Corporate governance in a radically changed world - a fresh look at the Rhineland model

Richard Tudway

The collapse of the global financial system raises critical issues in corporate governance, particularly in Anglo American jurisdictions. The global financial crisis, triggered by events in the US and the UK, has destroyed global wealth and output on a huge scale. In spring 2010, world stock markets recorded an astounding $20tr loss in value from highs of some $61tr in December 2007 (World Federation of Exchanges, March 2010). OECD growth slumped in the immediate aftermath of the crisis but has since recovered, though very slowly as growth in advanced economies is expected to remain broadly unchanged at 2.5% in 2011 according to the IMFs World Economic Outlook. Recent data on the US and the UK may yet herald a slide back into recession. Indeed, according to the OECD September forecast, the annual rate of growth in the G7 countries will fall to around 1.5% in the second half of 2010, a full percentage point lower than its forecast in May 2010. In the case of the US, fears that weak employment numbers in September may foreshadow a double-dip recession have prompted further quantitative easing by the Federal Reserve. The Made in America financial crisis and the role of the Anglo American model of corporate governance urgently needs to be re-examined.

This model has indeed spectacularly failed to protect shareholder wealth, its professed primary intention since, under Anglo American corporate law, directors are portrayed as having a first duty to protect shareholder value. Workers’ capital (the pension funds of working people that are invested by institutional investors into stock markets) has been squandered also. The prospects for many millions of working people have also worsened. The sense of public outrage is understandable. Yet, despite the promises of politicians and policymakers that things will be changed, it seems that, far from changing, things are returning to business as usual. The bankers are back in the saddle. Generous bonuses are being paid. The boards of many bank and non bank corporations alike in Anglo American jurisdictions have learnt little from the damage that has been inflicted, and the reasons that explain it.

If politicians won’t act, then global trade unions must press resolutely for change. Bank and non-bank corporations alike have to be properly, effectively, independently and transparently supervised. Drawing strength from the excellent co-determination habits of Rhineland democracies (Germany and other democracies that border the Rhine) and others (notably Sweden and other Nordic countries), the autocratic, non-inclusive style of Anglo American unitary board governance arrangements has to be challenged. To drive home the argument, trade unions need to be able to prove that independently supervised corporations are better at protecting both worker prosperity and shareholder value.

The voice of working people has to be taken into account in the supervision of the world’s largest corporations. Democratic self-determination at the work place demands no less. This is the only way that the wrecking instincts of personal greed can be controlled. The well rehearsed argument that independent supervision will stifle innovation (because decisions would never get taken and business opportunities would be lost) is self-serving propaganda. Commercial risks are, of course, unavoidable - they can never be eliminated. The role of supervision is to ensure that significant risks are thoroughly and objectively assessed (while there is evidence that bank failures in the US and Britain occurred because the advice of risk managers was suppressed) before workers’ capital and their livelihoods are endangered by reckless, unsupervised and unaccountable decisions. Here it is important to remember that all information provided by corporations in Anglo American jurisdictions is ex post – after the event.

To get the debate moving, the OECD has to challenge the ‘hidden agenda’ which still stifles the debate on corporate governance; the OECD Framework of Corporate Governance and Roundtable discussions have ignored warnings in the past. There is an urgent need to look openly and objectively at alternatives to the now discredited Anglo American model. In doing so, it is crucial to ensure that the interests of workers and all legitimate stakeholders are properly represented. The GLU and its associates need to focus research on how different governance structures rank in terms of protecting corporate wealth. The Anglo American shareholder value model has been extensively researched. In contrast, the stakeholder model has not (Allen and Gale, 2002). The research needs to develop appropriate methods for assessing short and medium term performance in the largest publicly traded corporations, according to the governance model in use.

