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THE IMPACT OF THE GLOBAL RECESSION TO MULTI-NATIONAL CORPORATIONS AND THE INTERNATIONAL FINANCIAL INSTITUTIONS By Kaycie Woodard Fin 534 International Finance Final Research Paper Introduction There is a broad, global systemic crisis with environmental, social, economic and democratic dimensions (Two Summits and a Hemisphere at the Crossroads, 2009). There is a need for new structures and a new paradigm. European civil society groups have proposed deep reforms to international financial institutions and policies and are determined to persuade European governments to back these now. Developing countries are paying the consequences of a crisis for which they are not responsible. Strengthening solidarity with developing countries is a vital matter both of ethics and of self-interest (Two Summits and a Hemisphere at the Crossroads, 2009). The world’s poor will be hard hit by a financial crisis and ordinary citizens in all regions are suffering. They will pay the bill for the multi-billion bank bail outs, through higher taxes, or less spending on public goods other than financial stability. Never before has there been such a broad consensus that the current financial system does not work properly, has resulted in an inequitable transfer of resources to a narrow group of richer people and an unsustainable pressure on natural resources, and has to be transformed (Two Summits and a Hemisphere at the Crossroads,2009). The public anger offers a unique opportunity that must not be wasted. Several countries, including European ones, have already needed emergency assistance from the IMF. The IMF and its sister organisation the World Bank have played a part in making countries vulnerable to such a crisis (Wedgwood, 2009). Their conditionality has limited policy space and promoted financial deregulation and liberalisation. Conditionality has also guided the reduction of State’s intervention in areas of public interest, including the provision of public services. Lack of trust in international institutions has been a key reason for the build-up of large current account imbalances in recent years (Wedgwood, 2009). At the same time capital outflows from developing countries have far outweighed the amount of money provided as aid by the richer countries. The gaps in the financial regulatory system that allow such outflows must be plugged as part of a new approach to securing economies and resources for poor countries(Opoku, 2009). The new financial architecture which must be built for the twenty-first century should be strongly accountable to citizens across the world. The UN as the most legitimate international body must play a key role in the reform of the financial and economic system but the UN system must also be democratized and reformed (Opoku, 2009). To agree reforms to the international architecture, a broad and inclusive process needs to be convened under the auspices of the UN system. It must involve all governments, parliaments, trade unions, the private sector and civil society organisations. Our priority demands, as first steps to transform the current unstable and inequitable financial system, are: A. Regulating global finance and fighting capital flight • Ban tax haven and corporate accounting practices that enable tax evasion. • Close the shadow banking system: • Allow countries to introduce capital controls: B. Reacting to the debt crisis • Immediately stop debt servicing for countries in difficulties • Introduce responsible finance principles to prevent unsustainable and illegitimate debt: • Institute fair and transparent debt workout mechanisms. C. Reforming the International Financial Institutions • Democratising the governance of the Bank and the Fund and hold them accountable to citizens. • IFI finance must comply with responsible finance principles and avoid any new economic policy conditionality. • Remove the IMF’s roles in long-term development finance and restrict the Bank’s roles in climate change finance. A. Regulating global finance and fighting capital flight Capital account liberalization promoted by IFIs in developing countries has led to financial volatility, fostered short term speculative capital flows and fostered capital flight. This liberalisation has been required not only from the IFIs, but also in bilateral investment and trade agreements. The liberalisation increased speculative flows and increased the frequency and severity of financial crises in all the regions of the world over the last decades. The current dollar based reserve system has triggered global imbalances and high instability and vulnerability for developing countries. Free floating exchange rates have created many problems and volatility in the financial system. Liberalisation and deregulation of the banking sector, aside from the damage it has caused in developed countries, has also had negative impacts on developing countries. The spread of the current financial crisis from the United States sub-prime housing markets to the real sector and developing and transition countries has been facilitated by this deregulation. Again, this has been forced on developing countries through both IFI conditionality and bilateral agreements (United Nations Convention on the Law of the Sea, 2009). The acquisition and control of many developing countries’ banking sectors by big international banks from rich countries, has created risks for developing countries. Bank bailouts in the North have not addressed the problems of lack of resources flowing to developing countries. Banking self regulation promoted by the undemocratic Basel committee has fostered irresponsible and risky behaviour of banks as well as disadvantaging the banks of developing countries. The shadow banking system, made up of unregulated financial instruments and financial institutions, has helped to feed the instability and volatility. Highly leveraged institutions have been particularly involved in dangerous speculative activity that has destabilised markets, currencies and real economic activity (United Nations Convention on the Law of the Sea,2009). Tax havens otherwise known as secrecy jurisdictions have played a key role in the financial crisis by providing locations for opaque financial products and enabling the build up of the shadow banking system(James,2009). They have also