G20-IMF-FSB Update - April 16, 2010
By Adam S. Hersh
G-20 April Summit PreviewFrom April 22-23 G-20 Finance Ministers and Central Bank Governors will meet in Washington, DC, ahead of the IMF-World Bank Spring Meetings (G-20 Labor and Employment Ministers will also meet earlier in the week). Two items will likely top the G-20 summit agenda: plans for a global bank levy and efforts to coordinate compatible macroeconomic policies to support global growth; the IMF will present to the G-20 documents assessing both of these issues.
Bank Levy. A previous update discussed in detail recent developments with and proposals for a global bank levy. With the IMF delivering a preliminary assessment of bank levy proposals and a number of bilateral discussions on the issue in recent weeks, it is hoped that the April meeting will forge consensus and pave the way for a definitive agreement of G-20 leaders at the upcoming June summit in Toronto. However, substantial discord remains over the approach to a global bank levy. The direction that discussion is heading seems likely to sell short the potential for a global bank levy to promote financial stability as well as to promote structural rebalancing towards a financial system that privileges long-term real sector economic growth over short-term financial profiteering. Moreover, it appears discussion is trending toward a policy that narrowly benefits the countries home to the super-sized “systemically important” financial institutions over widely-shared monetary benefits and benefits from greater systemic stability.
Plans for a global bank levy originate in desire to make the financial sector pay for the costs associated with future bailouts and to recoup some of the current fiscal expenditures supporting the financial sector. Up for debate are plans to impose a tax on bank balance sheets, a tax on bank cash flows, and a financial transactions tax (FTT), a.k.a. a Tobin tax or Robin Hood tax. The European Union, Germany and France are additionally discussing a balance sheet-type tax, revenues from which would be collected on a national basis and used to pre-commit resources to insurance funds to be drawn for the resolution of insolvent banks. In the US, President Obama proposed a similar measure in January 2010. The IMF is behind the proposal for a tax on bank cash flows for being "non-distortionary," which is to say that it theoretically would not alter the incentives facing banks and therefore would not alter banks' behavior (although it is hard to see why one would not want to alter the incentives for bank behavior that led to the collapse?). Many countries including the UK, France, Germany, Japan, Australia, Belgium, the European Parliament have expressed support and even enacted implementing legislation for a FTT; a group of 350 economists also urged the G-20 to implement a FTT. And this week, Canada threw a spanner in the works by coming out against a coordinated global bank levy, instead favoring a contingent (or “countercyclical”) capital regime that would not tax banks at all, but would require banks accumulate additional reserves in good economic times that can be drawn down in times of financial duress. Countercyclical capital requirements make a lot of sense and have been endorsed by the BIS, but face difficult political-economy hurdles to be implemented in practice.
Unfortunately, it is likely that the G-20 will settle on just one of these proposals—even though the proposals could be complementary and would each address different problems in the international financial system. A balance sheet tax could disincentivize excessive leveraging and excessively risky asset portfolio, while deterring banks from becoming so large as to pose systemic dangers.Standard and Poor's has warned that a balance sheet tax could perversely encourage banks to choose a higher risk profile for a given level of assets, offsetting a lower quantity of profits with higher potential profit rates. But there is no reason why this should be the case if implemented to reflect the relative risk profile of balance sheets and to discriminate between assets tied to real sector economic activity and fictitious financial capital. A contingent capital regime would require banks to self-insure against unknown future adverse economic conditions and would help limit the accumulation of financial fragilities during economic expansions, unnoticed due to tendencies to underestimate risk. A FTT, though imposing a tax on financial transactions of fractions of one percent—so miniscule as to avoid market distortion—would help deter destabilizing and unproductive financial speculation while raising hundreds of billions of dollars in annual revenues (see global estimates and US estimates). Importantly, an FTT would impact the incentives for speculation facing big banks as well as unregulated financial institutions.
Proposals for a bank balance sheet tax and a cash flow tax face three obvious drawbacks. First, as we have learned once again from the present crisis, banks are quite skilled at jiggering their balance sheets and income statements in ways they see fit to maximize profits and executive bonuses while avoiding taxation and regulation. One motivation for the Basel II self-monitoring bank capital standards was that regulators did not feel that they could assess balance sheet positions with any veracity in a relevant time frame. Skirting regulations and taxes through clever accounting also means banks can end-run new incentives intended to encourage productive lending to finance real economic activity over financial speculation. Second, revenues from taxes on bank balance sheets and cash flows, as are being discussed, would fall only to the handful of countries home to affected banks—developing countries and the majority of G-20 member countries would not benefit from these proposals. Third, it is questionable whether such taxes would generate sufficient revenues for insurance funds with a capacity to cope with future crisis episodes, let alone to repay taxpayers for the direct costs of the financial sector bailout or the broader damage caused to the real economy worldwide.
In contrast to the narrowly construed bank taxes, a FTT would generate substantial revenues, offer a simple and transparent policy instrument, and generate widely-shared benefits by reducing financial volatility. Although many G-20 countries would support an FTT and the tax has been field-tested in Sweden and China, the US government has discouraged it and the IMF and Dominique Strauss-Kahn are openly hostile to the idea, declaring it “all but dead.”
