The world’s rapidly changing geopolitical, economic and social landscape demands that this year’s G20 Summit be different from previous years.

The last 12 months have witnessed the Japanese triple disaster, the Middle Eastern and North African ‘Arab Spring’, nuclear-powered North Korea’s leadership succession to a 27-year-old, Western condemnation of the Iranian nuclear power program, and the shift of US military strategy to the Asia Pacific. Popular movements saw national leaders from Europe (including Italy, Greece, Portugal, Ireland and Spain) to the Middle East and North Africa (Libya, Tunisia and Egypt) toppled from power. Tensions rose between old-power G7 nations and rising-power BRICS countries over currency and trade, the South China Sea, bans on Iranian oil, and most recently, the Syrian regime. Many countries resorted to rising protectionism through tit-for-tat strategies, while the WTO Doha Round has remained stalled. Competition in the food and energy sectors has become increasingly intense. And the US presidential election and the leadership change in China later this year could further add to global uncertainty. All this while prolonged economic turbulence emanating from the euro zone threatens to devastate global economic growth.

With so little space to move and so little time to spare, what can this year’s G20 do differently?

Broadly speaking, the agenda must be continuous, implementable and focused if it is to deliver concrete outcomes. Previous commitments by G20 leaders, while promoting win–win strategies for the international community, have lacked focus and practical implementation plans.

With so much global social unrest and economic turmoil threatening political and social stability, social safety net programs should be prioritised. In particular, the Social Protection Floor, endorsed by G20 leaders last year, must be made central to the coming G20 Summit. The plan must act to attenuate the adverse impacts of the global recession and to maintain social cohesion. Meanwhile, the Multi-Year Action Plan on Development (2010) and recommendations from the G20 Employment Task Force must also be consistently enforced.

Judging by the Finance Ministers’ and Central Bank Governors’ Deputies Meeting in January, there are four key issues that may help shape the G20 Summit’s agenda: IMF quota and voting reforms, financial-sector reforms, commodity and derivatives markets, and disaster-recovery management.

First, the IMF quota and voting reforms will see emerging-market and under-represented countries receive higher shares. With the emerging countries’ share of the global economy rising, IMF quota and voting changes will better represent the new global economic landscape. The IMF’s plan to expand its war chest and increase its firepower is an opportunity for emerging markets to play a contributive role in this new landscape.

Second, although emerging countries have ostensibly committed to financial regulatory reform, including Basel III, scepticism continues to exist. But it is essential that the G20’s developing-economy members overcome this to adopt a strong position on financial regulatory reform, moving beyond the excuse that such measures are for more-developed economies only. There are clearly flaws in the current financial system, and developing economies should not be passive, but active, reformers.

Ways to better connect financial and real sectors must also be discussed. If left unaddressed, such a disconnect may increase scepticism over market capitalism, globalisation, financial greed and inequality — which could ultimately trigger more social unrest.

Third, the co-chairing of a commodity- and derivatives-market working group by Indonesia and the UK is a positive step. Indonesia is an emerging economy with an under-developed derivatives market and volatile commodity prices, partly due to derivatives trading on commodities. By pushing for regulated commodity and derivatives markets, Indonesia would be a counterbalance to the UK. This is the sort of ‘balancing’ agenda needed at the G20 level — one that strikes a compromise between developed and developing economies.

Fourth, disaster-recovery management will benefit many G20 members, including Japan, Indonesia, Australia and the US — all located in disaster-prone areas. Here there is room for alignment with regional initiatives. APEC, which includes nine G20 members, has initiated the APEC High-Level Policy Dialogue on Disaster Resiliency (2011) and the APEC Trade Recovery Programme. The East Asia Summit, encompassing seven G20 members, has also initiated the Practical Approach to Enhance Regional Cooperation on Disaster Rapid Response (2011). This includes efforts to improve efficiency for visa applications, customs, quarantine issues and bureaucratic impediments to disaster-relief efforts, including NGO assistance. The G20 may also contribute to the financial aspects of disaster-recovery management.

With only seven months of preparation time since meeting in Cannes, the G20 Summit in June must ensure the continuity of its agenda, but also recognise the current economic recession. Social protection plans to prevent more political and social instability, and genuine progress toward financial regulatory reform are priorities that should be addressed at the coming summit. Meanwhile, emerging countries should become more active, rather than passive, reformers.

Maria Monica Wihardja is a researcher at the Centre for Strategic and International Studies, Jakarta, and a lecturer at the Department of Economics, University of Indonesia. She is currently on leave to work as a consultant at Bank Indonesia.

1. Will Asia step up to the global challenges of 2012?
2. 2011 East Asia Summit: New members, challenges and opportunities
3. Kim Jong-un’s regime: facing up to domestic challenges, China and the US

As developed countries struggle to recover after the global recession and try to confront the looming sovereign debt crisis in Europe, big emerging markets are now driving global growth.

Given the slow down in developed countries, emerging economies are trying to boost domestic demand to sustain growth — and this is particularly the case in China. But in recent months these developing economies have started to feel the pressure from the slowdown in the West, leading the G20 to put global growth high on its agenda.

Emerging economies have managed to keep up their growth rates and exports, and have thus experienced a trade surplus, while developed countries are facing huge trade deficits and have come to favour protectionism. The importance of recovering growth and jobs in the US, for example, and efforts to sustain export-led growth in China are now creating trade and currency friction between these two countries. For several decades there has also been a consistent increase in the trade deficit between the two — in favour of China — and this imbalance reached over US$200 billion per annum in 2010. The US kept quiet over this for a long time, as the trade deficit helped contain inflation due to cheap imports from China, and the unemployment level was still manageable. But as soon as the US realised this trade friction with China was affecting employment and there was no level playing field for its domestic industries, the Americans resorted to protectionism.

