Mon, Jun 08, 2009 - Page 9 News List

IMF reforms can preserve the world’s faith in globalization

By Raghuram Rajan

As governments do more to coax the world economy out of recession, the danger of protectionism is becoming more real. It is emerging in ways that were unforeseen by those who founded our existing global institutions. Unfortunately, the discussion between countries on trade nowadays is very much a dialogue of the deaf, with countries spouting platitudes at one another but no enforceable and verifiable commitments agreed upon. There is an urgent need to reform global institutions — and more dramatically than envisaged by the G20 thus far.

Protectionism is not just about raising tariffs on imports; it is any government action that distorts the global production and allocation of goods, services and capital to favor domestic producers, thereby reducing overall efficiency. So, for example, government pressure on multinational banks to lend domestically, or to withdraw liquidity from foreign branches, is protectionism, as are capital injections into multinational companies with the explicit requirement that domestic jobs be preserved.

Such actions are problematic not only because they insulate inefficient forms of production, but also because foreign countries respond by adopting similar measures toward their national champions so that everyone is worse off. The number of inefficient workers protected by these measures is offset by the number of efficient workers laid off by foreign multinationals responding to political pressures in their home country.

Perhaps of greatest concern, moreover, is that the public, especially in poor countries that cannot undertake offsetting measures, will come to distrust global integration, with multinationals viewed as Trojan horses.

In addition to explicit protectionist measures, governments now plan actions that will affect others across the globe. For example, the large volume of public debt that industrial countries will issue will undoubtedly raise interest rates and affect developing country governments’ borrowing costs. There is little dialogue about how industrial country issuances can be staggered to minimize the impact on global markets, and what alternatives can be developed for countries that are shut out. If developing countries are left to their own devices, they will conclude that they should self-insure by rebuilding foreign-exchange reserves to even higher levels, a strategy that has clearly hurt global growth.

We need a moderate-sized representative group of leaders of the world’s largest economies to meet regularly to discuss such issues, informed by an impartial secretariat that will place its analyses before the group. Initially, the group should only exert peer pressure on its members to comply with international responsibilities. But, as confidence in the group’s decision-making — and in the impartiality of the secretariat — improves, members might give it some teeth, such as the ability to impose collective economic sanctions on recalcitrant members.

The UN is too large to serve this purpose, and the most obvious candidate for the group, the G20, is not representative. There is, however, a representative alternative — the International Monetary and Financial Committee (IMFC), a group of finance ministers and central bank governors that meets twice a year to advise the IMF.

While the IMFC could be shrunk (for example, if eurozone countries agree to a common seat), the real challenge is to make it a venue in which countries talk to one another rather than at one another. To meet this goal, some changes would be in order.

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