The international response to the global financial crisis required acknowledging the changing balance of power among states and the urgent need for a coordinated reform of global financial governance.  Recognizing financial interdependence as the domain of developed and developing countries alike mandated a shift from the G7 to the G20 and the subsequent role of the G20 as the international steering committee for economic cooperation.  The promotion of the G20 as the world’s premier institution for coordinating and monitoring economic policies, however, is political hyperbole.  While some progress has been achieved, it remains to be seen whether or not expanded membership will result in more effective regulation of financial markets in the future.

Regulatory failings played a significant part in the financial crisis; regulators, central banks, and international financial institutions were unable to identify and warn against ballooning hazards in the pre-crisis system.  It follows, then, that one of the primary responsibilities of the G20 is to develop and implement analytical tools to untangle the web of macro-financial linkages in the international financial system, thus enabling more effective multilateral surveillance of economic policies:

Financial stability, at its most elemental level, depends on regulators’ effectively monitoring, preventing, and addressing systemic risk… not only at the domestic level but also in the context of the global financial system and the pseudo-system of international regulatory cooperation which has evolved to address its regulation.[1]

The OECD notes, however, that heterogeneous takes on economic policy – such as those within the G20 – abrogate the objectives of multilateral surveillance, notably improved policy changes.  Peer pressure only works if there is a consensus amongst the peers themselves on objectives and strategy and their consequent relation to the overall financial system.  Naming and shaming – the G20’s sole enforcement mechanism – proves ineffective in this context.  Moreover, even when countries do agree on appropriate policy objectives, the difficulty inherent in obtaining valid macroeconomic forecasts for a sufficient period of time inhibits the detection of system-wide problems.  Analysis is piecemeal at best and warnings typically absent, inconsistent, or incongruent.

Thus, the effectiveness of the G20 is limited both because of the mosaic of views and preferences within the institution as well as the market forces keeping the lid on its toolbox outside of it.   Though it has made some progress in adapting surveillance mechanisms by strengthening commitment to the IMF/World Bank Financial Assessment Program and allocating thematic reviews of financial systems in G20 countries to the Financial Stability Board, resulting conclusions drawn from information on narrow subject matter will likely be unable to identify and elucidate wider macroeconomic problems.

Going forward, the G20 will likely be effective in select instances.  The success of the London G20 summit at the height of the financial crisis compared to the weaker outcomes of successive summits evidences a higher success rate in times of severe economic distress, when cooperation among countries is especially critical.  As recovery progresses, however, the record shows that the different and at times opposing political and economic philosophies of respective member states inhibit consensus building.  Indeed, the outcome of recent G20 summits is largely an agreement to disagree, an outcome perhaps best exemplified by the communiqué from the Toronto summit.  US antagonism towards proposed European austerity measures resulted in a communiqué encouraging “growth-friendly fiscal consolidation plans,” poorly disguised double-speak allowing both sides to claim consensus in a fit of political posturing.

The later G20 summit in Seoul proved slightly more successful.  Member states endorsed a stronger financial safety net through IMF reform and agreed upon core elements of the revised Basel capital adequacy regime.   However, studies suggest the more stringent capital requirements in Basel III would still be insufficient to withstand the worst of the present financial crisis.  This paradox likely results from a conflict of interests between developed and developing countries: higher capital rates will presumably increase the cost of financial intermediation, a cost justified in countries with advanced financial markets but not in emerging economies.  Though the proposed capital rates reflect a compromise, they also illustrate the prioritization of domestic over international interests within the G20, a situation that often leads – as in this case – to everyone losing.

Dominance of developed country interests is evident in the promotion of a G7 agenda within the G20.  A preoccupation with financial regulation and remuneration occurs at the expense of principle topics of interest to emerging economies, namely, trade liberalization and reform of antiquated Bretton-Woods institutions.  In spite of a G20 summit communiqué calling for selection of future heads of the IMF and World Bank based on merit, European countries recently rallied around Christine Lagarde as the newest IMF Managing Director.  Like all of her predecessors, Lagarde is European; like all of his predecessors, her first Deputy is American.

Such episodes suggest a limited influence of developing G20 countries in the so-called reform of global financial governance.  It often appears as if old regime is still in the saddle, yet “the G20 is not just a G7 with extra chairs.”[2]  Shifting poles of power reveal unwillingness among developed economies to relinquish privileges afforded them back in the day; however, effective reform can and will occur provided developing G20 countries demand an equal voice at the rule-makers’ table.  The stronger the role played by developing countries, the greater the legitimacy afforded the institution, thus enhancing compliance with financial reform not just within the G20 but among non-member states as well.

Nevertheless, an inherent trade-off persists between achieving legitimacy as a representative body and achieving legitimacy as an effective body.  The plurality of voices within the G20 sometimes leads to coordination failure.  While member states have agreed, generally speaking, on the causes of the current financial crisis and outlined measures to prevent financial institution failure, they have been less successful at assembling a financial regulatory system to address future crises.  Increasingly, limited goals are the order of the day:

The slide into stagnation, the eurozone sovereign debt crisis, the US debt ceiling crisis and the re-emergence of currency wars with the Swiss decision to cap the value of its franc have ensured that efforts to revive growth in the world economy will form the centrepiece of the French presidency for the rest of [2011].[3]

An enduring focus on immediate issues stifles any attempt to address the intricate constellation of forces and factors in the new global economic order.  Likewise, the absence of coordinated large-scale strategic leadership begets incalculable, potentially reverberant risks in the world economy, as evidenced by the greatest indictment against the effectiveness of the G20 thus far: “the post-crisis international regulatory reforms that have been agreed would not have prevented the global financial crisis nor are they sufficient to lay the foundations for future global financial stability.”[4]

Even though the G20 possesses the potential to shake up the geopolitical order and provide a framework for strengthened global cooperation, it must somehow advance a more forward-looking approach or risk regressing into little more than a “talking shop.”  Because the G20 comprises systemically important economies with asymmetrical ideologies and levels of development, consistently effective standard setting requires member states to substitute pragmatic for ideologically driven decision-making in order to ensure a safer financial system the world over.  In practice – given both the nature of contemporary politics and the disappointing track record of the G20 thus far – this may be too much to ask.

The role of the G20 in making globalization work remains contested, though evidence points to effective international cooperation regarding specific issues and in specific instances, especially periods of fiscal free-fall.  The shift from the G7 to the G20 remains rife with heterogeneous state interests, conflicting developed and developing country agendas, insistence on domestic solutions to global problems, and a tempered ability to adopt a forward-looking approach in the face of immediate issues.  There has been and will be less significant reform than meets the eye; and yet, the need for more effective regulation of global financial markets has never been greater.   Whether or not the G20 will prove successful in its transition from “crisis committee” to “steering committee” remains to be seen.  In the meantime, however, the states of the world hang in the balance.

Contributed by Hibba Itani.