Reforming the International Monetary and Financial Systems in the Wake of the Global Crisis

Joseph Stiglitz

[The final chapter of The Stiglitz Report, prepared by Joseph Stiglitz and
Membrs of a United Nations Commission of Financial Experts; 2010]

CONCLUDING COMMENTS

This is the most significant global crisis in eighty years. The crisis is not just a once in a century accident, something that just happened to the economy, something that could not be anticipated, let alone avoided. We believe that, to the contrary, the crisis is man-made: it was the result of mistakes by the private sector and misguided and failed policies of the public.

WHAT WENT WRONG: A RECAP OF FAILED POLICIES AND PHILOSOPHIES

This Report is premised on the belief that if we are to respond adequately to the crisis-both if we are to have a robust recovery and if we are to prevent a recurrence-we must have an adequate diagnosis of the crisis. Both policies and economic theories played a role. Flawed policies helped create the crisis and helped accelerate the contagion of the crisis from the country of its origin around the world.

But underlying many of these mistakes, in both the public and private sectors, were the economic philosophies that have prevailed for the past quarter century (sometimes referred to as neoliberalism or market fundamentalism). These flawed theories distorted decisions in both the private and public sector, leading to the policies that contributed so much to the crisis and to the notion, for instance, that markets are self-correcting and that regulation is accordingly unnecessary. These theories also contributed to flawed policies on the part of Central Banks.

Flawed institutions and institutional arrangements at both the national and international level also contributed to the crisis. Deficiencies in international institutions, their governance, and the economic philosophies and models on which they relied contributed to their failure to prevent the crisis from erupting, to detect the problems which gave rise to the crisis and issue adequate early warning, and to deal adequately with the crisis once it could no longer be ignored. Indeed, some of the policies that they pushed played a role both in the creation of the crisis and its rapid spread around the world. All of this facilitated the export of toxic products, flawed regulatory philosophies, and deficient institutional practices from countries claiming to be exemplars for others to follow.

The debate about appropriate institutional practices and arrangements and the economic, political, and social theories on which they rest will continue for years. The ideas and ideologies underlying key aspects of what have variously been called neo-liberalism, market fundamentalism, or Washington Consensus doctrines have been found wanting. Other ideas, which might have been more helpful in avoiding the crisis and mitigating its extent, were overlooked.

The last quarter of a century has had some notable successes, not the least of which has been the rapid growth in Asia which has lifted hundreds of millions of people out of poverty and brought many benefits, including extended life spans, higher literacy, and improved health. But while some countries have done well, others have not. International financial and economic arrangements have in many cases worked to the disadvantage of developing countries. The global arrangements that have facilitated rapid growth in many parts of the world have not come without a cost: growing inequality in many countries and, in some cases, excessively rapid depletion of natural resources and degradation of the environment.

The last quarter century has also been marked by high levels of instability. In the past, the successes in preventing crises originating in developing countries from becoming global have come at a great cost, with many facing unnecessarily severe recessions and even depressions and with the assistance sometimes being accompanied by a loss of national sovereignty in matters of vital importance to a country's citizens. This, the Great Recession of 2008, is only the worst of the frequent crises that have plagued the world, but there was a complete failure in preventing this crisis that originated in the developed countries from bringing down with it even those developing countries that had put into place sound macro-economic and regulatory policies. While globalization offered the promise of greater economic stability, it has instead led to greater instability.

WHAT HAS BEEN DONE

The international community has responded to the crisis in an unprecedented way. The massive stimulus and rescue packages adopted by most governments have brought the world back from the precipice of a global depression. By and large, government expenditure policies to support economic activity have worked as predicted. In most countries these expenditures have been on productive investments so that new assets corresponding to the new liabilities have been created. Particularly commendable are the many stimulus packages that have included a "green" component, which addresses the major long-term environmental problems facing the planet at the same time that the spending enhances the strength of the global economy in the short run.

The substitution of the G-20 for the G-8 as the major forum for global discussions is to be welcomed, as it allows greater participation and includes some emerging markets. Yet the majority of the countries of the globe, whose voices need to be heard, are still excluded. There is particular concern about political legitimacy of discussion that excludes the voices of the least-developed countries. The Commission recognized the importance of combining effectiveness (which may be enhanced by the relatively small size of the deliberative group) with political legitimacy, and a key proposal presented has suggested how this might be done. It is essential for the success of any proposals for reform of the international trade and financial system that these concerns be addressed.

Also welcome are commitments to reform the international financial institutions. The agreement that the heads of the institutions would be chosen on the basis of merit is long overdue. Reforms in governance are essential if these institutions are to fulfill their mandates. Chapter 4 has provided an explanation of why the proposed reforms are not likely to go far enough and what additional reforms are desirable.