The Anglo American model relies critically on the neoclassical Arrow-Debreu theorem and efficient markets hypothesis. In the first instance this demonstrates that if(1) the objective of the corporation is to maximise the value of its shareholders, and this is achieved, then it is said to be Pareto optimal (i.e. its behaviour is beneficial to all, even outside the corporation). The issue of income distribution in society is otherwise settled by progressive taxation. This leaves company directors with the clear duty to maximise shareholder value(2) . The pursuit of that objective, it is argued, will in turn promote efficient resource allocation, as posited in the efficient markets hypothesis. In contrast, corporation law in Rhineland jurisdictions is clear in stating that the objective of larger corporations is to promote interests that are wider than simply those of the shareholder. Stakeholder concerns thus become a central feature of board behaviour, decision making and investment. Research should examine the consequences if the objective of the corporation is not exclusively to promote shareholder value. According to Allen and Gale (op. cit.), over 80% of managers surveyed in Germany, France and Japan agreed that stakeholder interests are more important than shareholder interests. In contrast, more than 80% of British and American managers surveyed saw shareholder interests as being the most important interest.

Whilst the stakeholder model has been politely dismissed by a generation of Anglo American corporate financiers, corporate legal theorists and financial analysts, the tide is now turning. There is an increasing awareness that the Anglo American model of corporate governance fails to meet its single declared objective – maximisation of shareholder value. At the same time, it compromises the longer term investment of other stakeholders, most notably working people. Time has now come to change corporate governance for the benefit of all. The debate has to be opened up and the evidence independently evaluated.

(1) The significance of the if is that if the proposition can be effectively contested then the force of much of the argument is lost. The truth of the matter in law is that in Anglo American jurisdictions the fiduciary duty is to the company, a separate legal entity, and not to the shareholders, which radically changes the justification for its particular portrayal.

(2) The unclear distribution and supervision of power between directors and managers in Anglo American jurisdictions is a natural consequence of the evolution of the doctrine of separation of ownership from control, over which there is no effective countervailing influence by absentee landlord institutional investors who have no long term interest in the corporation in which they are invested.

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Richard Tudway is a director of the Centre for International Economics in London. He is a researcher in corporate governance and a visiting professor of management, economics and finance at several international business schools.

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References:

Allen, F. and Gale, D. (2002), A Comparative Theory of Corporate Governance, Wharton Business School

Further Reading:
Tudway, R. (2009), Evidence to the OECD’s Corporate Governance Steering Group Roundtable
Tudway, R. (2002), The Juridical Paradox of the Corporation, International Corporate Law Annual, Vol 2

FIFA 2010 World Cup: fair play on the pitch but foul play for workers

Crispen Chinguno

South Africa hosted the 2010 FIFA World Cup behind unprecedented fanfare and rituals. Nearly a billion viewers watched this showcase worldwide. However, few would ever be privy to the dark side behind this façade. Debate on the event was largely dominated by questions related to the capacity of South Africa to host such a mega event, as well as discussions on business profits, or socio-political and symbolic benefits. FIFA reported that it was the most commercially successful World Cup ever. The event was ironically hosted in the world’s poorest continent and hence brought to fore the contradictions of opulence and poverty. It raised questions on who really benefited from the event and what it represented. Did it make any contributions in alleviating the plight of the workers and the poor? This column is a ‘snap-shot’ of some of the debates and contradictions.

Construction

The sector by nature is highly cyclical and hence a majority of workers are in precarious employment. It is one of the most exploitative sectors, characterised by flexible forms of employment and migrant labour. Trade unions in the sector are weak (density below 10%) and fragmented. This was one of the first sectors to ‘feel’ the impact of this mega event. It was propelled out of a decline which had persisted for almost three decades by the World Cup construction projects and massive government infrastructure development in energy and transport. Employment in the sector increased from just over 200,000 in 1998 to over a million in 2008, at the peak of the boom.

The unions organised workers strategically through an initiative by the global federation Building and Woodworkers International (BWI)’s decent work campaign. This brought together three of the main unions in the sector and achieved marginal gains for the unions. At the end of the campaign, unions reported a 10% growth in membership. However, many of the workers were retrenched soon after completion of the projects. In addition, its sustainability is questionable as it was not initiated nor driven locally. The campaign, however, afforded a rare opportunity for a ‘united’ labour movement in the sector, though unions remained divided and fragmented.