facilitated the illicit flows of wealth that flee developing countries every year. Global Financial Integrity’s new analysis shows that illicit flows from developing countries represent $800 billion to $1 trillion per year and grow at around 18% per year (Clinton, 2009). Over 65% of these illicit flows are driven by translational corporations’ tax evasion and tax avoidance schemes through the misuse of internal financial transactions (Clinton, 2009). Tax havens are also one element feeding a race to the bottom in tax policy. This dangerous tax competition prevents both developed and developing countries from investing in public services, social protection and human welfare; investment which is necessary for the fulfilment of the state’s obligations to ensure human rights(Clinton,2009). Tax competition also penalises small and medium sized enterprises particularly in developing countries. Most multinational corporations use the accounting standards that are set at the unaccountable and undemocratic International Accounting Standards Board (IASB). While countries approve the use of IASB standards, the body is composed of major private accounting and other transnational companies. The IASB operates in conflict of interests, its governance is undemocratic and its decision making is opaque. It has been complicit in the excessive risk taking by financial institutions and tax evasion by transnational corporations. 1. Reform the international monetary system: A multilateral framework must be agreed for a new monetary system. This new system must not privilege any national or regional currency as the single reserve currency, must ensure stability of exchange rates, and must build upon the principles of cooperation and solidarity. Mechanisms for regional cooperation merit special attention and could form the basis of a new international order. 2. Allow countries to introduce capital controls: New international and national mechanisms of capital controls should be introduced. All countries should be allowed and encouraged to use capital controls if they deem it necessary to manage their economies, prevent contagion, raise revenue, and reduce volatility. This would imply the removal of existing provisions of trade and investment treaties that require the liberalisation of capital flows. 3. Rethink the banking system: A new regulatory system should include an international supervisory and regulatory body. Particular focus should be put on ensuring developing countries retain the policy space necessary to use financial regulation for development purposes. It must also prevent banks from becoming too big to fail without adequate public control. At the same time state participation in banks should be seized as an opportunity to transform the mandate of the banks themselves according to a social and sustainability vision. As an immediate measure, financial institutions that profit from taxpayer-financed bail-outs should end their operations in and with secrecy jurisdictions. In this respect, the current credit crisis should not jeopardise the provision of credit by these financial institutions in those developing countries where they have subsidiaries. 4. Enforce binding social and environmental standards: A new regulatory regime should be put in place in order to constrain banks and financial institutions to deploy capital in ways that support the protection of the environment and meet social needs and the requirements of the real economy. Sustainability-oriented standards should be taken into account in all bank supervision, including the granting of licences, and the extension of central bank-provided credit and insurance. Furthermore, environmental and social clauses should be incorporated into risk assessment processes for bank financing activities. 5. Close the shadow banking system: Massive securitisation of dubious products has fed an increasingly dangerous, risky and speculative behaviour of financial institutions. This has been facilitated by special investment vehicles established in secrecy jurisdictions. Given the risk from highly leveraged speculative activity, unregulated financial instruments and unregulated financial institutions, all financial activity must be properly regulated. Derivatives, insurance instruments and other financial transactions must be conducted on standardised exchanges and be strictly regulated and supervised. Activities of a purely speculative nature on food and energy should be stopped. 6. Introduce the speculator pays principle: Global taxes should be implemented both to address speculative behaviours and to finance global public goods. 7. Tackle tax havens and address tax evasion: An International Tax Organisation, under the auspices of the UN, to address tax competition and tax evasion and avoidance should be put in place. As a first step, the UN tax committee should be upgraded into an intergovernmental body and deal with these issues. As a starting output it should produce an international code of conduct on tax matters, as a first step towards a binding framework that will make possible socially and environmentally sound progressive taxation systems. In order to enhance transparency and end bank secrecy, automatic exchange and public disclosure of information should be globally extended and implemented by a multilateral tax information exchange treaty. As a first measure, sanctions should be implemented for non cooperative tax havens and their users. All cross-border financial transactions, especially within multinational corporations, must be individually identified, coded, and traceable. At the EU level the European savings tax directive that establishes automatic exchange of information for individual’s income on interests should be expanded. The scope of the directive should be broadened to all legal entities and to all sources of income and should be expanded to other territories. All European Union member states must rigorously enforce the savings tax directive 8. Reform accounting standards: Accounting standards must be improved in order to prevent excessive risk taking as well as tax avoidance and tax evasion practices (James, 2009). While it is estimated that 60% of global trade occurs intra firms, the existing reporting standards allow companies to present their accounts on an aggregated basis, without any details on what financial