It is important to remember the unfolding financial panic that spurred the G-20 into action in October 2008 was only the tip of the ice berg of a severe and enduring economic crisis created by banks and financial markets grossly misallocating resources into a real estate bubble—worth $8 trillion in the US alone. The bursting of this real economy bubble destroyed trillions of dollars of wealth, sending the construction sector and consumption more broadly into a tailspin and delivering a rude awakening to financial institutions that had gambled heavily on real estate assets and related derivative financial products. The economic meltdown caused by a collapsing real estate bubble created a tsunami of unemployment and lost economic output, with severe knock-on effects rippling out towards developing country economies from lost export markets and tourism revenues, higher interest rates and external borrowing constraints. A new study out from the IMF suggests that developing countries' debt service capacity will be permanently lower due to the economic crisis originating in the advanced countries. Not only does the real economy spillover threaten to derail growth and fiscal paths in developing countries, but also willreverse progress on the Millennium Development Goals for poverty reduction and broadly shared living standards improvements.
At the September 2009 Pittsburgh Summit, G-20 leaders pledged, “We cannot rest until the global economy is restored to full health, and hard-working families the world over can find decent jobs.” So far G-20 member countries and international institutions under the G-20's direction have trained the majority of their efforts on financial aspects of this broader global economic crisis: containing the financial panic and getting the ball rolling on revising the rules of the financial game. As the G-20 meets this spring (Washington, DC) and summer (Busan, Korea and Toronto) to discuss how to secure a sustainable global economic recovery, it is long overdue that leaders look beyond policies to stabilize and strengthen financial systems to deal with the real economy crisis. To this end, the G-20 asked the IMF to assess the compatibility of G-20 macroeconomic policies as part of a “Mutual Assessment Process” (MAP).
The locus of conflict over macroeconomic policy compatibility relates to which countries will bear the brunt of adjustment to international imbalances—namely China's surpluses and US (and others) deficits. A joint letter from the Canadian, Korean, British, American, and French heads of state to G-20 member countries offered thinly veiled criticism of China and signaled coming discord within the ranks. The IMF's MAP report highlights that, in fact, G-20 macro policies are remarkably incompatible and under current policy they forebode continuing widening of the imbalances.
Closely tied to the issue of imbalances will be how and when G-20 countries tack macro policy to “exit” from the exceptional fiscal and monetary policies adopted in response to the crisis. Already the IMF, the OECD, Ben Bernanke, and others are setting the stage for a hasty retreat from fiscal and monetary economic stimuli with warnings about fiscal deficits and inflation. But the G-20 is far from fulfilling its responsibility and commitment to restoring the global economy to full health. In the eight G-20 countries (together amounting to 42 percent of the world economy) for which the IMF produces output gap estimates (the amount that actual GDP falls below estimated potential GDP), economic output is running on average (weighted by economic size) 5 percent of GDP. In other terms, these eight economies combined are running about $1.6 trillion short. IMF forecasts for emerging and developing economies see their combined real output falling 1 percent of GDP or more below potential GDP through 2014 (pdf - see p. 5). The harmonized unemployment rate in the OECD countries stood at 8.6 percent in February 2009, with headline unemployment in the US at 9.7 percent (March 2010). In an advance release of the World Economic Outlook, the IMF forecasts that unemployment will remain high, around 9 percent, through 2011 in the advanced economy countries. (Elsewhere, in a draft of the G-20 Mutual Assessment Processreport to be released at the April 2010 meeting, the IMF projects unemployment will “decline rapidly.”).
How might the G-20 member countries work to improve their economic lots? The IMF stresses "the standard macroeconomic policy levers—monetary policy and fiscal policy—remain the primary tools for boosting employment,"but recalcitrant central bankers—many with mandates to target policy towards stable inflation rather than broader economic goals like full employment and many who ignored or missed signs of the impending crisis—should not be counted upon to deliver the world back to economic prosperity. In fact, they stand poised to pull the plug on economic stimuli even before signs of the real economy recovery.
Rather than further fiscal stimulus, the IMF is urging fiscal budget cutting (after 2010), privatization of public services, and cuts to public sector pensions. TheOCED, also, is pushing for fiscal consolidation by 2011. Instead of helping “hard-working families the world over find decent jobs,” the IMF imagines thatlabor market deregulation and cutting social services and public employmentwill pave the way to a brighter and broadly-shared economic future.
While G-20 finance ministers and central bank governors appear contented to have contained a financial panic, rescued the financial sector, and made sufficient machinations toward revising the rules of the financial game, for the first time, President Obama has invited the G-20 labor and employment ministers to meet alongside their financial counterparts. Unfortunately, the issue of how to get the world's real economy and employment back on track remains relegated to these back bench officials. In principle, all countries are on board with tackling the real economic recovery. To this end, the ILO member countries unanimously adopted the Global Jobs Pact in 2009. Now, what is needed, is for G-20 political leaders to direct the finance ministers and the IMF to work together with the labor ministers and the ILO to deliver on the promise of a global recovery that puts puts people and employment at its core.
More (Unused) IMF Resource
Although they aren't doing much lending with the resources they have, the IMF announced approval of a ~US$500b increase in the Fund's New Agreements to Borrow—part of the additional US$750b in resources committed by the G-20. Under the NAB facility, funds are committed from lending member countries as standing lines of credit to the IMF, to be drawn at the Fund's discretion if its lending needs exceed quota resources. Previously, about US$50b in resources had been made available to the IMF.