G20-IMF-FSB Update – May 7, 2010
By Adam S. Hersh
G20 Debrief
The G20 finance ministers and central bank governors meeting in Washington, DC from April 22-23 largely followed the expected script, but events from the weekend nonetheless yielded some interesting new information and developments on international cooperation for financial reform. (A meeting of the G20 labor and employment ministers on April 20th and 21st—the first such meeting, though segregated from and overshadowed by the financial meetings—offered platitudes toward the critical need to focus recovery efforts on job creation, social protection, and poverty alleviation.)
FSB Progress Report
Though much of its work is carried out behind closed doors, the Financial Stability Board emerged to deliver a report to G20 leaders on its progress in shepherding international financial reform since the November 2009 G20 summit. Though much of the details have been covered in New Rules’ regular G20-FSB-IMF updates, the progress report also provided some important new information.
More details emerged about the Basel Committee on Banking Supervision’s work on developing and assessing measures to reform global capital standards. We’ve covered the initiatives before (here and here in Section 3.2 – (pdf)), but the FSB provided more details on how tentative proposals will be evaluated for impact assessment (and subsequently revised as a result thereof). The Basel Committee is conducting both “bottom-up” (assessing each individual financial institution) and “top-down” (assessing systemic implications) quantitative impact assessments (QIS) to estimate how much proposed standards will increase minimum capital requirements. While it is important to assess the impact of new policies, the available econometric tools are not well developed and tend to be biased toward over-estimating the level of adequate bank reserves (bottom-up) as well as the systemic resilience to financial shocks (top-down). Ironically, BIS economists have been leading the way in showing the inadequacy of such assessment methods. The QISs will be used by the Basel Committee to calibrate the level of new bank capital standards. The risk here is that the QISs will understate risks and thus capital adequacy, potentially providing cover for the Basel Committee to weaken the more progressive elements of its proposals. Based on calibration, the Basel Committee will present a revised draft for review at its July meeting and finalized proposals to the G20 Governors and Heads of Supervision in September, ahead of the November Seoul G20 leaders meeting.
A new working group was launched in April, spearheaded by the FSB’s Committee on Payment and Settlement Systems (CPSS) for standardizing mandatory central clearing (or electronic trading) over-the-counter (OTC) derivatives. CPSS will work in coordination with the International Organization of Securities Commissions (IOSCO) and the European Commission. A joint CPSS-IOSCO consultative document is expected in December 2010 or January 2011.
Bank Levy
The IMF provided G20 leaders with an interim report on financial sector taxation (pdf) (though not intended to be released publicly before the Toronto G20 summit in June 2010; the BBC obtained a leaked copy). While many member countries have taken their own steps toward a variety of financial sector taxation policies, the IMF threw in its two cents, offering two proposals for financial sector taxes: (1) a Financial Stability Contribution (FSC) paying into a resolution mechanism fund; and (2) a Financial Activities Tax (FAT) levied on financial institution profits and excessive compensation.
The report also provides estimates of the costs of the current crisis. In the G20 countries, gross direct government support to the financial sector has averaged 3.5 percent of GDP. Net of resources recovered, costs have averaged 2.7 percent of GDP, although unrecovered costs are substantially higher in the UK (5.4 percent), Germany (4.8 percent), and the US (3.6 percent). In designing a financial sector levy, the IMF espouses the principle that the tax should recognize that “the costs to countries of crises exceed the fiscal cost of direct support” to the financial sector. Not mentioned by the IMF is that most of these costs are borne by regular people through declines in household consumption. To date, the IMF estimates average output losses of 27 percent of GDP in the affected G20 countries, and costs could rise to a total loss of 40 percent of GDP by 2015. This begs the question: Are the two proposed IMF taxes sufficient to offset a 40 percent loss of GDP over eight years? While the interim report does not provide baseline estimates of revenues to be generated by the proposed taxes, it is difficult to imagine a scenario where a tax on bank profits and bonuses would generate sufficient revenues. National estimates of some of the proposed bank levies have run in the (low) tens of billions of dollars per year—peanuts compared to the hundreds of billions in revenues estimated generated by a financial transactions tax.
