WORRIES TOP THE POLICY AGENDA: GROWTH DOWN, PRICES UP
U.S. POLICY MAKERS AND INTERNATIONAL INSTITUTIONS HAVE STEPPED UP EFFORTS TO CONTAIN THE DAMAGE FROM THE U.S.-CENTERED CREDIT CRISIS. The crisis is throwing the U.S. into recession and spreading abroad. Its spread is intersecting a separate global worry � spiraling food and commodity prices. U.S. policy-makers and international institutions are groping for an effective response, developing new initiatives to halt the spread. The watchwords of these initiatives echo terminology familiar from the world of development assistance: transparency, accountability, good governance, surveillance/oversight/monitoring, risk management, confidence restoration, and policy coordination. These themes have had some actual but limited success in their original sphere of application (for example, the Bush Administration�s Millennium Challenge Account). They are now being called upon by the G7 and IMF to underpin attempts to shore up shaky private sector financial institutions and by the World Bank to productively channel producer-country commodity windfalls that otherwise threaten to underwrite corruption.
But these efforts must contend with contradictions inherent in the shifting world conditions:
the emerging crises make global cooperation, particularly agreement on a Doha Round accord, more important than ever yet more politically difficult to achieve;
higher commodity prices should ease the way for rich countries to cut farm subsidies to facilitate a trade accord, yet the short-term impact would be to push up food prices for poor importing countries;
further opening rich country markets to poor country food exports would help reduce poverty but would put further strain on these countries� domestic supplies;
the credit crunch calls for flexible fiscal and monetary policies yet the inflationary pressures from the commodity price rise and dollar�s fall circumscribe the use of these instruments;
incentives for holding bad debt must not be perpetuated but the worst debtors need an escape mechanism to assure their predicament doesn�t infect the broader economy;
poor countries need economic growth, yet it is the growth in the largest developing countries that has spurred the commodity inflation hitting poor countries especially hard;
poor countries need to boost their agricultural productivity but doing so pits them against the exigencies of climate change mitigation;
the most obviously available pool of financing for investment in poor countries is sovereign wealth funds, but efforts to direct them there could contradict the demand that these funds have only purely commercial objectives;
finally, there is the basic contradiction that popular sentiment tends to turn against globalization just when cooperation on a global scale is needed most.
Following is a look at how Washington is responding and how the world community is proposing to address the new economic realities.
RECESSION: HERE, BUT CONTAINED � Most observers now recognize what the U.S. Federal Reserve has itself suggested: the U.S. economy is in or slipping into recession. The economic numbers now lead to that conclusion. Fears of a downward spiral have been somewhat calmed, though, thanks to intervention by the Fed (the Bear Stearns rescue and liquidity infusions). The question now is, what kind of recession? The Fed�s answer � two quarters, mild, followed by recovery. Others fear something more protracted as the financial contraction takes a deeper toll on the real economy than the Fed foresees � deeper, longer, and more uncertain, potentially even catastrophic if the financial sector woes takes the real economy down. The Fed�s recent moves have been a strong signal that it won�t allow this � that an economic plunge would be answered by aggressive government action, including using the government�s balance sheet to shore up shaky assets, likely accompanied by euro interest rate cuts � but uncertainty remains and, at any rate, there is no longer much thought of avoiding a recession.
The Policy Response: The response by Washington policymakers has focused on easing the pain in the housing sector. The credit problems started here, and it remains the sector to which asset prices are most sensitive and thus the one posing the most persistent danger. The White House and the Democratic Congress disagree over the remedy -- the Democrats want a more direct intervention, using government funds; the President wants to prod the private sector; Republican presidential candidate Senator John McCain takes a middle position. Still, many observers expect a workable compromise to surface. Unlike on trade matters, on this issue politicians are likely to gain more from effective action than from staking out ideological positions that could appear obstructionist at a time when homeowners need relief and broader economic dangers lurk. Thus, Washington may well enact steps to moderate the home price decline.
The Inflation Complication: Complicating the U.S. response to recession, inflation has emerged on a global scale. Driven by commodity prices (not labor) and dollar depreciation, it springs from the shift in global growth to the more commodity-intensive emerging economies that are enjoying rising living standards (the Chinese and Indians are eating better and consuming more). This rebalancing of global growth is a fundamental change, not expected to end soon and thus expected to prop up high commodity prices into the foreseeable future. Nor does dollar weakness appear set to end soon, though the currency may rise against the euro if Eurozone recovery lags that in the U.S.
FINANCIAL AUTHORITIES RESPOND TO �FIRE AND ICE� TRAP � The International Monetary Fund and World Bank met in Washington April 12-13, preceded by the Group of Seven finance ministers and central bankers meeting. These are semi-annual gatherings, and unlike other recent ones when the world economy was seen to be enjoying �sustainable growth,� this time the assembled authorities had much truly urgent business to discuss. The G7, IMF, and World Bank all endorsed plans for coordinating responses to the twin crises of slowing growth and rising commodity inflation � what IMF Managing Director Dominique Strauss-Kahn termed the trap between �fire and ice.� The IMF, he said, is �one of the rare institutions� that can address both sides of this trap.
IMF Casts Gloom: The IMF�s new economic projections see global GDP growth of 3.7% this year (down from 2007�s 4.9%). Forecasting slower growth throughout the developed sector � slower than many governments and private economists expect � the IMF sees the U.S. likely falling into �a mild recession� this year with growth of just 0.5%. The IMF further predicts a spreading impact from the subprime mortgage-sparked credit crisis, costing the global economy almost $1 trillion, and points out that the coupling of this financial stress with the inflationary pressure of rising oil and food prices constrains the use of fiscal and monetary policy in combating the slowdown.
