Earlier this month, in his speech to Congress, Gordon Brown declared that “the new shared truth is that global problems need global solutions". Similarly, on a regional level, the former head of the International Monetary Fund, Jacques de Larosière has published a report suggesting that responsibility for both financial regulation and judging systematic risk be given to one pan-European body. The financier George Soros has also called for a single European government bond. Although protectionism would be a severe barrier to any recovery and some co-operation is inevitable (especially on tax evasion), attempts to take away further fiscal and regulatory powers from national governments would be risky.
Economic history has shown that international agreements have had a decidedly mixed track record. Although the post-war Bretton Woods agreements undoubtedly moved the world economy toward ever freer trade, the fixed exchange rate system was unable to withstand the impact of persistent fiscal and trade imbalances between the major world economies, and ended up stoking the protectionist sentiments it was meant to discourage during the late 1960s and early 70s. Similarly, the attempt to impose global capital requirements on banks contained in the two Basel agreements, prevented national regulators from adjusting those requirements to fit economic conditions. They made it too easy for banks to take on leverage in the boom times and now risk being too stringent during the current global recession.
There also many practical problems with the idea of a single worldwide financial regulator. Although national governments are prone to horse-trading, populism and opportunism, they at least have to face the electoral consequences when overregulation produces unemployment and lowers economic growth. While the hysteria over AIG shows Congress at its worst, it has checked some of the worst excess of government intervention during this crisis. Although Congress was ultimately unable to stop the TARP plan, its initial rejection of the package in September forced Paulson and Geithner to rethink their original plan. Had the response been in the sole hands of a global regulator, it is likely that there would have been a lot more intervention by now.
A related drawback to a more global approach to financial regulation is that it would lock in place one particular set of policies, leaving little room for subsequent innovation or change, or at least slowing it down considerably. Experimentation by national authorities has been an effective check on the tendency for academics and regulators to unquestioningly praise a particular system. Although supporters of deregulation may be quiet at the moment, they have less cause to be embarrassed than those in the late 80s and early 90s who sang the praises of the Japanese financial system and continental European style “stakeholder capitalism”, both of which delivered over a decade of stagnant growth and double digit unemployment.
From reading the rhetoric of many of the key players in this current financial farce, one gets the cynical impression that the idea of a “global solution” is being touted as an excuse to avoid difficult questions. Certainly, it is much easier to accuse your opponents of “protectionism” and “selfishness” than it is to explain why, if Lehman Brothers was able to be wound up without government handouts, the same principle cannot be applied to other institutions. Interestingly, despite his enthusiasm for more pan-European regulation Jacques de Larosière has not yet criticized his compatriot Nicolas Sarkozy for the protectionist elements within French industrial policy.
Of course, skepticism on the benefits of a supranational financial regulator does not detract from the need for either further reductions in trade barriers or action in certain areas by national regulators. Restarting the Doha trade round should be a top priority, while there is no excuse for not clamping down on either tax evasion or money laundering. However, needed action on tax havens can be accomplished by national bodies taxing citizens on their worldwide income, without the need for any additional regulations on hedge funds or tax harmonization. Indeed, far from being synonymous with freer trade, negotiations over global financial regulation could be a distraction from the more important business of combating protectionism.