- Background
- Finance is a form of intermediation, a symbolic language that facilitates communication and assessment of values, much as speech helps us to communicate between ourselves as individuals. The role of finance as an instrument of intermediation makes clear that it is not something of intrinsic value itself, in other words, it is a service that creates value in something else, and this value is ultimately connected to trade.
Trade can exist without finance, albeit at a very undeveloped level, but finance cannot exist without trade, for without trade what would be the point of finance? I hope that with this in mind, we can all agree on the link between trade and finance and therefore at least understand why financial liberalization has become a focus of WTO efforts and negotiations. Trade cannot thrive without a healthy and developed financial system, and a financial system will not likely be healthy without free trade. When we constrain trade, we constrain finance. When we constrain finance and trade, we constrain our economy and our society in general.
§ The Arab financial sector was once the strongest and the leader of the world. During the glory days of Moslem hegemony, Arabs invented numbers, algebra, credit systems, and ran the world’s trade and finance system. At the same time, there was open and free trade between the entire Arab world, from Spain to Africa to Asia. There were no borders, no customs, no tariffs, and no impediments to the free trade in goods, services and money. The Arab world was the leader of free trade! Quoting from Stephan Glain’s recent Newsweek article,” As late as the collapse of the Ottoman Empire, a century ago, the Levant was a robust economy of 40 million people with no borders to impede the flow of goods and services.”
§ According to Mr. Abdel-Hamid Mamdouh, the Director of service Division at the WTO, “The creation of the General Agreement on Trade in Services (GATS) was one of the landmark achievement of the World Trade Organization. In fact, the GATS is the first multilateral agreement to provide legally enforceable rights and commitments covering a huge and rapidly growing area of international trade: Services. Moreover, the GATS constitutes indeed the world’s first multilateral agreement covering investment related obligations, since it addresses not only the cross-border trade in services, but all means of supplying a service, including the establishment of a commercial presence in a foreign market. Throughout the Uruguay Round negotiation, the financial services sector was always perceived as a special sector in terms of its strategic importance and political sensitivity, in fact, the interests first articulated by the financial services industry itself almost two decades ago were instrumental in introducing the “services chapter” into the multilateral trading system.”
2. An Ideal Solution
§ Let me propose to you an ideal solution. Let’s create a real Arab Free Trade Area! Let’s look to the glory of our shared history for inspiration, and let us create a free trade zone that elements all borders, customs, export controls, and tariffs between Arab countries. Let us go further and remove barriers on movement of natural persons and trade across the Arab World. Period. Let’s create complete and absolute MFN status between all Arab countries and 100% national treatment across all sectors. What would be the result of such a radical development? Arab trade would no doubt be stimulated far beyond its current moribund levels, and the excitement of the rest of the world over such a development would result in vastly increased business with the rest of the world. But the current straitjacket of economic and financial controls, tariffs and other regulations that currently restrict Arab countries, would begin to crack at the foundation. An Arab world was open within itself and to itself would begin to become strong enough to compete with the rest of the world. It is in all our interests to take this step.
§ Just imagine! If overnight the Arab World was to eliminate all internal customs, tariffs, borders, restrictions on movement of natural persons, on investment, on trade and created a fully free Arab market. Do you think it would destroy us? Do you think we would be worse off? I think the opposite. Why are we so reluctant to do so? Do the American states suffer because a truck driver can drive a load of oranges from Florida to Montana without going through customs, getting a visa, paying tariffs, waiting for hours at every state border, filling countless reams of paperwork for approval prior to and after the transaction? Does it harm the Europeans that English truck drivers carry goods all the way down to Spain without any borders, or vice versa? I think we see that the opposite is true. Do you think that they would find it a winning proposition to change our system? So that they have better control and protection of their own national industries? What do you think?
