The G-20 action plan addresses fundamental global economic issues, but could be constrained by time and capacity, says Subir Gokarn
Will the G-20 summit that was held in London last week make any difference to the ability of the global economy to deal with the current crisis? Like all collective efforts to deal with a crisis, the G-20 process and, consequently, its outcome is far more heavily weighted towards preventing the next crisis than to alleviating the current one. This is not necessarily a problem. A key objective of the process is to quickly restore confidence amongst global companies, consumers and investors. One important component of this is to convey the impression that the causes of the current crisis have been identified and understood and the measures that have been announced are adequate.
Broadly, I think that the steps proposed for the global financial system meet that standard. Greater transparency and better prudential management are, of course, on the top of any financial sector reform agenda, crisis or no crisis, but they gain a particular significance in the current situation, since the fundamental cause of the crisis is now generally accepted to be directly related to these two attributes. Beyond this, the other focus areas of the action plan directly address issues of distorted incentives and conflicts of interest to which the crisis has also been attributed.
But, all of these actions need a substantial ramping up of global capacity to implement effectively. The upgrading of the Financial Stability Forum, which has so far been an ideas and knowledge-sharing arrangement to a Board, with a formal mandate of surveillance based on information-sharing, harmonisation of standards across countries and, at least on paper, enforcement of compliance. If all of this works as intended, we should have a global financial system, which is better equipped to pre-empt the next shock as well as to absorb it if it cannot be avoided.
The potential problem is the time and effort it is going to take to match the institutional design and capacity with these very ambitious objectives. Two kinds of barriers could impede the process. One, the global economy recovers in response to a combination of individual monetary and fiscal stimuli and inherent self-correcting forces, such as sharp declines in property prices. If this were to happen over the course of the next year, the appetite to persist with what will unquestionably be a complicated and painful process will diminish. Two, the capacity of a hugely weakened system to subject itself to new requirements is limited. The summit declaration recognised the need to let the system recover before imposing a new regime, but as useful as a delay might be, it could also dissipate the momentum.
While the measures on financial regulation have an eye on the future, the steps announced at the summit to enhance the resources available to multilateral institutions will have a much more immediate impact. They could reinforce the policy packages implemented by individual governments to stimulate business. Constraints on the flow of trade finance have increasingly been viewed as a major contributor to the sharp decline in world trade witnessed since October. The $250 billion provision for various national trade finance institutions to support trade flows will help to facilitate a recovery in trade as global demand increases.
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The International Monetary Fund (IMF) will see its capacity to lend to countries with emerging balance of payments problems to the tune of $850 billion. This should allow the institution to deal with the threats of default from over-extended economies that are going into recession. Significantly, the summit declaration implicitly acknowledges the critique that has been made of IMF conditionalities, which are often equated with the cure being worse than the illness. Flexibility in lending will be a hallmark of the new approach. This is a welcome development, but it is difficult to anticipate what it means in concrete terms. Since the current crisis has turned many of the benchmarks of reform and structural change on their heads, how easy is it going to be for the institution to evaluate the merits of a loan application?
Similar opportunities and constraints are visible in the proposal to enhance the resource base of the World Bank and the regional development banks. The summit clearly recognises the dangers of private capital flows to developing countries being significantly reduced in the aftermath of the crisis. When it comes to infrastructure and other areas which are relatively new as far as foreign investors are concerned, the flows may not resume even as there is an economic recovery. In this scenario, the multilaterals come back to centre stage as financiers of development. But, how quickly are they going to re-orient their lending practices, which contributed to their displacement by private investors over the past few years?
The summit has set a timeframe for a reform strategy for the entire multilateral financial framework, but this will take a minimum of a year! Will the anticipated flow of funds have to wait until there is a consensus on what new shape these institutions will take? In which case, while they may help to restore the long-term availability of finance for development, they will not contribute much to addressing the current crisis.
As the nature and possible response to the crisis has been debated over the past few months, an ongoing debate on how the world economy emerged from the Great Depression has apparently re-surfaced. There are those who say that President Franklin Roosevelt’s New Deal, which essentially consisted of a combination of financial regulation and public spending, was the cause of the recovery. There are others who argue that the New Deal measures were useful, but inadequate and it was World War II and all the spending that ensued that finally did the trick. This debate is relevant in today’s context on two counts.
First, it is rather difficult to assess whether the sum total of policy responses to a crisis are ever going to be enough to deal with it. Crises are dynamic, evolving phenomena and each one is, in a sense, unique. Past experience can be a guide, but only a guide. But, second and more importantly, whether the New Deal helped in taking the economy out of the Great Depression or not, it certainly put a new economic framework in place, which ensured that both the frequency and severity of subsequent crises was much less. If the actions taken as a result of the G-20 initiative can achieve the same thing, it will indeed be a global new deal.
The author is Chief Economist, Standard & Poor’s Asia-Pacific. Views are personal