In most parts of the world today (except
perhaps in India, where optimism about the benefits of unregulated financial
markets still seems to dominate over the undisputable evidence of their
many fragilities) most policy makers talk about imposing regulations on
the financial sector. Of course, the events of the past two years in the
world economy, and particularly in the core capitalist countries, have
brought this about, for it is quite a change from the earlier presumption
of ''efficient markets'' that led to widespread lifting of controls and
shift to ''self-regulation'' in the financial sector.
In the United States, President Obama recently unveiled a set of proposals
to control and regulate the activities of both bank and non-bank financial
players. In the UK, the Governor of the Bank of England has been talking
about the need to break up banks that are ''too big to fail''. In many
developed countries, public outrage generated by the economic destruction
caused by finance is now being expressed as animosity against the large
bonuses that are still being paid out to finance professionals.
The proposals that are now being considered, not only by the Obama administration
in the US but also in Europe and elsewhere, include limits on the activities
of particular types of institutions, trying to limit bank size and ensuring
that derivatives trading occurs only in regulated exchanges with clearly
specified margin requirements, rather than in over-the-counter (OTC) transactions
that are completely unfettered.
These are all important and necessary changes. In fact, it is clear that
without such changes, the economies of the core capitalist countries -
and therefore the world economy - will continue to lurch from crisis to
crisis, necessitating ever larger bailouts and leading to even greater
damage to the citizenry. But the question is, are they feasible at all
given the legally binding commitments made with respect to financial services
liberalisation by the US and several other WTO members?
A relatively little known aspect of the General Agreement on Trade in
Services (GATS) is the implication that this agreement - and various elements
of it and a related Understanding signed by some members - affects the
ability of countries to regulate financial services. While GATS is still
the most flexible of the various Uruguay Round WTO agreements, in that
it is based on a request-offer process in which individual countries can
determine the extent and pace of liberalisation in particular sectors
and modes, there are some important caveats.
It is true that, as for all other services, member countries are required
to provide their own GATS schedules of financial services commitments.
However, the Annex on Financial Services already makes some crucial limitations
on countries' ability to be flexible on these commitments. The Annex applies
to all WTO member countries, irrespective of the extent to which they
have individually or collectively decided to make liberalisation commitments
in financial services.
The section on domestic financial regulation in the Annex makes the following
point: ''Notwithstanding any other provisions of the Agreement, a Member
shall not be prevented from taking measures for prudential reasons, including
for the protection of investors, depositors, policy holders or persons
to whom a fiduciary duty is owed by a financial service supplier, or to
ensure the integrity and stability of the financial system. Where
such measures do not conform with the provisions of the Agreement, they
shall not be used as a means of avoiding the Member's commitments or obligations
under the Agreement'' [emphasis added].
So, if countries have already made commitments to allow certain kinds
of financial activities of foreign financial institutions, they cannot
impose any prudential regulations (even when they are necessary for the
stability and viability of the system) if they run counter to such commitments!
What this means is that much of the regulation now being considered or
proposed in developed countries would run counter to this provision in
the Annex to GATS. Any such regulation could be opposed by another member
country whose financial firm is affected by such rules. Given the cross-border
proliferation and complex entanglements of financial institutions, it
seems to be almost inevitable that such challenges will occur.
It gets even worse. The organisation Public Citizen in the US, which has
done a lot of work on the implications of the GATS on financial regulations
(http://www.citizen.org/documents/PrudentialMeasuresReportFINAL.pdf)
notes that the financial services liberalisation commitments that have
already been made are apparently irreversible under various GATS rules.
This makes new regulations that are required to deal with finance today
next to impossible in strictly legal terms.
The GATS Market Access rules (contained in Article XVI(2) of the GATS
text) prohibit government policies that limit the size or total number
of financial service suppliers in ''covered sectors'', that is those in
which liberalisation commitments have been made. So if countries have
already committed to certain kinds of deregulation, they cannot easily
undo them, even in relation to critical issues like bank size. Under the
same rules, a country may not ban a highly risky financial service in
a sector (i.e. banking, insurance, or other financial services) once it
has been committed to meet GATS rules.
The case law on this matter is disturbing to say the least. A WTO tribunal
has already established the precedent of this rule's strict application:
the US Internet gambling ban - which prohibited both US and foreign gambling
companies from offering online gambling to US consumers - was found to
be a ''zero quota'' and thus violating GATS market access requirements.
This ruling was made even though the US government pleaded that internet
gambling did not exist when the original commitment was made, and therefore
could not have been formally excluded from the commitment list!
For the 33 countries that have signed on to a further WTO ''Understanding
on Commitments in Financial Services'' in 1999, the situation is even
more extreme. These 33 countries include almost all the OECD members,
as well as a few developing countries like Nigeria, Sri Lanka and Turkey.
This Understanding established further deregulation commitments by specifying
a ''top-down'' approach to financial liberalisation, which means that
sector is by default fully covered by all of the agreement's obligations
and constraints unless a county specifically schedules limits to them.
For the US, UK and the other 31 countries that have signed on to the Understanding,
there is effectively a standstill on further financial regulation of any
kind: ''Any conditions, limitations and qualifications to the commitments
noted below shall be limited to existing non-conforming measures.'' And
there is no possibility of any kind of ban on specific financial products
that are deemed to be too risky like certain derivatives, etc. because
the signatories to the Understanding have promised to ensure that foreign
financial service suppliers are permitted ''to offer in its territory
any new financial service.''
What all this means is that most of the new reform proposals for the financial
sector in the US, the UK and other major capitalist countries, are effectively
illegal given their GATS commitments. This has huge implications for other
countries, since the extent of financial entanglement is such that all
of us will be affected by the volatile functioning of unregulated financial
markets. And since GATS rules tend to prevent any backtracking on liberalisation
commitments that have been made, it means that developing countries like
India need to be doubly careful before making any commitments.
While this situation may appear to be bizarre and even incredible, it
is a real comment on the immense political and lobbying power of finance.
Most of these specific financial agreements were signed without the knowledge
of either the political groupings or the public at large in the countries
concerned. For example, in the US, congressional process is required to
vet international economic agreements, but this did not occur in the case
of the Understanding on Financial Services.
Obviously, these GATS rules are now completely out of date and constitute
a major constraint on necessary reforms in the financial sector. There
are two possibilities in such a context. First is that such rules get
more or less ignored and become a bit like the ''Maastricht rules'' for
European economic integration, which tend to be more honoured in the breach,
especially by large countries. The second is that the GATS itself - and
specifically these provisions - gets renegotiated, eliminating all these
provisions which demand and insist on comprehensive financial deregulation
even when it is irrational and socially undesirable.
In either case, change is going to require political reconfiguration of
the power of finance. At present, it looks like this will happen only
with more extensive crisis - which unfortunately is also only too likely
to occur.