The author is one of several CIGI-sponsored Canadian university students who attended the INET conference, Crisis and Renewal: International Political Economy at the Crossroads, at Bretton Woods, NH, April 8–11, 2011. Each student was asked to write a short reflection on the conference themes.
Introduction
The importance of re-evaluating the nature and structure of current governance systems was made abundantly clear at the recent INET conference. Gordon Brown, the former prime minister of the United Kingdom, noted that for the first time, the combined gross domestic product (GDP) of the United States and the European Union was smaller than that of the rest of the world. Thus it will become increasingly important to foster agreement between countries that may not traditionally be allies. Cooperation is often difficult among countries with strong allegiances, to say nothing of countries with complex and perhaps hostile histories. For this reason alone, this process must be afforded every advantage — global and national institutions must truly be designed to facilitate negotiations, and not be a hindrance. The world economy is increasingly global in nature. It will no longer be dominated by one or two nations and existing bodies such as the International Monetary Fund should make convincing its member countries of the importance of cooperation a priority.
Financial Stability
Unsurprisingly, a large portion of the discussion at the conference was devoted to large, international financial institutions. Andy Haldane from the Bank of England demonstrated that equity flows have grown tremendously over the past 30 years; perhaps more importantly, the composition of global equity holdings is now far more reflective of the composition of equity in emerging markets. This implies a huge flow of capital from developed to emerging markets and suggests that, if capital controls are needed now (which seemed to be the consensus at the conference), this need will be magnified in the future. Furthermore, the stock of international equity will be held increasingly in emerging economies, requiring the developed economies to include the smaller economies in negotiations towards international financial accords sooner rather than later.
Any agreement will need to involve and address the large international banks, but this is a very difficult task. As Andrew Sheng of the China Banking Regulatory Commission and Simon Johnson of the Sloan School of Management discussed, the largest banks now have more power than many governments. The current capital adequacy ratios, which largely reflect the wishes of the banks and not objective research, are evidence of this.[1] Any regulation of these banks will require a great leap forward in international cooperation; only when countries negotiate together will a sufficient stabilization policy be developed.
The next financial crisis is not far on the horizon. This is because the large reserves accrued by the central bank of China may be prone to large movements. Victor Shih of Northwestern University notes that China's capital controls are more porous than many believe. A slight change in the investment patterns of the wealthy will have a great effect, as they control much of the capital and are very aware of foreign investment opportunities. Cross-border flows of capital are a significant source of volatility, and to a greater degree this capital will emerge from China. Adding to this uncertainty is the source of growth in Asian economies. Brad DeLong of the University of California suggests that the growth is “catch-up” and cannot be relied on to continue.
Fiscal Policy and Investment
Fiscal policy is one of the major economic tools made available to governments. During severe recessions such as the recent financial crisis, the use of this tool is brought into question for two basic reasons. The first is the efficacy of using government spending in an effort to boost employment and output. The debate focuses on the size of the “government multiplier. ” This can be defined as the contribution that $1 of government spending creates towards GDP. Estimates tend to range from zero to something between unity and two.[2] The second is the issue of timing: It is unclear whether modern governments can quickly devise and approve an effective spending plan.
Both of these issues were addressed at the conference, though not directly. A typical refrain of those who offer direction for the economy is that we must innovate and invest in order to maintain a healthy level of growth. Joseph Stiglitz from Columbia University suggests that this should be the focus of western governments, rather than short-term deficit reduction: “a large-scale public investment program would stimulate employment in the short term, and growth in the long term, leading to a lower national debt” (Stiglitz, 2010: 1). Refocusing on the long term adds further justification for government spending and suggests calculations of the multiplier should take these benefits into account.
Phillipe Aghion of Harvard University suggested that economists should abandon their usual distrust in government intervention in investment. As these policies are used, we should instead focus on how to increase their effectiveness. Aghion thinks that policy should emphasize market flexibility by encouraging investment in such a way that it does not hinder competition. His suggestion is to devise a system that extends the “automatic stabilizers”[3] already used in the labour market to firms. In short, the state should not only act as an insurer, but also as an investor.
Conclusion
The most pressing need in the international community is a system for regulating the flows of capital between countries. As I have discussed above, the separation between developed and emerging economies is shrinking as banks increase their foreign presence and more equity flows from large to small economies. The risk for financial contagion is high and was a primary cause of the recent global recession. Any international agreement will require the inclusion of more countries than in the past, making the task that much more difficult. It would be wise to make an aggressive push towards this goal while the memory of a painful recession, and thus the global appetite for reform, is high. On the domestic front, achieving global financial stability will aid in attaining the desired policy goal of increased innovation and investment.
The INET conference has had a direct influence on my current research. I am currently exploring the relationship between large firms, credit rating agencies and the government, but have been convinced that the interaction between banks and credit rating agencies is also very important. As capital adequacy ratios are determined, in part, by the rating on each asset held by the bank, the value of a bank's assets is largely subjective and perhaps not as reliable as previously thought.
For more information and videos from the INET conference, visit http://ineteconomics.org/initiatives/conferences/bretton-woods/agenda.
Works Cited
Admati, Anat, and Paul Pfleiderer (2010). “Increased-Liability Equity: A Proposal to Improve Capital Regulation of Large Financial Institutions,” Stanford Graduate School of Business Working Paper. Revised June 2010.
Stiglitz, Joseph E. (2010). “What Lies Ahead in 2011?” Prague. Available at: www.project-syndicate.org/commentary/stiglitz132/English.
Zandi, Mark (2008). “A Second Boost from Government Could Spark Recovery.” New York. Available at: www.economy.com/mark-zandi/documents/Small%20Business_7_24_08.pdf.
[1] An example of such work is Anat Admati and Paul Pfleiderer, “Increased-Liability Equity: A Proposal to Improve Capital Regulation of Large Financial Institutions” (2010).
[2] See, for example, Mark Zandi, “A Second Boost from Government Could Spark Recovery” (2008).
[3] Roughly speaking, this is the system of counter-cyclical (to GDP) unemployment benefits and pro-cyclical tax receipts.