The G20 declaration at the London Summit: a global ‘new deal’?

Posted by Anis Chowdhury on 20 April 2009

Written on Tuesday, 09 April 2009

The G20 declaration at the London Summit: a global ‘new deal’?

Iyanatul Islam[1] and Anis Chowdhury[2]

‘Developing countries should have expanded scope … to implement appropriate counter-cyclical policies.’

(Members of the Commission of Experts of the President of the UN General Assembly on reforms of the international monetary and financial system, March 19, 2009)

Key messages:

* The G20 communiqué of April 2, 2009 promises an injection of USD 1.1 trillion into the global economy with the specific aim of assisting low and middle-income countries

* About 70 per cent of the announced amount goes to the IMF

* These additional resources will translate to an injection into the global economy if member states use them

* The IMF is finding it difficult to attract middle-income countries in Latin America and East Asia to even use their existing facilities

* The addition to ‘pure’ development finance is USD 100 billion

* One study suggests that sub-Saharan Africa alone will need USD 50 billion to implement a job-rich public investment strategy in order to remove the crisis-induced output losses

* All the major evaluations suggest that existing fiscal interventions undertaken by the OECD economies and G20 will not be able to close the global output gap

* There is also the unresolved issue of the necessary institutional reforms that need to accompany a substantially expanded role for the IMF

* The G20 Summit has given insufficient attention to the role that regional and local solutions can play in fortifying the capacity of developing countries to cope with the global economic crisis

* Developing economies should seek lessons from successful cases of crisis management undertaken by their peers in Latin America and East Asia

Introduction

How does one fortify the capacity of the developing economies to respond to the current global economic downturn? The G20 Communiqué of April 2, 2009 represents the first major attempt by the global community to tackle the issue. As the Communiqué notes:

‘We have …agreed today to make available an additional (USD) 850 billion of resources through the global financial institutions to support growth in emerging market and developing countries by helping to finance counter-cyclical spending, bank recapitalization, infrastructure, trade finance, balance of payments support, debt rollover, and social support’. (italics added)[3]

The G20 communiqué of April 2, 2009 promises an injection of USD 1.1trillion into the global economy. This headline grabbing number appears to be the sum of USD 750 billion to augment existing IMF resources, USD 100 billion for MDBs (multilateral development banks), and USD 250 billion to support trade finance. This proposal was foreshadowed by a number of suggestions made by multilateral agencies and development practitioners;[4] Nancy Birdsall’s suggestion was rather close to the mark.

Evaluation

Is the G20 initiative a ‘new deal’ that will bring the global economy out of the recession and assist developing economies to cope with the crisis? The leaders of the G20 understandably claim that a global solution to a global crisis has been found. The G20 Summit declaration has also received the endorsement of some leading development practitioners.[6] The planned USD 1.1 trillion programme (billed as ‘support to rescue credit, growth and jobs in the world economy’) is added to the existing fiscal stimulus packages announced by the members of the G20 to proclaim that it will raise world output by 4 per cent, which is equal to the estimated output gap.[7]

An obvious point to be made is that it is misleading to add the USD 1.1 trillion to the existing fiscal stimulus packages.[8] As serious analysis shows, some of it had already been decided long before the Summit, and some of it reflected only an intention rather than concrete pledges.

The biggest winner of the new deal appears to be the International Monetary Fund (IMF). Close to 70% of the package of USD 1.1 trillion will go to the IMF. It was announced that the IMF would get USD 500 billion more funds. Japan and the European Union had already offered about USD 100 billion each. The Summit did not formally announce when or from where the other USD 300 billion will come. However, one can figure out from unofficial and unconfirmed reports that the United States would put in USD 100 billion and China USD 40 billion. But this still leaves a short-fall of USD 160 billion.

