Beyond the G20 Toward effective global economic governance Jakob Vestergaard

1. Beyond the G20Toward effective global economic governanceJakob Vestergaard DIIS ∙ DANISH INSTITUTE FOR INTERNATIONAL STUDIES

2. Epigraphs • Stewart Patrick, US Council on Foreign Relations: G20 is “the most significant advance in multilateral policy coordination since the end of the Cold War” (2010). • Foreign Minister Norway: creation of G20 was “one of the greatest setbacks since World War II” (Spiegel 2010). • Uganda CB Gov: G20 is but extension of “the old architecture” (2011)

3. Structure of lecture G20 output legitimacy: effectiveness G20 input legitimacy: representation G20 at a crossroads: what to expect from the Cannes summit? From G20 to GEC DIIS ∙ DANISH INSTITUTE FOR INTERNATIONAL STUDIES

4. Output legitimacy: effectiveness DIIS ∙ DANISH INSTITUTE FOR INTERNATIONAL STUDIES

5. G20 effectiveness (1) ”The concerted and decisive actions of the G20…has already delivered a number of significant and concrete outcomes: Financial regulation “broadened” and “strengthened”. “Great progress” in macroeconomic policy coordination – cf. framework for “strong, sustainable and balanced growth” Global governance “dramatically improved” – “to better take into consideration the role and the needs of emerging and developing countries, especially through the ambitious reforms of the governance of the IMF and the World Bank”. DIIS ∙ DANISH INSTITUTE FOR INTERNATIONAL STUDIES

6. G20 effectiveness (II) “Failure to reach an (admittedly difficult) agreement on a piloted across-the-board adjustment of balance of payments should not overshadow the rapid agreement achieved with regard to the Basel 3 Accord, which would not have been possible without the political momentum of the G20 leaders” (Domenico Lombardi, Brookings) DIIS ∙ DANISH INSTITUTE FOR INTERNATIONAL STUDIES

7. G20 effectiveness (III) • Financial regulation: alleged ”main accomplishment” is the new international standard in banking, ’Basel 3’ • G20 delegated this task to the Basel committee • Basel committee: G20 plus six additional European c’ies (Switzerland, Spain, Sweden etc) and two financial hubs in Asia (Hong Kong and Singapore) • Basel 3 negotiated in less than a year, compared to Basel 2 which took more than five years. DIIS ∙ DANISH INSTITUTE FOR INTERNATIONAL STUDIES

8. International banking standards Two fundamental objectives (BCBS, 1988: §3): “strengthen the soundness and stability of the international banking system” “be fair and have a high degree of consistency in its application to banks in different countries” Key governance tool: capital adequacy requirement: 100 euro loan => at least 8 euro in reserves DIIS ∙ DANISH INSTITUTE FOR INTERNATIONAL STUDIES DIIS ∙ DANISH INSTITUTE FOR INTERNATIONAL STUDIES

9. The pre-crisis approach (Basel 2) DIIS ∙ DANISH INSTITUTE FOR INTERNATIONAL STUDIES Three pillars: Pillar 1: Capital > 8 pct of ’risk-weighted assets’ Pillar 2: Supervisory review process – more capital than Pillar 1 minimum can be demanded Pillar 3: Disclosure requirements, to encourage ’market discipline’ (misbehaviour punished) From binding to less binding… DIIS ∙ DANISH INSTITUTE FOR INTERNATIONAL STUDIES

10. ’The end of lightly regulated finance’ DIIS ∙ DANISH INSTITUTE FOR INTERNATIONAL STUDIES DIIS ∙ DANISH INSTITUTE FOR INTERNATIONAL STUDIES

11. Regulatory capture (1) DIIS ∙ DANISH INSTITUTE FOR INTERNATIONAL STUDIES …BUT: reform initial proposals watered down, after intensive banking industry lobbying Aims of banking industry lobbying – the four Ls: • Lower • Leave out • Least-binding • Later DIIS ∙ DANISH INSTITUTE FOR INTERNATIONAL STUDIES

12. Regulatory capture (II) DIIS ∙ DANISH INSTITUTE FOR INTERNATIONAL STUDIES DIIS ∙ DANISH INSTITUTE FOR INTERNATIONAL STUDIES

13. Basel 2 vs Basel 3 DIIS ∙ DANISH INSTITUTE FOR INTERNATIONAL STUDIES DIIS ∙ DANISH INSTITUTE FOR INTERNATIONAL STUDIES

14. Basel 3 – overview of outcomes DIIS ∙ DANISH INSTITUTE FOR INTERNATIONAL STUDIES DIIS ∙ DANISH INSTITUTE FOR INTERNATIONAL STUDIES