A major allegation against China is that its exchange rate is fixed and is not allowed to appreciate — all in the name of stability. As a result, China’s currency is undervalued, making its exports particularly competitive in the international market. The US has adopted several measures to counter the growth of Chinese exports and boost its own domestic economy. First, it has upped the number of anti-dumping cases against China. And second, the US government passed legislation to punish Chinese exports, as it believes that China is heavily subsidising its export items to the US. There have also been instances of tariff hikes on several import items from China.

The currency friction between China and other developed and developing economies is a matter of concern for the G20. China and the US are not only the world’s biggest economies, but they are highly dependent on each other for their growth — and of course the rest of the world also depends on them. China has nearly US$1.5 trillion worth of dollar-denominated assets, and it will be problematic for the US if China stops buying US government bonds. The US is equally dependent on China for its exports of primary commodities such as meat and fruit, and many US companies are based in China in the hope that domestic demand will rise and they will make profits. But Chinese domestic demand is still largely suppressed, meaning the US is not able to obtain sufficient market access. Meanwhile, China depends largely on the US market to sell its labour-intensive manufactured items. Nearly five per cent of China’s GDP comes from exports to the US. So, the trade friction continues.

The world’s two largest economies must work together toward solving this trade friction and to help avoid a currency war. China must allow its currency to be market determined, while the US must do away with its harsh protectionist measures.

India is an active member of the G20 and works alongside China and other developing countries on major international issues, including the restructuring of global financial architecture, and achieving progress on climate change and the Millennium Development Goals. India is aware the trade and currency friction between the US and China will not only hurt the G20’s agenda and the world economy, but will also affect its own future growth prospects. The US and China are India’s major trading partners, and any slowdown in these two countries would affect India as well. So Delhi has been opposing any protectionist measures adopted by developed countries, and pushing for market reforms by phasing out wasteful and distorting subsidies in countries like China.

India also understands the impact of China’s undervalued currency on its exports and expects China to understand the fair principles of trade. India believes there are bigger and more pressing problems that need the attention of the G20. Its member countries need to focus on solving the European debt crisis, help countries resolve trade and currency friction and give fresh impetus to the Doha Round. Against this backdrop, India needs to play a proactive role in the G20 to make it an effective body for dealing with these issues.

Dr Geethanjali Nataraj is a Fellow at the National Council of Applied Economic Research, India.

1. India losing ground to China on trade with Bangladesh
2. The India-China Strategic Economic Dialogue
3. India, China and Asian economic integration

The World Bank recently published a valuable research paper (World Bank Policy Research Working Paper 5940 by Justin Yifu Lin and Doerte Doemeland) which presents the evidence needed to justify a globally coordinated initiative in carefully selected infrastructure investment.

A G20 initiative in 2012 could make this happen. G20 leaders have the opportunity to launch a concerted effort to remove the policy and market failures causing serious infrastructure bottlenecks to growth, especially in developing economies. The prospect of a new sustainable source of effective demand could counter the current drift toward a ‘lost decade’ — an extended period of high unemployment, high risks and low returns on investment leading to continued weak growth,high unemployment and debt.

There is no prospect of repeating the coordinated 2009 Keynesian stimulus of increased government spending. Some countries have run out of fiscal space, while others have opted for needless short-term austerity. Consequently, the World Bank paper advocates a new form of fiscal stimulus that is not simply a boost to public consumption, but an investment in future productivity.This form of stimulus would catalyse parallel private investment and serve as a globally coordinated investment initiative, rather than an attempt to stimulate individual economies.

Such a global Keynesian initiative would remove constraints to growth in developing economies, and create new demand in developed economies suffering from high unemployment and excess capacity. Investment in infrastructure can thus generate a virtuous cycle of higher demand, productivity and growth that isconsistent with long-term deleveraging.

The proposal, based on extensive research, argues for the need to find a way out of the current situation, when monetary stimulus is proving inadequate, and when structural adjustment can only be expected to gain traction when demand is revived. Governments need to support demand and employment without adding further to debt levels in the medium run. Providing capital for potentially self-financing infrastructure investment to remove logistic and other constraints to growth would be the best way of doing this.

The report also cites evidence that such a stimulus does not risk crowding out private spending, but can be expected to contribute significantly to employment and growth. The authors demonstrate the potential for profitable infrastructure investment in all economies, while noting that the highest needs and potential returns are in developing economies.

By learning from experience, including the disappointing experience of Japan in the 1990s, it is possible to select the right kind of investment in infrastructure. The paper draws attention to initiatives that support good project selection and design, such as the Infrastructure Action Plan — drawn up in 2011 as part of the G20’s contribution to the development of low-income countries — and the Infrastructure Finance Center of Excellence, which aims at leveraging Singapore’s expertise in urban development and financing.

The G20’s ongoing effort to improve infrastructure in low-income economies should be extended to all economies. Recent estimates of annual requirements for investment and available financing for infrastructure identify a financing gap in the range of US$400 billion to US$650 billion per year. Narrowing this gap would have a significant global macroeconomic effect. The paper discusses numerous options for mobilising additional finance, ranging from domestic revenue raising to local and international bond issuance, and public-private partnerships. These are just some of the ways to steer more of the available global savings toward productivity-boosting infrastructure.

