Although the short-term challenges facing G20 leaders have rarely been more daunting, failure to address the immediate risks to the global outlook could result in an even more difficult challenge – preserving the system of international trade and payments that has been constructed over the past 65 years and which has lifted millions out of poverty.
This challenge reflects the fact that the global financial and economic crisis has left a legacy of large adjustment burdens. Many advanced economies face the "triple threat" of tepid growth, high public debt burdens, and looming demographic changes that, if not offset by higher productivity growth, will constrain medium-term growth prospects. At the same time, countries that have benefited from their integration into the global economy and have achieved higher rates of growth by exporting to the advanced economies must adjust to an environment of lower consumption growth in those countries. And countries, such as Canada, that prudently avoided the worst of the financial excesses and maintained sound fiscal management, are nevertheless vulnerable to disruptions in the global economy; they too have to adjust to the changes underway in the global economy.
Making the adjustments that are necessary will not be easy; they entail difficult decisions about policy frameworks and responses that have worked in the past, but may no longer be appropriate. One thing is clear: retreating from the consensus on the importance of maintaining an efficient, dynamic international trade and payments system is not the answer. By working together, G20 leaders can resist the temptation to adopt measures that may provide some temporary relief or allow needed adjustments to be deferred.
What does this means in practical terms? To begin, each country will have to identify the adjustments they need to make and implement the necessary policy measures. Such measures will be good for own economies and for the global economy. In this respect, the objective of international cooperation is not get countries to do things that are contrary to their own interests. It is, rather, to reassure them that others are not, in the words of the IMF Articles of Agreement, adopting measures "destructive of national and international prosperity." By doing so, countries can have confidence that their support of open markets and efficient, integrated capital markets will help ensure that the global economy continues to be a source of growth and development for all members of the international community.
On an individual basis, three broad policy measures stand out:
- Governance arrangements to facilitate risk-sharing among euro zone members and to create a euro-zone wide system deposit protection system with clear rules for European Central Bank lender of last resort facilities;
- In the U.S., credible commitments to fiscal sustainability that are conditional on the state of the economy as Larry Summers has proposed, which would anchor expectations regarding future fiscal probity, reducing uncertainty, while guarding against a near-term risk of an unwanted, damaging fiscal shock;
- Clear commitments to inflation targets and concomitant exchange rate flexibility in dynamic emerging economies that are currently conflicted by a desire to prevent excessive appreciations of their currencies and the need to contain inflationary pressures emanating from abroad – attempts to achieve both could guarantee success at neither and impart a deflationary bias to the global economy.
In some respects, the third of these is the most difficult, since the risks to the dynamic emerging economies seem (at present) the most remote. But, make no mistake: China faces significant adjustment challenges. The short-run outlook for growth has dimmed recently, likely reflecting the continuing crises in Europe and the growing recession there, as well as the tepid recovery in the U.S. Slowing growth in China reflects the fact that, with most advanced economies languishing under conditions of weak or negative growth, it will be more difficult for an export-led growth model to sustain previous growth levels. And, over the medium- longer-term, China also faces the prospect of slowing growth owing to demographic factors, as labour force growth slows, and as capital deepening continues. These trends are not unexpected and should not be a source of alarm; indeed, high growth is possible if productivity growth rises sufficiently to offset the decline in labour force growth. Securing this productivity growth is easier in an open, growing global economy.
In this respect, both short- and longer-term challenges and their impacts on the global economy underscore the importance of preserving the global economy as a source of growth, innovation and opportunities to all.
China has long played an important, responsible role in the collective management of the global economy. It played a stabilizing role in the Asian financial crisis in 1997-98 and helped lead the G20 response to the global financial crisis. That being said, consistent with its increasing size and influence, China's obligations and responsibilities to the international system will also increase over time.
A key issue is the recognition that, as the relative economic size of China increases, so too do the demands on its policy frameworks. Of critical importance, whereas it could assume that it was a "small" open economy taking world prices as given at the start of its reform and integration process, it is now sufficiently large that developments in China jointly determine world prices, financial conditions and, of course, global growth prospects.
What this means is that policy decisions made in China affect the rest of the world. But, as noted above, this does not imply that China cannot or should not pursue its self-interest. Yet, its policies should be consistent with its role as a large player. This is China's dilemma: while it remains a developing country in terms of per capita income, the rapid growth of per capita income combined with its large population makes it a very larger partner in the global economy. In this regard, its greatest contribution to global growth would be continued strong, sustainable and balanced growth, consistent with the objectives of the G20 Mutual Assessment Process.
Given the potential for policy spill-over effects, the biggest challenge is to ensure that the monetary policy framework is consistent with this goal. A large, dynamic economy such as China needs to have monetary policy consistent with financial stability and stable growth. These considerations will only grow in importance over time as the economy grows and the financial sector becomes a larger player in global markets.
These considerations underscore the importance of the G20 process.
Summits have two basic roles. The first is crisis manager, as clearly demonstrated in the wake of the global financial crisis. The remarkable degree of cooperation achieved then was made possible by the common threat of a possible collapse in global output, trade and employment and the need for a common response. That response drew on the three key lessons of the Great Depression: to provide liquidity to prevent wide-scale bank failures, to avoid pro-cyclical fiscal responses, and to resist protectionist measures.
Those responses were entirely appropriate. But, as noted above, the legacy of the crisis is a myriad of adjustment challenges faced by G20. Because the nature of these adjustment challenges differ, in contrast to the immediate crisis response, the obstacles to cooperation are greater.
In this regard, the second key role of summits is to foster strong personal relationships and create a structure for ongoing discussions between ministers and senior officials on technical issues. Strong relationships and technical discussions will be needed for the G20 to address the short-terms risks to the global and to avoid a possible retreat from the system of international cooperation that has been constructed over the past six decades.
This post is based on James A. Haley's recent interview with China Daily USA reporter Yuwei Zhang. To read Zhang's story, visit: http://www.cigionline.org/articles/2012/06/g20-chiefs-fight-fires.