G20: Economic Council?

Posted on November 9, 2009 by David Laidlaw 

The G20 declared itself “the world’s main economic governing council” during its summit held at the end of September.  It’s a grand proclamation, but it is unclear as to whether the G20 can deliver. 

The first stumbling block is whether the countries can agree on what needs to be done to promote economic growth.  The G7 subset of the G20 focused on financial regulation to prevent future collapses—banker’s pay, capital requirements and ways to wind down large bankrupt financial companies. 

The remaining G20 countries have different concerns, mainly removing trade barriers, especially in agriculture.  Developing countries have a comparative advantage in agriculture, i.e. they can produce food more efficiently than microchips, and want to trade on this advantage.  This is hindered by developed countries’ trade restrictions.  This topic was not a point of emphasis at the summit.

In fact, the US has talked about promoting free trade, but actions speak louder than words.  President Obama instituted large tariffs on imports of Chinese automobiles and tires.  China threatened to retaliate with tariffs on US chicken.  This is not the cooperation needed to govern the economy.

And while the G20 (G7) could agree on talking points, details were missing.  Changing the pay structure at financial companies to discourage risky behavior would improve conditions.  Banker’s can get paid large bonuses instantly for selling product, e.g. mortgage-backed securities, that pay off years later.  In other words, when the product turns out to be worthless the seller has already cashed in.  Altering the scenario is good in theory but difficult in practice.  The G7 countries could not agree on a method.  French President Nicolas Sarkozy wants to cap pay as a percent of revenue or assets.  Britain and the US want to allow clawbacks if the banks do not have sufficient capital.  No rules were set at the summit.  And some wonder what good they would do anyway—as soon as a rule is in place banks will unleash an army of accountants to figure out a work around.

President Obama also spoke to ending trade imbalances which create a world economy in which some countries’ spending (the US) fuel other countries exporting (everyone else).  This makes the world’s economy too dependent on the American consumer’s willingness to spend.  How this is altered is unclear: can the US demand other countries increase their deficits to fuel spending?

Cooperation will only go so far.  In the past, countries actually reduced regulation to attract financial companies.  It’s easy to imagine a scenario where this returns if capital requirements are increased and banker’s pay is curbed.  Let’s say in a few years Austria is having a tough time.  If you’re Austria’s president, why not call UBS or Deutsche Bank and tell them your capital requirements are low and you attach no strings to banker’s pay?  Pretty soon you’re a financial hub, mansions and restaurants are built for your millionaire bankers, and your economy is humming again.  You may pay later, but as president you survive one more election.  And as with the tire trade dispute noted above, countries will retaliate.  Before you know it, there’s a race to deregulate just as there was before the financial crisis.

The bottom line is President Obama, President Sarkozy and all world leaders were elected by their citizens so they will look out for them first and foremost.  The G20 can call itself “the world’s main economic governing council” but it will have 20 different agendas, which will make governing difficult.