Constructing stadiums for a world tournament instilled high expectations in ordinary workers, in contradiction to the ‘business as usual’ stance adopted by contractors and government. Conflict was inevitable and the 2010 World Cup construction projects have perhaps recorded the highest levels of industrial conflict in the event’s history. At least 26 strikes were reported from all the projects and most were not sanctioned by the unions. According to research by Eddie Cottle (2010), workers received an average of 12% wage increase which amounted to R2933 (€293) per month by the time the projects were completed, against an average increase in profit of 218% in 2007 for the contractors.

Security

South Africa has one of the highest crime rates in the world. Hence security was a major issue for the tournament. The security sector in South Africa is one of the largest and fastest growing in the world, with an average annual growth rate of 13% since 1994. There are at least 6400 accredited security companies and South Africa has one of the highest ratios of security guards to policemen with over 385,000 security guards to 180,000 police officers.

The World Cup brought windfall gains for security companies. Some reported increasing revenue and profit threefold. For personal bodyguards, for example, companies charged between R2000 (€200) and R40,000 (€2000) per day. This translated to the equivalent of over two year’s salary for some of the workers. The security sector is designated as a ‘vulnerable sector’ as it is characterised by precarious employment, low pay and long hours (60% of workers earns less than R1700 [€170] per month). There is no bargaining council, very little social and health protection and over 93% of workers are not unionized. This predicament was highlighted during the 2006 strike, the most violent strike in post-apartheid South Africa, in which over 60 security guards were killed. The situation of this sector reflects some of the contradictions of South African society, notably the relationship between the demand for security and levels of crime and inequality.

Accommodation and catering

Many of the 2010 World Cup guests in hotels and restaurants may never be privy to the fact that the workers who served them were ‘freemen de jure but slaves de facto’. Most are paid on commission or only depend on tips as a source of income. Such practices are prevalent even in up market hotels and restaurants.

The monthly minimum wage, for the few privileged to have a wage, is about R1800 (€180), but is often ignored. Unions are poorly organised and mostly confined to big hotels and restaurants. The sector is very complex to penetrate and density is low (below 20%). Interviews with union officials revealed that here is a very high prevalence of migrant workers, most of whom do not have documentation to work in South Africa.  In large urban centres, it is estimated that 80% of the workers in restaurants are foreign. This makes it risky for them to seek redress where they face unfair labour practices. According to the interviews conducted, the unions in this sector did not see any opportunities arising from the tournament. They argued that their problems were perennial and could not be tied to a once-off event. Most hotels and restaurants outsource services such as catering, cleaning and security; hence most workers are employed by third parties. Over 60% are in precarious employment without social benefits such as medical cover and pension. The conditions of work in this sector are very complex, exploitative and characterised by a very high decent work deficit.

Transport

South Africa has a very poor public transport system. The ‘minibus sector’, one of the legacies of apartheid, is dominant, accounting for over 60% of public transport, but is predominately informal. Ironically, despite heavy investment in modern train and bus systems, it represented one of the prime modes of transport for the 2010 World Cup. It employs over 185,000 workers who work under deplorable conditions. Most have no formal contracts, leave or health protection and earn very low pay. They work excessive hours (with an average as high as 16-18 hours) and have a limited collective voice at work as fewer than 20% are unionised.

A new rapid bus service was unveiled just before the tournament to ease the urban transport during and after the event. A number of minibus drivers were recruited for the rapid bus service. Most had been previously retrenched and were hired as casual workers with no prospect for secure employment. As they had been organised as minibus drivers, they immediately approached the union for protection from exploitation. They organised a strike against poor conditions of work which exposed the contradictions of the tournament.