The potential contribution of infrastructure investment to promoting global economic recovery has been discussed for a while. And at a time of deficient global demand, the huge savings of emerging economies — most of which are generated in Asia — are intermediated chiefly in the financial markets of New York and London. Rather than financing productive infrastructure, much of the world’s savings are financing the deficits of already heavily indebted developed economies. The time has come to deal with this massive global financial market failure. Asian members of the G20 have put the infrastructure opportunity on the G20’s growth agenda. This well-researched World Bank paper should ensure it rises to the top of that agenda.

It will take time and creative thinking to meet the financing needs for infrastructure.  A High-Level Panel on Infrastructure appointed by G20 leaders delivered a useful report at the 2011 Cannes Summit. That report contains recommendations for improving the institutional and enabling environment for investment in infrastructure, and ideas for financing infrastructure projects with significant but delayed returns to investors and how to manage project risks.  But the Panel focused only on much-needed infrastructure in the world’s most difficult investment environments, especially sub-Saharan Africa.

The issues of institutional capacity, innovative financing and risk management need attention everywhere and need to be addressed if investment in infrastructure is to provide a globally significant boost to effective demand.  G20 leaders should now challenge their officials, financial-sector managers, and international financial institutions to find ways to intermediate savings to finance more investment in infrastructure.  These ideas can be directed to financing both public and private investment in commercially-viable investment in infrastructure wherever it is needed.  A high-level conference of the world’s leading experts on these issues, which might be organised by the World Bank could be a useful first step in that direction.

Dr Andrew Elek is Research Associate at the Crawford School of Economics and Government, Australian National University. He was the inaugural Chair of APEC Senior Officials in 1989.

1. How can Asia help fix the global economy?
2. Global imbalances and the paradox of thrift
3. APEC’s new ‘financial inclusion’ initiative

The Indian government presented its National Manufacturing Policy (NMP) to the nation in early November.

Presumably, the announcement was timed to demonstrate that reform is alive and kicking before parliament reconvenes later this month. With the final text now available on the Department of Industrial Policy and Promotion website, it is possible to take a considered view of the policy’s goals, the means proposed to achieve them and the probability of success. It is also possible to speculate on the unintended consequences and possible collateral damage.

The preface of the NMP refers to ‘concern about the stagnant and low share of the manufacturing sector in India’s GDP’ as providing prima facie justification for policy intervention. In the body of the policy, this goal is further justified by reference to the superior manufacturing performance of other Asian countries, and by the employment challenges that India faces. This is a rather dubious basis for intervention.

On this rationale, the quantitative target is to raise the share of manufacturing value-added in GDP from the current 16 per cent to 25 per cent by 2022, implying that manufacturing needs to grow appreciably faster than overall GDP over the next decade. This will become progressively harder as the share of manufacturing rises in overall GDP. Given the shares of agriculture, services and industry (of which manufacturing is the dominant part) must add up to 100 per cent, it is also not clear from the policy which of the other two sectors is expected to give way within an aggregate growth target of nine per cent. This information will only become available when India’s 12th Five-Year Plan is finalised early next year; presumably, much of the ‘space’ will be ceded by agriculture.

The main positive instrument proposed to achieve this growth acceleration is the creation of national investment and manufacturing zones (NIMZs), to be developed as integrated industrial townships. The policy envisages that ‘the NIMZs would be large areas of developed land, with the requisite ecosystem for promoting world-class manufacturing activity’. In contrast to existing special economic zones, with their focus on exports, such NIMZs are envisaged as industrial townships of a minimum size of 5000 hectares.

Each NIMZ will be managed by a special purpose vehicle (SPV), which will exercise the powers conferred by the policy. The policy specifies that the SPV’s CEO must be a senior central or state government official. So, in principle, these townships are to become publicly run corporations for the benefit of the private sector, free from the political and governance failures that plague India’s existing urban local bodies. The aim is to permit both clustering and concentration of infrastructure. In many ways, this is a return to the past, except these townships are designed to facilitate manufacturing by a cluster of smaller units, rather than being dominated by a single large employer.

Is this a solution in search of a problem? Apart from India’s still stunningly low per capita income compared to all other G20 members, it seems there is no tight linkage between levels of income and a ‘natural’ share of manufacturing when G20 countries are compared. It is true that India’s Asian peers — Indonesia, China and South Korea — have a much higher share of manufacturing than India, but there is little reason to think they represent a ‘norm’ to which India should aspire.

Two conclusions follow. First, there is no analytical reason to conclude that India’s ‘low and stagnant’ share of manufacturing reflects major distortions in its economy. Second, if it is to privilege manufacturing through special, potentially costly, measures, such actions need to be justified for reasons other than merely to raise its share. By the same token, a blanket commitment to raise the share of manufacturing at any cost risks leading India into the same blind alley of interventionist industrial policy from which it so painfully exited.

These concerns emerge from several of the policy’s provisions that are not necessarily linked with the NIMZs. Particularly disturbing is the looseness of the formulation on trade and investment policy and government procurement, and the stress on specific industry verticals. By way of example, paragraph 1.22 contains the extraordinary statement on regional trade agreements that ‘it will be ensured that such agreements will not have a detrimental effect on domestic manufacturing in India’. What on earth is the point of such agreements if not to put competitive pressure on India’s domestic producers?

The policy’s authors will undoubtedly cite the new wave of academic thinking associated with Hausmann, Rodrik, Stiglitz, Ann Harrison and the like to justify a return to activist industrial policy. I would remind them that this literature finds very little reason to favour manufacturing as such, but strongly supports the long-term productivity benefits of outward exposure.