As expected, the IMF report came out against a financial transactions tax (FTT), a.k.a. a Tobin or Robin Hood tax—despite the fact that many countries support and have taken steps to implement such a tax. But, perhaps even more so than with their changing position toward capital controls (see below), the IMF offered a relatively measured assessment of FTTs. It is instructive to see why the IMF rejects the FTT. They do not reject the FTT due to administrative impracticality (an argument oft levied against the FTT). In fact, the report highlights several successful implementations of FTTs in Argentina, Turkey, and the UK (a number of unmentioned countries also have FTTs) and that most G20 countries already do tax some financial transactions.
The IMF rejects the FTT because, in their view, (a) an FTT is not well-suited to the purposes of the G20 mandate, (b) an FTT is not focused on core sources of financial instability, (c) the tax burden will be passed on to “consumers,” and (d) it is better to tax output than transactions. Point (a) may be true, but is no condemnation of FTTs, only of the G20’s vision for reining in the financial sector. On point (b), it is true there are more sources of financial instability than just speculation-driven price volatility, and the kind of instabilities targeted by an FTT may have been less prominent in the present crisis. But, to the extent that in our evolving financial system the large financial institutions earn more than half of their revenues from trading activities, a tax on trading provides incentives oriented towards more traditional financial activities—such as lending to the real sector rather than for trading. Points (c) and (d) are dubious and boil down to scare tactics rather than economics. For vanilla, market-based financial transactions, the market is highly competitive, meaning that traders have little pricing power (brokerage fees), and thus will find it difficult to pass along costs to “consumers.” But the “consumers” they are talking about are not Mom and Pop IRA investors, they are primarily large financial institutions. Point (d) may be true for the real sector economy, but “output” in the financial sector is a very different concept. In many ways, the “output” of finance is the buying and selling of assets in financial markets.
The interim report notes that further IMF staff reports on the policy and administrative aspects of FTT will be forthcoming shortly, so we may see more about the Fund’s thinking on FTT by the Toronto G20 summit in June 2010 (when it is due to deliver final recommendations on bank levies).
Momentum For Capital Controls
The policy position on capital controls is changing rapidly within the IMF. In a few short years, we have seen the IMF move from vehemently opposing capital controls and lobbying to amend its Articles of Agreements to prohibit controlsto providing limited theoretical support for controls to advocating their application in Southeast Asia. More evidence for this change was apparent in the IMF’s Global Financial Stability Report (see Ch. 4 – pdf). Recognizing that extraordinary monetary policy actions by developed countries have spawned a tsunami of capital flows heading towards developing countries, the IMF has put capital controls back on the policy menu, albeit as a nuanced last resort.
Dedication of an entire chapter of the GFSR to capital flows and capital controls reflects (at least) two developments. First, the intellectual center of gravity is shifting in the direction of capital controls. Whereas controls were once (and for some still are) treated as anathema, the failure of liberalized international financial flows to provide macroeconomic stability as promised has prompted rethinking of the full-scale financial liberalization agenda. Naturally, the IMF is reluctant to lose institutional and intellectual credibility (such as it is) by changing course too sharply, hence the tepid support. The fact that the IMF is openly addressing the issue is worth noting. Second, this new openness to capital controls reflects, in part, the shifting balance of power between developing and developed countries within the IMF and the world economy more generally. Developing countries, which have borne the brunt of the capital flow maelstrom, are moving ahead of the IMF to implement controls as part of macroeconomic stability policies. Brazil has responded to the crisis with new controls on inflows that the IMF tacitly supported (by not condemning) and China, largely insulated from financial aspects of the crisis, has long maintained stringent capital controls. In spite of financial interests in developed countries opposing capital controls, the fact that the IMF is addressing controls shows recognition for the position of developing countries that (a) did not cause the crisis, (b) are leading the global recovery, and (c) are left to defend against the consequences of developed countries’ loose monetary policies.
New academic research also adds to the pile of evidence that capital controls are effective policy tools for managing macroeconomic stability. Olivier Jeanne of Johns Hopkins University and Anton Korinek of University of Maryland argue that controls on capital inflows can reduce capital flight during periods of financial market duress, while also mitigating macroeconomic volatility and increasing welfare.