The G-20 and the World Economy
Speech to the Deputies of the G-20
© Institute for International Economics
Dr. Bergsten was invited by Germany, which is chairing the Group of 20 in 2004, to address the latest meeting of its deputies in Leipzig on March 4, 2004. The G-20 is a group of systemically significant industrialized and developing countries that account for almost 90 percent of the world economy. Its finance ministers and central bank governors have been meeting annually since 1999 and their deputies meet twice each year. The G-20 includes Argentina, Australia, Brazil, Canada, China, the European Union, France, Germany, India, Indonesia, Italy, Japan, Korea, Mexico, Russia, Saudi Arabia, South Africa, Turkey, the United Kingdom, and the United States.
I have been asked to address on this occasion your central agenda issues of macroeconomic stability and growth, the deeper sources of growth in both industrial and developing countries, and the relevance of the Washington Consensus in today's world economy. I am delighted to do so because I believe that the G-20 can play a major role in both developing a consensus on the underlying fundamentals of these issues and in directly addressing a number of the most important "stability and growth" questions facing the world economy at the present time. I will offer specific recommendations on the role of the G-20 after briefly surveying the state of thinking on growth strategies and especially the role that globalization plays in that context.
Globalization and Growth
Globalization is, of course, under attack throughout the world. Critics argue that some countries, and even entire regions, are affected adversely by the process. They argue that major groups within virtually all countries are losers and that the entire phenomenon should be rejected or, at a minimum, thoroughly revamped.
There is a very widespread intellectual consensus to the contrary, however, that demonstrates that globalization is an essential component of growth in rich and poor countries alike. The aggregate record is impressively positive, including for developing countries (Bhalla 2002). It remains the case that no country has ever developed on a sustainable basis without participating actively in the global economy. The eminent economic historian Jeffrey Williamson of Harvard has succinctly summarized the analytical results:
Every economist who has run a regression over the past fifteen years, with the exception of Dani Rodrik, has found the correlation we expect for recent historical experience. Controlling for religion, culture, geography and institutions, openness is always correlated with faster growth. Economists have been getting that result ever since the NBER did their simple comparative statics studies back in the 1960s and 1970s. Indeed there has not been a single study that has shown the opposite. That is, no study has shown that openness has been associated with slower growth (Williamson 2003).
In addition, a new study by David Dollar and Aart Kraay of the World Bank (2004) concludes that "changes in growth rates are highly correlated with changes in trade shares." They show that the one third of developing countries, accounting for well over half the population of the poorer countries, that doubled the trade share of their economies over the past 20 years have also come close to doubling their economic growth rates and have significantly reduced their income gap with the rich countries. By contrast, the nonglobalizing developing countries, where trade to GDP ratios declined, saw their growth rates fall by more than 50 percent and have fallen further and further behind both the rich and globalizing developing countries.
My own view is that increases in openness are particularly effective in leading to productivity enhancement and economic growth. The major growth stories of the present period-China, India over the last decade, Mexico, the United States-have experienced quantum jumps in their integration with the world economy. The United States, for example, has tripled the share of trade in its economy over the past 40 years, and our studies at the Institute for International Economics (Baily 2003, Mann 2003) suggest that this increase in openness accounts for as much as one half of the dramatic increase in its productivity growth over the past decade (from 1 percent annually to at least 2½-3 percent, more than 4 percent from 2001 to the present).
Conversely, countries and even whole regions that have failed to globalize have lagged. Africa's share of world trade and investment has dropped to minuscule levels. Brazil could quickly expand its trade, probably by a multiple of two or three, if it could obtain better access to foreign markets (mainly in Europe and the United States) and reduce its own barriers (Schott 2001). India might well achieve China-type growth numbers over the coming decade if it would complete its reforms and integrate further with the world economy (Srinivasan and Tendulkar 2003). In the industrialized world, Japan's globalization ratio has declined and Germany's has been flat-and those countries have been the growth laggards within the G-7.
Perhaps the most dramatic example is the Middle East, on which much current attention is rightly focused. The region did as well or better than Latin America and even Asia in the first postwar decades but has declined steadily for the last 30 years despite the dramatic rise in the price of oil-as its failure to engage with the world economy has become glaringly obvious (Noland and Pack 2004). Over the past 20 to 25 years, most of the region has essentially "deglobalized" at a time when its population was doubling. A variety of indicators point to this deglobalization:
- The Middle East share of world trade has dropped by 75 percent in the last 25 years.
- Half of the Arab League's 22 members have not even joined the World Trade Organization (WTO).
- The 22 nations of the Arab League, with a population of 260 million, receive half as much foreign direct investment as Sweden, with a population of 9 million.
