How Global Trade Rules Put the World at Risk for Financial Crisis

In the wake of the 2008-09 Global Financial Crisis, there was a movement by the International Monetary Fund (IMF), Group of 20 (G20) and many in the academic community to investigate how certain policies could help stabilize the world economy.
A critical focal point for this was capital flow management measures, or taxes and quantitative limits on the flow of money across borders that can slow speculative or unstable borrowing and lending. In 2012, the IMF ultimately developed a new Institutional View, a coherent analytical framework for providing IMF country advice, encouraging countries to deploy these measures in the face of a crisis, and even, in some cases, to prevent one from happening.
While this development was laudable, it was hindered by the lack of a parallel shift in international trade policy. Instead, the system of global trading rules has grown rapidly and locked countries into agreements that don’t align with the guidelines recommended by the IMF and others.
As a result, while there is a growing global consensus that regulating cross-border financial flows is highly recommended for mitigating future financial crises, existing trade and investment treaties are diametrically opposed to allowing this kind of policy tool. Now, as the global economy faces widespread destabilization in the face of COVID-19, there is a critical moment for trade rules to adapt and allow policy space for cross-border financial regulation.
A new journal article published in the Journal of International Economic Law by a team of researchers at the Boston University Global Development Policy Center reveals the extent to which the preferential and free trade agreements notified to the World Trade Organization (WTO) constrain government policymaking for financial stability. By reading almost 300 free trade agreements signed between 1960 and 2018, our study found that the vast majority of free and preferential trade agreements – almost nine out of ten – leave significant policy space for regulating cross-border finance, but critically, this takeaway is not true across the board. In evaluating treaties between Global North and Global South countries, we found evidence of negotiating power imbalances that exacerbate existing inequalities. Furthermore, treaties with the least amount of policy space govern almost two-thirds of the world’s gross domestic product (GDP) and almost half of global investment flows. Overall, global treaties are trending toward less policy space for all in maintaining financial stability, with developing countries the most vulnerable to the impacts of these crises.
Measuring policy space
Seeking to quantify the amount of policy space in each treaty, a composite score of treaty flexibility was created and a collective level of policy space was calculated through aggregation. To create the composite scores, the research focused on five key questions to capture the fundamental differences in policy space between the treaties:
- Which capital flows must countries allow to move in and out of their borders without restriction?
- Is there a safety valve, some general or specific exception for countries facing balance of payments difficulties, or other crisis?
- Is there a special safety valve for countries regulating financial services through prudential measures – a specific policy to slow down domestic borrowing and thereby impacting other flows of capital? When might it apply?
- Are investors able to enforce these rules through investor-state dispute settlement (ISDS)?
- Are there any limitations to such an investor suit in the case of financial crises?
For each of these five questions, the most flexible treaties received a score of one and the least flexible received a score of zero, so that the overall treaty scores range from zero to five. Each of the questions reveals one aspect of the policy space allowed under the treaties in the study. To visualize these data, we correlated our numerical scores with a four-color scale wherein green treaties allow almost all capital flow management policies and red treaties allow very few with minimum exceptions and strict enforcement measures. In the middle, orange treaties tend to restrict most capital flow management, while still maintaining ample safety valves in the context of a crisis, and yellow treaties are usually narrower in scope and have no recourse to ISDS.
By necessity, the research was limited in terms of the number and type of treaties included, the exact treaty provisions selected to measure policy space and in terms of the nuance that could be captured with a simple scoring method of zero to five.
The strictest treaties govern the majority of the global economy
Our initial findings showed the vast majority of preferential and free trade agreements leave significant policy space for regulating cross-border finance. Only 12 percent of all treaties in our data set are in the most restrictive category, as shown in Figure 1 below.
Figure 1: Treaties by Color Coding

By dividing the treaties by level of development, however, flexibility is dominant only in treaties where all parties are in the Global South, that is, countries not identified as “high-income” according to the World Bank’s Development Level Indicator. In fact, treaties that have both high-income and low- or middle-income parties (North-South treaties) have the lowest proportion of flexibility, as seen in Figure 2 below.
Figure 2: Policy Space by Trading Partner

Even more importantly, the image of global treaty flexibility reverses completely when we weight treaties by the relative amount of coverage of global gross domestic product (GDP) – such that countries amounting to 65 percent of global GDP have committed themselves to the most restrictive trade agreements, as shown in Figure 3 below.
Figure 3: Treaty Flexibility as a Percentage of Global GDP

Finally, the research shows a clear trend toward less flexible treaties over time, mandating increasing commitments to liberalize capital flows, as seen below in Figure 4.
Figure 4: Shrinking Policy Space Over Time

Despite the fact free trade agreements and economic integration have come under some criticism with the rise of nationalist movements globally, there is no evidence yet to suggest a substantial shift away from this trend.
New solutions for old problems
There is a clear collision course set between individual country desires to regulate capital flows for financial stability and crafting and negotiating new global trade rules that further constrain policymaking.
Critics of this narrative have pointed out that these treaty terms, while theoretically problematic for countries attempting to regulate for financial stability, have not actually been determinative in any WTO or investor-state dispute under these treaties. The cases that have arisen invoked commitments in bilateral investment treaties, which were excluded from this study.
Nevertheless, the commitments to liberalize capital flows remain an important aspect of global services and investment rules. These treaty provisions are important for foreign investors who want reassurance they will be able to transfer money across borders. Moreover, case law that has arisen under bilateral investment treaties demonstrates what is possible under the treaties studied. The apparent policy space under preferential and free trade agreements shrinks further in the shadow of almost 3,000 bilateral investment treaties.
Finally, as the major enforcement mechanism for these commitments, ISDS has been widely criticized for its inconsistency and unpredictability for respondent states. Even if a particular capital flow management measure has not yet been litigated in an arbitral tribunal, countries may be reluctant to deploy it out of fear of an investor-state suit.
The evidence clearly shows international trade and investment rules are actively narrowing the policy space for regulating cross-border financial flows, space that is legally granted under the IMF Articles of Agreement and to which the scholarly community has recommitted in recent years.
This research and others like it, however, are opening up the possibility for change. As the world faces various crises of health, climate, food, energy and finance, national leaders will need to find new solutions for old problems. They will have to address the tension between what the economic research recommends and what global trade rules require by increasing policy space for regulating economic and financial stability.
Read the Journal Article