Everyone knows that international policy coordination would be of benefit to all, but what structures, what mechanisms? Iain Begg looks at some of the EU devices that could help shape global governance thinking
In an increasingly inter-connected global economy, the actions of one government have repercussions for others. Co-ordination among them matters a great deal, yet it is hard to achieve because what is in the common interest, especially in the short-term, does not always makes sense for any single country, especially in times of crisis when governments are under intense political pressure to ‘do something’.
Around the world, governments have, on the whole, accepted that overt protectionist policies are ultimately counter-productive, despite the temptations that arise in a severe downturn. But they are less willing to see other policies in the same light and the current crisis has revealed shortcomings in mechanisms for assuring co-ordinated policy action at the global level. After the collapse of Lehman Brothers, it rapidly became clear that governments lacked an effective international toolkit for this, and as a result anarchy could well have broken out.
Governance arrangements that facilitate co-ordination offer a number of clear-cut advantages. Burdens can be shared, inconsistencies and incoherence in policy stances can be avoided, and participating governments’ collective response can be far greater than the sum of the parts. Co-ordinated policy also makes it less likely that any single country will be picked-on by financial markets, or that a domino effect is engendered that might lead to a vicious circle of defensive policy reactions.
Why then is co-ordination so difficult to achieve? One obstacle is that countries have different priorities that can affect their willingness to commit to specific policy orientations; another is that the incentives to be a free-rider are often sizeable – why risk your own public finances if someone else is willing to risk theirs? But often the problem is simply that the institutional mechanisms that could enable better co-ordination are not in place, a problem that can be exacerbated when the crisis for which co-ordination might be the answer is unanticipated and unfamiliar.
The financial and economic turmoil of the last two years has obliged governments when constructing policy responses to learn by doing. This has inevitably given rise to mistakes and misunderstandings, such as some of the immediate actions taken to protect national banking systems from the shockwaves of the Icelandic bank meltdown in 2008. This had the effect of passing the hot potato to the next in line, rather than providing a sound solution. Despite the difficulties in orchestrating rescues of financial intermediaries, especially those with significant levels of cross-border activity, there are some examples of successful co-ordination that nevertheless stand out. The world’s leading central banks engineered a 50 basis point cut in interest rates in October 2008 and, albeit somewhat haphazardly, the major economies put together national stimulus packages that de facto became a co-ordinated fiscal stimulus strategy.
What these examples reveal is that although a co-ordinated outcome was eventually achieved, it was cobbled together rather than created by design. The main institutional forum for the key decisions is now the G20, but before that it was the G8, the G7 and other configurations, meeting infrequently and with no effective executive or administrative back-up. As a highly integrated region, the EU has had to confront the challenges of co-ordination and has developed a number of over-lapping mechanisms. These include the Stability and Growth Pact (SGP) for the 16 eurozone members that is intended to curb irresponsible fiscal policies, the Lisbon strategy aimed at promoting economic reform and other mechanisms for achieving specific goals like social cohesion or shared energy policy objectives.
These various EU mechanisms reflect different motivations. First there is that of imposing discipline on what should be avoided, what should be encouraged and the role of co-ordination commitments in reinforcing governments’ implementation of unpopular measures, especially where there are vested interests. Another, less well-recognised motivation is stimulating policy learning to facilitate the adoption of improved policy. This can be achieved by exploiting ideas and practices from other countries, and is most likely to work well when there is a supportive governance framework.
All the EU co-ordination processes have their detractors and could undoubtedly work much better, but they provide a possible basis for the development of co-ordination as part of global governance reform. That makes the distinctive principles behind these EU approaches worth exploring. The rationale for the SGP is to deter and penalise fiscal policy behaviour that has potentially adverse ramifications for other eurozone countries. The SGP solution was to impose rules backed by sanctions which, though widely regarded as rather toothless, arguably had a moderating effect on national excesses – at least until the onset of the present crisis.
Could such a commitment device be envisaged at global level, and how might it be organised? The essence of the SGP is the rule that public finances should be kept within the prescribed limit of a 3% deficit, and should aim for balance over the medium-term, but with more flexibility in times of recession. When the original SGP was adopted in 1997, its critics objected to the simplistic nature and inflexibility of the policy rule and its dubious economic rationale, while non-compliance by Germany and France in 2002 raised doubts about its effectiveness. The pact was then reformed in 2005 to make it more flexible. Although the European Commission is responsible for surveillance of member states, a decision on whether to instigate disciplinary measures is taken by Ecofin, the body bringing together all the national finance ministers. The disciplinary measures theoretically include the eventual imposition of a fine on countries that fail to rein in deficits, but in practice the principal weapon is naming and shaming.
In principle, the IMF, too, has a duty to engage in surveillance of economies and could be assigned a similar role in implementing agreed fiscal rules alongside the more robust Financial Stability Board agreed by the G20 last April. The latter’s mandate, though, is mainly to police the financial sector, so it might be better to consider a new, multilateral Fiscal Stability Board. Although, the notion of sanctions in the form of fines at a global level is even more far-fetched than in the EU, the scope for naming and shaming is still considerable. And the IMF can also exercise some influence through the conditions it attaches to loans. In good times, the incentive for governments to comply will come principally from financial markets, which can be expected to penalise those that depart too much from agreed targets.
But the real advantage would come in times of economic crisis where a co-ordinated response, embodied in transparent targets that are mutually consistent, should help to mitigate the burden on any single country and assure a credible collective solution. In a severe downturn, speed of action and appropriate sequencing are essential and, although the actions taken by the G20 did eventually stabilise the world economy, vital time was lost and the recession was aggravated. However, the gradual reversion to business as usual will pose a sterner test, because the recession’s depth differs from country to country. The central bank money sloshing around the system will eventually have to be mopped-up and fiscal policy tightened. But if done in an unco-ordinated or, worse, incoherent manner, the effect could be to trigger precisely the sort of W-shaped double-dip recession that many fear.
The Lisbon strategy’s approach is more distinctive and promising, yet harder to relate to conventional thinking on co-ordination. It consists of the articulation of common goals and guidelines, the development of national reform programmes aimed at advancing economic reform, and an iterative process of scrutiny and evolution in these reform programmes. It has been criticised for its unrealistic ambitions and rhetorical flourishes that are belied by timid policy action, for its lack of incentives or enforcement mechanisms, and for being tangential to real policy-making. But its bad press has been exaggerated. Almost subliminally, the strategy has had an impact that is visible in the many shifts in national priorities and the adoption of new directions in policymaking.
In contrast to the SGP’s focus on what countries should or should not do, the Lisbon approach is to stress what they could do by being sufficiently receptive to different influences. It seeks to achieve this by creating templates for good policy, providing a pool of ideas, fostering exchange of experience and establishing mechanisms like peer review and benchmarking that can help to identify better solutions to policy problems.
Could something similar be constructed at global level? The OECD already provides some co-ordination through its Going for Growth initiative, which tries to influence structural policies, but this is confined to its richer country members and has limited provision for policy learning. The expertise of policy advisers in the global institutions could also play a part, but what is missing are suitable international fora or specific mechanisms to promote policy learning. Nevertheless, by drawing on these sources it would be possible to develop guidelines similar to the Lisbon ones. To overcome the inevitable resistance of governments to being told what to do, an incremental approach probably makes good sense. A first answer could be to experiment with some of the low key approaches employed in the EU, such as setting targets, mutual surveillance and thematic seminars. More elaborate structures might subsequently be envisaged, including a role for constructive scrutiny by international agencies and some sort of global policy learning agency.
Effective co-ordination is never going to be easy, but that should not deter us because the benefits are simply too great to ignore.