- The ratio of foreign direct investment to gross domestic product in the Middle East countries is at least three to four times lower than that found in other developing countries.
- Tariff rates in the region remain very high-ranging from more than 40 percent in Pakistan to 20 percent or higher in nations such as Egypt, Syria, or Saudi Arabia.
- While regional economic integration has become a top priority throughout Asia, Latin American and even Africa, conflicts, boycotts, and sanctions limit the possibility in the Middle East.
- Foreign equity investment in the entire region roughly equals that of Indonesia, suggesting a very undeveloped capital market and poor allocation of the very limited savings pool it has to draw upon.
- The Middle East countries together spend about half as much per year tapping international technology as does Brazil.
In contrast to this bleak picture, the US-Jordan Free Trade Agreement, which was implemented in 2001, offers an interesting case study of what happens when a Middle East nation makes a determined and bold effort to integrate itself more closely with the international economy. In the past five years, Jordan's exports to the United States have increased 30-fold, from $4.1 million in 1998 to $133.3 million in 2003. Jordan's exports to the United States in 2003 alone increased 80 percent-the second fastest of any country in the world. Moreover, the composition of these exports has started to shift toward more capital-intensive goods, and Jordan has experienced rapid economic growth. Clearly, deglobalization can be reversed in the Middle East. President Bush's proposal for a new free trade agreement between the United States and the entire Middle East, starting with the current agreements with Jordan and Morocco (and Israel) and perhaps shortly adding Bahrain and Egypt, would be one way to advance such integration on a much broader basis. The Middle Eastern and other countries cited here obviously have problems that range beyond their lack of globalization, but their failure to take advantage of international economic integration is clearly a major factor in their lagging performance.
A second key conclusion is that the political leadership in countries with some of the most remarkable development success stories has consciously used globalization, especially formal international economic integration, to overcome domestic resistance to effective reform strategies. Mexico sought NAFTA importantly to complete, and then lock in, the liberalization of its domestic as well as external economic policies. China joined the World Trade Organization largely so that it could employ the international rules to override opposition to its internal reforms. Egyptian reformers are now seeking a free trade agreement with the United States for precisely these reasons. The lesson is that sharp increases in openness, especially if they can be managed through major domestic initiatives that become national political priorities and thus enable a country's top officials to overcome entrenched resistance to change, can produce huge breakthroughs in development strategies and subsequent performance.
Globalization, however, while clearly a necessary condition for (rich or poor) countries to achieve sustainable growth, is equally clearly not a sufficient condition. Many studies show that countries must put additional supportive policies in place to enable them to take full advantage of globalization. Moreover, globalization generates costs and losers just like any other source of dynamic economic change. It thus becomes essential to elaborate sophisticated globalization-based development strategies, as the so-called Washington Consensus has attempted to do for the past decade or so.
The inventor of the term Washington Consensus and chronicler of its results to date, my colleague John Williamson, has recently offered a comprehensive update of that strategy. Addressed primarily to Latin America and conducted with a team of 14 top economists from that region, his new study concludes that the original consensus produced a disappointingly slow revival of growth mainly because its reforms "were not pushed far enough" and because a series of crises, reflecting the vulnerability of countries in the region, disrupted economic performance. The authors also acknowledge shortcomings in the strategy, however, notably an excessively narrow focus "on restoring growth [that] never really faced up to the need to expand employment in particular and opportunities in general so as to give poor people a chance to contribute their talents. . . ." (Kuczynski and Williamson 2003, 308). Hence they propose a program of reforms "after the Washington Consensus" that emphasizes four areas (320-21):
- Crisis proofing. This can be furthered by anticyclical fiscal policies, hard budget constraints on subnational governments, stabilization funds, flexible exchange rates, inflation targeting, further strengthening of fiscal positions and completion of pension reform so as to reduce dependence on foreign savings, and regional peer monitoring of commitments to fiscal responsibility.
- Completion of first-generation reforms. It is important to liberalize the labor market so as to give those currently in the informal sector the opportunities that come only with formality; this should be sought by cooperation rather than confrontation. The labor market could also be made more flexible through comprehensive programs of labor retraining. Trade reforms need to focus primarily on improving market access to industrial countries, via the FTAA and WTO. There are still many enterprises, including state-owned banks, to be privatized.
- Aggressive second-generation (institutional) reforms. Needs differ by country and leading candidates include the political system, the civil service, the judiciary, and the financial sector.
- Income distribution and the social agenda. The fiscal system should be made more progressive, not by reverting to penal marginal tax rates but by imposing property taxes and by focusing expenditures on the universal provision of high-quality basic education and health care. Poor people need to be empowered by giving them access to the assets that will enable them to earn a decent living in a market economy: education, land, credit, and titling.