This promised additional money to the IMF would be loans by the countries to the IMF, which will recycle them as loans to crisis-hit countries that are running out of foreign reserves. This will only have an impact on the ability of developing countries to enhance their resources if they use IMF financial assistance. The irony, as The Economist and others emphasise, is that the IMF is finding it difficult to attract middle-income economies in East Asia and Latin America to even use their existing facilities.[9] This is largely the result of a so-called ‘reputational’ effect. Given that the IMF has played a controversial role in past crisis management episodes, and given onerous conditionalities that are attached to IMF assistance programs, this reluctance by member states is understandable. Furthermore, such member states can observe that the 13 countries that are under current IMF agreements are being subjected to a typical IMF macroeconomic stabilisation-cum-adjustment program.[10] According to a news report, the same day that the G20 Summit was giving a boost to the IMF to help countries undertake counter-cyclical policies, the IMF suspended lending to Latvia (one of the countries it has recently extended emergency crisis loans to) "until it sees more progress in cutting public spending". Whether the reluctance of developing countries to approach the IMF is justified or not is certainly worthy of debate, but this should be the subject of another paper. What matters is that perceptions drive decisions.[11]

An important point to note is that countries should not be requested to provide loans to the IMF to augment its resources. This would compromise the ability of the IMF to carry out its surveillance function and to discipline the policies of countries that provide the loans. Instead, the IMF should obtain resources from the market or from the issuance of Special Drawing Rights (SDRs).

The G20 leaders did agree for the IMF to issue $250 billion in SDRs, but this will not be used to assist countries in need. Instead, it will be allocated to the 186 IMF members according to their quotas or voting shares. As a result, 44% will go to the richest seven countries, while only $80 billion will go to middle-income and poor developing countries.

Once the funds allocated to the IMF and trade finance are taken out, the current G20 initiative appears much more modest- amounting to about USD 100 billion new monies proposed for the MDBs to finance a variety of initiatives with both short term and long term effects. One study on sub-Saharan Africa suggests public investment in infrastructure has to be at the core of a fiscal stimulus package in developing countries that can compensate for the output loss due to the global economic crisis and sustain long-term growth. This is tantamount to USD 50 billion in sub-Saharan Africa.[12] In other words, 50 per cent of the proposed allocations for the MDBs would need to be spent in one region of the developing world alone. To set this number in a broader context, the estimated output loss so far in the developing world is over USD 800 billion.[13]

Critics of the G20 initiative make two important points. First, the leaders of G20 did not come up with fresh and practical ideas to fix the financial system that is at the core of the current global economic crisis.[14] Second, they did not commit themselves to `spend the hundreds of billions of dollars in additional fiscal stimulus that the world economy needs to pull out of its frighteningly steep dive’.[15] Various cross-country evaluations of fiscal stimulus packages show that the size of the fiscal expansion aggregated across the G20 is inadequate to close the global output gap. It also appears that the composition of the discretionary fiscal packages does not maximise the size of the fiscal multipliers.

There is the unresolved issue of the necessary institutional reforms that need to accompany a substantially expanded role for the IMF. The G20 communiqué makes it clear that this is an agenda that will be tackled later (in 2011). Advocates of the reform of the IFIs (International Financial Institutions) are understandably disappointed.

Critics of the G20 initiative contend that insufficient attention has been given to the role that regional and local solutions can play in fortifying the capacity of developing countries to cope with the global economic crisis.[17] Some make the stronger point that it is only through regional cooperation that developing countries can develop effective mechanisms for coping with external shocks. In Latin America, for example, there is a ‘Bank of the South’ initiative that seeks to develop regionally rooted facilities that can respond to both short-term financing needs and long-term development finance. In East Asia, there are continuing attempts, since the Chiang Mai Initiative of 2000, to develop regional cooperation to enable participating countries to tide over temporary economic setbacks engendered by external shocks. There is also some evidence of collaboration between middle-income countries in East Asia and Latin America, such as the currency swaps between China and Argentina. These regional innovations can be seen as attempt to offer opportunities to participating countries to seek access to fast-disbursing, low-conditionality external sources of finance without having to go through the IFIs.[18]

