Beyond the G20 Toward effective global economic governance Jakob Vestergaard

DIIS ∙ DANISH INSTITUTE FOR INTERNATIONAL STUDIES

Beyond the G20Toward effective global economic governance

Jakob Vestergaard

Epigraphs

Stewart Patrick, US Council on Foreign Relations: G20 is “the most significant advance in multilateral policy coordination since the end of the Cold War” (2010).

Foreign Minister Norway: creation of G20 was “one of the greatest setbacks since World War II” (Spiegel 2010).

Uganda CB Gov: G20 is but extension of “the old architecture” (2011)


Structure of lecture

G20 output legitimacy: effectiveness

G20 input legitimacy: representation

G20 at a crossroads: what to expect from the Cannes summit?

From G20 to GEC


Output legitimacy: effectiveness


G20 effectiveness (1)

”The concerted and decisive actions of the G20…has already delivered a number of significant and concrete outcomes:

Financial regulation “broadened” and “strengthened”.

“Great progress” in macroeconomic policy coordination – cf. framework for “strong, sustainable and balanced growth”

Global governance “dramatically improved” – “to better take into consideration the role and the needs of emerging and developing countries, especially through the ambitious reforms of the governance of the IMF and the World Bank”.


G20 effectiveness (II)

“Failure to reach an (admittedly difficult) agreement on a piloted across-the-board adjustment of balance of payments should not overshadow the rapid agreement achieved with regard to the Basel 3 Accord, which would not have been possible without the political momentum of the G20 leaders”

(Domenico Lombardi, Brookings)


G20 effectiveness (III)

Financial regulation: alleged ”main accomplishment” is the new international standard in banking, ’Basel 3’

G20 delegated this task to the Basel committee

Basel committee: G20 plus six additional European c’ies (Switzerland, Spain, Sweden etc) and two financial hubs in Asia (Hong Kong and Singapore)

Basel 3 negotiated in less than a year, compared to Basel 2 which took more than five years.

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International banking standards

Two fundamental objectives (BCBS, 1988: §3):

“strengthen the soundness and stability of the international banking system”

“be fair and have a high degree of consistency in its application to banks in different countries”

Key governance tool: capital adequacy requirement: 100

euro loan => at least 8 euro in reserves


The pre-crisis approach (Basel 2)

Three pillars: Pillar 1: Capital > 8 pct of ’risk-

weighted assets’ Pillar 2: Supervisory review process –

more capital than Pillar 1 minimum can be demanded

Pillar 3: Disclosure requirements, to encourage ’market discipline’ (misbehaviour punished)

From binding to less binding…



’The end of lightly regulated finance’


Before After ProposalsMicroprudential approach (atomistic perspective)

Macroprudential approach (systemic perspective)

Surcharge on ’systemically important financial institutions’

Great moderation: we are beyond boom and bust

Credit growth may indeed be excessive, highly destabilizing

Higher capital reserve requirements and leverage ratio

Standards do not impact on the economic cycle

Standards should be revised to be countercyclical (instead of procyclical)

Countercyclical capital reserve requirements


Regulatory capture (1)

…BUT: reform initial proposals watered down, after intensive banking industry lobbying

Aims of banking industry lobbying – the four Ls:

- Lower

- Leave out

- Least-binding

- Later



Regulatory capture (II)


Initial proposal

Industry recommendation

Outcome

International leverage ratio in Pillar 1 (binding)

Move to Pillar 2 (non-binding)

Pillar 1, but set at low level, and delayed…

Introduce countercyclical buffers in Pillar 1

Move buffers to Pillar 2

Adoption in Pillar 2; set at only 0-2.5 pct; delay


Basel 2 vs Basel 3


Basel 2 Basel 3

Core Tier 1 capital

2 4.5

Other Tier 1 capital

2 1.5

Total Tier 1 capital

4 6

Tier 2 capital 4 2

Total 8 8


Basel 3 – overview of outcomes


Where? How much?

When?

