Stalled Post-crisis Reforms Must Be Restarted

--structural reform is necessary (deleverage, tax, rebalance)

--centralized financial system is needed (IMF representation/governance)

Stalled Post-crisis Reforms Must Be Restarted

Mohamed A. El-Erian

• In the early part of this crisis, swift coordinated global policy action saw a painful economic collapse replaced by employment gains and greater financial stability.
•  However, the marked failure to continue coordinated action reflects two critical weaknesses that now must be taken seriously: an insufficient appreciation of the mix of post-crisis forces; and a growing void at the center of the international system.
• For the IMF this means acting on long-standing governance and representation problems – and doing so by going well beyond what is being currently contemplated.

This article was originally published on FT.com on October 7, 2010.

When the financial crisis erupted, policymakers around the world gathered in Washington for the International Monetary Fund’s annual meeting, and responded impressively. They won the war against global depression by showing an unusual and much-needed common purpose. Now those returning to meet at the IMF in Washington this weekend, and especially policymakers from industrial countries, need to do much more to secure the peace.
 

In the early part of this crisis, swift coordinated action saw a painful economic collapse replaced by employment gains and greater financial stability. The recovery in industrial countries was aided by an impressive rebound in emerging economies. Having entered the crisis with strong financial conditions, these developing nations demonstrated a resilience unthinkable a few years ago.

Unfortunately, declarations of victory proved premature, especially for the U.S. In the middle of 2010 job creation slowed, talk of a “recovery summer” faded and growth projections were revised downwards. Even worse, global coordination through the IMF and the Group of 20 industrialized nations gave way to narrow domestic agendas. More recently, an escalating round of currency tensions is rightly being viewed by markets as “a race to debase,” which will ultimately do great damage to the world economy. This marked failure to continue coordinated action reflects two critical weaknesses that now must be taken seriously: an insufficient appreciation of the mix of post-crisis forces; and a growing void at the center of the international system.

On the first, three domestic policy slips were made by industrial countries in the immediate aftermath of the crisis. We did not respond forcefully enough to the deep structural distortions accumulated during the age of leverage and debt entitlement. The disruptive nature of balance sheet contamination (and related overhangs in debt and housing inventory) were not fully appreciated. And there was little understanding that the financial system would return to normal much more quickly than the real economy, aggravating an already huge rift between Main Street and Wall Street.

To make progress, industrial country governments must break out of their cyclical mindsets and act decisively on the structural front. Fiscal stimulus and quantitative easing, while relevant, are not enough. A comprehensive package of measures is needed, including pro-growth tax reform, infrastructure investment, housing finance reform, more support for education and research, expanded social safety nets, job retraining and medium-term fiscal rules.

Emerging economies, and especially those major markets such as China, must help too. They should be more resolute in shifting the emphasis of their policies from just the producer to the consumer. They must also strengthen pension systems and other social sectors (particularly health and education), harnessing the purchasing power of their growing middle classes.

However, even that will not be sufficient if the growing void at the core of the global system is not fixed. Multilateral institutions, and especially the IMF, must step up to fill it. These institutions have unique human talent, and they are structurally more adaptable and agile than national bureaucracies. Yet they too must be reformed if they are to deliver.

For the IMF this means acting on long-standing governance and representation problems – and doing so by going well beyond what is being currently contemplated. Europe must show leadership and allow a much-delayed redistribution of IMF board seats and voting power. Its insistence on maintaining outmoded entitlements serves only to undermine our challenged global governance. Without greater legitimacy the IMF can do little to inform and influence the behavior of individual countries. Its analysis will fall on deaf ears, and its ability to advance peer reviews and policy coordination will be damaged.

Without these steps, growth will continue to disappoint, unemployment will become ever more structural in nature, and today’s currency tensions will turn into tomorrow’s currency wars. History books will report with admiration on the crisis management phase. Unless policymakers hear a loud wake-up call this weekend, these books will be a lot less generous about the management of the post-crisis world.