Reforming Global Economic Governance: An Unsettled Order 9781351109277, 9780815363460, 9780815363477

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“Carlo Monticelli provides a unique insider’s perspective that combines the insights of a seasoned economist with the personal reflections of a concerned global citizen. A rewarding and enjoyable read for anyone interested in the causes and lessons of the global financial crisis!” Masood Ahmed, President, Center for Global Development “The author is an insider. When reading him on how the Europeans missed all opportunities by just looking inward, you oscillate between hilarity and despair.” Agnès Bénassy-Quéré, Professor, Paris School of Economics, University Paris 1 Panthéon-Sorbonne “There is no going back to the old multilateralism. Based on first-hand experience and sharp analysis, this book provides the economic and political-economy arguments to understand why this is the case, wrapped in a captivating narrative accessible to the non-specialist. Don’t miss it!” Erik Berglöf, Director, Institute of Global Affairs, London “An authoritative assessment of global economic governance at a time of pressing global challenges in an unsettled and fractious global order. A must, and a compelling read.” Amar Bhattacharya, Senior Fellow, Brookings Institution “Emerging market countries now play a more relevant role in the G20 and all the IFIs. With analytical rigour and an engaging style, this book analyzes the events and underlying reasons that brought about this radical change in global governance. Highly recommended.” Sri Mulyani Indrawati, Finance Minister of Indonesia “This book gives an inside story of how international financial architecture is created and reformed as advanced and large emerging market countries play power games.” Takatoshi Ito, Professor of International and Public Affairs, Columbia University “Combining an insider view with a multidisciplinary approach, this book offers fresh insights on why and how global economic governance has changed. A must read.” Nouriel Roubini, Professor of Economics, Stern Business School, New York University “Over the last decade, the international economic and financial landscape has changed much more than you think. This is the surprisingly convincing leitmotiv of this book. As a former official who has been involved in all the big issues from the inside, I did not expect Carlo Monticelli to be so candid and, in many ways,

so radical. The book is loaded with a myriad of facts and yet the reader will not get lost because the powerful underlying analysis constantly brings all the pieces into a coherent lot. It makes you think hard but the style is so smooth and engaging that you do it with intense pleasure.” Charles Wyplosz, Professor of Economics, The Graduate Institute, Geneva

REFORMING GLOBAL ECONOMIC GOVERNANCE

The architecture of global economic and financial governance has undergone a deep and pervasive reform in the last ten years, radically transforming international institutions and groups, such as the International Monetary Fund, the G7, and the G20. This book investigates the new, unsettled order which is now prevailing, driven by the change in the balance of power between advanced economies and key emerging market economies. Bringing together multiple strands of analysis, traditionally kept separate, Reforming Global Economic Governance: An Unsettled Order particularly explores the role of Europe within this changing world. The book documents and examines a broad range of events, building on methods from economics and other disciplines, as well as on the insights from the author’s personal involvement. This innovative approach allows the reader to ascertain the defining features of the reform: the increasing fragmentation of governance; the interconnectedness of its different elements; and the strong concern for inclusiveness. Furthermore, it presents analyses highlighting the controversial nature of the new order which underpins the current policy debate on international economic relations, including the resurgence of nationalism and trade conflicts. Through these explorations, this engaging book has direct relevance for the future prospects of international economic affairs. Offering a comprehensive view of these issues, this accessible text will appeal to scholars, insiders, and the general reader. Its detailed and thorough analyses will also be of great use to those studying economics, international political economy, and international relations. Carlo Monticelli is Vice Governor of the Council of Europe Development Bank. His career has straddled both private and public sectors, with positions including Deputy Director in the Research Department of the Bank of Italy; Head of European Economics, Deutsche Bank, London; and Head of International Financial Relations of the Italian Treasury. In this capacity he represented Italy in key international fora such as the G7, the G20, and the Economic and Financial Committee of the European Union.

Economics in the Real World

1. Education Is Not an App The Future of University Teaching in the Internet Age Jonathan A. Poritz, Jonathan Rees 2. The Privileges of Wealth Rising Inequality and the Growing Racial Divide Robert B. Williams 3. Neuroliberalism Behavioural Government in the Twenty-First Century Mark Whitehead, Rhys Jones, Rachel Lilley, Jessica Pykett, and Rachel Howell 4. The Rise of Big Government How Egalitarianism Conquered America Sven R. Larson 5. Money What It Is, How It’s Created, Who Gets It, and Why It Matters Sergio M. Focardi 6. The Political Economy of Fracking Private Property, Polycentricity, and the Shale Revolution Ilia Murtazashvili and Ennio Piano 7. Reforming Global Economic Governance An Unsettled Order Carlo Monticelli For more information about this series, please visit: www.routledge.com/Economics-in-the-Real-World/book-series/ERW.

REFORMING GLOBAL ECONOMIC GOVERNANCE An Unsettled Order

Carlo Monticelli

First published 2019 by Routledge 2 Park Square, Milton Park, Abingdon, Oxon OX14 4RN and by Routledge 52 Vanderbilt Avenue, New York, NY 10017 Routledge is an imprint of the Taylor & Francis Group, an informa business © 2019 Carlo Monticelli The right of Carlo Monticelli to be identified as author of this work has been asserted by him in accordance with sections 77 and 78 of the Copyright, Designs and Patents Act 1988. All rights reserved. No part of this book may be reprinted or reproduced or utilised in any form or by any electronic, mechanical, or other means, now known or hereafter invented, including photocopying and recording, or in any information storage or retrieval system, without permission in writing from the publishers. Trademark notice: Product or corporate names may be trademarks or registered trademarks, and are used only for identification and explanation without intent to infringe. British Library Cataloguing-in-Publication Data A catalogue record for this book is available from the British Library Library of Congress Cataloging-in-Publication Data Names: Monticelli, Carlo, author. Title: Reforming global economic governance an unsettled order / Carlo Monticelli. Description: 1 Edition. | New York : Routledge, 2019. | Series: Economics in the real world | Includes bibliographical references and index. Identifiers: LCCN 2018045626 (print) | LCCN 2018049984 (ebook) | ISBN 9781351109277 (Ebook) | ISBN 9780815363460 (hardback : alk. paper) | ISBN 9780815363477 (pbk. : alk. paper) Subjects: LCSH: Economic policy–International cooperation. | International finance–Law and legislation. | Economic development–Finance. Classification: LCC HF1359 (ebook) | LCC HF1359 .M6676 2019 (print) | DDC 338.9–dc23 LC record available at https://lccn.loc.gov/2018045626 ISBN: 978-0-815-36346-0 (hbk) ISBN: 978-0-815-36347-7 (pbk) ISBN: 978-1-351-10927-7 (ebk) Typeset in Bembo by Swales & Willis Ltd

To Francesca and Silvia The brain is wider than the sky: let your soul stand ajar, as forever is composed of nows.

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CONTENTS

List of figures List of abbreviations Acknowledgments Introduction and overview 1

Unsettling the balance of power

xii xiii xv 1 17

Many failures led to the crisis 20 The waning grip of the G7 23 The upheaval in the (relative) wealth of nations 27 The need for international cooperation 30 The serendipitous G20 34 No finger-pointing in Washington 38 Conclusions 41

2

Success and failures of the G20 The crowning of the G20 as the world-saver 46 Revamping macroeconomic coordination 50 The old issues of international coordination confront the G20 53 Overhauling the international financial architecture? 56 Cannes (and Los Cabos) hijacked by the European crisis 59 Russia and the overbearing return of high politics 63 The BRIC(S) and the G20 68 Conclusions 73

45

x

3

Contents

The reform of the International Monetary Fund

77

IFIs, their shareholders, and global governance: a multifaceted interaction 79 The withering of IFIs 83 Palingenesis 86 The (latest) IMF quota reform 90 The Seoul package and its implementation 92 There is more to influence than quotas 96 Paradigm regained: the persistence of the Washington orthodoxy 99 Conclusions 102

4

Multilateral Development Banks in fashion again

107

The birth of the MDB business model 109 More development (and more MDBs) in global architecture 112 Defending and enriching the mainstream view of development 115 More than affordable finance 118 Malaise and revival of the MDBs 120 The reform of the MDBs 123 The brand new MDBs 126 Evergreen tensions and dilemmas 132 Conclusions 136

5

Re-regulating finance

144

The international standards regime and the creation of the FSF 146 What’s in a letter? From the FSF to the FSB 150 The daunting tasks of the FSB 154 Halfway, half-empty, half-hearted, yet significant 159 Rule-taking behaviour 163 The exorbitant persistence 166 Conclusions 171

6

Europe and global governance The long tradition of punching below one’s weight 181 Missing a crucial opportunity: the G20 185 Missing a crucial opportunity: the IMF 186 The IMF and the European crisis 188 Three misconceptions 191 The European decision-making process does not help 195 The decline is not inevitable 199

178

Contents

xi

A more effective Europe is also good for the world 203 Conclusions 206

References Index

213 238

FIGURES

1.1 Current account balances and G7 communiqués 2.1 The age of diminishing expectations: global growth forecasts in successive issues of the IMF World Economic Outlook 4.1 Growth in China and India and the fall in world absolute poverty

26 67 134

ABBREVIATIONS

Af DB AIIB AsDB BCBS BRIC BRICS CEB CRA EC ECB Ecofin EIB EU FSB FSF GAB GDP IADB IBRD ICT IDA IEO IFC IFIs IMF IMFC LDCs

African Development Bank Asian Infrastructure Investment Bank Asian Development Bank Basel Committee on Banking Supervision Brazil, Russia, India and China Brazil, Russia, India, China and South Africa Council of Europe Development Bank Contingency Reserve Arrangement European Community European Central Bank Economic and Financial Affairs Council European Investment Bank European Union Financial Stability Board Financial Stability Forum General Agreement to Borrow Gross Domestic Product Inter-American Development Bank International Bank for Reconstruction and Development Information and Communication Technology International Development Agency Independent Evaluation Office International Finance Corporation International Financial Institutions International Monetary Fund International Monetary and Financial Committee Less-developed countries

xiv

Abbreviations

MDBs MDGs NAB NDB NGOs ODA OECD OTC PPP SDGs SDRs SIFIs SSBs ToRs UN WB WTO

Multilateral Development Banks Millennium Development Goals New Agreement to Borrow New Development Bank Non-Governmental Organizations Official Development Aid Organization for Economic Cooperation and Development Over-the-counter Purchase Power Parity Sustainable Development Goals Special Drawing Rights Systemically Important Financial Institutions Standard Setting Bodies Terms of Reference United Nations World Bank World Trade Organization

ACKNOWLEDGMENTS

On occasion, during the 2008 and the European sovereign crises, as an official of the Italian Treasury attending international meetings, I had the distinct feeling of being a fortuitous eyewitness to economic history in the making. The ensuing urge to report “my testimony” was tempered by the awareness that memoirs have a pernicious inclination to be exaggerated and self-righteous – or simply boring, unless one is a literature-Nobel-prize-winner prime minister. But the insights that the experience had offered me I thought should not be lost. A pungent mixture of amazement and concern provided the stimulus to embark on the long and arduous journey of research, building on methods from both economics and international political economy, which resulted in this book. The effort to use a style as accessible and enjoyable to the non-specialist as possible, while preserving rigour and precision, made the enterprise even more challenging. Another motivation to write about the momentous transformation in global economic governance was to lubricate the communication between the academic and the policy-making communities – this time having an official respecting the constraints posed by academic standards. Many fora provide opportunities for the two groups to interact and explicitly exchange views on the burning policy choices of the moment – think of the Bellagio Group gatherings, the seminars and conferences organized back-to-back to G7, G20, and informal Ecofin meetings, to name but a few. Yet, fruitful communication has plenty of room for improvement. In fact, during the most recent crises, discounting respectful politeness, policy proposals elaborated in academic circles typically gained minimal, if any, traction in the policy debate in striking contradiction with the intellectual calibre of the proponents – a circumstance that would warrant a rigorous scientific investigation. It is a pleasure to express my gratitude for direct help and encouragement for this work to Svein Andresen, Catherine Avraam, Richard Baldwin, Lorenzo Bini

xvi

Acknowledgments

Smaghi, Claudio Borio, Marco Buti, Bruno Cabrillac, Guillaume Chabert, Benoit Coeuré, Marco Committeri, Francesco Contesso, Carlo Cottarelli, Riccardo De Bonis, Luigi De Chiara, Barry Eichengreen, Filippo Giansante, Charles Goodhart, Randall Henning, Yi Huang, Alessandro Leipold, Sergio Lugaresi, Marco Magnani, Kristina Maslauskaite, Emmanuel Massé, Edo Omic, Pier Carlo Padoan, Patrizio Pagano, Ugo Panizza, Luca Papi, Miria Pigato, Salvatore Rossi, Fabrizio Saccomanni, Stefano Scarpetta, Marc Olivier Strauss-Kahn, Roberto Tedeschi, Daniele Terlizzese, Rupert Thorne, Cedric Tille, Gianni Toniolo, Margerita Topalli, Marc Uzan, Nicolas Véron, Ignazio Visco, Charles Wyplosz. Finally, in the acknowledgements it is customary for authors to confess that the completion of their project took much longer and required a much more strenuous effort than original envisaged; admit an intellectual debt to a much wider group of people than those they name for their direct help in the preparation of the manuscript; and finally apologize to their family for their guilty absence and foul mood. With no originality but with genuine truthfulness, I dress old words new and wholeheartedly underwrite all of the above. At end of this long journey, it is a pleasure to thank, deeply and devoutly, my wife for her unflagging support, encouragement, intellectual stimulus, and palpable interest for issues distant from her academic domain. Paris, November 2018

INTRODUCTION AND OVERVIEW

The world as we know it has come to an end: a new, unsettled order prevails in global economic and financial affairs. It took a crisis to act as a catalyst and precipitate the change in regime. But the transformation had fundamental causes; the financial turmoil that erupted in 2008 cannot be blamed or praised as the origin of the new order. In contrast to the last major reform in global economic governance associated with the Bretton Woods conference, the demise of the old regime was not marked by the setting up of a new, well-structured financial architecture with the consensus of the major countries. Rather, it came as a radical and pervasive change in the balance of power between the “old” players, led by the G7 club of advanced economies, and the key emerging market economies. This shift in power overwhelmed all international economic and financial relations: it radically modified the functions and modus operandi of the most important international groups, the G7 and the G20; it deeply altered the equilibrium among shareholders in the formal and informal control of existing international financial institutions; and it led to the creation of several new organizations: an institution to promote cooperation in financial regulation, two multilateral development banks, and various regional financial arrangements. The diffused and unsettled character of the reform in global economic governance requires a special analytical effort to detect its multifaceted consequences, recognize its relevance, and grasp its coherent nature, while acknowledging its inadequacies. This is precisely the task set for this book, which requires an eclectic approach: bringing together different strands of analysis traditionally kept separate; documenting and examining a broad range of events and institutional changes; building on methods from economics, international political economy, and political science. Further insights come from the author’s direct involvement in all the major international economic fora as an official of the Italian Treasury.

