The G20 after the Crisis

2013/06/20

abstract

The G20 was formed in crisis, in the form of a meeting of finance ministers, central bank governors, and representatives of various international organisations, as a response to the Asian financial crisis of 1997. The Great Recession of 2008 saw U.S president, George W Bush then call the first meeting of the leaders of the G20 countries in Washington DC. Since this first crisis meeting, the G20 has become more structured. Leaders’ summits are now held annually, with the country chairing each summit chosen and announced two years before the summit is held, allowing time to plan and consult with other member countries on the issues to be worked on through the year. A troika system has been established, and the current, future, and immediate past chair countries jointly manage the activities of the G20, assuring a degree of continuity from year to year.

Yet, a sense exists that the G20 is struggling to find a role after managing the immediate threat of a crisis, and the formalisation of its management has not helped to clarify what the role of the G20 should be in normal times. The lack of a guiding idea creates discontinuity in the work of the G20, and helps foster the view, common in commentary on the G20, that it has become less effective as the heat of the crisis has passed.[①]

At the same time, the world cries out for more cooperation between its major economies. Indeed the huge globalisation of the past thirty years has meant that economic developments in one country have a greater effect on economic developments in others than they have arguably ever had in the post-war period. International trade in 2010 was US$30.3 trillion, or 48.1 percent of global GDP,[②] while international financial flows were US$100 trillion, over 150 percent of global GDP, a more than six-fold increase in value in fifteen years.[③] As a result of this interdependence, government economic policy-making in the world’s largest economies is felt throughout the world.

Hence, there are serious coordination problems in economic policy-making among the world’s largest economies, which it is in the interest of all countries to see resolved in a cooperative, globally socially optimal manner, and the G20 is the right place to do it. The set of globally significant countries that have the ability to affect economic conditions in other countries is now larger than it was thirty years ago, and it no longer makes sense for the old G7 countries to try to coordinate their policies among themselves. The G7 countries only account for 41 percent of the global economy in 2010, compared with 56 percent in 1980.[④] Without involving newly significant countries, even total agreement in the G7 on policy coordination would still leave the world at risk of uncoordinated, potentially harmful, economic policies.

II. Coordination beyond Crisis

So the world needs a way for its major economies to coordinate economic policies if all countries are not to periodically feel the ill effects of uncoordinated economic policy-making. In the absence of a global enforcer, this coordination problem needs a decentralised solution – that is, whatever cooperative outcome is agreed on needs to be consistent with the self-interest of each country involved. At first blush this might appear inconsistent – if the point of cooperation is to overcome divergent self-interest, how can it be compatible with the pursuit of this same self-interest? The answer lies in the fact that the choice to cooperate is not made once, but over and over again. In such situations, an important game-theoretic result known as the Folk Theorem, says that even countries with no incentive to cooperate at a given point in time might have an incentive to cooperate at every point in time when all the decisions about whether to cooperate are considered jointly.

Three conditions underpin this insight. Firstly, it requires that decision-makers care enough about the future. While this might be true if one considers the country as a whole as the decision-maker, it stretches the imagination a little to suppose that a country’s political and bureaucratic decision-makers are always so far-sighted.

Secondly, it requires that decision-makers be well-informed about the decisions others are making and the payoffs to other countries under different alternative scenarios. Thus the sharing of information between politicians and policy-makers that happens at G20 summits, officials and ministers meetings and in working groups is a precondition to the emergence of cooperative solutions to policy coordination problems, and is therefore one of the G20’s most important functions.

The third condition needed for successful international economic policy coordination is that countries be willing and able to punish each other in the event that one or more countries renege on the cooperative agreement. In the absence of some supra-national power over individual countries, it is such reciprocal enforcement that makes decentralised cooperative agreements work. An example where this kind of mechanism has been central to a cooperative outcome is in the area of trade policy, where the possibility of WTO sanctions keeps countries from going back on liberalisation agreements. Crucially, these sanctions are enforced by individual countries, which must themselves bring disputes before the WTO and can retaliate if a country remains in violation of its agreements. The WTO merely facilitates the operation of this enforcement by identifying, at the request of members, which policies indeed violate previous agreements and which do not.

Given the many areas of policy-making where coordination problems exist, the enforcement of cooperative agreements mostly needs to occur without the involvement of the G20. The G20 will automatically play a small part in actually enforcing agreements by offering decision-makers opportunities to apply peer pressure to each other. But ultimately, specialised international bodies, like the WTO in the case of trade policy, will be the best lubricant to individual countries’ enforcing G20 agreements. The activities of G20 summits, working groups, ministers’ meetings and the like are instead best focused on agreeing on how policies will be coordinated in different domains, which includes explicitly setting out how countries will enforce the agreements.

III. Practical Suggestions and Priorities

Based on this understanding of the importance and character of international policy coordination, what, substantively, should the G20 be about? The evidence reveals that there are large costs associated with uncoordinated fiscal[⑤] and monetary[⑥] policy. These problems are not new; they have simply become more acute as flows of goods and capital across borders have grown. While the G20 has attempted to better coordinate fiscal policy, its Mutual Assessment Process, supposed to be the cornerstone of fiscal coordination, is yet to be made effective, by clarifying the role of the IMF and spelling out how agreements will be enforced. Domestic political conditions and the ability to borrow, not international agreements, have, as ever, determined government budgets since the creation of the G20.

