Thursday, April 9, 2009

Was the G20 London Summit a Success?

Augusto Lopez-Claros1

Whether to view the G20 London Summit as a success or as a disappointment is very much a function of one’s reference point.2 Viewed against the needs of the moment—a global economic crisis without parallel since the Great Depression—it could be argued that the Summit did not go far enough. The fact is that in the past 30 years the global economy has become both more complex and more interconnected, but the mechanisms and institutions that we have to deal with crises have not kept pace with the tempo of change and what has emerged is a “governance gap”. An inability to cope with complex global problems either because the institutions we have are woefully unprepared or, in some cases, because we do not even have an institution with the relevant jurisdiction to address the problem in question (e.g. climate change). Against these challenges the Summit’s achievements—a combination of well-meaning declarations and a few hard decisions—were at best a mixed bag.

On the positive side, it is no doubt an achievement of sorts to have brought into the decision making some of the larger emerging markets. The G7, accounting for 11 percent of the world’s population, was clearly not a broad enough forum. The G7 was originally created to discuss “major economic and political issues facing their domestic societies and the international community as a whole.” In time, it became a good forum for open debate about global problems, but not a particularly effective problem-solving vehicle. In the public imagination, its semi-annual meetings were largely perceived rather as excellent photo opportunities, not as brain-storming sessions focused on particular problems requiring urgent solutions as was, for instance, the 1944 Bretton Woods conference which lasted 22 days, involved over 700 delegates from more than 40 countries, and resulted in the creation of a new world financial system, G7 meetings are actually intended—as noted by a former G7 prime minister—to preserve the status quo. The creation of the G20 in 1999 was seen as recognition of the new economic and political realities, but neither the Swiss nor the Dutch nor the Spanish were particularly happy at being excluded. Switzerland manages a third of the world’s private wealth and the Netherlands is the most generous donor and, by far, the country with the most development-friendly policies. Spain, a country whose economy is more than 5 times the size of Argentina’s (a member of the G20!), took great exception to being excluded from the November 2008 G20 Summit—only strenuous lobbying delivered a last-minute invitation.

Of course, both the G7 and the G20 remain, in fact, official bodies. Their deliberations bring to the table heads of state and a small coterie of civil servants. There is no representation from the business community, nor do civil society representatives participate. Given the global nature of the problems we face and the increasingly shared perception that solutions to these will require broad-based collaboration across various stakeholder groups, for many, these groups still suffer from a deficit of legitimacy. They are not a fair representation of humanity and, as such, cannot be expected to make any important decisions on its behalf. There are no low income countries among the G20—their voices simply do not count. Despite these flaws, some progress was made in London and I would like to focus on those that pertain to the International Monetary Fund.

During much of the past decade the IMF has found itself in the middle of virtually all major emerging market crises and questions about its effectiveness have been raised; indeed some have argued that the organization is no longer needed in a world of largely floating exchange rates. It is clear, however, that with fully globalized financial markets and in which policy missteps in one country have costly spillover effects on others (as we have seen over the past year), an institution that will have sufficient resources to deal with episodes of financial instability and that will help cushion or prevent the effects of future crises is indispensable.

Like a central bank the IMF can create international liquidity through its lending operations and the occasional allocations to its members of SDRs, its composite currency. The IMF already is, thus, in a limited sense, a small international bank of issue. As seen during much of the past decade and a half, the Fund can also play the role of “lender of last resort” for an economy experiencing debt-servicing difficulties. But the amount of support it can provide has traditionally been limited by the size of the country’s membership quota and there is an upper limit on total available resources; as of early-2009 this amounted to about $250 billion, a puny amount when compared with the sorts of sums that are necessary to intervene in industrial countries in distress or even some of the larger emerging markets.

