In the last few years, the debate about the supremacy of the G20 over the G7 was simple: the G7 didn’t anymore represent the key players in the global economy, and thus had lost legitimacy. It was time to move to the G20 as the center of global policy coordination.
And the success was immediate. The G20 managed to agree quickly on a global fiscal stimulus and on a sharp increase in resources for the IMF, thus contributing decisively to greatly reduce the tail risk of the global economic downturn. Once economic agents realized this, and with the help of aggressive easing of monetary policy, markets and the global economy rebounded sharply. The G20 had saved the day.
Since then, however, it is no longer clear whether the G20 was a good ad‐hoc formulation for a very specific moment in time – a global economic and financial crisis – or a desirable permanent feature of the global economic architecture. Because the “post‐crisis agenda”, namely the framework for sustainable growth and the financial reform agenda, is proving to be much more difficult to manage in such a large group.
The framework for sustainable growth remains stuck in the old global imbalance debate. The briefing papers argue that the US has to save more, Asia has to consume more, and exchange rates have to be more flexible, while the key players continue to ignore it and behave in the same old manner. In the financial reform area, the divisions are even starker, as the debate on the bank tax shows. Some countries want to finance the repair of their financial systems with taxes, and are pushing others to emulate them to achieve a level playing field. But the countries whose financial systems don’t need repair are, quite logically, not willing to cooperate. Similarly, the debate on the global financial architecture looks frozen, as Emerging
Markets continue to accumulate precautionary reserves while the proposals of the Korean presidency to advance towards a systematic framework of currency swaps look unlikely to see the light of the day.
It seems clear that there is a sharp division inside the G20 along three groups: (1) those countries at the heart of the crisis, mostly US, EU and UK; (2) developed countries in the periphery of the crisis, such as Canada, Japan or Australia; and (3) and emerging markets. They have very different agendas and objectives for the “post crisis period” and thus any G20 action is unlikely to move beyond de minimus agreements. At this point, it would be legitimate to wonder whether the G20 remains the right architecture for global decision making.
The upcoming meeting in Toronto offers a good opportunity for the G20 to think hard about its future and address some of these doubts. It won’t likely be able to advance much on financial sector reform, given the idiosyncrasies of the many different financial systems, but it must try to move forward with the framework for sustainable growth. And here there is an aspect that has not perhaps received enough attention. The crisis in the euro area has had a clear consequence: a permanent increase in the risk premium associated with euro area assets and the need to adopt a tighter fiscal policy stance. And, as such, the equilibrium exchange rate of the euro has very likely declined. In other words, the euro area is likely going to be forced to rely more on external demand in the next few years. This is something that wasn’t in the initial plans for the framework, where the EU was considered to be in equilibrium and thus it was mostly a US‐Asia debate. If the EU has to run some current account surplus in the next few years, who will have to run the offsetting current account deficits, and how will this be achieved? This change is something that the G20 must accept and address, even if it disturbs the current plans of some of the major players.
In a related fashion, the European discussion about intra‐european imbalances matters for the G20 (see Ubide (2010), “The European bicycle must accelerate now”, in the new e‐book Baldwin and Gros (2010), “Completing the Eurozone rescue: what more needs to be done?”, www.voxeu.org). The German strategy of focusing only on debt reduction and fiscal adjustment as the solution to all problems is flawed – the choice of structural policies, and thus the composition of growth, matters as much. Germany is focusing on fiscal adjustment and ignoring much needed goods, services and banking sector reform that would boost domestic demand. This persistent lack of domestic demand growth in Germany exacerbates intra‐EU imbalances and complicates the resolution of the global imbalance.
The G20 must press Germany to stop hiding behind the euro and start being part of the solution, and not part of the problem. For example, the April 2010 Global Financial Stability report of the IMF indicated a potential capital shortfall in the German banking system of over 30b USD. Germany could thus follow the Spanish example and adopt a comprehensive program of reform, restructuring and recapitalization of its banking sector, including running and publishing individualized stress tests.
There are still plenty of challenges ahead for the global economy. The G20 can become just a talking shop where issues fester or a decision making body. If it wants to continue to be taken seriously, it must start taking decisive actions now.