What Can We Expect from the G20

Introduction

Finance ministers from the Group of 20 (G20) will meet in London this weekend in preliminary talks before the heads of state of the G20 meet in London beginning April 2. The Obama Administration is hoping that the April 2 meeting will be used as a springboard for greater stimulus from all the nations. But the Americans are facing stiff resistance from many of the parties involved. What’s more, the participants can’t seem to agree on the nature of the problem or on the actions that should be taken to correct the situation.

In this article, we will try to sort out the issues and make some predictions regarding the meeting itself.

Background

In 1971, as the Bretton Woods system was breaking down, finance ministers from five major developed nations - the US, UK, France, Germany and Japan - began meeting informally to discuss many of the problems then facing the world economy. This group became known as the Group of Five, or G5. About fifteen years later, the group was expanded to include Italy and Canada and became the Group of Seven (G7). The finance ministers from the G7 met regularly, with heads of state from the seven nations meeting formally on an annual basis. The meetings were used as means to discuss current economic problems.

In the early 1990s, Russia was occasionally invited to join the meetings. Around this time, it was recognized that the influence of some of the original G7 members was declining in importance while many nations in the developing world were exercising a greater economical impact. The G7 nations realized that many of these developing countries needed a voice in global affairs as well and the Group of 20 (G20) came into being. The G20 included the original G7 countries plus twelve of the developing nations with the European Union itself as the twentieth member.*

The Problem

It is generally recognized that the current recession is global in nature, unlike the recessions of the 1970s and 1980s, which were strictly US problems, or the Asian contagion of 1997-1998, which was essentially an Asian problem. Consequently, the recession of 2007-2008 needs a global solution.

It is also widely recognized that the forces involved in the current crisis are major ones: a tremendous loss of wealth (estimated in the area of $50,000 billion worldwide); excessive use of debt in the deficit countries with the result that much of this debt has become "toxic", that is, unlikely to be repaid; and a general breakdown in the normal functioning of the financial system.
What is not recognized, or agreed upon, is the degree to which the global recession affects the various players involved. Nor is it agreed as to who caused the problem, or just what is necessary, or how, to even attack the problem. Can monetary policy do the job? Or do we need a mix of monetary and fiscal policy?

Finally, what should the solution look like? Do we try to restore the system to its state before the crisis developed, i.e., with consumer demand in the West, particularly in the United States, supporting export-dependent economies in The East? Or do we attempt to create some other economic model?

The Issues

The Obama Administration wants each country in the G20 to aggressively increase its fiscal stimulus. The Administration’s stance stems from the belief that any action to stem the current crisis must be massive, decisive and sustained. It is based on the US experience during the Great Depression of the 1930s, when failure to provide a large and sustained stimulus prolonged the Depression. Larry Summers, former Treasury Secretary under Bill Clinton and now Senior Economic Adviser to the President has said that the G20 should agree to boost domestic demand. Christina Romer, chair of the White House Council of Economic Advisers said, "The more that countries throughout the world can move toward monetary and fiscal expansion the better off we will all be." Treasury Secretary Tim Geithner, in calling for a tripling of IMF resources (from $250 billion to $750 billion - twice as much as the IMF itself has asked for), said that each country in the G20 set a goal of fiscal stimulus equal to two percent of GDP in both 2009 and 2010.

Not everyone in the American camp, however, agrees with this goal for the G20. Fed Chairman Ben Bernanke has said, of the upcoming meeting, that it is "asking too much (of the G20) to come out with detailed proposals in many different areas." He believes that a better goal would be to establish some principles that would guide reforms around the world. He is urging caution on fiscal stimulus initiatives, preferring to balance the short-term benefits of stimulus against long-term risks to public financing.

And there are those who feel the current level of stimulus put forth by the Obama Administration is too little. Martin Wolf, senior economic writer for the Financial Times, for one, feels the US package is "disturbingly modest" at only 4.8 percent of GDP (over the next two years). He quotes a recent report from the IMF that says that fiscal policy, in the current situation should be " timely, large, lasting, diversified, contingent, collective and sustainable."
Martin Feldstein, former chairman of Ronald Reagan’s council of economic advisers, believes that the US package will offset only 40 percent of the lost demand from 2009 and 2010. He believes a second fiscal stimulus package is likely.

