28 January 2009
The creation of the G20 reflects the bad instincts of politicians. A rushed decision to pretend that "we are in command", with no ex ante substance, poor preparation, and conflicting aims, can the G20 do some good when it meets in April in London? The odds are clearly dark, but miracles sometimes happen. Here are a few ideas.
Dealing with the original sin
There is something strange with the creation of the G20.
For years, the G7 has been pronounced in terminal phase and we have been debating how it could be replaced.
One option was a narrow leadership, the Gang of Four (China, the EU, Japan and the US).
The main advantage of a G4 would be its size, best for conducting effective negotiation. Its drawback would be, well, its size. Leaving out some important players would undermine its legitimacy. After all the G4 would roughly be the G7 plus China, and the G7's main weakness was that its leadership was no longer recognised in the globalised world.
The opposite option was to seek acceptance by being wide.
But wide means that it will be very hard to achieve common ground among a large number of countries with diverging interests and at different stages of development. No easy choice, really.
With the G20, a plausible decision has been taken, but for the wrong reasons.
In the midst of a ferocious global crisis that revealed how little they were organised to deal with integrated markets, the leaders clearly wanted to show that they were ready to take the challenge. The more of them, the more global they would be and therefore, they thought, the better able to respond on the right scale.
The problem is that we were then facing a financial crisis, which called for joint action among the financially-significant countries. Not Russia, South Africa, India, or China, but Hong Kong, Singapore, and Switzerland. The big countries may be needed, but not for this task.
It may be too late now to craft a new G-something. Having won a seat at the high table, no country will want to be dismissed. So the G20 will have to deal with the "original sin of its own creation".
No silver lining
Since the Washington meeting in November 2008, concern is shifting from financial markets to a worldwide recession. Could this be a silver lining that makes the G20 relevant at the right time?
It would seem that the world now needs that all countries that can afford it to undertake strongly expansionary policies. With monetary policy partly or fully incapacitated, this means fiscal expansions. Here we face a clear externality. It is in the interest of each government to rely on foreign fiscal expansions while doing little at home. The risk, therefore, is that there will be insufficient stimulus. The G20 has a role to play.
Can G20 coordinate fiscal expansions?
Unfortunately, there might be little to coordinate at the G20 level. To start with, most of the emerging market countries are facing a decline in external demand, which concerns products that domestic consumers and firms buy in very limited quantities. A fiscal stimulus is likely to do little to restart the industries that are the usual engines of growth. In addition, most emerging market countries have limited fiscal policy tools at their disposal. They can raise spending on domestic social spending or on infrastructure, which will help them cushion the blow but would not weigh much on world demand. For example, what can Saudi Arabia do to pump up demand in Europe?
In addition, it remains very unclear how the stimulus effort could be apportioned among the G20 countries. The only example of coordinated fiscal policies harks back to the G7 Bonn Summit in 1978, which foresaw fiscal expansions to be carried out by Germany and Japan. Reaching agreement took considerable time - the principle of coordination had been endorsed a year earlier - and created much aggravation. Worse, the lags meant that the agreed-upon policies turned out to be pro-cyclical.
Still, there are things to be done
All this suggests that it is most unlikely that the G20 Summit in London will be part of the solution that the world needs to exit from the current crisis. Yet, now that it has been created, the G20 should try to prove its usefulness. There are many good things that it can try to do, even if their effects could be felt after the crisis has receded (on the assumption that the crisis will not be long-lived).
A resurgent IMF short in cash
A year ago, a financially hard-pressed the IMF was under a streamlining process. In just a few weeks, it has agreed to five stand-by arrangements. If history is any guide, the likely combination of low growth and rising interest rates in developed countries when they bottom out will create difficulties in many developing and emerging market countries. One other lesson of the past is that emergency lending to globalised countries requires considerable larger resources than it used to be the case. So far the IMF has been able to rely on friendly countries to increase the size of its packages, but this is both cumbersome and unhealthy, for both the IMF and the recipient countries. An urgent task for the G20 is to agree on increasing the Fund's resources. Several options exist, from a new allocation of SDRs to borrowing from all member countries. All the options have proven to be controversial. The G7 has been unable - possibly unwilling - to break the deadlock. The G20 has a chance to show that it can do better.
IMF governance once again: Focus on the Executive Board
The link between resources and influence lies at the heart of the IMF.1 In addition, the spirit of setting up a G20 clashes with the distribution of power in the Fund. There is little appetite to reopen the issue now, soon after years of difficult negotiations delivered a merely symbolic redistribution of 5% of voting rights. Yet, more important changes can be achieved without engaging in another bruising zero-sum game. They involve the composition and role of Executive Board, the decision-making body.
