Finding common ground

In a two-part essay, in these columns on July 31-August 1, 2018, I had laid out three multilateral challenges facing the world: a) the need to fix the global financial system, b) activating the WTO to spur world trade and settle disputes and c) the need to agree on a global climate change accord. To this, we can add a fourth challenge: need of a coordinated effort to face global pandemics like the current COVID-19. I had argued that these situations are global public goods which are in urgent need to be supplied: a robust global financial system, an active and independent WTO, a fair and inclusive climate accord and now, pooled efforts to find a vaccine for the SarsCov2 virus. However, these public goods are also stuck in a classic prisoners' dilemma situations where all countries are pursuing individual benefits rather than collective benefits. (This is certainly true of the three public goods discussed in my earlier article. As for the vaccine, it is perhaps too early to comment and hence we will focus our discussions here to the three older public goods.).

Two years have passed since I wrote of the three-fold challenge facing the global community. We are again faced with a global pandemic, which will probably have a more lasting all-around effect than the 2008 financial crisis. It will, therefore, be useful to revisit the issue of global financial stability, which needs a solution even more urgently today. In this article, we will discuss the threat to the global financial system arising from the pandemic and the role of the G20. Let us do so from a NIE+ framework.

COVID-19 recession

As the pandemic has unfolded, all economies, developed and emerging, have been affected. Growth rates have plummeted and economic activity has stagnated because of the repeated lockdowns. Manufacturing has also come to a halt. What is needed is coordinated monetary and fiscal policies among the leading economies of the world so that the global financial system is protected from obvious vulnerabilities. Governments and central banks must be in sync to overcome one of the worst recessions since the Great Depression of the 1930s.

It must also be kept in mind that developed economies have deeper pockets and have responded with large fiscal packages, emerging economies and less developed economies would not have the same capabilities. The World Economic Forum (WEF), in a report released in May 2020, has underlined the asymmetry in the response of the developed economies and others. The report said that:

"……while financial system resilience, fiscal support, regulatory flexibility and liquidity provision to date have helped ensure that the financial system is supportive of economic recovery, a more protracted slowdown may present new risks to the financial system. Whereas most advanced economies are addressing emerging recessions with large fiscal packages, many emerging-market and developing economies lack the fiscal space to adequately respond. Moreover, since the beginning of the crisis, investors have fled from emerging markets, with portfolio outflows exceeding those during the GFC and other periods of major stress,"

We are therefore faced with a collective action dilemma, which needs to be overcome with concerted efforts so that the global public good (a stable global financial system and return to pre-COVID growth rates) can be supplied. In the context of the global financial crisis, we may recall that the G20 was handed the responsibility to coordinate the actions of governments and the central banks and calm the financial markets. While the challenges in the wake of the pandemic are different and banks are not at the centre of the problem, they still have an important role. Not only that, but the global financial system may also be vulnerable to the challenges arising out of the pandemic.

G20 and today's challenges

Recall that Paul Martin (then FM of Canada and later PM) and Larry Summers (then US Treasury Secretary), had first proposed the formation of the G20 in late 1990s, in response to a series of financial crises that first hit the emerging markets in the late 1990s, the Mexican Peso Crisis, the 1997 Asian financial crisis and the collapse of the hedge fund Long Term Capital Management in the US in 1998. It was felt that G8, the then-dominant grouping was too centred on the US and Western Europe and economic activity was slowly shifting to Asia. Even the Bretton Woods institutions such as the World Bank, IMF and GATT (now WTO) would be unable to provide global financial stability. The primary objective of the G20 continues to be global financial stability, though the mandate has become much broader since 2008 to include the global economy, energy security, agriculture, employment and even travel and tourism. The G20 covers 90 per cent of the world's GDP, 70 per cent of the world's population and half of the geographical area.

But has the G20 been up to the task? Has it been able to meet its objectives or is it a mere talking shop? Or has its agenda become too unwieldy? If we look at the action points of the recent G20 meeting held in April 2020, in wake of the COVID-19 pandemic, it has provided the right pointers. The communique reads as follows:

"The Communiqué merely aims to present the immediate and exceptional measures to be taken internationally and domestically against the financial impacts of COVID-19. The Communiqué welcomes the important steps already taken by the International Monetary Fund ("IMF"), the World Bank Group ("WBG") and other financial institutions ("IFIs") to help countries in need.

Action Plan includes; (i) delivering a comprehensive IMF support package, implementing urgently the support proposed by the WBG and multilateral development banks, (ii) addressing debt vulnerabilities in low-income countries and (iii) enhancing coordination among international organizations to maximize their impact and optimize the use of resources."

While the action plan has made all the right noises and the substantial resources of the IMF and World Bank have been proposed for deployment to fight the disease and support the financial system, something seems to be lacking. And I believe that it has much to do with what Dunning calls 'social or relational capital' among the group members. For one, the group is composed of countries with very different financial and health systems and with very different imperatives. Further, there is no follow up of decisions taken and mechanisms to ensure that the low-income and debt stressed countries do get the support at the right time. Even in the best of times, it is difficult to believe that dyads of countries (say Argentina and South Korea) in fact consult each other or even have deep cultural, social and economic ties. It seems that the G20 is driven mostly by the richer countries (the G20 relies on the OECD, a grouping of developed countries for secretarial support). Ultimately, each member has to look out for itself.

