U.S. Refusal to Join Financial Services Pact Is a Big Mistake

Last July 28, 43 nations signed an agreement in Geneva under the auspices of the new World Trade Organization to liberalize trade and investment in financial services. Remarkably, the United States was not among them. Short-sighted opposition from Congress and certain elements of the domestic financial establishment have kept the United States out of an agreement that clearly serves our national interest.

Opponents of the agreement have focused on the issue of “reciprocity,” arguing that foreign countries should provide U.S. companies the same access to their markets as the United States gives foreign firms.

This may seem fair and reasonable, but insistence on reciprocity is flawed in two crucial respects: it flies in the face of long-established trade principles and, when applied to financial services, it does the United States more harm than good.

Let’s begin with the principles. A fundamental pillar of the international trading system is the concept of “national treatment.” It calls for governments to treat all foreign firms operating within their boundaries as they do their own.

For example, when Holland’s NMB-Postbank merged with Nationale Nederlanden in 1993, it ran afoul of U.S. regulations prohibiting banks and insurance companies from being in each others’ businesses. Under national treatment, the United States required ING to divest either its U.S. banking or insurance operations. However, ING could have claimed that the U.S. laws violate reciprocity rules, since no such restrictions applied to U.S. banks and insurance companies in Holland.

A second basic trade principle, the “most favored nation” clause, stipulates that any concession made by one trading partner to another must be extended to all other members of the world trading system. Thus, the bilateral agreements in financial services reached between the United States and Japan last January, and with the European Union previously, would become available to all nations under the WTO umbrella.

Under reciprocity, however, each country would need to apply different rules to each foreign investor depending on the rules which apply in that firm’s home country. The result would be a regulatory nightmare subject to constant conflict and abuse.

Principles aside, opposition to the pact ignores many realities of international competition in financial services, such as the distinction between wholesale and retail services. The former generally involves large, sophisticated international companies which will transact their business in the location with the lowest costs and regulatory burden, and the widest variety of products. Countries that limit competition of these services will simply see that business move offshore.

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In Japan, for instance, neither traditional ties between banks and members of keiretsu (groups of interlocking businesses) nor the presence of “administrative guidance” by the Ministry of Finance have kept leading-edge trading businesses--such as equity derivatives--from moving overseas. And in the area of financial advisory services--acquisitions and privatizations, for example--it is nearly impossible to constrain the flow of ideas and expertise across boundaries.

Indeed, U.S. companies dominate the world’s financial wholesale businesses, accounting for nearly 80% of wholesale and investment banking services in 1994. Of the top 10 companies, nine are American (and CS-First Boston, although Swiss-owned, has U.S. roots). One can hardly argue that U.S. firms are disadvantaged in global markets.

Retail financial services are a different story, since individuals or small firms cannot readily seek insurance or savings products outside their home markets. But the costs of barriers to trade in these areas are borne by the protectionist nation’s own citizens.

Singapore, for example, still requires the management of its Central Provident Fund (a compulsory national savings scheme) to forgo investment in foreign equities or bonds, despite the obvious advantages of international diversification. In Germany, foreigners are barred from joining the national association of mutual funds and must promote their wares in a decidedly hostile environment. (Yet of the 100 top-performing funds available to German investors, 82 were under foreign control.)

Opponents of the WTO agreement point to countries such as India, Brazil, Indonesia or Korea, which restrict access to their growing retail financial services markets in order to protect their home industry.

But what is really at stake here? First of all, reciprocity is meaningless in this context. If we were to retaliate, how many Indonesian insurance companies, or Malaysian M&A; specialists will be barred from the U.S. market? And if they choose to hurt their nationals by restricting the flow of financial services, why should we do the same?

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In fact, our international competitiveness in this industry derives precisely from the unfettered access that financial service providers have to the U.S. market. Foreign participation brings with it innovation and clients, thus adding jobs and reducing the cost of capital to industry.

An excellent example is provided by the city of London. Since the “big bang” deregulation of 1986, the number of foreign entrants has risen dramatically. By 1994, more than 500 foreign banks operated in the city, and recent acquisitions have included such blue-chip English merchant banking houses as Morgan Grenfell, Barings, Warburg and Kleinwort Benson. Yet London’s share of many major international financial services is on the rise, employing more than 600,000 people and adding a princely sum to England’s foreign earnings.

Finally, the changes desired by U.S. firms are already occurring in many places. Recently the Philippines announced plans to allow foreign companies to enter its insurance sector after 49 years of restrictions. Mexico accelerated access to its banking sector after last December’s financial crisis, recognizing the contribution foreign banks can make to stability in its financial sector. The same may happen in Taiwan following last month’s banking crisis. In India, Goldman Sachs recently opened an investment banking joint venture, while Morgan Stanley has gone into business in China.

In sum, it is difficult to understand the United States’ refusal to participate in the WTO’s agreement on financial services. Not only are we leaders in most sectors of this industry, but our tactics provide no incentives for others to accelerate what they are already doing on their own. And in so refusing, we have sacrificed 50 years of leadership in multilateral trade liberalization at a time when the WTO could most use our support.

We can only hope that the Clinton Administration will find a way to save face and rejoin this process before it expires in December, 1997.