The Los Cabos summit comes at a critical time. Indeed, it is tempting to assert that it marks a crossroads in terms of leadership of the global economy.
The global crisis has tarnished the cachet of leadership enjoyed by the advanced economies, which dominated global institutions and international decision making for the past half-century. Europe is consumed in a paroxysm of the euro’s making. Japan continues its decades-long flirtation with secular stagnation and a burgeoning public debt burden. And the United States is seemingly paralyzed by political polarization and Congressional gridlock, even in the face of an unsustainable medium-term fiscal path and the near-term risk of a disruptive fiscal shock. Only Canada, of the G7 group of countries, having avoided the worst of the financial excesses that afflicted others, can lay claim to recognition for sound economic and financial stewardship.
In contrast, dynamic emerging economies outside the core of the global financial system quickly returned to the path of rapid growth from which they were temporarily diverted. That growth path is consistent with slow, steady convergence on the income levels of the more advanced economies. In this respect, the integration and rapid growth of key emerging economies over the past several decades is a true globalization success story. But the gradual convergence of income-per-capita levels is only part of the story: given differences in populations and population growth rates, several key economies — China, India and Brazil — can expect to continue to increase in relative size (in comparison to the more mature advanced economies) for some time.
For much of the past 65 years, the United States provided the leadership to promote international adjustment in a manner that was broadly consistent with financial stability and economic growth. That leadership — firmly entrenched by the Bretton Woods agreement that established the governance arrangements for the global economy at the close of World War II — is being questioned in the wake of the global financial and economic crisis. Of course, the global crisis was not the fault of only the United States. But, arguably, it was exacerbated by a failure of the United States to exercise the global leadership expected and required of a global economic and financial hegemon prior to the crisis.
Under the Bretton Woods system, other currencies were tied to the dollar; the dollar was pegged to gold. Other members of the system chaffed under the “rules of the game” that gave the United States an “exorbitant privilege” in terms of the role of the dollar, but benefited from US growth, investment and, not incidentally, the US security umbrella. The foundation on which the stability of the system rested was sound fiscal policy consistent with long-term price stability. When cracks appeared in those foundations, as they did in the late 1960s, stresses emerged in the system and the Bretton Woods exchange rate system collapsed. The G7 process emerged in the 1970s from the economic uncertainty that followed.
More recently, US fiscal deficits incurred prior to the crisis and the lax approach to financial regulation fuelled the financial market excesses that undermined global financial stability. And, in its wake, the global crisis has created pervasive uncertainty that clouds the outlook for the global economy.
Leadership is required to orchestrate global efforts to deal with the lasting effects of the crisis, avoid dysfunctional policy choices and address the shared challenges ahead. In this respect, we are, arguably, in a time of transition in global leadership. The last such period was the interwar years of the last century. At that time, the United Kingdom’s ability to coordinate the international community was impaired by war debts; the United States was unprepared or unwilling to assume the mantle of leadership. As a result, when the global economy was stressed by financial crises in the late 1920s, the international response was inadequate. The resulting economic stagnation led to the polarization of societies and the radicalization of politics, with tragic consequences for millions.
The Challenge of Collective Leadership
The question today is whether the G20 is capable of providing the collective leadership that is required to deal with the formidable challenges that its members must address. With dynamic emerging economies growing in economic size and exercising their voices in international fora, the United States handicapped by fiscal challenges and political paralysis, and most other advanced economies preoccupied by their economic, financial or monetary challenges, neither the United States alone, nor the G7 collectively, has the capacity to project its will on the rest of the international community. This is evident in a number of areas, including multilateral surveillance and the issue of global adjustment in which each player thinks the others are the problem, providing the resources for the provision of critical public goods and reforms to the international financial institutions (IFIs).
The G20 has assumed de facto responsibility for global economic and financial management, but collective leadership is difficult —the more so the larger the number of players, reflecting a fundamental trade-off between effectiveness on the one hand, and representation on the other. Moreover, the creeping expansion of the G20 agenda beyond the core economic and financial base is worrying. The legitimacy of the G20 was established by the unprecedented degree of cooperation members demonstrated to prevent a catastrophic collapse in global output, employment and trade. While broadening the agenda allows all members to claim success on an issue of their interest or to “commit” to actions they were going to do in any event, it does not address the real economic problems in the global economy, which gave the G20 process legitimacy. The Mexican presidency is to be commended, therefore, for ring-fencing this tendency.
That being said, the combination of adjustment challenges in the advanced economies and potential frustration over voice and representation in key dynamic emerging markets could pose a risk to the global economy. Most disconcerting is the possible retreat from the cooperative arrangements built on the foundations of the Bretton Woods conference. This would be hugely disruptive. Fortunately, however, the cornerstones of those foundations remain — the IFIs are the key institutions of international cooperation, assisting their members through the provision of key public goods. And in this respect, they have demonstrated their usefulness in the midst of the crisis by helping mobilize a concerted international response to the threat of economic collapse. But, going forward, fundamental governance reforms are required to ensure they are viewed by their members as legitimate, credible and effective. In some respects, that is the real challenge of collective leadership that leaders should address at Los Cabos.
Managed well, the process of financial and economic integration that has created the dynamic emerging economies can provide a sound foundation for global growth that would benefit all in a “positive sum” global economy. Mismanaged, the result could be a zero — or worse, negative — sum game of beggar-thy-neighbour policies. The experience of the last “hand-off” in global leadership, from Pax Britannia to Pax Americana between the two world wars of the last century, vividly illustrates the tragic consequences of getting it wrong.