BRICS Mechanism and International Financial Governance Reform

By Li Wei

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BRICS Mechanism and International Financial Governance Reform

By Li Wei

Institute of International relations China People’s University

Catalyzed by the global financial crisis in the year 2008, the most significant changes presented by the international economic governance, especially the financial governance are that the Group-20 (G-20) replaces the Group-7 (G-7) and becomes the most important governance mechanism at the core of the international financial affairs, so the world formally enters the G-20 era.1The G-20 most prominent feature is to accommodate more emerging economies into the international financial governance process, which, to some extent, reverses the imbalance of strength and rights in the international financial system. In 40 years after collapse of the Bretton Woods system, the situation of the international financial affairs jointly monopolized by major developed countries has basically come to an end. In addition to reliance mainly on the G-20, the four major emerging economies of Brazil, Russia, India and China have set up a new cooperation mechanism of the BRICs (BRICs), in the form of holding regular summit and other levels of meetings, to state their collective views on the international financial reform, and to take the lead in regional financial cooperation among member states so as to enhance their voice and influence in the international financial system. In the year 2011, South Africa was formally invited to attend the BRICs summit, to further strengthen the power and position of the BRICS (BRICS with South Africa) mechanism.

Since the 1990s, the international community has witnessed a large number of multilateral cooperation mechanisms, but most of these mechanisms are on the common geographical basis, and a manifestation of economic regionalism.2The BRICS mechanism is lack of a common geographical basis, is a completely multilateral international mechanism based on functional cooperation and emerging economies identity. This raises a new research topic for the existing international institutional theory, i.e. can the BRICS mechanism form a powerful mechanism for international cooperation? What kind of role has the BRICS mechanism actually played in the international financial governance since its establishment? What kind of challenges are faced and institutional improvements needed by the mechanism in the future development? This paper intends to come up with some understanding of the above issues on the basis of studying the joint participation in international financial governance of the BRICS countries over the past four years.

I. The Changing Strength Structure and the Traditional Mechanisms Defects

In the second half of 2008, the global financial crisis triggered by the United States completely spiked the confidence of the international community in the traditional international financial governance mechanisms with the G-7 and the International Monetary Fund (IMF) as the core, thus, leading to the universal mentality for reflection and reform.

In the early 1970s, after collapse of the Bretton Woods system, Western major developed countries created the G-7, which indicates that, after the declining U.S. hegemonic status, major developed countries manage the international financial system by a coordinated "soft system" replacing the Bretton Woods era "hard system". The IMF also correspondingly sees the important changes in its functions, that is developing from exchange rates regulatory in the Bretton Woods era to provide short-term financial assistance in the post-Bretton Woods era, and collaborate with the G-7 to manage the international financial system together. Enjoying an overwhelming share of the IMF, the G-7 has the IMF largely as its implementing agency.

However, since the 1990s, with rising China, India and Brazil as the representatives of emerging economies, the G-7, as the developed countries’ closed club, has become increasingly powerless in the management of international financial affairs. Guided by the G-7 governance model, although no large-scale outbreak of the global financial crisis, yet, regional financial crisis including the Latin American debt crisis, the Mexican financial crisis, the Asian financial crisis, etc. cropped up one after another. The G-7 "stabilizer" role in the global financial markets continues to decay. In response to its own deficiencies in the face of international challenges, and at the same time, with the continuous expansion of issues-related concerns by the G-7, after the end of the Cold War, the G-7 also try several institutional reforms, and strive to become an effective global governance center by expanding members, agenda creation and deepening mechanisms.3

Firstly, improve representation through inclusion of Russia. According to the founding statement of the G-7, the member states shall have two qualifications: the introduction of the market economy and the practice of Western democracy as well as having a significant impact on a global scale, and neither are indispensable. This is a rather stringent access standard. Hence, the G-7 in the 20 years after the establishment admits no new member. Although the G-7 later has absorbed Russia progressively to become a member state in order to encourage its democratization and transformation, yet, Russia is still excluded from the core of the G-7 -- finance ministers and central bank governors mechanisms, so its voice in the international financial agenda is far weaker than the other member states. The Russia’s participation in the G-7 does not change the fact that developed countries monopolize international financial affairs.

