"Enthusiastically recommended for advanced international economics scholars and college library reference shelves." Midwest Book Review, 5/1/2007
Regional Financial Cooperationby Jose Antonio Ocampo (Editor), Jos Antonio Ocampo (Editor)
Using the experience of postwar Western Europe as a benchmark, José Antonio Ocampo and his colleagues assess how regional financial institutions can help developing countriesoften at a disadvantage within the global financial framework finance their investment needs, counteract the volatility of private capital flows, and make their voices heard.
Using the experience of postwar Western Europe as a benchmark, José Antonio Ocampo and his colleagues assess how regional financial institutions can help developing countriesoften at a disadvantage within the global financial framework finance their investment needs, counteract the volatility of private capital flows, and make their voices heard. The 1997 Asian financial crisis generated extensive debate on the international financial architecture. Through this discussion, it became clear that services by financial institutions including adequate mechanisms for preventing and managing financial crises, and instruments for safeguarding global macroeconomic and financial stabilityare undersupplied. Furthermore, private international capital markets provide finance to developing countries in a way that effectively reduces the ability of those nations to undertake countercyclical macroeconomic policies. International capital markets ration out many developing countries, particularly the poorest, from private global capital markets. While these deficiencies in the financial architecture are clear, the post-1997 debate has done little to evaluate the role that regional institutions could play in improving global financial arrangements. Regional Financial Cooperation aims to fill that important gap. Contributors include Ernest Aryeetey (Institute of Statistical, Social and Economic Research, University of Ghana), Georges Corm (Saint Joseph University, Beirut), Roy Culpeper (North-South Institute, Ottawa), Ana Teresa Fuzzo de Lima (Institute of Development Studies, University of Sussex), Stephany Griffith-Jones (Institute of Development Studies, University of Sussex), Julia Leung (Hong Kong Monetary Authority), José Luis Machinea (ECLAC), Jae Ha Park (Korean Institute of Finance),Yung Chul Park (Korea University), Fernando Prada (FORO Nactional/International, Lima), Guillermo Rozenwurcel (School of Politics and Government, University of San Martin, Argentina), Francisco Sagasti (FORO Nacional/Internacional, Programa Agenda: Peru), Kanit Sangsubhan (Fiscal Policy Research Institute of Thailand), Alfred Steinherr (European Investment Bank, Luxembourg and University of Bozen-Bolzano), Daniel Titelman (ECLAC), and Charles Wyplosz (Graduate Institute of International Studies, Geneva, and Center for Economic Policy Research).
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Regional Financial Cooperation
Brookings Institution Press
Copyright © 2006
Brookings Institution Press and the Economic Commission for Latin America and the Caribbean (ECLAC)
All right reserved.
Chapter One Regional Financial Cooperation: Experiences and Challenges
JOSÉ ANTONIO OCAMPO
The period following the 1997 Asian crisis generated an extensive discussion on the international financial architecture. The debate made clear that there is an undersupply of services by international financial institutions that has become more glaring as a result of the growing economic linkages created by the current globalization process. The associated "global public goods" that are being undersupplied include adequate mechanisms for preventing and managing financial crises, as well as for guaranteeing global macroeconomic and financial stability. The debate also underscored the fact that private international capital markets provide finance to developing countries in a highly procyclical way, effectively reducing the room for maneuver of developing countries to undertake countercyclical macroeconomic policies. Finally, the debate emphasized that international capital markets squeeze out many developing countries, particularly the poorest among them, from private global capital markets.
The possible role of regional institutions in providing these services was underestimated in the debate on how to improve global financial arrangements. It was, indeed, absent in major northern reports and from the views of international financial reform coming from the Bretton Woods institutions (for example, in the reports on international reform presented by the International Monetary Fund [IMF] to the Interim Committee and its successor, the International Monetary and Financial Committee). It was also given at best a passing reference in major academic analyses of reforms of the international financial architecture. There was even open opposition to regional arrangements, particularly to the 1997 Japanese proposal to create an Asian Monetary Fund, although this idea was revived in 2000 in the form of the Chiang Mai Initiative among the Association of Southeast Asian Nations (ASEAN) countries, plus China, Japan, and the Republic of Korea.
There were obviously exceptions to this rule. Among the many reports, that of the United Nations stands out for its defense of the potential role of regional financial arrangements in an improved international financial architecture. Strong defenses of regional financial arrangements were also made by Percy Mistry, José Antonio Ocampo, and the Emerging Markets Eminent Persons Group convened by the Ford Foundation. Regional and subregional development banks have been given greater attention. As already pointed out, after the crisis Asia took the most important steps forward, while the Economic Commission for Latin America and the Caribbean (ECLAC) provided a strong defense of the role of regional financial arrangements in Latin America and the Caribbean.