Suman Bery is Country Director, India Central, International Growth Centre. This article first appeared here in the Business Standard.

1. Can India match East Asia as a manufacturing powerhouse?
2. Is India in need of a new investment policy?
3. Reviving India’s manufacturing industry

The G20 Summit in Cannes probably made its most important contribution to global financial stability and economic growth before it even commenced.

The summit, held 3–4 November, became a deadline for European leaders to deal decisively with the economic and financial crises in the euro zone.

Europe is experiencing at least four deep, structural, overlapping and mutually reinforcing crises: a crisis of institutional design; a fiscal crisis; a crisis of competitiveness and a banking crisis. None of the four crises can be solved in isolation, and there does not currently seem to be any single comprehensive solution that will end the crisis promptly.

At the Cannes summit, euro zone leaders agreed on a new set of measures to try and tackle these problems. Though inadequate in scope to bring the crisis to an end and calm financial-market volatility, these measures will help prevent further economic deterioration in Europe. Consequently, the risk of catastrophic spillovers from Europe to the rest of the G20 was reduced.

Ahead of the G20 Summit, euro zone leaders agreed on three principal strategies to contain the crisis: reduction of Greece’s debt; a bank recapitalisation target and new options to leverage the European Financial Stability Facility (EFSF).

First, the planned debt reduction takes the form of a voluntary bond swap with private holders of Greek government debt, resulting in a 50 per cent reduction in the nominal value of their debt. While urgently needed, this will not independently restore Greek fiscal solvency, and additional financial support for the country will be needed. As future support will undoubtedly involve the IMF, G20 members will also have the opportunity to discuss potential approaches to restoring Greece’s fiscal solvency. This voluntary debt swap is unlikely to trigger sovereign default swaps, and it removes a potential short-term source of dislocation in the financial markets. But the lack of payout after a 50 per cent reduction in debt may ultimately lead to the demise of sovereign credit default swaps — at least for industrialised nations — which may lead to increased financial-market volatility.

Second, euro zone leaders agreed to raise capital requirements in banks to 9 per cent Tier 1 equity, and adjust for the effects of market prices of sovereign debt. Although superficially helpful, the imposition of a capital ratio target runs the risk that banks will shrink their lending to businesses (due to denominator effects), rather than raising new capital. Regulators must be vigilant to avoid aggravating a building credit crunch.

Third, two options were agreed on to boost the financial firepower of the EFSF. Both are almost certain to fail. Option one, providing credit enhancement to new state-issued debt, is meaningless; the significant overlap between the insurer and the insured in the euro zone means any stability the measure achieves will be minimal. Option two foresees attracting investments from private and public financial institutions and investors. But few, if any, such investors exist — and possess the willingness and ability to make a material difference for European financial stability.

Fortunately, this does not matter, as both options are a smokescreen to provide cover for the European Central Bank (ECB) to remain directly involved in stabilisation measures. This is critical, as ultimately it is only the ECB, as a central bank with the ability to create new money, that commands the financial resources to stabilise Europe. By creating a distraction in the form of a ‘leveraged EFSF’, the ECB can continue intervening directly in the European debt markets to avoid a catastrophic rise of Italian and Spanish interest. Ironically, by supporting this ruse, G20 leaders will reduce the need to offer money themselves by helping the ECB keep the spread between, on the one hand, Italian and Spanish interest rates, and on the other hand German interest rates.

Usually, international gatherings like the G20 Summit in London in April 2009 deal with large crises by restoring confidence through the credible commitment of large sums of government money. Europe cannot do this. As was evident ahead of Cannes, Europe and the ECB rely on the economic pressure exerted by financial markets to push reform-reluctant leaders into ‘doing the right thing’.

Indeed, were the ECB to publicly declare its intention to act as a ‘lender of last resort’ for Europe, or the G20 to cobble together €2 trillion for the EFSF, the financial market pressure on such leaders to implement reforms would abate. Paradoxically, with Europe’s fundamental economic problems requiring years of tough reforms, Europe can only ultimately solve its economic crisis by prolonging it.

This logic will easily trump anything in the G20 Communiqué calling for enhanced global financial stability and strong balanced global growth. Instead, we can expect high levels of uncertainty and volatility.

Jacob Kirkegaard is a Research Fellow at the Peterson Institute for International Economics, and a Senior Associate at the Rhodium Group.

1. European debt crisis: European fragmentation?
2. China into the European breach, but not just yet
3. The Greek tragedy: Global debt crisis and balance sheets

The 2008 global financial crisis catalysed a long-overdue transformation in the oversight of global affairs, bringing large emerging Asian economies to the G20 table.

A transition in the role of Asian countries at the G20 — from cautious and sometimes defensive to visionary and exemplary — was expected to unfold slowly, possibly taking a decade or more. Yet the renewed threat to recovery arising from the self-created problems of the US and EU has created an urgent demand for Asian leadership in 2011.

As in 2008, the world is looking to the G20 to deal with the renewed threat of recession.

The US and EU are certainly not going to boost global demand. Asian and other emerging economies have some scope to stimulate domestic demand, but not nearly as much as in 2008. By the time G20 leaders met in France in November 2011, the short-term prospect was, at best, to avoid recession in the US and EU.