performance is made in each country where the company and its affiliates operate, how much taxes are paid in each country, what profits are made(James,2009). This allows companies to shift profits from one country to another, generally through tax havens, without any public record and facilitates abusive tax avoidance behaviours. For this reason, financial reports for all transnational companies should be required by the International Accounting Standards Board (IASB) on a country by country basis. Furthermore, the issue of conflict of interest in the IASB should be addressed and its governance democratised and made transparent. B. Reacting to the debt crisis Several years of high economic growth and commodity price boom had helped to reduce the debt burden for many developing countries. This situation has been suddenly reversed by the effects of the financial crisis. Most developing countries, more precisely their financial institutions, had not been involved in derivatives trading and other forms of speculation which caused huge losses for the financial sector in the developed countries. But the credit crunch and recession in the North and the subsequent withdrawal of credit, fall of export volumes, commodity prices and migrant remittances have already had a devastating impact on several developing countries’ balance of payments. According to latest UN projections, export revenues of developing countries will fall in 2009. The impact of tumbling commodity prices is felt most in Sub-Saharan Africa, where export revenues are expected to drop by 22,5% compared to 2008 (Opoku, 2009). Current account deficits will therefore widen, and in times of restricted private credit and increased competition by Northern countries issuing new bonds it will be difficult and costly to find sources to refinance the deficits that Southern countries are increasingly facing. While poor countries are in urgent need of funds to finance their trade deficits, and development and poverty alleviation in general, donor pledges to substantially increase official development assistance have never been realized and are even less likely now. Debt relief has never been sufficient, and measures to curb capital flight have never been implemented. The cushions of currency reserves that many countries had built up in previous years are now in real danger of running out. Several countries have faced severe pressure on their currencies, which puts particular strains on their ability to service foreign currency-denominated debts. In this context, a new round of debt crisis is imminent, as many developing countries have to rely on expensive capital to refinance their debt. Different countries might be affected differently by the crisis and at different moments, depending on their income levels, dependence on external flows and debt levels. Those countries that had to follow past IMF conditionality most closely, particularly with regard to financial liberalisation, are now the most vulnerable and lack the fiscal space to react, underlining how much these policies have failed. Current discussions around emergency funding for developing countries so far seem to be focusing on new lending, without due regard to its sustainability or responsibility in the longer term. CSOs have analyzed the different phases of the debt crises for many decades and have developed analyses and proposals to prevent unsustainable or illegitimate debt, or react to it when prevention failed. The ongoing financial crisis requires decision-makers to take action to implement what civil society groups are proposing for many years. Actions to be taken are not charity or assistance, they are necessary and adequate compensation for past mistakes made by Northern countries and the International Financial Institutions they dominate. Past mistakes shall not be repeated. Compensation is urgent and has to be implemented promptly. It is the only way to regain legitimacy. 1. Immediately stop debt servicing for countries in difficulties At a time when developing countries are facing an unprecedented crisis not of their making, they must be helped to provide the same stimulus and support to their economies that we are witnessing through the large-scale packages in the North. Debt relief is critical to enhance government’s fiscal space to boost the real economy and maintain social spending, rather than using scarce financial resources to fulfil creditors’ demands. Development economists and donor countries have long recognised the strengths of debt cancellation, on a basis of a due process scheme, as a form of financing for poverty reduction which is predictable, flexible and non-cyclical, and has low transaction costs. This makes it all the more appropriate for the current crisis. Therefore, countries in immediate need of funds to mitigate negative effects of the crisis on their population should be allowed to stop servicing their debts, while fair and transparent debt workout mechanisms and debt audits should be set up to decide on and deliver cancellation of unsustainable and illegitimate debts. These developing countries which are being most affected by the financial and economic crisis unleashed in the North need to be freed of debt payments immediately, without the imposition of onerous, undemocratic conditionality. No compound interest should be accumulated and there should be no repercussions for the countries freezing their debt servicing. Reducing foreign exchange outflows is the fastest, cheapest and most effective way of easing their balance of payments difficulties. This is greatly preferable to providing new IMF/World Bank loans or bilateral aid often tied to harmful conditional, or to expensive private sources of credit. Indeed, the argument that countries applying for such a debt cancellation scheme would lose access to the international credit markets no longer has any force as these markets have imploded. 