The G20 - the final score

G20headsofstate Yesterday afternoon we got the final communique.  Has The London Summit been a success?  Have British taxpayers got good value for the huge expense and aggravation associated with hosting and securing the G20?

The first thing to note is that this plan won't do much about the crisis currently affecting Britain and other countries.  There is nothing on restoring lending and the health of the financial system but a commitment to carry out existing efforts to clear out toxic debts in a more standardised fashion.  Even leaving aside Ricardian criticisms of the effectiveness of fiscal stimulus, there is no commitment to expanding existing stimulus and the leaders settle for congratulating themselves on what they have done already.

It is always nice to hear an affirmation of support for free trade from powerful people, and the G20 have pledged to "reject protectionism", but the rhetoric is less important than action.  Unfortunately, the Legatum Institute have documented how protectionism is advancing in many of the countries that supported the communique.

The most significant measures are on two fronts, increasing the funds available to the IMF and shifting it towards less conditional lending and pushing for standardised international regulations of financial markets.

The extra funding for the IMF is by far the largest financial measure that has been put in place, at around $1 trillion.  Unfortunately, the risk is that with conditionality weakened on some of the IMF loans that will mean ploughing money into unreformed regimes that just add IMF loans to big piles of debt.  The role of IMF conditions, and the credibility they give an inflation fighting government, in curbing inflation might also be undermined.




Beyond that, some of the new spending is financed by increasing global liquidity, by creating new Special Drawing Rights, which had been opposed as inflationary.  Concerns about inflation are being set to one side as the world is believed to be facing deflation.  That could be dangerous.  Deflation is being used to justify a range of new expansionary policies - interest rate cuts, quantitative easing and others - that governments can normally only make limited use of for fear of stoking inflation.  Those policies could easily go too far if governments forget how quickly inflation can return and it will be difficult to stop a serious surge in inflation once it gathers momentum.  The final effects of the new powers and funding given to the IMF may not be known for some time.

The key countries that this new IMF money is intended to help are those in Eastern Europe.  Their financial position is extremely precarious and Western European countries could be in trouble if things get worse, as the Telegraph reports:

"If mishandled by the world policy establishment, this debacle is big enough to shatter the fragile banking systems of Western Europe and set off round two of our financial Götterdämmerung.

Austria's finance minister Josef Pröll made frantic efforts last week to put together a €150bn rescue for the ex-Soviet bloc. Well he might. His banks have lent €230bn to the region, equal to 70pc of Austria's GDP."


Beyond the merits of this particular measure, what it tells us about European politics is significant.  This is a problem that the European Union was trying to organise a response to.  Instead, it appears that a response has been organised through the G20.  When the EU can't even attend to a problem like this within its own borders and instead a wider supranational summit is used, it is hard to see what the EU's much vaunted co-operation brings in return for its wasteful and undemocratic institutions.  China may have come out of this summit with its status enhanced, the EU's is further diminished.

This is the G20's pledge on regulation:

"We each agree to ensure our domestic regulatory systems are strong. But we also agree to establish the much greater consistency and systematic cooperation between countries, and the framework of internationally agreed high standards, that a global financial system requires."

What the summit hasn't done is seriously address how regulations might have contributed to the crisis and how that might be prevented from happening again. A range of regulations and policy choices from procylical capital adequacy rules to low interest rates drove the financial crisis, as we showed in a report (PDF) last year.  Those rules need to be reformed.

Instead, the communique focuses on establishing tighter and more standardised regulation.  That may be an exceptionally dangerous mistake.  Common capital adequacy rules encourage firms to hold the same assets, reducing diversification and making the financial system more vulnerable.  At the same time, common international rules mean that booms and busts in individual countries are more likely to occur at the same time, increasing the amplitude of global credit cycles - making the booms and busts stronger.  There is more detail on this in our report (PDF).

The idea that an international financial system needs international regulation can sound appealing.  However, it may be that such international regulations make the world a riskier place.  We may not know the final score following this summit for some years to come.  It is entirely possible that the seeds of the next financial crisis were sowed yesterday.  The potential unintended consequences of government policies need to be taken very seriously, particularly when policy is being written on such a grand scale.
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