2

Introduction and overview

The analyses conducted in this book reveal the unsettled and controversial essence of the new order which, deliberately or unknowingly, underpins the current policy debate on international economic relations, including the resurgence of nationalism and trade conflicts. A proper evaluation of these tensions and the available policy options must rest on an understanding of the reform in global governance, considering its features in detail together with the dissatisfactions and mutual recriminations they give rise to. For this reason, the findings of this research, which examines how these features came about during the crisis, have a direct relevance for the future prospects of international economic affairs that goes beyond the historical interest of the events that changed the global order for good. Despite its focus on policy issues, this book offers a contribution to positive analysis, based on an eclectic but rigorous method, rather than taking a normative perspective on the “right way” to address the challenges facing international economic relations or venturing scenarios about the future of the global economy. Only the final chapter partly deviates from this principle. Following an historical and institutional analysis of Europe’s external representation, Chapter 6 advocates a stronger role for Europe in global economic governance, argues that this would be beneficial both to Europe and to the world as a whole, and puts forward a concrete and expedient strategy to pursue this objective.

A radical reform That global economic governance has undergone a radical transformation with the emergence of a new and unsettled, yet consistent and pervasive, global order is the first major finding established in this book. To the officials directly involved in international economic and financial relations, this conclusion is self-evident – an analytical confirmation of the change in the balance of power between major countries they daily experience in their formal and informal meetings at international groups and institutions. Yet, it stands in stark contrast to the assessment of several distinguished scholars of international relations:1 the absence of a novel international financial architecture and the resilience of the system, which did not collapse in spite of severity of the crisis, motivate their conclusion that no real change in governance occurred. True, continuity has been a remarkable feature of the functioning of global governance since the 2008 crisis. In addition to aspects of a cosmetic nature – such as the ecumenical choreography of the annual meetings of the International Monetary Fund – there are three substantive elements of continuity also evidenced in the present analysis: the persistence of the US dollar as the pivot currency of the international system; the endurance of the international standards regime in financial regulation; and the survival of the orthodox approach to macroeconomic policies outlined in the “Augmented Washington Consensus”.2 Yet, these important elements of continuity do not warrant the misleading conclusion that no fundamental change has taken place. Crucial transformations have occurred too, causing a regime break: the international supremacy of the US in

Introduction and overview

3

economic affairs has been repeatedly and successfully defied – suffice it to recall the US opposition to the emblematic establishment of a new, Chinese-led multilateral development bank. The voting power and the informal clout within international financial institutions have dramatically shifted in favour of the key emerging market countries, whose concerns are now as important as those of the G7 in defining the viable policy space. The proliferation of regional financing arrangements, despite their inadequacies, has questioned the G7-led monopoly of the International Monetary Fund in the provision of emergency financing during crises. Most conspicuously, the G20 has replaced the G7 as the key decision-making forum on global economic and financial matters. Its effectiveness in this function is arguably inferior to the achievements of the G7 in its heyday, as shown by its inability, which emerged soon after the acute phase of the 2008 crisis, to marshal consensus on many of the crucial issues facing the global economy. The drift of the G20 towards irresolution – which contrasts with the enthusiasm for its achievements expressed by some scholars3 – ultimately derives from its members’ marked heterogeneity in economic, political, and social systems, especially when compared to the relative cohesion of G7 countries. But this profound divergence on many fundamental aspects across systemically important economies is a fact which global economic governance has to come to terms with. Certainly it cannot be addressed with the return to a G7-based governance, more or less openly advanced in some quarters: since the early 1990s this group has lost more than a third of its share in the world economy, and its position is set to decline even further. Despite its shortcomings and mixed track record, the G20 is the forum where, since the 2008 Washington summit, all the key international decisions have been formally made or informally negotiated and politically agreed. The G20 has become the ultimate setting to seek the key countries’ consensus over the issues regarding macroeconomic policy coordination as well as the other institutions and processes that are part and parcel of the day-to-day functioning of global economic governance. The central role of the G20, with the influence it gives to emerging market countries, is the most emblematic aspect of the new order and crowns all the other transformations, including those described earlier. The ascendancy of the G20 in the reform of global governance can be seen as the conspicuous indication that “this time it’s real”, to quote the title of one4 of the many analyses contending the end of the pax Americana, the unipolar governance structure hinging on the accepted supremacy of the US. This overhaul in the balance of power that has materially changed global economic governance has not yet been accepted in principle and absorbed in practice by the US and the other advanced countries, which still resent it and try to resist it. For their part, emerging economies consider the transfer of power in their favour as insufficient and continue to question the legitimacy and representativeness of international financial institutions. The new global regime remains unsettled and incomplete, fuelling frustrations and mutual recriminations. These

4

Introduction and overview

impulses underpin the resurgence of nationalism and trade disputes, which threaten the liberal order and the global economic integration it allowed.

Key features of the new order Against the backdrop of the persistent tensions between advanced and emerging market countries, the limited capacity of the G20 to mediate and reach compromises with the outright endorsement of all its members has led to a proliferation of new regional arrangements and institutions in the economic and financial sphere, such as the Asian Infrastructure Investment Bank and the Contingency Reserve Arrangement. Even more emblematically, the G20 leaders’ summits have to coexist with the continuation of yearly summits of the G7 and with the high-profile annual meetings of the leaders of the BRICS – the club comprising Brazil, Russia, India, China, and South Africa, established in 1999 as the antagonist of the G7.5 The resulting fragmentation of many aspects of global governance is the first feature of the new order that is worth highlighting. Although some authors see fragmentation as a proof of the continuing absence of effective governance,6 most consider it as an inevitable component of a multipolar system, although with different gradations of optimism for the benefits it can bring to the effectiveness of global governance.7 The analyses in this book elucidate the functional links between fragmentation and the unsettled nature of the reform in global governance, establishing that fragmentation is not the result of the intention to relinquish the pursuit of a cohesive institutional architecture. Among the several facts that support this conclusion, one might recall emerging economies’ struggle to increase their influence in the Bretton Woods institutions and the attention they pay to the issue of congruity of frameworks across international institutions and arrangements, as illustrated by the co-financing operations between the Asian Infrastructure Investment Bank and the World Bank, and by the explicit reliance of many regional financing arrangements on the surveillance framework of the International Monetary Fund. In the absence of an off-the-shelf model of global institutional architecture adequate to the economic and financial multipolarity that has emerged since the 2008 crisis, the quest for a satisficing, rather than optimal, governance design has been actively pursued through a trial-and-error process. This process has given plenty of room to serendipity in establishing new arrangements and defining their characteristics. Fortuna is always imperatrix mundi, but more so at this particular juncture. Yet, the more marked role for happenstance has been compatible with an overall consistency because of the purposeful experimentation, which is the second remarkable feature of the reform in global governance. Driven by the twofold objective of defying the status quo and searching for a satisficing order, emerging market countries have directly established or pushed to put in place a host of new arrangements which share a common characteristic: their potential to become, as originally set up or duly adapted, the building blocks of a more accomplished and multipolar global architecture.

Introduction and overview

5

Clear examples of this approach are the foundation of the New Development Bank, with the explicit ambition to elaborate an alternative paradigm for development; the démarches to become members of the rule-making bodies which set the international standards of financial regulation; China’s success in having its currency inserted in the basket of the unit of account of the International Monetary Fund – the Special Drawing Right – and its advocacy for the latter to perform a more relevant function in the international monetary system. Moreover, such initiatives have been complemented by the emerging economies’ resolute efforts to develop the human capital necessary for an efficacious participation in international processes and institutions, as indicated by the conspicuous rebalancing in the nationality of both international organizations’ staff and senior international appointments. In addition to the pursuit of this dual objective, another powerful factor contributed to the internal consistency of the reform: the interconnectedness of the different elements that shape global economic governance, which has acted as a centripetal force balancing fragmentation. Interconnectedness, which is the third noteworthy feature of the reform, originates from several concurrent factors: the greater awareness of the importance of the interdependence between different domains of global governance that became apparent during the crisis; the function of the G20 as the hub for many interacting international groups; and the wider access to global networks, as well as the closer interactions between them, brought about by the direct involvement of new actors and stakeholders in international relations. This interconnectedness is ultimately a reflection of the increased interconnectedness of the global economic and financial system, which has reached an intensity unconceivable just a few years ago, driven by two major factors: i) the radical transformation in global value chains and trade patterns, made possible by the revolution in information and communication technology;8 and ii) the impressive deepening of global financial integration, in turn due to new technologies and to “swollen finance”9 – that is, the phenomenal expansion of the stock of financial assets both in absolute terms and in relation to global production. Nations are now more interdependent than ever. Thus, the disastrous scenario in which the outbreak of a global political crisis would precipitate the end of multilateralism and the “balkanization” of global trade and finance into regional blocs, would have even more disruptive effects than those of “the end of globalization”, as the period following the Great Depression was dubbed.10 And such a catastrophic outlook cannot be regarded as totally implausible, given the widespread and multifaceted backlash against globalization in spite of the fact that it enabled generalized improvements in welfare and an emancipation from poverty and disease like in no other epoch in history. The dissatisfaction with globalization has been an important element of the public debate on economic developments for many years, at least since the unexpectedly violent demonstrations at the World Trade Organization summit in Seattle in November 199911 – an outcry of radical dissent against the liberal

6

Introduction and overview

order that initiated the series of street protests that have ever since accompanied G8 summits (and G20 summits too, as soon as their relevance was perceived by the “antagonist” demonstrators). But the critique of globalization has not been confined to political radicalism. With different ideological and analytical underpinnings, it has also entered mainstream academic and policy discussions, leading to widespread calls for reform and political action to ensure that the economic benefits from globalization are more evenly distributed. The backlash against globalization and the relative debate, which is too articulated to be outlined here,12 are the fundamental motivations of the fourth notable feature of the reform in global governance: the concern for inclusiveness in economic growth. This is a sensitive and divisive issue, since the notion of inclusive growth is given different interpretations both across the political spectrum and among different countries. Yet, it is an inescapable element of the reshaping of global governance, because inclusiveness, both within countries and across nations, is by now recognized as an essential element for the sustainability of growth and the long-term viability of international arrangements.13 The goal of inclusive growth has even become an integral part of the orthodoxy of the major international organizations.14 Before moving to the overview of the material covered in the various chapters of this book, there is one final element that has to be mentioned because of its pervasive impact on national politics and international relations: the social media revolution. The study of the implications for social interactions and political processes of the enormous increase in the accessibility of information is in itself a specific topic of investigation that has been garnering growing scholarly attention.15 In particular, the analysis of the consequences of the social media revolution for the reform of global economic governance stands as a compelling area for future research. Here one cannot fail to highlight that the 2008 financial turmoil was the first global crisis ever to be managed with a direct public feedback on the policy response taking place in real time. These events have illustrated how strong the impact of social media can be on international interactions in the economic and financial field, and have shown that it unfolds through two main channels. The first one is the increased “impatience” of policy makers: the real-time scrutiny and feedback to which they are subject constrain their attitude in international relations. Politicians have to show (or they perceive they have to show) that their country “won”, or directly benefitted from, every single piece of international negotiation. Conversely, international cooperation thrives on the repeated nature of commercial, financial, and political interactions that offer scope for compromises across issues and over time.16 The second channel of influence originates from the much more diffused and unverified production of information. This innovation has been both hailed as a powerful instrument of empowerment and material democracy – the Arab Spring in 2012 is the example cited most often – and blamed as an insidious threat to a genuine public debate because of the frequent diffusion of fake news, in some cases with the deliberate plan to interfere directly with the political process – as

Introduction and overview

7

some argue was the case in the election of President Trump. With an informed and articulated analysis of this phenomenon still in the making, one can only flag the issue of the growing importance of public perceptions, not always based on true facts, in setting constraints on the politically viable outcomes of international relations, to the likely detriment of mutually beneficial international cooperation.