Secondly, enhance the effectiveness to solve specific problems by holding dialogue sessions with other countries. Beginning with the new century, the G-8/G-7 has strengthened dialogue with major developing countries in order to strengthen the response to the challenges of global issues such as food security, energy security, terrorism, threats of diseases and economic stability. However, in this framework, the leaders of non-member states are difficult to participate fully in, on equal footing, the discussions and decisions of the major issues.4Moreover, discussions on international financial affairs are still kept within the G-7 framework, so almost no major institutional changes have recorded regarding its monopoly on the international financial governance issues.5

Third, strengthen links with the established mechanism in order to enhance the ability to perform. Since the 1990s, the G-7 has invited representatives of the United Nations, the World Trade Organization, the World Bank and the International Monetary Fund and other important international institutions to participate in the G-7 summit or the dialogue and coordination of working conferences. Through these contacts, G-7 attempts to leverage the ability of these international organizations so as to carry out and implement the resolutions and specific policies adopted by its meetings. Not only that, the G-7 also strengthens its dialogue and communication with international non-governmental organizations, hoping, from the bottom of society, to solve global issues having plagued the international community as a whole.6

Fourth, establish the G-20 Ministerial Conference to strengthen coordination with developing countries. In December 1999, the G-7 invited finance ministers and central bank governors from the world's emerging economies to have the first informal meeting in Berlin. Some scholars point out that the establishment of the G-20 Ministerial Conference is the first step toward a "global" international financial governance reform, and is also a crucial step. Because it is the first time that emerging economies are incorporated into the discussions of the international financial governance structure.7The total GDP of 19 countries included in the mechanism accounts for 81% of the world's total, making it sufficiently legitimate for the global financial governance. However, in the first decade from 1999 to 2008, the routine G-20 two ministerial-level meetings are held yearly, but no actual effect of the financial governance is produced as expected.

Through efforts of the afore-mentioned four aspects, the G-7 vigorously secures its own core position in the international financial governance; generally speaking, the G-7 is extremely conservative on relaxing its monopoly of the international financial governance. These rather limited institutional reform does not help reverse the deepening crisis of legitimacy faced by the G-7.

More importantly, in the first decade of the 21stcentury, the human society has witnessed in recent decades the most significant structural changes of the world economy, i.e. emerging economies have achieved large-scale economic rise, which may be the most fundamental characteristics of the 21stcentury different from the 20thcentury. In terms of a number of economic and financial indicators, emerging economies represented by the BRICS countries are seen among the top ten and begin to pose challenges to international financial governance, international financial rules and many other aspects of international financial system dominated previously by developed countries, which constitutes the most fundamental driving force for changes of the international financial system.

Some scholars call for turning the G-7/-8 into G-20 at the national leaders level is rational and appropriate, at least theoretically, so that this transformation will help to patch up the current crisis of legitimacy faced by the G7-/-8.8

In the end of 2008, in order to win support of emerging economies, developed countries are forced to make more substantive institutional changes, i.e. upgraded the G-20 Ministerial Meeting established about 10 years before to the summit and finalize it as the core platform for international economic cooperation at its 2010 summit in Pittsburgh, having achieved an institutional mutation of international financial governance.

Despite the political demands to participate in the international financial governance system realized by major emerging economies in the process of the institutional changes from G-7 to G-20, however, in the face of the international financial arena dominated by major financial players for decades, emerging economies in the international financial arena show many disadvantages, lack of experience and inadequate strength, and unprepared for agenda-setting, reform objectives, policies and programs, which may reduce the G-20 to become tools again for the developed countries . It is in this context that major emerging economies set up a separate BRICS cooperation mechanism to coordinate their positions in order to strengthen the capacity for collective action within the G-20.

II. BRICS Common Identity and Common Interests

From the article published in November 2001 by economist Jim O'Neill to the research report in October 2003 by the investment bank Goldman Sachs, the "BRICs countries" concept was originally a pure market investment one for finding valuable targets on business investment. Nevertheless, this concept starts nurturing a common identity for the "BRICs" members in a subtle way. This identity indicates that it is not represented by the G-7 developed economies, but at the same time, the label of the ordinary developing country can not fully express its identity, because the "BRICs" countries have bigger scales of economy, faster development and greater international aspirations than the ordinary developing countries. Therefore, the concept of "BRICs countries" just happens to demonstrate their identity so that gradually a common identity takes shape.