Such an outcome may be adequate for one year but risks the future of the G20. Continued stagnation of mature economies will accelerate the ongoing shift of economic power and influence towards emerging economies. Economies with growing shares of wealth and dynamism will be blamed for not doing more. But aggressive attempts to attribute blame to dynamic economies, China in particular, just makes it politically harder for these economies to implement reforms.

To avoid falling into a swamp of unproductive recrimination, the G20 needs to find a strategy to stimulate effective demand which all its members can support.

At a time of deficient global demand, substantial savings generated by emerging economies are locked up in excessive foreign exchange reserves alongside vast potential for investment in economic infrastructure. Much of the vast unmet demand for infrastructure is in the emerging economies of Asia, which are also the source of much of these savings.

Asian governments have recognised the costs and risks of continuing to accumulate reserves. Those risks include significant capital losses, ongoing blame for inadequate global growth, and the costs of prolonged weak global demand on their own economies.

Now is a good time to address a global financial market failure in order to reduce these growing risks. Bringing forward some badly needed investments in infrastructure could be a decisive circuit-breaker to spark sustained global recovery.

Asian governments can put the challenge of fixing the current massive market failure squarely on the G20 agenda. A concerted effort by all members of the G20 to gradually make better use of Asia’s huge accumulated savings will allow them to work constructively to solve a shared policy problem, rather than blaming each other for there being too little growth and too many exports.

Channelling more of Asia’s savings into productive investment in infrastructure will not happen quickly or easily. G20 leaders can challenge their officials, financial-sector managers, and international financial institutions to use their expertise to find creative ways to intermediate savings to finance more investment in infrastructure.

The Asian Development Bank (ADB) and other multilateral development banks can step up their roles. They can be sound borrowers of Asian savings; they can invest them in productive projects, including projects to improve connectivity among economies. Commercial banks can also do more in credit-worthy emerging economies.

There will be some risks. One or two governments may act irresponsibly and make a mess of some investments. But, with care, most investments in infrastructure will prove to be viable. There is a lot of international experience on designing public-private partnerships and shaping policies to set prices and contain project risks within acceptable limits. And the risk of some projects being less successful than expected is far less than the risks of prolonged recession.

An effort to create more effective demand for investment will need to be accompanied by ongoing efforts to cope with long-term problems of debt in mature economies and structural adjustment in emerging economies. These complementary efforts can restore confidence in the world economy.

In the meantime, G20 leaders might delay thinking about other significant global problems. Unfortunately, the window of opportunity to avoid disastrous climate change is closing fast, and the future of an open non-discriminatory WTO-based regime for international commerce is being undermined by misplaced faith in preferential trade deals.

It will take a long time to find consensus on how to contain, let alone resolve, such problems. In a voluntary process of cooperation like the G20, there will be no big breakthroughs in any one year. It will not be possible to deal with these big problems in sequence. A more prudent option is to start a discussion of these issues in a patient, non-confrontational manner.

Right now, the US and EU are both caught in a vicious circle of acrimony and repeated attempts to defer hard decisions. They cannot be expected to lead the consensus-building needed to deal more adequately with global warming or rescue the WTO. Nor can Asian governments rely on them to deal wisely with global issues, respecting differences and searching for consensus rather than confrontation.

At a time of weak global governance the challenge of leadership is being thrust on Asia sooner than it had hoped.

The agenda of Asian institutions for regional cooperation can move beyond preoccupation with local issues and trade negotiations to an outward-looking effort to address important matters which require global solutions. Forums like ASEAN+3 and the East Asia Summit can be used to consult on how Asia can use the G20 opportunity — an opportunity which may not be repeated — to defend, then reform, the international economic order in ways needed to complete their emergence from poverty.

Andrew Elek is a Research Associate at the Crawford School of Economics and Government, the Australian National University. 

This article was first published in the most recent edition of the East Asia Forum Quarterly, ‘Asia’s global impact’.

1. How can Asia help fix the global economy?
2. Asian leadership and the global economic crisis
3. Asia’s challenge: to rebuild the global economic order in a generation

Last week the world was reassured by the thought that Europe had done a deal which avoided default by Greece, the threat to its southern members and to the euro zone itself.

All that unravelled as Greek Prime Minister George Papandreou surprised European leaders and world markets with his referendum plan — just as the G20 meeting got under way in Cannes. It’s been a scary few days in world politics and for the world economy. ‘We are looking straight into the face of a great depression’, declared Simon Johnson, former chief economist of the IMF, or at least a ‘financial storm’, according to British Prime Minister David Cameron.

Spinning out of control from the crisis in Greece, the politics of the fraught and the exhausted had taken over and it was time for calm, hard heads to explain where the euro stopped. If the rescue package were rejected, Greece would be out of the Union and there would be no funding, German Chancellor Angela Merkel and French President Nicolas Sarkozy made clear. That was the first step in stopping the rout. Europe’s recovery strategy was back on the table. While Europe still has a long way to go — and it will take at least three to five years to get there — the beginnings of a way forward have been put in place at Cannes.

Europe, as the White House doesn’t tire of saying, has to sort out its own problems. And the heart of the problem is European, not global. Specifically, the euro zone needs to address the underlying structure of its fiscal system. Europe needs a proper fiscal union, and the ability of member governments to issue new debt must be severely curtailed.

But Europe’s (even Greece’s) problems are now everyone’s problems. How else would it be politically tenable to expect that Chinese peasants should contribute to propping up European welfare systems and indulgent lifestyles? Responding to Europe’s problems was core business at Cannes. Important initiatives included the proposal to boost IMF resources for dealing with bailouts, of which Australian Prime Minister Julia Gillard was a, properly, active proponent, despite American reluctance. They also included proposals to bolster the European Financial Stability Facility (EFSF), the mechanism for bankrolling European bad debt and an Australian plan to go forward around the Doha logjam on WTO reform.