Minimum capital reserves

Pillar 1 8 pct (but higher quality)

2013-2015

Capital conservation buffer

Pillar 1 2.5 2016-2019

Countercyclical capital buffer

Pillar 2 0-2.5 2016-2019

Leverage ratio

Pillar 1 3 pct. 2018


Finance professors ’going political’

“Banks’ high leverage and the resulting fragility and systemic risk contributed to the near collapse of the financial system. Basel 3 is far from sufficient to protect the system from recurring crises.

If a much larger fraction, at least 15 per cent, of banks’ total, non-risk-weighted, assets were funded by equity, the social benefits would be substantial. And the social costs would be minimal, if any”.



Finance professors ’going political’

Key points of joint letter by 20 of worlds leading finance professors published in Financial Times in run-up to Seoul summit:

-- Basel 3 fails to ”eliminate structural flaws in the system”

-- please remember that ”healthy banking is the goal, not profitable banks”

Unfortunately, this support from academia came too late, says anonymous CB governor



Basel 3: ’more heat than light’?

Basel 3

- intensification of Basel 2

- marginalization of counter-cyclicality

- ’grandfathering’ (to be implemented by 2019…)

Three years after crisis:

- banking not ”sound and stable”, espec Eurozone c’ies

- threat to global economy as least as severe as in ’08

- social upheaval and protest, nationalism, even war?


In conclusion, on G20 effectiveness

Before Seoul summit (Nov 2010): G20 is “divided, ineffective and illegitimate” (Rachman, FT).

After Seoul summit: G20 had shown “how not to run the world” (FT editorial)

Summer 2011: G20 marginalized (G Brown called for meeting, but nothing happened)

Conclusion: G20L not “effective” as global steering committee = low “output legitimacy”


Input legitimacy: representation

G20 claims input legitimacy

G20 says: its “economic weight & broad membership gives it a high degree of legitimacy & influence over the management of the global economy & financial system” (G20 2010a).

G20 says it is representative: covers 90% of world GDP, 80% world trade, 66% world population.

G20 says it is big improvement over G8.

Input illegitimacy (1)

Regarded as illegitimate by many of 174 UN member states permanent excluded

Membership endorsed by G7, in 1999, selected in transatlantic calls btw US and Germany.

G7 claimed they were all “systemically significant” c’ies. No explicit selection criteria.

No process for changing membership in line with changes in global distn of econ power.

Input illegitimacy (II)

The 19 member countries not the 19 biggest economies by any indicator (neither in 1999 or 2008)

Europe not “over-represented” by GDP criteria: Spain, Poland, Netherlands shd be in; Argentina, Saudi A, S Africa out. Yet widely believed (esp USA) that Europe over-rep.

No regional representation – except EU If EU removed, G20 “represents” 77%

world GDP, 60% world trade, 62% world population

Input illegitimacy (III)

Big majority simply cannot be used to argue a case of input legitimacy

Consider example of national elections (urban dominance; religious dominance)

Without explicit – and widely accepted – criteria of inclusion/exclusion, there can be no such thing as input legitimacy

Irony of G20s claim of “dramatic improvement” of global governance, in interest of developing countries: the G20 itself further marginalizes those countries

G20 countries – by region and income classification

Low-income countries

Middle-income countries

High-income countries

Total

Africa 0 South Africa 1

Americas & Australasia

0 Argentina, Brazil, Mexico

Australia, Canada, USA

6

Asia 0 China, India, Indonesia

Japan, Korea, Saudi Arabia

6

Europe 0 Russia, Turkey France, Germany, Italy, UK

6

Total 0 9 10 19

Ad hoc participant expansion

G20L has responded to “unrepresentative” criticism by issuing “invitations” to “outreach participants” and “observers”.

Spain invited as “permanent guest”.

ASEAN invited as “outreach participant” to all 5 summits.

Hosts of last 2 summits (Canada, Korea) invited African Union to send 2 reps.

Status of ‘invitees’ unclear…

So: G20= 19 countries + EU + 5 “invitee states” (of wh 3 rep regions)

G19+6, or simply G25


The G20 at a Crossroads: what to expect from the summit in Cannes


Two opposing trends in GEG

1. Drift back towards G7/G8: Summer 2011: G20Fs did not meet but G7Fs

did (despite formers self-declared status of ’premier forum’..)

Obama has announced that he will host G8 and Nato summits in May 2012, just one month before G20 summit in Mexico

=> Is G20 being reduced to a secondary body?

