by C. Fred Bergsten, Peterson Institute for International Economics
Keynote Speech at the Global Human Resources Forum, Seoul, Korea
November 4, 2009
The International Economic Order of the 20th Century
The International Economic Order of the 20th Century
The current international economic system was created at the end of the Second World War. Its overarching goals were to avoid a repetition of the Great Depression of the 1930s, which was severely deepened by the trade wars and competitive currency devaluations of that period, and the worldwide military conflict that followed. The system has evolved considerably over recent decades but its basic structure remains that of sixty years ago.
The Great Recession of 2008–09, by far the worst for the world economy since the 1930s, is providing the first real stress test for that system. This was the first truly global turndown in modern history, with most countries experiencing sharp reductions in their level of economic activity and virtually everyone experiencing at least a sharp decline in growth. The situation required an effective global response. Moreover, it had been widely argued that the existence of the Bretton Woods architecture was a major reason that the 1930s "could never happen again." How has the system responded?
To date, the results are mixed. Virtually all countries adopted a combination of monetary and fiscal stimulus measures that appear to have arrested the precipitous downward slide and, in most cases, restored at least some positive momentum. The key international institutions, mainly the International Monetary Fund (IMF) and the newly ascendant G-20 (on which there is much more below), have played supportive if not active coordination roles and the Fund has again ridden to the rescue of the countries that were hardest hit. The rules and procedures of the World Trade Organization have helped limit the damage from the inevitable outbreak of protectionism in a number of countries. There have been only a few competitive devaluations (or currency nonappreciations, though the ongoing sizable undervaluation in China, which long pre-dates the crisis, remains of significant importance).
Several of the specific actions taken in recent months by the key international institutions have been particularly helpful. The G-20 agreed to triple the resources of the IMF to enable it to credibly respond to potential crisis requirements. The creation of $250 billion of special drawing rights (SDRs) both provides additional stimulus in the short run and limits countries' need to run future surpluses to self-insure against subsequent crises. The G-20 standstill agreements on trade barriers, albeit implemented imperfectly, have surely helped preserve the relative openness of the commercial system. The calamitous outcomes that were so widely feared just a year ago seem to have been averted, due in important part to these constructive responses of the global economic order.
At the same time the crisis has revealed—or reemphasized—a number of key shortcomings in the system that the current generation has inherited from the past. Financial regulation both within and between countries proved inadequate to prevent the meltdown that triggered the crisis. The buildup and maintenance of huge international imbalances, with their accompanying capital flows, contributed substantially to the overleveraging of finance and underpricing of risk— especially in the United States, where the crisis erupted. The inability of the trading system to revive its past momentum of liberalization, through the Doha Round or otherwise, created a vacuum within which protectionist initiatives could more easily flourish.
The Systemic Needs of the 21st Century
Underlying these manifestations of systemic inadequacy were fundamental structural problems that were already apparent but that the crisis has pressed to the fore. The IMF has failed repeatedly to exercise effective surveillance over the policies of its major member countries and to create mechanisms that would foster coordination of either their macroeconomic policies or their financial regulation. There were clear gaps in the rules and institutional arrangements themselves, including the inadequacy of macroprudential guidelines in the financial domain (a fairly new problem) or any instruments to induce adjustment by large surplus countries (a perennial problem dating back to Bretton Woods itself). The incumbent global steering committee, the G-7/8, had long since failed to provide effective leadership for the system.
Apart from the crisis, there are a number of other issue areas where the international economic architecture clearly needs to be expanded and/or reformed:
There is growing recognition that all these systemic shortcomings have at least one common cause: the increasing erosion of the political legitimacy of a regime that was created so long ago on the basis of such a different distribution of economic weight among nations. A global economic order erected on the basis of economic positions in the middle of the 20th century could hardly be expected to thrive in the face of the dramatically altered power configuration of the early 21st century. We must turn to that issue to provide a foundation for a viable "blueprint for global leadership in the 21st century."
The New Global Order
The emerging markets and developing countries now account for slightly more than half the world economy when real GDP is converted at purchasing power parity exchange rates. At market rates, they account for about 40 percent.
Even more importantly, they were growing two to three times as fast as the high-income countries prior to the crisis: about 6 percent annually relative to 2 to 3 percent. Hence their global share was rising by 1 to 2 percentage points per year. The gap between the two groups has expanded even further during the crisis period to about 7 percentage points in 2008 and an expected 5 percentage points in 2009. The world share of poorer countries will continue to climb steadily as the process of global income convergence continues. They will increasingly dominate the global output totals as they have already come to dominate global growth.
Asia is of course central to this dramatic change in the structure of the global economy. China is about to become the second largest national economy. Most projections suggest that India will become the third largest within the next couple of decades. Korea will clearly be in the top ten, especially once it is unified.