The lack of adequate attention to regional financial arrangements was surprising in at least three ways. First, it is evident to all observers that the new wave of globalization is also one of "open regionalism." Second, postwar Western Europe is widely recognized as a successful example of regional financial cooperation, which in the financial area encompasses a history that extends from the creation of the European Payments Union and the European Investment Bank (EIB) in the 1950s to a series of arrangements for macroeconomic coordination and cooperation that eventually led to the current monetary union among most members of the European Union. Third, regional development banks have been recognized as an important part of the world institutional landscape since the 1960s. In the developing world, there are also several experiences with "developing-country-owned" multilateral development banks, regional payments agreements, at least one successful reserve fund, and a few monetary unions. These experiences coincide in several ways with those of regional and subregional trade agreements, with undoubtedly a mixed history in both cases.
Reflecting the lack of adequate attention to this issue, there is no book or report that makes a comparative evaluation of experience with regional financial arrangements. This book aims to fill this important gap. The different forms of financial cooperation are clustered into two groups: (1) development financing, the area where there is more extensive experience, including novel ideas, such as the Asian initiatives to strengthen regional bond markets, and (2) mechanisms for macroeconomic and related financial cooperation (liquidity financing during balance-of-payments crises), which include mechanisms of policy dialogue and peer review, and more elaborate systems of macroeconomic surveillance and policy consultation or coordination; reserve funds and swap arrangements among central banks; and, in the most developed form, monetary unions. Two additional forms of cooperation that belong to the second cluster are regional payments agreements and cooperation in the area of prudential regulation and supervision of domestic financial systems. This study makes only passing reference to them. It should be emphasized that, although our central aim is to explore the potential service that regional financial cooperation can make to developing countries, the experience with such cooperation in Western Europe is used as a benchmark.
This chapter provides an overview of a set of relevant experiences with both forms of regional cooperation and links the comparative evaluation of these experiences with the broader debate on international financial reform. In this regard, it looks not only at the advantages of regional financial cooperation in comparison with global arrangements, but also at its revealed shortfalls and, equally important, at the possible complementarities between regional and global institutions. The chapter is organized into six sections, the first of which is this introduction. The next two sections provide the case for regional financial arrangements and analyze some of the challenges they face. The fourth and fifth sections look at major experiences with regional cooperation in the areas of development financing and macroeconomic cooperation respectively. The last draws some conclusions.
The Case for Regional Financial Institutions
Several arguments can be made for a more active use of regional financial arrangements to strengthen the international financial architecture. This chapter groups them into four major arguments. The first relates to the fact that, as already pointed out, the current globalization process is also one of open regionalism. Intraregional trade and investment flows have deepened as a result of both policy and market-driven processes of regional integration. This process is, of course, uneven, being clearly stronger in Western Europe, East Asia, and North America and much weaker in other parts of the world, particularly South Asia. However, even in regions that have lagged behind, a web of regional initiatives has played an important role in reshaping the world economic system since the early 1990s. In addition, since the 1980s the contagion effects of financial crises have also had important regional dimensions. As a result of all these processes, macroeconomic linkages among countries and the externalities generated by national macroeconomic policies on neighbors have increased.
A stronger case can thus be made than in the past for policies and institutions that build regional defenses against financial crises and explicitly internalize the effects of domestic macroeconomic and financial policies on regional partners. In this regard, regional reserve funds and swap arrangements can serve as a first line of defense against crises. In turn, macroeconomic dialogue or stronger forms of regional surveillance and policy consultation could internalize, at least partially, the externalities that national macroeconomic policies have on regional partners. Furthermore, the effectiveness of national macroeconomic policies may be enhanced (or reduced) by the credibility generated by the willingness (or refusal) of regional partners to support a specific country. A complementary argument is that, in a world where the room for maneuver of national macroeconomic policies has become more limited, the regional arena has become crucial for exercising what remains of macroeconomic policy autonomy. On the contrary, macroeconomic policies that take into account only domestic considerations (as has been traditional in IMF programs) may be said to contribute to the contraction of regional trade and to encourage competitive devaluations that effectively compound contagion.
Growing regional linkages also mean that there is a role for regional development banks or other mechanisms to support investments in regional infrastructure and other "regional public goods." Indeed, the limited financing for "regional public goods" in current development cooperation has led Birdsall to claim that the underfunding of regionalism is one of the major problems of current international arrangements. Classical risk-pooling arguments also enhance the potential role of regional and subregional development banks. An advantage of all these mechanisms is that information asymmetries may be smaller at the regional level, and that the mix of peer pressure and the strong sense of ownership of regional institutions may reduce the risks that these development banks face, and have positive effects on investment and the financial development of members of a regional club.
