Preliminary version

JOHN EATWELL / LANCE TAYLOR
Towards an Effective Regulation of International Capital Markets

Liberalisation of the international capital markets has without doubt allowed some developing countries to achieve a higher level of economic growth. Overall, however, it has resulted in a marked slowdown in worldwide growth. Liberalisation contributed to this in a number of ways. It led to wider fluctuations in exchange rates and interest rates and therefore increased uncertainty for investors. Uncertainty results in stronger orientation towards investment options which allow for short-term correction. On the public-authority side, liberalisation with its inherent destabilisation risk has brought to the fore new priorities for economic policy. The key focus is no longer on growth and employment but on "macroeconomic discipline". Although this is essential, it tends in itself - in the absence of explicit growth orientation - to lead to stagnation. The behaviour of financial investors has repeatedly resulted in crises, with a collapse of exchange rates not only in countries with major economic imbalances but also, through contagion, in countries with a sound economy. Such crises have a destabilising and growth-impairing effect on the entire world economy. Their prevention is in the worldwide interest; it is a key task of international regulatory policy. The financial markets must be regulated in a reasonable and appropriate manner which still allows the benefits of open markets to prevail. Complete liberalisation, though, is inefficient and should be abandoned as a policy objective. Appropriate regulation must be binding. This requires an institution with worldwide enforcement power, a World Finance Authority (WFA), along the lines of the World Trade Organisation (WTO). This institution should take over the functions which are already carried out to some extent by the Bank for International Settlements (BIS) and the International Organisation of Securities Commissions (IOSCO). It would have to develop systematic solutions to the individual regulation and control problems. It would also have to ensure that its regulations were observed worldwide. It should co-ordinate national regulatory and risk-management initiatives in a binding fashion, aiming at both the demand for credit and its supply. Countries should be able to restrict capital inflows and outflows by agreement with the WFA. The International Monetary Fund should be accountable to the WFA. The WFA would develop a framework within which the Fund could act as lender of last resort. This would require regulations which would reduce the risk of crises and would mean that creditors participated in the cost of crisis work-outs.