von Furstenburg: Economic Issues Fit for the L'Aquila G8

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Economic Issues Fit for the G8 at L'Aquila 2009

George M. von Furstenberg
J.H. Rudy Professor of Economics Indiana University
G8 Research Group
vonfurst@indiana.edu
July 8, 2009

Groups of advanced industrial countries, such as the G8, that engage in regular exercises of joint decision-making in areas of systemic significance have been pressed to extend membership to other countries regardless of their qualifications. The inflation of the Gs is commonly driven by the alleged need for greater inclusiveness and legitimacy. However, for a system of setting rules and imposing standards to be legitimate does not require all the “stakeholders” that are affected by the system to have a direct voice in its design. Often all that is needed is that the system should pass the political and economic market test of being widely adopted and also that it prove adaptable as innovative system alternatives emerge.

To clarify this point by analogy: producers and consumers of an item both have a stake in its design and quality, but they generally do not get together beforehand in market system to decide what is to be produced. Rather, producers decide what they want to offer, and the reaction of consumers to that offer is registered in the sales figures and profit margins achieved. Focus groups and test marketing may reduce uncertainty about consumer acceptance, but it is ultimately the market test where producers and consumer connect and learn in what direction the invisible hand is pointing. Of course, the invisible hand cannot rest its arm and point clearly if the market is allowed to function in a way that does not serve to reveal crucial aspects of product quality and of user or investor risk.

It thus becomes clear that there are distinct roles for producers, the givers of international public goods, and those who also utilize those public goods as adopters or consumers. What then do the G8 have to give to a much greater measure than broader groups?

International Financial Regulation. The leaders of financial market innovation and development necessarily are the ones who are qualified to engage in systematic error learning and cumulative improvement of financial product, institutions, and market regulations. They alone have a natural responsibility, derived from technical competence in this area, to lead the way to expertly improving prudential regulation, transparency, and incentive compatibility in sound finance. The combination of securities-market based systems in the 3 “Anglo-Saxon” members of the G8 with highly developed bank-dominated systems in France, Germany and Japan provides sufficient breadth to design regulations compatible with, and applicable in, both types of systems. With Switzerland not being a member of the G20, it is fair to say that all non-G8 members of the G20 are solely consumers of these regulations. Since consumer-producer cartels are undesirable and inefficient in planning production, these other members will contribute nothing of value, and perhaps waylay appropriate prompt action, at the design stage. Hence the G8 minus Russia is the natural (law)giver for itself and the rest of the externally open world under capital-account convertibility. Mending “fundamental weaknesses in the global economy related to propriety, integrity and transparency”— in the language of the G8 Finance Ministers’ Lecce Communiqué -- is the G7’s financial-order business.
Fiscal Stimulus. The advanced industrial countries have the capacity to take on greater public debt without driving up the expected rate of inflation and long-term interest rates in the present crisis. A few other countries, in particular China, South Korea, and India, and to a lesser extent Russia and most non-G8 European countries, also may have some of that capacity. Hence while the G8 is not entirely inclusive of all producers who may safely be called upon to provide increased fiscal stimulus, at least three-quarters of the world’s countercyclical discretionary fiscal stimulus will be delivered by countries which are members of the G8. Certainly no one would be looking for increased fiscal stimulus from G20 countries like Argentina which are already in a substantial external and domestic financial bind. Hence, with the exception of the three Asian countries mentioned that are members of the G20 but not the G8, the G8 comprises the group of countries in which fiscal stimulus primarily needs to be planned. They, and not serial defaulters like Argentina, should decide on the degree of temporary economic stimulus that is appropriate for them and the world. What exit strategy to follow thereafter also is for them to decide individually and collectively, and not usefully for any larger group.
Monetary Stimulus Policy. The world level of real interest rates on liquid dollar, euro, and yen-denominated instruments, and the rate of inflation in the respective currency areas comprise the products of monetary policy, interacting with market forces and expectations, which are important for the world. In a few cases, such as China, monetary policy may affect a systemically significant exchange rate and thereby impose exchange-rate pass-through effects on other countries. Yet the monetary policy of most non-G8 countries is primarily of domestic consequence: It affects their country risk premiums, inflation premiums, and interest rates. Hence again, the monetary policy that is of global significance is provided by the G8 minus Russia; monetary policy decisions even by large G20 countries like Indonesia and South Africa tend to have little direct effect beyond their immediate economic region. There is no point for producers of the coordinated G7 monetary policy to negotiate that policy with all of its international consumers or to try to agree on an exit strategy from central banks’ liquidity and balance-sheet expansion with them beforehand.

The G8 l’Aquila Communiqué on the Economy has centered on common action in the three areas identified above. The G8 comprises the group of countries most competent, and in some sense therefore most legitimate, to lay down the “law” in these matters. This note has tried to show that there is nothing functionally useful about arranging consumer-producer groups like the G20 to decide on the best method of supplying international public goods that should be adopted by the G8. It is for the producers, and not those who only consume such goods, to determine for the G8 how much is to be supplied by when by each of its members. This does not mean that arguments and pleas from non-G8 countries, like consumer suggestions and complaints in business, should not be heard and carefully considered on their merits in the G8’s own decision process.

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