2. Introduce responsible finance principles to prevent unsustainable and illegitimate debt: Moving forward, emergency funding being released or suggested is in danger of contributing to future unsustainable and illegitimate debts. Developing countries need debt cancellation, grant based finance or at least highly confessional and untied lending to enable them to tackle poverty and invest in their own economies. It has to be ensured that new emergency lending doesn’t contribute to further illegitimate and unsustainable debt. This includes the economic stimulus packages that some western countries are currently adopting which contain among others export credits and tied aid to promote their export industries. These criteria aim to ensure that terms and conditions are fair, that the loan contraction process is transparent, that human rights in recipient countries are respected, that the environment is protected, and that repayment difficulties or disputes are resolved fairly and efficiently. Many of the provisions in the charter are drawn from international treaties and conventions to which lender and borrower nations are signatories. These existing measures should be enforced and new measures should be adopted multilaterally as well as by individual creditors. 3. Institute fair and transparent debt workout mechanisms In addition to the immediate stop of debt servicing by those countries hit by the crisis, further debt cancellation is also needed. In this sense, a new debt cancellation scheme is needed that is inclusive, impartial and faster in achieving results than previous debt relief schemes such as HIPC. All debt cancellation must be additional to funds received through Official Development Assistance. In the current context it becomes even clearer that the global regime lacks a proper institution to deal with debt crises. Decisions are currently made on a case-by-case basis, and in arbitrary and creditor-dominated way, such as in the Paris Club and the London Club. As more countries become vulnerable to such crises, it is vital that a new mechanism be established. An orderly, effective and fair debt workout mechanism should be implemented as an option for indebted governments to approach. This debt work-out process would place the same moral and legal obligations on companies as it does on governments, thus tackling the current lack of participation by commercial creditors at a time when many developing countries’ debts have an increasing commercial element. A fair and transparent debt work-out mechanism should have the following characteristics: • An independent and impartial debt sustainability assessment, including illegitimacy concerns, should decide on the amount of outstanding debt that has to be cancelled, taking into account the domestic resources needed to fight poverty and achieve the internationally agreed development goals. This assessment should be transparent and locally owned. • One single “insolvency” process involving all creditors, • An automatic stay on loan enforcement, to prevent that individual creditors request debtors to continue to service their debts while the arbitration process is ongoing. • A due process which is transparent and allows for public scrutiny should be set up in order to determine the use of financial resources freed through debt cancellation. 4. Debt audits and cancellation of illegitimate claims This crisis has irresponsible finance at its heart. Reckless lending is, however, nothing new to developing countries. Much of the debt burden of developing countries has arisen through irresponsible lending practices and there is an urgent need to assess and cancel these debts based on their illegitimacy. Civil society, academics and several international institutions have established criteria to evaluate the illegitimacy of debt, which needs to be acknowledged and promoted further by governments and international institutions. Debt audits are required so that citizens, parliaments and governments can scrutinise lending and borrowing practices and outcomes, and judge which loans were illegitimate, through a democratic and transparent process. It is encouraging that several countries are following the example of Ecuador and moving towards an official debt audit. This should be strongly encouraged, and findings of such audits fed into arbitration processes binding on creditors. Cancelling illegitimate claims must be considered as the single most important incentive for lenders to behave more responsibly in the future. C. Reforming the International Financial Institutions The direction taken by governments now will be of critical importance in defining the shape of global, regional and national financial governance systems over the coming decades.  Decision-makers must take the first steps to put in place a new financial architecture that will: • channel funds to areas of the economy most important for the eradication of poverty, and support low-carbon development pathways at local, national and regional levels; • enable public/ civil society participation in and scrutiny of decision-making and delivery of financial inflows; • enable countries to pursue a range of economic and social policy measures appropriate to support state capacity to deliver on basic social services and to regulate the financial sector to prevent further exposure to financial crisis and speculation; • respect and be consistent with internationally agreed treaties and standards on human rights, the environment and development cooperation. Ultimately, a new financial architecture guided by these principles will necessitate re-conceptualising the nature, role and governance of international financial institutions, possibly including the emergence of new conduits of development financing both at the global and regional levels. It will mean cancelling all unsustainable and illegitimate debt of impoverished countries, and establishing a system of democratic, accountable and fair sovereign borrowing and lending that serves equitable and sustainable development. It will require a reformulation of the international monetary system, involving a new system of reserves to ensure financial stability and an end to dependency on the dollar as the dominant global currency. It will involve a shift in institutional bias away from easing the entry and exit of short-term corporate capital flows and instead towards grants for long-term investments in equitable development and poverty eradication. Crucially, it will also assist the rehabilitation of states to provide and deliver public services, offer social protections and exercise strong regulation of their financial and trade sectors. It also requires a re-evaluationectors. It als of the basic assumptions behind the nature and direction of policy advice provided by IFIs. To the extent that these institutions continue to provide advice around use of grants or emergency funds, the primary orientation will be around stimulating economic activity at the local, national and regional levels, rather than through global export orientation. Policy advice as it exists will therefore need to be directed towards a range of options, for instance, investment in small-scale enterprise, the creation of jobs in green industries and stimulating domestic economic sectors crucial to the eradication of poverty.  