Fault Lines: How Hidden Fractures Still Threaten the World Economy (38 page)

Our existing global institutions, like the IMF and the World Bank, will likely prove ineffective in fostering global cooperation if they continue to operate as they have in the past. They will have to make radical changes in how they function, appealing more directly to the people than to their leaders, to soft power rather than to hard power. I discuss how such an approach dovetails well with the reforms that are needed in China. Clearly, the soft power of multilateral organizations can also be used to promote the reforms, discussed in the previous chapter, that are necessary in the United States.

In September 2009, the leaders of the world’s largest economies met in Pittsburgh and designated their group, the G-20, as the primary forum for global economic cooperation. Much like its predecessor organization, the G-7, the new self-proclaimed guardian of the world economy excludes many countries—almost a necessity in order to get dialogue rather than a cacophony, but undemocratic nevertheless. Who is in and who is out is also somewhat arbitrarily decided: Argentina is a member, while Spain, with a GDP that is nearly five times the size of Argentina’s, is a member only indirectly, through the European Union. Be that as it may, the leaders of the G-20 patted themselves on the back for a “coordinated” fiscal and monetary stimulus in response to the crisis and had an unusually brief (for an official communiqué) description of the result: “It worked.” They went on to say: “Today we are launching a Framework for Strong, Sustainable, and Balanced Growth. To put in place this framework, we commit to develop a process whereby we set out our objectives, put forward policies to achieve these objectives, and together assess our progress. We will ask the IMF to help us with its analysis of how our respective national or regional policy frameworks fit together…. We will work together to ensure that our fiscal, monetary, trade, and structural policies are collectively consistent with more sustainable and balanced trajectories of growth.”
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So the G-20, having successfully coordinated responses to the crisis, is now taking on the bigger challenge of making sure national growth strategies fit together to rebalance global growth. This is precisely what I have argued must be done. Given its recent achievements during the crisis, however, can we have any confidence that the G-20, working through the IMF, will be effective?

Unfortunately not. It is very easy to get politicians to spend in the face of a crisis and to get central banks to ease monetary policy. No coordination is required, as every country wants to pump up its economy to the extent possible: the G-20 leaders were pushing on an open door when they called for coordinated stimulus. The real difficulties emerge when countries need to undertake politically painful reforms, reforms that might even seem to be more oriented toward helping other countries in the short run rather than the reformer itself. Politics is always local: there is no constituency for the global economy.

I know, because we have been through an attempt at global policy coordination before, precisely to deal with the problem of large global trade imbalances. That effort failed, and it is instructive to understand why.

In 2006, as the U.S. current-account deficit broke record after record and as China’s current-account surplus soared, the IMF became deeply concerned. The managing director, Rodrigo de Rato, decided a new approach was warranted. We at the Fund (I was still the chief economist then) called on the five entities most responsible for the imbalances—the United States, the Euro zone, China, Japan, and Saudi Arabia—to come together to discuss how they would jointly bring the imbalances down. To prepare for the meetings, I jointly headed an IMF team, which traveled around the world in the summer of 2006, trying to secure some agreement among the countries that had been called together for the consultation. We were following the adage that nothing of substance is settled at most international meetings; all important issues are usually settled beforehand.

The weather ranged from 122 degrees in the shade in Riyadh, Saudi Arabia, to unseasonably cool in Tokyo. The response from our interlocutors was, however, pretty uniform. Countries agreed that the trade imbalances were a potential source of instability, and economic reforms were needed to bring them down before markets took fright or politicians decided to enter the fray with protectionist measures. But each country was then quick to point out why it was not responsible for the imbalances and why it would be so much easier for some other country to push a magic button to make them disappear.

For instance, the United States authorities argued that it was not their fault that the rest of the world was so eager to put their money in the United States: imbalances were the fault of the Chinese, who were buying dollars to restrain the appreciation of the renminbi. It was the pressure of these enormous inflows that led the United States to consume. The Chinese argued that if they allowed the renminbi to appreciate faster, exports from China to the United States would fall, while exports from Cambodia or Vietnam would pick up, and the U.S. trade deficit would remain unchanged. In their view, the real problem was that the U.S. consumer had no self-restraint. Moreover, their trade surplus was so large only because the United States limited Chinese purchases of high-tech equipment. And so it went. Everyone pointed the finger at someone else. The truth was that everyone contributed in some way to the problem, but no one wanted to be part of the solution.

At the end of 2006, I returned from the Fund to the University of Chicago, dejected that we had accomplished so little. When the consultations eventually concluded in 2007, the Fund declared that they had been a success: there had been a free and frank exchange of views, which is bureaucratese for total disagreement. Every country agreed to do what it had always intended to do, which was very little. The consultations had failed to produce concrete action. A few months later, born partly from the actions that created the imbalances, the crisis began.

The IMF did not fail because our arguments were not convincing. The reason everyone pointed a finger at everyone else was not that they did not understand their own responsibility but because no one we spoke to could really commit to the actions that were needed. Indeed, these were decisions that even the head of government could not take. For instance, no U.S. president can commit to reining in the budget deficit: that is a decision that only Congress can take. Similarly, no Chinese president can unilaterally agree to allow the renminbi to appreciate: that is a decision deliberated for months by various echelons of the State Council and the Communist Party. Moreover, the needed changes went beyond reining in the budget deficit or letting the currency appreciate. They required deeper fundamental changes to the economy. And the global good counts for little among the politicians in the U.S. Congress or the Chinese Communist Party when it comes to contemplating fundamental change.

