PACIFIC BASIN ECONOMIC COUNCIL
MAIN PAGE | SPEECHES & EDITORIALS | 1999 | REFORMING FINANCIAL SYSTEMS

Reforming Financial Systems Dean R. O'Hare Chairman and CEO, The Chubb Corporation Thursday, February 11, 1999 International Economy in Crisis: Options for Sustaining Growth and Stimulating Recovery 1999 Annual Policy Conference Pacific Basin Economic Council United States Member Committee One of the great disappointments to me from the Asian financial crisis has been the rhetoric about "go slow" liberalization in the financial services sector. Experts and governments may not agree on the suitability of the various multilateral rescue packages applied to particular countries, but the one truism which seems to have emerged is that shallow, non-transparent, unsophisticated financial services markets in the most affected countries were a main contributor to the crisis. Now, I don't need to recite here what others have written volumes on elsewhere. And I also don't want to suggest that my own company didn't get caught up in the idea of the "Asian miracle" and the almost limitless growth it implied. I'm also not going to suggest that the best of Asia's economic history has already been written. Asia will recover and, with its bountiful economic and human resources, will prosper once again. Nevertheless, the questions we face are how long the recovery will take and whether a similar crisis could occur again. Certainly, with regard to the latter, much probably depends on coordinated action that might be taken by the U.S., Europe, Japan and others to reduce the chance of unpredictable, volatile capital flows destabilizing weakened economies. Whether greater monitoring of short-term capital flows or some other mechanism is the answer, I've left to Tim Geithner, Gary Hufbauer and other technical experts. From a business perspective, however, I can tell you that once investor confidence in the integrity of financial markets has been so thoroughly shaken, it is hard to resurrect. Yes, there will always be some money willing to take the risk of loss for big returns on a short-term basis. But, the vast capital needs of Asia can't be met by short-term capital flows. Consequently, long-term investors will need greater assurance that fundamental changes are taking place in these markets. Moreover, as I understand it, one of the big differences between the current crisis and those we have faced in the recent past, such as with Mexico, is that, in Asia, this is a crisis of private, versus public, debt. And so, the impact has been broad and deep, drying up liquidity for businesses of all sizes in the affected countries and also for those in other countries which do business with them. Breaking Out from the Paradigm of Protectionism Let me tell you what I think needs to be done to get money flowing back into these economies and to establish a secure foundation for locally-generated economic growth. First, we need to break out of the "paradigm of protectionism." By that I mean, it's time for developing countries to recognize that financial services provide a kind of infrastructure that promotes sustainable economic growth and development. And liberalization that opens these markets to foreign financial firms is the key to creating this infrastructure. Too often, policymakers and, I'm afraid, trade negotiators, think of financial services liberalization in the same way as trade in goods. Economic costs and benefits are weighed in terms of a zero sum game where participation of foreign financial services firms in the market is viewed as a substitute for local financial services providers. Forgotten in all of this is the fact that up-to-date, competitively priced, quality financial services products are "enablers" for other sectors of the economy to innovate, expand and prosper, and are especially important to generate new businesses and jobs. However, liberalization alone will not make the critical difference in these markets that is needed to promote stable, long-term growth. So, in addition to breaking the paradigm of protectionism, we need to encourage the development of "pro-competitive regulatory reform." Promoting Pro-Competitive Regulatory Reform What do I mean by pro-competitive regulatory reform? Essentially, I mean abandoning outdated forms of regulation, by which governments limit the number of participants in the market and restrict the introduction of new financial services products and market-based pricing. Instead, regulators should focus on three major things -- ensuring the solvency of financial services firms, promoting the transparency of intra-company transactions and improving the reliability of economic data that allows customers and investors to make better informed judgements about the soundness of financial institutions themselves and the quality of their investments. PBEC began looking at the issue of pro-competitive regulatory reform in May 1997, about two months prior to the onslaught of the Asian financial crisis. While we have been given credit for our foresight, the truth of the matter is that we originally began to explore the condition of financial services markets in PBEC member economies to determine if they were serving the needs of individual and commercial customers. This was the outgrowth of earlier work documenting a broad range of barriers in member economies limiting market entry for both domestic and foreign firms, and restricting product innovation and price competition. In the course of our work, we visited seven PBEC economies -- Chile, Chinese Taipei, Korea, Japan, Indonesia, Malaysia and the Philippines -- to gather information and opinions from consumers and providers of financial services on the impact of domestic regulatory regimes on the availability of better, more affordable, financial services. Even in economies left relatively unaffected by the financial crisis, both users and providers openly discussed the benefits of liberalization and the need for progressive regulatory reform to build modern financial markets. Ultimately, there was a strong consensus on the need for Asian