On the EFSF, European expectations of China’s stepping into the breach were high. Yet, the People’s Bank of China international department chief, Zhang Tao, made it clear in the lead up to the summit that China has ‘confidence’ in the European market, and it was not about to provide a blank cheque to the EFSF. Foreign exchange management in China is based on ‘the principle of safety, liquidity and adding value’, Zhang said. Vice Finance Minister Zhu Guangyao, said, at the same time, it was ‘too soon’ for China to discuss further bond purchases from Europe’s revamped rescue fund.

This week’s lead essay, from Sourabh Gupta, provides a cool-headed appraisal of how, for China, ‘with the euro zone in deep distress, and with the euro along with the dollar comprising 90 per cent of globally allocated foreign exchange reserves, there is only so much safety to be had’. Extricating itself from this reserve management predicament is driving China’s currency internationalisation strategy, as Gupta argues.

Going forward, an international monetary system that is characterised by a paucity of global reserve assets and is overly dependent on an insufficiently credible dollar as its sole monetary anchor will stand little chance of surviving in a world of free capital flows, Gupta explains. ‘Equally, a future global multicurrency order characterised by hybrid exchange rate regimes and free capital mobility, yet backed by only a weak and fragmented governance structure, will repeatedly be trumped by narrow and domestically generated protectionist compulsions. Hence building flexibility and capacity within the international monetary system’s regulatory mechanism to accommodate — and accelerate — the financial liberalisation trajectories of its rising stakeholders, most notably China, is the foremost medium-term priority of the day. This is the context in which novel ideas that advocate acceptance and use of emerging market currency-denominated instruments as reserve assets, such as the issuance of emerging market GDP-linked bonds, and other forms of pooling and securitisation of emerging market debt into composite assets, as well as a significant expansion in size and share of large, dynamic emerging market currencies within the SDR’s (IMF Special Drawing Rights) basket composition, each bears considering’.

Indeed, the G20 pressed ahead at Cannes with its review of the international monetary system through the IMF, the international banks and other financial agencies, noting specifically that the SDR basket composition should reflect the role of currencies in the global trading and financial system and be adjusted over time to reflect their changing role and characteristics. ‘As China graduates from net consumer to net issuer of such … assets, commensurate with its heft in the global economic, trading and financial system, its ability to fill the breach in supply of such assets will lend stability to the international monetary order’, Gupta observes.

The value and performance of the G20 has entrenched it as the world’s premier body for global economic governance. Its incorporation of the key emerging economies, as demonstrated again through Cannes, is a huge strength. Europe in fact cannot handle its problems alone. Interestingly, the assessment of a G20 Research Group at the University of Toronto’s Munk School of Global Affairs of G20 member country performance against commitments (on exchange rates, trade, financial reform and the like) between the Seoul Summit and Cannes scores them highly, except for Argentina which came in with a grade under 50 per cent. Inexplicably, the EU was ranked above all its individual members. Australia was top of the class with over 90 per cent. South Korea and Russia (like Australia, not former G7 members) were also in the top 10 and, although emerging economies (and the United States) were in the bottom half, the modal score was high. The G20 is gradually earning its stripes.

Weaknesses in the process, by its nature, there are bound to be; but the G20 continues to confound the naysayers with the value it has added to global cooperation through the crisis and it no doubt can continue to add through the long haul of recovery and return to global growth.

Peter Drysdale is the editor of the East Asia Forum.

1. European debt crisis: European fragmentation?
2. The European crisis and the G20 Summit
3. China and European unity

On 2 November, on the sidelines of the G20 leaders meeting in Cannes, Zhang Tao, director general of the international department of the People’s Bank of China (PBoC), averred that China’s foreign exchange management strategy was based on ‘the principle of safety, liquidity and adding value’.

Given the US$271 billion in reserve losses presumed to have accrued during the 2003-2010 period as a result of the US dollar’s depreciation, this notion of ‘safety’ appears to be a rather elastic one. With the euro zone in deep distress, and with the euro along with the dollar comprising 90 per cent of globally allocated foreign exchange reserves, clearly there is only so much safety to be had. With the recent recourse to unconventional monetary policies in key developed country markets heaping an added dimension of complex cross-border spillover effects, PBoC’s reserve managers appear to be trapped between a rock and a hard place.

Extricating themselves from this reserve management predicament has been the driver of China’s currency internationalisation strategy. In time, as graduated steps towards internationalisation serve as veritable stepping stones to cross the perilous river of global financial integration, a fully convertible yuan, it is hoped, will assume its appointed role as one of the select few reserve currencies within the international monetary system. More long march than the quick sprint that some observers have recently posited, notably Arvind Subramanian and, more cautiously, Barry Eichengreen, the endgame is neither destined nor assured; it is a journey begun. For reasons that impinge reciprocally on the interests of Beijing and the larger international monetary system, its swift success though is deeply desirable.