Textile and footwear

The textile and footwear sectors in South Africa have been overwhelmed by cheap imports, especially from China. The unions attempted to minimise imports and support local brands, but were not very successful. However, one of the major unions in the sector collaborated with Adidas and identified local factories for production of soccer regalia for the local market at affordable prices. Three factories complying with the bargaining council agreements were identified. The initiative created about 2500 jobs for three months. Adidas was apparently protecting itself from the global unions’ Clean Clothes Campaign which targets major sports events. In interviews, however, the unions did not view the tournament as an opportunity for organising and claimed it was unsustainable as it created temporary jobs. A significant proportion of the South African production takes place in sweatshops and homes where there are no standards of work (Shane Godfrey et al., 2005). Hence the sectors are largely characterised by a very high decent work deficit.

Street traders

This was perhaps the first time that the FIFA World Cup was to come ‘face to face’ with the informal economy. South African street vendors, like any business persons, had big dreams. However, they were shattered by FIFA’s ban on trading on all venues and surrounding vicinity to protect big global capital. For many, this was a nightmare as informal trading in and outside stadiums is part of the African football ‘culture’. Some inhabitants of informal settlements, who naturally are mainly confined to the informal sector, were forcibly evicted in the name of cleaning up the cities before the event.

Conclusion

The 2010 FIFA World Cup deceived and shattered the dreams of many workers and poor people. Initially, it obscured class differences and its underlying ideological agenda as it was associated with a rhetorical sense of national identity, self-esteem and pride. However, this was deceptive as it did not represent or advance such values. The super exploitation of workers and the economic exclusion of street traders to protect and advance the interests of global capital (McDonald’s, Coca Cola, etc) epitomise the meaning of the FIFA World Cup. It is a phenomenon of neoliberal globalisation designed to represent, reinforce and advance the ideology and hegemony of global capital at the expense of workers and poor people. There may have been fair play in the soccer field at the World Cup, but foul play was the rule for workers.

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Crispen Chinguno is an alumnus of the Global Labour University Masters programme at Wits (South Africa) and currently an International Center for Development and Decent Work (ICDD) PhD fellow at SWOP, Wits.

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References:

Cottle, E. (2010), ‘A Preliminary Evaluation of the Impact of the 2010 FIFA World Cup™: South Africa’, Available at: http://www.sah.ch/data/D23807E0/ImpactassessmentFinalSeptember2010EddieCottle.pdf

Godfrey, S., Clarke, M., Theron, J. and Greenburg, J. (2005) ‘On the Outskirts but Still in Fashion: Homeworking in the South African Clothing Industry – The Challenge to Organisation and Regulation’, Labour and Enterprise Project, University of Cape Town, Available at:
http://blogs.uct.ac.za/gallery/679/Homeworking%20in%20the%20South%20African%20clothing%20industry%202-2005%2004-03-08%20SW.pdf

What does wage-led growth mean in developing countries with large informal employment?

Jayati Ghosh

The past decade has been one in which export-led economic strategies have come to be seen as the most successful, driven by the apparent success of two countries in particular - China and Germany. In fact, the export-driven model of growth has much wider prevalence as it was adopted by almost all developing countries.

This was associated with suppressing wage costs and domestic consumption in order to remain internationally competitive and to achieve growing shares of world markets as far as possible. Managing exchange rates to remain competitive, despite either current account surpluses or capital inflows, became one of the major elements of this strategy. This was associated with the peculiar situation of rising savings rates and falling investment rates in many developing countries, and to the holding of international reserves that were then sought to be placed in safe assets abroad.

This is related to a classic dilemma of mercantilist strategy, which is evident in exaggerated form for the aggressively export-oriented economies of today: they are forced to finance the deficits of those countries that would buy their products, through capital flows that sustain the demand for their own exports, even when these countries have significantly higher per capita income than their own. The flows of capital from China and other countries of developing Asia is an egregious example of this.

The strategy also generated fewer jobs than a more labour-intensive pattern based on expanding domestic demand would have done, which meant that employment increased relatively little, despite often dramatic rises in aggregate output. This is why, globally, the previous boom was associated with the South subsidising the North: through cheaper exports of goods and services, through net capital flows from developing countries to the US in particular, through flows of cheap labour in the form of short-term migration.