15. Finance professors ’going political’ DIIS ∙ DANISH INSTITUTE FOR INTERNATIONAL STUDIES “Banks’ high leverage and the resulting fragility and systemic risk contributed to the near collapse of the financial system. Basel 3 is far from sufficient to protect the system from recurring crises. If a much larger fraction, at least 15 per cent, of banks’ total, non-risk-weighted, assets were funded by equity, the social benefits would be substantial. And the social costs would be minimal, if any”. DIIS ∙ DANISH INSTITUTE FOR INTERNATIONAL STUDIES

16. Finance professors ’going political’ DIIS ∙ DANISH INSTITUTE FOR INTERNATIONAL STUDIES Key points of joint letter by 20 of worlds leading finance professors published in Financial Times in run-up to Seoul summit: -- Basel 3 fails to ”eliminate structural flaws in the system” -- please remember that ”healthy banking is the goal, not profitable banks” Unfortunately, this support from academia came too late, says anonymous CB governor DIIS ∙ DANISH INSTITUTE FOR INTERNATIONAL STUDIES

17. Basel 3: ’more heat than light’? DIIS ∙ DANISH INSTITUTE FOR INTERNATIONAL STUDIES Basel 3 - intensification of Basel 2 - marginalization of counter-cyclicality - ’grandfathering’ (to be implemented by 2019…) Three years after crisis: - banking not ”sound and stable”, espec Eurozone c’ies - threat to global economy as least as severe as in ’08 - social upheaval and protest, nationalism, even war? DIIS ∙ DANISH INSTITUTE FOR INTERNATIONAL STUDIES

18. In conclusion, on G20 effectiveness • Before Seoul summit (Nov 2010): G20 is “divided, ineffective and illegitimate” (Rachman, FT). • After Seoul summit: G20 had shown “how not to run the world” (FT editorial) • Summer 2011: G20 marginalized (G Brown called for meeting, but nothing happened) • Conclusion: G20L not “effective” as global steering committee = low “output legitimacy”

19. Input legitimacy: representation DIIS ∙ DANISH INSTITUTE FOR INTERNATIONAL STUDIES

20. G20 claims input legitimacy • G20 says: its “economic weight & broad membership gives it a high degree of legitimacy & influence over the management of the global economy & financial system” (G20 2010a). • G20 says it is representative: covers 90% of world GDP, 80% world trade, 66% world population. • G20 says it is big improvement over G8.

21. Input illegitimacy (1) • Regarded as illegitimate by many of 174 UN member states permanent excluded • Membership endorsed by G7, in 1999, selected in transatlantic calls btw US and Germany. • G7 claimed they were all “systemically significant” c’ies. No explicit selection criteria. • No process for changing membership in line with changes in global distn of econ power.

22. Input illegitimacy (II) • The 19 member countries not the 19 biggest economies by any indicator (neither in 1999 or 2008) • Europe not “over-represented” by GDP criteria: Spain, Poland, Netherlands shd be in; Argentina, Saudi A, S Africa out. Yet widely believed (esp USA) that Europe over-rep. • No regional representation – except EU • If EU removed, G20 “represents” 77% world GDP, 60% world trade, 62% world population

23. Input illegitimacy (III) • Big majority simply cannot be used to argue a case of input legitimacy • Consider example of national elections (urban dominance; religious dominance) • Without explicit – and widely accepted – criteria of inclusion/exclusion, there can be no such thing as input legitimacy • Irony of G20s claim of “dramatic improvement” of global governance, in interest of developing countries: the G20 itself further marginalizes those countries

24. G20 countries – by region and income classification

25. Ad hoc participant expansion • G20L has responded to “unrepresentative” criticism by issuing “invitations” to “outreach participants” and “observers”. • Spain invited as “permanent guest”. • ASEAN invited as “outreach participant” to all 5 summits. • Hosts of last 2 summits (Canada, Korea) invited African Union to send 2 reps. • Status of ‘invitees’ unclear… • So: G20= 19 countries + EU + 5 “invitee states” (of wh 3 rep regions) • G19+6, or simply G25

26. The G20 at a Crossroads: what to expect from the summit in Cannes DIIS ∙ DANISH INSTITUTE FOR INTERNATIONAL STUDIES

27. Two opposing trends in GEG DIIS ∙ DANISH INSTITUTE FOR INTERNATIONAL STUDIES 1. Drift back towards G7/G8: Summer 2011: G20Fs did not meet but G7Fs did (despite formers self-declared status of ’premier forum’..) Obama has announced that he will host G8 and Nato summits in May 2012, just one month before G20 summit in Mexico => Is G20 being reduced to a secondary body? 2. Appeals to G20 to step up: ’rescue WE, please’ EU, OECD, etc Much depends on the Cannes summit DIIS ∙ DANISH INSTITUTE FOR INTERNATIONAL STUDIES