At the heart of the recent dislocation in the chain of global financial intermediation is the paucity of safe, short-term and liquid instruments — be it government guaranteed or privately guaranteed — that can serve as attractive reserve assets globally. Driven by frantic considerations of safety, the secular rise of vast and footloose institutional cash pools (that is, centrally managed, short term cash balances of institutional investors and global non-financial companies) that reside outside the government-insured banking system, has made the global financial system increasingly run-prone. In time, as China graduates from net consumer to net issuer of such risk-free assets, commensurate with its heft in the global economic, trading and financial system, its ability to fill the breach in supply of such assets will lend stability to the international monetary order. Full convertibility, such that PBoC can — in the extreme — serve as a ‘market maker of last resort’ for such instruments, is a prerequisite. Along the path to convertibility, as PBoC allows its external surpluses to gradually feed into the domestic price level, a more consumption-driven domestic economy as well as a more internationally balanced monetary system is expected to emerge. Reserve management anxieties too will be consigned to the past.

At the time of the demise of the Bretton Woods gold-dollar standard, it was imagined a world of floating yet managed exchange rates operating alongside a world of convertible yet malleable capital flows would establish a ‘golden mean’, dynamically eradicating the balance of payment deficits that the United States had perforce needed to run to furnish liquidity to the global economy. The reality has proven otherwise. Capital flows have been anything but pliable, their tsunami-like effect exacting terrible punishment on exposed banking, capital and other asset markets in developing and developed countries alike over the past three decades. Terrified, meanwhile, of ceding exchange rate stability or domestic monetary policy independence, PBoC and its BRICS compatriots have largely opted to impose varyingly stringent capital control restrictions — even as they have collectively accumulated trade surpluses and/or a war-chest worth of reserve holdings. Correspondingly — and an irony that the original critic of the Bretton Woods system, Robert Triffin, would have instantly recognised — the primary issuer of the benchmark risk-free asset (the US) continues to run a persistent balance of payments deficit to furnish liquidity to the system, yet at the same time strives to preserve confidence in its currency as a store of value … a confidence eroded daily by its persistent and large external deficits.

Far from establishing a new ‘golden mean’, the current international monetary system appears to suffer from the worst of both worlds — a de facto anchor currency of increasingly uncertain worth and an adjustment mechanism that is frustrated in its means to redress imbalances within.

Going forward, an international monetary order characterised by a paucity of global reserve assets and overly dependent on an insufficiently credible dollar as its sole monetary tether will stand little chance of surviving in a world of unconstrained capital flows. Equally, a future global multicurrency order characterised by hybrid exchange rate regimes and free capital mobility, yet backed by only a weak and fragmented governance structure, will repeatedly be trumped by narrow and domestically generated protectionist compulsions. Building flexibility and capacity within the international monetary system’s regulatory mechanism to accommodate — and accelerate — the financial liberalisation trajectories of its rising stakeholders, most notably China, hence is the foremost medium-term priority of the day. In this regard, novel ideas that facilitate the acceptance and use of emerging market currency-denominated instruments as reserve assets — such as the issuance of emerging market GDP-linked bonds, other forms of pooling and securitisation of emerging market debt into composite assets, as well as a significant expansion in size and share of large, dynamic emerging market currencies within the SDR’s basket composition — each bear considering.

A comprehensive framework, further, that enables China to cope — as it liberalises its foreign exchange and financial system — with the unpredictable herding behaviour of cross-border capital flows, merits examining with an open mind too. A network of permanent currency swap lines, provision of liquidity risk insurance based on simple ex ante conditionality and orderly insolvency processes that on balance privatise the allocation of risk to the vendors of cross-border capital, are but a few examples of the elements that such a comprehensive framework could contain. Full currency convertibility, correspondingly, to avoid frustrating the monetary system’s essential adjustment mechanisms, is the reciprocal imperative for PBoC — currency internationalisation being a necessary but insufficient end. Embedding China’s capital account liberalisation program within this proposed broader institutional framework of inter-governmental liquidity and solvency risk management, rather than the current effort to erase global imbalances via a peer pressure-driven Mutual Assessment Process, ought to be high on the agenda of future G20 summits.

Sourabh Gupta is a Senior Research Associate at Samuels International Associates, Inc. in Washington DC.

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For many reasons, the G20 may be justifiably considered the world’s premier economic forum. These reasons are often associated with problems inherent in the earlier G7 grouping.

The most prominent among those problems was that the G7 consisted only of advanced industrial countries and thus could not legitimately claim the privilege of making important decisions on global economic issues. For the G20 to maintain its authority in future it must continue to incorporate the developing world, and Asia in particular.

Developing economies now account for around 40 per cent of global GDP and their share is expected to continue rising in the coming years. The Asian economy is projected to take up one half of global production by 2050, given its current pace of growth. This has led many economists and futurists to predict that the centre of gravity for the global economy will shift toward Asia. In fact, that shift is already taking place.

Asia has shown a strong presence at all stages of the G20 process during the global economic crisis, from its first meeting in Washington DC in 2008 to the Seoul Summit last year. While the international community as a whole has been active in cooperating on policies to overcome the crisis and in drawing the basic blueprint for global economic governance, the actions of the Asian countries in this effort were vital. The weight and influence that Asian countries brought to bear was felt throughout every major issue on the agenda, including the resolution of global imbalances, the reform of international financial institutions, the creation of a global financial safety net and deliberations on development issues.

Needless to say, maintaining the vitality of the G20 as the world’s premier economic forum hinges on the continuing and dynamic role of Asian economies. This is underscored by the fact that Asia is home not only to the world’s second and third largest economies, but also to 60 per cent of the world’s population. The region also holds more than half of the world’s foreign exchange reserves.

