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Leaders from the Group of 20 (G-20) countries are to meet in London on April 2 to discuss how to respond to the global economic crisis. The summit, which follows G-20 meetings in late 2008, has inspired heady expectations from policymakers and market watchers. Britain’s Prime Minister Gordon Brown, for instance, surfaced the idea of a "global New Deal" coming out of the meetings. But given the scale of the world’s economic problems, experts say expectations for the G-20 summit should be more modest. Similarly, they encourage world leaders to focus on immediate steps to restore market confidence. As for broader regulatory reforms, experts say the best outcome of the summit would be for leaders to set an agenda for developing long-lasting reforms, a process that could take years, without trying to enact changes in a hasty manner due to political pressures.
Types of Reform
Economists distinguish between reforms aimed at stabilizing markets and those aimed at revamping regulation. They say alleviating market concerns requires the most immediate attention. Regulatory reforms, by contrast, are more complex, require more forethought, and have little to do with stabilizing markets in the near
term. The G-20 distinguished between these two types of reform in a communiqué following its November meetings in the United States--but experts fear political pressures could compel some leaders to try to tackle complex regulatory issues too hastily. Similarly, experts distinguish between problems that require international solutions and those that can be addressed by sovereign governments. Getting bad debt off the books of beleaguered U.S. banks, for example, requires a U.S.-specific solution. Ensuring against rising trade protectionism, on the other hand, requires international coordination, as do efforts to prevent against regulatory arbitrage, in which institutions pick and choose markets based on where regulatory structures are most lenient.
The following matrix shows this dynamic. Experts say officials at the G-20 summit should focus on addressing the green quadrant--that is, reforms that require both international coordination and immediate attention--while laying out a detailed agenda for addressing reforms in the other three quadrants.
The following list summarizes recommendations from experts about which economic concerns should command the most attention at the April G-20 meetings.
The United States has signaled it will encourage other countries, specifically some European countries and Japan, to boost domestic fiscal stimulus spending, whether through tax cuts or through expenditures on infrastructure development. The goal is to boost global demand, stabilize export-reliant nations, and prevent a collapse in industry that could lead to even greater economic problems. Most of the world’s leading economies have already implemented some form of stimulus. The International Monetary Fund (IMF) estimated in February 2009 that G-20 countries would spend approximately 1.5 percent of their gross domestic products (GDPs) for 2009 on stimulus spending. But the amount spent by many European countries and Japan lags that spent by the United States and China, even as a percentage of GDP. In a March 2009 interview with the Financial Times, Lawrence Summers, President Barack Obama’s top economic adviser, said world leaders face a "universal demand agenda" and must meet it by pumping more money into their economies in the short term. The IMF, in a December 2008 paper (PDF), called for stimulus that is "timely, large, lasting, diversified, contingent, collective, and sustainable." FT columnist Martin Wolf, currently a CFR visiting fellow, wrote in a recent column that "against these standards, the stimulus packages [thus far] are disturbingly modest." It’s important for stimulus packages to do "more than enough," Wolf writes. "It will always be possible to withdraw stimulus a year or two hence. It will be far more difficult to make action effective if depression, both economic and social, takes hold."
Some national leaders have reacted against this strategy. At recent EU talks, Bloomberg reported, Luxembourg’s finance minister said U.S. pressures on stimulus "were not to our liking," adding that Europe should gauge the effect of its recovery package before making more expenditures. One fear among European countries, experts say, is that the relative ease of cross-border capital flows could lead to a situation where one country’s stimulus boosts another country’s economy. With this in mind, three experts from the Belgian think-tank Bruegel argue in a policy brief that Europe should implement additional stimulus, but that it should be coordinated at the "EU level to ensure consistency and avoid free-riding behavior." To date, EU stimulus efforts have all come unilaterally at the country level. CFR’s Brad W. Setser argues that the G-20 meetings ought to target coordinated global stimulus boosts. "European stimulus has been small compared to the United States and China, and Chinese stimulus hasn’t translated into sufficient local demand to keep China’s current account surplus from rising," Setser says. He suggests the G-20 leaders send a "strong signal" that countries are willing to boost stimulus spending but adds that he doesn’t think markets are currently expecting any kind of firm commitments to come out of the meetings.
Some analysts dispute the effectiveness of stimulus spending. CFR’s Amity Shlaes, in a recent interview, said stimulus outlays can have the perverse effect of stimulating industries that are "really pretty weak, and maybe should fade." Other analysts question the very premise that stimulus spending is "stimulative"-that is, that it has any multiplier effect on private sector activity beyond the initial government outlay. A recent Backgrounder explains some of the concerns about stimulus as a strategy.
Many experts fear the economic crisis will prompt greater trade protectionism. Carla A. Hills, former U.S. trade representative, noted at a March 2009 meeting that G-20 leaders pledged to promote trade openness for the benefit of the global economy--but that seventeen of the twenty member states, including the United States, have raised some form of trade barrier since that meeting. Hills says policymakers should view trade as "one component to deal with the economic crisis." She adds: "It’s not a silver bullet, but if we turn inward and go toward a protectionist mode, which is being evidenced around the world, we will greatly elongate and deepen the current economic crisis." CFR’s Benn Steil says the G-20’s "biggest risk in terms of failure of international coordination is to get a spiral of protectionist initiatives." Steil, accordingly, urges the group’s leaders to make a "robust statement on that front that would be backed up by independent monitoring of what sorts of policies are implemented over the next six months or so."
Many economists also think the G-20 summit should take concrete steps to address problems with trade financing--the system through which trade transactions are underwritten. Turmoil in credit markets has wreaked havoc on trade financing, adding a further obstacle at a time when trade flows are already contracting at their sharpest pace since the 1930s. The Wall Street Journal reported in early March 2009 that U.S. and British officials were working to draft a global plan that would provide hundreds of billions of dollars in trade financing to provide credit to both national trade finance agencies and the World Bank.
