In the fifth session of Carnegie Europe’s New Vision Conference: Post-Bush America and the World, experts discussed the implications of the current worldwide financial crisis and how the international community should respond.
Participants included David Rennie, European Correspondent for The Economist, Kemal Dervis, Administrator of the United Nations Development Programme, Freddy Van den Spiegel, Chief Economist with Fortis Bank, and Paul Taylor, Chief Brussels Correspondent for Reuters.
David Rennie began the session by briefly outlining the context of the discussion. In the financial boom which preceded the current crisis, we heard that economies have become globalized and interdependent. Now that we are facing the meltdown of financial markets worldwide, government responses have been primarily focused on domestic solutions, with very little coordination between major economies, including within the EU. Rennie asked the speakers to consider whether that signifies a nationalization of economies rather than the continuation of interdependence.
Kemal Dervis began by stating that the global economy is much more interdependent than ever before, as indicated by the trade to GDP ratio which currently stands at 51%. Global production and supply chains only increase our interdependence.
But interdependence does not equate to peace and harmony. The financial crisis needs to be managed with much greater international coordination. We also need to achieve equilibrium between efficiency and robustness in the global economic market. At the moment, there is too much of a focus on efficiency.
Freddy Van den Spiegel added that the financial crisis is acute but that it is only a symptom of the lack of global governance. The economic boom was a win-win situation that allowed growth all round. Because growth was too easy, there was a concerted movement for deregulation. At the same time, an abundant amount of capital was available to finance deficits.
With respect to the political dimension of the crisis, Van den Spiegel cautioned that in Europe that there needs to be an overt warning signal before politicians take notice and start acting. In Europe there was now effective mechanisms to debate the decisions that helped precipitate the crisis. Until recently it was politically incorrect to question who would pay the bill for these defcits.
Impact on Europe
Paul Taylor stated that the financial crisis is presenting challenges for which Europe, especially the EU, is ill-prepared. It is in a half way house because not all of its members are in the single currency. The European Central Bank (ECB) has gained tremendous international credibility but it does not cover the currency of Europe’s biggest financial sector, the British pound.
Around the world, the financial crisis is seen as real trouble, but not in Europe. The first reaction of European banks and member states was ‘each for himself.’ The Fortis solution, and the cooperation underlying it, won admiration, but there remain different banking systems and different safety mechanisms spread across the various member states. For instance, the Irish have taken to depositing in Irish-only banks where savings are guaranteed. HSBC is not as good an option.
The 300-billion Euro rescue plan is three times the annual budget of the EU, Taylor added. Europe has never seen a market it did not want to regulate. There are forty large cross border banks in Europe – what would happen if multiple banks collapsed? The EU could not apply the Fortis solution because it does not have the resources. Who is the lender of last resorts? It must be the national banks of member states, Taylor argued, which requires Europe to come up with a unified response.
Role of the IMF
Dervis agreed with Taylor and called for the re-emergence of the International Monetary Fund (IMF). With experts from around the world, it is the only institution that can provide a framework for cooperation on what is a global issue.
Rennie, however, suggested that there would be a backlash against the IMF because they have been so unsupportive of developing countries. For the IMF to intervene just because the West (and particularly the U.S.) is in trouble would seriously undermine its credibility.
In response, Dervis explained that when he was working on the recovery of the Turkish economy, working with the IMF was his biggest political liability. Despite that, the IMF provided more help than damage. The annual IMF meeting in October will be a good opportunity to bring the organization to the center of the discussion.
Taylor asked Dervis why he has not heard many saying that now is the time to turn to the IMF. Dervis responded by stating that in times of crisis, the initial reflex is to go back to the nation state. There is a worldwide feeling that globalization has destabilized countries. However, the world is much too interdependent to resort back to the idea of the nation state. There is thus a very strong need for an international forum and cooperation between key global players.
Van den Spiegel argued that we can see the euro as a micro IMF, with a fixed exchange rate and a policy of disciplining governments so that they do not go into excessive balances. It is necessary to not use the economy for competitive purposes. The euro works for those who are willing to give up some of their independence – they see it as a success.
The key issue in this crisis with regards to Europe, Van den Spiegel continued, is that no one is sure who has the mandate of the citizens. Who is it that is able to use tax payers’ money to help manage the crisis? There have been four years of discussion on this topic, with no conclusions.
Positive Outcomes of the Crisis
Niansheng Zhang from the People’s Daily, quoted a Chinese saying – ‘there is always connection between fortune and misfortune’ – and asked if the crisis represents an opportunity for the world to reform. He also asked whether there was a moral problem behind the financial crisis.
Dervis responded by saying that that the crisis does makes it possible for a new U.S. administration to reengage with the world. If a new administration approaches the financial crisis well, this could change the attitudes of others. We need to consider how the IMF can be reformed. If there is an invitation on behalf of the U.S. to address this question, then it is likely that the global response will exceed our expectations.
Van den Spiegel added that discussion about the financial crisis is in chaos. At the moment, we cannot identify a financial bubble until it has burst. This is acceptable when the bubbles are relatively small. When they are as big as they are at the moment, the central banks are unable to clean up afterwards. There needs to be a discussion about how to create a pre-emptive policy when imbalances are clearly identified.
Taylor pointed out that the institutions are already there, they just need to be used. The UK, for instance, has inhibitions about using EU institutions for any policy matters. Regarding Zhang’s question on morality, he argued that we need to ask whether the banks and financial institutions are prepared to settle for lower rates of return in order to prevent future crises. If we are to make globalization secure, capitalism needs to focus more on the long term. At the moment, global capitalism is based on pleasing shareholders, which is deeply dangerous, as we have seen.
The Feasibility of Reform
Nigel Inkster of the International Institute of Security Studies (IISS) questioned the risk-based approach to financial management, asking whether the system of risk management is an illusion, or if it is possible to develop risk based approaches to management.
Van den Spiegel responded by stating that risk management is a strange concept. Risk is an uncertainty – it means that we do not know. Economic models and risk management always fail because they are based on, and simultaneously change, human behavior. If they are successful, human behavior changes, leading to their ultimate demise. Intervention needs to take place before that happens in order to correct the imbalances.
Rennie asked Dervis if we are being too complacent when we think about tweaking the global architecture. He questioned whether we were politically in a position to do that or if we needed to make a bigger effort.
Dervis responded that this depends on how quickly the crisis can be overcome. We cannot forget that there is a large part of the world that has not been keeping up with the West and that there is an increasing level of inequality. This was acceptable in a time of growth because everyone’s lives were improving. In a situation where the quality of life is not improving, indeed where it is becoming worse, there needs to be an attempt to address that inequality, or risk a tremendous political backlash. There is no reason for there to be a world depression, but there does need to be prompt action in order to prevent it.
Taylor agreed with Dervis, adding that the anti-globalization sentiment is big and growing. With regards to risk management, he said that it was his opinion that it has much to do with how companies incentivize their workers. If they set stretched targets, workers will take risks and cut corners. There needs to be the formulation of a new, sustainable business model.
In their final statements, Van den Spiegel optimistically asserted that the crisis is under control. Dervis reiterated that the global economy needs to be made more robust and there needs to be a global initiative in which governments cooperate. Taylor closed by saying that there needs to be a return of government in financial economic management, and that the IMF is a good multilateral structure to manage the decline of U.S. influence.