There are a number of ways to deal with these funding shortfalls. One proposal some years back was to create a Financial Stability Fund, to supplement IMF resources. This would be a facility that could be financed by an annual fee on the stock of cross-border investment; a 0.1% tax could generate some $25-30 billion per year, which could then be used over time to create a $300 billion facility. An alternative and more promising proposal would give the Fund the authority to create SDRs as needed, as a national central bank can in theory, to meet calls on it by would-be borrowers. When this idea was first put forward, in the early 1980s, concerns were raised about the possibly inflationary implications of such liquidity injections, but international inflation was a serious problem then in ways that, in the midst of a global recession, it is clearly not one today and measures could be introduced to safeguard against this.

The London Summit went some ways toward strengthening the capacity of the IMF to play a supportive role to emerging markets currently suffering the effects of the international financial crisis. This was achieved mainly by significantly expanding the resources available to the organization under special borrowing arrangements negotiated with a few central banks and by allowing a $250 billion SDR issue. The Summit seems to have been less successful in moving more quickly to update the voting power of its member countries, to better reflect the changes which have taken place in the structure of the global economy during the past quarter century. Slowly and grudgingly, kicking and screaming, EU members finally appear to be coming around to recognize the absurdity of a system where the voting power of the EU currently stands at 32.4 percent, whereas the combined voting power of the United States, China, India, Brazil and Russia, accounting for about half of the world’s population is 26.9 percent, though, collectively, these countries account for a much larger share of global GDP. This distribution of power leads to such anomalies as Belgium having a larger quota than India and China having a quota only marginally higher than Italy’s and well below that of France, facts which have undermined the institution’s credibility. Not surprisingly, Asian countries do not see they have a stake in empowering the IMF, regarding it increasingly as embodying power relationships which no longer reflect contemporary economic and political realities. An IMF without credibility, of course, is of no use to the international community, particularly at a time of global crises. That these so-called “voice reforms” have to wait until 2011 is a good indicator of the enormous inertia which has to be overcome to modernize our sclerotic global institutions, at a time when it is of the utmost urgency to strengthen mechanisms of international cooperation.

Also welcome was the decision to finally break with the convention adhered to ever since the IMF’s creation, which establishes that it’s managing director (MD) must be an EU citizen.3 Like the veto power in the UN Security Council this practice is an aberration and should have been done away with long ago. It is, in fact, surprising that this practice has persisted for so long given that whereas IMF lending operations have no budgetary implications for members such as the US and the EU (indeed they earn a return on their SDR reserve assets), the salaries of the Fund’s MD and of its entire staff as well as all other administrative expenditures are entirely financed by the interest paid by borrowing countries. In other words: the IMF functions thanks to taxpayers in middle and low-income countries, not the rich countries who have run it since it was first founded.

Despite the important symbolism of the G20’s decision, efforts will have to be made not to allow the new system to turn into something actually worse. The main risk is that we could now move to the system in place at the UN, where the Secretary General is chosen, on a rotating basis, from different regions of the world. The problem with that system is that it tends to breed mediocrity, with the top job going to someone who is acceptable to all constituencies—a process which then leads to the lowest common denominator.

It remains an open question whether, in retrospect, the London Summit will be seen as a good starting point for a more multilateral approach to global problem solving. In my view the main risk we face at present does not stem from the financial crisis itself. Rather, the risk is that within a year the global economy will have entered a phase of recovery and governments will start feeling complacent again and, as I noted some months ago in a letter to the Financial Times, we will miss a once-in-a-life-time opportunity to address the serious vulnerabilities in the world’s financial system which the current crisis has revealed. The next crisis—most likely hitting us from some totally unforeseen corner—would find us with much higher levels of public debt and, therefore, far more constrained in our ability to respond to the emergencies at hand. Crises can be opportunities for urgent reforms, but they can also be wasted through lack of political will and imagination.

1. Augusto Lopez-Claros was IMF resident representative in Russia and chief economist of the World Economic Forum. In 2007 he was co-editor of The International Monetary System, the IMF, and the G-20: A Great Transformation in the Making? published by Palgrave Mcmillan.
2. For the record, the G20, in fact, is the G22 as it also includes Spain and the Netherlands, two countries originally excluded from membership.
3. A similar recommendation applies to the World Bank, whose president has traditionally been an U.S. citizen.