Financial Post, Weekly edition, Wed 21 Jun 95, page 13

International Monetary Fund falls short in three important areas

John McCallum

As long as we do not set expectations too high, the Halifax G7 summit should be judged a success. Under the strong chairmanship of Prime Minister Chretien, the leaders agreed on financial reforms that are likely to reduce the chances of future Mexico-style crises. On the other hand, the communique had little to say on three other major economic problems - an abruptly slowing world economy, the Japan-U.S. trade dispute, and the problems for the world economy created by the serious difficulties facing the Japanese banking system.

Beginning on the positive side, a stable world financial system is not just a subject for specialists. It affects the well-being of ordinary citizens. For example, when the Mexican peso came under attack, the Canadian dollar also weakened and Canadian interest rates were forced up. So Canadian households paid a direct price for the Mexican crises. Almost all of us would be better off in a world less prone to crises.

There are two prongs to the G7's attack on future Mexico-style crises. First, the G7 proposes to provide the International Monetary Fund with a greater arsenal of preventive measures. These should induce governments to pursue more stable policies, thereby reducing the risk of financial crises. However, even with the best preventive medicine, future crises will still happen.

The second prong of the G7 attack is to allow the IMF to respond more quickly to crises, and with greater resources.

On the matter of potential failures of financial institutions in the style of Barings, the leaders gave clear support to a deepening of cooperation among regulators. This is a matter of great importance and urgency, but because of its technical complexity, it is not the stuff of summit headlines.

Turning now to the three important issues not addressed at the summit, the leaders put a brave face on the state of the world economy, saying little about the current slowdown in economic growth. That slowdown has been most abrupt in North America, while the Japanese economy has been struggling for several years.

On the second issue, it appears that little or no progress was made in resolving the U.S.-Japan dispute over automobile trade. The United States is due to impose 100% tariffs on Japanese luxury car imports in just eight days. While it is easy to sympathize with American frustrations over access to Japanese markets, it is also true that the Americans' unilateral approach is a significant threat to the rule of law in international trade.

Canada, with some four fifths of our exports destined to the United States, would be a big loser if trade issues came to be settled less by law and more by raw economic power. Recent congressional statements criticizing Canadian business relations with Cuba raise similar concerns.

Finally, in the most recent issue of The Economist, it is argued that Japan's financial troubles are the ''real danger'' facing the world economy. The bad debts of the Japanese banks, which are probably greater than Canada's gross domestic product, could be the trigger point for the next downturn in the world economy. Yet there was no mention of this issue in Halifax, at least not in public.

Despite these three omissions, I would argue the summit was a success because it made progress on the prevention of financial crises. The G7 could not have been expected to make public progress on the other issues.

This is because the U.S.-Japan trade dispute is primarily a bilateral issue, while a solution for Japanese banks is mainly a matter for the Japanese. As for strengthening the world economy, the main levers are fiscal policy, controlled mainly by governments, the monetary policy, controlled mainly by central banks. Since no one is advocating higher deficits, the G7 leaders were not in a position to announce fiscal measures to strengthen the economy. On the monetary side, scope for significant reduction in world interest rates will depend on actions taken by the world's largest central banks in the context of the economic fundamentals.

As a result, not much could have been said in public on any of these three pressing problems. On the other hand, we see only the tip of the iceberg of what goes on at summits. One can only hope that private talks among the leaders moved us closer to a solution on the slowing world economy, the Japan-U.S. dispute, and the problems of the Japanese banks.

(Ed. note) John McCallum, who attended the G7 Summit as an observer, is Chief Economist for Royal Bank of Canada.

	This information is provided by the Financial Post.
	Please send comments to: g8@utoronto.ca Revised: June 3, 1995

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