The G-20 could provide a benchmark for the entire globalization process, for the next decade or so, if it could reach agreement on significant portions of this very ambitious reform agenda. Such a consensus would add enormously to the luster and reputation of the G-20 if it decides to seek a leadership role in the evolution of the conceptual foundations, as well as operating modalities, of the world economy-as I believe it should.
There is, of course, a second set of requirements that must be present for globalization to succeed: a hospitable global economic environment. In particular, developing countries can only reap the expected benefits from globalization if the markets of the industrial countries are truly open to their most competitive products and their people. Here again is a major reason for the G-20 to focus on these issues, as it is the only possible steering committee for the world economy that comprises the leading countries from both sides of the per capita income divide.
Macroeconomic Stability and Growth
In the shorter run, and hopefully operating within the consensus on broader strategies just suggested, the G-20 could-as indicated in the list of purposes of the group cited by its ministers at their first meeting in Berlin in 1999-"promote cooperation to achieve stable and sustainable growth that benefits all" by forging international agreements in cases where the G-7 has increasingly failed to perform. The latest meeting of the "finance G-7" at Boca Raton, Florida, dramatically illustrates the opportunities that now present themselves to the G-20.
For example, the G-7's effort to manage a constructive adjustment of the global imbalances centered on the US current account deficit (without putting excessive pressure on other individual components of the world economy, notably Europe) has achieved limited success, at least to date, in large part because the G-7 excludes countries whose participation in the necessary adjustment of exchange rates is essential. The most obvious example is China, whose currency policy holds the key to the participation of all of East Asia in the realignment process. But other non-G-7 countries, including Korea and probably India, will need to participate in the process as well. Several other G-20 members outside the G-7, such as Australia and Mexico, also have major direct interests in the outcome because of the substantial implications for their own exchange rates and economies.
The G-7 has also found it difficult to function as an impartial and thus effective arbiter in major debt cases, such as Argentina at present, because of the skewed nature of its membership. The creditor countries have traditionally been able to impose their views on the debtor countries, including through their voting control of the international financial institutions. Their recent initiatives in that direction have triggered substantial backlash, however, most notably at present in the case of Argentina but also in the efforts of the East Asian countries through their Chiang Mai Initiative to eventually create an Asian Monetary Fund (Henning 2002, Wang 2004).
Hence the G-20 should gradually but steadily succeed the G-7 as the informal steering committee for the world economy in addressing topics such as these, for reasons of both effectiveness and political legitimacy. The G-7's share of world output, trade, (especially) monetary reserves, and everything else is declining steadily. More important, it is likely to decline much further over the coming decades (table 1). Virtually all of the offsetting increases are in non-G-7 members of the G-20.
The G-7 is therefore increasingly unable to manage the world economy effectively. Its increasingly unrepresentative membership is simultaneously eroding the political legitimacy that is essential to win international support and thus acceptance for many of its proposals. Moreover, the G-7 has not even run its own "internal" affairs very successfully. While preaching fiscal stability and equilibrium exchange rates to outsiders, for example, the G-7 has permitted huge budgetary imbalances and massively misaligned currencies to proliferate in its midst without any serious effort to remedy them. Hence the performance of the G-7 has deteriorated badly and institutional reform is required (Bergsten and Henning 1996). The G-20 should thus gradually but steadily become the forum within which the rich and poor countries encourage each other to adopt more constructive policies.
The Morelia Communiqué of the G-20 Ministers, at their meeting in October 2003, clearly recognized these substantive problems and the opportunities for this group to address them. The G-20 now needs to take effective actions to do so. The group has now had five years of experience and has begun to develop a real sense of camaraderie, so it should be time to begin the transition from "discussion forum" to "action committee."
The case for G-20 leadership in steering global economic and monetary policies is underlined by recent developments in the management of global trade policy. The "other G-20," comprised solely of developing countries, demonstrated at Cancún in September 2003 that it can exercise effective veto power over multilateral trade negotiations in the World Trade Organization, even in the face of a joint position of the "G-2" (European Union and United States), which has previously dominated virtually all previous initiatives in that domain. The inevitable outcome, toward which both groups are now groping, is some new steering committee for the trading system that comprises both the key developing and industrialized countries. It would not be surprising if the new steering committee for world trade policy turns out to look a good deal like the "finance G-20" (except perhaps for the two "finance G-20" members that have not yet entered the WTO, Russia and Saudi Arabia).
The G-20 Agenda
As the G-20 contemplates its agenda for "Macroeconomic Stability and Growth," it should thus seek to fill the gaps left so conspicuously by the G-7. It could do so in both the systemic and current policy contexts.