The formation of this common identity begins encouraging them to carry out some of the non-institutionalized political contacts. In September 2006, the BRICs foreign ministers met at the UN headquarters for the first time. In July 2008, at the G-8 summit dialogue in Japan, the BRICs heads of state held "subsidiary" talks.

On September 15, 2008, the global financial crisis broke out, the BRICs countries almost at the same time suffered from the criris, which prompted them to come together based on common interests, but not just a common identity. The crisis was the first outbreak of the financial crisis at the global core markets since the collapse of the Bretton Woods system, but because the international economic system is built on the basis of the international monetary system with U.S. dollar as the center, the United States can manipulate the dollar leverage to shift the crisis externally, which makes emerging economies bear the costs of U.S. monetary policy, collateral victims of the global financial crisis.9

By late 2010 after the outbreak of the European debt crisis triggered by the Greek difficulties, it is even more urgent for the emerging economies to get united for mutual assistance and jointly cope with the external financial risks.

In this context, On November 7, 2008 and March 13, 2009, the BRICs four finance ministers were meeting on the eve of the G-20 summit respectively, coordinating the reform of the international financial system and enhance the voice and representation of emerging and developing economies. With deepening of the financial crisis as well as the gradual institutionalization of the G-20, on June 16, 2009, the BRICs members held its first summit in Yekaterinburg, Russia and announced the establishment of the BRICs cooperation mechanism, which officially presents the "BRICs countries" itself on the international arena as an association of nations, and which has important significance in the international politics.

In addition to jointly coping with the dollar hegemony and the European debt crisis externally, the natural resources reserves and industrial advantages of BRICS countries are different with each other, so their economic cooperation has a stronger complementarity and larger space for development.

At present, the economy and trade among the BRICS countries show a basic pattern as follows: China provides plenty of cheap manufactured goods, India provides information software and service products as well as mineral ore while Russia, Brazil and South Africa provide a large amount of energy and mineral resources needed by China's development. A stable mechanism for economic cooperation established among the BRICS countries carries great significance for stabilizing the supply and demand of energy, mineral resources and other commodities and promoting economic stability and sustainable development.

BRICs summit in 2009 held for the first time caused a strong reaction in the international community. The international public opinion and media focus on the relationship between the emerging economies and the U.S. hegemony, arguing that this meeting is the greatest challenge to the United States in the 21stcentury. Some scholars believe that the BRICS summit is the world not asking the U.S. approval.10

After the first BRICs summit, the BRICs countries began the BRICs mechanism institution building. Soon, the BRICs countries establish a series of mechanisms for cooperation such as the meeting of high representative for security affairs, the meeting of foreign ministers during the UN General Assembly, the informal meeting of permanent envoys for multilateral mission and maintain close communication on international issues. Not only that, the BRICs countries have also established within the framework of the G-20 the meeting mechanism of finance ministers and central bank governors. March 25, 2011, the BRICs countries held in Beijing the think tank meeting, aiming at providing intellectual support and policy recommendations for the future leadership meeting of the BRICs.

As core of the mechanism, the Four Summits of the BRICs countries continue to make progress. At the second summit in Brasilia, the Development Bank of the four countries signed an agreement to promote cooperation in the field of infrastructure investment and business investment. In addition, the four countries together for the first time released statistical data, and took the first step sharing statistical information. The third BRICS summit held in Sanya, China, the bright spot of which is South Africa joined the BRICS summit for the first time, the BRICS mechanism developed from four countries to five countries. In 2012, the fourth BRICS summit held in New Delhi, India, the meeting proposed to establish a common development bank, if this goal is achieved, it would mean that the financial cooperation between the BRICS countries has taken a substantial step.

