At this weekend's meeting of G20 finance ministers, talks should focus on some form of coordinated fiscal stimulus to address Europe's sovereign debt crisis. As with the financial crisis in 2008-09, there is no shortage of economic advice from global financial institutions for world leaders. But are they listening and, more importantly, should they bother listening?
In this week’s CIGI Interview, CIGI Senior Visiting Fellow Manmohan Agarwal, a former senior economist at the International Monetary Fund (IMF) and the World Bank, suggests the problems facing the global economy rest not with the actions of elected officials, but with the economic prescriptions that led to the current situation.
CIGI: A lack of political will is often cited as the underlying problem in the current global financial turmoil. Is that a fair assessment?
Manmohan Agarwal: The official briefings at the annual IMF meetings expressed serious concerns about the state of the world economy and there were stirring words to get political leaders to act to correct the problem. The call on political leaders echoed the sentiments of many analysts. I would suggest this is a misplacement of the problem. Even if you believe that political leaders are merely guided by their re-election hopes and desires, given that the current crisis affects all countries, it is likely that many of these leaders will lose in the next election. So it is in their best interest to act to try to influence economic conditions.
CIGI: Then what explains their inability to act?
Agarwal: What I would suggest is that these leaders are not economists, by and large. They have been guided in their policy actions by the experts in major international institutions and their interpretations of developments in financial markets. Now a situation has arisen where their policy choices have aggravated the problem. So they’re in a dilemma as to what they should do and in particular to what extent they can trust the advice they are being given. The big organizations – the European Central Bank, the OECD, the Bank of International Settlements and the IMF – all called for fiscal austerity; this has been pointed out by US economist Paul Krugman, and was the theme of the Toronto G20 Summit. And financial austerity is what the governments delivered. So it’s not the politicians’ fault.
Saying “there’s lack of political will” always seemed to me to be a very weak argument. Because if the solution is there, why wouldn't the politician grab it? What purpose would President Obama or Chancellor Angela Merkel have in not seizing a solution? The only example where you really have a logjam is the United States because of its divided system of government.
CIGI: Given economists’ questionable record in recent years, if they were able to come up with a “magic bullet,” how would they convince politicians to adopt it?
Agarwal: That’s the problem. It’s not that good advice has not been given to the politicians. But whom can the politicians believe? Do they believe Krugman, Stiglitz and a handful of others? Or do they believe a large part of the profession and the financial experts, who are all saying the same thing? And the general tendency of policy makers is to believe the practitioners rather than theoreticians. Politicians won’t accept theoretical arguments. But theoretical economists tend to be more accurate than the people practicisng in the markets.
CIGI What are the implications for international governance?
Agarwal: The IMF lost considerable credibility in developing countries, as previous research at CIGI found. Before the financial crisis, the IMF was running at a loss as countries were not borrowing and there was retrenchment of staff. Recent events have further eroded its credibility. That leaves international governance in a bit of a bind, and politicians have little leeway.
CIGI: What about the advice on the problems in Greece and the rest of the euro zone?
Agarwal: While it is true that the Greek government's behaviour was fiscally irresponsible, this is not true of the governments of the other countries in trouble. Ireland and Spain had surpluses and Italy and Portugal had small deficits. After the introduction of the euro all countries had reduced fiscal deficits. The borrowings had been for investment — in all, consumption had declined. So I would say the advice has been based on the wrong diagnosis.
CIGI: In a recent commentary, you laid out the case for coordination among central banks and treasuries. How difficult is it to achieve that kind of coordination when policy makers are generally told to stay out of the markets?
Agarwal: Coordination is always very difficult on the technical side. Again, let’s not blame the policy makers too easily. The theoretical work on coordination is very unclear on what the benefits of coordination would be and how you would go about doing it.
CIGI: Is the G20 the best starting point for this type of coordination?
Agarwal: It is, and it is a gradual process of learning for the G20 and for the leaders as to what’s achievable and how to do it. One doesn’t go and win the Olympic gold medal overnight. One puts in 10, 12, 15 years of hard work. And yet we expect that the politicians will solve complex problems of the world economy overnight.
CIGI: What are your predictions on Greece’s ability to meet its current debt-reduction obligations and to solve its long-term problems?
Agarwal: Well, Greece is not going to disappear. It’s very clear also that the Europeans do not want to throw Greece out of the euro zone. So something will be done, probably some form of debt forgiveness and Greece will limp along for a while. It won’t be a clean solution, but it won’t be a collapse of the euro zone either. Greece is like a person with cancer – a lot of cancers can be treated, but it’s a long, hard struggle. Europe has come a long way in the last 40 years to get to where it is in terms of monetary integration. It doesn’t want to go back to where it was 40 years ago.