Back to square one

Published : Jul 02, 2010 00:00 IST

WHETHER we like it or not, the G-20 has clearly emerged as one of the more significant mechanisms through which economic policies are coordinated internationally. It is obviously not ideal since it began simply as an expansion of the G-8, the elite power grouping that effectively bypassed more democratic fora like the United Nations. But there were those who drew some comfort from the inclusion of developing economies such as China, India, Brazil, South Africa and Argentina, hoping that thereby the broader concerns and aspirations of the developing world would at least find some voice.

In the immediate aftermath of the global financial crisis, the G-20 called for and effectively achieved the implementation of expansionary fiscal stimuli and monetary easing by all its member-countries as part of an effort to combat the massive downswing created by the crisis. Without doubt, this had a positive impact in terms of preventing a really major global crash and depression and enabling the current recovery.

But even by then, the G-20 had disappointed those who were hoping that the severity of the global financial crisis would force the governments of these countries to rethink the main structures and processes of international capitalism. One major disappointment was the crucial role given to the International Monetary Fund (IMF), effectively bringing back to the centre stage of global economic decision-making an institution that had lost power and credibility. Resources and influence were once again given to the IMF, especially to provide emergency finance to countries in distress. But this was done without any real attempts at significant reform of the IMF itself or substantial change in the harsh pro-cyclical conditionalities that it usually advocates.

Another disappointment was the lack of real movement in terms of financial re-regulation, which is absolutely critical to prevent continuing financial fragility and the huge moral hazard that has emerged among banks and other institutions because of the large bailouts. Even the promise to crack down on international tax havens was riddled with so many exclusions that it was little more than a damp squib.

But these disappointments of the past G-20 meetings pale into insignificance when compared with the outcome of the latest meeting of its G-20 Finance Ministers in Busan in the Republic of Korea on June 5 and 6. The previous meetings at least made vague promises and attempted measures in the right direction. But the outcome of this meeting suggests a course reversal, with governments apparently bowing to the pressure of financial markets to focus on the reduction of public deficits and government debt, and that too largely through cutting expenditure rather than raising taxes even from financial activities.

The past year has been an extraordinary one for observers of economic policy as we have watched governments suddenly discover or relearn the economic insights of Keynes and then abandon them almost as quickly at the first incipient signs of recovery. Nowhere is this more marked than in Europe, where monetarist orthodoxies have become deeply ingrained, especially, in policymaking over the past generation. The differences between core economies such as Germany and periphery economies such as Ireland, Greece and Spain have already created sovereign debt problems in the Eurozone.

Since Europe accounts for seven members in the G-20, it may not be surprising that the theme has changed so quickly, indeed so prematurely, from fiscal expansion to fiscal discipline. So the communique from the Busan meeting declares, The recent events highlight the importance of sustainable public finances and the need for our countries to put in place credible, growth-friendly measures, to deliver fiscal sustainability, differentiated for and tailored to national circumstances. Those countries with serious fiscal challenges need to accelerate the pace of consolidation. We welcome the recent announcements by some countries to reduce their deficits in 2010 and strengthen their fiscal frameworks and institutions.

The move to shift the focus from growth and employment to fiscal consolidation (read retrenchment) was apparently led by the British Chancellor of the Exchequer, George Osborne, who has made the Tory obsession with fiscal austerity something of a rallying cry for the newly elected Conservative-Liberal coalition government in the United Kingdom.

But it reflected a growing view among leaders, particularly those in Europe, that private market sentiment is now focussed on budget deficits and that this could rebound on growth prospects if shifts in investor sentiment caused large-scale capital outflows. This was evident by the end of the first week of June, when the Hungarian government scrambled to reassure markets as the currency collapsed after the new Economy Minister rashly spoke of a possible Greek style crisis because of supposed fiscal cover-ups by the previous government. Similarly, the French were forced to take note that loose talk by leaders about deficits could threaten the French government's triple A rating in bond markets even when its public finances were basically sound.

The irony is that when all these G-20 governments announce that they will aim at fiscal consolidation, the outcome is likely to be counterproductive even in their own terms. Obviously, such a focus will adversely affect output and employment growth at a time when the global recovery is still fragile. And when growth prospects are lower, private market sentiment will also be affected, and private investment is much less likely to make up the difference to prevent another recession. Indeed, on June 7, markets across the world fell. They were probably depressed not just by fears regarding government debts but also by the suspicion that the cure may be worse than the illness.

As a result, the more that individual governments announce budget cuts and other measures to squeeze out savings in their economies, the more the bond markets react by increasing the spreads on their sovereign debts. So, instead of being rewarded for good behaviour by the financial markets, they are being further punished because even financial markets know that cutting back on public spending will reduce growth in the current context.

The only way out of this peculiar trap is for coordinated fiscal stimuli to continue and to focus especially on increasing employment. The Busan summit would have been a good platform to announce that plan and thereby prevent markets from attacking individual economies. Instead, by announcing very different intentions, the G-20 has made sure that the roller-coaster ride in global financial markets will continue to inflict pain on real economies everywhere. Not for nothing has Mohamed El-Erian, the head of the major transnational financial firm Pimco, announced that investors should keep their seat belts on and tight.

In any case, cutting back on public spending is only one of the ways to reduce what are seen as excessive budget deficits. Another effective method, which is usually less painful for the average citizen, is to increase taxes particularly on the comparatively wealthy sections.

One major item on the G-20 agenda was the coordinated imposition of a levy on banks, a move that would have been positive on several fronts. It would have brought in much-needed tax revenues, forced banks to pay at least partly for the large bailouts they had required, and imposed some discipline on their activities. But, like most good ideas, this one faced a lot of opposition, led in this case by the Canadian and Australian governments and fuelled by bank lobbyists in all countries who had actively campaigned against such a measure.

In the event, no such levy was announced. Of course, governments are still free to impose such taxes within their own countries, but fears of banks shifting their capital away to non-tax countries are likely to keep such taxes so low as to be practically irrelevant. Meanwhile, there were no more than platitudes on financial regulation, including the (by now embarrassing) reiteration of the belief that stronger prudential norms can prevent future financial crises.

So what has the developing world got out of the latest G-20 meeting? And what have the developing countries who are lucky enough to be members got out of it? Remarkably, almost nothing. In fact, the outcomes are likely to be adverse. Even the head of the IMF, Dominique Strauss-Kahn, noted that fiscal consolidation in advanced economies has big and, of course, negative effects on emerging countries.

In terms of reforming the multilateral donor organisations to make them more democratic, the official communique was confined to welcoming the agreement on the World Bank's voice reform to increase the voting power of developing and transition countries by a paltry 3.13 per cent, with some worthy platitudes about the IMF.

It will take a lot more for most people in the developing world to feel even minor satisfaction that a few developing countries have managed to gain admittance at the high table of international power brokers. Meanwhile, they will continue to suffer from the imposition of macro-economic policies that reduce their chances of stable employment and viable livelihood.

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