The most noteworthy systemic impact of the crisis to date, reflecting this dramatic shift in global economic power, has been the replacement of the G-7 by the G-20 as the chief steering committee for the world economy. Fully half of the G-20 is emerging or developing countries. It includes five Asian countries (China, India, Indonesia, Japan, Korea)—or seven if Australia and Russia are included—whereas the G-7 had only one (Japan). A similar if little-noticed shift has occurred in the membership of the Financial Stability Board, which is playing a central role in devising the needed reforms in financial regulation; it quickly added all G-20 member countries that were not included in its previously euro-centric makeup.
This shift in the locus of decision-making power was inevitable, in light of the rapid and dramatic shift in economic weights, but the crisis probably accelerated its realization by 5 to 10 years. The G-7 will now become simply a rich-country caucus within the G-20, perhaps with a focus on security rather than economic issues, in the same way that the European Union and the BRICKs already meet together prior to G-20 sessions. Another possible combination is Asia Pacific: half the G-20 is members of the Asia Pacific Economic Cooperation forum (APEC) (the seven Asians plus the three NAFTA members) so it could play a major role in the new configuration as some Asian leaders have proposed.
The next step is to replicate this fundamental governance change in the standing multilateral institutions. It has already occurred to some extent in the WTO, where the formal voting rules require consensus but the leadership is exercised in a group of five or six key members that most recently includes China and India along with Australia and the traditional United States, European Union, and Japan. The most important remaining reforms are in the IMF. Four changes are needed:
The Regional Dimension
A separate but closely related issue for the "21st century leadership blueprint" is the relationship between the growing array of regional economic arrangements, especially in Asia, and the global institutions. The European Union has of course already created its own economic community and common currency, and has coexisted reasonably well with the multilateral system. Trade conflicts have arisen, especially due to its Common Agricultural Policy and earlier due to some of its association agreements, but most have been resolved through the dispute settlement mechanism and negotiations of the WTO. The European Union has wanted to have it both ways in the IMF, however: it has insisted on maintaining excessive chairs and shares on a national basis while shunning Fund surveillance of its members' policies on the grounds that they now represent a single economic entity that can take care of itself.
Asia has of course already created a regional financial mechanism, the Chiang Mai Initiative Multilateralization (CMIM), and a series of subregional trade agreements (including most notably the "10 + 1" pacts that China, Japan, and Korea have signed with the Association of Southeast Asian Nations [ASEAN]). It is quite conceivable that they will evolve, respectively, into an Asian Monetary Fund and East Asian Free Trade Area (whether they are ever called by those names or not). A key question that then arises is how such Asian regional arrangements would relate to the global economic order. Both the regional entities themselves and the multilateral institutions need to address these issues on a priority basis.
The best outcome would be for the architects of the new Asian arrangements to assure that their rules and institutions were compatible with those of the global system, perhaps with some modifications in the latter to take account of the former. On the trade side, another possibility would be for the Asians to negotiate simultaneous liberalization with their transpacific partners in APEC and/or their European partners in Asia-Europe Meeting (ASEM) in order to avoid major new discrimination in those directions. This is what Korea has already done at the national level, demonstrating extremely positive global leadership by negotiating free trade agreements with both the European Union and the United States to parallel the free trade agreements it has concluded or is pursuing with ASEAN and other Asian neighbors.
A Blueprint for the 21st Century
It is clear that the global economic order of the 21st century, which will hopefully evolve in a gradual and orderly manner, will look very different from its predecessors of the 20th century:
Strengthening financial regulation is the most urgent requirement for extension of current systemic arrangements. Virtually all regulation will have to actually take place at the national level, in light of the need for legal enforcement and the inherent differences in national institutional frameworks, so a three-stage process can be envisaged:
This is the strategy that was essentially implemented after the Asian financial crisis a decade ago to implement the international banking standard that all agreed was needed to avoid replication of that disaster. Monitored by the IMF through its Financial Sector Assessment Programs (FSAPs), that standard helped produce such far-reaching reforms in a large number of emerging market economies that they were able to withstand the current crisis quite effectively. A similar approach is now needed for the high-income countries at the core of the international financial system to reduce the systemic risk of another crisis like that of the past two years.
A second postcrisis reform must address the global imbalances to prevent their replication from again sowing the seeds for financial disruption (as well as causing trade and other problems). The largest of the imbalances, the US deficit and the Chinese surplus, have both been cut in half from their recent peaks, so good progress in this regard is being recorded. More effective IMF surveillance of national policies must be implemented and respected, however, perhaps along the lines proposed by President Lee and Australian Prime Minister Rudd and largely adopted by the G-20 at Pittsburgh, under which all G-20 member countries would submit their recovery strategies to the Fund and it would notify them if changes were needed to achieve an internationally compatible pattern. Exchange rates will as always be an important part of this picture and there remains the systemic problem that the IMF has no leverage over the policies of surplus countries; it may thus be necessary to invoke, and probably strengthen, the WTO proscription against competitive devaluation and authorization of trade sanctions against countries that violate it. Additional creation of SDRs will help countries meet their desires for larger international reserves without having to run current account surpluses; I believe the IMF should issue another $1 trillion in annual increments of $200 billion each over the next five-year "basic period."