governments, in particular, to develop a set of pro-competition principles that would help restore confidence in the region, enhance the competitiveness of financial service providers, and improve the quality of services for consumers. The results were a series of recommendations to PBEC member governments, which were also sent to multilateral institutions, such as the World Trade Organization, World Bank and IMF, as well as the APEC leaders. The recommendations for pro-competitive regulatory reform fall into four major categories and include: One, develop a public sector/private sector dialogue on deregulation and its goals including development of a regulatory "road-map" for consumers and providers to prepare for a new, more open marketplace. Too often plans are drafted by government bureaucrats or favored industry groups without broad public participation. Two, construct a predictable, responsible and transparent regulatory regime built on professionalism and the independence of regulators, the strengthening of public and corporate governance, and the reliability of financial data tied to accounting and auditing standards based on international best practice standards. The third set of recommendations calls on governments to implement tools for promoting financial sector development by ensuring the solvency of financial services, not by restricting the number of firms in the market, new product introductions or pricing. Market forces should be allowed to determine winners and losers, tough remedial measures should be implemented when necessary, and financial sectors should be restructured without delay. Lastly, avoid postponing liberalization unnecessarily as delays are likely to impede the development of a modern regulatory framework and deny to consumers the benefits of deeper capital markets, foreign capital and expertise, and lower cost of funds and financial services. Where Does This Leave Us? Well, where does this leave us? Let me make two suggestions. First, setting aside the question of what might, or might not, need to be done to the international financial system's architecture - an issue I've punted to Messrs. Geithner, Hufbauer and others, I raise the upcoming GATS 2000 negotiations as the next major opportunity for leaders in Asia to "break the paradigm of protectionism" by shedding the tie that has bound them to weakened financial markets and economic instability, and by taking a strong stand for progressive market opening and strengthened financial markets. Just think where we might have been today, if some of the wise heads that brought about the amazing industrialization and high-tech development of the Asian economies had focused adequate attention on the development of modern, open and transparent financial markets. For some reason, the same minds that readily recognize the critical role of foreign investment and technology in closing the gaps in manufacturing competitiveness don't see that there is similarly a gap in capital and expertise in domestic financial markets that foreign financial institutions can fill. And for financial services, the deficit in expertise can only be turned around by a presence in the market and the transfer of technology through training of local employees. Although the last round of GATS financial services negotiations ended in the ground-breaking agreement that goes into effect March 1, many countries didn't make commitments to market opening that went beyond the "status quo." I hope developing countries, learning the right lessons from the current financial crisis, will now see that it is in their own best interest to grab hold of the next round of negotiations, beginning in 2000, to say "we're open for business" by creating conditions that will attract, not keep out, foreign financial services firms, their capital and leading edge technology. Of course, any enlightened self-interest that results in liberalization prior to commencement of GATS 2000 would be welcome. The second suggestion I have to make is that, building on what we've done in PBEC, pro-competitive regulatory reform be on the agenda for the GATS 2000 negotiations. We made a start in this area by including the U.S.-Japan bilateral insurance agreement in the GATS Financial Services Agreement. These insurance provisions deal solely with creating a pro-competitive regulatory environment in Japan and were aimed at leveling the playing field for foreign insurers in the Japanese insurance market. Of possibly greater importance, however, is the fact that, if these provisions were fully implemented by the Japanese - an issue of contention currently between the U.S. and Japan - Japanese insurers, themselves, would eventually be in a far stronger financial and competitive position internationally than they are today. I can promise you that, as a trade advisor to President Clinton and a member of a number of industry groups which have already looked at the issues I've outlined today, I will press for the GATS 2000 negotiations to include both meaningful market liberalization in those countries where financial capital and expertise is so sorely needed, and for principles of pro-competitive regulatory reform essential to maintain solvent, stable and competitive financial markets. I have no illusions that the path will be easy. But, there is much to lose if we fail. Globalization and the spread of technology have woven our interests together in economic and strategic relationships to which we are inextricably bound. We must do all we can to ensure that the fabric of these relationships is made of whole cloth and that it does not unravel because we didn't do all we could to maintain its strength and durability. With this in mind, let me mention that PBEC will be sponsoring a full day conference, entitled "Regional Reform in Financial Services: Building a Better System," on May 20th in Hong Kong, immediately following the 32nd PBEC International General Meeting in that city. I hope you will consider participating. Information on the conference is available at the back of the room. Thank you for your attention and interest.