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The G20 Mirage

September 24, 2009

The Baseline Scenario


The G20 Summit in Pittsburgh: Should You Care?

Posted: 24 Sep 2009 12:50 PM PDT

On Thursday evening and all day Friday, heads of government from countries belonging to the G20 will meet in Pittsburgh.  On paper, this looks important – 90 percent of world economic output and 67 percent of world population will be at the table: the G7 (US, Canada, Japan, UK, Germany, France, and Italy), plus the European Union, the largest emerging market countries (including China, India, Brazil, Mexico, and South Africa) and a few others.  And unlike the G7, which is really a club for rich industrialized countries, every continent and almost all income levels are represented in the G20.

The last time this group met – in London at the beginning of April – they had one of the most productive summits in living memory, agreeing to triple the resources of the International Monetary Fund (IMF) so that it could help troubled countries, while also projecting an image of determination to “do whatever it takes” to avoid a Second Great Depression.

There could still be dramatic moments at or around the summit.  There will be some street protests, mavericks could rock the boat (President Sarkozy of France is always threatening to do this), and there is always scope for mini-drama and quirky photos when so many heads of government rub shoulders.

But in terms of the economic agenda – and this meeting is supposed to be about the global economy – the likely deliverables look thin. Three issues are up for discussion.

First, whether the countries can agree on “rebalancing” global growth, which means – in its current iteration — that the US would commit to save more and China would commit to save less.  But “commit” will not mean that the countries agree to any penalties if they fail to comply.  The US may well save more as it struggles along the road to recovery – after all, households have been saving very little for over a decade – but this won’t be much or at all affected by any agreement at Pittsburgh.

Second, whether lower income countries can have more representation at the International Monetary Fund.  This is a long-standing issue, which should eventually help the IMF rebuild the legitimacy that was sorely damaged by its handling of the Asian Financial Crisis in the late 1990s.  Unfortunately, real progress on this issue is blocked by some rich West European countries, who are overrepresented at the IMF for historical reasons and who would lose out in any reshuffle; they will not be in Pittsburgh and there is no sign of any new concessions from this side.

Third, to what degree and precisely how financial regulation will be tightened around the world.  Here there is scope for a deal, with the US pushing for higher capital requirements for banks, while the Europeans (and Mr. Sarkozy in particular) are demanding changes in how bankers are compensated.  These are crucial question, but here we face our greatest potential disappointment.

The open secret is that even the US is not pushing for significantly higher capital requirements – the US Treasury view is that our largest banks currently “have enough capital,” even though Citi and JP Morgan have roughly only about as much of an equity cushion against losses as did Lehman Brothers the day before it failed.  So the US proposal is largely meaningless – which does not prevent the continental Europeans from opposing it; many of their banks are very thinly capitalized but their governments don’t want to draw attention to this fact.

The Europeans want, instead, to focus on how bankers are paid.  Compensation systems in big banks encourage reckless risk-taking, but more this is more of a symptom than a cause.  Unless the underlying causes are tackled – the excessive size of our biggest banks, their thin level of capital, and the revolving door that has top Wall Street people running bailout strategy in Washington – changing compensation rules would just increase the effort that smart lawyers and accountants put into figuring out new ways to pay people.

If the G20 fails to deliver, is it really possible that we are doomed to repeat the same mistakes with regard to building up vulnerabilities in our financial system?  Amazingly, the answer is: a definite yes.  How can this happen, with so many smart people in government?  Unfortunately, it is not about having clever individuals on the job; it is about their incentives, their world view, and whether or not they really face pressure for change. 

During World War I on the Western Front, well-educated British generals with great practical experience insisted on repeating the same mistakes again and again, at great cost.  Democratic oversight, in that context, was worth little.  If you delegate to “experts” and they fall into dangerous groupthink – and are allowed to construct sophisticated sequential cover-ups – expect the worst.

By Simon Johnson

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