Such policy choices will in turn need to be mediated and controlled by the people and communities potentially affected by financial inflows, who will be involved – through appropriate representative mechanisms – in the governance and accountability systems of the new international financial institutions. The end goal is a democratic system of financial governance which closes rather than widens the gap between rich and poor, increases rather than decreases environmental sustainability, and respects rather than undermines fundamental human rights. 1. Democratising and holding the Bank and the Fund accountable No continuation or increase of lending or other IFI roles can be envisaged without a major democratisation of their governance. In the medium term, IFIs should fully comply with the basic principles of democracy, accountability and transparency, including the abolition of economically weighted voting. However, in-depth governance reforms at the IFIs should start without further delays, including: a) Establishing a truly democratic structure, which would satisfy the standards of democracy expected at the national level. This implies recognising the principle of population weighted voting which should be implemented at the IFIs through: double majority voting at the IMF; parity between Annex I and Annex II countries at the World Bank (including the IFC); IMF quota reform; increase of basic votes. b) Increasing the voice and representation of the beneficiaries in International Development Association (IDA) governance; c) Reforming the Executive Board: European representation at the IFIs should consolidate, by reforming existing constituencies and progressively grouping the European countries in fewer constituencies. Executive Directors should be more accountable to their constituencies; d) Greatly improved transparency based on the principle of the right to information and the presumption of disclosure for all documents. Discussions of the executive board must be fully transparent; e) Establishing a transparent, democratic and merit-based selection process for the top levels of leadership at the institutions, including the Development Committee and IMFC; f) Clearly committing to proactively inform citizens in recipient countries, and enable genuine consultation with interested stakeholders; g) Strengthen the role of the Inspection Panel and Compliance Adviser Ombudsman by expanding their mandates to all operations and enabling a follow-up on the IP findings by monitoring the implementation of action plans. This should be combined with mandatory compensation for the negative outcomes of the Bank’s operations. 2. Reforming the World Bank lending principles and objectives WB development finance must comply with responsible finance principles. Eurodad’s responsible finance charter provides a solid basis of principles and processes for the longer-term, including ending policy conditionality. World Bank lending should only be subject to fiduciary measures, to ensure that funds are spent for the intended purposes of poverty reduction The International Finance Corporation (IFC) lending must also comply with agreed principles on responsible finance. Companies requesting finance from the IFC and other IFIs instruments must comply with Extractive Industry Transparency Initiative (EITI) transparency standards and tax codex (James, 2009) The IFC should implement the Extractive Industry Review (EIR) recommendations, especially those on phasing out of fossil fuel lending and concentrating its energy sector lending in energy efficiency, low carbon, decentralised and renewable energy projects (James,2009). New regional development banks under a principle of subsidiarity should be phased in to replace the infrastructure and similar long-term development financing function of the IFIs (Opoku, 2009). Specific arrangements should be sought for Africa, where regional sources of funding are severely limited. 3. Supporting local based initiatives and development models Local authorities and communities in developing countries urgently need resources to strengthen their capacity to asses their needs and make informed decisions for appropriate development alternatives. Resources should be allocated for an independent multi-stakeholder institution with the primary goal to provide technical assistance for long term local capacity development. The Bank lending should respond to these groups’ deliberations and needs assessments, rather than taking a proactive role in project and programme planning. In this regard, we acknowledge the advances provided by the PRSP processes, but these should be radically reformed in order to be country-driven, and not Bank-driven. 4. Changing the development paradigm Development cannot be measured in terms of economic growth and increase of GDP. The Bank guiding criteria for assessment of development outcomes of its lending portfolio should be people and environment oriented and measured by indicators such as carbon impact, improvement in people's livelihood, creation of green jobs, respect of human rights and social standards. This should lead to a critical assessment of the Bank promotion of the development of large infrastructures as a vehicle to delivering development and public goods. 5. No new mandates on global public goods The Bank initiatives to respond to the global crisis have not been adequate to provide long term sustainable solutions. Until a comprehensive reform as described above is undertaken and tested, the Bank should not be given the mandate for the provision of global public goods. Donors should not set up additional trust funds at the Bank which could undermine multilateral processes. The corresponding UN fora must remain in charge of setting norms and policies in these areas. 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