It now seems to have been recognized (even by those who pushed for deregulation) that there is a need for more, or at least better, regulation and enforcement, especially in the arenas of finance. But, as noted in Chapter 3, the task ahead is large, and it is not clear that there is yet an adequate understanding of the dimensions of the required action. The Commission, for instance, focused attention on the ways in which capital market and financial market liberalization and deregulation may have contributed not only to the creation of the crisis but also to its rapid spread around the world. Reforms must, moreover, go beyond finance, for instance, to laws and regulation affecting corporate governance, competition, and bankruptcy. Because the devil is often in the details, announcements of agreement on certain principles may not suffice.

While the numerous instances of protectionist actions which have been taken around the world, including by governments who had committed themselves to not doing so, have been a setback, matters might have been far worse without those commitments and an international framework designed to prevent such policies.

WHAT IS TO BE DONE

It is essential that, as the international community works for a robust and sustainable recovery and for reforms that ensure long-term, democratic, equitable, stable, and sustainable growth, it do so with a broader respect for a wide range of ideas and perspectives. At the very least, we need to be more modest about our confidence in particular economic theories, and our policies have to be robust enough not only to withstand shocks to the economy but also to hold us in good stead if some of the premises of our theories turn out to be wrong.

It is also imperative that policies be framed within a set of goals that are commensurate with a broad view of social justice and social solidarity, paying particular attention to the well-being of the developing countries and the limits imposed by the environment. It would be wrong and irresponsible to seek only quick fixes for this current crisis and ignore the very real problems facing the global economy and society, including the climate crisis, the energy crisis, the growth in inequality in most countries around the world, the persistence of poverty in many places, and the deficiencies in governance and accountability, especially within international organizations. To many, the crisis is but one symptom of a deeply dysfunctional set of global arrangements. Our Report approaches the current crisis from these broader perspectives.

We believe that a comprehensive agenda is required to attack the problems we have identified and to achieve the goals we should be seeking. This Report has focused on some of the Key Reforms in both national and international policies, regulations, and institutions. This is a macro-economic crisis, caused in part by micro-economic failures, bringing home the intertwining of these often disparate aspects of economic analysis and policy. Some analyses have focused on one, some on the other. We believe that these problems have to be approached from a coherent framework, and in this Report we have attempted to do just that.

SOME COMMON THEMES

There are several common themes that run through the analysis. One is that the growing inequalities in most countries around the world are not only socially unjust but have also contributed to the problem of potentially weak effective demand.

Another is that the crisis has to be seen as a global crisis. Accordingly, the responses have to be framed from a global perspective. The imbalances that marked the global economy in the years preceding the crisis were not sustainable; poorly designed responses, however, could exacerbate these imbalances. The high level of global volatility, combined with inadequate international arrangements enabling developing countries especially to manage this risk, has prompted many of the latter, at least those which had the means to follow an export-led strategy and to create their own self-insurance. This is one of several motivations which have led to the buildup of high levels of reserves, which also contributes to the global demand deficiency.

A third theme of the analysis is that there are large global asymmetries, illustrated by the differences in responses imposed on the East Asian countries at the time of the last crisis and the policies pursued by developed countries in response to this crisis, which is a disadvantage of developing countries. These asymmetric responses may contribute to greater volatility in developing countries and thereby to a higher cost of capital, with adverse effects on growth and poverty. The problems are compounded by the fact that the poor countries have almost no say in the design of the rules of the game. Even allegedly symmetric rules, because they are applied in such a heterogeneous world, have strong asymmetric effects. Government guarantees to financial institutions by some of the advanced industrial countries contributed to the ironic situation of capital moving from the developing countries to those countries whose failed policies had caused the global conflagration.

A fourth is that the financial sector has systematically failed to perform its key roles of allocating capital and managing risk, all at low transactions costs. Governments, deluded by market fundamentalism, forgot the lessons of both economic theory and historical experience which note that if the financial sector is to perform its critical role, there must be adequate regulation.

A fifth is that economic globalization has outpaced the development of the political institutions required to manage it well. Economic integration implies increased economic interdependence, and that implies a greater need for global collective action, as illustrated by recent events. While this is a global crisis, policy responses are framed at the national level. The host of areas in which national governments have had to take action-from bankruptcy to competition policy to financial market regulation-now have to be addressed at the international level. Current institutional arrangements are not up to the task. They will either have to be reformed, or new institutions will have to be created. A strong, independent, and politically neutral body offering advice to relevant international institutions to improve their ability to shape economic policies in a sustainable and globally responsible way is necessary. In one way or the other, if our global economy is going to work for the benefit of the majority of the citizens of the world-and if it is to exhibit greater stability than it has in recent decades-something will have to be done. We cannot continue to let these problems fester.