III. The BRICS Demands for Financial Reform

The BRICS mechanism incubated from the global financial crisis from its inception in 2009 has quickly made their independent voices in the international financial system, and adopted a series of substantive measures to pressure the reform of the international financial system. In view of the four summits held and final communiqué released, the BRICS mechanism is concerned about a wide-range of global issues including political, economic, security, environmental and energy issues, but the issue of international financial reform has been the most concerned by the BRICS mechanism. In the four BRICS summits joint statements, the member states position on the international financial affairs is placed in front. Regarding the international finance area specifically, the BRICS member states adhere to the collective appeal on the issue of reforming the existing system.

First, the BRICS members collectively support the G-20 as the core mechanism of the international financial governance. Emerging economies are the main beneficiaries of the upgraded G-20 mechanism, and show very positive attitude in support of the G-20 activities. In the joint declarations of the four BRICS summits, the support given to the G-20 to play a central role in response to the financial crisis is confirmed in very prominent paragraphs, and the G-20 to become the main platform for international economic coordination is welcome. Not only that, each BRICS summit also actively urges the international community to speed up implementation of the specific agreements reached by previous G-20 summits and conducts policy coordination in advance on the G-20 topics for discussions.

The BRICS support to the G-20 means that the BRICS does not deliberately provoke the North-South confrontation, but encourages the North-South cooperation and supports, in the framework of the G-20, major developed and developing countries together to resolve the global financial problems. The BRICS is not for "making a fresh start".

Second, oppose the U.S. dollar hegemony, and promote establishment of a diversified international monetary system. General awareness of the dollar hegemony being one of the main causes for the crisis spreading to the world, so in the previous joint statements issued, the BRICS members promote the establishment of a more diversified international monetary system.

Not only that, over the past four years, the BRICS members put forward more practical measures to reduce dependence on the U.S. dollar as the dominant international currency. In Brasilia summit, the member states for the first time request the finance ministers and central bank governors to study the relevant regional monetary mechanism, and to study and promote the use of national currencies in trade settlement. In Sanya Summit, the members for the first time state to welcome the current discussions on the role of the Special Drawing Rights of the current international monetary system, including the composition of the SDR currencies package.

From mentioning establishment of a diversified international monetary system to strengthening regional monetary cooperation and promoting the local currency trade settlement and further to discussing the status and the composition of SDR, the BRICS members have experienced a more in-depth process on reform of the international monetary system, and proposed more specific measures and programs.

In short, the BRICS members show tendency to reduce the proportion of U.S. dollars in foreign trade and financial system and to strengthen the position and role of the local currencies. For example, China, in the past four years, actively promotes the RMB in cross-border trade settlement, and gains some pilot experiences in strengthening trade settlement in local currencies with Russia, Brazil and other countries, and attempts to avoid dollar exchange rate risks and cost in trade. And among them, Russia is the most active and even promotes the BRICS "common currency".

Third, reform the existing international financial institutions and enhance the voice and representation of emerging economies in international financial institutions. In the first joint statement, the member countries request to play a greater role in the international financial institutions, and particularly to increase the voting quota in IMF and World Bank, enabling them to reflect the changes in the world economic situation. On November 5, 2010, the IMF Chairman announced the quota reform program adopted by the IMF Executive Board, transferring a share of more than 6% to emerging economies so as to better reflect the legitimacy and effectiveness of the organization. This is the most important governance reform program by the IMF since it was founded 65 years ago, but also the largest share transfer programs for the emerging market and developing countries. The voting quotas of the BRICS members in the IMF and the World Bank increase from 10.5% and 11.3% up to 14.1% and 13.1% respectively. In view of the slow implementation of the reform program, the New Delhi Declaration of 2012 directly expresses its concerns about the slow progress of the IMF quota and governance structure reform.

In addition to increase the quota shares, both international financial institutions’ personnel system, especially the high-level leadership selection and appointment are the main focus of the BRICS. The joint statement released in Brasilia states that the IMF and the World Bank should not care about the nationality of the executives candidates, should pay particular attention to increasing the participation of developing countries, otherwise relevant international bodies will be phased out. This is a very strong collective demand on personnel reform of the international financial institutions.