Similar arguments can be made for cooperation in developing the financial infrastructure to support domestic financial development and to expand regional capital markets. Regional mechanisms can also play a role in supporting national systems for the prudential regulation and supervision of domestic financial systems, including the adaptation of international standards to regional conditions, or even in setting special regional norms (for example, in the developing world, on maturity and currency mismatches in the portfolios of financial institutions). In all of these areas, regional cooperation can help to reduce learning costs and help countries share the experience of institutional development.
According to the second argument, the heterogeneity of the international community implies that world and regional institutions can play complementary roles, following the principle of subsidiarity that has been central to European integration. The need to fill the gaps in the world's current highly incomplete international financial architecture makes this role even more important, as Roy Culpeper argues in this volume. Furthermore, some of the services provided by international institutions may be subject to diseconomies of scale, and it is unclear whether others have large enough economies of scale to justify single international institutions in specific areas. In particular, regional and subregional institutions may be better placed to capture and respond to specific regional needs and demands. The diverse portfolios of existing multilateral development banks are tailored to the specific needs of countries in the regions where they operate, and they are also capable of operating successfully on very different scales.
In the same vein, macroeconomic surveillance and consultation at the world level are necessary to guarantee policy coherence among major countries, but they are inefficient for managing the externalities generated by macroeconomic policies on neighbors in the developing world (or even within Western Europe). Thus, while the IMF should play a central role in macroeconomic policy coordination at the global level, there is plenty of room for regional and subregional processes of a similar nature. Also, although regional and international contagion implies that the role of the IMF should be to manage the largest balance-of-payments crises, regional funds could actually provide full support to small and medium-sized countries during crises. Indeed, the rising concentration of balance-of-payments support on a few countries indicates that there may be biases in the response of global financial institutions according to the size of countries. Thus, an argument can be made for a division of labor in the provision of financing between world and regional organizations, with the latter assuming a greater role in the support of smaller countries.
The third is an argument for competition, particularly in the supply of services to small and medium-sized countries. Owing to their small size, the power of these countries to negotiate with large organizations is very limited, and their most important defense is therefore competition in the provision of financial services. For these countries, access to a broader menu of alternatives with which to finance development or to manage a crisis may be relatively more important than the "global public goods" that the largest international organizations provide (such as global macroeconomic stability). Furthermore, since they can assume they have little or no influence on the provision of those "global public goods," they are prone to take the attitude of "free riders" toward them. This implies that, aside from the case for complementarity between global and regional financial institutions, competition between the two sets of organizations in the provision of development bank services, liquidity financing, or technical support is the best arrangement for small and medium-sized countries.
The final argument in favor of regional arrangements is of a political economy order, and may be called the "federalist" argument. In this regard the essential issue is that regional and subregional institutions enjoy a greater sense of ownership because member states feel that they have a stronger voice in these organizations. This creates a special relationship between them and member countries, which in the case of financial institutions may generate a strong "preferred-creditor status." The preferred-creditor status may, in turn, reduce the risks that regional and subregional development banks and reserve funds face, further encouraging the virtues of risk pooling.
One element of this argument is that, no matter what arrangements are adopted at the world level, the voice of small and medium-sized countries in global institutions is unlikely to be strong. The inadequate representation of developing countries in existing financial arrangements, an issue that was underscored at the International Conference on Financing for Development, held in Monterrey, Mexico, in 2002, and the even greater informal concentration of power in international financial institutions, contributes to this view. This means that, within the global order, the smaller countries will be able to make their voice heard (or heard much more clearly) only if it takes the form of a regional voice. In fact, a paradox of the global system is that global rules are most important for small countries, even though it is precisely they that have the least influence over the formulation and defense of such rules. This problem can only be solved if the smaller countries organize themselves and if regional institutions are truly made part of a broader international order.
The foregoing discussion implies that, although there is a strong case for greater international macroeconomic and financial cooperation, it is unclear whether the increasing supply of services from the associated institutions should come from a few world organizations. Rather, in some cases the organizational structure should be one of networks of institutions providing the required services on a complementary basis, and in others it should function as a system of competitive organizations. The provision of services required for financial crisis prevention and resolution should probably be closer to the first model, whereas in the realm of development finance, competition should be the basic rule (and in fact should include competition with private agents as well). But purity in the model's structure is probably not the more desirable characteristic: it may be better for parts of the networks to compete against one another (for example, regional reserve funds or swap arrangements versus the IMF in the provision of liquidity financing) and for rival organizations to cooperate in other cases.
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Meet the Author
José Antonio Ocampo currently serves as United Nations under secretary general for economics and social affairs and is the former executive secretary of ECLAC. He has also held a number of posts in the government of Columbia, including minister of finance and public credit. He is the author of several books on globalization and development, including Beyond Reforms: Structural Dynamics and Macroeconomic Vulnerability (World Bank and Stanford University Press, 2005).
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