Peter D. Sutherland
Chairman of Goldman Sachs International and
Chairman of the Overseas Development Council

October 4, 1998

I am honored, not merely to have been selected to deliver this year's Per Jacobsson lecture, but by the presence of so many distinguished guests. I am also delighted that two previous Per Jacobsson lecturers could be here this afternoon, and I would like to recognize them: Jacques de Larosiere, the former Managing Director of the IMF and more recently the President of the European Bank for Reconstruction and Development, and Joseph Yam, the Chief Executive of the Hong Kong Monetary Authority.

As many of you know, Per Jacobsson was a major figure in international economic and financial policy circles for more than forty years. He served as Managing Director of the IMF from 1956 until his untimely death in 1963. During his tenure at the IMF, he was admired for his strong leadership, and he was recognized within and without the Fund for his powerful intellect.

This distinguished and dynamic Swede devoted his professional life to sound money. He believed that stable monetary and financial conditions were essential to the promotion of trade, prosperity, social justice, and political freedom. He would have much to teach us today, at this time of difficulty in the international financial system.

The current emerging market financial crisis has ignited a great debate about the character of the world economy and the institutions that govern it. Important questions are being raised about the validity of economic assumptions and the adequacy of institutions we thought we could take for granted in the aftermath of the Cold War.

I will touch on the financial crisis in my remarks today. But my focus will be both wider than the international financial system and more long-range than its current difficulties. I want to talk about a variety of challenges that globalisation poses for the management of the international economy, of which financial volatility is but one -- although certainly the most pressing. And several of the other challenges I want to discuss will remain with us long after the current crisis subsides.

Let us recognize at the outset that the story of the post-World War II world economy is one of remarkable achievement. There was an intentional underlying logic to the design of that economy. What we might call the "logic of 1945" was no less essential to the success of the world economy than were its formal institutions and rules.

The key element of the logic of 1945 was the conviction that, to be successful, international liberalisation had to be anchored in social compacts in which national governments provided for the social welfare needs of their citizens in exchange for public support for an open world economy. Two other convictions were shared by postwar leaders. One held that a sound international economy required the widest possible inclusion of nations from the ranks of the war-damaged and former enemies. The other held that national governments were the only international actors of any consequence, and that, therefore, economic diplomacy would be reserved for them and for the international institutions they controlled.

The performance of the post-war economy has affirmed both the validity of the logic of 1945 and the genius of our institutions. The intensification of economic interdependence has been both a cause and a consequence of growth. World goods and capital markets are more open than they have ever been. And with limited exceptions, major liberalizing steps have been supported by national publics throughout this period.

Recently, however, a qualitatively new world economy has been emerging, and it is this economy that we refer to when we speak of globalisation.

1.  A Global Capital Market

The most obvious way in which today's economy differs from what preceded it is in the volume and pace of international capital flows. Capital account liberalisation, the development of new financial instruments, and new digital technologies have created a fully integrated global capital market of astonishing scope. The average daily value of foreign exchange transactions grew from $15 billion in 1973 to $1.2 trillion in 1995, and daily foreign exchange transactions now exceed total global currency reserves. International capital flows exceed trade flows by a 60 to 1 margin.

2.  Changing Structure of Production

The second set of developments that justifies the assertion that a qualitatively new economy is emerging is the changing structure of international production. In increasingly complex ways, firms are integrating the production and marketing of goods and services across national borders. International transactions that formerly took place between independent entities are being internalized within single firms or corporate alliances. New technologies are enabling services to be delinked from production and traded or performed remotely. And, of course, the relevant market for a growing number of internationally integrated but geographically dispersed firms is global, rather than national or regional.

What is driving the internationalization of production? One analyst put it well: "The minimum size of market needed to support technological development in certain industries is now larger than the largest national market." But firms are also integrating production globally and forming international networks and alliances because these changes allow them to bring under administrative control transactions that previously had to be conducted at arms-length in external markets.

3.  The Benefits of Globalisation

The overall economic impact of globalisation has undoubtedly been extremely positive. Increased trade and capital flows have generated gains in productivity and efficiency that are spurring growth and creating millions of jobs in advanced industrial countries. For many middle-income and developing countries, globalisation has opened the door to export-led industrialization. Foreign capital is building roads, airports, power plants, and factories, and it is giving local entrepreneurs investment resources unavailable domestically. Even though international investors have temporarily deserted some of them, emerging-market countries are aware that a successful return to the global capital market remains essential to their long-term recovery. In many of the world's low-income countries, globalisation is lifting living standards faster than many thought possible a few years ago.

