An opportunity to shape the future of the global economy

The G20 has given a major contribution to containing the financial crisis and fostering a recovery of the world economy from a dramatic synchronised downturn that could well have turned out worse than the Great Depression. Yet the task it faces now is perhaps more difficult than it was at height of the crisis. At that time, the display of coordination itself helped, as showing a united front shored up confidence at critical junctures. In hindsight, one could now even argue that the degree of actual policy coordination
turned out to be much lower than the official statements suggested and that at least in the case of fiscal stimulus measures it reflected a simultaneous coincidence of needs and incentives rather than a true joint
action.

That, I believe, would be unfair—but it does contain a grain of truth.
Today, with an economic recovery underway and encouraging signs of normalisation in the financial system, we no longer have the same sense of urgency. But the challenges ahead are perhaps more complex, and the substance of a coordinated response will be far more important than the visible display of coordination.

The first key challenge, in my view, is to engineer a durable reduction in global imbalances in a way that safeguards a healthy rate of global economic growth. This is not a trivial task. While the main emerging
markets are seeing a strengthening in domestic demand, they cannot yet act as the sole driver of global growth—and as the US hopefully picks up speed, its current account deficit will therefore widen anew.

Greater currency flexibility in China and other countries should play a role, but cannot compensate for the structural limits to domestic demand growth, which will take time to address. The challenge is daunting enough that everyone needs to contribute towards a solution, no country or region can call itself out.

Europe’s position is particularly interesting in this regard. In past occasions, the Eurozone has noted that as it ran a broadly balanced external position, it did not contribute to global imbalances and therefore
should not be asked to take much responsibility for their elimination. Today the Eurozone finds itself in an odd position, as cross-country imbalances within the area have attracted renewed attention and triggered
a debate on whether and how the area needs to adjust its growth model to reduce such imbalances. One argument that has been made is that Eurozone members running a current account surplus, notably
Germany, should increase domestic consumption, so as to help export growth in weaker members.

An opposite point of view is that Eurozone members running a current account deficit should improve their competitiveness and also pursue an export-led growth strategy. That, however, could potentially turn the
Eurozone as a whole into a significant current account surplus, thereby adding to global imbalances. Not an easy circle to square, but the Eurozone in my view needs to take the initiative and send a strong signal
that it is ready to move forward with decisive steps to bolster fiscal discipline and growth potential across its member countries. The G20 needs a strong, confident Eurozone, and European leaders in Washington
for the G20 will need to show that they are ready to surmount together the current turmoil and that the Eurozone will remain an anchor of stability in the global economy.

The second key challenge is the strengthening of the international financial architecture. Here G20 policymakers will need to reconcile a number of priorities and pressures, some of them in apparent contrast to each other—and in a situation where political imperatives, however understandable, might end up biasing decisions in undesired and suboptimal ways. The first priority is to ensure a stronger degree of resilience in the financial sector, via higher capital and liquidity requirements, and to discourage excessive risk taking with potentially systemic consequences.

Then there is a desire to ensure that financial institutions can pay back at least some of the support that they received during the crisis, and help to set aside the resources that might be needed to confront future bouts of instability—the IMF has advanced specific proposals in this regard in preparation for the G20. Finally, there is the desire to limit future
volatility in financial markets via a greater reliance on regulated exchanges and possibly with tougher restrictions on the use of some financial instruments.

These goals, however, need to be balanced against the risk of an undesired reduction in the longer term flow of credit, and bearing in mind that financial institutions still face the powerful headwinds of lower economic growth and volatility in some sovereign bond markets. A further risk is that of an undue loss of efficiency in the financial sector—even if currently the financial sector’s ability to contribute to economic growth is being reassessed with a much greater degree of skepticism. G20 policymakers, together with the
relevant international institutions, should make quick progress towards finding the right balance. Operating with an unusually high uncertainty on future capital and liquidity requirements poses a serious challenge
to the banking sector, which could ultimately be detrimental to credit flows and economic growth.

It is a tall order for the G20, but the stakes are high—a year ago it seemed that the challenge was to ensure that the global economy could still have a future…now the challenge is to design what this future will look like; more than ever, the global economy needs strong global leadership.