The recent collapse in export markets halted that process for a while. Although there has been a recovery, it is very evident that such a strategy is unsustainable beyond a point. This is particularly true when a number of relatively large economies seek to use it at the same time. So, not only was this a strategy that bred and increased global inequality, it also sowed the seeds of its own destruction by generating downward pressures on price because of increasing competition as well as protectionist responses in the North.

So there are both external and internal reasons why it is hard to sustain such a strategy beyond a point. Externally, deficit countries will either choose or be forced to reduce their deficits through various means, and protectionist responses. Internally, the potential for suppression of wage incomes and domestic consumption will meet with political resistance. In either case, the pressures to find more sustainable sources of economic growth, particularly through domestic demand and wage-led alternatives, are likely to increase.

The process of global economic rebalancing was initiated by the financial crisis and is now likely to get accentuated through the current fragile recovery and potential instability of the near future. One important result is developing countries (and the surplus countries like China in particular) can no longer depend on exports to US as their primary engine of growth. The US trade deficit is set to shrink, and at a fundamental level it really does not matter whether this occurs through exchange rate changes, changes in domestic savings and investment behavior or increased trade protectionism.

So countries must diversify their sources of growth, looking for other export markets as well as for internal engines of growth. This is what makes arguments for a shift in strategy towards domestic wage-led growth so compelling.

In developed countries with relatively strong institutions that can affect the labour market, including collective wage bargaining, effective minimum wage legislation and the like, it is probably easier to think of wage-led growth and strategies to allow wages to keep pace or at least grow to some extent) along with labour productivity growth. But what about most developing countries, where such institutions are relatively poorly developed and where many if not most workers are in informal activities, often self-employed? How are wage increases and better working conditions to be ensured in such cases? And what does a macroeconomic policy of wage-led growth entail in such a context?

In fact, it is still both possible and desirable to get wage-led growth in such contexts. There are five important elements of such a strategy in developing countries with large informal sectors:

• Make the economic growth process more inclusive and employment intensive: direct resources to the sectors in which the poor work (such as agriculture and informal activities), areas in which they live (relatively backward regions), factors of production which they possess (unskilled labour) and outputs which they consume (such as food).


• Ensure the greater viability of informal production, through better access to institutional credit to farmers and other small producers, greater integration into supply chains and marketing that improves their returns, and technology improvements that increase labour productivity in such activities.


• Provide increases in public employment that set the floor for wages (for example, in schemes such as that enabled by the National Rural Employment Guarantee Act in India) and improve the bargaining power of workers.


• Provide much better social protection, with more funding, wider coverage and consolidation, more health spending and more robust and extensive social insurance programmes, including pensions and unemployment insurance.


• Increase and focus on the public delivery of wage goods (housing, other infrastructure, health, education, even nutrition) financed by taxing surpluses.

The last point is often not recognised as a crucial element of a possible wage-led strategy, but it can be extremely significant. Furthermore, such a strategy can be used effectively even in otherwise capitalist export-oriented economies, as long as surpluses from industrialisation and exports can be mobilised to provide wage goods publicly. Indeed, this has been an important and unrecognised feature of successful Asian industrialisation from Japan to the East Asian NICs to (most recently) China. The public provision of affordable and reasonably good quality housing, transport facilities, basic food, school education and basic healthcare all operated to improve the conditions of life of workers and (indirectly) therefore to reduce the money wages that individual employers need to pay workers. This not only reduced overall labour costs for private employers, but also provided greater flexibility for producers competing in external markets, since a significant part of fixed costs was effectively reduced.

What are the macroeconomic advantages of such a strategy? Quite apart from the obvious benefits in terms of reducing poverty, improving income distribution and the conditions of informal workers, there are positive implications for the growth process. It allows for more stable economic expansion based on increasing the home market, and need not conflict with more exports either. It encourages more emphasis on productivity growth, thereby generating a “high road” to industrialisation.

