Spotlight G-20: Global Economic Cooperation: The Alternative to Agreed Rules is Anarchy, Not a Free Market

Michael Prowse, Guest Blogger
Part of a Triple Crisis series leading up to the Nov. 11-12 G-20 meetings.

Whenever liberal policymakers make a serious plea for global economic cooperation, it elicits a knee-jerk reaction from conservatives. Don’t interfere with free markets which require freely adjusting exchange rates.

Tim Geithner’s proposed numerical targets for current account deficits and surpluses met just this response. And Chinese communists, ironically, allied themselves with traditional conservatives. Cui Tiankai, a Chinese deputy foreign minister and leading G-20 negotiator, said the 4 per cent proposed ceiling for surpluses and deficits harked back “to the days of planned economies”.

The one reform of the international monetary system conservatives will countenance is a return to the gold standard, or renewed reliance on what Keynes called the “barbarous relic”. For instance, Mr. Robert Zoellick, the World Bank president and a senior Treasury official in George Bush (Senior)’s administration, argues that gold should play a role in any future reform of the global system, in part to anchor inflation expectations.

Conservatives’ reluctance to accept cooperative management of the global economy is all the more relevant given the sharp swing to the right in the US midterm elections. The Obama administration is less likely to propose bold cooperative initiatives now that Republicans control the House of Representatives.

Indeed, Mr. Geithner is already backtracking in response to vociferous criticism abroad and a changed political landscape at home. While still advocating a larger role for the International Monetary Fund as a supervisor of the global economy, he now says numerical targets for current account surpluses and deficits do not make economic sense. Yet without clear targets and sanctions for non-observance, it will be more difficult for the IMF to exert meaningful pressure on the nation’s most responsible for global imbalances, such as China and Germany.

In the light of events it is important to understand why the conservative argument for global laissez faire is fallacious. Even in a domestic market there is, of course, no such thing as a “free market”. Business activity must always take place within a legal context: rules governing contracts, property ownership, company formation, product quality, workers’ safety and so forth.

But as soon as companies operate internationally, the situation is more complex. There is no longer one background set of rules, but many, corresponding to different national jurisdictions. Corporate opportunities depend on the nature of the rules overseas as well as at home. So in this context a refusal to cooperate in setting global rules for capitalism simply means acceptance of whatever inconsistent set of national rules already exists– a surely sub-optimal state of affairs.

Refusal to cooperate in creating a stable international monetary regime is especially damaging for business. There are almost as many national monies as there are sovereign jurisdictions– the Eurozone being the one major exception. But, currencies are not “normal” prices: they are not at all similar to prices of goods and services which move in response to the buying and selling decisions of consumers and businesses.

A shift in the value of a currency is like a government dictate: if the euro falls relative to the dollar, the terms of trade of every business transaction entered into by every American exporter or importer in the Eurozone changes, even though there may be no change whatever in underlying market conditions. Every item sold generates fewer dollars and every item purchased is correspondingly less expensive. These across-the-board shifts in prices are in no sense the product of “free markets”.

The value of one currency in terms of another is only partly a product of aggregated consumer and business decisions. And this remains the case if we include in business decisions, the highly volatile movements of private capital. Currency values depend heavily on national monetary policies: for instance, the Fed’s resumed quantitative easing is increasing the global supply of dollars and thereby putting downward pressure on the dollar’s value.

And currency values, of course, also depend on a host of other government polices: for example, the rate of accumulation of foreign currency reserves, the nature of trade and capital market restrictions, the degree of regulation of domestic markets, the level and nature of taxation, and even the generosity of welfare states because this affects private savings decisions, and hence consumers’ willingness to buy imports. The Chinese Yuan’s value is product of all these forces.

Since the “free market” option does not exist in a global economy, the choice is a simple one. Nations can choose not to cooperate, which amounts in practice to the anarchic pursuit of self-interest by each sovereign state. This is what happened in the 1930s and the recent “currency wars”, in which every major exporting nation has sought a weaker exchange rate, are a worrying remainder that a Hobbesian war of all against all could erupt again.

The alternative is to engage constructively with other nations in the search for rules and policies from which all stand to gain. Cooperation can occur at various levels of sophistication. The Plaza Accord of 1985 sets targets for the dollar against other major currencies, such as the yen. But the disadvantage of targeting exchange rates is that they are the outcome, as we saw earlier, of a host of other policies. If possible it is better to reach agreement on the fundamentals that drive exchange rates up or down.

Under Mr. Geithner, US policy has advanced considerably. He has shifted the focus from exchange rates to current account imbalances. For the first time, a senior US official has publicly embraced Keynes’ principle of symmetry– the idea that surplus as well as deficit nations must accept the need to adjust their policies in the facing of persistent external imbalances. To refuse to accept this is to deny nations’ economic interdependence as well as the arithmetic reality that some nations can enjoy surpluses only if others accept deficits.

Mr. Geithner tried to put teeth in the proposal by arguing that G-20 member states should limit their current account imbalances– surpluses as well as deficits– to 4 per cent or less of gross domestic product. This was hardly an onerous proposal, but it was dropped after complaints from surplus nations. Germany in particular sees no reason why it should curb an external surplus of 6 per cent of GDP, which it attributes to superior efficiency. It’s a pity Germans have forgotten the lessons of their great philosopher Kant, who argued that behavior is ethically acceptable only if “universalisable”.

In Seoul Mr. Geithner urged his G-20 partners to accept monitoring of current account imbalances by the IMF as part of its “mutual assessment process”. As Mr. Geithner has already conceded, no one country– the US included– can any longer impose global economic rules on others. Cooperation has to be managed by a supra-national organization that can credibly represent the interests of the world as a whole. The G-20 is not a credible rule-setter because it leaves 172 nations unrepresented.

There is only one institution that can plausibly create and monitor economic rules for the world as a whole: the IMF. Following the governance reforms agreed at Seoul, seats and national quotas, while still imperfect, will better reflect the balance of global economic power. The challenge for the future is to find ways of persuading the most powerful economic players to cooperate constructively under the auspices of the IMF.

Michael Prowse is a Senior Visiting Fellow at the New Rules for Global Finance Coalition.