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September 28, 2009

G-20 Summit: Yes, Actually Dangerous

Yep, the G-20 did it a third time: they called for reregulation and deregulation simultaneously. Here's the leaders' statement from the Pittsburgh meeting last week:

We will keep markets open and free and reaffirm the commitments made in Washington and London: to refrain from raising barriers or imposing new barriers to investment or to trade in goods and services, imposing new export restrictions or implementing World Trade Organization (WTO) inconsistent measures to stimulate exports and commit to rectify such measures as they arise. We will minimize any negative impact on trade and investment of our domestic policy actions, including fiscal policy and action to support the financial sector. We will not retreat into financial protectionism, particularly measures that constrain worldwide capital flows, especially to developing countries...

We remain committed to further trade liberalization. We are determined to seek an ambitious and balanced conclusion to the Doha Development Round in 2010...

As my colleague Lori Wallach noted after this was released:

The G-20 leaders have announced a very perplexing plan of action that calls for reregulation of the financial sector to try to avoid the next economic crisis while simultaneously calling for completion of the WTO Doha Round, which would require additional financial deregulation, including new WTO limits on accounting standards through a text the disgraced Arthur Andersen firm had a hand in formulating.

Perversely, the Europeans at the G-20 have been the strongest proponents of a new global floor of financial regulation while simultaneously being the strongest proponents pushing for a G-20 agreement on a new deadline for completion of the WTO Doha Round, which European negotiators have packed with new financial deregulation requirements. The G-20 leaders cannot have it both ways: They cannot follow through on desperately needed reregulation of the financial sector while also pushing for completion of the WTO Doha Round, which requires additional financial deregulation.

Over at the Baseline Scenario, Simon Johnson asks a good question: "Was The G20 Summit Actually Dangerous?"

consider for a moment the key way in which the G20 summit has worsened our predicament.

There is broad agreement that capital requirements need to be increased and a growing consensus that very large banks in particular should be required to hold bigger equity cushions.  This is a pressing national priority – if our financial system is to become safer – and reasonable people are starting to put numbers on the table, ever so quietly: Joe Nocera is hearing 8%, but Lehman had 11.6% tier one capital on the day before it failed and the US banking system used to carry much more capital – back in the days when it really was bailout free (think 20-30% in modern equivalent terms (see slide 40 here).

Obviously, raising capital standards in the US is going to be a long and drawn out fight.  The G20 could help, if it set high international expectations, but the opposite is more likely.  As Nocera suggests this morning, the inclination of the Europeans – largely because of their funky “hybrid” capital, but also because they have some very weak banks – will be to drag their feet.

Why should we care?  This administration seems to think that we need to bring others with us, if we are to strengthen capital requirements.  Our progress will be slowed by this thinking, the glacial nature of international economic diplomacy, and the self-interest of the Europeans.

Instead, the US should use its power as the leading potential place for productive investments to make this point: If you want to play in the US market, you need a lot of capital.  If you would rather move your reckless high risk activities overseas, that is fine.

I couldn't agree more, and while we're at it, let's break up all the big banks, and divide up their investment from their commercial arms.

But I think Simon errs in his passing comment that "this process needs to be WTO-compliant." The solution is to walk and chew gum at the same time: reform the banking sector AND reform the WTO.

As I've commented before, the mandate coming out of the Uruguay Round (which established the WTO) was to ensure that domestic regulations like minimum capital requirements are "not more burdensome than necessary to ensure the quality of the service" and that "international standards of relevant international organizations" will be taken into account when determining members' compliance with such rules. (Check out Article VI of the General Agreement on Trade in Services, or GATS.)

These rules are very troubling, because the WTO has ruled against countries' challenged policies about 90 percent of the time, and has ruled against so-called necessity pleas for public-interest policies about as often. Countries almost always water down or eliminate the challenged measure... otherwise, they face hefty trade sanctions.

As we also note in the report, ongoing negotiations at the WTO on domestic regulations appeared to be softening the "necessary" requirement. But that was before a set of meetings earlier this year, where various WTO members complained loudly that the necessary requirement should be reinserted into the draft disciplines - similar to what had already been agreed for the accountancy sector, thanks to a big push from Arthur Andersen. Note that these Domestic Regulation rules would apply to all WTO members, not only those that made commitments in financial services (which is a little over 100 of the total 153 members).

Finally, there is the further requirement in GATS Annex on Financial Services 2(a)- as we noted in a report last week - that prudential measures not get in the way of members' WTO commitments, a deeply troubling requirement.

Let's walk through how a WTO tribunal might look at a U.S. measure as advocated by Simon.

  1. Would it be "not more burdensome than necessary to ensure the quality of the service"? As I understand the proposal, banks in the United States and Europe would be essentially offering the same service (deposits, lending, etc.) at the same quality. The only difference would be that the U.S. measure would be more burdensome (and likely more trade restrictive) for banks... something that doesn't trouble me or Simon in the slightest, but which of course will trouble the Barclays and Deutsche Banks of the worlds that will have to comply in the US but not in the EU.
  2. In regards to "international standards of relevant international organizations", I believe Simon is proposing something that would by definition go beyond what the G-20 and Basel Committee have called for. And recent academic papers and also interventions by WTO members themselves show that the relevant "international standards" mean Basel II and G-20.
  3. The United States might try to raise the GATS Annex on Financial Services' prudential measures language as a defense. But, here too, if the U.S. measure impaired its WTO obligations, which it would by definition, the language wouldn't seem to offer a defense. Indeed, Kaufmann and Weber state that the prudential language could not be used as a defense "if national regulation is more restrictive than generally accepted international financial standards." They also quote the decision in the WTO Internet gambling case that "sovereignty ends whenever rights of other members under the GATS are impaired." Whoa.
  4. Finally, the U.S. might have a defense for trade-restrictive, beyond-"necessary" capital requirements if it had made some sort of relevant exception in its schedule under deposit-taking or lending institutions. And I don't see anything like that in the U.S. schedule.

In the end, it seems like the best hope is to adopt Simon's policy, while scrapping the Doha Round altogether, as we've advocated. (That way, the obnoxious Domestic Regulation rules might never be adopted - in their more pleasant or less pleasant forms.) We need to also rewrite Annex 2(a), to make sure it doesn't get in the way of prudential measures.

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Comments

Todd Tucker

For the record, I should add that there are some ambiguities about:

1. What types of domestic regulations count as "qualification requirements and procedures, technical standards and licensing requirements."

2. Whether VI(4) will eventually cover all service sectors, or only those that countries committed to GATS coverage. Textually, the former would seem to be the case.

3. How VI(4) and VI(5) relate prior to the conclusion of the Doha Round (i.e. now), and what needs to be proved by claimants in order to bring cases under either of these provisions.

The real point is that, more binding disciplines are on the way, and in any case, we're outsourcing many of these determinations on domestic isuses to WTO tribunals.

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