Toward a New Foreign Policy.

Washington has been crusading simultaneously for worldwide free trade and free capital mobility. But the architects of Bretton Woods were right. These two goals conflict in both theory and practice. If economies are unable to directly restrain destabilizing capital flows, they will be tempted to do so indirectly by imposing trade restrictions. The mission crises of the IMF and the World Trade Organization (WTO) are thus causally linked. Curbing hot money flows is essential for reducing exchange rate volatility and contagious currency crises. Controlling short-term flows is also essential for allowing countries more scope to implement monetary and fiscal policies and to initiate environmental and other programs that complement their socioeconomic structures and social welfare objectives.

Discussions now under way among the G-7 leaders and at the IMF aim to curb exchange rate volatility and contagious currency crises by "reforming the global financial architecture." But the reforms under active consideration still target government policies, not market failures, as the root cause of financial disorders. They stress greater "transparency" from governments, calling for governments to provide more timely and comprehensive information to the financial markets on domestic economic conditions and impending regulatory and policy changes. Proposed reforms aim to further reassure foreign investors by pressing developing and "transitional" economies to model their banking and capital market institutions and bankruptcy laws on those of the advanced economies.

Underlying these official discussions about financial architecture reform is a mounting tension. While there is a continual reaffirmarion that capital decontrol for all IMF members remains the long-term goal, there is rising anxiety that the polarizing distribution of income and wealth accompanying the free market globalization is threatening the effort. Also haunting the discussions is a growing awareness that new demands for increased transparency can't fulfill the lack of information about the future, condemning mortals who invest competitively to form imperfect expectations about future returns from their capital assets. It cannot, therefore, prevent recurrences of the sudden reversals of financial flows that afflicted the European Union in 1992, Latin America in 1982 and 1995, and East Asia (as well as Russia and other former Soviet Union republics) in 1997-98.

Given this shortcoming, is it politically wise to increase the pressure on widely diverse countries to reshape their central institutions primarily to comfort opportunistic foreign investors? From a Bretton Woods perspective, the official architectural reform agenda is short on proposals to deal with market failure. The official agenda, therefore, is dangerously one-sided in demanding that developing countries reform to accommodate the needs of the financial markets of the creditor countries, while devoting little attention to taming the volatility of these markets.

But Bretton Woods-like proposals that would redress the global financial balance have been kept off the official agenda. A prime example is James Tobin's well-known proposal to impose a small globally uniform tax on all foreign exchange (forex) transactions. The tax, a "market friendly" substitute for direct capital controls, reduces hot money flows by squeezing the profitability of large-volume, quick round-trips (maneuvers that exploit interest rate differences across currencies and speculate on exchange rates) while barely affecting returns from the longer round-trips related to foreign trade and direct investment. Exploratory guestimates suggest that a 0.1% tax might cut forex turnover by up to 50% and generate annual tax revenues of perhaps $200 billion.

Such a move would facilitate another Bretton Woods objective, stabilizing key exchange rates. Since 1985 the financial powers have intermittently sought to realign their exchange rates within target zones that set bounds to rate movements. But these efforts broke down, became large speculative flows dwarfed the capacity of central banks to use their forex reserves to counter opportunistic attacks on exchange rates. This is not surprising, since official worldwide forex reserves had shrunk from 17 days of global forex turnover in 1977 to a one-day turnover by 1992. By shrinking private flows, the Tobbin tax would improve prospects for jointly curbing dollar, euro, and yen fluctuations. This would enable the Big Three currencies to replicate the dollar's stabilizing role during the Bretton Woods era, when the greenback served as a relatively reliable anchor for the lesser currencies.

The tax would also reduce the power of financial markets to coerce domestic policies. A 0.1% tax allows country A's interest rate on 30-day notes to diverge from B's by an additional 2.5% before triggering profitable arbitraging and speculative capital outflows, thus strengthening the economic feasibility of socioeconomic measures that take time to bear fruit. And the annual tax revenue---collectively administered, perhaps by a reformed IMF--could be an important building block of the international architectural structure needed for more stable worldwide financial integration and a more equitable sharing of the costs and benefits of globalization.

Led by the U.S., both the G-7 and the IMF have blocked consideration of the Tobin tax. In 1996 the U.S. forced the UN Development Programme to cease promoting a volume of expert papers assessing the tax. In 1999 the U.S. Treasury forced the World Bank to fire its chief economist, Joseph Stiglitz, for inducing the bank to take too critical a stance regarding capital decontrol and the distributional inequities of free market globalization.

Defecting mainstream economists offer diverse hypotheses to explain the tenacious U.S. commitment to globalizing capital decontrol, notwithstanding its collapsing theoretical and empirical support. Many emphasize that the risk/reward structure biases financial bureaucrats toward status quo positions---some asserting that the frequent interchange of personnel has formed a Wall Street-Treasury complex. Others stress ideological antipathy toward reinvigorating welfare capitalism or toward subordinating U.S. sovereignty to strengthened international institutions.

The hypotheses imply that for such Bretton Woods-like reforms to be adopted, they must first be made politically feasible by grassroots support that is strong enough to change the political climate and bureaucratic risk/reward parameters. For this to happen before the next crisis hits, unions, environmentalists, and social welfare advocates here and abroad must step up their demands for real reform of the international financial architecture. Taming global financial markets is essential if social reformers are to achieve their broader objective of a more stable and equitable world economy.