Monday, September 27, 2010

By Michael Prowse, Senior Visiting Fellow

Last week marked the 25th anniversary of the Plaza Accord, one of the few unambiguous examples of international economic cooperation since the demise of the Bretton Woods fixed exchange rate system in 1971. Then, as now, the US was running large current account and budget deficits. To rebalance the global economy, the G 5 (the US, Japan, Germany, the UK and France) agreed on concerted action to bring down the dollar, especially against the yen.

The Plaza Accord was a rare instance in which nations came together to solve a collective action problem in international economics. Such problems are endemic to social life and often arise because individuals (or States) pursue their self interest without taking account of the consequences for others. The result is typically that everyone ends up worse off than they might have been had they agreed to cooperate.

The classic example is a football stadium. If some people stand up to see better, they gain a temporary advantage. But this encourages others to act selfishly too. Once everyone is standing it is just as hard to see the match. And everyone is less comfortable.

In the approach to the G20’s Summit in Seoul this November, there is again a pressing need for international economic cooperation. And, unlike in 1985, practical machinery for achieving permanent cooperation is under construction. Last year, G20 members agreed to participate in a “Mutual Assessment Process” (MAP) which is administered by the IMF*.

What is supposed to happen is roughly this. G20 countries supply the IMF with details of their policy plans and expected economic performance over three to five years. IMF staff aggregate the plans and check whether they are mutually consistent. This produces a “base-case” scenario: what the future holds without cooperation.

IMF staff and a G20 working group (chaired by Canada and India) then examine other policy options. The goal is to see whether amendments in the policies of each G20 member state can produce an overall “win-win” outcome in which all members do better than without cooperation. If such policies exist, revised plans are sent back to G20 members which must then come up with the practical measures needed to implement them.

The MAP is an important tool for promoting global economic cooperation. In today’s multipolar economic world no one country can assume responsibility for crafting a cooperative solution to a collective action problem. If the US tried, it would be accused of promoting its own interests.

The IMF, on the other hand, is a genuine global institution, “owned” by the community of nations, and if not exactly democratic at least representing all relevant interests. It is thus uniquely well placed to orchestrate global economic cooperation.

Through the MAP, the IMF has identified the outlines of a “grand bargain” that could propel the world economy on to a faster growth path. The basic principle is that countries can be persuaded to take greater risks – for example switch from export-led to consumption-led growth – if they are convinced other countries are taking similarly bold steps and if they are convinced the net outcome will be beneficial for all.

Asian nations are telling the US to solve its deficit problems by curbing the runaway costs of “entitlement” programmes such as healthcare (which explain why the share of consumption in GDP is especially high in the US). The US, meanwhile, is telling the Asian countries to boost global demand by raising domestic consumption (which at 36 per cent of GDP is still ludicrously low in China).

Japan and Germany are under pressure to liberalise domestic markets which would release pent up demand for home ownership and consumer goods, much of which would be imported. What the MAP shows is that if all G20 members simultaneously addressed their very different economic weaknesses, all would stand to gain.

Is the MAP more than a technocratic pip-dream? Perhaps not: it is one thing to identify “win-win” policies, quite another to persuade politicians to adopt them in the teeth of domestic opposition. In Seoul the cooperative process is supposed to be entering its second (and tricky) phase, in which G20 members identify practical ways of achieving previously agreed policy goals.

Yet few analysts expect much progress. The fact that the G20 was able to agree a concerted fiscal stimulus in 2009 when the world stood on the brink of a second Great Depression does not prove it can solve collective action problems in more normal times.

Cooperation is harder to orchestrate than in 1985 because the world economy is so much more complex. The number of participants in putative “grand bargains” has quadrupled.  The 20 nations represented at Seoul will also be far more diverse than the G5 group that met at the Plaza Hotel in New York - in terms of living standards, technological progress and political cultures.

The waning spirit of cooperation is evident in the quarrelling among the G20’s representatives at the IMF over how to adjust members’ “quotas” to reflect the larger relative size of emerging economies such as China and India. Europeans know their slice of the global cake is shrinking yet are reluctant to concede voting rights to others. It is also evident in more frequent spats over exchange rate policy.

Although China reluctantly agreed to “float” its currency in June, it is determined not to follow Japan’s example of the mid-1980s and submit to pressure for a major revaluation. So it has allowed the renminbi to appreciate against the dollar by less than 2 per cent – a derisory adjustment.  

Japan, beset by deflationary woes, also seems in a less cooperative mood. In recent days the Bank of Japan has intervened in foreign exchange markets for the first time in six years, buying some $20bn of dollars. It wants to prevent further yen appreciation against the dollar, if not to reverse recent trends.

Indeed, it’s fair to say that every nation now seeks a lower exchange rate – a mathematical impossibility.

Deficit nations such as the US and UK want weaker currencies to facilitate a shift of resources from domestic consumption to exports. But the major surplus nations are either unable or unwilling to accept appreciation. If the D-Mark still existed it would have soared in recent months, alongside the Swiss franc, but thanks to the weak euro Germany is enjoying yet another export-led recovery – the reverse of what MAP technocrats are demanding. 

Selfish individualism – failure to take account of the needs and interests of others – is the root cause of much human misery. What is true of individuals is equally true of nation states. In Seoul, G20 members must try to rise above their narrow national interests and cooperate in implementing policies from which all can benefit.

The MAP is a tentative first step towards creating permanent machinery for meaningful economic cooperation. In today’s interdependent global economy it deserves more than rhetorical support from G20 leaders.

* A Problem Shared is a Problem Halved. The G20’s “Mutual Assessment Process”. Olivier Blanchard, iMFdirect.