3. A Practical Solution
§ Unfortunately, I have lived long enough to know that an ideal situation is usually one that is unrealistic to hope for. In fact, one of the solutions I have seen for the Arab countries is the World Trade Organization (WTO). No other mechanism has achieved as great a deal of positive changes in as short a time in our region. What the WTO does is provide a politically expedient excuse for implementing changes, which face strong resistance from domestic constituencies that favor the status quo; this forces change that would otherwise never occur. It provides an external pressure for liberalization that offsets domestic inertia.
- I know that many people in the developing world feel a suspicion if not outright hostility towards the WTO. I understand their feeling, but I am here to say that it might be based on a misunderstanding or misinformation. First of all, WTO membership is strictly voluntary and rule-based; no one forces a country to join; they do so because it is in their interest to do so. All members must live according to the same rules. I know that some people resent that the more powerful and developed WTO members dominate and take advantage of developing countries and use the WTO for this purpose. Well if they do so through an organization that is based on fair and equal treatment, just imagine how bad things would be without the WTO!
- In fact the WTO helps not only the developing countries but also developed countries to resist temptation to give in to protectionist trade measures. The thing about protectionism is that it is predicated on the premise of weakness, the idea that one cannot compete without protection. Another important thing about protectionism is that if nobody else practices it except oneself, if pays handsome dividends. But in the real world, nobody wants to be taken for a fool, and as soon as one party starts, everyone else follows. This happened in the last century when President Herbert Hoover signed one of the most aggressively protective tariff bills ever enacted by the United States. The European countries quickly responded with equally strong protectionist measures and world trade practically collapsed and with it the economy. Accordingly, nations began the GATT system, which has developed to its present institution of the WTO.
- Where do we go from here? That is a question that we really need to ask. Some Arab countries have already joined the WTO; others are still waiting to take that step. There is nobody who will force us to join the WTO. If we want to join the club we can. But what will it mean to us? First it means acceding to certain basic obligations that are required for all WTO members; for example, all members must implement minimum standards of protection for Intellectual Property (IP) in accordance with the WTO agreement on trade-related Intellectual Property Rights (IPRs) and all members are required to reduce tariffs on goods by agreed upon amounts.
- A new opportunity for further liberalization of trade in financial services was presented in January 2000, with the beginning of a new round of services negotiations under the auspices of the GATS. So far, they have progressed satisfactory. Eleven WTO members [1]- from both developed and developing countries - have submitted general negotiating proposals on the liberalization of financial services trade. These proposals raise general policy issues which require multilateral discussions such as classification of financial services, the most prevalent market access barriers in the sector and issues relating to prudential regulation.
- The decision taken in November 2001 by the WTO Ministers meeting in Doha (Qatar) has certainly provided a new sense of direction to these negotiations. The Doha Agenda provides positive negotiations to continue with the same momentum. Furthermore, the Doha Declaration identified specific benchmarks for the submission of the requests by the end of June 2002 and initial offers by the end of March 2003 in the area of services.
- With the submission of bilateral market access requests, the negotiations on services have progressed to an important stage.
- Although we do not have complete knowledge of what is going on bilaterally, the information at our disposal leads us to say that some 20 WTO members have exchanged requests focusing on sectors of their interest, presumably including financial services. And there are certainly more to come - this includes both developed and developing countries, an unprecedented fact indeed in these negotiations.
- It would be certainly difficult to predict with any degree of accuracy what the outcome of the negotiations will be. Notwithstanding, the multilateral proposals submitted, together with the negotiation positions taken so far, have revealed a tremendous interest in achieving higher levels of liberalization in all financial services such as banking, insurance and securities, without jeopardizing the stability and integrity of financial systems.
4. Financial Services and GATS
An agreement on financial services, based on the Most Favored Nation principle (MFN principle) has eluded negotiators on two occasions - at the end of the Uruguay Round and again in July 1995 - until some 102 WTO members managed to conclude a far-reaching set of commitments on financial services in December 1997. On December 13, 1997 104 WTO members signed the Financial Services Agreement (FSA), which in addition to locking in signatories commitments on financial sector openings, also had the effect of extending the GATS to cover financial services.
