Global Trends by Martin Khor

Monday 25 October 2010

G20 make progress, but differences remain

Last weekend the G20 finance ministers made some progress in their pledge to deal with some important global problems, but differences remain and whether the pledges are implemented remain to be seen.


On 22 and 23 October, the G20's Finance Ministers and Central Bank Governors met in Gyeongju, South Korea, and issued a communique that was hailed by the media as having made progress in dealing with some recent global economic issues.

The issues include volatility in currency movements, accusations that major countries were engaging in a “currency war” that could spill over into trade protectionism, huge capital flows that could swamp some developing countries with too much funds and cause inflation and asset price bubbles.

The communique indeed referred to these issues, but in general and in some cases rhetorical terms.  It lacked specific details or quantitative commitments, and thus countries have the flexibility to interpret the principles and good intentions in their own way.

The differences in approach by various countries that were evident in the days just before the meeting may thus remain.  But the fact that the meeting did not break down, and that at least some principles were agreed to, provides relief and some hope of future progress, perhaps during the G20 Summit next month.

The global economic problems remain, however.  So too do the differences of view, either among the G20 members, or between some leading economists and the policy makers of many G20 countries.

For example, the communique said that the advanced countries would implement “clear, credible,
ambitious and growth-friendly medium-term fiscal consolidation plans”.

Many prominent economists including Paul Krugman and Joseph Stiglitz in the US and Robert Skidelsky in Britain have strongly argued that the developed countries are making a big mistake in moving too quickly from the consensus just a year ago that they should undertake “fiscal stimulus” to get out of recession, to the present near-consensus that the same countries should now go on a “fiscal austerity” drive.

The big cuts in government spending (to reduce budget deficits) will cause their economies to putter, before the recovery becomes self-sustaining.

In his column on 23 October, Krugman criticised the British budget, which was presented last week,   for its massive cut in government spending (and the loss of 490,000 government staff) and for following the austerity fad.  He predicted that the premature fiscal austerity will lead to a renewed economic slump in Britain.

The G20 communique pledged to continue with appropriate monetary policy to achieve price
stability and thereby contribute to the recovery.

However, this pledge papers over the recent sharp criticisms of the US Federal Reserve for its  intention to undertake “quantitative easing” (or pumping large amounts of funds into the banking system).  This attack has come not only from China but last week also from the German Chancellor Angela Merkel.

China and other developing countries have voiced the concern that the expansion of liquidity will tend to depress the US dollar, and also to cause large and unwanted flows of funds to developing countries.  The capital inflows, which are already taking place, cause the recipient developing countries to have  higher inflation, asset price bubbles and pressures on their currencies to appreciate.

The communique commits the Ministers to “move towards more market determined exchange rate systems that reflect underlying economic fundamentals and refrain from competitive devaluation of currencies.”

This will be a welcomed part of the communique, as there has been growing and serious concerns that some of the G20 countries have been engaging in a “currency war.”

The US has accused China of manipulating its currency by preventing the yuan from appreciating, while China in turn has criticised the US for printing money to expand liquidity which results in the dollar's devaluation. 

At the G20 meeting, many officials expressed concern to the US about its policy.   “Excessive, permanent money creation in my opinion is an indirect manipulation of an exchange rate,” said the German economy minister, Rainer Brüderle.

Meanwhile, several developing countries are countering excessive capital inflows (and pressures for  currency appreciation) either by intervention in the currency market, or by capital controls such as taxes on certain types of foreign capital entering the countries.  The governments concerned have a good case when they argue that these measures are needed to protect their countries from the damaging effects of speculative capital inflows, and that they are not manipulating their currencies.

The communique also states that “advanced economies, including those with reserve currencies, will be vigilant against excess volatility and disorderly movements in exchange rates. These actions will help mitigate the risk of excessive volatility in capital flows facing some emerging countries.”

This is also a welcome statement.  However, it remains to be seen whether the developed countries, especially the US, will stand by it.  For example, will the US give up its expected new quantitative easing, or will it instead argue that the communique does not really imply that it should refrain from this measure?

The Ministers also committed to pursue policies to “reduce excessive imbalances and maintaining
current account imbalances at sustainable levels.”  They add that “persistently large imbalances, assessed against indicative guidelines to be agreed, would warrant an assessment of their nature and the root causes of impediments to adjustment.” 

This complex paragraph reflects a watered down proposal by the United States which reportedly called for the G20 countries to keep their current account balance (whether a surplus or a deficit) to below 4 per cent of gross domestic product.

The current account balance is a combined measure of the balances (exports minus imports) of a country's trade in goods, trade in services, flows of income and transfer payments such as migrant workers' remittances.   

The US proposal for having a numerical restriction on the current account balance was reportedly opposed by Germany, Russia and Italy.  The European Commissioner for Economic Affairs

said that “setting specific numerical targets would have been easily counterproductive.”

The US Treasury Secretary Timothy Geithner however called the language in the communique 
a step forward, saying “the most important achieved is agreement on a framework for curbing excess trade imbalances in the future.”

The G20 communique also announced a decision to increase the share of developing countries in the IMF's quota (and thus voting power) by more than 6 percentage points by 2012.