China’s rise requires new formation

By Stewart Fleming

Date: 16/06/05

On 22 September 1985, the ten most powerful economic policymakers in the world - the finance ministers and central bank governors of the five richest industrial countries - huddled together in a conference room in New York's Plaza Hotel.

Pressured by US treasury secretary James Baker, they issued a statement favouring an orderly devaluation of the dollar and launched a period of intense international economic policy co-operation, including joint intervention in foreign exchange markets and co-ordinated movements in official interest rates.

Fast forward to 2005. Once again the US economy is burdened by huge deficits, which dwarf the mid-1980s figures. The budget deficit is 4% of gross domestic product (GDP) and the current account deficit is heading for almost $900 billion next year, 6.7% of GDP. And there are fears that reducing these deficits could trigger a hard landing and a global recession.

But today the Group of Seven (G7) industrial countries has been paying at best lip-service to the idea of economic policy co-ordination to try to manage the orderly unwinding of these economic imbalances. For some, this is because such co-ordination is not necessary. Others say that in today's complex global economy it cannot be achieved.

But the fact that representatives of the major currency blocs are gathering, just below the level of finance minister, suggests that there is a third explanation. It is recognised that the G7 is now the wrong forum for such co-operation. If so, the meetings of officials from the major currency blocs could be a step towards the creation of an alternative grouping, which could be expanded later to include countries such as India and Brazil.

It is not a new idea. The restructuring of the G7 was recommended in a report published last year titled International Economic and Financial Co-operation: New Issues, New Actors, New Responses. Its authors included the former top British Treasury official Nigel Wicks.

The report called for the creation of a new forum to focus on balance of payments adjustment dubbed the 'G4'. It would operate alongside the G7, which would continue to deal with multilateral institutions such as the International Monetary Fund (IMF) and the functioning of the global financial system.

Its members, the report said, should come from the US, the eurozone, Japan and China, and their job would be to "co-ordinate national policies so that balance of payments adjustment does not damage global growth". This was necessary, it added, because the G7's "ability to carry out its traditional financial and economic role is already ebbing and will continue to ebb in the years ahead". Why ?

International economic policy co-operation within the G7, when it worked, usually involved getting agreement from a few US allies. In the 1980s these were Germany and Japan. They had huge incentives to work with the US, not least because they enjoyed American protection from strategic threats posed by the Soviet Union and China. The G7 players also had the ability, as nation states, to deliver on their promises.

The landscape is different today. The Soviet threat has gone, diminishing the incentive for Europe and Japan to accept US leadership. The EU has a single currency, the second most important in the world. But it lacks the political underpinnings to deliver on macroeconomic policy promises. And independent central banks would have to be persuaded, not pressured, into policy co-ordination.

In Washington, the Treasury Department has laboured under weak leadership throughout the George W. Bush era. The White House's reflexes have been domestic, not internationalist.

And without the active participation of China, which is not a G7 member, international economic policy co-operation is just an empty phrase. China is now the world's third largest trading nation. Its massive purchases of dollar assets (its mainly dollar denominated foreign exchange reserves hit $600 billion last year) are aimed in part at maintaining a fixed exchange rate with the US and keeping its export-driven development policy on track.

But with the US savings ratio at close to zero and with a huge budget deficit to finance, inflows from China are helping to keep the American economy afloat.

Unlike Germany and Japan in the past, however, China is a strategic rival for the US, not an ally. So it is more difficult to deal with. On Tuesday (14 June) before the European Parliamant, Caio Koch-Weser, Germany's deputy finance minister, who is deeply engaged in the dialogue with China, warned that the US should be careful in its attempts to pressure China to revalue the yuan. "You have to understand how you dialogue behind the scenes with China," he said.

Officials have been watching with anxiety as US Treasury Secretary John Snow and the Congress ramp up the pressure on China to revalue its currency. China, they believe, does not respond to threats such as congressional proposals for punitive tariffs on imports.

Since the September 2003 IMF meeting in Dubai, China's policymakers have been drawn towards the top tables of economic governance. They are invited to have breakfast or lunch with the G7 finance ministers when they meet. The G4 talks are part of this process.

From the eurozone perspective they are seen as an opportunity to try and persuade China that it is in its own interests to undertake economic reforms and accept that its greater weight in the world demands that it take on greater responsibilities.

On this view, talking to China, not bullying with threats of retaliation, is the least risky approach at a time when the global economy is so vulnerable..

Author supports the creation of a new international forum for the co-ordination of global economic policy. This Group of Four, or G4, should include the Eurozone, the US, Japan and China and should work alongside the G7 which, he says, is the wrong forum for such co-operation.

CEPR: Reports and books: International Economic and Financial Cooperation: New Issues, New Actors, New Responses [summary]. http://www.cepr.org/pubs/books/cepr/booklist.asp?cvno=P171

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