§ Today, 113 WTO members [2] including China, have binding commitments in the sector - more than in any other sector except tourism. That number of commitments speaks for itself and testifies to the importance that countries attach to the financial sector. However, an important note, the FSA did not succeed in extending liberalization of signatories financial service sectors far beyond their previous level of openness. The significance of the agreement lay more in the principal, than in the actual concessions.
§ The principal of the GATS commitments is that countries agree to ‘lock in’ the level of openness that they can commit to; after that, other nations can count on them not deviating from that commitment. It is also built upon the principle of continuing improvement in members’ commitment to market access. What was most remarkable about the timing of such a significant agreement was that it was reached in the midst of a major financial crisis in South-East Asia, one of the most serious episodes of financial turmoil to hit the world since the Second World War. Yet, a crisis that many feared could have slowed down or halted altogether the global trend towards financial liberalization, had a somewhat different effect for trading system. By taking that step, in such difficult times, governments reaffirmed that greater openness of their financial sectors within a rules-based system offered the only viable and endurable path towards financial stability.
§ When developing countries talk about the WTO and financial services, there is often a mistaken understanding about the linking between liberalization of market access and opening or liberalization of the capital account, or the ability of a country to take measures to protect its balance-of-payments. In the context of the WTO, financial liberalization refers to liberalization of access to foreign financial service providers, and the concepts of Most Favored Nation (MFN) and national treatment. GATS does not prevent members from enacting sound prudential regulations; they simply have to follow a non-discriminatory policy implementing them.
§ Macroeconomic policy management in general, and monetary and exchange rate policies in particular, fall completely outside the GATS realm. Furthermore, the negotiating mechanism of GATS is based on the ‘positive list approach.’ What this means is that countries agree to lock in only those commitments that they specifically list. If they don’t list it then it is not included. A negative feature of this approach is that countries are more reluctant to include substantial commitments and thus far has generally proved to be the case; also with this approach, new innovations in financial services, which is a continually evolving field of business, are not automatically covered by previous commitments. GATS, especially in the area of financial services, has accomplished much less than has been achieved in other WTO instruments such as GATT-94 and TRIPs. A negative list approach would have accomplished more, in which everything was included for all participants, except that which they specifically negotiated not to include. But from the point of view of those countries who are worried about the implications of financial services trade liberalization, the structure of the GATS process, built on a positive list approach, means in effect that even if you are a member of the WTO you cannot be forced to liberalize any financial services, unless you choose to.
§ I believe that based on what I have said already, you will understand that my view is that the liberalization of our financial services sectors under GATS is ultimately in our interest.
5. Key Issues Regarding the Liberalization of Financial Services Trade
I believe it is safe to say that not only is it ultimately in our interest to liberalize our financial services sectors, it is essential to the future of our economy and Arab society. Ultimately, we will find that a dynamic trade sector will not be healthy without a free and open financial services sector. Foreign participation contributes to transfer of technology, development of new services, greater value for clients and more capital for financing of trade and consumer needs.
§ The question we should ask is when and how, not if, we should liberalize our financial services trade. This raises several pertinent issues. First, while most studies show that the long-term impact of liberalized financial services trade is beneficial, there is no clear evidence in the short-term. Over time, competition results in the deepening of the system, introduction of new services and a strong capability to meet the overall finance needs of the nation’s trade system. Particularly in the present era when rapid innovation is taking place, spurred by information and communications technology, and the development of a global knowledge economy, a nation without a competitive finance sector is at a severe disadvantage.