The ascent of the G20 The analysis starts with the symbolic event that marks the beginning of the reform in global economic governance: the unannounced participation of President Bush, on 11 October 2008, in the G20 meeting of finance ministers and central bank governors. That extraordinary session was convened because the crisis was so intense and systemic that it could only be credibly addressed with the direct involvement of the major emerging economies, even though they still had little influence over international institutions. Their direct engagement in the global policy response changed this for good and put an end to the G7-based global governance, paving the way for a new, multipolar order. After a brief review of the achievements of the G7 order, Chapter 1 examines its progressive failings, in particular its inability to exert peer pressure on its own members and to prevent the inappropriate macroeconomic policies and the inadequate supervision of the financial sector that caused the 2008 crisis. The waning grip of the G7 on world economic affairs, however, had an even more fundamental reason: the drastic reduction in its relative economic weight. Since the late 1990s, the G7 countries have lost a third of their share of world GDP, which returned below 50 per cent, as it was at the end of the 19th century. The gains of this epochal shift in economic power mostly accrued to a relatively small number of countries, with three – China, India, and Brazil – benefitting from about two-thirds of the fall in the G7 share of the world economy. The loss in effectiveness of the G7-based system of global governance was thus accompanied by a progressive decline in its legitimacy. The inadequacy of the G7 became apparent just when effective international cooperation became all the more crucial because of deeper economic and financial interdependence. The explosion of the crisis provided the key emerging market economies with the opportunity to demand a more important role in global governance to which they had long been aspiring. Due to a series of serendipitous events, chronicled and analysed in detail, the G20 was the setting where this demand was most forcefully expressed. It became the group around which the reform in global governance was centred with a marked shift in power towards emerging economies. To perform this function, the G20 had to transform its format, with the upgrade at the leaders’ level, the creation of several specialized working parties preparing its deliberations, and pervasive changes in its modus operandi. Chapter 2 assesses the role of the G20 in the reform of global economic governance and its performance, which has been extremely varied in the span of only a decade. Under the pressure of the raging crisis, the G20 successfully

8

Introduction and overview

marshalled the consensus to implement ambitious and coordinated policy measures that avoided a global collapse. It also managed to agree on launching the revamp of the key areas of economic governance: i) the coordination of macroeconomic policies; ii) the international financial architecture, with a rehabilitation of the function of international financial institutions and a revival of the debate on the role of the SDR; and iii) the international standards underpinning the regulation and supervision of the financial sector. With the recovery in economic activity and the stabilization of financial conditions, the traditional difficulties in international macroeconomic cooperation, such as the dispute about the burden sharing of the adjustment of outstanding imbalances, powerfully resurfaced and stifled the effectiveness of the G20. This happened despite the major improvements that had been implemented in the coordination process, such as the explicit and consensual definition of the objectives of the exercise. No widely agreed, structural reform in the international financial architecture took off either. Advanced countries defended the status quo and emerging countries opted for a piece-meal approach: fighting for a rebalance of power in old institutions, creating two novel multilateral development banks, and establishing new regional financing arrangements. The inquiry of Chapter 2 also covers the BRICS group, the club created by the major emerging economies to boost the public profile and the efficacy of their common demand for a more influential role in global governance. In spite of the achievements on this score and the great visibility of its yearly summits, as soon as the BRICS ventured beyond this agenda, its cohesion practically vanished, strained by its members’ differences over strategic objectives and overarching political values. For these reasons, in contrast with the more optimistic assessments of some authors,17 this analysis concludes that the BRICS group is unlikely to remain as a central element in the new international architecture. The mix of G20 successes and failures is testimony to the unsettled order emerging from the reform of global governance, characterized by significant elements of continuity with the G7-based regime, which coexist with a drastic power shift in favour of emerging economies, the establishment of new institutions, and the fragmentation of many international arrangements. The uneven performance of the G20, however, should not be mistaken for an indication that other institutions are more relevant or effective, since it is the forum where all the key international decisions were, and still are, formally made or informally initiated and negotiated. Although its wide membership has often proven an obstacle to its decision-making capacity, the flexibility of its working methods is an important asset for its leading role in the reform of global governance.

Vying for control of the International Monetary Fund Chapter 3 addresses another key element of the reform in global governance, the international financial institutions, and provides new insights into the two-way interaction with their shareholders. These institutions have been, at the same time,

Introduction and overview

9

instruments to pursue the objectives of their key members, pro-active agencies capable of enormous influence over their masters’ policies, and the terrain for large countries’ disputes to exert their control. Among them, the International Monetary Fund has always had a special relevance because of its role as international lender of last resort. The decision of the G20 to give international financial institutions major responsibilities in the policy response to the 2008 crisis revived their prominence in the mechanics of global governance, after many years when their function and legitimacy had been bitterly criticized. In April 2009 the G20 London summit deliberated on a massive increase of the Institutions’ resources, including the tripling of the lending capacity of the International Monetary Fund. The G20 could only agree to this increase on the condition of a significant shift in voting power in favour of emerging economies. The ensuing struggle to gain more influence within the Fund became one of the defining elements of the transformation in global economic governance emerging economies championed in the G20. This struggle involved protracted and harsh negotiations – whose technical aspects are presented in a way accessible to outsiders – that took place in different fora but remained always under the constant supervision of the G20. The resulting agreement, which provided for a substantive shift in voting power in favour of emerging market countries, took nearly five years to enter into force: the embroilment in US domestic politics delayed its ratification by the US Congress, necessary because of the US veto power over the Fund’s major decisions. This episode further questioned the political appropriateness and the economic benefits of centring global economic governance on the hegemonic role of the US, providing renewed momentum to the shift towards a more multipolar system. The transfer in power in favour of emerging economies went beyond the increase in their voting rights: it also involved a significant boost in their clout on day-to-day decision making, acquired through greater recognition in the informal contacts that shape the Fund’s decisions. Although insufficiently appreciated because of the confidentiality of the Fund’s deliberations, this influence is one of the qualifying elements of the reform in global governance. In spite of these radical changes in the power balance within the Fund, substantive continuity in the paradigm underpinning its policies has prevailed. Under the influence of emerging economies, new elements – such as a more benevolent attitude towards some form of capital controls – have been incorporated in the Fund’s framework, revealing its adaptive nature as well as its widespread acceptance as an element of the new order.

The key role of multilateral development banks Chapter 4 is devoted to the role of multilateral development banks in global governance – a role which has been traditionally neglected despite their importance in determining the mainstream approach to development as well as the

10

Introduction and overview

policy frameworks of countless countries. As the analysis shows, views on development have greatly evolved over time, sparking controversies that are still open, most notably about the priority of investment in infrastructures over interventions to alleviate poverty immediately. Development banks, and the World Bank in particular, have led this debate, shaping the definition of the international community’s development goals – most notably those adopted by the United Nations at two special summits in 2000 and 2015. Chapter 4 starts with an in-depth analysis of the development banks’ business model – an innovation introduced with the establishment of the World Bank and perfected over the years – which proved very successful by virtue of its capacity to offer a flexible and efficient use of their members’ financial resources. Building on its operational achievements, unrivalled in scope and geographical diversity, the World Bank has established its intellectual leadership by defending the mainstream view of development, while actively contributing to adapt it in response to the concerns of an ever wider range of stakeholders. Regional development banks, such as the African Development Bank, were established in the wake of the World Bank, in some cases with the unconcealed objective of elaborating an alternative model of development. Although they did not succeed in this goal, they proved effective catalysts of economic integration at the regional level and useful mediators between local governments and the World Bank regarding regional policy objectives and investment priorities. This function partly sheltered regional banks from the malaise that affected the World Bank before the 2008 crisis, with mounting doubts about the effectiveness of its policies, a weakening leadership, and a flagging lending activity. This situation drastically changed with the G20 decision to use development banks as a key instrument of the response to the crisis, supporting global demand by financing investment. To this end, multilateral banks received a huge boost to their capital on the condition that they reformed to enhance emerging market economies’ voting power and influence. Chapter 4 also probes into the economic and political reasons why this aspect of global governance reform was far less controversial within the G20 and was approved by the US Congress far more easily, although it was as important as the reform of the Fund. Conscious of the effectiveness of the multilateral banks’ business model, emerging economies were eager to deploy financial and political capital in a bold move of defiance towards the prevailing order: founding two new institutions to challenge advanced economies’ monopoly in this instrument of global governance, and to prepare useful building blocks for the new international financial architecture. The setting up of two new institutions rather than one reflects the pursuit of a twofold goal: challenging the mainstream view of development through a novel global institution, aptly named New Development Bank, and defying Japan’s economic leadership in Asia, usually taken as an integral part of the post-war order. China swayed the setting of this agenda, directing it towards its commercial and geopolitical priorities, much to the irritation of the other emerging

Introduction and overview

11

economies, which went along nonetheless: the foundation of new institutions was too important a step towards a more multipolar governance. Negotiations with China were harsh and led to various concessions on its part both on various aspects of the two new banks and on the resources to establish a new financial arrangement providing support to the BRICS in the event of a crisis. Like all the others, this regional financing arrangement has limited resources and insufficient analytical capacity, and has to be taken as yet another expression of emerging markets’ challenge to the existing financial architecture. In spite of their limitations, for a period, regional arrangements were considered within the G20 as elements of a global financial safety net to be established by encompassing them and the International Monetary Fund within a single operational framework. No real progress has been achieved in this direction. Thus, without a substantive increase in their resources, which is unlikely, regional arrangements cannot become relevant building blocks of the new financial architecture. The importance of multilateral development banks for global governance received further corroboration by yet another sizeable increase in resources which, after insistent pressures by the banks, shareholders eventually started to grant in 2018. Emerging economies’ success in advancing their formal power and informal influence in this crucial facet of global governance, both through their stronger clout over the “old” Banks and through the establishment of two new institutions, is one of the most significant aspect of the reform.

The persistence of the international standards regime and the dollar Emerging market countries were definitely less successful in acquiring influence in the other new institution which was established after the crisis: the Financial Stability Board, whose function in the reform of global governance is analysed in Chapter 5. Given the blatant flaws in the regulation and supervision of the financial sector which were exposed by the crisis, the urgent repair and the re-regulation of the financial sector were key elements of the policy response. They featured prominently in the agenda of the G20 with a persistence and an attention to technical details that have no historical precedent for international relations at the leaders’ level. The focal point of this action was the establishment of the Financial Stability Board, with the mandate of strengthening and ameliorating the international standards regime, which Chapter 5 analyses both in its economic function and in its political economy aspects. The Board was tasked by the G20 with the ambitious objective of spearheading “sweeping reforms” on a very wide range of issues. Such a broad scope led to the dispersal of international negotiations in many processes, each involving different institutions, stakeholders, and political-economy dynamics. Chapter 5 evaluates the attainments achieved by these efforts in the most important areas, namely: capital adequacy, too big to fail, transparency and integrity, excessive risk taking, shadow

12

Introduction and overview

banking, and over-the-counter derivatives. It concludes that the results were mixed and uneven, in many cases unsatisfactory, with continuity and incremental revisions as the most recurrent features. Various factors account for the mixed results, most of which were specific to the particular issue. Two common causes, however, stand out for this unconvincing performance: the dispersal of the reform momentum in so many threads of work and the financial industry’s persistent ability to capture regulators, thanks to its unmatched technical skills and its key role in finding viable solutions to international regulatory disputes. International financial regulation was an important concern for emerging economies, given that the pre-crisis international standards regime was firmly entrenched in the power relations of the G7-based system: standards largely drew on US rules and practices, while emerging market economies were members of neither the standard-setting bodies nor of the predecessor of the Financial Stability Board. The latter instead provided for the participation of all G20 countries, meeting emerging market countries’ demands in line with their objective of power rebalancing in global governance. The Financial Stability Board was not the treaty-based, international institution that some advocate.18 International financial regulation has continued to be based on soft law, mainly because, even after the crisis, each country has continued to defend its own financial industry’s interests in the negotiations for the scope and method of international regulatory cooperation. Yet, the Board has become an important element in the reform of global governance, as the unavoidable hub for the key international negotiations in its field, promoting international consistency of regulatory and supervisory policies in a system of ever-growing financial interconnectedness. Despite their participation in the Board and all the standard-setting bodies, emerging market economies have gained little clout on the shaping of financial regulation. They have maintained a rule-taking attitude, which stands in sharp contrast to the influence they have acquired in all the other aspects of global economic governance. In addition to the resistance of advanced countries, other factors account for this puzzling finding. First, emerging countries are reluctant to invest political capital in international regulatory disputes. Second, they do not have sufficient technical expertise and human capital to be effective in the negotiations. Finally, and so-far unnoticed as an explanation for advance countries’ command over financial regulation, the dollar has continued to be the pivot of the international monetary system. The dollar’s role is a key factor in the shaping of financial regulation through two main channels: the support it provides to the supremacy of US banks in global finance, and the priority assigned by all large international banks, irrespective of their nationality, to have direct access to the Federal Reserve’s dollar facilities, requiring them to be chartered in the US and hence subject to US regulation. The crisis, which originated in the US and was fuelled by its macroeconomic imbalances, was initially expected to lead to a substantive depreciation of the dollar. On the contrary, the dollar was taken once again as a safe haven and thus

Introduction and overview

13

it appreciated, confirming its role as the key reserve currency. Although many structural imbalances suggest that a diminution of the dollar is prospectively inevitable, this has not yet happened and it is unlikely to occur soon. The demise of a pivot currency takes a very long time, as the historical experience of sterling has shown. Moreover, the two potential alternatives are not yet ready: the renminbi is not backed by deep and resilient financial markets, and China’s capital account and financial industry have not been liberalized, while the euro lacks the support of adequate institutional background and political cohesion.