28. G20 summit in Cannes: the context DIIS ∙ DANISH INSTITUTE FOR INTERNATIONAL STUDIES Drama similar to first two G20 summits: recovery in danger (for instance, gloomy OECD forecast yesterday). Global economy more vulnerable now than in 2008: fiscal stimulus at similar scale not likely Growth in EMEs remain strong – BUT: increasing risk of inflation, prospect of further weakening of export markets, partial retreat of foreign capital Quasi-insolvent European banking sector? Will banks reduce lending to meet capital reserve requirements by June next year? New credit crunch in Europe? European agreement: ”too little, too late”? (Brookings, yesterday). Espec German discontent (Bundesbank). Greek referendum – radical uncertainty.. DIIS ∙ DANISH INSTITUTE FOR INTERNATIONAL STUDIES

29. Growth, please – but how? DIIS ∙ DANISH INSTITUTE FOR INTERNATIONAL STUDIES OECD: adopt ”bold growth strategy”, if not: drop in GDP of up to 5 pct by mid-2013 EU leaders: G20 should approve ambitions plan to ”ensure strong, sustainable and balanced growth while implementing credible fiscal consolidation” Many G20 leaders constrained by domestic politics to undertake big fiscal stimulus – constrained by fiscal austerity ideology DIIS ∙ DANISH INSTITUTE FOR INTERNATIONAL STUDIES

30. Action items for Cannes summit DIIS ∙ DANISH INSTITUTE FOR INTERNATIONAL STUDIES With fiscal policy constrained and monetary policy reaching its limits, what can be expected? Non-European contributions to the EFSF? (China etc) Expansion of IMF’s financial capacity? Global food crisis: more resources for investment in agriculture? Or, at least, meeting prior commitments to fund the Global Agriculture and Food Security Program? Most likely little on main issues: global imbalances etc Main risk: conflict btw European leaders and non-European leaders (on terms of support etc.) DIIS ∙ DANISH INSTITUTE FOR INTERNATIONAL STUDIES

31. Two scenarios DIIS ∙ DANISH INSTITUTE FOR INTERNATIONAL STUDIES 1. Marginalization of G20 Continues as talk-shop, but secondary to G7/G8 How will the BRICs react? Wider process of deglobalization of international economic governance? More emphasis on regional level 2. G20 resumes global leadership Further institutionalization, incl secretariat DIIS ∙ DANISH INSTITUTE FOR INTERNATIONAL STUDIES

32. Four good reasons… .. to look for a different, more viable format for effective global economic governance: • The G20 is not effective (low output legitimacy) • The G20 excludes 174 UN member states and membership criteria arbitrary (low input legitimacy) • The G20 undermines the existing multilateral system of GEC • And the G20 is losing momentum…

33. From G20 to GEC DIIS ∙ DANISH INSTITUTE FOR INTERNATIONAL STUDIES

34. Global Economic Council • Start with BWI system, not G20/G25. Constituency system has long-established legitimacy. • Advantages over G20: (1) all states represented in governing bodies, (2) some consultation within constituencies, (3) some rotation at top table • Disadvantages: (1) no heads-of-govt. level; (2) system of single country seats unsustainale (3) voting power system out-of-sync with realities of global economy

35. Allocation of seats among regions • 25 seats, based on reformed BWI constituencies. Allocation of seats: • Divide world into 4 regions: Africa; Americas & Australasia; Asia; Europe. Each region to have 4 seats. Subtotal = 16. (ii) Distribute 9 more seats between 4 regions proportional to regional share of world GDP*. All regions except Africa get 3 more seats. Result: Africa = 4 seats, other regions = 7

36. Constituencies and rotation • No single-country seats; all countries in constituencies (minimum size: 3, average: 7). • Mechanism of rotation within each constituency: Each constituency one director & 2 alternates. • Constituency decides whether all 3 positions rotate b/w members, or only alternates. If only at alternates’ level, large c’ies cld always be at table – but still obliged to consult with other states. • BWI constituencies to be reformed in same way

37. GEC decision-making Two models: • Binding agreements, based on a combination of majority voting and special majority voting (as in BWIs) • Informal “talk-shop” council, as the G20 – on the assumption that big powers otherwise will not go along • Possible compromise: start out as informal council, replacing the G20, testing ground for future potential formalization • UNSC as model? Two forums: “consultation room” (strictly private, no formal decisions); formal room.

38. The way forward • GEC based on formal treaty • Treaty focusing on one issue: international macroeconomic imbalances • Correction of imbalances as joint responsibility of surplus and deficit countries • Limits on imbalances – deficits and surpluses – as share of GDP • The how of correction/adjustment is left to discretion of countries in question, but non-correction to come at high cost • All other issues: non-formal