In the midst of the worst global economic crisis since the Great Depression, pledges of a cooperative approach among large economies to address the sources of instability in the global economy were one truly hopeful sign. Since then, the combination of worldwide extraordinary monetary ease and fiscal stimuli has enabled the global economy to escape a slump of epic proportions. In spite of these responses, the world economy has suffered a major economic contraction.
The G20, at their third meeting in Pittsburgh in September 2009, recognized that its members “have a responsibility to the community of nations to assure the overall health of the global economy” and announced a new “Framework for Strong, Sustainable and Balanced Growth.” Within this framework, leaders pledged to pursue responsible fiscal policies, prevent destabilizing credit and asset price cycles, promote more balanced external accounts, undertake structural reform to increase their potential growth rates and, where needed, improve social safety nets.
That is the good news. The bad news is that it is far from obvious that the will to cooperate, re-affirmed on April 23, 2010 by the G20 finance ministers and central bank governors, can translate into positive results going forward. The strident verbal shots taken by some G20 members at the perceived failure of others to address courses of action that apparently contributed to the 2008 crisis are a sure sign that cooperation is easier said than done right. The Pittsburgh summit may thus be remembered as the high-water mark of G20 cooperation on global imbalances, unless officials draw some lessons from past attempts at international economic reform. What are these lessons?
Lessons Learned from Past Reforms
First, there is the danger of overreaching. As an example, the 1922 Genoa Conference failed largely because participating countries fell back on their parochial interests while ignoring political problems that made it exceedingly difficult to come to terms with economic reforms. The sheer magnitude of the economic problems and rivalries in post-war Europe, the emergence of the Soviet Union and United States isolationism, overwhelmed the purpose of the talks. Today, we are witnessing elements of the same phenomenon. A grand redesign of the world’s financial infrastructure was the essence of the London G20 summit in April 2009. Since then, Great Britain has sparred with its European counterparts over controlling executive salaries and derivatives legislation. There is debate on whether draft financial reform legislation in the United States truly addresses the core issues, such as the problem of institutions that are “too big to fail,” and meets Europe’s insistence that hedge funds’ activities should be severely circumscribed. Americans and others may well complain that the European Union (EU) has, so far, been unwilling to tackle its own failure to come up with consistent banking and financial supervision rules. Reform, therefore, may well be limited to patchwork changes that will not reduce the prospects of a future global financial crisis.
Second, the G20 must agree on "core" principles to ensure that all members are accountable to the international community. Just as important, the set of economic principles need to be internally consistent with each other. When the Bretton Woods Conference was held to create a new international financial system at the end of World War II the leading powers, namely the United Kingdom and the United States, effectively implemented a system based on pegged but adjustable exchange rates, and on domestic policies geared to ensuring that domestic imbalances which threatened international economic stability would be avoided. But a central flaw in the setup was ignored, namely that a pegged exchange rate could not be sustained when the country at the centre at the world’s trading system was perennially generating excessive balance of payments deficits. Such global imbalances could not be contained either because the trigger was a large economy that would not willingly bend to the will of the international community, or because countries could always rest on the imperative of protecting their sovereignty over policy choices. The ensuing failure of Bretton Woods in the early 1970s was followed in short succession by two oil price shocks and a decade of stagflation.
Third, if the G20 is to succeed where previous attempts at cooperation failed, there has to be a clear demonstration of leadership by key members of the group. At present, this means that China and the United States must demonstrate how they plan to manage a mutually coherent approach to the continuing threat from ongoing global imbalances. There is nothing to be gained in asking a body such as the G20 to coordinate a variety of policy variables when nations at the centre of what ails the world economy are incapable of demonstrating any willingness to bear the required burden of adjustment. The history of the EU is an instructive example. When the euro was introduced, Germany insisted on including a Stability and Growth Pact to accompany the rules for monetary stability in the euro area enshrined in the Maastricht Treaty. Germany would, however, soon undermine the very rules of fiscal probity it insisted that other countries meet because it was domestically convenient to do so. It is even more ironic that, as Greece and other euro area countries experience debt problems, Germany continues to insist that the rest of the euro area toe the line of fiscal rectitude when there are no guarantees that Germany will invoke for itself some escape clause in future. Indeed, the tortuous recent negotiations over financial support for Greece reveal an often neglected aspect of reform, let alone global reform, namely whether the public most affected by the change has the will to tolerate the costs of changes perceived to be large. Matters are exacerbated when the changes are arcane, such as when the subject of reform is the financial system.
The Bottom Line
The bottom line is that cooperation is essential but not sufficient. It must produce arrangements that are demonstrably realistic, tangible, transparent and consistent on behalf of the global economic good, while preserving each country’s sufficient scope to satisfy the perfectly legitimate needs of their own electorates.
Countries are now contemplating strategies to exit from their extraordinary stimulus measures. The receding tide of stimulus will re-expose the structural weaknesses that contributed to poor economic stewardship in the first place. In this context, it seems difficult to us to envisage an effective implementation of the G20’s pledge to provide strong, sustainable and balanced growth without a realistic, principles-based, coherent approach to what each country will bring to these global objectives, and without tangible leadership from the most important players in the system.
Daniel Schwanen is special advisor, programs, to the acting executive director at The Centre for International Governance Innovation (CIGI) in Waterloo, Ontario, Canada. Pierre Siklos is a senior fellow at CIGI, professor of economics at Wilfrid Laurier University and director of the Viessmann European Research Centre.