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Lessons from Europe for the G20 and the world economy
This week, on 15 and 16 of February, the finance ministers and central bank governors of the world’s largest economies will meet in Moscow at a delicate time for the world economy: While the existential fears sparked by the global financial crisis and the ensuing tensions in the eurozone may be receding, the global outlook remains uncertain and the temptation to ignore the lessons of the past is spreading
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his week, on 15 and 16 of February, the finance ministers and central bank governors of the world’s largest economies will meet in Moscow at a delicate time for the world economy: While the existential fears sparked by the global financial crisis and the ensuing tensions in the eurozone may be receding, the global outlook remains uncertain and the temptation to ignore the lessons of the past is spreading.
As it assumes the presidency of the G20, the group of the world’s biggest economies, Russia is taking on a weighty responsibility — that of maintaining the pressure for reform and warding off the twin threats of complacency and false remedies at a time when the cement binding the G20 is showing signs of wear.
If there were one lesson to be drawn from the cascade of crises that have swept the industrialised world over the past five years, it is the lesson that when sovereign debt reaches a tipping point, it can trigger a collapse of confidence in the affected state which, if left unaddressed, may push this state into illiquidity or even insolvency. Without a credible fiscal policy, no state is viable in the long term.
And because confidence is hard-won and easily lost, it was right for the G20 to make sound public finances its priority.
Today, however, sovereign indebtedness among the most mature economies of the G20 still towers alarmingly high. It is expected to reach 100 percent of gross domestic product this year, according to the International Monetary Fund.
In the G7, this ratio has risen by 75 percentage points since 1980 to reach 120 percent of gross domestic product (GDP) at present. Debt on such a scale is not just a threat to financial stability but, as the economists Kenneth Rogoff and Carmen Reinhart have demonstrated, a hindrance to growth too. Common sense and economic theory agree: Such record peace-time levels of public debt are deeply unhealthy.
I am therefore very grateful to the Russian presidency for keeping this issue at the top of the G20 agenda. We agreed at the Toronto summit to halve public deficits by 2013 and stabilise our debt by 2016. This commitment must be met, even if this requires fresh fiscal measures. For how can we expect our economies to inspire confidence if we are incapable of meeting self-imposed objectives? Credibility is key in economic policy.
Indeed, we should be more ambitious still and set ourselves new objectives beyond the horizon of 2016. European Union member states are already bound to bring their debt below 60 percent of GDP as set in the EU’s fiscal rules. Adopting equivalent goals at the G20 level would emphasise our determination to combat excessive debt and help restore confidence in our economies.
And why not apply it to industrial, developing and emerging nations alike? Even if more mature economies have been in the spotlight lately, developing nations are not immune to debt crises. Solid public finances provide the best buffer against external shocks. This is one of the core lessons to be drawn from our experience in Europe.
Sustained structural consolidation in our European economies has coincided with a nearly continuous fall since before the summer of last year in refinancing costs for the sovereigns most affected by the crisis. Despite a challenging economic environment, the European Commission predicts that the overall budget deficit for the eurozone will fall to the reference value of 3 percent of GDP this year, in line with the EU’s fiscal rules and, incidentally, with the Toronto commitments on deficit reduction.
Such a fiscal performance is quite remarkable in the difficult global context. By comparison, both Japan and the US had budget deficits in excess of 8 percent of GDP in 2012. Our European success, however, did not come about by accident. It is the result of the eurozone’s policy of tackling its debt crisis at the root and eschewing short-term symptomatic treatments, such as debt mutualization or fiscal stimuli, in order to focus on the structural causes of the crisis.
This structural approach to crisis management in Europe has not just had an impact on public finances, but has made our economies more competitive — a precondition for sustainable growth. All eurozone member states currently under an assistance program saw unit labor costs fall in 2012 and are therefore better positioned to compete on global markets today.
The large balance-of-payment deficits that were characteristic of the weakest economies at the outset of the crisis have been falling at a fast pace and are turning into surpluses. Having achieved a structurally balanced public sector budget last year, and currently enjoying robust domestic demand, Germany is actively supporting this positive development.
The sustained reform effort undertaken by national governments with the support of the eurozone authorities has set in motion a virtuous cycle that is boosting confidence in the region.
While Europe is successfully repairing itself, the G20 as a whole is standing at a crossroads. Fundamental questions are being raised about the future frameworks of monetary and fiscal policies among the group’s members. In more mature economies, central banks’ balance sheets have expanded significantly throughout the crisis.
The temptation to take a short cut on the way to economic recovery and financial repair by relying on monetary policy or competitive devaluations has become as real as it is dangerous. Discussions about exchange rates routinely take place in the G7 and G20. But as we have all agreed in our published statements in the past, these rates should reflect the fundamentals of our economies. Competing efforts to weaken our exchange rates — what some have dubbed a “currency war” — would leave only casualties in its wake and no victors.
There are two things we should not forget: This crisis is one of confidence, and the weaknesses in public finances that have come to the surface in its wake are structural, not cyclical, in nature. Any attempt to restore confidence without addressing these deep structural causes is ultimately bound to fail.
Beggar-thy-neighbor policies can assume many guises, all of them damaging in the long term. A race to the bottom in corporate tax rates, with the goal of attracting a bigger share of what would soon become a dwindling global tax pool, would be another example.
Such policies are not just cynical but also self-defeating as they play into the hands of the multinational companies that are using legal arbitrage to reduce their tax bills down to shockingly low, irresponsible levels.
Instead, G20 members should cooperate much more closely in ensuring that all international businesses not only pay their fair share of taxes, but also that they do so in those markets and societies where they generate their profits.
Germany has offered its support to the OECD initiative on closing international tax loopholes and we are looking forward to seeing the Russian presidency make this issue another of its priorities.
Indeed, what better forum than the G20 to address such challenges of cross-border cooperation, where no state or government could hope to achieve lasting success on its own anymore? It is therefore right to convene in Moscow now and join forces in this ongoing undertaking.
The writer is Germany’s Finance Minister.
