Fund and the World Bank, and a new issue of Special Drawing Rights (SDRS) is now in order.
The Trilateral countries do not exist in a vacuum, but rather function in a global environment. Three dimensions are especially noteworthy. 1) The current account surpluses of some newly industrialized countries in Asia have become large enough to constitute a significant part of the global imbalances. Their economic policies, particularly their exchange rate and trade policies, have a measurable impact on the world economy; and their stake in international economic cooperation has increased. 2) The heavy indebtedness of a number of major middleincome developing countries acts as a drag on world economic growth as well as on their own growth, impedes the correction of global imbalances, and contributes to international financial instability. Progress in this policy area is of global importance. 3) Increased regional economic integration in the European Community and North America simultaneously marks a move away from multilateralism and advances economic liberalization in important new areas. The Trilateral countries, principal custodians of the broad multilateral system, must take care that regional progress is not sought at global expense. The first of these three dimensions was addressed in a 1988 report to the Trilateral Commission, and the second in a 1987 report, but all three require at least brief treatment here to round out our report.2
A reminder before we proceed: Basic numbers routinely used in formulating economic policy are really quite weak, and in some ways are getting worse. The intellectual efforts that have gone into refining the economic interrelationships among the Trilateral countries have certainly not been matched by efforts to improve the statistical data underlying the sophisticated econometric modelling of the world economy, For example: 1) Conventional statistics for our domestic economies were devised in a time when traditional economic activities industrial and agricultural production, retail sales, housing construction were dominant, and do not adequately capture newly growing service activities such as tourism and a variety of professional and technical services. 2) Monetary indicators require constant review. There are enormous ongoing changes in deregulated financial markets; the distinction between transaction and investment balances in monetary aggregates is increasingly eroded; and the internationalization of financial markets raises questions concerning the significance of national money supply measures. 3) The current account balances of different countries present baffling discrepancies when added together, with a recorded global deficit amounting in the mid-1980s to $40-80 billion. The increasing internationalization of economic activity makes it more difficult to interpret conventional balance of payments statistics based on the resident principle. In sum, traditional statistics need to be reviewed from time to time, and adapted as necessary to the changing character of the world economy. In the meantime, they must be used to inform policymakers but they should be used with caution.
Shijuro Ogata, Deputy Governor, Japan Development Bank; former Deputy Governor for International Relations, Bank of Japan
Richard N. Cooper, Maurits Boas Professor of International Economics, Harvard University; Deputy Chairman, Federal Reserve Bank of Boston; former U.S. Under Secretary of State for Economic Affairs
Horst Schulmann, Managing Director, Institute of International Finance; former State Secretary, Ministry of Finance of the Federal Republic of Germany
Table of Contents
I. Introduction: The Need for International Collaboration
II. Macroeconomic Policies
- Reducing the U.S. Fiscal Deficit
- Macroeconomic Policies in Japan and the European Community
- Poor Fiscal Policies Force Excessive Reliance on Monetary Policies
III. Structural Adjustment
IV. Exchange Market Policies
- Intervention an Important Tool
- "Target Zones" Unrealistic in Current Circumstances
- Lessons from EMS
V. Financial Market Policies
- Trends in Financial Markets
- Common International Framework
- Harmonization of Taxation and Regulation
VI. International Institutions
VII. Global Context
- Newly Industrialized Economies
- Developing Country Debt
- Dangers of Regionalism
- Topics: Economics, Multilateral Cooperation
- Region: North America, Europe, Pacific Asia
- Publisher: The Trilateral Commission
- Publication Date: © 1989
- ISBN: 0-930503-07-4
- Pages: 28
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