4.  The Political Structure of the World Economy

I want to say a few words about the political structure of the world economy, which has also evolved substantially since World War II.

Dozens of new nations have been born since the end of the war, and a number of countries have become influential economic actors. To be effective, efforts to address key international problems now require the support of a much larger number of countries than was the case after the war.

Another significant change is the emergence of non-state actors. Some private firms have come to rival national governments as consequential players in the world economy. Non-governmental organizations, or NGOs, and research institutions have also gained influence. The stature of firms and NGOs is likely to grow further in coming years.

Let me turn now to the challenges of globalisation. Despite its substantial benefits, globalisation is testing governance at both the national and the international level. These challenges are linked: Many of the things that individual countries find difficult about globalisation are already, will be, or should be matters of international concern.

1.  Emerging-Market Countries and Financial Volatility

It makes sense to start with the emerging-market countries. Not only are they having the most difficult time with globalisation at this moment, but their struggle threatens the economic prospects of many poorer and richer countries.

The financial crisis of the past year, the Mexican crisis of 1994-95, and the Latin American debt crisis of the 1980s all suggest that globalisation's preeminent challenge for emerging market economies is not how to prevent massive outflows of capital, but how to manage inflows. For all their benefits, large capital inflows can increase vulnerability to external shocks and shifts in market sentiment. But long before there is any risk of a catastrophic currency run, capital inflows of the size seen in recent years can generate inflationary pressure, exchange rate volatility, declining export competitiveness, and inequality.

The turnabout over the past two years in Asia's finances has been especially remarkable: from a net private inflow of $100 billion in 1996 to a net outflow of $12 billion in 1997. Capital flows fueled Asia's boom on the way in, and intensified its downturn on the way out, slashing the values of local currencies and forcing borrowers to repay in local currency equivalents a multiple of what they had borrowed in dollars.

The social impact of the crisis has been severe. Years of progress on poverty have been erased in a matter of months. Throughout emerging market economies unemployment is soaring, businesses are collapsing, wages are dropping, and prices for basic commodities are rising.

The crisis has underscored the vulnerability of weak national systems of financial regulation in a globalized financial market. Nearly every serious analysis cites poor banking supervision, inadequate capital standards, government-directed lending, and limited transparency as principal causes of the crisis. Stock and property market bubbles, an excessive reliance on short-term capital, inadequate reserves, and unwise foreign investment decisions also made major contributions to the mess, of course.

Future market sentiment is hard to predict, but emerging-market countries are likely to face the challenge of restoring growth without the help of large amounts of private foreign capital. And when capital flows resume, they will be more costly, and the bulk may initially go to a handful of the largest emerging markets.

Emerging market financial crises also test international economic governance in several ways.

First, the international system lacks effective means of predicting or preventing the kind of national financial crisis that can ignite or intensify a systemic crisis. Following each crisis, sensible changes have been made in national policies, international institutions, and business practices. But the next crisis invariably exposes new and unanticipated vulnerabilities. We are always "fighting the last war."

Second, the international response to financial crises is inadequate. From this point forward, a financial crisis in any single major emerging market economy must be an international concern. The reason, of course, is the so-called "contagion" effect. We can stabilize individual countries that move quickly to implement tough reforms, but we seem unable to prevent them from infecting others. We lack an effective quarantine strategy. As interdependence intensifies and capital becomes even easier to manipulate, the risks of contagion could grow. It is essential that we improve our understanding of its mechanics.

Finally, the current crisis could have a lasting impact on the attitudes of governments and peoples toward the world economy. Many in emerging-market countries are understandably alarmed by the extent to which participation in the global financial system can undermine national policy autonomy. This sense of lost autonomy, together with the extraordinary social and economic costs of the crisis, has begun to undermine confidence not only in globalisation, but in the Western version of free-market capitalism. The pain of adjustment has led several emerging market governments to reverse course on liberalisation, and similar measures are under consideration elsewhere. A sustained and widespread turn away from free-market principles would easily be the most damaging legacy of this crisis.

2.  Low-Income Countries and Marginalization

For the people and governments of the world's low-income countries, the main challenge posed by globalisation is to avoid marginalization. The problem for many of these countries is not what globalisation has or has not done to them, but that it threatens to pass them by altogether. Many of the world's poorest countries lack the human capital, the institutions, the physical infrastructure, and the policies necessary to seize the trade and investment opportunities of globalisation.

