Smart Governance: Solutions for Today's Global Economy
IMF News, December 5, 2013
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- Authors: Nemat Shafik Deputy Managing Director
- Published: December 5, 2013
Overview
- Speech by Nemat Shafik, Deputy Managing Director, International Monetary Fund, delivered in Oxford, United Kingdom, December 5, 2013.
- Purpose: make the case for "smart governance" and outline how global economic governance and policy coordination should evolve to manage globalization.
Making the case for smart governance
- Global shocks reveal shortcomings of international rules and institutions; failures in banks and capital markets can spread through the international financial system.
- Global challenges cited: climate change, nuclear weapons proliferation, health pandemics—"What happens anywhere affects everybody—and increasingly so."
- Cites Martin Wolf’s argument for extraordinary creativity in providing global public goods and managing overstretched and at-odds states.
A world in transition — key facts and trends
- Emerging and developing economies already make up more than 50 percent of global GDP (on a PPP basis); ten years from now this number is expected to increase to 64 percent.
- Cross-border bank claims grew from $6 to over $30 trillion between 1990 and 2008.
- Global merchandise exports of goods and services increased from $4 trillion to $20 trillion (period up to 2008).
- Typical manufacturing company relies on inputs from more than 35 different contractors from around the world; for some companies (e.g., car and airplane manufacturers) this number can range in the tens of thousands.
- Despite rising interconnectedness, global governance did not expand commensurately prior to the 2008 crisis.
Crises as opportunity — historical examples
- Historical link between crises and governance reform:
- Post-World War I: creation of the League of Nations.
- 1920s hyperinflation: efforts to restore the gold standard.
- Great Depression and World War II: creation of the United Nations, IMF, World Bank, and GATT (now WTO).
- U.S. 1907 financial crisis: creation of the Federal Reserve.
- Great Depression: Glass-Steagall Act in 1933, separating commercial and investment banking for more than sixty years.
- Asian crisis: Chiang Mai Initiative (regional currency swap arrangements).
- The 2008 global financial crisis exposed an "undersupply of global governance" and created a window of opportunity for governance reforms.
A mixed score card — governance reform since 2008
- Reforms split into three categories: coordinating macroeconomic policies, fixing global financial regulation, and strengthening regional and global safety nets.
- Coordinating macroeconomic policies:
- Six major central banks announced a coordinated cut in policy rates in October 2008.
- The U.S. Federal Reserve and 14 different monetary authorities established temporary U.S. currency swap arrangements.
- The first ever G20 Leaders’ Summit took place in November 2008, leading to coordinated fiscal stimulus and a pledge to refrain from protectionism.
- Recent slowdown in momentum for policy coordination; challenges include unwinding unconventional monetary policies and managing spillover effects and debt burdens accumulated during the crisis.
- Global financial regulation:
- Financial Stability Board (FSB) created in 2009 with a mandate to develop and promote effective financial regulation.
- Progress: strengthening system-wide oversight, increasing capital and liquidity buffers, promoting the exchange of financial information, implementing macroprudential policy frameworks, and facilitating cross-border resolution.
- Remaining challenges: ending the too-big-to-fail problem, reforming shadow banking, making derivatives markets safer, reversing financial fragmentation in the euro area, and moving towards a full banking union.
- Strengthening regional and global safety nets:
- Trebling the size of the IMF’s resources and increasing the allocation of SDRs were measures taken to strengthen the global financial safety net.
- Europe: creation of the European Stability Mechanism (ESM) and the ECB’s Outright Monetary Transactions (OMT) framework.
- Regional financing arrangements reinforced: Chang Mai Initiative and the Eurasian Economic Community Anti-crisis Fund.
- IMF governance reform: the 2010 agreement on quota and governance reforms has not yet been implemented; "two of three required conditions have been fulfilled," but further support is needed for the final condition to allow the reform to take effect.
- Overall assessment: a "somewhat mixed" report card; urgency needed to keep reform momentum alive while political opportunity remains.
Soft versus hard policy coordination
- "Hard" policy coordination:
- Characterized by quid pro quos, focus on specific and tangible outcomes.
- Examples: initial G20 Leaders’ Summits and coordinated fiscal policy response; creation of the FSB.
- "Softer" coordination:
- Process-based, facilitating exchange of views and information without expectation of substantial outcomes.
- Example: regular discussions among central bankers at the Bank for International Settlements (BIS).
- Complementarity: soft arrangements can sustain dialogue in quiet times and provide a framework for harder cooperation during crises.
Soft versus hard governance
- "Hard" governance:
- Treaty-based, legal obligations, independent institutions (UN, IMF, World Bank, WTO).
- Advantages: strengthens credibility and legal enforcement powers.
- Drawback: slow to establish and adapt to changing circumstances.
- "Soft" governance:
- No international legal personality or obligations (G20, BRIC groupings, FSB, FATF).
- Advantages: more flexible and quicker to put in place.
- Drawback: limited ability to enforce commitments, potential challenges for long-term relevance and effectiveness.
- Private sector governance examples: Collective Action Clauses (CACs) and IFRS.
A mosaic of solutions — combining hard and soft governance
- Future global governance may be an ecosystem of complementary hard and soft elements, issue- and context-driven.
- Examples of mixed approaches:
- Trade: WTO dispute resolution ("teeth") complemented by mega-regional agreements addressing standards and non-tariff barriers.
- Euro area crisis: hard governance from IMF and ECB, soft governance from the Eurogroup; existing European arrangements worked in peace time but were not well suited for crisis decision making.
- Financial regulation: IMF’s mandatory Financial Sector Assessment Program (FSAP) every 5 years (hard surveillance) complemented by FSB peer reviews every two years after an FSAP (soft governance).
- Risk noted: if hard institutions adapt too slowly, soft institutions may substitute rather than complement, potentially weakening the global governance system.
The case for IMF governance reform
- IMF’s historical adaptability cited: responses to the fall of the fixed exchange rate system in the early 1970s, the debt crisis of the 1980s, and the collapse of the Soviet Union in 1991.
- Factors in IMF’s relevance:
- Political governance structure that adapts slowly but does adapt.
- Independent staff and Articles of Agreement allowing a longer-term perspective.
- Integration of hard elements (mandatory surveillance) with soft elements (voluntary Reports on the Observance of Standards and Codes, facilitation of standards for sovereign wealth funds).
- Consensus-based decision-making enabling member countries’ perspectives to be heard.
- Argument: IMF governance should reflect relative positions of member countries in the global economy; approval and full implementation of the 2010 reforms is an important step.
- Political challenge: some countries will need to accept relative declines in quota and voting shares to ensure IMF strength and legitimacy for the entire membership.
Conclusion — policy implications and recommendations
- Momentum for governance reform and policy coordination has slowed since the initial crisis response.
- The current system is effective in crisis ("when there is a lot to lose") but less effective at galvanizing action in normal times ("when there is potential for mutual gain").
- Two modes of governance can be complementary:
- Soft governance: works when innovation is needed, there is time to act, and a subset of countries acting is sufficient.
- Hard governance: needed in a crisis or when global approaches and consistent enforcement are key.
- Recommendation: integrate soft and hard governance intelligently, use political opportunity when it appears, and be "smart about the governance we need" to achieve better outcomes for all countries.
As prepared for delivery by Nemat Shafik, Deputy Managing Director, International Monetary Fund, Oxford, United Kingdom, December 5, 2013.