Europe and global governance Finally, Chapter 6 addresses the reasons why Europe has exerted such a small influence in the reform of global governance. The continent has obtained remarkable achievements in economic, financial, and political integration, which have been enshrined in a succession of ever more ambitious Treaties and the introduction of the euro. In spite of these successes, which have brought about the longest uninterrupted period of peace and prosperity in history, European countries have remained very jealous of their prerogatives regarding the relations with third countries. As a result, European external representation has always been weak, confused, divided, and derivative with respect to national positions, even when strategic objectives were obviously coincident, as in the International Monetary Fund or in the G7. “Who do I call when I want to call Europe?” Henry Kissinger supposedly quipped in the 1970s. After several revisions of the European Treaty, he would now have a well-defined answer, even though not as clear as he desired: the correct addressee of the call depends on the subject matter, because the process to determine Europe’s external position and external representation remains complex and topic-dependent. The complexity of the process to define a common European position and the reluctance to defend it with conviction is not only the result of bureaucratic impediments. It reflects the widespread idea that European and national external interests differ, which is based on three misconceptions that stand to be corrected: i) in contrast with the ambition, rekindled by a new powerful wave of nationalism, to continue playing a significant global role as an individual country, no European nation has the economic weight to maintain world relevance on its own; ii) despite the belief that differences across Europe are so deep that they cannot possibly be encompassed in a common European position, they are dwarfed in comparison with the divergences with extra-European countries; and iii) contrary to the idea that national economic interests are overwhelmingly different, contrasts across European countries in extra-EU economic matters are not of any strategic significance. Intricate procedures for the definition of a single European external position, a lukewarm response to championing it, and defensiveness in safeguarding national prerogatives have resulted in an ungainly and ineffectual European stance. Such discouraging ineffectiveness is in blatant contradiction with the

14

Introduction and overview

high number of European representatives and the large size of European voting power in international financial institutions and groups. The reform in global governance initiated by the crisis highlighted the inadequacy of the European position: at that crucial juncture, Europe missed the chance to influence the events in line with its economic size and potential geopolitical power. It was so absorbed by its internal disputes over the management of the sovereign crisis as to be unable to join forces and defend its own interests in the rebalancing of power within the G20 and in the negotiations over the reform of the International Monetary Fund. Moreover, Europe badly mismanaged its relationships with the Fund during its involvement in the European crisis. Europe’s declining influence in the reform of global governance is not inevitable. The most compelling and expedient strategy to this end is to arrange a more effective representation in international fora and institutions by systematically following, at the European level, the same approach that countries adopt in international financial institutions when they are jointly represented by the same executive director. This approach requires no change in domestic or international legislation, only political goodwill. And it is no utopian proposal, as the recent decision to form a euro-area constituency in the Asian Infrastructure Investment Bank has shown. Flexible in its implementation and highly symbolic in the message of European unity it conveys (think of a euro-area executive director at the International Monetary Fund!), this arrangement could be an important step for a more effective role of Europe in the reform of global governance. A more united Europe, capable of exerting significant influence over global economic and financial architecture would benefit not only Europe itself but the whole world too. A more prominent Europe would help the diffusion of the features of its social model, such as consumer protection, that could contribute to mitigating the costs associated with globalization, thus helping to preserve an open multilateral system. Moreover, a stronger Europe could contribute to the resilience and stability of the global economy, reducing the risks associated with a governance based on a US-China bipolar system. Finally, a more united Europe could underpin the function of the euro as an international reserve currency, which could facilitate the ordinate correction of the huge outstanding imbalances that pose a disquieting threat to global financial stability.

Europe and global governance “Never let a good crisis go to waste”19 was the precept often repeated in international official circles to provide impetus to the reform efforts initiated by the Washington G20 summit in November 2008: crises offer opportunities for radical changes that are not otherwise possible. Ten years on, the deep and pervasive reform in global economic governance, which this book has documented and analysed, suggests that the crisis was not wasted, at least in this domain.

Introduction and overview

15

The reform has attained a radical change, which was long due, in the balance of power between advanced and emerging economies, associated with a remarkable enhancement of its legitimacy and considerable progress towards multipolarity. The reform has led to the establishment of new international financial institutions and arrangements, as well as to profound and pervasive innovations in the modus operandi of pre-existing formal and informal institutions. These transformations have provided the international community with a new array of institutional and operational tools which have greatly increased the potential flexibility and effectiveness of internationally coordinated policy actions. Yet, in spite of these innovations and attainments, the global order remains unsettled in its architecture and institutional arrangements. Moreover, it is shaken by lacerating tensions fuelled by the resurgence of nationalism and protectionism, which are in turn rooted in the wide dissatisfaction with globalization, the alarming implications of the increase in inequality, both within and across nations, the growing threats to global commons, with climate change at the top of the list. Other factors too add to the risks of an outbreak of disruptive instability: longstanding global imbalances persist, and worrying fragilities in the financial sector have resurfaced, originating from a return of traditional excesses that the post-crisis regulatory reform proved unable to prevent as well as from the very high levels of private and public debt. Against this backdrop, risks loom large of another episode of severe financial instability or, even worse, of an international crisis precipitating the end of multilateralism and the fragmentation of trade and finance into regional blocs. History has time and again shown humankind’s inability to avoid repeating past mistakes – so that these adverse scenarios cannot be shrugged off relying on the guidance offered by past crises. Yet, the analysis of this book has shown that, even if still unsettled, the reform in global governance has strengthened the world’s resilience through the increased flexibility and effectiveness of international policy action which the new tools can provide if there is sufficient policy agreement. Challenges might appear insurmountable, but the tools to address them are available. Solutions lie in the international community’s own hands – which, indeed, are our own hands.

Notes 1 The System Worked and the Status Quo Crisis are the self-explanatory titles of the books by, respectively, Drezner (2014b) and Helleiner (2014a). 2 Rodrik (2006). 3 For example, Kirton (2013), Cooper and Thakur (2013), and Hajnal (2014). The fervour about the G20 as the lynchpin of a revamped international architecture has even extended to the elaboration of academic proposals to change its composition with the addition of seats assigned to geographical constituencies in order to improve its representativeness and legitimacy, as in Vestergaard and Wade (2012). 4 Layne (2012). 5 To be precise, South Africa became a member of the BRICS and started to participate in the annual summits only in 2011, while G8 summits have been replaced by the

16

6 7

8 9 10 11 12 13 14

15 16

17 18 19

Introduction and overview

return to the G7 format only since 2014 – see Chapter 4 for a full discussion. It is interesting to notice that, in the period between 2009 and 2013, Russia brazenly participated in a whole assortment of leaders’ summits: G8, BRICS, and G20. For example, Bremmer and Roubini (2011), and Temin and Vines (2013). For example, Helleiner (2016a) talks of “cooperative decentralization” (p. 1), Larionova (2016) proposes the “governing in alliance model” (p. 70), and Acharya (2016) sees “creative fragmentation [. . . as the reflection of . . .] broader forces in world politics” (p. 454). On the other hand, Plesch and Weiss (2015) lament that “a variegated institutional sprawl [. . . can only result in . . .] a ‘good-enough global governance’, [. . . which however . . .] ain’t good-enough” (p. 198), while Weder and Zettelmeyer (2017) argue that to ensure “coherent governance in a multipolar system [ . . . ] requires (at a minimum) consistency between the frameworks of the International Monetary Fund and those of the new sources of financing” (p. 3) – a condition that cannot be taken for granted. Baldwin (2016). Turner (2017). James (2001). The symbolic status of the Seattle events is also acknowledged by (some of) the protesters themselves in their “short history of anticapitalist alterglobalization”, available at https://antig7.org/en/node/57. The reader is referred to Stiglitz (2017) for a recent (and opinionated) review of the debate on globalization. Boughton et al. (2017), Buti and Tomasi (2018), and Snower (2018) are among the recent papers that focus on this. Loungani (2017) documents in detail how inclusiveness became a component of the orthodoxy of the International Monetary Fund. Promoting Inclusive Growth (De Mello and Dutz, 2012) was jointly published by the Organization for Economic Cooperation and Development and the World Bank. See, for example, Sunstein (2017) and the literature quoted there. The importance of patience, or rate of time preference in game-theoretic jargon, for international cooperation is discussed in Chapter 1. China’s attitude in international negotiations reveals more patience and a longer time horizon than all other major countries. For example, Stuenkel (2015, 2016) and Nayyar (2016). For example, Kono (2017), who however insists on the need to retain sufficient flexibility at the national level. The video available at www.youtube.com/watch?v=1yeA_kHHLow shows Rahm Emanuel, President Obama’s chief of staff, uttering this phrase. Other attributions are also available, including to Winston Churchill.

1 UNSETTLING THE BALANCE OF POWER

“I come from a culture that says that, if a business does not make it, it has to fail. Now, people I trust, including Secretary Paulson here, have explained to me that for banks things are different. If banks fail, they can cause harm, serious harm, to many hard-working people who have done nothing to deserve that”. These are the words that President Bush uttered on 11 October 2008 to a surprised audience of ministers, central bank governors, and senior international officials. The words of President Bush marked the beginning of a new phase in global economic governance. Not because of their content – after all, the awareness they expressed came too late to avert the decision to let Lehman Brothers go, something that had already pushed the global financial system to the brink of collapse. Rather, the historical significance of the words lay in the venue at which they were pronounced: a G20 meeting, the first one ever to be attended by a leader. That particular G20 meeting of finance ministers and central bank governors was hurriedly convened to seek the involvement of a wider group of countries in the extraordinary line of action that had been decided on the previous day by the G7, the advanced economies’ club at the centre of global economic governance. In the most drastic international effort ever made to stem financial panic, the G7 had basically committed to provide a State guarantee to all shortterm liabilities of the financial sector towards other financial intermediaries. This was an extreme response to the mounting risk of a generalized bank run and to the freeze of the basic flow that underpins all modern economic activity: the day-to-day short-term lending between financial intermediaries that was paralysed by the widespread terror that any bank could suddenly go bust, just like Lehman had. The incipient implosion of the financial system had originated in its very core – Wall Street – but it was not confined to it. It was global. It was as global as the network of financial relations that, for volume and interconnectedness, had long

18

Unsettling the balance of power

transcended the capabilities of control and emergency remedy by national authorities. The collapse risked dragging the entire world with it, causing “harm, serious harm, to many hard-working people” well beyond the US and the other advanced economies. The notion that a global crisis could no longer be credibly addressed by the traditional economic powers within the established framework of international governance was catalysed, with a sense of urgency, into a need for action. To stand a chance of success, the policy response required the endorsement – indeed, the active participation in ways yet to be defined – of the emerging powers, in particular China, whose persistently colossal trade surplus epitomized the perilous disequilibria besetting the world economy. The severity of the situation precipitated the need for the involvement of new powers in the emergency action plan that had just been conceived. Reflections on the most effective way to organize their engagement and negotiations on the set of invited countries were a luxury that could not be afforded in that moment. They were replaced by a brief, informal meeting of G7 finance ministers with the US president, arranged on the spot. There, it was determined that use would be made of the presence in Washington of ministers and governors for the ritual jamboree of the International Monetary Fund (IMF) and the World Bank’s Annual Meetings and that advantage would be taken of an existing network, the Group of Twenty, which had been established some ten years before. In his capacity as holder of the G20 rotating chair, the Brazilian finance minister Guido Mantega – who would years later gain popularity for his outspoken castigation of “currency wars” – expediently summoned an extraordinary meeting of the G20 ministers and governors, within a few hours’ notice and with a one-item-only agenda. Last minute emergency meetings to cope with a crisis had been called countless times. This one had a very different background with respect to the responsibility for the crisis and the perceived need for a joint policy response. G7 countries could not play the role of benevolent firefighters, wisely dispensing resources and advice, when in fact they had been the arsonists. And they were the ones, in particular the US, which most compellingly felt that a common G20 position was necessary to dazzle the public so as to restore orderly market conditions. The new economic powers had plenty of reasons to accommodate this request, spanning from the direct benefits of a (hopefully) more effective action to cope with the emergency, to the political gains of being (and being recognized as) part of the solution rather than the problem, as they had so many times in the past. But some coaxing and admission of responsibility by advanced economies had to be part of the deal. The US obliged, and, unannounced and unexpected, their president participated in part of the G20 meeting. President Bush did not apologize for the mistakes in US financial regulation and supervision that had been the detonating cause of the dangerous mess world markets were in. Yet, to those who were present at the meeting, like this author, his body language could hardly conceal the humbling uneasiness of having the US on trial by the public opinion of the world, his disbelief that the troubles with subprime mortgages were not a minor glitch but the symptom of much deeper

Unsettling the balance of power

19

problems, and his consternation that sticking to common-sense principles could have such devastating consequences. Bush nodded gravely when listening to the coarse voice of his Treasury Secretary, who was marshalling the consensus for the G20 to endorse a communiqué1 in which the G20 “stressed their resolve to work together to overcome the financial turmoil” and committed to “remain[ing] engaged and in close contact”. These words reflected the agreement in principle to a common, cooperative attitude that had to be filled with operational and political content. The follow-up to this understanding was rapid and momentous, as befitted the worst financial crisis in eighty years. Just two days later, G20 capitals were notified of the US intention to convene a G20 meeting in Washington within a few weeks – a meeting with a formidable innovation in format, purposefully meant to signal the importance attributed to the involvement of a wider group of countries. For the first time, the reunion was to be at the leader level2 with finance ministers as part of the delegation, while central bank governors – habitual participants in G20 meetings – were not invited to attend. This discontinuity in the G20 process was significant for both the enhanced deliberating power of the Group and the upsurge in its symbolic status vis-à-vis the insiders of the international community as well as the public at large. It was the first application, concrete and meaningful, of the slogan that would be tirelessly repeated in the coming years in all sorts of circumstances, relevant and inappropriate: “the crisis is global and requires a global solution”. Yet, the choice of the leader-level format for the G20 signified the beginning of the profound change in global economic governance which is the subject of this book. As is often the case, the crisis was not by itself the main cause of the change. Rather, it acted as a potent catalyst, accelerating the transformation in the international decision-making process on economic and financial issues, and the related institutional modifications that, in some form or another, would have occurred regardless to reflect the new power balance in the world economy. No doubt the new powers, China in particular, were quick to seize the opportunity. They deliberately leveraged the stronger negotiating influence granted to them by the crisis to make the change faster and more pronounced. However, the economic and political reasons underpinning the need for a deep reform in the governance of the world economic and financial system had been there for a long time. The reasons for reforming global governance were profound and compelling. To start with, the prevailing framework for international interaction in economic and financial policies was inadequate because of its conspicuous inefficacy and litigiousness, as manifestly confirmed by the outburst of the crisis. Even more importantly, relative weights in the world economy had undergone drastic transformations that had eroded not only the effectiveness but also the legitimacy of a system unwilling or unable to adapt at the required pace. The circumstances and reasons behind the emergence of the G20 as the premier forum of international economic cooperation and the potential lynchpin of new economic governance, unsettling the international power balance,

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Unsettling the balance of power

are the focus of this chapter. The outburst of the crisis and its causes, meanwhile, are the starting point of its analysis.