A variety of data suggest that marginalization is already a reality. The per capita GDP of developing countries as a whole has nearly tripled since 1960, but real per capita income in Sub-Saharan Africa was only $28 higher in 1995 than it was in 1960. The income ratio between the world's richest 20% and its poorest 20% was 30 to 1 in 1960; by 1990 the gap had widened to more than 60 to 1. The UNDP reported last month that the world's richest 20% account for 86% of total private consumption; the poorest 20% consume only 1.3%. Approximately 1.3 billion of the world's people still earn less than $1 day.

Other data underscore the limited participation of the world's least-developed countries in the international economy. Exports account for about 24% of GDP in the developing world as a whole, but only 9% in the least-developed countries. One third of developing countries have experienced a decline in their ratios of foreign direct investment to GDP over the past two decades.

Global trade negotiations could offer a partial solution to marginalization, but low-income countries are not well-equipped to drive a hard bargain, and, indeed, progress on opening markets to their important agricultural and textile exports has been slow.

Ensuring that low-income countries don't miss out on the benefits of globalisation is a crucial test for international economic governance and for developed countries. Poverty remains the world's most urgent moral challenge. Yet particularly following the end of the Cold War, there has been a disturbing tendency to look on the widening gap between rich and poor with indifference. This is short-sighted. Eliminating poverty is not only the right thing to do; it is essential to fulfilling the world's growth potential. Even if a moral imperative to address human suffering did not exist, it would be in the self-interest of developed countries to confront global poverty aggressively.

3.  Advanced Industrial Countries and Labor Insecurity

Globalisation poses less severe challenges to advanced industrial countries. For them, the main challenge of globalisation is the pressure it imposes on lower-skilled workers. By making it easier -- through trade, investment, and outsourcing -- for firms to substitute lower-skilled labor from one country with lower-skilled labor from another, globalisation forces workers to bear a higher share of the costs of improved benefits and reduces their bargaining power relative to employers. The result is greater job insecurity and downward pressure on wages and benefits.

Capital mobility can also make it harder for advanced industrial governments to promote domestic social welfare. It can undermine the effectiveness of labor legislation and standards. By weakening the tax base, capital mobility can also make it harder for governments to pay for social insurance programs. As economic integration has proceeded, tax burdens have shifted from capital to labor, the less mobile factor of production.

The upshot is that globalisation simultaneously increases the demand for social insurance in advanced industrial countries while decreasing the capacity to provide it. While it has been a net plus for workers in advanced industrial societies, globalisation has increased the vulnerability of some lower-skilled workers. Anxiety about the fate of the lower-skilled fueled some of the protests against EMU-inspired budget cuts and the U.S. Congress's rejection of fast-track trade authority. If this anxiety is not addressed, it could undermine the domestic social compact that has sustained public support for policies of free trade and openness. The fraying of the social compact in the world's principal economies would put the integrity of the international liberal order at risk.

4.  Shared Challenges

In a variety of ways, the political authority of governments no longer corresponds to the geography of the markets and production networks in which firms and workers now operate. The policy capacity of governments at all levels of development is being challenged by this growing disjunction between national political and economic space. I want to highlight several of the most difficult of these challenges.

First, the globalisation of production is making it more difficult for governments to pursue national trade, industrial, and competition policies. Governments can no longer easily distinguish between domestic and foreign firms for the purposes of R&D spending, investment promotion, export subsidies, or import protection. Globalisation also poses difficulties for competition policy, as new international production arrangements sometimes force governments to choose between promoting national industries and limiting excessive market power.

Second, the growth of intra-firm transactions is complicating the work of national authorities responsible for taxation and economic policy.

Third, governments are having difficulty managing electronic transactions facilitated by new digital technologies. An increasing number of global markets have only the most tenuous relationship to geographical territory.

Fourth, globalisation is making it harder to achieve social welfare goals. The mobility of corporate productive assets -- capital, technology, managerial skills -- enables firms to minimize their tax exposure and forces governments to compete for investment with tax breaks and subsidies. This puts pressure on the revenues governments need to pay for social welfare programs.

Finally, liberalisation and changes in the structure of production are generating new trade disputes over policies and practices that have traditionally been regarded as domestic. The fact that some of these policies have deep roots in national history, values, and interests makes the new disputes especially hard to resolve.

Perhaps the most vexing of these new trade conflicts have to do with the relationship between trade, on the one hand, and labor standards, environmental standards, and other social and economic factors, on the other. Influential NGOs and trade unions argue that competition for trade and investment creates pressure to suppress or downgrade environmental, labor, and other standards. This so-called "race to the bottom," they argue, degrades the quality of life in countries where standards are lower and unfairly disadvantages workers in countries where standards are higher. They propose bringing these new issues into the international trading system.