Finally, there is considerable scope for ‘peer group’ learning. Developing countries can learn from their peers in nurturing national initiatives to enhance fiscal and policy space. They can seek lessons from successful cases of crisis management without compromising on policy autonomy (such as Malaysia during the 1997 financial crisis).[19] They can learn from successful operations of national stabilisation funds (as in the case of Chile).[20] What is, important, however, is not to be tempted to regard such national funds as a time-bound operation that is wound up once the global recession is over. This approach is costly and inefficient. The goal of a stabilisation fund is to create the necessary ‘fiscal space’ to sustain investments in human capital and basic infrastructure across business cycles and to scale up programs pertaining to passive and active labour market policies to cope with external shocks. Such a fund can be financed from excess revenues collected by the government during normal and boom periods. This illustrates once again the critical role that renewed commitment to domestic resource mobilization can play in enhancing fiscal and policy space on a sustainable basis.[21] Such a commitment entails efforts to raise the revenue share of GDP in developing countries that have a low tax burden and to ensure efficient utilisation of existing budgetary resources.[22] The donor community can provide seed funding and technical assistance, but the success of a national stabilisation fund in developing countries ultimately depends on country ownership and commitment.

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[1] Professor of International Business, Griffith University, Australia. ([email protected])

[2] Professor of Economics, University of Western Sydney, Australia. (a[email protected])

[3] London Summit – Leaders’ Statement, 2 April, 2008

[4] See Bergsten, F (2009) ‘Needed: A Global Response to the Global Economic and Financial Crisis’, Presentation before Subcommittee on Terrorism, Non-proliferation and Trade Committee on Foreign Affairs, US House of Representatives; Goldstein, M (2009) ‘A Grand Bargain for the London G20 Summit’, February 19, 2009, voxeu.org. Both Bergsten and Goldstein emphasise a substantial replenishment of IMF resources. Dervis and Birdsall (2006) and Akyuz (2007) also offer proposals on enhanced global financing facilities for developing countries that pre-date current versions. See Dervis, K and Birdsall, N (2006) ‘ A Stability and Social Investment Facility for High Debt Countries, CGD Working Paper 77, Washington DC: Center for Global Development; Akyuz, Y (2007) Global Rules and Markets: Constraints Over Policy Autonomy in Developing Countries, Penang, Malaysia: Third World Network, p.40

[5] Sources: ILO and IILS (2009) The Financial and Economic Crisis: A Decent Work Response, Geneva: International Labour Organization and International Institute for Labour Studies, p.45; Members of the Commission of Experts of the President of the UN General Assembly on Reforms of the International Monetary and Financial System, March 19, 2009; World Bank (2009) ‘Zoellick calls for Vulnerability Fund Ahead of Davos Forum,’ News and Broadcast, January 30; Birdsall, N (2009) ‘How to Unlock the USD 1 trillion that the Developing Countries Desperately Need to Cope with the Crisis’, CGD Notes, February 2009, Washington DC: Center for Global Development, p.5.

[6] Sachs (2009) argues that the G20 accomplished ‘beyond what many expected’. See Sachs, J (2009) ‘The G20 Summit: Accomplishments beyond expectations’, 3 April, voxeu.org. Dadush (2009) from Carnegie Endowment claims that ‘(d)eveloping countries are the greatest likely beneficiaries of the large planned increases in IMF and Multilateral Development Bank resources.’ See Dadush, U (2009) ‘G-20 Falls Short on Crisis Response, but Advances a New World Order’, April 3, Carnegie Endowment for International Peace.

[7] Wolf, M (2009) ‘Why the G20 leaders will fail to deal with the big challenge’, Financial Times, April 1. Note that the author is a forthright critic of the G20 summit. After adding the USD 1.1 trillion, the headline number of a supposed fiscal stimulus that the G20 leaders claim in the Communiqué is USD 5 trillion. The evaluations that have done an aggregation of all announced fiscal stimulus packages come up with a figure of approximately USD 2 trillion. If one adds the USD 1.1 trillion to the existing fiscal stimulus packages, it still falls short of the USD 5 trillion highlighted in the Communiqué.

[8] Throughout the analysis, we make the simplifying assumption that all announcements represent firm commitments that will be readily implemented.

[9] The Economist (2009) ‘The IMF: Battling Stigma’, March 26. See also Pomerleano, M (2009) ‘The IMF’s global fumble- as the IMF tries to please everyone, it serves no one’, 26 March, voxeu.org

[10] These 13 countries are: Armenia, Belarus, El Salvador, Gabon, Georgia, Hungary, Iceland, Latvia, Mongolia, Pakistan, Serbia, Seychelles, Ukraine (source: IMF, Table 2a, Current Financial Arrangements, April 2, 2009). They are all required to raise interest rates and reduce budget deficits, mainly by cutting public expenditure.

