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Draft report: Future of globalized markets will depend on institutions capable of sustaining them, says Soros

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
January 2001
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On October 25, financier and philanthropist George Soros came to the Institute for International Economics in Washington armed with a draft report on globalization and a message: if global markets are to prevail, there must be international institutions capable of sustaining them.

The draft report, which focuses on globalized markets, provides a follow-up to Soros’s earlier book Open Society: Reforming Global Capitalism, but with a greater emphasis on prescriptions. His audience of current and former policymakers in international and national organizations, think-tank analysts, nongovernmental activists, and others was invited to comment on his diagnosis—a globalization process imperiled by its imbalances—and his remedies, which emphasized carrots rather than sticks. The gathering provided the spirited exchange he was looking for.

Lopsided development

Soros opened his remarks with a cautionary note. If the nineteenth century is any guide, the heady globalization of financial markets over the past two decades is not impervious to reversal. Globalized markets have accelerated economic development—but at a cost. A sharply lopsided development has, in Soros’s view, created three key imbalances: considerable private wealth but limited public goods; international institutions constrained by national sovereignty and crucially unable to deliver global public goods; and arrangements that favor established markets (the “center”) at the expense of emerging markets (the “periphery”).

This lopsidedness, Soros argued, is no accident. The political forces driving globalization over the past two decades are working to reduce the influence of the state and curb its intervention in the economy. A more balanced system, however, could use globalization’s substantial benefits to correct its drawbacks, and international institutions can play a crucial role in this regard. But Soros fretted that an unwitting alliance between the far right and the far left seems intent on sinking or shrinking international financial and trade institutions.“My aim”he said, “is to create a different coalition” to bolster globalization by strengthening existing institutions and creating new means to provide global public goods.

Three controversial goals

Atop his “to-do” list are three goals that Soros himself labeled controversial—addressing unstable financial markets; leveling the playing field for emerging markets; and improving governance in those countries lagging behind in economic, social, and political development. Market fundamentalists, he said, will oppose the first two because they view them as interventionist, and the antiglobalization movement has been “strangely blind” to the impact of bad governance, although Soros believed much of the world’s poverty and misery could be traced to failed states, repressive regimes, corruption (“state capture”), and the inability of poor countries to deliver needed services.

According to Soros, internal conditions have been at the epicenter of recent crises, but international financial and trade institutions are “really not very well designed to interfere in the internal affairs of countries because they are subject to the sovereignty of the states.” What can international institutions do given the constraints of sovereignty? And how should they do it? Incentives figured prominently in his suggested reforms.

Institutional opportunities

Soros singled out the World Trade Organization (WTO) as the most developed and best honed of the international financial and trade institutions. It has created international law, to which states subordinate their sovereignty; it has a judicial function; and, most important, it has developed a means of enforcing its judgments, permitting countries to take countervailing measures if an infraction does not cease.

Soros was not about to give the WTO a clean bill of health, though. He sided with its critics, who saw a bias in favor of its dominant country members, and he chided the organization for its involvement in enforcing intellectual property rights. This, he said, had “let the genie out of the bottle” and opened the way for other nontrade demands.

How can the world address a pressing concern like child labor without resorting to punitive WTO measures? Soros suggested that a much more effective route would be to provide resources for universal primary education. This, he said, was a prime example of how a voluntary compliance-based system for providing public goods might complement the rules-based WTO system.

As for the World Bank, Soros credited President James Wolfensohn with moving the institution away from big projects and toward the provision of human capital and public goods. But he saw an organization still seriously constrained by its constitution, as it must make loans guaranteed by recipient governments and still relies heavily on lending rather than grant-giving. But Soros believed now was not the time to embark on a major reform of the Bank.

Turning to the IMF, Soros noted two asymmetries that had, until recently, characterized the way the IMF functioned: a disparity in its treatment of debtors and creditors (to the detriment of debtors) and a preference for crisis intervention rather than crisis prevention. Both problems have now been recognized, though he argued that market discipline made it easier to correct the moral hazard created by treating lenders more favorably. He also noted that “curing” moral hazard had a steep price. There will be no repetition of the boom-bust sequence of the late 1990s because “we are not going to have a boom.” The markets now have a new, and too-little-discussed, problem—inadequate capital for emerging markets.

