June 4, 1996
|Contact:||C. Fred Bergsten||(202) 328-9000|
|C. Randall Henning||(202) 328-9000|
Washington, DCThe Group of Seven (G-7) finance ministers have become almost totally ineffective in recent years and the world economy has suffered substantially as a result. The group achieved dramatic successes in the past, however, and could again assert effective leadership of the world economy through adopting new systemic arrangements to promote currency stability and to avoid Mexico-type financial crises. The summit of G-7 political leaders in Lyon, France on June 27-29 should launch this process by building on steps initiated at their last two meetings in Naples and Halifax.
The decline of the G-7, its causes and possible remedies are analyzed in Global Economic Leadership and the Group of Seven, a new Institute book by C. Fred Bergsten and C. Randall Henning. The authors argue that the G-7 has failed repeatedly in recent years:
This dismal record derives in part from traditional disagreements within the group, particularly between the United States and Germany, over its basic goals. Should it give priority to fighting unemployment or inflation? Should surplus or deficit countries lead in adjusting international imbalances? Should the G-7 members address financial problems globally as a group or divide up responsibilities along regional lines? These conflicts have become more acute with the relative decline in American power, the growth in the relative power of Germany as leader of an increasingly integrated Europe that focuses on its internal problems, and the reduced proclivity of Japan to side with the United States within the G-7.
The major source of G-7 decline, however, is a growing consensus within the group that effective coordination is beyond its grasp. Its members have implicitly concluded a "nonaggression pact" under which they eschew serious criticism of each other even when policies are far off track. The United States, despite the stated goal of the Clinton Administration to "revitalize the G-7," was afraid to ask for foreign help in rescuing Mexico or supporting the dollar on some occasions. The G-7 did not even address the European monetary crises of 1992- 93, and has not addressed the potentially huge global implications of monetary union in Europe. Bergsten and Henning argue that this loss of will by the G- 7 is based on an erroneous interpretation of several fundamental shifts in world economic conditions:
The authors conclude that the G-7 can and in fact must be revived, albeit with a different focus than in the past. It should seek to create a more stable currency and financial system, rather than attempting to fine tune the world economy à la earlier "locomotive strategies." It can emphasize the use of currency arrangements to avoid international imbalances now that the United States, the European Union and Japan are structurally similar in their (moderate) reliance on trade. It should seek to induce closer policy coordination through the new currency commitments, as has been achieved under the Bretton Woods system of fixed exchange rates in the 1960s and the European Monetary System during the past fifteen years.
Based on these principles, Bergsten and Henning recommend an action plan to revive the G-7:
Installation of a new exchange-rate system is particularly important. An effective target zone regime could have deterred Japan from its easy monetary policy in the late 1980s, thereby avoiding both the "bubble economy" and the weakening of the yen that produced Japan's subsequent huge trade surpluses. It would have promoted timely appreciation of the German mark shortly after unification in the early 1990's, avoiding high interest rates and prolonged recession in Europe. It would clearly have avoided the excessive rise of the yen in early 1995, prolonging the Japanese recession and raising widespread fears of a financial crisis in that country. It might even have limited the excessive rise of the dollar in the middle 1980s, and pushed the United States toward lower budget deficits.
The authors conclude that the G-7 financial officials are unlikely to reform themselves. They have never done so historically, and all major monetary advances have been decided by political leaders. The monetary authorities have a particularly strong bureaucratic preference for the current regime of flexible exchange rates, despite its poor results, because it enables them to blame "the market" for all problems and to shift the burden of responsibility to other parts of their governments (notably the trade officials who must battle protectionist pressures that result from currency misalignments).
Bergsten and Henning thus call on the G-7 summit of political leaders to launch the reform program, in light of its potential for substantially improving both global economic outcomes and overall relations among nations. They applaud the initial steps that the leaders took in this direction at Naples in 1994, when they expressed considerable concern about international financial developments and called for a review of their institutional structure, and at Halifax in 1995, when they directed initial steps to deal with future Mexico-type crises. The upcoming summit at Lyon on June 27-29 should expand the latter initiatives and commence the needed effort to stabilize currency arrangements, with final decisions to be taken at the 1997 summit in the United States. The United States and Japan should begin the currency stabilization program by agreeing on a yen-dollar target zone centered at 100:1, in light of the critical impact of that particular exchange rate and the destabilizing gyrations that it has experienced over the past twenty-five years.