The Europeans are not buying the US arguments. The UK has passed a fiscal stimulus package equal to 1.4 percent of GDP, but Prime Minister Gordon Brown said that there will be no additional stimulus in next month’s budget package (fiscal stimulus already enacted will comprise only 0.1 percent of GDP in 2010). His Chancellor of the Exchequer, Alistair Darling, said that the G20 summit should focus on implementing fiscal measures already in the pipeline.
European Union ministers, meeting last week in Brussels have taken an even firmer stand. They have said they have no plans to add to recent stimulus packages. They prefer to see what effect the packages that have already been passed will have. Their main concern is that more government debt at this time could threaten the stability of the European Union.
Peer Steinbruck, the German finance minister, categorically stated that "we are not debating any additional measures." And Jean-Claude Juncker, the chair of the "Eurogroup" of ministers said: "The sixteen finance ministers agreed that recent American appeals insisting Europeans make an added budgetary effort were not to our liking."

In regard to the argument that they should step up their stimulus as a percentage of GDP, they point to the fact that they have more automatic stabilizers in place than the Americans. Therefore, their stimulus, as a percentage of GDP, is actually higher than it would seem at first blush. (Automatic stabilizers are conditions of economic spending already built into the system that automatically increase as the economy slows, and vice versa. One example of an automatic stabilizer would be unemployment benefits, which increase as unemployment increases and more unemployed men file for benefits. The resultant spending of unemployment checks automatically provides a fiscal stimulus.)

But the Europeans may be underestimating the severity of their own economic problems. Most European economies are extremely export-dependent and their economies are expected to underperform the US economy in 2009. French industrial output contracted by 13.8 percent, year-on-year, in January, its worst performance since the data began being recorded in 1991. German industrial production also contracted sharply in January and February. In addition, German exports were down 20.7 percent in January from January 2008 and were also down 4.4 percent from December of 2008. Industrial production in the UK fell by 5.6 percent in the three-month period ending in January, compared to a decline of 4.6 percent in the three-month period ending in December.

The other country that many have been counting on to help out in the fiscal effort has been China. Last week, in fact, markets rallied when Chinese Premier Wen Jiabao was expected to announce an additional stimulus package, on top of the $585 billion package the Chinese announced last November. The hope was that the Chinese would make an attempt to prop up domestic demand. Instead, the Chinese declined to provide any additional stimulus, insisting that the Chinese economy would still achieve 8 percent growth in 2009.

Eight percent growth this year will be a stretch for the Chinese. Exports were down 25.7 percent in February, while imports, which declined 43 percent in January, fell another 24 percent in February. So much for a growth in domestic demand.

The Chinese have continued to blame the US for the current crisis and maintain that the US should take the lead in correcting the problem.

The Wrong Solution?

Not everyone believes massive stimulus for the US and other economies is the right solution. Stephen Roach, chairman of Morgan Stanley Asia, argues that policies aimed at recreating the boom years, that is, policies that encourage US consumers to take on more debt and begin spending again, are the wrong policies. He feels that these policies will only perpetuate the imbalances that existed before the current recession began: a global system that depends on excessive demand in the US and export-dependent economies in Asia - these policies led to record debt burdens, zero savings rates and asset-market bubbles in the West and over-dependence on exports in the East.

What is needed, Roach feels, is a solution that would provide better balances in these economies: higher savings rates and the reduction or elimination of current account deficits in the West and lower savings rates and greater domestic demand in Eastern countries.
Failure to achieve this balance only sets up the global economy for the next crisis, which he believes will be worse than the current crisis.

Conclusion

We look for little substance to emerge from next month’s G20 meeting. The gulf between the two sides just seems too great. It is unfortunate, but a great opportunity will be wasted and the current recession will probably last longer than necessary.

* Members of the G20: Argentina, Australia, Brazil, Canada, China, France, Germany, India, Indonesia, Italy, Japan, Mexico, Russia, Saudi Arabia, South Africa, South Korea, Turkey, United Kingdom, United States and the European Union

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