§ On the other hand, introduction of competitive forces into a closed financial system may have mixed or negative results in the short term. I think this is the crux of the issue we need to address today. Arab countries want to know that they will not pay too high a price from opening their financial systems. With the economic and social problems facing many Arab countries, the last thing we want to do is precipitate a crisis. Following liberalization (opening) of the financial sector and introduction to foreign competitors there is a potential risk to domestic banks and other institutions. While there is no clear financial model established to perfectly assess the promise of success or risk of crisis as liberalization is introduced, there are some general indications of which type of environments are more flexible and which are more prone to problems. “Most crises share common features, including macro-management errors, weak or absent legal systems, weak court systems, poor regulation and supervision. Insufficient capital, incapable management, and lack of accounting standards.”[3] Unfortunately, this means that a good number of Arab countries could potentially face trouble. The solution is to begin implementing internal reforms while at the same time planning a process of gradual liberalization. Some of the key issues that need addressing include:
§ Reducing political influence over banking management and loan processes.
§ Implementing the ‘Core principles For Effective Banking Supervision’ published by the Basle Committee on Banking Supervision in September 1997.
§ Adoption of international accounting standards (an authorized Arabic translation is currently produced and published by the Arab Society of Certified Accountants (ASCA) and Talal Abu-Ghazaleh & Co. International (TAGI).
§ Policy makers resisting the temptation to count on an immediate economic expansion as a result of liberalization - i.e. take a long-term view, and plan for the long-term.
§ A careful analysis of the balance to be made between commitments made under the GATS to open financial sectors to competition, with the relationship those commitments would have to parallel the change rate system, and the financial regulatory system.
§ Building of the financial information systems that can provide accurate and timely information on the state of financial risks and exposure.
§ A cautious approach to capital account convertibility in the short-term with a long-range commitment to fully achieve convertibility.
§ Finding a way to explain the necessity of liberalization of both financial trade and financial monetary policy in a way that political leadership and civil society can understand and support.
We see then, that the most important action item on our agenda is reform and liberalization of the domestic financial system.
§ Particularly important are development of new systems of financial information. A good example of this are credit agencies, which up until now have not existed in the Arab World. I am happy to say that Talal Abu-Ghazaleh & Co International (TAGI) is working with USAID to develop the Arab World’s first domestic credit agency. Credit agencies are considered essential to the functioning of the financial system in developed countries yet we somehow have gotten by without them in the Arab World. However, somehow the result is not only reluctance to provide loans, but an inability to do so, because loans cannot be made without proper defaults which are a result of the lack of functional financial information systems in the Arab World.
§ In tandem with this, state ownership masks the severity of problems. A sound regulatory system is essential, which is why a good place to start with is the implementation of the ‘Core Principles for Effective Banking Supervision.’ This reference document was published specifically to deal with the sorts of problems that we are here to discuss today. We need to radically improve the regulatory environment for banks in the Arab World. At the same time, we need to find ways to improve the competitiveness of banks, prior to opening the domestic market to outside competition. This is particularly important because the banking sector is even more significant in the Arab World than in other regions.
- Conclusion
Basically, our urgent priority is to reform, liberalize and modernize our financial systems, irrespective of, and prior to opening up to outside competition. We must also pay special attention to the need for legislative action to lay the groundwork for introduction of new types of services and financial intermediaries that do not now exist here.
However, it would be a mistake not to set strict time lines for progress, and one of the best and proven ways to achieve progress in our region has been to engage in the multilateral process. The best way to attract international support and positive acclaim is through a policy of engagement with the WTO and for the financial service sector this means GATS.
§ While the structure of GATS is such that it may ultimately prove unable to meet the purpose for which it was created at the same time, this structure is well suited to allow a policy of gradual liberalization for the Arab countries, and other developing nations that seek the advantages of trade liberalization with a policy of careful risk management. This will not be easy, and too much caution will be just as bad as too much recklessness. As I noted in my introduction, we need a policy of radical change in conjunction with risk mitigation. The exact nature of this strategy will need to be determined by the finance ministries of each country.
§ I would like to highlight that, ambitious and broad in coverage as it may seem, the GATS deals with some but not all types of policy interventions affecting the financial sector. The GATS’ primary objective is trade liberalization, i.e. the removal of barriers affecting both domestic and foreign suppliers’ ability to establish a commercial presence or to provide services on a cross-border basis. But in so doing, the GATS does not curtail the ability of governments to introduce prudential regulations, both to protect financial services consumers or to ensure the integrity and stability of the financial system. More importantly, macroeconomic policy management in general, and monetary and exchange rate policies in particular, fall completely outside the GATS realm.