There are also important coordination problems in liberalising trade policy, which the GATT, and then the WTO, were created to help overcome. But the failure of the parties to the Doha round of negotiations to come to any agreement has for some shown that preferential agreements will be the future of trade liberalisation.[⑦] The G20 can help counter the trend towards preferential trade agreements. Central to this will be reaffirming the most-favoured nation principle as the foundation upon which trade is liberalised.[⑧] This will allow coordination on freer trade between smaller groups of countries to be readily expanded to include new countries, the opposite of preferential agreements.

One newer coordination problem is the reduction of global greenhouse gas emissions. There are good reasons for making it a more important priority of the G20: ultimately, agreement on the size and distribution of reductions in greenhouse gases will be chiefly a concern for the economies of the G20 which, as the world’s largest economies, are also its most copious emitters. Since the failure to come to an international agreement on reductions in greenhouse gas emissions, coordination has happened at a regional level, and much international disagreement has focused on the effect of trade sanctions against countries that do not participate, ostensibly intended to prevent carbon leakage. One possible role for the G20 here would be to agree that such regional agreements be in a sense non-discriminatory. This requires that they focus on setting certain conditions on emissions reductions to be met by prospective member countries, potentially determined by level of development, and then be open to all comers.

Outside of these timeless coordination problems there is a possibility for more immediate, but no less significant gains for the world if the G20 were to pay more attention to infrastructure investment in emerging economies. The need for infrastructure in emerging economies, particularly in Asia, is large – the ADB recently estimated that Asia needed over $8 trillion in new infrastructure by the end of the decade. Greater investment in emerging economies would also provide a stimulus to global economic activity, boosting demand for capital goods from developed economies, where there is much spare capacity.[⑨]

Yet the way forward on increasing investment is not a simple matter of governments, or multilateral development banks, spending more on it. While there is certainly scope to improve the capacity of government bureaucracies and multilateral development banks to identify projects and get them investment-ready, the greatest returns will come from domestic reforms in two areas. The first is greater liberalisation of financial markets in emerging economies, so that the huge savings of Asia start financing projects at home, instead of being lent abroad, depressing interest rates.[⑩] The second area is the reform of critical domestic markets, for example removing subsidies for fuel and state-granted monopolies in transport, so that socially desirable infrastructure projects yield a sufficient return to attract to public funders and private finance.

Working on infrastructure in this way, there is also scope for the G20 to coordinate its activities with regional organisations that share with it the goal of boosting investment in infrastructure. ASEAN has already made infrastructure a priority, with the release of its Master Plan on ASEAN Connectivity in 2011, and by creating a new ADB fund to finance some of the projects identified in the Plan. APEC has also prioritised the infrastructure problem. The G20 can complement these activities by focusing more on the obstacles to private investment in infrastructure, identified above. More generally, there should be no fear that the G20 will supersede smaller forums and groups. Rather, the G20 will be at its most effective when it and regional forums are debating the same problems, and where their solutions complement and reinforce global actions on different dimensions of the problem. [①] J. Pisany-Ferry, “Macroeconomic Coordination: What Has the G-20 Achieved?” in K. Dervis and H. Kharas eds., New Challenges for the Global Economy, New Uncertainties for the G20, Washington, D.C.: Brookings Institution, 2012.
[②] IMF, World Economic Outlook database, October 2012, http://www.imf.org/external/pubs/ft/ weo/2012/02/weodata/index.aspx.
[③] S. Cecchetti, Global Imbalances: Current Accounts and Financial Flows, Myron Scholes Global Markets Forum, University of Chicago, 2011.
[④] IMF, World Economic Outlook database, October 2012.
[⑤] A. Auerbach and Y. Gorodnichenko, “Output Spillovers from Fiscal Policy,” NBER Working paper, No. 18578, 2012.
[⑥] Q. Chen, A. Filardo, D. He, & F. Zhu, “International Spillovers of Central Bank Balance Sheet Policies,” BIS papers, No. 66, 2011.
[⑦] G. C. Hufbauer and J. J. Schott, “Will the World Trade Organisation Enjoy a Bright Future?” Peterson Institute for International Economics Policy Brief, No. PB12-11, 2012.
[⑧] P. Dee, “What Can the G20 do about the WTO?” East Asia Forum, February 24, 2013.
[⑨] Justin Yifu Lin and Doerte Doemeland, “Beyond Keynesianism: Global Infrastructure Investments in a Time of Crisis,” World Bank Policy Research Working Paper, No. 5940, 2012.
[⑩] For a discussion of the effects of artificially low interest rates in China, see S. Bernanke, “Global Imbalances: Recent Developments and Prospects,” Bundesbank Lecture, September 11, 2007.

author： Peter Drysdale and Sébastien Willis