The Challenges of Global Policy Coordination
28 September 2009 - The previous G20 meeting, in April, focussed on crisis management, aimed at preventing the world economy from sliding into a deeper recession. Now that the worst of the downturn is over, attention has shifted to ensuring a sustained recovery and addressing reforms in the financial system. As always, diplomatic language was used to cover up differences among the principal participants at the Pittsburgh summit, which has just ended.
President Obama, who hosted the meeting, needed a show of unity even if in reality there was plenty of underlying discord about policies. Many of his initiatives, such as healthcare and the Israel/Palestine peace process have ended up in the quagmire. So anything smacking of even a modicum of success will be most welcome.
One of the main underlying issues is that of protectionism, which poses a substantial risk to sustaining a rapid rate of growth of the global economy in the future. In April, policymakers pledged to desist from taking protectionist steps. But the grand talk has not been reflected in actual practice, as virtually all of them have broken their pledges. The World Trade Organisation, which has been keeping a record, can point to hundreds of infractions that are still continuing.
A significant risk is that tit for tat measures could potentially descend into a more serious trade war. It is important that the G20 countries have procedures in place to prevent such an outcome. But in many countries political pressure in favour of protectionist polices is very strong and difficult to resist, given the high unemployment rates.
Rebalancing the global economy has been one of the biggest underlying themes at Pittsburgh. Of course, in reality, if market forces are allowed to function without too much hindrance, any imbalances are corrected reasonably quickly. But, historically, meddling with the market has been the rule. Curiously, some countries with the most fervent free-market ideologies have also been highly interventionist.
The prime example of this is the United States, which has engaged in market-distorting policies for a long time. It is well known that an expansionary monetary policy, sustained over a long period, contributed to significant global imbalances, the housing bubble and a credit boom that eventually resulted in a financial crisis and a crash. But others also contributed to the imbalances by adopting policy measures that mimicked or accommodated American policy moves.
Blaming the market for the debacle of the past two years is incorrect. The problems have been created principally by bad policies that distorted market signals. Many of those countries that have been responsible for excessive, market-distorting, policies were gathered at the summit. But the need for decorum at such meetings means that there wasn’t any finger-pointing at some of the guiltiest parties.
However, to move ahead, it is always useful to clear the air by admitting to egregious mistakes instead of papering over the cracks and enunciating inane statements. Failure to do so raises the suspicion that policy mistakes will be repeated in the future. Indeed, given the reality of political pressure on policymakers, and their responsiveness to certain sectional interests, it is absolutely certain that there will continue to be market-distorting policy errors in the future.
Another main theme at the summit was the reform of the financial system. As before, the US and the UK want a soft approach to regulation, and France and Germany want a harder one. The Obama administration’s often tough talk about abuses in the financial services sector is not matched by their actions on bringing in stricter regulations.
Wall Street has considerable clout in Congress and within the administration. It was always highly unlikely that the villains of the financial crisis would be dealt with severely and the door closed on new opportunities to engage in excessive risk-taking. And the bankers aren’t exactly powerless in other major countries, either.
For all the talk about severe consequences for firms in the financial services sector, as a result of upcoming changes to regulations, there is little sign of major discomfort in the top echelons of the banks. It is more the case of business as usual. Great, they say. We’re glad to have been rescued by the government but now let’s get back to making lots of money. Don’t bother us with too much regulation but save us from sinking if our bets don’t work out.
The “too big to fail” banks pose even bigger systemic risks than before. Currently, there are no plans in the offing to downsize them. In the case of the US, giving the Fed greater tutelage over the banks is a cosy arrangement that increases the risk of moral hazard. Earlier, a report prepared by a number of entities, primarily on the buy side, recommended that the administration should not extend the Fed’s power and oversight; particularly in the light of its past failures.
In sum, to nobody’s surprise, differences of opinion will remain within the G20 on the question of tighter regulations. Coordinating the final set of rules, internationally, will be difficult to achieve. As for the banks, they are well prepared to play the game of regulatory arbitrage if there are incompatible reforms in Europe and the US.