For example, the Emerging Markets Eminent Persons Group (EMEPG), chaired by former Korean Finance Minister Il Sakong and including such distinguished reformers as Manmohan Singh of India and Roberto Zahler of Chile, concluded in 2001:
The wide swings of dollar/yen/euro exchange rates are one of the most important sources of external shock to emerging market economies, undermining their efforts to maintain sound financial policies and macroeconomic balances. We strongly urge the G3 countries to develop a system by which stable exchange rates among major currencies can be maintained. (p. 26)
The debate over the "international financial architecture" has ignored this central topic. The chief reason is that the G-7/G-3 countries have wished to avoid (or evade) confronting the implications for their own policies of managing their flexible exchange rates in a more systematic, cooperative, and internationally compatible manner.
International agreement on new rules, or even norms, for the exchange rate system would make it far easier to deal with the recurrent problem of global imbalances such as those we are seeing now. Such a regime would be of great help in answering the questions that must be faced today: How large must be the adjustments in the main countries' current account imbalances? How should those adjustments be achieved? Which countries should be responsible for corrective actions? Over what periods? These are very difficult questions, and it is understandable that officials shy away from addressing them. The alternative of leaving the outcome to a combination of market forces and wholly unilateral actions by national authorities, however, demonstrably produces results that are both unsustainable and manifestly unbalanced.
The current exchange rate regime is very weak, and even its minimal rules, such as the prohibition on "protracted large-scale intervention in one direction in the exchange market" to block currency adjustment, are being ignored by the IMF and the G-7 in important country cases today (Goldstein 2003). Hence there is a need for fundamentally new understandings on the global exchange rate system. The G-20 should add this set of questions to its agenda.
Regional Economic Integration
One aspect of the backlash against globalization in its present form-and especially against its current lead institutions, including those located in Washington-has been the pursuit of regional alternatives, another item on the agenda for this meeting of the G-20. In particular, East Asian countries are actively negotiating a series of regional, subregional, and bilateral agreements in the areas of both money (i.e., the network of bilateral swap agreements under the Chiang Mai Initiative) and trade (e.g., China-ASEAN and Japan-Korea). Extensive subregional arrangements also exist in Latin America (Mercosur, Andean Pact) and elsewhere (South African Customs Union, Gulf Cooperation Council) with respect to trade but increasingly with an eye toward monetary and even macroeconomic cooperation as well.
Two implications of this trend are germane for the G-20 as it evolves toward becoming an important steering committee for the world economy. In the short run, it will be essential to assure that these new regional and subregional entities are compatible with the existing global rules and institutional arrangements-or that these rules and institutions are amended to encompass the regional newcomers in an agreed and harmonious manner.
The longer run significance for the G-20 could be even greater. Successful realization of these regional aspirations-especially in Asia, where until recently they have lagged far behind Europe and even the Western Hemisphere-could lead to the emergence of a tripolar world economic structure (Bergsten 2001). Such a construct would encompass the European Union and its neighboring associates, a Free Trade Area of the Americas (or perhaps NAFTA and an expanded Mercosur in South America that were linked only loosely) and an East Asia Free Trade Area/Asian Monetary Fund. In such a world, a global steering committee that included the key players from each of the three regions-including China and Korea in East Asia, Brazil and Argentina in South America-would be of cardinal importance in managing relations among the regions, which would in turn be central for global harmony and stability.
The prospect of such a tripartite world, which is quite feasible over the next decade or even less, provides a powerful additional rationale for the proposition that the G-20 should gradually but steadily supersede the G-7 as the informal steering committee for the world economy. The G-7 would be even more inadequate for that task in a world where not only its share of the world economy continued to decline substantially but where leaders of key regional arrangements were outside the group.
In such a world, the G-7 could, of course, expand to include such countries. The far better course, however, especially in light of the other problems facing the G-7, as described throughout this paper, would be to anticipate such developments and start now to build the institutional framework that will be required to handle them. The creation of the G-20 five years ago already implied a judgment that the current institutional structure was inadequate, even outdated, for dealing with the main problems of the world economy. Recent events, notably the inability of the G-7 to resolve some of the most salient issues now facing the global system because its membership excludes countries whose participation is essential for doing so, underline the need for the G-20 to become an effective action organization. Achieving this role and addressing such problems forcefully should be the true agenda for the G-20 in 2004 and beyond.
|Others in G-201|
|Others in G-202,3|
p=projected by Goldman Sachs, Global Economic Paper No. 99, October 2003.
1. Australia and Canada.
2. Argentina, Indonesia, Mexico, Saudi Arabia, South Africa, and Turkey.
3. Projected using growth rates of other G-20 emerging market economies.
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