§ The financial services sector account for more than five percent of GNP in most developed countries and in many developing countries, being the backbone of all other economic activity, the magnitude of benefits arising from liberalization can be very significant. Recent studies have provided additional empirical evidence of the benefits of liberalizing financial services internationally. A recent study performed under the auspices of the World Bank showed that liberalization of financial services had generated stronger economic growth, particularly in developing countries. Based on a sample of 60 countries, the research found that those countries that fully liberalized their financial sectors have increased their growth rates by about 1.5% in the last decade. This study confirms previous research on the relationship between financial sector openness, financial sector performance, and economic growth. Another study conducted recently under the auspices of the Australian Productivity Commission shows that the complete liberalization of financial services trade is expected to increase world real GNP by around U$ 24 billion. It is worth nothing in that regard that this piece of research shows that, unlike telecommunications (also addressed in the study), there is much larger flow of FDI across the region when financial services are liberalized.
§ However, while these estimates suggest that there are substantial gains from liberalizing financial services, it would be wrong to infer that these gains can be realized simply by opening up markets to foreign competition. Further liberalization - if it is to bring gains for all-cannot be without a sound regulatory environment for the operation of financial institutions. Successful financial reform often requires careful sequencing of policies, and the appropriate sequence between the different areas addressed by reform processes-domestic reform, trade liberalization, and capital account liberalization-depends largely on the particular circumstances of each country. There is no such thing as a “one-size-fits-all” model for financial reform. However, the experience has shown that trade liberalization and domestic reform in the area of financial services can and should be mutually reinforcing. Adequate prudential regulation and supervision, enhanced transparency and corporate governance, strengthened competition policy, proper legal and accounting systems are all preconditions to benefiting from liberalization.
§ Important challenges lie ahead in the negotiations on financial services. On the one hand there is a need to keep improving access to foreign financial institutions through rights of establishment and operation. On the other hand, it is becoming increasingly crucial to ensure that the GATS is responsive to the major technological changes witnessed in the last decade with the advent of Internet and e-finance in particular.
§ Important as it is, the trade dimension must be placed in a broader policy context. It is and must be, a part of the wider discussion about the promotion of international financial stability. Ensuring the strength and stability of the financial sector is seen-and rightly so - as a crucial pre-requisite for the achievement of growth and development. Many countries, particularly developing ones, regulatory structures and legal frameworks are in place to accompany further steps for liberalization. There is arguably a need for continuing international cooperation on such matters. The efforts of various international forces, including the WTO, must be highly appreciated since they represent a major contribution to ensuring the stability of financial systems. The WTO[4] system can indeed contribute to international financial stability by securing liberalization on a non-discriminatory basis; and by ensuring that markets remain open, and will continue to liberalize, and that the momentum for reform is not lost.
As we work together to put together a proper policy response to the multifold challenges and opportunities that technology, globalization, and liberalization offer us, I encourage you to reflect on our glorious past, and to reinvent the Arab World, the past and future leader of global free trade and finance.
[1] Australia, Canada, Colombia, Cuba, the European Communities, Japan, Kenya, Republic of Korea, Norway, Switzerland, and the United States.
[2] Counting EU members states individually
[3] Page 39, Trade Finance and Financial Crises, Published by WTO, 1999; K. Michael Fingerand & Ludger Schutnecht,
[4] For more information on the WTO Agreement, kindly refer to the only authorized Arabic version of the “Business Guide to the World Trading System” published by Talal Abu Ghazaleh & Co. in coordination with the International Trade Center UNCTAD/WTO (ITC) and Commonwealth Secretariat (CS) in London, or refer to the Arabic WTO website www.wtoarab.org