Clearly, if countries in which the majority of the world’s population are concentrated are actually to achieve their development project in a sustainable way, new and more creative economic strategies have to be pursued. Wage-led growth, including through measures such as those outlined here, is likely to be an essential element of such strategies.

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Jayati Ghosh is Professor of Economics at Jawaharlal Nehru University, New Delhi, and Executive Secretary of International Development Economics Associates (http://www.networkideas.org/). She has consulted with many international organisations and governments, and works actively with progressive organisations in India and elsewhere.

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Reform Options for Financial Systems

Rainer Stachuletz

Hansjörg Herr

The neoliberal globalisation project gained momentum in the late 1970s through free market policies in the United Kingdom and the United States. Domestic and international financial systems have been increasingly liberalised and deregulated with the following important results:

a) Integration of financial systems

The deeper integration of international financial markets resulting from the deregulation of capital flows, together with the switch to flexible exchange rates after the breakdown of the Bretton Woods System, created a new source of shocks and uncertainty, as well as a new field of speculation.

b) The increasing role of non-bank financial institutions

Non-bank financial institutions such as investment banks, hedge funds, and private equity funds, became important players. These institutions usually have a speculative orientation, look for high short-term returns and work partly with extreme leverages. Non-bank financial institutions did not only use their own huge funds for their speculative activities; they also tapped the commercial banking system to mobilise additional funds for diverse investments in and outside the financial markets. Thus, commercial banks became more exposed to extreme kinds of risk. In addition, - segments of the financial market which had once been sheltered, like the real estate sector, became fully integrated.

c) Development of a shadow financial system

A shadow financial system with a low level of regulation (or none whatsoever) flourished and became important. Scarcely regulated offshore centres became international financial centres facilitating tax evasion, money laundering and other internationally organised criminal services.

d) Securitisation, financial innovation and derivatives

Securitisation exploded after the 1970s: firms and financial institutions preferred to hold short-term marketable papers instead of bank deposits; economic units of all types issued a growing variety of debt securities to get funds; banks sold their rearranged credit portfolios to non-bank financial institutions whereas rating agencies without any legally binding mandate gave these papers high ratings. Any government supervision was put in a ridiculous dual position: first they were consulting how to design those credit derivatives, then had to evaluate their quality.

Derivatives are initially designed to reduce price-related risks of financial instruments, e.g. changing asset prices, the price of foreign currencies or changing interest rates. The pricing of those derivatives is relatively transparent and the derivatives are marketable. Default and other qualitative risks (climate, temperature, natural disasters) are evidently hard to price, thus less tradable. Nevertheless, those products – hard to standardise or even to value – were developed and actively traded on less-regulated Over the Counter (OTC) markets.

The fundamental problem with risk markets is that risks are not eliminated through trade - they are simply reallocated. As in many cases, both contract partners are speculators, the market is transformed into a big casino where governments and tax-payers become unwitting guarantors.

e) Powerless central banks and supervisors

Central banks became onlookers in the new financial system. In fact, the interest rate remained their only tool to control price level changes, asset price bubbles, exchange rate movements and GDP growth. Central banks do not have instruments to guide funds resulting from expansionary monetary policies towards productive investment. Due to unstable international capital flows, monetary policy in many historical episodes had to follow the primacy of external stabilisation.

As a consequence, price bubbles in all asset markets have become more frequent, with negative economic consequences. At the same time, exchange rate volatility and increasing current account imbalances added to the instability of financial markets.

Frequently, price bubbles went along with credit expansion, in many cases not financing real activities. The big picture is that indebtedness increased. For example, private household debt in percent of GDP in the US increased from below 50% in the 1970s to over 100% in the late 2000s; enterprise debt increased in the same period from around 75% to over 125% (1). Government debt to GDP in many countries also increased sharply over recent decades.