A sixth and crucial theme, to which we have already referred, is the pervasiveness of externalities, one of several market failures that help explain why markets on their own are not necessarily either stable or efficient. These externalities are pervasive within countries and across borders. The failure of one financial institution contributed to weaknesses in others; the failure of the financial system to perform its core functions has imposed huge costs on society-on the economy, on taxpayers, on home owners, on workers, on retirees, on virtually everyone-and the world will be paying the bill for their mistakes for years to come. Mistakes in one country have imposed huge costs on other countries; in this case, the mistakes of a few developed countries have imposed large costs on many developing countries. Well- functioning globalization might have protected them; well-functioning financial markets might have shifted these risks from those less able to bear them to those who were more able. Neither globalization nor financial markets performed well.

The response to the crisis must recognize these externalities. Regulations in one country can have impacts on others. At a minimum there needs to be coordination of global financial regulation. While this crisis has become global, the responses to the crisis are designed at the national level, with a minimum of coordination between nations and with each country doing whatever it can to protect its own economy. The developing countries-including many that managed their monetary, fiscal, and regulatory powers far better than those in the advanced industrial countries from which the crisis emanated-have been put in a particularly disadvantageous position, as the problems of unfair competition, that they simply can't match the subsidies and guarantees of the wealthy countries, are compounded with a lack of resources to conduct countercyclical fiscal policies.

A seventh theme concerns innovation. Financial markets prided themselves on their innovativeness. Yet they failed to innovate in ways that led either to more sustained growth or greater stability, that enabled ordinary citizens to manage better the risks which they faced, and that enabled risks to be effectively shifted from those who are less able to bear them to those who are more able. Indeed, some of the innovations may have contributed to the problems: they enhanced problems of information asymmetries, and the increased complexities made assessments of risk harder and therefore the management of risk more difficult. Some of the innovations were directed at circumventing accounting and financial regulations that were designed to ensure the efficiency and stability of the financial system. The notion sometimes put forward that more regulation may stifle innovation may be false: better regulation may direct entrepreneurial talents to innovations that enhance societal well-being. We believe that modern technologies combined with advances in the understanding of economic processes have enhanced the scope for such innovations, and we have devoted considerable efforts at identifying some of the institutional innovations that might contribute to improvements in the well-being of ordinary citizens and to the functioning of the global economic system.

While discussions of the failures of markets have focused on the financial sector, it should be clear that some of the key problems are more pervasive. Flawed incentive structures that led to excessive risk taking and shortsighted behavior were, in part at least, a result of problems in corporate governance, which are manifest elsewhere. The problems of too-big-to-fail, too-big-to-be-resolved banks (discussed in Chapter 3) are a reflection of inadequate competition laws and/or deficiencies in enforcement.

A final theme is that in responding to the exigencies of the moment, we must take care not to worsen the underlying problems. This crisis should be seen as an opportunity to engage in necessary reforms. Historically, moments of crises often provide a rare chance for fundamental reforms that would otherwise be impossible. But there is also a danger: existing power structures can seize hold of these moments of crisis and use them for their own benefit, reinforcing inequalities and inequities. There may be a greater concentration of economic and political power after the crisis than before. This has happened in the past and seems to be happening in this crisis in certain countries, as the share of the too-big-to-fail banks has in- creased even further.

SOME KEY RECOMMENDATIONS

This crisis poses a deep question: can we have the benefits of globalization without bearing all of its most adverse costs? Can we manage the global economy in ways that enhance the well-being of most citizens around the world? We believe we can. We can at least manage the world economy much better than we have. This Report presents a large number of recommendations that suggest how this can be done, focusing, in particular, on how we can reduce the risk of the kind of crisis that the world has just experienced and how we can respond to the crisis in ways that especially help the poorest countries.

We have proposed short-term remedies-measures that can and should be taken up immediately-as well as longer-term actions, which may take months, even years, of debate. In some areas, such as the reform of financial regulations, we have provided rather specific recommendations (e.g., on the treatment of derivatives or the too-big- to-fail banks). In other cases, we have laid out a menu of options: we believe that a new global reserve system is absolutely essential, but there are many alternative designs, some of which would provide better macro-economic stability and some of which might enable the international community to address a number of other social and economic objectives. It should also be clear from what we have already said in these concluding remarks that we believe it is absolutely essential to create better institutional arrangements for coordinating global economic policy-for instance, along the lines of the Global Economic Coordination Council and International Panel of Experts discussed in Chapter 4.

