Friday, September 18, 2009

What's in Play at Pittsburgh?

What's in Play at Pittsburgh?

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The London G-20 summit last fall may go down in history as the meeting that saved the world. That's a huge exaggeration of course, but leaders did agree to a program of co-ordinated monetary and fiscal stimulus which may have arrested an economic free-fall, and they agreed to an agenda for financial re-regulation with a view to making sure that it never happened again. At a minimum, the G-20 process provided cover for governments to temporarily deviate from the imprisoning economic orthodoxies of sound finance and balanced budgets which tipped the world into the Great Depression of the 1930s, and it opened a space for serious discussion about a “new architecture” for global economic governance.

Several months on, the debate before the G-20 Pittsburgh summit which takes place later this month is about the need for “exit strategies” and, still, about the need for financial re-regulation.

There are now clear signs that the global economy has bottomed out (at least temporarily) in terms of the sharp contraction of industrial production, trade and GDP which began last October. Some governments, such as Germany and France and, probably, Canada as well as the OECD want to at least set a time line or agenda for withdrawing massive monetary stimulus before provoking inflation, and returning to fiscal balance before public debt rises too sharply. That translates into an agenda for medium – term spending cuts. Pittsburgh is likely to see the development of a broad framework for a return to normal. At the same time, the IMF, the OECD and most governments do recognize that the recovery is extraordinarily fragile and narrowly based on the stimulus that has been and will be injected this year and next. It is widely recognized that downturns which are globally synchronized and those that follow financial crises tend to be followed by very slow recoveries, and this crisis scores very high on both counts. Any premature tightening could easily tip the world back into a double-dip recession. Like the young Saint Augustine who prayed to God to make him chaste, but not just yet, the dominant line among governments appears to be that they should stay the stimulative course through this year and next, and only gradually raise interest rates and return budgets to balance.

The main problem with this view is that it is assumed that stimulus will eventually, indeed sooner rather than later, return the world to something like normal. However, it is far from clear what will lead to renewed global growth as stimulus is withdrawn given that the old engine – debt fueled household spending in the U.S. and elsewhere – is not about to resume anytime soon given the huge loss of housing wealth, uncertainty about jobs, and increased savings rates. Moreover, there is a very real risk that the crisis will continue to deepen as unemployment and underemployment continue to increase. Unemployment is conventionally seen as a “lagging indicator,” meaning that job growth will follow the return of output growth as night follows day, but output growth must be more than slow and tepid to have any impact on jobs. There is a real danger that a still intensifying jobs crisis could further depress household spending and choke off any “nascent recovery.” In the U.S. (and Canada), high unemployment and a shift into part-time jobs and self-employment risk producing a generalized fall in wages long before the economy can get back on its feet. In some European countries, especially Germany, unemployment has been held in check by subsidized work-sharing schemes, but the risk is that there will be huge layoffs before any recovery really gets off the ground.

Heed the Call of Labour

A note prepared by the U.S. Treasury for G-20 governments (G-20 Strategies for Promoting Global Growth) notes candidly that “the source of private demand capable of powering the global economy without dependence on unsustainable consumer spending or un-remunerative (and in some cases subsidized) residential and corporate investment remains uncertain.” In this context, governments should heed the call of the labour movement and others to maintain stimulus packages so long as is needed. This is especially true for those governments which can well afford to do so. There are limits to the ability of the U.S. in particular to run huge fiscal deficits and large trade deficits at the same time without risking either a collapse of the dollar or a counter-productive increase in interest rates. The UK government is also running a huge fiscal deficit. The onus for increasing stimulus efforts should mainly rest with others, notably China which has done a lot but is still running a large trade surplus and has huge fiscal resources – but also countries like Germany and Japan which have large trade surpluses and could do more to boost spending at home. In the medium-term, as the U.S. note again argues, medium term global growth will depend not just upon continued co-ordination of macro-economic policies, but also upon bringing trade balances (especially between the U.S. and developing Asia) into much closer balance.

What is also largely absent from the G-20 discussion is the question of how to make current and future fiscal stimulus policies more effective. The largest impact on jobs comes from public investment in infrastructure and green jobs and from income support for unemployed workers, but the G-20 has left it to individual countries to put together their own packages. Many (including Canada) have relied too much on unproductive tax cuts, and the effort that has gone into environmental investment has been quite disappointing. What is needed is not just “stimulus” but major medium-term investments which will take time to develop and implement. And some countries – the U.S. and Canada in particular – provide very limited income support to unemployed workers, many of whom will soon run out of benefits if they got them at all. The International Labour Organization – which has been invited to Pittsburgh – has, through the global jobs pact, called for improved unemployment benefits, maintaining a wage floor and increasing spending on job creation, training and other active labour market policies. But these themes are not at the centre of the discussions between the finance ministers who largely set the G-20 agenda. Hopefully they will be brought forward by relatively labour-friendly governments such as Brazil, South Africa and Australia.

The other large set of issues in play at Pittsburgh will be financial re-regulation. With the exception of clamping down on offshore financial centres, governments have largely failed to deliver on the London G-20 promises to much more closely control the exotic financial products and shadow banking system which got us into the mess. Key issues were handed off to the shadowy Financial Stability Board which consists mainly of central banks and financial regulators and has been slow to bring forward binding new rules, at least to date. In fairness, most of the regulatory action will remain national and the U.S. and others are overhauling existing regimes to some degree.

The big issue that has arisen pre Pittsburgh is the drive by Germany, France and most of the EU to limit financial sector bonuses, not just through loose rules, but also through hard caps. The U.S. and the UK approve linking bonuses to multi-year performance and holding back part of them to counter very risk short-term bets, but the idea of binding limits is being strongly resisted. While governments are broadly agreed on the need to regulate more closely at home and to cooperate more to promote “systemic stability,” there are clearly deep underlying differences over how much to intrude into the actual day to day behaviour of financial institutions. The reticence of the U.S. and UK is difficult to justify given the eye-popping bonuses recently being awarded to the same financial players who were being bailed out by equally eye-popping bailout packages only a few months ago.

The Pittsburgh summit must also move forward the agenda of increasing the clout of developing countries at the IMF and World Bank through a reallocation of voting rights, and will have to set the stage for any successful new global agreement on climate change.

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