Isolation and Stalemate

Editor’s Note: This article was originally published in the July 2012 edition of
Longitude
, a monthly Italian publication on world affairs.

Another G-20 summit has come and gone but the world economy and the euro area in particular are doing no better. There are, in fact, visible signs of a slowdown in the emerging economies, economic recovery has stalled in the United States, and, of course, the eurozone crisis has worsened further with one of its systemic economies, Spain, currently seeking official assistance for its troubled financial sector.

Against this backdrop, a few days ago at the Los Cabos Summit, 37 countries pledged $456 billion to the IMF. Pledging countries include those from the EU for $240 billion, and other advanced and emerging economies for the remaining $216 billion.

It is almost more remarkable, however, to see who is not on the list. For the first time in history, the US has not participated in this collective effort, forfeiting an important opportunity to exert political leadership among the systemic economies.

US disengagement has also created problems for China: for its own $43million pledge, as opposed to the $100 million initially requested by the IMF, China had to overcome domestic opposition to the fact that a still fundamentally poor country should contribute when the Fund’s biggest shareholder had pulled out.

In the end, emerging economies bolstered the efforts to strengthen the IMF’s financial capacity, but not before garnering assurances that their quota and their relative voting power in the organization will be further increased.

Already, on the basis of the latest reform package approved by the IMF Board of Governors in December 2010, due to be ratified by the membership over the coming months, China will become the third largest shareholder, with 6% of the voting power, while the other BRICs will feature among the top ten shareholders.

With these new pledges, the emerging economies will manage to secure amore favorable outcome by the end of the current round of IMF quota negotiations, scheduled to conclude by early 2014.

To this purpose, the communiqué unambiguously states that G-20 leaders “are committed to completing the comprehensive review of the quota formula, to address deficiencies and weaknesses in the current quota formula by January 2013, and to complete the next general review of quotas by January 2014.”

The message is then made even clearer: “the distribution of quotas based on the formula should better reflect the relative weights of IMF members in the world economy, which have changed substantially in view of strong GDP growth in dynamic emerging markets and developing countries.”

As a result of these pledges, the IMF’s lending capacity will increase to approximately $800 billion. As high as that may seem, it won’t make the IMF a systemic lender to the eurozone, or put it in a position to offer credible, precautionary arrangements, as was the case at the height of the international financial crisis.

At that time, the IMF played an important, stabilizing role vis-à-vis Colombia, Mexico, and Poland, through its uncapped, crisis-prevention flexible credit line (FCL). Indeed, following news of their precautionary programs, market spreads narrowed in these countries.

To suggest that Italy and Spain represent analogous situations is an unfair comparison, however, even if they qualified for an FCL, which is very unlikely. With FCL-supported countries such as those mentioned above, the IMF boasted the financial resources to stabilize the countries’ rollover needs, had their economies been cut off from markets.

For the larger eurozone sovereigns, the Fund today is not in a similar position. At least $400 billion would be required for a credible two-year arrangement for Spain; Italy would require close to $750 billion. Together they would exhaust the capabilities of both the IMF and the European rescue fund.

Then why hasn’t the G-20 stepped up to the plate, as it did – to great effect – at the height of the international financial crisis in 2009? The answer is that since then, two forces have been at work, leading to the political paralysis of what had been hailed early on by its leaders as their premier forum for international economic consultations.

The first is the internal dynamic of the eurozone in the management of its crisis, which exerts a disruptive effect on the dynamic of the G-20 as a whole. Germany has managed to establish the principle that the European countries must express a common position in international fora, which, inevitably, tends to reflect Germany’s own position.

Harmless on the surface, in reality this principle deprives Italy, France, and Spain, the three members of the eurozone that belong to the G-20 together with Germany, of the leverage that would derive from forming coalitions with important members of the group in support of their own positions, which differ more and more from those of the Germans.

Subscribing to the principle of a common position does not allow these countries to engage other systemic members of the G-20. By preventing conflict from materializing openly in the discussion, Germany, with the tacit support of the systemic countries of the eurozone, has prevented the possibility of a mediation within theG-20, while ensuring that its own position remains intact.

The isolation of Germany in the G-20 has therefore translated into the isolation of the eurozone. But, then, if G-20 members do not agree on the European position – and there is no scope for negotiations – how can they be expected to support the eurozone?

This has, indeed, been the dilemma of the US, which has constantly advocated a more balanced approach resting on credible medium-term consolidation in the context of growth-enhancing measures. Speaking of which, this brings us to the second factor hampering a more constructive G-20 dynamic. The Obama administration has taken a strategic pause vis-à-vis the G-20 since December 2010, reflecting growing unease with China.

In some circles in Washington the idea has taken hold that, in response to the unprecedented openness of the present administration, China has done little or nothing to reciprocate by initiating a change in its economic policy stance.

The importance of export-led growth has remained fundamentally unchanged. The barriers to access by foreign firms posed by the public procurement framework have also remained unchanged, despite pressures from the WTO and the US in this regard. Finally, the exchange rate with the dollar, which in Washington is considered the litmus test for a new course in Chinese economic policy, continues to be determined by monetary authorities’ interventions.

It is not a coincidence that the ratification of the IMF reform package has not yet been presented to Congress, and it probably will not be presented until after presidential elections later this year. Which means that the very administration initially creating the political premise for the approval of the package has in fact blocked its approval within the previously agreed timeframe of October of this year.

All in all, given the current status of play and the little efforts the eurozone has made to elicit international support, the latter bears an even greater responsibility to rise to the occasion at the forthcoming EU summit at the end of June. If expectations for a decisive move to counter the crisis fade again, we will all have to tighten our belts for months to come.