CHAPTER 2
FINANCIAL STABILITY
AS AN INTERNATIONAL PUBLIC GOOD
FOR DEVELOPMENT
T
he financial storms that hit international markets during the 1990s made it clear
that regulatory and institutional frameworks were inadequate to promote finan-
cial stability or to respond to crises and their effects at an international level. A
well-known study (Dobson and Hufbauer 2001) estimates that since 1975 financial in-
stability has reduced the incomes of developing countries by roughly 25%. Financial
instability cost Latin America alone some 2.2 percentage points of growth a year in the
1980s and 0.7 percentage points in the 1990s.
Financial markets are becoming increasingly integrated internationally, with the
liberalization of capital flows, rapid financial innovation (futures, forwards, options and
swaps), the development of telecommunications technology and its capacity to complete
orders and transactions in real time and the growth of strong institutional investors with
highly leveraged hedge operations.
But the international financial arena has only a limited normative framework for
preventive regulation, supervision and intervention. There are no mechanisms to en-
sure control of externalities derived from national decisions. This regulatory asymmetry
facilitated the development of international transactions, but it also increased the risk of
instability and negative effects connected with growing market interdependence.
While the institutional framework for international financial cooperation was
formed some 50 years ago, the participants and interactions that are the target of regula-
tions have changed considerably in recent decades. Several emerging economies are
active on the international scene, including some potential economic giants with the ca-
pacity to affect international financial markets. The range of matters requiring interna-
tional cooperation has widened: balance of payment adjustments, financial regulation
and supervision, debt management and financial crisis resolution—new matters requir-
ing new institutional and normative responses.
But as the global economy has moved further away from the harsh effects of the
last financial crisis, ambitious proposals for a new international financial architecture are
losing their appeal, and discussion now focuses on the technical requirements for im-
proving information and the levels of preventive regulation and supervision of national
markets. These issues are also important, of course, and can lead to improvements in
market efficiency at a microeconomic level. But it is doubtful whether these methods
alone can reduce systematic risks, such as economic volatility or contagiousness.
PUBLIC GOODS FOR ECONOMIC DEVELOPMENT 3
9
FINANCIAL STABILITY
AS AN INTERNATIONAL PUBLIC GOOD
FOR DEVELOPMENT
T
he financial storms that hit international markets during the 1990s made it clear
that regulatory and institutional frameworks were inadequate to promote finan-
cial stability or to respond to crises and their effects at an international level. A
well-known study (Dobson and Hufbauer 2001) estimates that since 1975 financial in-
stability has reduced the incomes of developing countries by roughly 25%. Financial
instability cost Latin America alone some 2.2 percentage points of growth a year in the
1980s and 0.7 percentage points in the 1990s.
Financial markets are becoming increasingly integrated internationally, with the
liberalization of capital flows, rapid financial innovation (futures, forwards, options and
swaps), the development of telecommunications technology and its capacity to complete
orders and transactions in real time and the growth of strong institutional investors with
highly leveraged hedge operations.
But the international financial arena has only a limited normative framework for
preventive regulation, supervision and intervention. There are no mechanisms to en-
sure control of externalities derived from national decisions. This regulatory asymmetry
facilitated the development of international transactions, but it also increased the risk of
instability and negative effects connected with growing market interdependence.
While the institutional framework for international financial cooperation was
formed some 50 years ago, the participants and interactions that are the target of regula-
tions have changed considerably in recent decades. Several emerging economies are
active on the international scene, including some potential economic giants with the ca-
pacity to affect international financial markets. The range of matters requiring interna-
tional cooperation has widened: balance of payment adjustments, financial regulation
and supervision, debt management and financial crisis resolution—new matters requir-
ing new institutional and normative responses.
But as the global economy has moved further away from the harsh effects of the
last financial crisis, ambitious proposals for a new international financial architecture are
losing their appeal, and discussion now focuses on the technical requirements for im-
proving information and the levels of preventive regulation and supervision of national
markets. These issues are also important, of course, and can lead to improvements in
market efficiency at a microeconomic level. But it is doubtful whether these methods
alone can reduce systematic risks, such as economic volatility or contagiousness.
PUBLIC GOODS FOR ECONOMIC DEVELOPMENT 3
9