In Soros’s view, the only way the IMF can exert more influence on a country before a crisis occurs is by offering incentives. His report cited the IMF’s progress on Contingent Credit Lines (CCL) and suggested that the IMF could rate countries, with the highest rating making countries automatically eligible for the CCL. He also suggested opening up the discount windows of the central banks of the United States, the United Kingdom, Japan, and the euro area to countries, such as Brazil, that face high risk premiums as a result of crises elsewhere. If the bonds could be discounted, the risk premium could be substantially lower and the margin required could be varied “to keep the moral hazard problem at bay.”

Missing link

Existing international finance and trade organizations can be strengthened, but how is the need for more global public goods to be met? Where’s the financing? Who delivers the goods? Traditional foreign “aid” has become a “bad word” he admitted, and with good reason. Poorly administered and often counterproductive aid may have met the needs of donors but did little for recipients. Expanded global public goods will require more money and less donor interference.

While remaining open to other options, Soros professed a preference for a special issue of SDRs to finance more aid. Such an SDR allocation could provide a mechanism for rich countries to donate their share to a “common pot.” They would control where “their chips” are used, but eligible projects would have to meet certain criteria and ensure that they serve recipient interests.

This process, to be overseen by an independent board that would monitor and evaluate projects but have no powers to allocate resources, offers “a marketlike interaction between donors and recipients” that would enhance competition for funds, increase efficiency, and fund three types of programs: the provision of global public goods (such as the HIV-AIDS fund), worthy government-sponsored programs, and matching funds for social entrepreneurship (a category of nongovernmental assistance that should be particularly valuable in countries plagued by poor governance).

Audience feedback

Soros sought, and got, a lively response to his draft proposals. His focus on global public goods found support, as did his desire to forge a new alliance between international institutions and groups anxious to make globalization a fairer process. Virtually everyone agreed on the need for greater resources, but the devil, as always, was in the details.

Michael Mussa and J.J. Polak, former directors of the IMF’s Research Department, strenuously objected to using the SDR as a funding device. Mussa labeled the SDR route “extremely complicated” and “nontransparent” and strongly suggested that Soros would do better fighting with national legislatures over their “miserably low” aid allocations. Polak warned that an SDR allocation may commonly be misunderstood as a cheap financing mechanism, but countries like the United States know full well that contributing SDRs is just like contributing dollars.

Soros insisted the SDR allocation held special attractions. It provided a means of “avoiding donor control” and could also serve, if the allocations were annual and larger, as an instrument of monetary policy in controlling global money supply. Given what he saw as a potential for global deflation, these allocations were attractive because they both created money and ensured that it would be spent.

Mussa was also sharply critical of the proposal for central banks to open a discount window. Very risky business, he said. This would jeopardize responsible monetary policy and open the door to all deserving clients seeking a means of soft finance. Keep this proposal completely off the table, Mussa advised.

Stanley Fischer, recently retired First Deputy Managing Director of the IMF, argued that the different treatment accorded “center” and “periphery” countries may reflect market awareness of good and bad policies rather than biases about which group they fall into. For instance, if a country’s underlying fiscal position was strong enough, it could use countercyclical fiscal policy. Markets did not look askance when East Asian countries with strong track records used fiscal stimulus as a response to crises there.

Fischer also cited concerns about rating countries and announcing policies that provided strong ex ante incentives for good behavior but that could be difficult to apply ex post. Soros suggested that the IMF should announce that it would lend only to low-rated countries in a crisis if there was explicit private sector involvement. But that meant that any risk of a crisis in such countries would accentuate capital outflows; then when the crisis came, however serious the country’s condition, the IMF might find itself unable to lend. He doubted the international community would want to be in such a position, punishing the country’s citizens, especially if the government was willing to implement the measures needed to deal with the crisis.

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