Bridges Weekly Trade News Digest • Volume 14 • Number 24 • 30th June 2010

G-20 Compromise on Deficit Reduction, But Spectre of Mercantilism Looms

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Leaders from the world’s biggest economies agreed over the weekend to a timeline for reducing their budget deficits and debt levels, as well as to plans for new regulations aimed at enabling banks to withstand severe financial crises.

At a summit in Toronto, the Group of 20 leading industrialised and developing countries said that solidifying the still-fragile economic recovery required governments to strike an appropriate balance between fiscal stimulus and restoring health to battered public finances. Rebalancing global demand would go a long way to making growth more sustained, they stressed.

The leaders’ statement also contained the standard incantations against protectionism and about concluding the Doha Round that were present in declarations from their previous summits in Pittsburgh, London, and Washington. Notable by its absence was mention of any date for reaching an agreement in the struggling multilateral trade talks.

Fiscal consolidation: now or later?

For all the apparent concord, the Toronto meeting papered over gaps on some significant issues.

Foremost among these is a divide on whether the fragile global economy needs fiscal consolidation right now or whether this can wait until the economic recovery is firmer. The issue reflects differences of opinion that could have enormous ramifications for international trade relations.

Policymakers and analysts are divided on whether governments should continue to spend freely, at least in the short term, to make up for shortfalls in private demand, or whether spending must be ramped down and revenues increased – soon – to prevent more debt crises like the one in Greece.

Germany has led the latter camp, warning about the risk of inflation and the dangers of becoming “addicted to borrowing” as a means of stimulating demand.

Berlin argues that cutting government spending will actually spur investment by a private sector spooked by the prospect of higher interest rates. The United Kingdom’s new government has also backed the push for austerity sooner rather than later, as has Jean-Claude Trichet, president of the European Central Bank.

In contrast, the United States has warned that, if introduced too soon, spending cuts and tax increases could kill the economic recovery and job creation, damaging progress towards medium-term fiscal health.

“We must be flexible in adjusting the pace of consolidation and learn from the consequential mistakes of the past when stimulus was too quickly withdrawn and resulted in renewed economic hardships and recession,” President Barack Obama wrote to G-20 leaders ahead of the Toronto summit.

“I am concerned by weak private sector demand and continued heavy reliance on exports by some countries with already large external surpluses,” he added, in a phrase widely understood to be directed at Germany and China. Stressing that a durable recovery would rest on “our ability to achieve a pattern of global demand growth that avoids the imbalances of the past,” he urged surplus economies to take steps to boost domestic consumption.

Some of the rhetoric has overtaken reality. Germany’s generous social benefits acted as ‘automatic stabilisers’ that increased government spending as unemployment grew. Nevertheless, the policy differences are real, and the product of each country’s historical memory. Washington’s nightmare is the Great Depression; Germany’s, the hyperinflation of the interwar period.

In Toronto, the G-20 nodded to both sets of concerns. Developed country members of the G-20 agreed to halve deficits by 2013 and stabilise or reduce government debt-to-GDP ratios by 2016. But they also agreed that how governments pursue fiscal consolidation should depend on their national circumstances.

The compromise, proposed by the host, Canadian Prime Minister Stephen Harper, allowed both camps to claim victory. Germany could point to a focus on deficits and debt. Meanwhile, the timeline fit neatly with several countries’ existing goals for medium-term fiscal consolidation, including the US’s as outlined by Obama in his letter to the G-20.

The declaration outlined what different countries would have to do to create a more even basis for global economic growth. Industrialised countries with deficits would try to boost savings and enhance export competitiveness, without closing their own markets. Those with surpluses would try to boost domestic demand. Developing country surplus economies, such as China, promised to increase domestic consumption by increasing exchange rate flexibility and strengthening social safety nets to reduce precautionary savings.

Obama: Exporting to US not world’s path to prosperity

The fact that leaders could agree on a statement does not mean that they will carry out the policies necessary for reducing imbalances.

Simon Evenett, a professor of trade and economic development at the University of St. Gallen in Switzerland, noted that while the G-20 had made “the right observations” on how to rebalance the global economy, they made no plans for monitoring each others’ policies or exerting peer pressure. “It’s got to make you wonder how much agreement there really is,” he told Bridges.

Fears are growing that Germany will try to rely on the newly cheap euro to base growth on exports rather than domestic demand. This would do little to rectify the imbalances – surpluses in Germany and Asia, deficits in an increasingly indebted United States – that helped bring the global economy to grief two years ago.

Arvind Subramanian, an expert at the Peterson Institute for International Economics in Washington, said that China’s announcement of greater exchange rate flexibility (presumably leading to smaller surpluses) just before the Toronto summit signalled Beijing’s willingness to contribute to global rebalancing. “It is time to demand the same of Germany, which is the other large surplus country in the world economy,” he wrote in the Business Standard, an Indian newspaper, last week. While sympathetic to Germans’ “visceral need” to balance their books, he said the world would be better off if the G-20 could persuade Germany to shed what he called “its basic but neighbour-unfriendly instincts.”