Disputes are already proliferating at the other end of the standards continuum. Countries have initiated several WTO challenges to stringent foreign environmental and health-related standards on the grounds that they are inconsistent with multilateral trade rules. Over time, the list of governments and NGOs with grievances against the WTO is bound to grow.

5.  Global Leadership Deficit

As this discussion of the WTO suggests, globalisation is imposing new pressures on key international institutions. It is also exposing weaknesses in the current system of global leadership.

International institutions are being asked to resolve disputes and take on missions for which they lack either the mandate, the expertise, or the resources. When they fail to handle these new disputes and missions effectively, governments and NGOs criticize their performance and question their legitimacy.

International institutions and agreements are under pressure, and expectations for their performance unreasonably high, in part because international political leadership has been missing in action. Many of the things institutions are being asked to do can only be done either by governments themselves or by institutions with stronger and clearer guidance from governments. The absence of political leadership partly explains the lackluster way in which the world has responded to the current financial crisis. But more fundamentally, inadequate leadership threatens the viability of key institutions and the integrity of the liberal international economy.

Considerable hope for economic leadership has been pinned over the years on the G-7 summit process, and G-7 summits have achieved some success. But the G-7 process started losing momentum and a sense of purpose more than a decade ago. Globalisation issues have been on the agendas of several G-7 summits, but the full range of countries and interests that have stakes in those issues have not been represented at the table. The absence of leaders from key regional powers and other countries has limited the G-7's effectiveness and, most importantly, its legitimacy.

The broad conclusion I would draw from this survey of the challenges of globalization is that nations acting alone can no longer hold up their end of the social compact necessary to sustain an open world economy. That was the core of the logic of 1945. The social compact remains no less essential today, but sustaining it requires a different logic. The logic of 2000 calls for a new division of labor and new forms of interaction among private actors, national governments, and the international system.

1.  The Role of the International System

First, the international system. Problems that formerly were the responsibility of national governments must now be addressed at the international level. This will require an evolution in our understanding of the meaning of sovereignty in an interdependent world.

International institutions and agreements will need to assume two principal missions, both of which will help bolster economic and social management. First, they will need to play a larger role in managing competition and promoting cooperation on the shared globalisation challenges I identified earlier. That will require more active involvement in conflicts over issues, policies, and values that until recently were regarded as exclusively national concerns.

The second critical mission for the international system in the new division of labor will be to help governments better manage the insecurity and volatility associated with globalisation. We have succeeded in our postwar objective of generating economic growth in a liberalizing world economy. While sustaining that growth, we must now enhance economic security and stability in an integrated global economy.

The international system can help do that, in part, by giving governments space -- by tolerating national variations in capitalism and limited measures to cushion the domestic impact of the world economy. No two countries will come to the same conclusion concerning the best way to organize an economy and link up with the international system. Value and interest trade-offs are bound to differ from country to country. An open global economy must accommodate these differences.

The recent volatility has led some to propose a fundamental overhaul of the international financial system. Reforms of existing institutions and changes in their assignments clearly need to be on the table, particularly in the area of finance. But I am not persuaded that we need new institutions. The institutions we have today are not unsound; much of what they are criticized for can ultimately be laid at the feet of governments. With some renovation, and stronger leadership from governments, our institutions should be able to play the role that the logic of 2000 requires of them.

But, above all, we must expand the circle of international decision-makers. It is simply no longer possible to make progress on global economic issues without the participation of key, or representative, emerging market and low-income countries.

2.  The Role of National Governments

What about the role of governments in this new division of labor? Governments and the people who elect them will need to be more prepared to give international institutions and agreements authority to address new international challenges. Sovereignty anxieties, particularly in the United States, will make this a difficult process. We must advocate a sensible middle-ground position on sovereignty: World government is not on the table. It is neither achievable nor desirable. Absolute sovereignty is no longer a viable option either; in fact, going it alone ultimately diminishes autonomy. But voluntarily participating in more robust international institutions and agreements strengthens, not weakens, national capacity to influence events, which is the essence of sovereignty.

There is no better proof of the viability of this middle-ground position on sovereignty than the European Union. The development of the EU over the past few decades has been a noble and remarkable achievement in the sharing of sovereignty. Its nobility derives from the willingness of nations to share power through common institutions. The EU is, of course, a supra-national rather than an inter-governmental undertaking, but it is deeply worrying that even inter-governmental multilateralism is now being attacked by some serious politicians in the developed world.