This is why, despite hoping for the best, I have deep skepticism that anything will come of the ambitious G-20 declaration. Nor is it likely that the IMF will achieve anything more than it did in the multilateral consultations that ended in 2007, crisis notwithstanding. Change will come only when countries are forced to change, or decide it is in their best interest to do so, but that process may be too costly, or too slow, for the global economy.

If doing nothing is not a viable option, how can we get global cooperation? I think any answer lies in a fundamental remake of multilateral institutions like the IMF and the ways they interact with sovereign countries.

Multilateral institutions have hitherto worked in two ways. One approach is the quasi-legal one followed by the World Trade Organization (WTO), which regulates trade between participating countries. The WTO bases its actions on a set of agreements that limit barriers to trade. These agreements have been signed and ratified by member governments after long and arduous negotiations. The WTO has a dispute-resolution process aimed at enforcing participants’ adherence to the agreements, and because the rules are relatively clear, adherence can be judged in a quasi-legal setting. Penalties against violators, usually in the form of sanctions on their trade, are easily imposed. Countries do give up some sovereignty, such as the freedom to set import tariffs or subsidize favored industries, in exchange for others doing the same, and these concessions promote mutually beneficial trade. When industry presses national politicians to protect them, the politicians can simply throw up their hands and blame the WTO.

A second approach, one that is far less effective because of the nature of the task, is the way the IMF goes about international macroeconomic management and coordination: essentially through a process of exhortation that fails to move anyone except those who need the Fund’s money. The problem here is that the rules of the game are not clear at all. When does a pattern of actions by a country create global harm? When the Fed cuts interest rates to the bone, and thus sets off a global wave of risk taking, do countries elsewhere have the right to protest? Could the Fed not say it is focused solely on U.S. economic conditions, which is its primary remit? When China intervenes in exchange markets to hold the value of the renminbi against the dollar, is it using unfair means to gain a competitive advantage? Some have argued that China’s huge buildup of reserves is evidence of an unfair policy.
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But unlike developed countries, China restricts its citizens and private firms from holding foreign assets, so it is almost inevitable that its holdings of foreign assets will show up as central bank reserves. And even if it were proved that it had a policy of deliberate undervaluation, could it not claim it is a poor country, using exchange-rate undervaluation to offset its other natural disadvantages?
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Unlike the WTO, therefore, the IMF cannot frame a careful and universally agreed-upon set of rules. And there is some virtue to rules. Although establishing such rules requires an enormous amount of negotiation and bargaining, many of the parties who would be adversely affected by specific aspects of them also see broad long-term gains from the framework. As a result, in the WTO, disagreements can typically be papered over during the long and tortuous trade-negotiation rounds, with some give-and-take possible in setting the detailed rules. The problem with trying to secure an agreement on policy reforms across a set of countries on a case-by-case basis, as the Fund has to do if it is to bring down trade imbalances, is that winners and losers are clearly identified, both across countries and within countries. Each agreement is sui generis, and the Fund cannot make commitments across agreements to try to appease those who feel they may lose out in a particular instance.

Of course, countries could dispense with rules or agreements and give discretion to one agency, such as the IMF, to judge disputes and identify policy violations that cause international harm on a case-by-case basis, with some penalties for noncompliance. But because macroeconomic policy covers such a broad area, this would require countries to give up a tremendous amount of sovereignty to an international bureaucracy, an unlikely scenario. Historically, the world’s great powers have been reluctant to see independent, strong multilateral organizations emerge. When strong, multilateral organizations have not been independent; and when independent, they have been largely irrelevant. The growing power of developing countries like China and India is unlikely to change this situation because they too have little desire for their policies to be scrutinized.

Even if an organization like the IMF could be independent of the big powers, it has a limitation: a mindset driven by a particular experience. Almost inevitably, organizations like the IMF recruit students trained in industrial countries, especially the United States. Most of the macroeconomic principles that are taught derive from the experiences of industrial countries, where organized markets typically function fairly well. So it is natural for the staff to favor certain kinds of intervention in the functioning of markets, such as monetary policy, while being critical of other kinds of intervention, such as those in the foreign exchange market. Of course, developing countries, where fewer markets work well and a broader set of interventions may be warranted, may be at a disadvantage when their policies are scrutinized by the Fund.

Also, economic growth happens in mysterious ways. If all countries had followed the prevailing economic orthodoxy in the 1950s and 1960s, we would never have had the Japanese or East Asian growth miracles. If countries did allow their macroeconomic policies to be policed by an international organization with the power to impose penalties for deviation, it could lead to a lack of diversity in policies that could limit learning and greatly dampen world growth.

Finally, even if the IMF could come up with a set of recommendations that were theoretically acceptable, not all countries would be willing to implement them. The WTO’s rules not only are backed by the possibility of sanctions but can also be quietly implemented by governments through executive order: the commerce ministry can reduce a tariff here or remove a subsidy there. The IMF’s recommendations are not backed by any power of enforcement: most industrial countries and large emerging-market countries do not need IMF funding, which constitutes its main means of persuasion. Moreover, the kind of reforms recommended are typically the kind that go against a ruling party’s electoral calculus, making it impossible for a finance minister or head of state to commit to implementing them.

In sum, the IMF’s role in macroeconomic policy coordination is quite different from the WTO’s role in trade facilitation because, first, there are no clear rules on what is permissible and what is not, and any attempt to formulate such rules is likely to be unacceptable to many countries. Second, and in consequence, reforms have to be agreed to on a case-by-case basis, and governments typically do not have the domestic political support to commit confidently to the reforms they would have to undertake as part of an international agreement. Third, the inability to commit means that grand international agreements requiring fundamental reform by each country are hard to pull off, even when the reforms are in each country’s long-term interest.