Martin Wolf, the Financial Times’ widely respected economics commentator, has warned that Europe is blundering into a “beggar-my-neighbour” policy with respect to the US – a policy that would be exacerbated by premature fiscal retrenchment.

“A decision to turn the eurozone into a huge Germany would – and should – be seen as an act of mercantilist warfare upon the US,” Wolf recently wrote. “How long would the latter put up with the hypocrisy of surplus countries that blame borrowers for the deficits their own surpluses make inevitable? Not much longer, would be my guess.”

President Obama sounded a similar warning at a press conference following the G-20 summit. “After years of taking on too much debt, Americans cannot – and will not –borrow and buy the world’s way to lasting prosperity. No nation should assume its path to prosperity is simply paved with exports to the United States.” He pointed to China’s currency reforms as something that Washington would be watching closely, stressing that he expected the yuan to rise.

Governments pledge to refrain from protectionism

While system-wide mercantilist pressures may be growing, the G-20 pledged to avoid specific protectionist policies. “We renew for a further three years, until the end of 2013, our commitment to refrain from raising barriers or imposing new barriers to investment or trade in goods and services, imposing new export restrictions or implementing World Trade Organization (WTO)-inconsistent measures to stimulate exports, and commit to rectify such measures as they arise,” said the statement, echoing a pledge from last fall’s summit in Pittsburgh.

They also expressed support for bringing the Doha Round to “a balanced and ambitious conclusion as soon as possible,” although they dropped last year’s call to do so by the end of 2010. G-20 leaders are to “discuss the status of the negotiations and the way forward” at their next summit, scheduled for November in Seoul.

Professor Evenett, who also directs the Global Trade Alert, a service that provides real-time monitoring of protectionist policies along with their likely victims, said that the failure to mention a date for a Doha accord was “just an inevitable recognition of where things are at.”

“The question is where they pick [the round] up and under what circumstances,” he said, but “they can’t say when, and they won’t say how – this is what’s missing.”

Evenett also noted that the G-20’s request for several international organisations “to report on the benefits of trade liberalization for employment and growth” at the group’s next summit risked turning up some surprises. If studies link trade to jobless growth, with GDP increases but no employment creation, it could potentially strengthen the hands of protectionists, he suggested.

One of the G-20’s top priorities, financial sector reform, saw a separate compromise, which evolved in the weeks prior to the summit. European countries dropped a proposal for a global bank levy to build a contingency fund for future crises, in the face of opposition from governments such as India, China, and Canada, whose banking systems did not require bailouts in the past two years. G-20 leaders agreed to “aim” to implement, by the end of 2012, a to-be-developed set of capital requirements for banks. The looser deadline made more stringent requirements easier to swallow. Individual governments may still pursue national bank levies.

In addition, the leaders’ statement highlighted cooperation on several issues, such as funding increases for the multilateral development banks, giving developing countries greater voting shares at the World Bank and International Monetary Fund, and debt relief for earthquake-stricken Haiti. They also pledged to maintain efforts to increase trade-related development assistance.

Progress on phasing out fossil fuel subsidies has largely been abandoned to the initiative of individual governments. The Indian government did announce on the eve of the summit that it would end subsidies to gasoline and make small cuts to support for kerosene (used by many poor people for cooking and light), diesel, and natural gas.

The G-20 reiterated its commitment to the Millennium Development Goals, an agenda adopted by the United Nations that calls for halving extreme poverty by 2015, in addition to making progress on hunger, disease, education, and women’s equality.

But the World Bank warns that the economic crisis threatens to reverse progress towards these goals. In a report prepared for the G-20 summit, it estimated that this year, 64 million more people in developing countries would be living on less than $1.25 per day (and 76 million more on less than $2 per day) than there would have been in the absence of the crisis. Much of this increase is projected to persist through 2015, thanks in part to job losses.

Even though developing countries now contribute half of global growth, the report warned that increased borrowing by industrialised countries risked crowding out developing country borrowers.

The report stressed that investments in human capital and ‘soft infrastructure’, such as governance and regulation, would help developing countries boost growth. So too would a return to growth in the world as a whole, including Europe. “Without it, fiscal adjustments will be more painful and politics more unmanageable. What we are seeing is not just ‘financial crisis, part two’, it is ‘sustainable growth challenge, part one.’”

ICTSD reporting; “Germany Warns US Not to Become ‘Addicted to Borrowing’,” DER SPIEGEL INTERNATIONAL, 25 June 2010; “Why plans for early fiscal tightening carry global risks,” FINANCIAL TIMES, 15 June 2010; “New imbalances will threaten global recovery,” FINANCIAL TIMES, 10 June 2010; “Toronto summits: Leaders divided over tackling national deficits,” THE GUARDIAN, 25 June 2010; “Arvind Subramanian: The G20 and ‘Chermany’,” BUSINESS STANDARD, 23 June 2010; “India Cuts Subsidies for Fuels,” NEW YORK TIMES, 25 June 2010.