The largest "new need" for the economic system is a comprehensive regime on global warming. Here the new G-20 steering committee must play a particularly important role, both to provide political impetus for the negotiations to limit emissions and to work out effective linkages between the new environmental regime and the rest of the economic order, particularly the trading system. Failure to coordinate these two key components of the broader system could both imperil the climate change talks themselves and stimulate major new trade conflicts; on the other hand, negotiation of a new "Green Code" could revitalize (or supplant) the moribund Doha Round and restart the process of modernizing the trading system. Somewhat similar linkages with the monetary system, particularly regarding the sizable financial transfers from richer to poorer countries that must be part of any successful climate change compact, must be addressed as well.
Korea and the New Global Leadership Blueprint
Korea can, and indeed must, play a pivotal role in designing and implementing this new blueprint. As the next chair of the newly ascendant G-20, it will lead the global effort in this direction over the coming year. In light of the "troika" process for the G-20 leadership, under which the previous and succeeding chair countries form a management committee with the current chair for each year's activities, Korea will remain deeply engaged in that process throughout 2011 as well (when France is scheduled to take over the chairmanship role).
Korea's unique international position provides it with particularly strong credentials and credibility to provide this leadership. It will be the first non–G-7 country to chair the G-20 summits. It will be the first Asian country to do so. As a middle-income country, with membership in the Organization for Economic Cooperation and Development (OECD) but a per capita income still below those of the traditional industrialized nations, it can bridge the two groups that make up the G-20. With its strategic (geographic and economic) position between China and Japan, it has a promising opportunity to forge new global strategies that can win the support of the two Asian giants. With its close ties to the United States, and thus its keen interest in maintaining strong transpacific relationships, it is in a strong position to foster transpacific initiatives (e.g., in APEC) to parallel the Asia-only initiatives that are well underway and thus avoid the risk of new tensions between the two regions on which it depends so heavily.
Korea's chairmanship year will be particularly critical for the G-20 as an institution if it is to consolidate its new leadership opportunity and establish its credibility to both private markets and governments around the world. The Group will have to make a smooth transition from its sole focus of 2008–09 on crisis response, which was of course wholly appropriate, to systemic management of more underlying and long-term structural issues. Since the crisis will not be fully resolved, even under the best of circumstances, this means that the G-20 agenda for 2010 will have to address both sets of topics.
Hence Korea, as chair, will have to assert leadership on both the carryover crisis topics that will still be germane (such as the appropriate timing of exit strategies from fiscal and monetary stimulus) and systemic issues that demand the attention of the heads of state (such as the climate change negotiations and new efforts to reenergize the global trading system). There will of course be issues that straddle these two time dimensions: Financial regulatory reform is needed both to assure lasting recovery from the current crisis and to provide a strengthened systemic defense against future disruption.
Korea itself must therefore play a central role in devising, and beginning to implement, "A Blueprint for Global Leadership In the 21st Century." It is wholly appropriate, indeed necessary, that leading Korean institutions host this Global Human Resources Forum to help launch that process. I deeply appreciate the opportunity to contribute to the discussion and look forward to meeting with my Korean friends as they pursue their historic opportunity to help shape a new global economic order for the years and decades ahead.
Policy Brief 12-25: Currency Manipulation, the US Economy, and the Global Economic Order December 2012
Op-ed: The G-20 Is Failing April 12, 2012
Testimony: An Action Plan for the G-20 October 20, 2011
Paper: Global Economic Prospects as of September 9, 2011: How Deep the Current Slowdown? September 9, 2011
Book: Flexible Exchange Rates for a Stable World Economy October 2011
Paper: Global Economic Prospects as of April 4, 2011: Continued Growth Despite the Turmoil April 4, 2011
Paper: Global Economic Prospects as of September 30, 2010: A Moderating Pace of Global Recovery September 30, 2010
Paper: Global Economic Prospects for 2010 and 2011: Global Recovery Continues April 8, 2010
Policy Brief 10-24: The Central Banker's Case for Doing More October 2010
Paper: World Recession and Recovery: A V or an L? April 7, 2009
Testimony: The Global Economy: Outlook, Risks, and the Implications for Policy January 29, 2009
Paper: Report to the President-Elect and the 111th Congress on A New Trade Policy for the United States December 17, 2008
Testimony: China's Role in the Origins of and Response to the Global Recession February 17, 2009
Testimony: The World Economy and the Outlook for the United States December 5, 2007
Speech: The G-20 and the World Economy March 4, 2004
Speech: The United States and the Global Adjustment Process March 23, 2004