by Morris Goldstein, Peterson Institute for International Economics
Op-ed in VoxEU.org
February 19, 2009
The London G-20 summit will take place when the global economy is in recession and in the most serious financial crisis since the Great Depression. In addition to reinforcing their crisis management strategy, leaders will focus on the lessons of this crisis and on what can and should be done to avoid a repetition.
Both the emerging economies and the advanced countries see this crisis as demonstrating dramatically the riskiness of today's global economy and they will want more "insurance" to deal with it. A key issue for the London meeting is what kind of insurance the leaders will create. Will it be insurance that is compatible with open markets, growth, and stability? Or will it be insurance that leads to protectionism, economic nationalism, instability, and stagnation?
Many emerging economies will henceforth regard "decoupling" from crises that originate in the larger advanced economies as a pipe dream. They are wondering how they will cushion the sharp fall in the volumes and prices of their exports. They are concerned that the massive borrowing and guarantees provided by advanced-country governments will crowd-out their own efforts to borrow in the market. The "sophisticated" and complex nature of the financial system in advanced countries now seems to many of them a source of instability not a role model. They will want to know who will serve as a lender of last resort the next time private capital flows to emerging economies suddenly stop. And they worry about the precariousness of their access to the markets of the advanced countries for both their exports and their excess saving.
No doubt some emerging economies will be tempted to conclude that the best insurance is a large stockpile of international reserves and that the easiest way to get it is to seek and maintain a highly undervalued exchange rate by way of large-scale, prolonged intervention in exchange markets. They will say that this is much better insurance than its main alternative, namely, waiting until the crisis hits and then going hat in hand to the International Monetary Fund (IMF) for a large loan.
They will point out that the IMF's access limits for loans are way too low to permit drawings big enough to deal with today's multiple economic shocks. Likewise, disbursements are not front-loaded enough, repayment periods are too short, and the IMF's main lending windows require onerous conditionality. On top of all this, many emerging economies will complain about the stigma of borrowing from an institution that doesn't provide its emerging- and developing-country members with "chairs and shares" commensurate with their growing weight in the world economy. And they will express their resentment that the United States and the European Union still maintain their monopolies on the leadership of the Fund and the World Bank and their vetoes over major policy decisions.
The rub, of course, is that not all countries can maintain undervalued exchange rates or run current account surpluses. Just as important, countries that have to compete with those employing such tactics will rightly regard themselves as suffering from a competitive disadvantage and ultimately will not keep their markets open to those that are flaunting the agreed international rules of the game. And if the designated umpire is not enforcing those rules, there will be a strong temptation to take unilateral action. In the end, as shown by the experience of the 1930s, such a system will break down into a series of beggar-thy-neighbor actions, international trade will contract, and growth and jobs everywhere will be the victims.
Meanwhile, the advanced countries too are grappling with this crisis, as their economies sink into recession, as unemployment rates surge upward, as their financial firms struggle to remain solvent under sharply falling asset prices, and as their central banks and treasuries engage in a set of unprecedented and costly interventions to get credit markets functioning better.
Here too there are those who advocate a particular kind of insurance. They argue that increased government expenditures ought to be restricted to domestic firms so that the expansionary impact is not weakened by increased imports and so that other countries that are not pulling their weight on fiscal expansion do not get a free ride. Similarly, they maintain that when there is a credit crunch at home, banks ought to cut back on loans to foreigners in favor of increased lending to domestic firms, and that foreign banks should be excluded from their markets. The same kind of thinking motivates efforts to get companies that might have been planning to open new plants in other countries to cancel their plans.
Just like the undervaluation path, this type of self-insurance is seriously flawed. If some countries implement buy-local programs for government expenditures, their trading partners are likely to retaliate in kind; hence, the country initiating such actions will see its exports fall in the next round and there will be no meaningful job creation.1 So too with policies that discourage foreign lending by domestic banks: This too will lead to retaliation and the end result is likely to be a decline in international lending that adversely affects all countries.
What then should the G-20 leaders do to meet the need for better insurance? The answer is to design and implement a "Grand Bargain" between the advanced and emerging economies. This bargain must meet the needs of both parties and it must do so in a way that supports open markets and expanding demand. The bargain should also favor multilateralism over nationalism, restore a more rule-based international monetary system, and strengthen the role of the International Monetary Fund. When G-20 leaders speak about a "new Bretton Woods," these are the goals they should have in mind.