Many failures led to the crisis Like many times in the past, the crisis was preceded by time-honoured excesses: unreasonable inflation of asset prices, inordinate borrowing, and overinvestment. Once again, warnings had been wisely propounded – irrational exuberance3 was the catch phrase – and blatantly ignored, creating the conditions for a disorderly adjustment. On that score, this time was not different, as documented in one of the most thorough and convincing post-mortems of the crisis.4 What was different was the depth and propagation of the crisis, both of which were flagrantly unpredicted. At the G20 deputies meeting of August 2008 – just a few days before the bankruptcy of Lehman Brothers – the Federal Reserve representative earnestly belittled the significance of the fall in the US stock market and housing prices as physiological corrections that the US financial system could easily withstand. Subprime mortgages, it was repeatedly stressed, were a negligible proportion of the mortgage market, let alone of the entire financial sector. Was this defensive eagerness meant to assuage other countries’ apprehension? Maybe. But no other delegation seriously challenged the US delegates’ reassuring interpretation, nor pointed out the severity of the imbalances in the US financial sector and the global economy. The moment of reckoning came a few days later, sweeping away all benign diagnoses and brutally uncovering that the troubles in the US financial system were much more acute than hoped or envisaged. Their parallel to the financial crisis that initiated the Great Depression immediately gripped the public imagination. The collapse in US stock market prices and industrial production after Lehman’s default was faster and deeper than the downfall that started with the ill-famed Black Monday of 28 October 1929.5 Indeed, the comparison with the previous financial crisis of similar magnitude would remain a constant in the narrative of the policy response, at the national and international levels. In particular, explicit emphasis was placed on the need to avoid economic disruptions precipitating the kind of political turmoil that had led to World War II. This narrative is a powerful and admittedly self-congratulatory discourse: several policy mistakes that caused the Great Depression were not repeated, and the post-crisis rebound in global activity came sooner (not to mention the fact that political tragedies have so far been avoided). And yet, it involves several fallacies that have been unwittingly ignored or deliberately exploited.6 Historical comparisons aside, where did the fragility in the system come from? How was it possible for the US economy to move so rapidly from an unprecedented series of mild business cycles, spanning a quarter of a century – the “great moderation”7 that some central bankers attributed to their own independence and wisdom – to an incipient collapse? “Why did nobody

Unsettling the balance of power

21

notice that the crisis was coming?”, as the Queen of England famously asked at a reception at the London School of Economics.8 Analyses of the causes of the crisis abound, and they all converge on attributing the central, detonating role to the excesses of finance – excesses that were old in their core motivation of greed and speculative mania. Opinions differ on the importance of the motives underlying the malfunction of finance and its disruptive implications for economic activity, in particular with regard to macroeconomic factors. Yet, ultimately, it is pointless to embrace a single interpretation, as views tend to be complementary rather than alternative. Indeed, the crisis has many deep-rooted origins with widespread responsibilities. Several remarkable failures prevented the operation of safeguard mechanisms that could, and should, have prevented the outbreak of the crisis by spurring (or forcing) gradual preventive corrections. First, markets failed. Market discipline and self-regulation in the financial sector proved grossly ineffective in guaranteeing the stability of the system. The outburst of the crisis blatantly disproved the view that market participants know better than public authorities when it comes to assessing the risks they take. Rather than increasing efficiency in the allocation of resources, financial innovation was geared towards taking advantage of regulatory loopholes and generating short-term profits, creating perverse incentives that undermined the integrity of the financial sector. The best-known example is that of toxic assets, by now becoming iconic. These assets were created by repackaging, in a technically sophisticated way, loans of poor quality, which nonetheless received the safest (triple-A) evaluation from credit rating agencies.9 When the underlying loans were not repaid, the allegedly safe assets turned out to be worthless, effectively “poisoning” the balance sheets of the banks who had bought them. Even more fundamentally, the balancing checks that the (in principle independent) risk assessment function should have provided in each financial firm turned out to be unreliable – unreliable in a systemic way which involved basically every financial player. The mechanism of market discipline signalling and punishing excessive risk taking either did not work or worked too late to be of any help. Part of the reason for this failure was that some of the instruments were so complex that not even their inventors, let alone the banks’ management or the regulators, could actually evaluate the risk they entailed. Even more importantly, risk assessment firmly hinged on the principle that variations in asset prices and their correlations had to be in line with past experience. This hypothesis was blatantly violated during crisis times, when panic and herd behaviour led to sharper price movements than past experience could possibly suggest. Resulting losses were far greater than estimated even in the most adverse scenarios and often larger than the capital available to cover them. These (and other) ingrained flaws became evident during the crisis. Together with the exorbitant compensations to bankers, they fanned the public outrage towards the financial sector that burst out in 2009 and has periodically resurfaced

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since then. They also triggered the adoption of regulatory remedies and more stringent capital requirements, discussed, together with the role of the Financial Stability Board in global governance, in Chapter 5. The second major failure at the root of the crisis was that of governments. Governments failed to implement appropriate policies at both the micro and macro levels. With respect to regulation and supervision, the progressive relaxation of rules and the lack of adequate surveillance allowed the progressive deterioration of standards, with a generalized worsening of credit quality. The laxity (and at times technical inadequacy) of regulation allowed excessive risk taking and an insufficient amount of capital. During the crisis, several banks, including some too big to fail, were unable to absorb the emerging losses. Their bailout with public money to preserve the viability of the financial system was necessary, even though it was a hard sell from a political point of view.10 Even discounting the wisdom granted by hindsight, the inadequacy of financial sector regulation and supervision is truly astonishing. Certainly, it cannot be properly accounted for without in some way invoking the notion of captive regulators. Too often, key officials in charge of defining regulatory standards would flip and work in the private sector, with vastly higher salaries (the so-called “revolving doors”). And then there was the almighty power, even celebrated in TV series, of the financial sector parliamentary lobbies and the munificent contributions to electoral campaigns, dispensed in carefully balanced bipartisan dosages. Government failures on the macroeconomic front were no less momentous, since policies were focused on addressing external imbalances that had been relentlessly increasing. China’s external reserves had soared by more than tenfold in a decade. US monetary and fiscal policies did not even try to contain consumption, allowing larger external deficits and household indebtedness to sow the seeds of instability. Although Europe’s external position was roughly balanced, its macroeconomic and structural policies can hardly be praised. Growth had been chronically anaemic, incapable of generating enough jobs and fulfilling citizens’ economic aspirations in a sustainable way. At the same time, intra-European disequilibria were accumulating, later to explode in the sovereign debt crisis. Last, and certainly not least, was the failure of the international community as a whole – or, in other words, of the prevailing system of global economic governance. Neither the network of informal relations revolving around the international economic policy fora, such as the G7 or the G10,11 nor international institutions, such as the IMF, proved effective in marshalling the consensus to safeguard the global system. They all failed to motivate collaborative policy adjustments to contain the risk of a global crisis, harmful to every country. Once again, both regulatory and macro policies are relevant, as coordinated action in both areas would have generated common benefits and might have averted the crisis. The financial industry had acquired a genuinely global scope of action for many years, yet supervision and regulation remained firmly at the national level.12 In the wake of the Asian crisis, the G7 started the establishment of an international regulatory regime based on common standards, extending the

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approach of the Basel Accord on capital requirements. However, the appetite for an effective monitoring of the adequacy of these standards and their implementation was conspicuously scanty. Talks to foster uniform accounting practices for the financial industry began, but a decade and a financial crisis later, the convergence of the European and US systems into a single standard appears even more unreachable. As for the failure of global governance on the macroeconomic front, facts speak for themselves – and very loudly, given the unrelenting expansion of global imbalances, despite preaches to the contrary from every single actor, formal or informal, in the international economic and financial architecture.13 A very widely shared responsibility indeed, though the heaviest burden of accountability falls squarely on the group that still managed the largest influence on world economic and financial affairs: the G7.

The waning grip of the G7 Until the eruption of the crisis in 2008, the G7 was the very core of global economic governance. It was the forum that made the key deliberations on the coordination of the macroeconomic policies most relevant for the world economy, and that acted as a control cartel for the International Financial Institutions (IFIs). The G7 had been playing this leading role since the early 1970s, when it was established to respond to the need for effective governance that arose after the Bretton Woods system broke down on 15 August 1971, with the abolition of the convertibility of the dollar into gold. Like the present transformation, that momentous innovation in global governance came about through a combination of “necessity” and “serendipity”: the same combination that has always characterized important changes in the international economic and financial architecture. Indeed, it was more the result of a blind watch maker than of an intelligent design, to use the well-known metaphor from modern evolution theory.14 The “necessity” was to find a way to cope with the unsettling consequences of the wild exchange rate instability that followed the circumstance, unprecedented in monetary history, whereby every single major currency had abandoned any reference to gold (or silver) for good. The brave new world of fiat money and market-determined exchange rates quickly turned out to be unbearably volatile, in particular because of the concomitant macroeconomic shocks – most notably, the hike in oil prices. The hope that a system of flexible exchange rates would automatically generate stability was rapidly dashed by hard facts. Financial markets were prone to gyrations also in the “prices of currencies”, with severe destabilizing effects on economic activity. The comforting silver lining was that flexible exchange rates granted independence to national monetary policies, allowing for the accommodation of national conditions and preferences without necessarily resorting to capital controls. This conviction has survived much longer, but it is now being challenged.15

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“Serendipity” was the series of events that led from a casual, off-the-record meeting of the finance ministers of the US, Germany, France, and the UK (convened by Secretary Shultz on 25 March 1973 in the White House library, hence the nickname “Library Group”), to the establishment of the G7 as the most influential decision-making process in the field of international financial and economic policy. True, no international treaty was signed, no institution was set up, and not even a permanent secretariat has ever been organized – thus the G7 has to be defined as an informal group. Beyond the communiqués issued after some of the meetings, no official record of its decisions, which only peer pressure from its own members can enforce, has ever existed. Yet, at least since the 1986 Tokyo summit (which precisely delineated the role of the finance ministers and central bank governors process), the G7 has become a consistently organized machinery for addressing the most relevant economic and financial issues, especially during crises. Indeed, most of the time, it has been capable of finding an agreeable course of action and imparting specific guidelines to the IFIs and the IMF in particular. In short, the G7 became the lynchpin of global economic and financial governance. The road to achieving an effective modus operandi was long and winding. The Library Group became the G5 with the addition of Japan, then the G6 with Italy, and eventually the G7 when President Gerald Ford invited Canada at the Puerto Rico meeting in June 1976. Even after that summit, many meetings, especially between finance ministers and their officials, continued to take place in the G5 format, much to the annoyance of Italy and Canada, with inconsistencies in the preparation of leader summits. In short, the fine-tuning of the G7 process practically took a decade of haphazard trials and errors – an important precedent to bear in mind when considering the faltering of the G20 process that followed the acute phase of the crisis. As has been pointed out several times,16 the assessment of the effectiveness of any system of global economic governance is conceptually problematic, because the counterfactual is difficult to define. Yet, it seems hard to deny that in the final quarter of the last century, the G7 was generally successful in piloting the world economic architecture and ensuring its resilience in the face of major shocks – resilience that in turn was at the basis of a successful period of growth and wealth creation for the global economy. Moreover, the G7 has to be credited with significant specific achievements in the area of policy coordination, notably on the very issue that had triggered its establishment: exchange rate instability. The Plaza and Louvre Accords are the best-known episodes because of their rapid and drastic impact on the notoriously fickle foreign exchange markets – a result too good to be repeated again with the same success. Yet, that result is by no means isolated. The last three decades of the 20th century recorded several episodes17 of concerted action in foreign exchange markets and macroeconomic policy setting, particularly through the direct cooperation of central banks. These results are even more remarkable when one recalls that in the 1970s and 1980s, views on desirable macroeconomic policies, as well as those on the global economic outlook, differed across countries