On May 24, 2011, the five executive directors representing the BRICS of the IMF Executive Board rarely released a Joint Statement saying that the selection of the new IMF Managing Director should examine the ability of the candidate rather than its nationality. Regarding the IMF next president to be served certainly by the European,11these five executive directors expressed their concerns. Although the BRICS does not take more substantial joint action in this regard, nor change the fact that the new president of the IMF is still held by the European, yet, the joint statement of the emerging economies still has a symbolic significance. Under the pressure of emerging economies, the IMF president election for the first time in its 60 year-history as candidates world-wide, and Zhu Min, a Chinese national, for the first time is permitted to act as an IMF executive vice president.

Not only that, the BRICS members have also put forward their views on the appointment of the World Bank governor. Since the World Bank established 67 years ago, whose governor is always served by the Americans. So the new governor candidates become the focus of attention. At the G-20 meeting in Mexico in February 2012, the BRICS unanimously requested the World Bank governor candidates be open to the entire world, not just to the Americans, and selection should be not nationality-based but merit-based. This is the first time the BRICS questioned the appointment mechanism for the World Bank. The "Delhi Declaration" more directly states a welcome to developing countries to nominate candidates for the World Bank governor, and reaffirms the IMF and the World Bank managements should be selected through an open and merit-based procedures.

Finally, the BRICS members promote relevant parties to improve the international financial regulatory system, to expand the scope of regulation, to clarify regulatory responsibilities, to develop generally accepted standards and norms of international financial regulation, and to improve the regulatory mechanism. The BRICS members have advocated supervision of the macroeconomic policies by the major reserve & currency issuing agencies and sovereign credit rating agencies.

IV. Challenges and Institutional Positioning of the BRICS Mechanism

The BRICS cooperation mechanism is a practice for emerging economies to turn their growing economic strength into international political influence. Especially in the field of international finance, the BRICS members are latecomers of the existing international financial governance mechanisms. The union of the BRICS is conducive for it to jointly cope with pressure from the West on major international issues and promote transformation of the old international order. However, some special characteristics of the BRICS members may limit the effectiveness of its cooperation mechanism in the future.

First, the limited strength of the BRICS. As the core representative of emerging economies, the strength of the BRICS is mainly reflected in the fast economic growth, especially in the development of the real economy, particularly in manufacturing. Economic development within the BRICS shows some defects, such as Russia's resource curse, China’s sluggish domestic demand, and so on. Compared with developed countries, the BRICS financial sector has many congenital weakness, such as the imperfect financial system, the small scale of the financial markets and the lack of financial professionals. This makes it unrealistic for the BRICS, in the short term, to change the developed countries-led situation while limitedly participating in international financial affairs,.

Second, the differences within the BRICS members. In the economic field, the differences may not lead to cooperation difficulties, but will weaken the identity of the BRICS, and the policy preferences differentiated by the differences may hamper deepening cooperation. Differences in the political system is easy to dampen their identity formation, for example, India often feels itself to much as a democratic country, and shows a deeper sense of intimacy to the political system of Europe and the United States and other developed countries.

Not only that, the internal differences of the BRICS is also reflected in the imbalance of strength and the imbalance of the internal relations development between BRICS members. Among the BRICS, the total economic aggregate of four does not match that of China. In addition, there exists a significant imbalance in the economic relations among the BRICS members. For instance, Russia and China have a total trade volume of about US$60 billion, while Russia and South Africa only US$0.2 billion. This may lead, within the RICS mechanism, to different development of bilateral relations, some countries may only have interest in developing relations with specific members, making it possible to dampen the overall cooperation attractiveness.

Third, the conflict of the interests within the BRICS. It is true that the BRICS members have a wide range of common interests in a series of major international issues such as the reform of the international financial system and the negotiations on responding to climate emission reductions, which does not completely hide the diversified interests existing in these countries. If the BRICS mechanism can not effectively coordinate the internal differences of interest, it as a whole will be difficult to play a powerful role in the reform of the international financial governance.

Firstly, there are trade disputes among the BRICS in the field of industrial finished products. Of trade between China and India& Brazil, India and & Brazil's exports of low-valued primary products to China occupy an absolute advantage, especially dependent on iron ore exports; China's exports to India& Brazil are electronic equipments and other machinery equipments and other high value-added manufactured goods. This trade structure results in the fears by India & Brazil. India imposes most anti-dumping on Chinese products, Brazil has recently increased dramatically trade protectionist measures against Chinese products.

