Benefits and challenges of a long-term perspective in financial activities : making the most of capital flows


Remarks by Angel Gurría, OECD Secretary-General, delivered at Eurofi High Level Seminar

Paris, 17 February 2011

Monsieur De Larosière, Monsieur Jouyet,  Ladies and Gentlemen:

It is my great pleasure to be here and speak to you today. The Eurofi High Level Seminars are a trend-setter platform in economic thinking. The fact that this session is organised together with the French Presidency of the G20 makes it even more relevant.

Assessing and promoting the long term perspectives of financial activities is not only a major global challenge and a central priority for the French Presidency of the G20, it is also one of the key objectives in the work of the OECD.

This is a great opportunity to share with you some of our main perspectives and recommendations.

Capital Flows: Great Benefits, Great Challenges

Capital flows are an integral component of international finance. They allow for savings to be channelled from surplus countries to deficit countries, where returns to investment are typically higher. However, as we have witnessed in recent years, these flows can also pose important challenges.

Capital inflows may challenge the absorptive capacity of recipient countries. Excessive inflows can lead the economy to overheat and fuel credit and asset price bubbles. The experience of many emerging-market economies also reminds us that sharp reversals in capital inflows are disruptive and often lead to currency and banking crises.

Let me highlight five policy instruments which we consider crucial to address these challenges:

1. Appropriate Structural Policies: A First Must

I want to start with structural settings, as they can have a strong effect on gross and net foreign capital positions.

Appropriate structural policies could contribute to narrow global imbalances by reducing net capital outflows from surplus countries, while supporting long-term global growth. They can also reduce potential risks associated with capital flows.

For example, greater financial liberalisation and capital account openness could reduce the probability of banking or currency crises, if they are accompanied by more effective prudential regulations.

2. Tax Policy: A Catalyst for Long Term Investments

Tax influences virtually every investment decision, and therefore has a crucial role to play in supporting growth and a long-term perspective in financial activity. We must learn to look at tax policy and its administration as an effective tool to support the reform and strengthening of financial markets. This is essential to ensure that taxation does not introduce distortions and does not promote excessive short-termism or instability.

At the OECD, we have made important progress in this direction. However, most countries’ tax systems still contain longstanding and systemic biases in favour of corporate debt financing. Indeed this is now one of the main remaining distortions in many corporate tax systems, and the need to tackle it has grown more urgent in light of the economic crisis.

As the G20 seeks to rebuild economic growth, a tax bias in favour of debt continues to favour short term risk, and to work against long term equity based investment. And as governments seek to rebuild public finances, a tax bias in favour of debt continues to offer opportunities for aggressive tax planning.

Global capital flows are acutely sensitive to after-tax returns, and this is not an area in which countries can act alone to remove distortions without significant impacts on investment decisions and therefore revenues. Tax policy makers and tax administrators need to work together, internationally. Within the OECD they have a forum to do so.

3. Coordinated Multilateral Action to Promote Orderly Capital Flows.

Both during the crisis and throughout this recovery phase, countries have been exposed to the risks of global imbalances and to the effects of these imbalances on capital flows.

Faced with this uncertainty, policy-makers can see the introduction of capital controls as an effective tool to isolate individual countries’ financial systems from the spill-overs from international imbalances. Recently, several countries that have been targets of destabilising capital flows, have responded by putting in place capital controls.

As capital control measures will continue to be taken at the national level, it is all the more important to reinforce mutual understandings on fundamental rules of the game and mechanisms for cooperation among parties concerned.

The OECD has much to offer in this field. It has accumulated ample experience on capital controls and would like to share this experience with our G20 partners in order to improve international cooperation.

The OECD Code of Liberalisation of Capital Movements has been the key multilateral legal instrument to set basic rules of the game for capital controls during a period of remarkable progress in financial integration. It has also provided a framework under which each country has retained control of its policies, enabling each of them to advance at their own pace towards liberalisation.

Moreover, the Codes have been the basis for a process of international dialogue on capital control issues. What is missing today is the means to extend this sort of international cooperation and dialogue beyond current OECD membership.

4. Supporting Institutional Investors as a Source of Long-Term Investments

The main institutional investors in the OECD – pension funds, insurance companies and mutual funds – held over US$65 trillion in assets at the end of 2009. Governments around the world increasingly recognise that it will be vital to tap into this important source of private funding if our growing need for long-term investments and sustainable development are to be met.

Institutional investors, such as pension funds have traditionally been sources of long-term capital due to the long-term nature of their liabilities. Such long-term investing can contribute to the development of capital markets, providing “patient” capital which can act in a counter-cyclical manner.

Yet behind this rosy scenario lies the fact that our institutional investors are being labelled as ‘short-term’, with investment holding periods declining, low asset allocation to long-term investments (such as infrastructure), and rising exposure to shorter-term trading vehicles,  such as hedge funds.

Why is this?  In some cases regulations are not helping, as short-term market pricing mechanisms are required for accounting and solvency valuations. There is also an important agency issue. Institutional investors often rely on external asset managers and consultants for much of their investment activity, and these external parties are being judged on the basis of short-term mandates and incentives.

Policy makers and regulators need to re-examine the investment and funding regulations relevant to these investors to ensure that they are not inadvertently encouraging a short-term approach.

As outlined in the OECD’s ‘Principles for Private Sector Participation in Infrastructure’, governments need to promote a more transparent investment environment, and provide the right investment opportunities for institutional investors.

Finally, I want to highlight the increasingly important role of financial consumer protection, which relates to all of us.

5. Promoting Financial Consumer Protection

Reforms to our financial systems have made each of us increasingly exposed to and responsible for our own financial planning – whether by selecting our pension products, choosing our mortgage or organising personal debt. We too need to act as long-term savers providing stability and much needed capital to the financial system.

Financial education, financial inclusion and consumer financial protection are three essential components in the policy trilogy to empower consumers in the financial market place. While the G20 issued principles for financial inclusion in 2010, the other components were still missing up to now.

The OECD thus welcomes the new G20 mandate related to enhancing consumer protection and the strong support from the French presidency. We are already working closely with G20 countries (in fact 74 countries) on financial education through our International Network on Financial Education. We are looking forward to contributing to the G20 agenda on this most important issue.

Ladies and Gentlemen:

We are still facing risks, but we are also facing a unique opportunity to build a stronger, cleaner and fairer global economy. For this to happen we will need to promote a significant shift in policy-making to introduce together a new era that favours long term investments for sustainable development. The OECD is eager to work with you on this challenge. Count on us!

Thank you very much.

OECD and the G20


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