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much more than they do now. Indeed, the policy dialogue within the G7, sustained in the face of diverging opinions, can be viewed as one of the main reasons for the progressive convergence at the international level on some basic policy tenets, such as the primary importance of the objective of price stability for monetary policy. The coordination of its members’ macro policies was not the only function – possibly not even the most important one – performed by the G7. Most significantly,18 it acted as a permanent network of rapid access to exchanging views, testing positions in the making, and addressing crisis situations. Under these circumstances, the combination of technical expertise and political awareness of finance and central bank deputies, which have always formed a close-knit circle, became very useful to devising effective and politically viable forms of intervention. Another crucial task carried out by the G7 was the steering of the IFIs, not only in strategic terms but also with a very hands-on approach during crises, when it was customary to arrange packages combining resources of the IFIs with concerted bilateral financing from G7 members. This interaction was decisive on several occasions in safeguarding the integrity of the system and should be regarded as an essential feature of global governance. To be sure, this essentially favourable assessment about the effectiveness of an international architecture centred on the G7 is not meant to offer an idyllic representation of world economic relations. The numerous crises of global relevance during that period should not be forgotten. The conflicting interests within the G7 that so many times led to the inability to reach consensus and to inconsistent policy actions cannot be ignored. Rather, recalling the overall achievement over a quarter of a century sets a benchmark that outlines the responsibilities of the G7, as the kernel of global governance, in failing to prevent – indeed, in hosting the epicentre – of the most severe crisis since the Great Depression. Figure 1.1 illustrates the fundamental deficiency of the G7 in marshalling, through consistent peer pressure, the political resolve to address growing disequilibria, even among its members. The ballooning of external imbalances in the US and Japan is simply juxtaposed with excerpts of the G7 communiqués that repeatedly expressed concerns about growing disequilibria and unfulfilled commitments to do something about them. The decline in the G7 capacity to have a grip on crucial economic developments eventually became so conspicuous as to undermine its credibility and authoritativeness in the eyes of the international community. It was not sudden but gradual, and it had several drivers. First, there were changes in the modus operandi of the G7 that led to a progressive decline in its focus on economic issues, which had always been at the very heart of the G7. There was an excessive broadening of the G7 agenda, with a proliferation of G7 meetings, dictated more by a search for the visibility of other agencies of the administration than by compelling cooperation goals. An ever-growing number of ministers19 and officials got involved in parallel streams of work in preparation for the leader summit and further back-to-back meetings

Unsettling the balance of power -900

United States, USD bn (inverted scale)

-800 -700 -600

250

"We will continue to pursue sound policies to foster sustained and balanced growth and support the orderly adjustment of global imbalances" (10/02/2007)

"High economic growth throughout the G7 will redress global imbalances that arise inter alia from uneven growth within the G7" (20/09/2003)

200

Washington Summit

-500

150

-400 100

Japan, USD bn

26

-300 "Progress in [...] fiscal areas and in the Agenda for Growth are key to addressing current global imbalances" (23/04/2004)

-200 -100

"Challenges remain, especially: persistent global imbalances [...] as well as a more balanced distribution of the benefits of globalisation" (11/06/05)

"We agreed that further progress needs to be made in implementing policies that contribute to the gradual resolution of global imbalances" (10/02/2006)

50

0

0 2000

2002

2004

2006

United States (Left scale)

FIGURE 1.1

2008

2010

2012

2014

Japan (Right scale)

Current account balances and G7 communiqués

of G7 leaders with various configurations of participants from emerging and developing countries and the business sector, and social partners in the so-called “outreaches”. Second, political developments in Russia also drained away energies from economic and financial matters in the G7 process. The geopolitical balance in the world was profoundly affected by the crumbling of the communist regime, dictating a shift in attention towards the engagement of the G7 with Russia. In 1989, just a few months before the fall of the Berlin Wall, President Gorbachev publicly wrote to President Mitterrand asking to be associated with the upcoming Paris summit. Views on the matter differed widely among G7 countries. It took two years for Gorbachev to be invited to meet the G7 leaders at the margins of the London summit, without, however, officially participating in the G7 meeting. Eight further years of piecemeal gradualism20 in Russia’s involvement in the G7 process were necessary to arrive at the establishment of the G8 at the Birmingham summit of May 1998. Distinct economic conditions and a wavering commitment to market freedom and the rule of law, combined with the unfamiliar personal background of its officials, made Russia an awkward, and ultimately not viable, partner in the G7 finance and central bank circuit. To preserve the old G7 club, especially in its function as a network for candid discussions on sensitive financial issues, the G7 format was retained in the finance circuit after the full establishment of the G8. This led to odd procedural contortions (and an increase in discrete conference calls as a working method) intended to avoid antagonizing Russia or belying the publicly touted vision of the G8 as the centre of geopolitical, rather than economic, international relations. Despite these efforts, a decline in political momentum and in focus on traditional economic issues was inevitable, with a heavy and irreversible toll on the clout of the G7 (and the G8 for that matter) in the world economy.

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Third, a more fundamental underpinning of the decline in the influence of the G7 on the world economy was external to the evolution in the group’s functioning. It was the drastic fall in the relative weight of the G7 in the world economy – a radical reshuffling of the nations’ rankings in the world economy that occurred with unprecedented speed.

The upheaval in the (relative) wealth of nations The decades at the turn of the millennium saw epochal changes in the relative size of the world’s major economies. In the period spanning the 1990s and 2000s, the G7 lost the gains in relative economic power that it had taken a whole century to build. Its share in world Gross Domestic Product (GDP) plunged from 68 per cent in 1993 to 46 in 2013, falling to the same level it had had at the beginning of the 20th century.21 Underpinning this massive shift was a wave of globalization with implications for the distribution of world economic power and with proportions that can only be compared to the 19th-century leap in international economic integration that was associated with steam,22 powering industry and transports. In between these major episodes of accelerating globalization, the relative economic weight of the G7 countries momentously ascended, reached its climax, and then started to recede. Driven by the fall in direct and indirect trade costs, the globalization wave that started around 182023 led to unprecedented gains in productivity, boosting the rapid expansion of the G7 economies and giving rise to what Lant Pritchett24 has labelled “income divergence big time”. Their combined share in world GDP more than doubled in the course of the 19th century to just below 50 per cent. For the first time in economic history, the economic weight of a nation was significantly disproportionate to the size of its population. The virtuous loop of falling trade costs and productivity gains continued for the large part during the following century. However, the progress in the 1900s of world economic and financial integration was far from smooth and steady. Most importantly, it recorded a disruptive interruption between the two world wars, with the deterioration of international relations and the commanding return of related protectionism – indeed, what looked like “the end of globalization”.25 The renewed impetus for globalization began in the 1950s, following the first GATT tariff cut (the Geneva-I round), with a slashing of the tariff rates by about one-quarter. The revamped self-reinforcing loop between trade and productivity growth sustained innovation and economies of scale, and further strengthened the G7’s primacy in the global economy. Its share in global GDP climbed further and so did the per-capita income gap with non-advanced countries. To offer an example: in the 1970s, the per-capita income of the US was some 20 times larger than that of China, even when using Purchasing Power Parity (PPP) exchange rates to adjust for differences in what money can buy in the two countries. Starting with the late 1980s, globalization changed nature – and gear. The latest strain of innovation had to do with information and communication

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technology (ICT), which reduced transportation costs and made possible a new type of unbundling:26 the unbundling of the production process itself. With the ICT revolution, transmitting ideas and instructions across continents became easy and cheap. Production stages, even when very narrow in scope, could be delocalized in separate countries, exploiting wage differentials and specific comparative advantages. Although internal to the same “firm” from a conceptual point of view, the value chain of the production process could run across factories based in different countries. This opened new opportunities, becoming the driving force for a renewed impetus to trade expansion and the diffusion of industrialization, in turn spawning higher productivity and growth. It was a process analogous to previous episodes, but on steroids, because this time low wages could be most effectively combined with advanced know-how, with portentous results. The ensuing transformation of the global economy was overwhelmingly fast and deep, leading to an upheaval in the ranking of the world economies. In particular, it was the group of countries at the centre of global governance that saw its importance in the world rapidly eroded. The G7’s share in global GDP shrank by one-third, returning below 50 per cent. Twenty years were sufficient to turn the clock back to the end of the 19th century, from this point of view. Not less spectacular was the fall of the G7 share in world manufacturing, which plummeted below half, and in world trade, which collapsed to less than a third. But if the G7 was the loser, which countries were filling the gap and increasing their importance? Gains, it turns out, were quite concentrated and accrued to a relatively small group of nations. Only twelve countries27 secured more than 80 per cent of the ground lost by the G7, while the rest of the world, comprising nearly 200 countries, gained only 3 percentage points in total. And even within the group of the twelve fastest growing nations, concentration was very high. China alone increased its share in world GDP by 10 percentage points (or about half of what the G7 lost) and set off to become, in 2014, the world’s largest economy in PPP terms. If Brazil and India, the next two largest winners, are added to China, the three of them account for about 80 per cent of the gains of the twelve fastest growing nations. These impressive summary statistics illustrate how large and concentrated the shift in the nations’ economic ranking was. They also show that the latest globalization wave, somewhat paradoxically, led to the return to a prominent role of the two economic superpowers of the past: China and India. In the first millennium AD, these two countries had uninterruptedly represented more than half of the global economy. Their comeback is partial, as the two nations combined currently do not even reach 15 per cent of world output (at market exchange rates). However, the return of China to the top spot (in PPP terms) is particularly evocative. It ends what can be viewed, and many people in China actually view, as a two-century parenthesis both in a millenary supremacy in terms of economic size, as well as in a variety of other indicators of social development which have been recently brought to the fore.28

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Unsurprisingly, the concentration in a small group of countries of the gains in relative economic weight that matched the G7 decline sparked the former’s ambition to have a more prominent role in global governance. This aspiration progressively mounted in strength and determination along with the constant rise in their share of world output and in their frustration with the lack of relevant change in global architecture. Due to a mixture of self-interest and short-sightedness, the G7 were not forthcoming in sharing their influence on world economic affairs, even symbolically. The G7 remained a closed shop except for the opening to Russia. The fora that provided for the participation of the finance ministers of the G7 and the emerging powers – most notably the G20 mark 1 and the International Monetary and Financial Committee (IMFC, the group of finance ministers from the countries that hold a seat on the IMF board) – offered the opportunity to vent discontent, but they were not venues for any real decision making. The shots were called in the G7 and in the consultations between the G7 and the IMF that prepared IMFC deliberations. Notwithstanding, or perhaps because of, the G7 resistance, the push from emerging powers to obtain a symbolic and institutional recognition of their increased economic importance and, accordingly, to wage a greater influence in global governance, kept mounting. The challenge to the legitimacy of the G7’s central role was not confined to the new emerging powers but had much wider traction in the international community. Many other emerging and less-developed countries were lamenting the inertia of global architecture in the face of the radical transformation of the world economy and the disappointing results in fighting poverty and sharing prosperity more widely. The advanced world, too, including a part of the public opinion in the very members of the G7, challenged the legitimacy of the G7-based governance. A widespread wave of protests radically questioned the liberal order that the G7 steered and symbolized, particularly with their yearly summits. The unrest gained momentum from the far-reaching economic and social consequences of the new globalization wave. It also took a more universal approach, denouncing the unsustainable exploitation of natural resources and the unacceptable inequality between advanced economies and poor countries. This time, because of the power of ICT, economic and social transformations not only took place faster and more intensely but also could be shared visually with greater facility and speed, within and across countries, thus motivating and empowering protesters. Demonstrations, in several cases turning violent, quickly became a constant feature of G7 summits and IMF annual meetings, tainting the image of democratic benevolence that their organizers desired to project. Political radicalism aside, many of the critical arguments of the No Global Protest resonated with a vast proportion of public opinion and could not be ignored, either politically or intellectually. They indeed prompted the public, passionate defence of globalization by several leading economists29 – who, however, had to concede that, in addition to its predominant welfare-enhancing

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advantages, globalization had several negative implications which should have been recognized earlier and should have been better managed at the national and international levels. These themes acquired a persistent relevance in public debate, contributing to shaping the policy response to the crisis and its narrative.

The need for international cooperation The acceleration in globalization at the turn of the 20th century led to the G7’s waning influence in economic and financial affairs, which, in turn, impaired the effectiveness of the system of global governance centred on the deliberations and networking of that Group. In one of the many paradoxes of globalization, the very process that was making effective international coordination more difficult to achieve was increasing the need for it. Expanding trade and financial flows were rapidly deepening the interconnectedness and interdependence of national economic systems, thereby strengthening the rationale for international cooperation. The more intense transmission of economic and financial shocks across countries, as well as a more widely shared interest in preserving an orderly system supporting global growth, provided ever more compelling reasons for policy makers to cooperate with their foreign counterparties. But what does “international cooperation” in the economic and financial field actually mean? Unfortunately, there is no straightforward answer. The expression “international cooperation” has different meanings in different contexts, which generates confusion, particularly with reference to the other expression, “international coordination”. In some cases, cooperation and coordination are contrasted; other times, they are used interchangeably, just to indicate mutually advantageous international interactions. A clarification might be useful. In real-world policy circles, starting with the G7, cooperation refers loosely to the act of collaborating together and does not necessarily imply accord, joint purpose, or commonly decided policy actions. Cooperating might simply boil down to exchanging views and information, perhaps with no other result than agreeing to disagree. This is the essence that typically underlies the notion of open and frank discussion so liberally used to find a silver lining in disappointing meetings. However, cooperation does not exclude the possibility of more substantive arrangements, especially when the purpose of using the word “cooperation” is to convey a sense of continuing engagement with possible future deliberations, the outcome of which is not to be prejudged. This is why “cooperation” so often recurs in the G7 communiqués. In particular, “cooperation” is featured countless times in the closing sentence of the section on exchange rates: “We continue to monitor exchange markets closely, and cooperate as appropriate” – meaning that the G7 might agree (or disagree) to do nothing, or, instead, to decide on a joint policy action. Such action may involve coordinated (or concerted, the other word of the lingo to mean “decided together”) changes in policy instruments, such as the interest rates, or open market operations, such as interventions in the foreign exchange market.