G7 Embraces FSF: With this assessment as a backdrop, the G7 endorsed a plan presented by the Financial Stability Forum (comprised of advanced sector financial authorities) to �minimize the possibility that the challenges we�ve faced will reoccur,� as a Treasury official put it. The 65-point plan focuses on improving the transparency of global credit markets (through �robust risk disclosure�) and improving the ability of regulators to monitor them and respond through tighter supervision (including the setting of new accounting standards for complex derivatives) and higher capital reserve requirements. It also calls for enhanced communication between private actors and state regulators and among regulators of different countries. These reforms are to be in place by year-end (some sooner), and the FSF is to monitor progress and report back to the G7. As summed up by the head of the FSF, �We need to� address several issues � make sure there are going to be adequate liquidity and capital buffers, proper risk management, and we�ve got to address the perverse incentives� for banks to make risky loans. (Critics faulted the effort as too timid and lacking enforcement.)
And Dollar Alarm: In addressing the currency issue, the G7 communiqu� expressed concern about the �possible implications for economic and financial stability� of the recent �sharp fluctuations in major currencies� � a formulation universally seen as signaling concern about dollar weakness, which has been increasingly alarming Japan and Europe. The statement also contained the now-traditional call for �accelerated� yuan appreciation.
IMF Sluggishness Hit: The G24 developing country bloc urged the IMF �to extend its vulnerability exercise to advanced economies� to provide early warning signals of emerging risks� and pursue �active policy coordination� since �downside risks� could spill over onto developing countries.� Others echoed the implied criticism that the IMF was too slow to react to the credit crisis. The UK finance minister declared that the IMF had to be reformed to focus more, in coordination with the FSF, on global financial risks. A U.S. Treasury official called on the IMF to �vigorously reform itself,� noting �there is clearly far more progress to be made� in the functioning of its currency surveillance mechanism. Perhaps the sharpest attack came from OECD Secretary-General Angel Gurria: �The entire institutional chain, well-oiled, all this sophistication, yesterday the pride of the authorities, has been put into question by this collective bankruptcy.� Less scathing but still blunt, Treasury Secretary Henry Paulson agreed that �the IMF must reform to retain its relevance and legitimacy.� It must, he said in his address to the body, �adapt to rapid technological change, the rise of dynamic emerging market economies and the increasing internationalization of financial markets.�
The IMF is making changes. With its core function of balance-of-payments lending waning, it may be happy to find new missions (e.g., currency and financial surveillance, and addressing the global food and financial crises) while it is looking to trim costs. On the substantive side, it has increased the voting share of developing nations. Though smaller than these countries wanted, the change makes the IMF among the first of the international organizations to institutionally recognize the increasing weight of the �emerging� economies.
WORLD BANK SEEKS EXPANDED ROLE TOO: A �NEW DEAL� AND MORE � The global commodities price stress shared center stage with the credit crisis at the IMF, but at the World Bank meeting, the rise in food prices grabbed the spotlight. The Bank has also seen its traditional function wane as developing countries increasingly turn to commercial credit markets. With the current crisis providing new grounds for relevancy, Bank President Robert Zoellick assumed an activist stance, calling for a �new deal� for global food policy, a new anti-corruption initiative tied to commodity windfalls, and the tracking of 1% of sovereign wealth fund (SWF) investments to poor countries. His �new deal should focus not only on� access to food� but also the interconnections with energy, yields, climate change, investment, the marginalization of women� and economic resiliency,� representing �a shift� to a broader concept of food� assistance.� His commodity-producer initiative � the �Extractive Industries Transparency Initiative Plus Plus� � is aimed against the corruption attending the sudden rise in financial inflows to poor country resource exporters. His call for channeling a portion of SWF wealth to Africa had to be carefully couched as an initiative to make such investment attractive to these funds rather than as pressure on them to invest for political reasons. In fact, the international community came together at these meetings in support of mutually supporting IMF and OECD projects to set guidelines for SWF activity that preclude political influence. The IMF is crafting a best-practice code-of-conduct for SWFs that requires they make investment decisions entirely on commercial grounds, and the OECD is crafting corollary guidelines for recipient countries to assure they won�t bar SWF investments on spurious national security or protectionist grounds.
ANOTHER UNCERTAINTY: TRADE POLICY � Looming in the background as the global community called for greater cooperation was a new setback for the U.S.-Colombia Free Trade Agreement. The White House moved to force a vote by submitting implementing legislation without the agreement of the House leadership. Thereafter, the Democrats under Speaker Nancy Pelosi (D-CA) succeeded in taking procedural action to alter the �Fast Track� requirement of a yes or no vote within 90 working days. This action has implications for U.S. trade policy beyond the Colombia accord. First, it may well mean that there will be no congressional action on FTAs this year. Second, it is a jolt to negotiating partners who can no longer feel assured, as they have for three decades, that if they made enough concessions to win White House agreement on a trade deal negotiated under trade promotion authority, that deal would come up unchanged for a vote in Congress. With the timing requirement removed, Pelosi has no stated plans to hold a vote this year. She has accused the President of breaking protocol by submitting the bill without consulting and winning approval from the congressional leadership. The White House counters that it waited until the last possible day to assure a vote this year.
The FTA uncertainty intersects the continuing uncertainty over the WTO Doha Round. There, progress remains only incremental, with a ministerial meeting now pushed off to May. Yet, as stressed by every leader at the IMF/World Bank meetings, a Doha success is crucial for the world economy and global cooperation in other arenas. With such responsibility riding on them, Geneva negotiators, if the needed compromises remain elusive, are likely to extend themselves whatever more time they require.
*****
International Business Government Counselors, Inc. (IBC)is one of the most experienced and prominent international government relations firms in the United States. Clients include major North American, Asian and European multinational companies. For more information, contact James D. Regan, Senior Vice President, jregan@ibgc.com