One of the factors leading to the sharp slowdown in global economic demand is frozen credit markets. Canadian Finance Minister Jim Flaherty recently signaled that he will use the G-20 forum to push for immediate changes to the U.S. and European banking systems to ensure "reasonable access to financing and credit internationally." CFR’s Steil notes that in the near term, the process will require primarily national, not international, policy initiatives. Steil urges the U.S. government to establish a new resolution trust corporation in order to get mortgage assets off, and cash onto, the books of major banks. The U.S. Treasury is currently experimenting with a series of "stress tests" aimed at determining the health of the nation’s largest banks. With respect to credit, national governments are considering providing funds directly to borrowers, rather than trying to stimulate credit through banks and dealers. Speaking recently at CFR, William C. Dudley, the president of the Federal Reserve Bank of New York, said the U.S. Federal Reserve has started doing this through a program called the Commercial Paper Funding Facility. Separately, Dudley noted, the Fed is attempting to rejuvenate securitization markets by providing loans to investors who can offer up AAA-rated consumer asset-backed securities as collateral. Steil notes that there are benefits to coordinating international efforts to boost credit and to protect banks, but he adds that it can also be beneficial for countries to experiment with different approaches--particularly given past experience with bank capital standards, which indicates that the world is likely to mimic quickly whatever seems to work well in the United States and Britain.
A grand-scale rethink of financial standards is also important, experts say, but will take more time. Merit E. Janow, a professor of international economic law and international affairs at Columbia’s School of International and Public Affairs, urges G-20 leaders to devise an "aggressive and meaningful work plan" to address these issues, but says this plan should not distract them from the more immediate need to boost credit and financial flows.
Speaking on March 11, 2009, U.S. Treasury Secretary Timothy Geithner called for a major boost to the IMF’s financial firepower, saying the G-20 countries should seek to triple the fund’s resource base of $250 billion. Given escalating concerns of national debt defaults--particularly in Eastern Europe, Mexico, Indonesia, and a handful of other emerging Latin American and East Asian countries--Geithner’s view has won support from many economists. Ted Truman, an economist at the Peterson Institute for International Economics, argued recently in the FT that the G-20 summit should target a one-time allocation of $250 billion worth of "special drawing rights," the international reserve asset used by the IMF, on top of the fund’s current reserve base. (Geithner is calling for twice that amount.) Truman argues that a one-time allocation to the IMF would be one of the most effective ways the G-20 could help the countries hardest hit by the economic crisis.
CFR’s Setser agrees with Truman and also calls for an expansion of bilateral financing to the IMF, such as financing that has already been offered by Japan. Steil agrees on the need for increased IMF financing, but adds that any large-scale expansion of funds will likely require a new "grand bargain" between the United States and China. "China’s not going to contribute major new resources without assurances that the IMF and the United States in particular are not going to interfere with their exchange-rate policy," he says. "That’s problematic, because at least in the United States there’s a strong consensus that a lot of the problems that we’re experiencing now on the international level are because of China’s exchange-rate policy." Experts, including Steil, say crafting a new "grand bargain"--or reweighting IMF voting rights, another goal most experts say will ultimately be necessary--will require significantly more time to plan. There is urgency now, however, to bolster the fund’s resources to protect countries on the brink of default.
Setting Agendas and Expectations
Given the problems facing G-20 leaders--and the fact that the summit itself will last a matter of hours--setting out a list of priorities for future meetings will be a major first objective. This is particularly true when it comes to coordinating financial reforms. "The United States has fairly clearly signaled that it’s not yet in a postion to articulate the principles for reforming the international financial regulatory structure," says Setser. "That will take more time." For instance, a rethink of the Basel II regime, which lays out recommendations for laws and regulations governing banking internationally, ought to be a lengthy and considered process, experts say, given the complexity of the topic. The same is true of reweighting the IMF’s national voting rights. Experts say G-20 leaders can reassure markets by broaching these issues and reiterating that they are on the agenda.
The IMF’s communiqué from November 2008 in fact recommended this approach, but experts say comments from the media and policymakers--Gordon Brown’s "global New Deal," for instance--create lofty expectations. In practice, experts note, finding consensus will be difficult. While economists hold out hope that the summit will be able to make productive steps toward addressing the economic crisis, they say policymakers would be well-advised to consider the scale of the task in front of them before making statements that could mislead markets.
First Do No Harm
"’First do no harm’ is an excellent place to begin for a policymaker, as it is for a doctor," says James Grant, the editor of Grant’s Interest Rate Observer, a journal focusing on financial markets. Columbia’s Janow echoes Grant’s point. "We’re in the middle of a crisis," she says, "so we need to ensure that what comes out of this doesn’t contribute to the down cycle. To me that’s the number one priority." Experts say policymakers could "do harm" by setting unrealistic expectations. At the same time, however, a failure to act on issues like trade protectionism could frighten investors and further entrench the economic mayhem. Looking at potential longer-term policy impact, Grant fears overzealous regulation could hamper financial flows and market creativity. Steil worries a desire to revamp international institutions in the long run will distract focus from what national regulators can do more immediately to mitigate the credit crisis. Setser says regulators calling for sweeping leverage and capital limits haven’t yet made more basic decisions about which institutions require regulation. "You need to expand the regulatory net beyond things that were narrowly defined as banks," he says. "But how far does that extend? Do you just try to suck in all large institutions that are systemically important? Does anything that’s called a hedge fund need to be regulated? There are differences here that aren’t going to be resolved quickly."