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The intense meaning, charged with the notion of commitment, given in international policy circles to the word “coordination”, in turn explains why it is used so rarely in the G7 or G20 communiqués and never without specifying the object and extent of the coordination itself. Conversely, for economists and political scientists, “cooperation” is a word associated with profound significance and policy implications. Cooperation is precisely defined in the most formal approach to the study of human interaction: game theory. In that context, which has been applied to international macroeconomic policy setting since the 1970s,30 cooperation refers to a situation in which different actors have agreed to set the policy instrument under their individual control in the pursuit of a commonly agreed objective. The crucial element here is the agreement to pursue a common objective and to consider the spillovers of each other’s decisions so as to make policy actions more effective. In game theory, cooperation stands in contrast to non-cooperation, an approach in which each policy actor pursues his/her own objective, which need not be mutually compatible with those of others – as in the case, less bizarre than one might think, where every country plans to increase its surplus by depreciating its currency. In the non-cooperative case, policy interdependence and a strategic attitude are an essential part of the picture, including the possibility of having a leader with a first-mover role,31 but each policy maker pursues his/her own objective, acting on the premise that the others behave in the same way. The rigorous definition of cooperation in game theory is very useful to pinpointing the fundamental question in real-world international economic relations. Why cooperate (in the sense of mutually taking into account the desires of other international partners in reaching an accord on policy actions) rather than “cooperate” in the loose language of public statements – that is, exchanging views and simply considering the implications of other partners’ decisions when setting policies? In abstract, the answer is straightforward: because it is mutually advantageous to do so. No solidarity or altruism; just enlightened self-interest. This potential reciprocal advantage from cooperation32 (in the game theory sense) is necessary for policy makers to behave cooperatively (again in the game theory sense), but is by no means sufficient. For cooperation to actually take place, two types of obstacles have to be overcome. The first is a question of information – for policy makers to be able to act together constructively, they need to know each other’s objectives and share some basic assessments of the conditions of the world economy and the effects expected from their policies. International meetings and the loosely defined cooperation that takes place there can be credited with helping this, even though the degree of candidness and transparency on the part of national authorities varies widely across circumstances. The second obstacle has to do with the incentive structure. Often, the single policy maker has an incentive to deviate from cooperation if the others instead cooperate. However, if everyone followed this logic, cooperation would break

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down and everyone would be worse off than in the situation where each actor resists the temptation to have an advantage by “cheating” and earnestly cooperates. This situation is illustrated by the well-known prisoner dilemma,33 which is often regarded as the idealized model of social interaction and has been used countless times in all social sciences (and in other fields, including biology). Leaving the technical aspects to game theorists, intuition is sufficient to appreciate that the decision whether to cooperate or not rests on two broad considerations. First, the expected benefits from cooperation must exceed those of alternative courses of action. The second consideration, relevant when policy interaction is repeated over time, is the degree of impatience.34 “Cheating” while the others cooperate may well be beneficial, but one cannot expect the gains to be repeated, as partners will retaliate. Depending on impatience, the short-term benefits of today’s non-cooperation may be preferred to the higher long-term gains of continued cooperation. However, if policy actors are patient enough, cooperation prevails in the case of repeated interactions,35 such as international relations. As we all know, real-world policy makers are quite impatient, especially when elections are approaching. For this reason, the existence of potential advantages over an extended period do not necessarily lead to cooperation in practice. Moreover, globalization and the ICT revolution have changed the way the results of international meetings are diffused and perceived by citizens and voters, increasing the impatience of policy makers and making international cooperation more difficult to achieve, just when it can potentially be more beneficial because of increased economic and financial interconnectedness. In this respect, China stands out as having a longer time horizon than all the other major countries due to both its unconcealed aspirations of its return to a mighty geopolitical splendour and a political process which does not require a high-frequency accountability of the country’s leadership. All this attention to strategic interaction is justified only insofar as the benefits from cooperation in economic and financial policies are sufficiently large. In practice, are they? The empirical measure of these gains is fraught with difficulties, in particular because the appropriate benchmark, the relevant counterfactual case, is hard to pinpoint. Though it does not do justice to the richness of the empirical research on this issue,36 the bottom line can be summarized as follows: if the benefits of cooperation are measured with respect to an optimal policy with full information about the structure of the economy and other authorities’ objectives, the gains are typically found to be small. If, on the contrary, the point of reference is a situation where policy makers have only a limited knowledge of other countries’ economies and objectives, then cooperation is found to be very beneficial. A qualified verdict that supports more the usefulness of cooperation in the public officials’ sense than of cooperation in the rigorous game-theory sense. This assessment is somewhat rectified if the notion of optimal policy, which requires too much information and fine-tuning to be practicable, is abandoned and the analysis is extended to situations, often following a crisis, in which structural

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adjustments are needed to address fundamental and protracted imbalances.37 Indeed, recent analytical work38 finds that significant benefits can be reaped if all systemic countries follow policies that are mindful of their implications in the global economy, thus favouring a more symmetric adjustment of existing imbalances that is supportive of world growth. The usefulness or practicability of cooperation – even in the more modest sense of policy makers taking into account the external implications of their policies – is by no means universally accepted. Some argue that the regime of floating exchange rates renders cooperation, by whatever meaning, unnecessary and, since the demise of the Bretton Woods arrangements, an international monetary non-system has ultimately prevailed – where non-system is meant as praise.39 Others more sceptically claim that, with some rare and long-gone exceptions regarding concerted intervention in the foreign exchange markets, international cooperation is only paid lip service. It is a “fair weather phenomenon” that only takes place when domestic and international interests happen to be perfectly aligned at a given point in time. Actual policies strictly respond to domestic interests and processes. Whenever external and internal considerations differ, as they typically do (or are perceived to do), domestic pressures always have the upper hand. Whatever the opinion on the potential gains of (or the practical difficulties in) international macroeconomic cooperation, one must acknowledge the strong common interest in making sure that there is in place a global system that provides the indispensable rules, conventions, and orderly market conditions that allow global growth spurred by economic integration and trade expansion.40 Indeed, some argue that the preservation of an international order with these features is the only motive powerful enough to rival domestic concerns and lead to effective cooperation.41 The power of regime preservation in spurring internationally motivated policy actions, even unexpectedly bold ones, is particularly evident during a crisis, when the viability of the regime is threatened. The distinction between regime-preserving cooperation and ordinary, day-to-day cooperation is, however, blurred in practice. Active maintenance of the international system, even outside major crisis episodes, is required for the system to work. The distinction between major crises that put the survival of the system in jeopardy, not-so-major crises, and large shocks, is debatable ex-post and uncertain when events are unfolding. Moreover, the ability to organize joint policies under the stress of a crisis rests on the network of relations and mutual understanding built through cooperation in normal, or not-so-critical, times. In any case, effective global governance must fulfil both functions: ensuring the preservation of the regime allowing further economic and financial integration, and creating the conditions fostering fruitful cooperation. Before the eruption of the crisis, the G7-based global governance was severely lacking on both scores. Global imbalances were mounting, the crisis was brewing, and its explosion brought the regime to the verge of collapse. Something had to be done involving a broader group than the G7. Enter the G20.

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The serendipitous G20 Why the G20 rather than another group? The chronicle of the fateful days in mid-October 2008, evoked at the beginning of this chapter, has already provided the gist of the answer. The G20 was already there – and it had satisfying features regarding its number of participants and flexibility as well as its informal nature. For these reasons, it was preferable to the other obvious candidate: the IMFC. This factually correct answer, however, in turn begs the question of why the G20 was “already” there. The answer to this question too has already been partly given. The decline of the relative weight of the G7 in the world economy and the increased economic and financial interconnectedness that globalization was bringing about required a closer dialogue between the G7 and the emerging market economies. Unsurprisingly, the decisive push to act to this effect came from a distress situation. The 1997–99 Asian crisis had started regionally and quickly become global, revealing an intensity and rapidity in the transmission of economic and financial shocks that astonished policy makers and required IMF financial interventions of unprecedented size (records to be broken in the crisis that started some ten years later). As in the case of the G7, a trial-and-error process was needed for the G20 to arrive at a defined format, although convergence was quicker. At the Vancouver Asia-Pacific Economic Cooperation summit in November 1997, President Clinton called for an ad hoc meeting of the G22 officials (or Willard Group, named after the Washington hotel where they met), which briefly turned into a G33 at a Bonn meeting in March 1999. In June 1999, at the G7 Cologne summit, the establishment of the G20 was announced and the format stuck.42 In parallel with the creation of the G20, the G7 was considering giving birth to the Financial Stability Forum (FSF), intended to broaden the G7 discussions on financial issues to a wider group of countries. It was a separate group because the focus on financial issues led to different criteria for the selection of its members.43 At the same time, it conveyed the message that neither the G20 nor the Forum (nor any other group) could rival the G7 as the hub of global governance. The final selection of the countries that would be part of the G20 was the serendipitous result of belaboured negotiations within the G7 to find a compromise between the differing views of its members. The US had initially proposed a new body to include a broader range of countries in the discussions, but was definitely more cautious on the scope and importance of the new group than Canada, whose finance minister, Paul Martin, was convinced that the flaws of the IMF response to the Asian crisis required a significant change in the way the G7 operated. The Europeans, including Germany (which had taken on the rotating G7 presidency in January 1999), were lukewarm on the notion of a new group. They feared a dilution of their role and were pressured against the idea by Spain and the Netherlands, which knew that they would be excluded. France, as well as the IMF, feared that a new group would steal the thunder from the IMFC and the IMF managing director (then, as often, a French national).

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In a transatlantic telephone call that has acquired a quasi-mythical status in the lore of international relations,44 Tim Geithner and Caio Koch-Weser (then US and German G7 deputies, respectively) finalized the list of countries capable of attracting consensus and circulated it to the others for approval. The composition of the new group was finally found: the G7, plus 12 others,45 plus the European Union (EU). Political expediency and compromise46 were the polar stars that led the process to its destination, given that the composition of the G20 was hard to rationalize in terms of “objective” criteria. The G20 started its operations following the basic framework agreed at the deputies’ meeting47 which prepared the first G20 meeting with the finance ministers and central bank Governors. The G20 would have two deputy meetings per year and one ministerial, at the end of which a communiqué would be released; and a rotating presidency but no secretariat or formal agreement, in line with the tradition of the “Gs”. The agenda was spelled out in the communiqué of the Berlin meeting – the shortest ever in the history of the G20 – and focused on stability and crisis prevention. Given the informality and broad composition of the group, it could, and indeed would, range over any relevant and not-so-relevant topic that it fancied. Although Canada had hoped that the G20 would become a deliberative forum, spurring the formation of consensus,48 actual developments fell short of these high expectations. The G20 showed fairly poor clout on sensitive global economic and financial issues, in particular the steering of the IMF and other IFIs – the shots continued to be called elsewhere. It became more a debating than a deliberating club: a forum where emerging powers had a seat at the table and could voice their dissatisfaction, particularly about IMF governance, with little practical consequence. The communiqués increased in length, but not in relevance, as did the drafting sessions for preparing them, which often became the occasions for the emerging countries’ futile efforts to modify the substance of agreements on topical issues that had already been enshrined in the IMFC press releases. After hours of extenuating negotiations on the text, the key sentences from that earlier document were repeated verbatim in the G20 communiqué. Some scholars49 offer a much more benign interpretation of the pre-crisis achievements of the G20, interpreting them as the slow but sure progress towards a more inclusive and legitimate model of global governance, with participation in the forum that could work as the hub of the system. It is difficult to deny that the G20 provided some services to the international community, helping with the exchange of information and opinions that, as argued earlier, is the basis of international cooperation (by whichever meaning). It is equally difficult to refute that the G20 was not perceived by the G7 as a crucial deliberation forum, as indicated by the principals’ participation in the G20 meetings, particularly those in Asia – participation that was not as assiduous as that in the G7 or the IMFC gatherings. G20 deliberations only carried operational weight, especially in steering the IFIs, if they derived from the G7 agenda. There were no hints of budding peer pressure, which is necessary for an informal group to deliver on its commitments.