2. Appeals to G20 to step up: ’rescue WE, please’ EU, OECD, etc Much depends on the Cannes summit



G20 summit in Cannes: the context

Drama similar to first two G20 summits: recovery in danger (for instance, gloomy OECD forecast yesterday).

Global economy more vulnerable now than in 2008: fiscal stimulus at similar scale not likely

Growth in EMEs remain strong – BUT: increasing risk of inflation, prospect of further weakening of export markets, partial retreat of foreign capital

Quasi-insolvent European banking sector? Will banks reduce lending to meet capital reserve requirements by June next year? New credit crunch in Europe?

European agreement: ”too little, too late”? (Brookings, yesterday). Espec German discontent (Bundesbank). Greek referendum – radical uncertainty..



Growth, please – but how?

OECD: adopt ”bold growth strategy”, if not: drop in GDP of up to 5 pct by mid-2013

EU leaders: G20 should approve ambitions plan to ”ensure strong, sustainable and balanced growth while implementing credible fiscal consolidation”

Many G20 leaders constrained by domestic politics to undertake big fiscal stimulus – constrained by fiscal austerity ideology



Action items for Cannes summit

With fiscal policy constrained and monetary policy reaching its limits, what can be expected?

Non-European contributions to the EFSF? (China etc)

Expansion of IMF’s financial capacity? Global food crisis: more resources for investment

in agriculture? Or, at least, meeting prior commitments to fund the Global Agriculture and Food Security Program?

Most likely little on main issues: global imbalances etc

Main risk: conflict btw European leaders and non-European leaders (on terms of support etc.)



Two scenarios

1. Marginalization of G20 Continues as talk-shop, but secondary to

G7/G8 How will the BRICs react? Wider process of deglobalization of

international economic governance? More emphasis on regional level

2. G20 resumes global leadership Further institutionalization, incl secretariat


Four good reasons…

.. to look for a different, more viable format for effective global economic governance:

The G20 is not effective (low output legitimacy)

The G20 excludes 174 UN member states and membership criteria arbitrary (low input legitimacy)

The G20 undermines the existing multilateral system of GEC

And the G20 is losing momentum…


From G20 to GEC

Global Economic Council

Start with BWI system, not G20/G25. Constituency system has long-established legitimacy.

Advantages over G20: (1) all states represented in governing bodies, (2) some consultation within constituencies, (3) some rotation at top table

Disadvantages: (1) no heads-of-govt. level; (2) system of single country seats unsustainale (3) voting power system out-of-sync with realities of global economy

Allocation of seats among regions

25 seats, based on reformed BWI constituencies.

Allocation of seats:

(i) Divide world into 4 regions: Africa; Americas & Australasia; Asia; Europe. Each region to have 4 seats. Subtotal = 16.

(ii) Distribute 9 more seats between 4 regions proportional to regional share of world GDP*. All regions except Africa get 3 more seats.

Result: Africa = 4 seats, other regions = 7

Constituencies and rotation

No single-country seats; all countries in constituencies (minimum size: 3, average: 7).

Mechanism of rotation within each constituency: Each constituency one director & 2 alternates.

Constituency decides whether all 3 positions rotate b/w members, or only alternates. If only at alternates’ level, large c’ies cld always be at table – but still obliged to consult with other states.

BWI constituencies to be reformed in same way

GEC decision-making

Two models: Binding agreements, based on a

combination of majority voting and special majority voting (as in BWIs)

Informal “talk-shop” council, as the G20 – on the assumption that big powers otherwise will not go along

Possible compromise: start out as informal council, replacing the G20, testing ground for future potential formalization

UNSC as model? Two forums: “consultation room” (strictly private, no formal decisions); formal room.

The way forward GEC based on formal treaty Treaty focusing on one issue:

international macroeconomic imbalances Correction of imbalances as joint

responsibility of surplus and deficit countries

Limits on imbalances – deficits and surpluses – as share of GDP

The how of correction/adjustment is left to discretion of countries in question, but non-correction to come at high cost

All other issues: non-formal

Documents

Beyond the G20 Toward effective global economic governance Jakob Vestergaard