The international community has recognized that it is both a matter of fairness and a matter of self-interest that something be done to help the developing countries. This Report has urged that more needs to be done. Too large of a fraction of the funds being provided are short-term loans; there is at least some risk that the effects of the crisis may be felt for a considerable period of time. It would not be in anyone's interest for there to be another debt crisis. We have empha sized that the funds that are provided must not be accompanied by the counterproductive pro-cyclical conditions that were often imposed in the past. While we have argued for a diversity of arrangements for the disbursement of funds and for critical reforms in existing institutional arrangements, we have also suggested that there is a need for a New Credit Facility, with a governance structure more in accord with the times and more responsive to both those providing the funds and the borrowers, thereby engendering greater confidence from both.

If this crisis has taught us nothing else, it has reminded us of the magnitudes of the risks confronting all economies, even those that are well managed. We need to admit that our systems of risk management, including the sharing and transferring of risk from those less able to bear them to those more able to do so, leave much to be desired. Our systems of resolving cross-border defaults, including restructuring sovereigns faced with the threat of default, are not what they should be to deal with 21st century globalization, nor are the institutional arrangements for handling cross-border commercial disputes or ensuring effective global competition. In some of these arenas, we have provided concrete suggestions on the way forward; in others, we have simply flagged the issue, hoping that others will follow up and develop alternative approaches.

The Commission has emphasized that, even after fixing the financial system, the problem of insufficiency of aggregate demand is likely to persist, making it imperative to begin work on some of the more fundamental reforms, such as in the global reserve system. These persistent problems also make the design of the "exit strategy" from existing stimulus policies of particular importance. Premature or unbalanced withdrawal of stimulus spending or government guarantees could impair a smooth recovery and exacerbate global imbalances.

The Commission drew its members from a diverse set of countries, backgrounds, and perspectives. The long hours of discussions and debates, extending over more than half a year, with meetings in New York, Geneva, Kuala Lumpur, Berlin, and The Hague, helped develop an understanding of the perspectives of each of the members and an appreciation of their viewpoints. This Report reflects the consensus among the members of the Commission that emerged out of these long deliberations.

In the course of our deliberations, we issued a Preliminary Report (in February 2009) and an Interim Report (in May 2009). We have been pleased with the reception that these reports received. We have incorporated many of the helpful comments and suggestions we have received.

As we note in Chapter 1, our Commission is but one of several efforts to address the challenges posed by this crisis. Readers of this Report will notice a considerable overlap between what we have said, and, say, the Communiques of the G-20, but they should also note the important differences. Whether one agrees with the conclusions of the Commission, we believe that the issues that we have raised have not been adequately dealt with to date and cannot be ignored. Nationally and internationally, they must be addressed. These include, for instance, the deficiencies in the existing global reserve system and the development of too-big-to-fail and too-big-to-be-financially resolved financial institutions. Policies of financial and capital market liberalization need to be looked at from new perspectives. Bank secrecy not only is a problem for tax compliance but also poses a problem for developing countries fighting corruption, and the problems occur sometimes in major money centers and not just offshore. Most importantly, if we are to make globalization work, we will need to have better-more democratic, with a greater voice for developing countries-institutional arrangements for managing it.

This crisis is complex and multi-faceted, as have been the issues that we have attempted to address. We cannot hope, in a short Report like this, to resolve all the issues that are in dispute. Our ambition is more modest: to convince the international community that there is room for improvement-substantial scope for improving the efficiency and stability of the world economy, especially in ways that promote the well-being of all, especially the less-developed countries and the poorest people in all the countries. They have been among the innocent victims of this crisis.

If we are to live together in peace and security on this planet, there must be a modicum of social justice and solidarity among the citizens of the world. We must be able to work together to protect the world from the ravages of climate change, to help each other in times of global crisis such as that confronting the world today, and to promote economic growth and stability in the long run.

The UN is the one inclusive international organization with the political legitimacy and the broad mandate to address all of these issues and to take into account, in a comprehensive way, all the relevant dimensions of the policies designed to address these global economic, social, and environmental challenges. The UN and the various institutions that constitute the UN family were borne of previous crises -- World War II and the Great Depression. This global crisis provides an occasion to strengthen the UN and its role in global economic governance. That is why the members of the Commission welcomed this initiative of the President of the General Assembly. The work of the Commission has reflected the broad concerns and mandates of the United Nations but with a particular focus on the impact of the crisis and of the policies designed to respond to the crisis and prevent a recurrence on the less-developed countries and emerging markets and on the poor in all countries.

This Report provides an outline of some of the reforms that we believe will help us move in the right direction. If it widens the space for more open debate on these issues of such vital importance to all of us, it will have fulfilled its missions, and all of our hard work will have been for good purpose.