The G20 and global finance: 20 ministers in search of a policy

By Michael Prowse

In Luigi Pirandello’s famous play there were six characters in search of an author. Each had a story to tell but as yet nobody to relate it. The situation in global finance today is somewhat similar: a rather larger number of presidents and finance ministers are just as desperate for a script. They have the best opportunity in decades to redraw the ground rules of international finance. But so far they have no long-term strategy worth talking about.

The fact that the world’s advanced economies got themselves into such a mess in 2007-08 was in some respects a blessing for the developing world. Without a financial shock of this magnitude, the rich western nations would have continued to dominate international economic policy-making for years – if not decades – through paternalistic groupings such as the G7 and G8. In principle at least a more diverse and representative body of national leaders now take decisions that affect the global economy.

The G20 represents about two thirds of the world’s population and 90 per cent of global production. But it fails to represent Africa or the Islamic world properly. And, as in nearly every international forum, Europe is grossly over-represented: there is a seat for the EU as well as for Germany, the UK, France, and Italy. But at least the big middle-income and emerging economies – Brazil, Mexico, South Korea, China, India and Indonesia, among others - now have a voice. There are also seats for the chairs of the International Monetary and Finance committee of the IMF (an Egyptian) and the Development Committee of the World Bank, thus formally linking the G20 with the major Bretton Woods institutions.

At its first meetings in Washington and London, the revamped G20 responded impressively to the global crisis. It agreed to prevent any further failures of systemically important financial institutions, it agreed a massive fiscal stimulus – a policy that many economists believe enabled the world to avoid another Great Depression – and it agreed in principle to regulate banks, hedge funds and rating agencies more rigorously.

The issue today is whether the G20 can provide effective leadership in more normal times. Was it simply the severity of the perceived challenge in the fall of 2008 that enabled global leaders to put the collective good ahead of national interest? Or was this just one of those rare occasions when everyone’s national interest coincided?

Last week’s preparatory meeting of finance ministers in Busan, South Korea, indicates that it will be far harder to reach a consensus on policies when the world economy is expanding, however unevenly. And the long-term challenge for the G20 is orders of magnitude more difficult than agreeing a fiscal stimulus at a time of crisis. It is to design global rules and institutions that meet the needs of the second decade of the 21st century – and these needs bear little resemblance to those in the aftermath of World War II when the IMF and World Bank were created.

In the Busan communiqué it was hard to detect any input from the representatives of middle income and emerging nations. The document reads just like a G7 communiqué, and one that is patching over significant differences of opinion. The finance ministers abandoned support for concerted fiscal stimulus, despite the US’s misgivings, and agreed that fiscally challenged members should “accelerate the pace of consolidation” even though inflation is out for the count everywhere.

There is a strong theoretical case for a global levy on banks and financial institutions, so as to ensure they pay the costs of any future bailout rather than taxpayers. The US, EU and UK accept this logic. Yet the G20 finance ministers retreated from a global levy, declaring that individual countries could adopt whatever policies suited them in the light of their national circumstances.

This was nothing short of an agreement not to cooperate – and it reflects the desire of national leaders to support their own banking industries regardless of what might be in the global public interest. Perhaps the G20 will demonstrate more backbone in Toronto when it comes to the detail of financial regulation, but don’t hold your breath.

Regrettably, groups such as G20 have natural limitations. The involvement of national leaders from emerging economies in global economic management was a watershed in financial diplomacy. But this forum meets infrequently and lacks a permanent bureaucracy of any significance. National leaders have numerous domestic challenges and can devote only limited time to it. We can expect the G20 to respond to crises and perhaps provide broad strategic guidance, but it is not a body that can itself design a new global financial architecture.

Global economic cooperation today is far more primitive than, say, European political and economic cooperation under the auspices of the decades-old European Union. But one can perhaps still draw loose analogies. The European counterpart of the G20 summits would be the European Council meetings of EU heads of state. These are highly influential in determining the EU’s longer term goals. But the EU could have achieved nothing substantive on the ground without the European Commission, its large and powerful civil service.

For the purposes of global economic rule-making and enforcement, there is only one bureaucracy of any significance: the IMF. And if the IMF is judged not fit for purpose, it would make more sense to reform it than to create a duplicate body. It appears, therefore, that the G20’s chance of achieving serious reforms will depend on its ability to use the IMF as a bureaucratic means for achieving its ends.

In press briefings at Busan, Dominique Strauss Kahn, the IMF’s managing director, indicated that the G20’s emergence as a global economic forum had greatly improved his chances of achieving meaningful economic cooperation. He predicted the leading economies were more likely to adopt mutually consistent policies – and to recognise the impact of their policies on other member states – than was the case in 2006 when the IMF’s attempts to promote global economic coordination failed.

But until China agrees to substantial revaluation of the renminbi, the US lifts its domestic saving, and Germany and Japan deregulate internally and boost domestic consumption, Mr Strauss Kahn is voicing aspirations rather than reporting solid achievements.

If the IMF – for want of any other comparable agency – must undertake the serious work of designing a new financial architecture, the emerging economies may discover their “equal status” with the advanced economies at the G20 table is of limited significance. What will matter more are their quotas and voting rights at the IMF itself. But these are based on economic criteria such as GDP rather than democratic criteria such as population. It is best therefore to view the G20 as just the first step in the construction of a less paternalist system of global economic governance.