Secondly, the BRICS members witness a fierce competition on the pricing of iron ore, oil and other huge volume commodities, especially the iron ore price negotiations between Chinese iron and steel enterprises and Brazilian mining giants, as well as oil and natural gas prices protracted negotiations between China and Russia. China has increased investments in resources businesses in recent years in Brazil, South Africa and other countries, which has caused concerns about their economic security by Brazil, South Africa and other countries.

Thirdly, Brazil and India recently strongly demand China to appreciate its currency. Following the global financial crisis, both the Brazilian and Indian currency against the U.S. dollar rebound sharply, the two countries worry about their currency appreciation harming the competitiveness of their products; then, they suffer heavily from capital inflow, currency appreciation and inflation so accelerated pace of appreciating RMB can substantially share the pressure.

Fourthly, the BRICS have differences on the approach to reform the international monetary and economic order. China maintains, under the premise of maintaining dollar dominance, gradually reducing dependence on the dollar because China and the United States are in a balance of financial terror, and too fast to reduce the dollar's status will cause huge losses to China. Russia, Brazil and other countries hold dollar assets less, actively advocate the adoption of radical measures to quickly reduce reliance on the dollar.

The abovementioned challenges are possible to weaken the internal cohesion of the BRICS summit. The future of the BRICS mechanism depends fundamentally on whether its existence and development are conducive to expanding the national interests and international influence of the BRICS. For China, the BRICS strengthens the rise of a group rather than highlighting single rise of China, which help to facilitate resistance from developed countries.12In order to develop a capacity to act as an international mechanism rather than just a "talk bar", the BRICS mechanism must clarify its institutional positioning, and the positioning should meet the strength status and interests preferences of the BRIC members.

Firstly, the BRICS mechanism must adhere to the current positioning, i.e., it is only a secondary coordination mechanism under the framework of the G-20. While promoting the reform of the international financial governance, the BRICS members must recognize that the G-20 is the only suitable platform for discussions, and the BRICS mechanism’s significance is to coordinate the position of the emerging economies. The BRICS members should recognize that, without the support of developed countries, the BRICS members are unable to promote progress of the international financial reform, so the BRICS mechanism is not an international mechanism seeking a confrontation with developed countries, but one looking for how to achieve more effective cooperation with developed countries.

Secondly, the BRICS mechanism should establish strict criteria for membership, for example, having a fairly strong international and regional influence, and being the non-OECD members. In the foreseeable future, the BRICS mechanism can admit a few new members from Asia and Latin America. Of course, this means that name of the BRICS cooperation mechanism may have to be renamed for the cooperation mechanism of emerging economies.

Thirdly, the BRICS mechanism should keep its concerns concentrated and learn from the G-7 experience to always keep discussions on the economic affairs, and never challenge the status of the United Nations politically. The BRICS members have different positions on some major political issues. Therefore, the BRICS mechanism should maintain a high degree of consistency with the G-20 on topics for discussions, especially focused on economic and financial issues. Over-involving in political issues, the BRICS mechanism may divert attention of the member states, and is also likely to lose its institutional advantages as a functional organization. Therefore，it should promote the reform of the international financial system and international financial governance as its core objectives and tasks.

Conclusion

The G-20 is the first major innovation for international financial governance mechanisms in the 21stcentury, which gains tolerance and acceptance for the first time of emerging economies to participate in international financial governance. The BRICS cooperation mechanism is an important component of the G-20, which reflects the joint interests demands by core members of emerging economies to reform the existing international financial system. Any single member of the BRICS has limited strength so the establishment of a cooperation mechanism is a realistic way to jointly promote the international financial reform.

As a new forum-type international mechanism, the BRICS members should make hard efforts to overcome various defects and shortcomings in order to reflect the demands of member states and to focus on the common interests more effectively, and play still bigger role.

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[10] David Rothkopf, "Do not need the world approved in the United States", Foreign Policy website, April 14, 2011.

[11] National Executive Board of IMF BRICS selection of the new president should abandon the concept of nationality, Xinhua, May 24, 2011.

[12] Quoted from the Xinhua News Agency, April 16, 2010.