Under this Grand Bargain, the emerging economies would get the insurance and governance reforms that they need.2 The IMF's resources (both quotas and the New Arrangements to Borrow/General Arrangements to Borrow) would be expanded substantially. Access limits (both annual and cumulative) for IMF loans would be increased markedly. The mix between unconditional and conditional lending would be tilted more toward the unconditional pole—at least until recovery from this global crisis is firmly established. This could be done by agreeing to and implementing a sizeable special drawing rights (SDR) allocation, by expanding the access limits for the Compensatory Finance Facility (the CFF, which provides upfront, unconditional lending to countries experiencing a temporary shortfall in export earnings), and by refitting the Fund's new Short-term Lending Facility so that it provides precautionary access and has longer repayment periods. On the governance front, the advanced countries could agree to double the increase in the voting share of the developing world in the Fund that was agreed upon last year, as well as to increase the "chairs" of the emerging economies not only in the Fund but in the Financial Stability Forum (FSF) and the Basle Committee on Banking Supervision as well. And the European Union and the United States would consent to give up their hold on the leadership of the Fund and the World Bank.
For their own sake as well as for the good of the world economy, the advanced countries would also vow to lay out and make more specific the plans for the reform of financial regulation, supervision, and oversight that were outlined at the first G-20 leaders summit in Washington, DC last November.3
For their part, the emerging economies would underline their agreement to abide by the IMF's guidelines on exchange-rate surveillance—with particular attention to avoiding large-scale, prolonged, one-way intervention in exchange markets (along with large-scale sterilization operations). In a similar vein, the emerging economies would also indicate their support for the IMF Managing Director's recent proposal to send ad hoc consultations to countries in cases where there are serious questions about a member's exchange-rate policy. It would be understood that the Fund's implementation of its exchange-rate surveillance would be completely evenhanded between large countries and small ones and between industrial countries and developing ones.
Two other elements are needed to make sure that the Grand Bargain is widely seen as confronting today's global crisis. First, all G-20 members would commit to fiscal policy expansion of at least 2 percent of GDP for two years; moreover, the IMF and the OECD would be asked to monitor G-20 members' compliance with this commitment and to publish the results. Second, both advanced and emerging economies would agree to an immediate standstill on any trade, finance, and industrial-policy measures that were incompatible with both the letter and the spirit of their WTO obligations and they would ask the WTO to expedite its monitoring of this commitment.
Designing a Grand Bargain is one thing. Obtaining agreement on it is quite another. With only six weeks remaining before the London summit, it would be unrealistic to expect agreement on such an ambitious agenda by then. But there is enough time to do two important things. G-20 leaders could agree to begin at that summit serious negotiations on the Grand Bargain and to regard its elements as a key organizing theme for the next two summit meetings. They could also announce a "down payment" on the Grand Bargain as a sign of their commitment and good will, including: agreement on both the fiscal-policy expansion and the trade- and industrial-policies standstill, an initial SDR allocation of at least $150 billion, an expansion of the CFF, increased emerging-market representation at the FSF, indication of progress made in the implementation of the action plan for financial regulatory reform, and a pledge by all G-20 members to refrain from taking any actions (in 2009–10) that would push or keep their real effective exchange rates away from their fundamental values.
To sum up, much has been said in the run-up to the G-20 leader summits about the need for a new international financial architecture. The global economic and financial crisis—and the policy responses in both advanced and emerging economies to it—have laid bare the inadequacies of the existing architecture as well as the risks associated with a strategy of self-insurance and economic nationalism. The opportunity now exists to go in a different direction. Now is the time to begin implementing a Grand Bargain that recalls the vision of the founders of Bretton Woods by rejecting beggar-thy-neighbor policies, by favoring open markets and policies that support economic growth, and by expanding the role of the IMF at the center of a more rule-based international monetary system.
1. For an analysis showing how small the employment gains of the Buy American provisions in the recent (February 2009) US fiscal stimulus program would be—even in the absence of retaliation by US trading partners—see Gary Clyde Hufbauer and Jeffrey Schott, 2009, Buy American: Bad for Jobs, Worse for Reputation, Peterson Institute for International Economics Policy Brief 09-2 (February), Washington.
2. For an analysis of how the IMF could be reformed to the benefit of emerging and industrial economies alike, see Edwin M. Truman, "IMF Reform: An Unfinished Agenda," VoxEU.org, January 28, 2009. An explanation of why and how a liberalized and expanded Compensatory Finance Facility could be helpful in cushioning the impact of this global economic and financial crisis on emerging economies can be found in Morris Goldstein, "Dig into the IMF's Tool Box to Tackle the Crisis," Financial Times' Economist Forum, November 11, 2008.
3. For a more specific treatment of the changes that would be helpful in reforming the framework for financial regulation, see Morris Goldstein, "Reforming Financial Regulation, Supervision, and Oversight: What to Do and Who Should Do It," notes prepared for conference on "International Governance: Toward the London G-20 Summit," London, February 9, 2009.
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