Having sketched out the logic of 2000, I would now like to make some suggestions for reform. My proposals fall in two broad areas: policy and global governance. I will start with the policy issues.

1.  Avoiding Marginalization

Preventing the marginalization of the world's least-developed countries will require initiatives in three inter-linked areas: debt relief, development assistance, and trade and investment.

a.  Debt Relief

In the short-run, the most helpful thing the international community can do for low-income countries is to reduce the debt of those committed to economic and political reform. Reduced debt payments will free up precious funds for domestic investment and purchases of foreign capital goods.

The pace and volume of debt reduction have been disappointing to date. Under the World Bank's and IMF's initiative for highly-indebted poor countries, as many as six years can pass before relief is provided. Without a change in policy, only four countries will have received any debt reduction by 2000. We will remain on a debt treadmill, with donor countries continuing to give just enough aid to reforming debtor countries to enable them to repay old debts.

The resources needed to offer substantial relief are not prohibitive. We should embrace the British government's proposal that debt reduction begin for all qualifying highly-indebted countries by the year 2000.

b.  Development Assistance

Low-income countries ultimately need private foreign capital to help build the institutional and physical infrastructure necessary to participate in international trade and investment. But they can't attract private capital without better infrastructure, policies, and human capital.

Development assistance remains essential to helping low-income countries overcome this frustrating "Catch-22." It can help low-income countries build the capacity to expand trade and attract investment. It can also reduce poverty and help them contribute more effectively to the resolution of global problems, such as containing the spread of infectious diseases and protecting the environment.

Unfortunately, bilateral and multilateral aid expenditures have been declining for several years. The decline in aid spending is especially regrettable because there is broad agreement today among aid specialists on the key development lessons of the past few decades. These lessons can provide the foundation for a broadly-agreed new international framework for development cooperation. A consensus on how to manage aid could also generate support for increased aid expenditures. What level of aid would be appropriate? The amount necessary to help cut global poverty in half by 2015, the target proposed by the OECD. Surely donor nations can achieve that modest goal.

Resource limitations require us to provide aid on a more selective basis. We will need to make judgments about the commitment and the capacity of governments to implement sound macroeconomic policies, saving and investment policies that promote growth, and measures that open employment and social services to the poor. Policies on governance, human rights, and environmental protection should also factor into our aid decisions. Countries that do not meet these performance standards should receive only humanitarian assistance.

c.  Trade and Investment Policy

Over the long-run, though, aid and debt relief will not suffice. We must also take steps to help low-income countries expand and diversify their trade and attract investment.

Many low-income countries have unilaterally moved to open their economies in recent years. The international system must reward these difficult reforms by expanding access to world trade markets. WTO Director-General Renato Ruggiero has proposed -- and others have seconded -- the elimination of tariffs on all imports from the world's 50 or so least-developed countries. This would not be a costly step for most advanced industrial countries, or even for many middle-income developing countries. This proposal should be on the agenda of the next WTO ministerial, which is scheduled for late next year.

The exports of low-income countries also face a number of non-tariff barriers. These barriers are common in two sectors that are particularly important to developing country exporters: textiles and agriculture. Even after the Multi-Fibre Agreement is phased out early next decade, textiles will still face higher-than-average import tariffs. Along with the proliferation of anti-dumping and countervailing duty measures in advanced industrial countries, these appear to be threshold trade issues for low-income countries.

Finally, we need to do more to help low-income countries negotiate and implement trade agreements. Many of these countries lack the analytical, legal, and negotiating skills necessary to participate effectively in multilateral trade talks. Some are also struggling to comply with existing agreements.

2.  Preventing and Responding to Financial Crises

Now let me turn to the struggle of emerging-market countries with financial volatility. Improving our capacity to prevent and respond to financial crises has clearly become the most urgent priority for international economic reform.

a.  Preventing Crises

With respect to preventing crises, we need to do several things.

On surveillance, the decision by the IMF Interim Committee earlier this year to require more intensive Fund monitoring of capital accounts -- in particular, the risks of capital flow reversals -- is to be welcomed. So also the Interim Committee's suggestion that the Fund adopt a tiered response to surveillance concerns, requiring progressively stronger warnings to governments.

On transparency, as many have suggested, there is no doubt that more timely, accurate, and comprehensive data on public and private finances are crucial. With G-7 support, the IMF has already taken important steps to promote greater transparency. My understanding is that more than 40 countries are expected to be in compliance with the Fund's 1996 Special Data Dissemination Standard by the end of this year. But more can be done in this regard:

• We should publicize the list of countries in compliance with IMF data standards.
• We should require more frequent and detailed reporting on foreign exchange reserves, including the size and maturity of all liabilities.
• We should insist on better data on the foreign currency liabilities of private financial institutions and major firms.
• And we should make compliance with transparency requirements a condition of IMF assistance.