Asia’s status in the world economy is unique in that, although it is a major contributor to the global imbalance, it is also in the best position to provide a solution to the problem. The G20 devoted the greatest amount of energy to the issue of global imbalances because it was the most important and difficult one facing the forum.  American consumerism can be readily pointed out as a major contributing factor, but the division of production now firmly established within the structure of the Asian economy must take an equal share of the blame.

The structure of the Asian economy involves tariff-free or low-tariff export of raw materials or intermediate goods from Korea, Japan and Southeast Asia to China. They are then processed or assembled in China for export to the US or Europe, thereby adding to the global imbalance. An earnest reform of such trade or production structures is no doubt essential for relieving the pervasive global imbalance. This reform could be realised through trade liberalisation among the countries in the Asian region, with complete removal of tariffs and non-tariff barriers — not just for raw materials and intermediate goods but for finished products as well.

Another remedy for the imbalance would be strengthening monetary cooperation among Asian economies to promote greater stability of financial markets in the region. This would alleviate strong tendencies by individual countries to accumulate foreign exchange reserves. In this regard, the multilateralised Chiang Mai Initiative (CMIM) regime established among East Asian economies needs to be strengthened and expanded further.

Asian countries are expected to play a more active role on the issue of development, a matter of great importance for the G20 and the world. It is worth noting that Asia is a region where major aid donors and recipients coexist. In the region there are OECD Development Assistance Committee (DAC) members such as Korea and Japan, emerging economies like China and India that are leaders in south–south cooperation, and recipients of large international aid like some Southeast Asian countries. The creation of an effective regime for cooperation on regional development in Asia will most likely lead to improvements in global regimes for aid and development.

It was through sheer determination and effort as well as economic growth that Asian economies have attained their place in the sun. But as Asian economies are now being asked to assume a more active role in the decision-making processes of the G20 on important global issues, they are coming under increasing pressure to improve their political and economic capacity. In order to achieve this requirement they will need to strengthen their respective market systems and democratic institutions.

Wook Chae is President of the Korea Institute for International Economic Policy (KIEP) and has served as a member of the National Economic Advisory Council, Seoul.

This article appeared in the most recent edition of the East Asia Forum Quarterly, ‘Asia’s global impact‘.

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The upcoming G20 Summit in Cannes will undoubtedly attract the world’s attention, as many look to see whether the G20 can play a positive role in the global economic recovery.

And while searching for an effective solution to the crisis, the world will also focus on China, asking whether it might become a responsible ‘leadership state’ in an emerging global governance structure like the G20. The answer, it seems, is that based on its own interests, China is choosing to become a responsible contributor to global governance and wants to become part of the solution to the current global crisis.

China has maintained a rapid growth rate and played a major role in stabilising the global economy since the 2008 global financial crisis — and it wants to remain the biggest engine of growth and the ‘stabiliser’ to the global economy into the future. This could be China’s most important commitment to the world at such a critical time, but Beijing must also be careful not to risk the stability of its own domestic economy. And while becoming a stabiliser for the global economy would clearly increase China’s weight in the G20, the world cannot expect China to assume a particularly substantial leadership role in the G20.

In the eyes of Chinese leaders and the public, China is not ready to take on such a role, as the country is limited in its strength and knowledge, and by its status as a developing nation. China’s economy is in high-speed growth, but it still faces internal social problems and difficulties with efficiency and fair distribution in its economy. Consequently, it is hard to imagine that Chinese leaders would have the legitimacy and support to help finance foreign economies.

China also believes that the global economy is a fundamentally unbalanced system, characterised by the disproportionate and unchecked role of the US dollar as the main reserve currency and the worsening of European sovereign debt. It also views reforms aimed at strengthening the international monetary system and the EU’s internal reform efforts as imperative to establishing conditions for stable, strong and balanced growth. And as for China itself, Beijing must work hard to transition from an export-driven model to one based on domestic demand.

In the meantime, the world should be paying more attention to the development interests of developing countries, in order to increase their representation in international economic institutions and to reduce the risks arising from the global market — especially the volatility of commodity prices. Achieving this goal will benefit China as well, as it is the world’s largest trading nation and needs a stable international market.

Still, China supports the objectives France has set for the upcoming G20 Summit and welcomes the leading role Europe will play. China identifies itself with Europe’s long-term goals of stabilising and reforming the international financial system. China also hopes to stabilise the European economy, which would not only help its own exports to the region, but would also help balance US power and influence in international affairs. Equally, both China and Europe support reforms to the international currency system, stabilising commodity prices and resisting protectionism. But China wants Europe to carry out a more thorough reform to protect the safety of relief funds and to further open its markets — it would be unrealistic to expect China and Europe to be fully consistent on all objectives.

The global economy would undoubtedly benefit from greater consensus building through effective global governance, and the G20 is lagging behind in effectively dealing with these challenges. Consensus is absent among key players, which only further highlights the difficulties of coordination and cooperation within the G20. In the end, China will likely play a ‘balancer’ role between the US and the EU, something which could ensure the protection of China’s own interests. But as its cooperation with France and Europe is strengthening, China does not want to overly complicate its relationship with the US either.

There is little doubt that China hopes to develop a greater platform for contributing to international governance, through which it can safeguard its interests. China would like to see reforms to the current system of global governance, including a reduced dependence on the US dollar as a reserve currency and reforming the IMF to make it more representative. Beijing’s policy is clear: it does not want to overthrow the current system of global governance; it wants to reform it. In this way, China will ultimately play the role of ‘responsible contributor’ — and this role is only set to strengthen as China grows into the future.

Wang Yong is Director at the Centre for International Political Economy, Peking University.

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