[11] As Woo (2008:24) puts it: `The IMF simply lacks legitimacy and credibility in the eyes of East Asia’. See Woo, W.T (2008) ‘What the US and Asia Should do: Establish a Global Financial Crisis Secretariat and an Asian Financial Facility’, in The G20 Financial Summit: Seven Issues at Stake, November, Washington DC: Brookings Instiution. Reiffel (2009:27) concurs: ‘The financial crises in Thailand, Indonesia, and Korea in 1997 left Asian countries feeling mistreated by the IMF. They have been saying since then that they must maintain large foreign exchange reserves because they cannot be certain of getting timely, sufficient, and fairly-conditioned help from the IMF the next time a crisis erupts.’ See Reiffel, L (2009) ‘What Asia Wants’ in The G-20 London Summit 2009: Recommendations for Global Policy Coordination, March 26, Washington DC: The Brookings Institution. See also Thomas Jr, L (2009) ‘IMF is pressured to redefine its role’, International Herald Tribune, 4-5 April. The IMF has recently made a determined effort to mend its image by offering a new ‘Flexible Credit Line’ (FCL) targeted towards countries ‘with very strong fundamentals, policies, and track records of policy implementation’. See IMF Survey Online, March 24, 2009. The IMF Factsheet on lending notes: ‘Disbursements under the FCL are not conditioned on the implementation of specific policy understandings as is the case under the SBA (Stand-By Arrangements)’. So far, only Mexico has signed up to the FCL.

[12] Overseas Development Institute (ODI) and National Institute of Economic and Social Research (NIESR) (2009) ‘A fiscal stimulus to address the effects of the global financial crisis on sub-Saharan Africa’, 25 March, London

[13] Velde, D.W (2009) ‘A rainbow stimulus’, ODI opinion 125, www.odi.org.uk

[14] Wyplosz, C (2009) ‘The outcome of the G20 Summit: a sceptic’s view’, voxeu.org

[15] New York Times (2009) ‘The Economic Summit’, April 3

[16] Sources: ILO and IILS (op.cit), as in Table 1; Prasad, E and Sorkin, I (2009) ‘Assessing the G-20 Stimulus Plan: A Deeper Look’, March, Washington: Brookings Institution; IMF (2009a) ‘The Size of the Fiscal Expansions: An Analysis of the Largest Countries’, February; IMF (2009b) ‘Global Economic Policies and Prospects’, Paper prepared for the Group of Twenty, Meeting of the Ministers and Central Bank Governors, March 13-14, London; OECD (2009) Economic Outlook, Interim Report, Chapter 3, March, Paris:OECD

[17] Baker, D (2009) ‘Why Support the IMF’? Guardian, April 2

[18] Wesibrot (2009) highlights the Latin American and East Asian experiments in developing regional sources of development finance. See Weisbrot, M (2009) ‘G-20 Should Think Twice About Lending Money to IMF’, Guardian, March 25. See Woo (op.cit) for further details on the East Asian experience.

[19] Islam, I and Chowdhury, A (2000: chapter 7) East Asian Political Economy: Post-Crisis Debates, Melbourne: Oxford University Press

[20] Islam, I (2005) ‘Circumventing Macroeconomic Conservatism: A Policy Framework for Growth, Employment and Poverty Reduction’, International Labour Review, 144(1), pp.55-84

[21] This point is of particular importance because studies show that tax revenues as a share of GDP of low-income developing countries have fallen between 1990 and 2004 and are now below the 15 per cent benchmark that is regarded as the minimum that low-income countries should target. See Culpeper, R and Kappagoda, N (2007) ‘Domestic Resource Mobilization, Fiscal Space, and the Millennium Development Goals: Implications for Debt Sustainability, March 27, North-South Institute, Toronto

[22] Heller,P (2006) ‘The Prospects of Creating ‘Fiscal Space’ for the Health Sector’, Health Policy and Planning, 21(2): 75-79