Turning to the supervision and regulation of private finance, I note that there is broad support for the development of standards of best practices for other financial sectors comparable to those the BIS has established for international banking. Domestic banking is an especially needy candidate for tough new standards, but we need new or strengthened standards for securities, accounting, auditing, asset valuation, corporate governance, and deposit insurance. We should also consider establishing for domestic systems of financial regulation and supervision a surveillance system parallel to the one we have for economic policy.

We all agree that financial sector reform must precede full capital account liberalisation. But the necessary reforms are complex and costly, and many governments will need financial and technical assistance to implement them. We also need to investigate ways to help countries build firewalls between governments and financial institutions, to reduce harmful patronage and directed lending.

b.  Responding to Crises

With respect to responding to crises, I have a couple of suggestions.

First, in those crisis situations in which it is clear that the World Bank will be called upon to provide financing or technical assistance, the IMF should develop and negotiate rescue programs jointly with the Bank. The two institutions play complementary roles in crises. Restoring stable growth in crisis countries requires a combination of the short-term liquidity that the Fund is best-equipped to provide and the long-term structural reforms that are the Bank's particular expertise.

The current crisis has produced some overlap between their operations, as the Bank has been asked to provide quick-disbursing loans. This overlap has led some to call for the merger of the two institutions. I do not believe a merger is the right course of action at this stage, as the two institutions have distinct missions and expertise. A wiser course would be simultaneously to clarify their division of labor and require them to work more closely together. I recognize that the staffs and managements of the two institutions do consult frequently, but I think we need to go further. The success of each institution's contribution is directly affected by what the other does. They should jointly develop emergency loan packages and conditions.

The role of private creditors in crises also needs to be reassessed, although not entirely for the reasons usually mentioned. One concern is moral hazard. Some emerging-market creditors have been made whole during the recent bailouts. While this may be an unavoidable result of international rescue efforts, it does pose some moral hazard risks, and those deserve attention.

The more important reason to address the private sector's role in financial crises is that there is a widespread public perception in creditor and debtor countries that large investors are not bearing the full cost of their investment decisions. Whether or not this perception is entirely true, it has political implications that we ignore at our peril. It has clearly contributed, for example, to U.S. congressional opposition to the IMF quota increase.

Several analysts say creditors should take a so-called "haircut" -- a mandatory loss -- whenever there is an international bailout. In principle, I support conditioning official assistance on some amount of rescheduling by private creditors. Korea's agreement with foreign bank creditors earlier this year was a model for public-private cooperation to forestall default. A number of interesting proposals for work-out mechanisms and other methods for restructuring debt have been tabled recently. These proposals deserve careful consideration, but this is an extraordinarily complex problem, and progress could be slow.

c.  Capital Controls

Finally, I would like to comment on the question of capital controls as a means both of preventing and responding to financial crises.

As a general rule, I believe capital should be permitted to flow freely, in search of its best return. There is little doubt that the free flow of capital -- of all kinds -- has been a net plus for developing economies. Long-term portfolio investment has made a valuable contribution to economic growth. Direct investment has been an equally indispensable conveyor of technology and builder of human capital. Nothing that has happened over the past year should cause us to question the value of long-term investment to developing countries, and I can think of no circumstances under which long-term capital inflows or outflows should be controlled.

However, very large inflows of short-term capital may sometimes be a different story, because they can clearly increase the risk of sudden and damaging outflows. Under normal circumstances, I see no persuasive case for controls on flows of short-term capital. If a country's financial system is sound, it should permit capital of all kinds to flow freely. But carefully structured controls on capital flows may be warranted when a country needs a pause during which to reform a weak financial sector. Under what conditions should controls be applied? I would propose four guidelines:

First, controls should seek to deter only short-term, overly speculative inflows at the point of entry into an economy. Long-term portfolio and direct investment should not be restricted. Nor should controls be used to prevent capital from leaving an economy.

Chile's successful use of a tax on short-term inflows deserves consideration by other countries. But Malaysia's new restrictions on capital outflows are certain to deter future private investment, increasing the long-term cost of its recovery.

Second, controls should be temporary.

Third, controls should be simple. Their design should seek to limit market distortions and opportunities for corruption.