Nine of the 25 Board members currently are European, including the Managing Director. Even though their collected share of the votes falls short of the same proportion, merely sitting and debating in the Board gives Europeans an out-of-proportion sway of decisions.
Statements that Europe's "right" to the Managing Director position would be forfeited represent a step forward, but more can and should be done. EU member countries could offer to form a single constituency with a single seat. This would give the EU 32% of the vote, and 23.5% of the vote for the alternative of a euro area single constituency. Collectively, the Europeans would benefit from this change since they would have de facto veto power on issues for which they care.
The Board would also gain in effectiveness since its size would shrink to 18 members. Future reallocation of voting rights might also become easier. For instance, with a 30% share of world GDP, the EU could offer 2% of its votes and still remain a major player.
An alternative improvement in IMF governance would be change the role of the Executive Board.
Currently the Board meets almost daily and gets involved ex ante in myriads of decisions, big and small alike. This means that the Executive Directors must reside in Washington, that they are far from their administrations and therefore rather influential at home.
Powerful Executive Directors would be high-level and influential civil servants - or even political appointees - who would travel, say, once a month to Washington to review decisions - possibly ex post - and set the direction of policy, leaving the Managing Director in charge of implementing that policy. In addition to improving managerial effectiveness, this would lessen the importance attributed to voting rights.
Global regulation and supervision
The failure of regulation and supervision on the way to the crisis is only matched by the failure of banks to exercise internal prudence. Both problems are bundled; good and well-implemented regulation would seriously limit bank misbehaviour.
A number of proposals on how to better regulate banks and financial institutions are currently being prepared or actively debated (see for example Brunnermeier et all 2009).
Rather than looking at the merits and shortcomings of these proposals, I rather wish to consider a related and simpler question: why have governments failed? This is the issue that the G20 Summit should consider.
It would be utterly counter-productive to involve heads of state and governments into the details of bank regulations, which require at least a PhD in Finance or a decade of professional experience, preferably both, to comprehend. They should receive an honest briefing of the failures of their administrations and an explanation of why country-level regulation and supervisions is nonsensical in the globalised world that they are meant to protect and develop.
It's the politics
As superbly explained by Kane (2008), regulation and supervision are "infested with incentive conflicts". Part of the conflict is due to political interference, but not only. Turf wars, capture, lack of controls, poor accountability, and competence issues affect most agencies. Righting the situation is not a technical issue, it is highly political. For many reasons, politicians have little incentive, and even strong disincentives, to wade into this swamp.
Similarly, the resistance to global regulation and supervision originates in government. All agencies want to preserve their autonomy. All governments instinctively want to preserve their ability to defend national champions, and that applies to the financial sector as well. Yet, national-level regulation and supervision is unlikely to solve the massive regulatory arbitrage that has been amply described in the various analyses of the crisis.
A depressing thought or a call to match words with deeds?
There is little prospect of achieving a better regulatory environment, and therefore to solve the private governance and prudential issues that have been lethal, unless governments tackle the failures of existing arrangements. These failures are not due to bad luck, but to incentives deeply ingrained in politics.
Realism suggests that, at this stage, the G20 is unlikely to seriously overhaul the existing regulatory structure and institutions, which virtually guarantees more financial crises in the coming years.
This may be depressing, but it needs not be. It points to how the Summit should be run.
G20 leaders should not be asked to approve technical issues and to ignore the political ones. Instead, they should be fully briefed on the fact that their agencies are ill-adapted and structurally weak, and why. Faced with such a diagnosis, their reaction would be to pledge undefined action and to do nothing for the time being. At least, the tough political issues would enter the official agenda.
That, in my view, is the best that we can hope for and it is far from negligible. After all, the world was not created in a day.
Editors' note: This column is a Lead Commentary on Vox's Global Crisis Debate page; see further discussion on Vox's "Global Crisis Debate" page.
Brunnermeier, Marcus, Andrew Crockett, Charles Goodhart, Avinash Persaud, and Hyun Shin (2009). "The Fundamental Principles of Financial Regulation", CEPR-ICMB. Downloadable from VoxEU.org
Kane, Edward J. (2008) "Regulation and Supervision: An Ethical Perspective", unpublished paper, Boston College.
Kenen, Peter B., Jeffrey Shafer, Nigel Wicks, Charles Wyplosz (2004), "International Economic and Financial Cooperation: New Issues, New Actors, New Responses", Geneva Reports on the World Economy 6.
Charles WyploszÂ© voxEU.org