The G-20, the IMF, and Legitimacy
Strong advocates of our new G-20 process are convinced that it will bring legitimacy to international economic policy discussions, rule-making, and crisis interventions. Certainly, it's better than the G-7/G-8 pretending to run things—after all, who elected them?
But who elected the G-20? The answer is: no one. And, in case you were wondering, there is no application form to join the G-20 (although you can crash the party if you have the right friends, e.g., Spain). The G-20 members have appointed themselves as the world's "economic governing council" (to quote Gordon Brown).
Is this a good idea?
Not really—it would be much better to have a structure in which all countries were represented, probably with some weighting according to their economic and financial importance in the world.
The problem is that we have what is supposed to be exactly that structure at the International Monetary Fund, and it doesn't work very well. The IMF has 186 members, represented by 24 executive board members, who live in Washington, DC, and work every day (almost) at the Fund.
The IMF's resident executive board members are often not very senior, meaning they are a long way below the real decision makers in their respective bureaucratic structures; this is cumbersome. But twice a year, finance ministers representing the 24 board seats meet as the International Monetary and Financial Committee (IMFC) to oversee the work of the Fund—with the next meeting in Istanbul, October 6–7.
You might think that Istanbul will advance the G-20 agenda—because the people meeting as the IMFC are almost the same people who will meet in November as the G-20 ministers of finance. But they are not the same and many other people will be in the room at Istanbul. This is all very awkward and will further slow down whatever progress there is at the global financial reform level. In fact, the G-20 suggested that the next productive meeting would be of its finance ministers in November, i.e., implying that Istanbul is a waste of time.
The relationship of the G-20 to the IMF is extremely delicate—smaller countries are already beginning to complain, and with some reason. If the goal is to rebuild the legitimacy of the IMF and to encourage countries to trust it to lend fairly in a crisis, this is not going very well. The rules around who will be supported and on what basis are becoming increasingly murky and not rules-based—e.g., Eastern Europe is almost certainly getting deals that would never have been offered to troubled countries in Asia.
It would be better for emerging markets to form their own Fund (let's call that the EMF). They have plenty of "hard" currency in hand to do so and no shortage of economic expertise; $1 trillion of paid-up capital would be more than enough to get it started (and this would also take the pressure off China with regard to its "excess" reserves).
The EMF could cooperate with the IMF but also operate independently—and just as much (vaguely) under the auspices of the G-20. This would go a long way toward restoring emerging market and developing country confidence in the international financial system—and toward assuring they will get timely and appropriate help in the event of another world crisis.
Also posted on Simon Johnson's blog, Baseline Scenario. The following was previously posted.
September 26, 2009
It is easy to dismiss the G-20 communiqué and all the associated spin as empty waffle. Ask people in a month what was accomplished in Pittsburgh and you'll get the same blank stare that follows when you now ask: What was achieved at the G-8 summit in Italy this year?
Perhaps just having emerging markets at the table will bring the world closer to stability and more inclined toward inclusive growth, but that seems unlikely. Should we just move on—back to our respective domestic policy struggles?
That's tempting, but consider for a moment the key way in which the G-20 summit has worsened our predicament.
There is broad agreement that capital requirements need to be increased and a growing consensus that very large banks in particular should be required to hold bigger equity cushions. This is a pressing national priority—if our financial system is to become safer—and reasonable people are starting to put numbers on the table ever so quietly: Joe Nocera is hearing 8 percent, but Lehman had 11.6 percent Tier One capital on the day before it failed and the US banking system used to carry much more capital—back in the days when it really was bailout free (think 20 to 30 percent in modern equivalent terms—see slide 40 here [pdf]).
Obviously, raising capital standards in the United States is going to be a long and drawn-out fight. The G-20 could help, if it set high international expectations, but the opposite is more likely. As Nocera suggests this morning, the inclination of the Europeans—largely because of their funky "hybrid" capital, but also because they have some very weak banks—will be to drag their feet.
Why should we care? This administration seems to think that we need to bring others with us if we are to strengthen capital requirements. Our progress will be slowed by this thinking, the glacial nature of international economic diplomacy, and the self-interest of the Europeans.
Instead, the United States should use its power as the leading potential place for productive investments to make this point: If you want to play in the US market, you need a lot of capital. If you would rather move your reckless high-risk activities overseas, that is fine.
It's time to get past the thinking that our economic prosperity is tied to the "competitiveness" of the financial sector when that means doing whatever finance wants and keeping capital standards low.
As we discovered over the past 12 months, undercapitalized finance is not a good thing—it is profoundly dangerous and expensive. Other countries should be encouraged to raise capital standards also, but if they can't or won't, then their financial institutions will (1) not be allowed to operate in the United States, and (2) be allowed to interact in any way with a US bank only to the degree that the US entity carries an extra (big) cushion of capital in those transactions. Any US entity found circumventing these rules will be punished and its executives subject to criminal penalties.
Of course, this process needs to be WTO-compliant and the G-20 is as good a place as any to manage the high politics of that. But stop worrying about what other countries might or might not do. Establish high capital requirements in the United States, and make this a beacon for safe and productive finance.
And prepare for the crises that will sweep undercapitalized parts of the world financial system in the years to come.