“Problems are rarely solved; they are usually overtaken by new problems” – an old friend of mine, unrepentant pessimist, used to say. This bleak assessment applies to the G20 today. While making an impressive breakthrough on financial reform with the approval of a new bank capital accord, the G20 has so far failed to devise a convincing approach to global imbalances. Its “Framework for Strong, Sustainable and Balanced Growth” never really took off the ground; more than a macro-policy coordination framework, it looks like an orderly presentation of independent policy intentions. Meanwhile, a bigger problem struck: the US, Europe and emerging Asia are clashing on the double front of IMF governance and the management of exchange rates. With the protectionist threat closer than ever since the Great Depression, it is time for the G20 to turn its focus on these new and more daunting challenges.
Let’s think back for a moment. At Pittsburgh (September 2009), the G20 political leaders committed to broad ranging reforms to help the global economy emerge from the crisis and make itself better able to prevent systemic risks in the future. A remarkable breakthrough at the time (see my comments), the Pittsburgh agreement was eminently “macroprudential” in the sense that it included complementary actions in both the macroeconomic and the microfinancial domains. Appropriately so, considering that the crisis originated from a mix of macro-policy as well as and regulatory and supervisory failures.
Unfortunately, implementation was not equally balanced. On financial regulation the Financial Stability Board moved swiftly, with the aim of delivering a first set of decisions at the Korean summit of November 2010. Actions were planned in four directions: the reform of the bank capital framework, including new standards for bank liquidity and maturity transformation; special provisions on buffers and resolution applying to systemically important institutions; strengthening of market infrastructures; market transparency and incentives, including accounting, ratings and remuneration standards. The new accord sealed on 12 September by the Basel Committee, commonly referred to as Basel III, comprises all three necessary elements: higher bank capital requirements for any given level of risk; a stronger definition of capital, centered on common equity and Tier 1 requirements; a countercyclical capital surcharge, requiring banks to build up capital in case of excessive credit growth.
The Basel agreement, a major deliverable for the next G20 summit, is at a time remarkable and insufficient. Remarkable for its ability to tackle all three aspects considered problematic (low capital, loopholes, procyclicality), and for the speed (by Basel Committee standards) with which it was reached. But insufficient because, as recognised by the FSB Chairman in a recent article, the new standards are likely to be ineffective if not complemented by other things: provisions on “too big to fail” institutions; cross border resolution authority; stiffer financial supervision; more resilient market infrastructures and closer supervisory focus on non-banks and shadow banking structures. These are the areas the FSB will need to address in the coming months to complete its mandate.
In the original plans, the “Framework for Strong, Sustainable and Balanced Growth” consisted of a set of mutually agreed macroeconomic objectives and policies, formulated and monitored with the technical advice of the IMF. The terms “sustainable” and “balanced” clearly suggested an emphasis on external positions and exchange rates, and a central goal of reducing global imbalances in the medium term. This goal is not being achieved. In practice, as recognised also by the IMF, the exercise turned out to be an “upside” collection of scenarios and policy intentions from the participating countries. No special emphasis is placed on external sustainability or exchange rates, and the IMF role is limited essentially to a technical reconciliation of national inputs, using econometric models. Evidently, the “Framework” was not sufficiently internalised in the individual nations’ decision making processes and the IMF does not have, or does not feel to have, a sufficiently strong mandate. This is unfortunate, because the lack of a framework for dealing with global imbalances deprives the G20 of an effective means to diffuse the present tensions over exchange rates.
The row over IMF governance (regarding, specifically, the representation in the Executive Board and the scope and speed of further shifts in quotas shares) and that on exchange rate policies are linked in many ways. Both originate from the difficulty of adapting international relations to new economic realities: in one case the rise of emerging nations, that requires them to follow, on external matters, agreed and cooperative rules; in the other the European integration process, increasingly at odds with an IMF representation map that still echoes Europe’s colonial past. Moreover, their solution can hardly be disjoint: it is hard to imagine how a more forceful surveillance like that proposed by the IMF in its recent “spillover” papers can be accepted by the emerging world without a more balanced representation. Finally, both issues are, at present, essentially “Chinese problems”: the exchange rate one for obvious reasons (though China is not the only nation manipulating the exchange rate), and the IMF governance one because China is, by far, the most underrepresented IMF member and the one whose influence on Washington’s 19th Street will increase the most in future years. Influence and responsibility must go together: this is a key message the G20 should convey.
Taken in isolation, the US and Europe’s negotiating positions on exchange rates appear too weak to be successful. Both of them are too much in need of external finance to effectively bargain with a large-purse counterpart. The recent European roadshow of China’s Wen Jibao, which emphatically included Greece, offered a demonstration in case one was needed. The US and Europe together have a chance of success if the two issues are implicitly linked at the negotiating table. A single European representation, though in the end desirable, is not necessary to achieve full symmetry with the US – in weight and prerogatives. So far the IMF governance issue has proved divisive for trans-Atlantic relations. It is time for this to change.
While some observers seem ready to dismiss the “new” G20 as an effective cooperation forum after just two years of life, the leaders meeting in Korea on 11 and 12 November will have in fact a unique opportunity to shape events. The G20’s broad representation, initially not justified by the immediate needs of the post-crisis reform agenda, will now become a factor of strength. Initiative and imagination can do the rest. Cross fingers.