The deregulation of financial systems which began in the 1970s produced an unsustainable credit expansion for almost all sectors in many countries and a general layering of debts. Bubbles, unsustainable credit expansions, international exchange rate turbulences and growing current account imbalances indicate a more and more fragile financial system. Even the current crisis could be overcome - without fundamental changes a new bubble with probably even more disastrous consequences will necessarily develop.

As a fundamental reform option, we favour a financial system in the tradition of the Glass-Steagall Act and the original Volker Plan. These plans were much more radical than the watered-down legislation which was passed in the US in July 2010.

What could the blueprint of a stable financial system which serves economic development look like?

The financial system should be divided into banks and non-bank financial institutions. Such a regulation implies a distinctive wall between banks, being the major source of finance for firms, and more risk-oriented and even speculative non-bank financial institutions. Commercial banks are then forbidden to engage in proprietary trading, e.g. speculating with their own or borrowed funds; they are not allowed to own investment banks, hedge funds or private equity funds nor to give credit to those institutions and other non-banks. If the latter want to get funds for their businesses, they are forced to attract money held by households. These funds will create sufficient venture capital for start-ups and risky innovations which are not financed by commercial banks. Financial or any other business relations to institutions outside the regulated financial systems (e.g. offshore) are strictly banned.

The allocation of loans originated by banks should be regulated by the central banks. Loans to the real estate sector can be quantitatively restricted as consumption credit. Equity holdings for such credit could be discretionarily changed by monetary authorities. This would allow counter-cyclical equity holding in contrast to Basel II, which leads to unwanted pro-cyclical effects.

Real estate financing and large parts of the private equity industry with their specific social and financial dimensions could be considered a special case and permitted only to specialised and state-licensed institutions. The real estate market can be made a special segment with regulated credit relationships to the rest of the financial system.

Banks in a liberalised environment are triggered to follow aggressive and risky business strategies to defend or increase their market share. To reduce destructive competition between banks, in a regulated financial system, competition among commercial banks could be limited by fixing, for example, real deposit rates of commercial banks. Also, ceilings for interest rates could be given by central banks. In a very highly regulated system, the central bank could even fix interest rates and the quantity of credits the banks are allowed to give. The advantage of such a regulated credit rationing system is that restrictive monetary policy can be implemented without increasing interest rates.

Derivatives should be sold and bought only in regulated and controlled markets. Strictly controlled position limits shall exclude speculative attacks. Only certain standardised products which have been checked by a supervision agency should be allowed, and only certain agents with licences should take part in the market. Securitisation of credits should be possible to a certain extent. If the originator of a loan is forced to keep a substantial part of the loan in its books and derivatives are standardised, securitisation is harmless.

Last but not least, such a system needs international capital controls to give central banks instruments to control unstable international capital flows. Current account imbalances should be kept small. The debates during the Bretton Woods negotiations in the 1940s could be a starting point for the development of such a system.

A financial system outlined above is not imaginary. It existed in the US and most other industrialised countries after World War II. Even comprehensively regulated systems existed and partially still exist in different versions in all East Asian miracle countries after World War II. The Chinese financial system after 1978 also fits such a system. Financial systems in these countries offered sufficient and cheap credit for the enterprise sector and thus stimulated growth and employment without financial market instability.

For many, the above blueprint of a reformed financial system does not seem politically enforceable. However, the fragility of the financial system will continue. History may create a window of opportunity for a change. If such an opportunity comes, we should know what to do.

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Hansjörg Herr is professor for Supranational Integration at the Berlin School of Economics and Law and at his university the economic director for the MA Labour Policies and Globalisation of the Global Labour University.

Rainer Stachuletz is professor for Finance at the Berlin School of Economics and Law. Currently he is working as a consultant for the State Bank of Vietnam at the Banking Academy in Hanoi.

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Further Reading:
S. Dullien, H. Herr, EU Financial Market Reform. International Policy Analysis 2010, Friedrich Ebert Foundation, http://library.fes.de/pdf-files/id/ipa/07242.pdf

(1) Fed, Flow of Funds Accounts Database 2010