The mood is different this year. Not exactly whooping with joy, you understand, but finance ministers and central bank governors gathered in Istanbul this weekend exuded a sense of relief and quiet confidence.
Relief because activity has started to pick up after its precipitous fall around the turn of the year. Quiet confidence because there is a belief that lessons have been learned over the past 12 months.
When the IMF and the World Bank last met in Washington in October last year, the global financial system was on the brink of ruin. Bank after bank had run into trouble following the collapse of Lehman Brothers in mid-September. Iceland looked like it was about to go bust. In Britain, cash points would have stopped working had the government not come up with a rescue package that provided billions of pounds of fresh capital in return for part-nationalization.
Dominique Strauss-Kahn, the fund’s managing director, says countries were forced to collaborate by the scale of the crisis, and the sense of togetherness will not vanish now the outlook is better. The replacement of the G7 by the G20, it is hoped, will improve global governance and make it easier to tackle the imbalances that lay at the root of the problems.
There has, of course, been plenty of this sort of stuff before. Back in 2006, well before anyone had heard of sub-prime mortgages, the fund launched a program of multi-lateral surveillance designed to see whether the policies being pursued by the big players on the global stage were compatible with reducing global imbalances. They weren’t, but nothing happened.
The feeling in Istanbul was that it is different this time. Having stood on the edge of the abyss, individual countries are now prepared to look beyond their narrow self-interest to consider whether policies help or hinder the cause of global economic stability.
It would be wrong to think that nothing has changed. There is a recognition that the financial system was close to collapse 12 months ago and that collective action helped prevent a severe recession turning into something worse. The decision to make the G20 — where the bigger developing countries are represented — the body that counts for global economic policy is a good one. The G7 will stagger on as a more informal gathering of finance ministers for a quiet chat, but it has had its day.
There is a willingness to accept that regulation of the sector should be toughened up. Unless banks are forced to hold more capital, UK finance minister Alistair Darling said on Saturday, we will quickly be back in the mire. He’s right about that, and the G20 in Pittsburgh displayed a greater appetite for more intrusive supervision.
So, yes, the atmosphere is different. Things have changed. The problem is that they have not changed nearly enough.
Growth has nudged up, but as the IMF said last week it has so far relied almost exclusively on governments doing the spending on behalf of the private sector, and on an inevitable rise in inventories following savage de-stocking. That is no basis for strong, sustained growth and there are already some worrying signs — US unemployment, last week’s survey of manufacturing in the UK — suggesting that the recovery is running out of steam. With governments likely to come under pressure to tackle budget deficit from both the financial markets and their voters, there is a risk that economic policy will be tightened too soon. The risks to growth next year are to the downside.
What’s more, the scars from such a deep recession will take time to heal. Even on the most optimistic scenario, we are facing a jobless and joyless recovery lasting two or three years at the minimum. That particularly applies to Britain, where growth in the pre-crisis years was pumped up by bubbles in financial services and construction. The IMF says that the economy has suffered lasting damage from the downturn, with the trend rate of growth reduced at a time when the next government is going to cut public spending and raise taxes to reduce the budget deficit.
There is, of course, a chance that things will turn out better than the IMF expects. It may be that global growth will exceed the 3.1 percent penciled in for next year and that 2011 will be better still. But unless the fundamental problems are tackled, the respite is likely to be brief.
There were those in Istanbul this weekend who predicted it would take a decade for countries to get to grips with the global imbalances. That is a reasonable assumption given the wide gap between rhetoric and action, but it is far too long to wait. The Germans, for example, are resistant to calls that they should run a smaller trade surplus by boosting domestic demand. China has used a cheap currency to build up manufacturing and so hasten the movement of the rural poor into the cities. It is in no hurry to revalue the yuan significantly. The reluctance by countries running trade surpluses to change their behavior reflects a design flaw in the post-war international system identified by economist John Maynard Keynes: the onus falls on deficit countries to deflate rather than on surplus countries to reflate. Unless this is remedied, global rebalancing will be an uphill struggle.
Meanwhile, the financial sector has regrouped and is lobbying hard against “excessive” levels of regulation. Joseph Ackermann, the chief executive of Deutsche Bank, said over the weekend that if banks were forced to hold too much capital it would impair lending and damage the economy.
In reality, what the financial sector calls excessive is what was once normal and prudent. Counter-cyclical capital requirements limiting the ability of banks to lend during booms and encouraging them to keep credit flowing during busts are vital for economic stability.
It is interesting, though, how the financial sector has managed to conflate its own interests with those of the wider economy. Any attempt at reform is met with the argument that the financial sector is an important part of the economy creating lots of jobs. And that is supposed to be that.
A different take comes from a new study (an alternative report on banking reform; www.cresc.ac.uk) by the Centre for Research of Socio-Cultural Change at Manchester University. It makes a series of points: There has been institutional capture of both main political parties by the City; this coalition thwarts reform by exaggerating the social value of finance while downplaying the cost of taxpayer bail outs; much of what the financial sector does is “banking for itself” and the pre-2007 era saw the creation of the wrong sort of debt, which encouraged speculation but not the development of productive resources.
What is needed, the study concludes, is a smaller financial sector better focused on the real future needs of the economy, such as investment in low-carbon technologies and better pensions for an aging population.
Don’t hold your breath. The power of the financial lobby remains immense, despite its role in pushing the global economy to within a whisker of a mark 2 Great Depression. Failure to tackle the imbalances and to reform finance would increase the chances of another crisis. But it may take that for politicians to turn words into action.
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