Fourth, and most important, capital controls must be used in support of structural reform, not as a means of avoiding it. While they can create better conditions for reform, controls can also limit incentives to undertake reform by reducing the costs of doing nothing. To improve the chances of successful reform, controls should be applied in conjunction with an IMF program.

Some will object to any form of capital control, arguing that governments should not intervene in the workings of the free market. But the multi-billion dollar international rescue packages of the past year already constitute significant free-market interventions. If the breathing space they provide is used for effective reform, controls on short-term capital inflows can decrease the likelihood of costly bailouts. And market actors will also welcome the more stable investment climate that financial sector reform can help create in developing countries.

3.  Responding to Shared Challenges

Earlier I identified challenges that globalisation poses to nations at all levels of development. I have several suggestions for how these challenges should be addressed.

a.  "New" Trade Issues

Efforts to link trade more closely with other issues, such as labor and environmental standards, pose risks for the WTO and for the trading system more broadly. The WTO is certainly one institution in which these linkages could be discussed and researched. But the WTO should not be the lead institution through which issues like these are addressed or resolved. The WTO's mission must remain the reduction of barriers to commerce. To burden the WTO with these controversial new trade issues would decrease its effectiveness in carrying out its core mission without promoting progress on the issues themselves.

Proposals to address these issues in new agreements that would be enforceable through trade sanctions pose perhaps the greatest threat to the trade system. Unencumbered by political agendas, trade can be a progressive force. The growth that trade stimulates generates resources with which countries can improve labor standards and strengthen environmental protection, if they so choose. Trying to turn trade institutions and agreements into tools of social and political reform will lead to protectionist measures and nasty disputes, ultimately reducing trade.

Two things must be done to prevent the WTO from being burdened with inappropriate missions and to reduce the threat posed by new trade issues.

First, rather than seek higher labor, environmental, and other standards through trade, we should seek to strengthen the international institutions and agreements directly responsible for those standards. Stronger institutions and agreements can resolve disputes and promote the gradual harmonization of standards.

Second, the WTO's staff and budget absolutely must be increased. I don't think any of us anticipated how active the WTO's dispute-settlement body would be, nor did we foresee the extraordinary demand for trade research and technical assistance. The rhetoric of support for the WTO by some of its largest member economies has not been matched by resource contributions. The WTO does an impressive amount with a small budget; it would not need much to sponsor a more active program of research, consultation, and technical assistance.

b.  Competition for Capital

The big postwar multilateral trade rounds established a system of rules for the regulation of trade. We now need a similar regime to help referee certain aspects of the international competition for investment.

The negotiations on a Multilateral Agreement on Investment were meant to address some of these issues. As you know, the MAI talks stalled earlier this year. But even if they are restarted, they have what I consider a fatal flaw: they are restricted to OECD members. There is already great suspicion about the MAI in the developing world. Any agreement negotiated exclusively by OECD nations seems bound to receive a hostile reception.

The MAI negotiations -- or any successor talks on investment -- should be brought into the WTO. Not only would WTO talks be more inclusive, but investment negotiations in the WTO could also be wrapped into a broader trade round, where advantageous cross-sectoral tradeoffs could be made. It also might be possible in the WTO context to take up subsidies and other investment issues that have been dropped from the MAI.

The new OECD convention requiring countries to outlaw bribery by their nationals also needs to implemented. The signatories must intensify efforts to pass the necessary ratifying legislation. Once the convention is secure, an aggressive campaign to sign on additional countries should commence. The accession of just a few prominent emerging-market countries could build momentum for widespread ratification, as governments seek to avoid being identified as soft on bribery.

c.  Competition Policy

Finally, a multilateral agreement on competition policy is also urgently needed. Such an agreement can only realistically seek to harmonize the essential elements of national laws, and to stimulate cooperation among national and regional authorities. To try to go further at this time would be futile.

A WTO work program on competition was initiated this year. A wide divergence of views is already apparent. Many developing countries, joined by Japan, have said they will not address concerns raised by the United States and the EU without new disciplines on anti-dumping. Perhaps we have the makings of a grand bargain?

The second major part of my reform agenda has to do with governance. The international system will need more effective governance if it is to meet the challenges of globalisation and help governments improve the lives and protect the economic security of their citizens.

There are two priorities for more effective global governance: stronger international institutions and a leadership strategy that corresponds to the global scope of today's challenges.

1.  More Effective International Institutions

International institutions will be asked to take on a variety of new assignments in the coming years. To carry out these new responsibilities effectively, the institutions must be strengthened. First, they must become more accessible to stakeholders in civil society. Second, their research and national capacity-building efforts need to be expanded, and that will require firmer financial support.

