Tuesday, September 29, 2009

The G20 Surprises

The Pittsburgh summit of the G-20 was a pleasant surprise. Having begun as a common front to restore calm during the 2008 global financial crisis, the Leaders’ forum finally got down to work: delivering a reasonable work plan complete with deadlines for progress. The strongest signal of its seriousness was its designation of the G-20 as “the premier forum for our international economic cooperation” effectively giving the major emerging market economies equal seats at the table and consigning the G-7/8 to security issues.

Canada will host the first meeting of this new configuration and has a major opportunity to set the tone. It should downgrade the smaller event and ensure the G-20 delivers on its commitments. Having one of the world’s soundest financial systems has gained Canada international credibility; some of this political capital might be used to push for completion of the Doha trade round next year.

The G-20 commitments at Pittsburgh are substantial but incomplete: they acknowledge the need for carefully phased withdrawal of government support as market forces once again drive growth, commit themselves to more realistic regulation of the financial sector and reform global governance, and they confront the need to reduce the international imbalances that were a significant seed for the crisis. They are incomplete because while climate change received attention there was only passing rhetorical commitment to completing the Doha trade round.

Many observers and people engaged in business decisions will dismiss the 16-page communiqué as obfuscating hot air that papered over some strong disagreements, such as European resistance to giving up some of their clout in governing the IMF, the US administration’s insistence that its duty on Chinese tires merely “enforces existing agreements,” and China’s sensitivity to discussion of sustainable exchange rates.

Some issues are ripe for action in 2010-11: on tightening financial regulation through higher capital and liquidity requirements on banks where consensus has emerged; now the actual numbers need to be negotiated. And on IMF reform where, if emerging market governments have more say, they are more likely to heed its analysis and listen to its advice.

Without stronger leadership other issues will disappoint: one is completion of the Doha trade negotiations in 2010. Business pressure has been notably absent as a driver of this round, in part because global supply chains and offshoring have reduced the impact of border barriers. On the climate change negotiations leading up to Copenhagen the prospects of a global compact by December are dim even though China provided an unexpected commitment to reduce the carbon intensity of its growth (mainly because of rising domestic pressures for cleaner air).

Deeper cooperation will be necessary to deliver some tangible process on reducing international imbalances. Is this possible in such a diverse group? Or will the majority of participants be free riders, leaving the hard bargaining to the United States and Europe or China?

I think deeper cooperation is possible. We tend to forget that G-7 governments engaged in policy coordination for a period from the late 1970s through the 1980s to reduce international imbalances and currency misalignments among Europe, Japan and the United States. International peer pressure played a role in encouraging governments to take unpopular policy actions that were in their own long term interest. Central banks engaged in unprecedented cooperation to accelerate dollar depreciation against the yen when the trend began in currency markets.

Policy changes and institutional reforms that would reduce imbalances today are similarly in countries’ own long term interests. Take the imbalances between the United States and China. The United States needs to save more and spend less while China needs to do the opposite. In the United States the administration is under considerable domestic political pressure to deliver on a commitment to reduce its fiscal deficit, expected to total 13 percent of GDP in 2009, to a more sustainable 2-3 percent by 2013. This will require deficit-neutral health care reforms and tax increases on households which have begun to repair their damaged balance sheets after a 30 percent decline in house prices. In the interim, continued Chinese purchases of US government securities is filling the gap despite publicly expressed concerns by the Chinese Premier and other senior officials about the sustainability of US fiscal policies.

For their part, the Chinese authorities have acknowledged the unintended consequences of their thirty-year dash for growth. Much of this growth was driven by investing nearly half of GDP in capital- and energy-intensive industrial production aimed at export markets. Rising income inequality and pollution are the unintended consequences. Rebalancing would shift the growth model towards one driven by domestic consumption in which services and less polluting and capital- and energy-intensive production play larger roles. To encourage more consumer spending the central government has increased its funding of health care, education and pensions which households have had to cover themselves from their savings. But other reforms are needed to change the model towards one that produces more jobs. These include reducing the manufacturing and investment bias in production by eliminating subsidized energy prices, reducing tax subsidies for manufacturing, requiring state enterprises to pay dividends, deregulating the service sector -- and even more fundamental—allowing greater exchange rate flexibility which would shift monetary policy away from exchange rate management, free up interest rates and force reforms in the government-owned banking system which relies heavily for profits on income from China’s administered interest rate spreads.

Reducing international imbalances will not be easy. Compared to US health care reform, which has dominated the headlines for months, China’s agenda is formidable, with inter-linked reforms of which exchange rate appreciation is one part. Little wonder that the Chinese authorities resist international pressures for exchange rate reform by itself. The package of social, industrial, monetary and financial reforms are very much in both China’s and the international economy’s long term interests, however, and should – like the US fiscal deficit -- be monitored and encouraged through peer review in the G-20 in the years ahead.

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