As a result of this wide variety among the G20, we see a duality in the actions, which has been alluded to above: the relatively rich countries, have been quick on their feet and have managed to commit large funds for a fiscal stimulus. Not only that, but the banks on Wall Street are also in a relatively better position than those in emerging markets like India, where they are weighed down by non-performing assets on their balance sheets (though the NPA problem in India pre-dates the COVID-19 pandemic). Other factors working against emerging markets include the massive decline in commodity prices stemming from a simultaneous supply-and-demand shock, disruptions in supply chains, dramatically reduced exports given recessions in advanced economies and, of course, the need to implement COVID-19 containment measures domestically. Add to this, issues such as the weak public health infrastructure in emerging economies in G20 as compared to the richer countries, and we see the limits of the G20. It is therefore not surprising that the economic and financial crisis in emerging market and developing economies may be more severe than in advanced economies.

The duality referred to above was also seen in the support granted to SMEs and larger businesses, which is considered as a key to maintaining both employment and financial stability, In the WEF meeting referred to above, many were encouraged by the speed with which advanced economies rolled out support packages to firms. However, concern was expressed that the size of packages may prove insufficient for the duration of the crisis; that disbursement may be slower than is needed; that not all firms in need would be targeted; and that such programmes may be overly reliant on debt financing. These concerns were expressed particularly in emerging economies and to prevent short-term liquidity problems from becoming solvency issues, availability of funds for SMEs and larger firms must be provided as the crisis persists. Further, we know that SMEs have greater working capital needs and short windows of cash on hand, and hence, programmes must be designed to ensure rapid disbursement of funds through simple and digital channels. This can happen only with a sound financial system, where again the richer countries may be better off.

Pointers from the NIE+ framework

Before going on, a brief statement of the NIE+ framework would be useful. In the last two articles, I introduced the concept of social capital in some detail and then integrated it into the New Institutional Economics (NIE) framework. I called this the NIE+ framework. Briefly, the argument runs as follows: social capital reduces the transaction costs and information costs within a collectivity, which makes it easier for institutions to supply the public good. Hence, the impact of social capital on the supply of public goods (in our case, a stable and robust global financial system) is mediated through institutions. Institutions are nothing but the incentive structure or the rules-in-use that allow the public good to be supplied.

To be sure, social capital at the state level has been studied by Naoki Yasuda. His study had argued that State-level social capital arises from the home governments' positions in intergovernmental networks and offers information and control benefits to MNCs. J.H. Dunning (2011), as noted above, also invoked the idea of social or relational capital among WTO members to analyse the future of the WTO.

My hypothesis is that levels of social capital in G20 are low and need to be strengthened through deeper engagements in social, economic and cultural fields. As a result of this, there is insufficient information flow, leading to higher transaction costs of decision making. For example, substantial funds are being expended in the development of the vaccine against the SarsCov2. Most of the funding is being done by the richer governments and the big pharma companies of richer countries (China and India are exceptions). Most other countries or their banks don't have the resources to commit to even reviving the industry or providing social security, leave alone developing a vaccine. The G20 could tie-up with organisations such as GAVI or other philanthropic organizations to ensure a systematic supply of the vaccine once it develops. This will deepen social and relational capital among the G20.

Such initiatives are not being carried out by G20 because it is largely a talking shop where only the leaders and ministers meet. A first step to do so would be to have a permanent secretariat (or two secretariats). This was in fact proposed by the then French President Sarkozy in 2010 (one Secretariat at Paris and the other at Seoul), but there was no agreement on this. This is a medium to long term intervention and will go a long way in raising social capital among the organization, which, in turn, will lower the transaction costs of decision making. Another advantage that a Secretariat will confer is that there be greater and more frequent interaction between the countries and a better appreciation of the positions of various member countries. Further, sub-committees could be set up to go into more details of the problems being faced in respect of the financial sector across the world (e.g. issues of working capital of SMEs, recapitalisation of weak banks, the merger of weak and strong banks, safeguards to prevent contagion of stock market crashes etc.)

Secondly, the richer countries must not divert all responsibility to the IMF, World Bank, WTO or WHO. There must be additional commitments to providing financing for SMEs, weak banks and

a transfer of technology, particularly in the fintech area and even medical equipment.

Thirdly, the G20 is spread too thin over a number of issues. It needs to return to global financial stability as the core issue and can take up only related issues that impact this stability (like the current COVID-19 pandemic). As mentioned above, additional funds need to be set aside for weak banks in emerging markets so that there is a free flow of credit and a return to the pre-COVID levels of manufacturing and economic growth.

Conclusion

In short, we need to have a supply of the 'global public good' such as a stable global financial system. For this to happen, we need to ensure that global collective action dilemmas are overcome, which in turn requires that incentive structures are tailored to suit the needs of all countries involved. The responsibility for this must lie with the G20. But the G20, in its current form, is simply not up to the task. It needs a healthy dose of social or relational capital, just as the world needs an early dose of a vaccine against the SarsCov2.

The writer is an IAS officer, working as Principal Resident Commissioner, Government of West Bengal