International economic institutions have long been criticized for not being sufficiently accessible to the civil society constituencies that have a stake in what they do. While all of the major institutions have taken important steps to enhance public access and accountability over the past few years -- steps for which they have not received enough credit -- some of their resistance to greater openness and public input has been unreasonable and, ultimately, harmful to their credibility and effectiveness. In this more demanding and volatile political environment, institutions cannot effectively shoulder new burdens and retain legitimacy without becoming more responsive to civil society. However, it should also be recognized that, at present, the resources available to many of the institutions -- the WTO, for example -- are inadequate to properly further the necessary dialogue.

That brings me to the second reform priority for international institutions, which is to make sure they have the resources necessary to handle the new assignments we are giving them. I have already mentioned the WTO, whose budget clearly needs to be increased. Big new loans to countries hit by the financial crisis are straining the World Bank's capital and increasing the riskiness of its portfolio. The IMF has nearly depleted its usable resources. If we want these and other institutions to do more to promote economic stability and security, we will need to take a hard look at the adequacy of their current funding.

2.  A Globalisation Summit

The ambitious reform agenda I have set out will require concerted, high-level political leadership. Existing mechanisms for the exercise of international leadership are inadequate. The G-7 is too narrow in its membership. The annual meetings of the World Bank and the IMF are preoccupied with narrow finance issues. WTO ministerials are devoted solely to trade. The yearly gathering of heads of state for the opening of the UN General Assembly is too ritualized.

The mechanism I propose for marshaling global leadership is a carefully designed summit meeting of heads of state -- a Globalisation Summit.

The Globalisation Summit would be dedicated to addressing the key challenges of globalisation. The meeting, which should take place before the end of 1999, would not be a negotiating session and would not supersede or replace any existing forum. It would involve a structured but informal discussion.

The goals of the summit would be to identify areas of common concern and to try to reach consensus on how to respond to them. The discussion would include an assessment of the adequacy of existing institutions and agreements and their relationships with national governments and private actors. Financial volatility would clearly be high up on the summit agenda, but it would not be the only item on that agenda.

At the conclusion of the Globalisation Summit, the participating heads of state would decide whether to reconvene periodically. We believe they will find such a meeting sufficiently useful that they will choose to meet again. But the widest possible participation in the initial meeting requires, we think, that no government be concerned that it must make a long-term commitment to a process of unknown value.

To be successful, participation in a Globalisation Summit must be fully representative of the world economy. Leaders representing all of the world's major regions and each of its levels of development must participate. While it might be desirable, in principle, for the leaders of all the world's governments to take part in a Globalisation Summit, a gathering of that size would be a logistical nightmare. Two dozen heads of state would perhaps be the ideal size for such a meeting: large enough to allow broad international representation, but not too large to prevent genuine give-and-take. In addition to heads of state, it would probably also be useful to include the heads of the World Bank, the IMF, the WTO, and the United Nations.

Which countries would participate in the Globalisation Summit? Several selection schemes could be explored. One might be to follow the memberships of the Development and Interim Committees of the World Bank and IMF. These include most of the major economic powers, plus constituency representation for smaller economies. Another option would be to include three groups of about eight nations each: all or most of the major industrialized countries; leaders of emerging market nations; and leaders of least-developed countries. Priority should also given to ensuring roughly equal participation from the five major geographic regions: Africa, Asia-Pacific, Latin America and the Caribbean, North America, and Europe.

The precise agenda of the summit should be determined by the participating governments, but a committee of independent experts should be charged with preparing background material and a proposed agenda. The material prepared by the experts group would be used to structure the discussion. It might also include recommendations for action. This structured approach to discussion has been used successfully before, most notably in the APEC context.

Let me conclude by returning to a persistent theme in my remarks.

While my focus today has been the international economic system, I have spent a lot of time talking about issues of political sustainability. Precisely because it has been so successful, the postwar economic system now threatens to undermine its own political foundation. Those of us who work for firms that benefit from the global economy or for international institutions that help manage it have a special obligation to help shore up that political foundation. We can do that by supporting the efforts of governments and international institutions to respond more effectively to the challenges of globalisation.

But in the final analysis, sustaining political support for an open world economy is a challenge for political leadership. It is especially a challenge for the leaders of the most powerful nations, because they must be willing to lead a more inclusive decision-making process than they are accustomed to. Along with many others, I have tried to suggest a number of steps these leaders might take if they choose to act jointly. But only they can supply the vision and courage necessary to move forward.