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The G7, quite myopically, showed no genuine intention of giving away any of its agenda-setting power to the G20, justifying even the cynical interpretation of the initiative as a merely cosmetic device. Irrespective of one’s assessment of the role of the G20 in global governance before the crisis, two points are undisputed. First, the emerging powers were deeply dissatisfied with their poor influence in global governance, in both the G20 and the IFIs. Second, the G20 had not yet acquired the authoritativeness and effectiveness to be considered the obvious broad forum to manage a crisis which, because of its scope and intensity, could not be handled by the G7 only. The G20 was already in place. This was the main reason why it was resorted to in an emergency situation. However, even after the Washington summit in November 2008, it was not obvious that the G20 would be the building site for the unavoidable transformation in global governance. Indeed, the meeting was not even called a G20 summit, but rather just the “Washington summit on financial markets and the world economy”. Moreover, the US administration had just changed. Its continuity in managing the crisis would not necessarily extend to assigning the central role to the G20, given the serendipitous selection of countries and the possibly broader foreign-policy implications of confirming a central role for the G20. For all of these reasons, 2009 was a year of format experimentation – and it was perceived as such in official circles. The effects of the financial crisis on the real economy had dramatically emerged. The expression “the crisis has moved from Wall Street to Main Street” was spreading awareness among the general public of the need for a global response, increasing the pressure on policy makers to deliver effective remedies. International crisis meetings, in a variety of regional and global configurations, were innumerable. They were convened to deliberate, to show that something was being done, and, in a me-too fashion, to assert the relevance of that particular forum. The US long remained a fence-sitter as regards the format to be chosen for “the group” that would occupy the centre stage in the global response to the crisis. In the end, it was the existing G20 that was preferred to the various alternatives that were tried, proposed, or foreshadowed. The decision was made at the Pittsburgh summit in October 2009, when the communiqué explicitly designated the G20 as the “premier forum for international economic cooperation”. This was more the result of casual events and the advantage of the incumbent than of reasoned arguments to prefer the G20 format to the G14, or the Major Economies Forum, which were tried, among others, that year.50 With events unfolding, one crucial factor for the success of the G20 turned out to be the UK presidency in 2009. The UK championed the G20 format with exceptional stamina and determination, which in other circumstances would have perhaps been channelled towards addressing the crisis in other groups. Gordon Brown, who was the prime minister at the time, had unrivalled hands-on experience in international economic and financial cooperation, given his tenyear tenure as chair of the IMFC. In addition, his investment of personal political

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capital in international affairs also had a domestic motive. That year of inevitable recession was to be shortly followed by a general election, and the success of the G20 summit could be the trump card inverting a trend of plummeting popularity. In 2009, Italy was in the G7/G8 chair and was keenly aware that the old format could not deliver a credible response to the crisis without the involvement of the new powers. At the same time, only a tepid enthusiasm was felt for the G20, which was believed to have too many members. Moreover, Italy’s support for the G20 would have implied very close links between the two presidencies, which were prevented by the lack of personal affinity between the two prime ministers (and the relationship between finance ministers was not any better). In the preparation for the G8 summit, which would be held in July at L’Aquila, considerable energy and ingenuity were devoted to formulating, and discussing with the G8 and non-G8 partners, possible alternatives to the G20. The most promising formats51 were given a try in the meetings organized the day after the G8 summit. The opportunity for discussion was certainly appreciated by the participants. In that critical moment, the appetite for sharing information and concerns was practically boundless, while “new entries” were thrilled to be at the table. However, no configuration sparked any excitement for its deliberating capability or marshalled widespread political support. In short, no alternative to the G20 seemed worth the diplomatic inconvenience of excluding any of the existing members or selecting some of the many candidates vying for inclusion. The G20 remained. Its original composition was somewhat tinkered with, starting at the first summit in Washington. In a flamboyant show of European spirit and diplomatic prowess, President Sarkozy convinced President Bush to extend the invitation to the leaders of Spain and the Netherlands as well – one as the beneficiary of the extra seat that France would have had as rotating chair of the EU, the other “as representative of France”, given the convergence of European views. A flurry of subsequent negotiations and consecutive “exceptional” invitations ended up with the admission of Spain to the group, although with no central bank, and a rejection of the Netherlands. Since then, the core of the G20 format has remained unchanged. Each presidency has, however, exercised the privilege of inviting two extra countries to all meetings during its tenure to further its foreign policy objectives, thus typically pleasing countries of the same region. For example, New Zealand was invited to all meetings during the 2014 Australian presidency. Despite the inordinate energy invested in the negotiations, the precise composition of the forum was not so relevant after all. All of the concrete options included the new key powers of China, India, and Brazil – the countries that, as we have seen, account for the lion’s share of the gains in relative economic weight corresponding to the G7 decline. (For obvious geopolitical reasons, Russia too was part of the inner circle, albeit with an ambiguous status, as it was signing both G8 statements and those of the newly formed group of emerging powers, as is discussed in Chapter 2.) Rather, the crux of the matter was the transformation

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in the relations between the new major economies and the G7, unsettling the existing balance of power in global governance. The heightened profile of the G20 associated with its upgrade at the leaders’ level was instrumental to this process, as became apparent at the very first G20 summit, held in Washington, on 14–15 November 2008.

No finger-pointing in Washington Just a few days after the momentous events of the IMF 2008 annual meetings that opened this chapter, an extraordinary reunion was convened by President Bush, directly inviting his G20 peers. The news of the upcoming meeting of the world leaders sparked great expectations and unbridled fantasies of a radical reform of the international financial architecture. While the crisis was raging and governments were under huge pressure to arrange an adequate policy response, many recognized the need for a deep change in the way the global economic system was organized and managed. The expression “Bretton Woods moment” was coined52 and became popular. But is the Washington summit really comparable to Bretton Woods? Possibly it is, in that both events mark a major watershed moment in the evolution of global governance. The comparison, however, must stop there. It certainly cannot extend to the degree of detail and institutional importance of the decisions made on the two occasions. Given the very short time for technical preparations and political negotiations available before the Washington summit, a Bretton-Woods-type conference could not possibly have taken place. Even without Keynes and White, having a fully fledged “Bretton Woods moment” would have required preliminary work on a scale comparable to that of the former historical episode. More fundamentally, the necessary political conditions were not present,53 as the need for a radical overhaul of the system was not felt by the G7 or by the US in particular. Their hope was to involve a broader group of systemically relevant countries for the management of the crisis, without giving away too much influence. As Ken Rogoff put it,54 “anyone expecting a mea culpa on the global financial crisis will be sadly disappointed”. Quite a few55 were disappointed and voiced their bitter discontent with the results of the Washington summit, which were well short of the foundation for a new global system. Most commentators, members of the general public, and financial market participants were, however, very positively impressed. Some heralded the summit as the beginning of the G20 era – a hasty judgement when considering the growing pains of the G20 that are discussed in the next chapter. However, leaving aside unwarranted commendations of the G20 format, the Washington summit was a major success on at least two grounds. First, the meeting offered a remarkable show of unity. It reflected a genuinely shared assessment that addressing the crisis was a matter of common concern, which required a global response to prevent the collapse of the system and “the end of

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globalization”, as in the 1930s. If the same policy mistakes were to be avoided, some form of cooperative coordination of national responses was necessary. The summit reached an agreement on this key political message. Moreover, the communiqué spelled out this central idea in broad but momentous commitments in various policy areas. The first area regards resolute policy measures, both fiscal and monetary, which were necessary to fight the fall in economic activity and employment. Second, governments would refrain from beggar-thy-neighbour policies on exchange rate and trade, excluding an escalation of protectionist retaliations. Third, the question of financial sector reform, which is invariably asked for after a financial crisis, would be addressed through a shared approach. Though not an explicit mea culpa, this commitment at least recognized that gross regulatory mistakes had been made and had to be redressed. The second key policy result of the Washington summit, which is at the core of the central theme of this book, is the significant and irrevocable power rebalancing in global economic and financial governance in favour of the “new” major economies – although “new” is of course with reference to a quite limited historical period. This evolution was not – and is not – inextricably linked to the G20 format. It could have been a summit with 16 or 24 members at the table. Rather, the crucial discontinuity lies in the very different attitude and influence that the new powers have since then gained in all multilateral fora, including the G20. For the reasons illustrated before, this change was bound to happen at a certain point in time. It happened in Washington. In contrast to the typical emergency meeting, the G7 and the US in particular this time had both the responsibility for the explosion of the crisis and the most pressing need to show that the international community was united in addressing it. It would have been much costlier in political terms for Bush, Sarkozy, or any other G7 leader to justify a meagre outcome of the summit to their domestic public opinion than for Jintao, Singh, or Lula. The latter had the option of claiming that they had been cooperative in accepting the summit invitation but were only offered a raw deal, which was unacceptable given where the responsibility of the crisis rested. The new powers too, of course, stood to benefit from cooperating with the G7 in devising an effective response to the crisis – they would not be spared by the calamitous effects of a collapse of the system, irrespective of their lesser responsibilities. At the same time, they had a very precise perception of their negotiating position as being stronger than it had ever been before, and they intended to make the most of it. In particular, they made it very clear that the Washington summit had to mark a discontinuity in global governance, starting a new phase in which they would gain a greater influence on world economic and financial affairs, and a widely recognized, more relevant role. The time for the preparation for the meeting was short in this respect too. The overarching demand by the new powers for a more prominent role in global governance could not be detailed in precise requests to be advanced during the Washington negotiations, save for an increase in IMF quota share and

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participation in the FSF, from which, as we have seen, they had been excluded at the time of its establishment. These issues were raised in Washington, though deliberations needed to wait until the following G20 summits. Despite the deferral of more precise demands, the new powers’ behaviour at the summit made abundantly clear that times had changed. They had no intention of being invited as extras, endorsing decisions made elsewhere so that those decisions could be presented as “global”. The dynamics within the communiqué drafting sessions offer the most vivid testimony of this change in the balance of power. Drafting sessions provide countries with the opportunity to flex their muscles and test each other’s red lines before the principals’ meeting. Officials are always more stubborn than their political masters. They lack leaders’ broader political vision and leeway, and follow the well-rehearsed role playing in which the principals are the good cops who give away the final concessions needed to cut the deal. With regards to the language used in the communiqués, this standard practice applies both to parts of the text that literally express the actual substance of the contention and to phrases that become coded expressions for the dispute at hand – even though the coding often becomes unintelligible to outsiders because conflicting positions are often formulated into alternative phrases that sound exactly the same to the general reader to whom they are in principle addressed. At the Washington summit, one of the expressions which was given a symbolic significance turned out to be “global imbalances”. In the initial version of the communiqué, global imbalances were quoted as one of the factors underpinning the crisis – an apparently common-sense, uncontroversial statement. The fragility of the world economic system, entailed by the soaring US deficit and China surplus, was a universally recognized fact. In addition, the reference to global imbalances did not single out deficits or surpluses as the main causes of the trouble. Yet, in a show of power and determination, the Chinese delegation decided that the very use of this expression represented an accusation addressed to their country – “finger-pointing” was the word used. No argument could convince China that the use of the expression “global imbalances” implied no reference, even implicit, to their responsibility. China insisted that the expression had to be taken out. And out it went. In this way, China successfully established the important precedent that in G20 communiqués, which had always been decided by consensus, its own veto power was as authoritative as that of the US or any other member – not only in principle but also in practice. The final version of the Washington communiqué used the expression “unsustainable global outcomes”, a circumlocution meaning pretty much the same as “global imbalance” to anybody who did not attend the meeting. The insistence on a point of that nature did not have an objective relevant for public communication. It was specifically directed to mark the beginning of a new phase in the relations among members around the table. The strengthening of China’s and other new powers’ roles in that forum, and more generally in global governance, was not a passing feature related to the crisis. It was there to stay.

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While the other new powers shared China’s claim to greater relevance at the G20 table, they offered lukewarm support to China’s insistence on the exclusion from the text of “global imbalances”. The disequilibria in their external positions were not as important a factor of global instability as China’s and they did not feel “finger-pointed at”. China’s display of determination was also directed at the other new powers so as to signal, even in that particular forum, that its national interests had priority over collective objectives. On many matters, the non-G7 camp was as divided as the G7 one. Presenting issues in terms of G7 versus new powers is just shorthand for expressing the main theme in the recent transformation in global governance and, of course, it is not an accurate characterization. Yet, as coarse as it may seem, the contrast between these two groups is a good first-order approximation for describing and comprehending the dynamics of contention and cooperation through which the change in global governance has taken place in the G20 and the IFIs. Other points of contention, needless to say, emerged during the meetings. Among them, the dispute over the division of tasks between the FSF and the IMF was prominent. The direct involvement of the heads of the two institutions, Mario Draghi and Dominique Strauss-Kahn, respectively, was needed to find a compromise: the former would lead the setting of standards and the latter would monitor their implementation. The focus of the summit, at any rate, was not the final round of negotiations over precise policy measures. Particularly when compared to the G20 summits of the following year, the Washington meeting had a relatively light agenda in terms of specific decisions. In fact, the political momentum concentrated on agreeing about high-level principles in the response to the crisis, pledging to adopt a common framework. The G20 made important commitments. The gravity of the situation required the commitments to translate into determined policy actions – and fast. The London and Pittsburgh summits would deliver in 2009.

Conclusions In the last decade of the 20th century, the need for a change in the global economic and financial governance system based on the G7 became acute for several reasons. The G7’s grip on world economic affairs weakened; its peer pressure, even on its own members, proved wanting; the imbalances and fragilities that underpinned the 2008 crisis were building up. Even more fundamentally, the portentous acceleration in the economic effects of globalization led to a drastic reduction in the relative economic weight of the G7, which in twenty years lost a third of its share of world GDP. The gains of this major shift in economic power mostly accrued to a small group of countries. China, India, and Brazil alone account for about two-thirds of the gains, with the remainder mostly benefitting some other ten countries. The loss in the effectiveness and legitimacy of the G7-based system of global governance took place in a world increasingly in need of effective international cooperation

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because of deeper interconnectedness and interdependence among national economic and financial systems. Although these factors had been looming large for many years, it was only the eruption of the crisis originating at the very centre of the system that triggered a deep transformation in global governance. The severity of the crisis required the involvement of a group of countries wider than the G7 to marshal a credible and effective policy response, which the G7, and the US in particular, most acutely needed. This change eventually provided the new powers (some of which were in fact quite old, as China and India, which had accounted for more than half of world GDP throughout the first millennium AD) with the opportunity to demand, and in part to obtain, a more important role in global governance, as they had been long aspiring to do. Due to many serendipitous circumstances, the G20 was the body at the centre of the transformation in global governance. To allow this change, the G20 itself had to evolve in both format, upgraded at the leaders’ level, and balance of power among its members. The crisis and the way the international community arranged the policy response to it radically upset the existing equilibrium in global governance. A new phase marked by the greater influence of emerging market economies began, and there was no going back. This shift in power is unmistakably apparent in the way the G20 has operated since November 2008, both during the initial heroic times, when the bold deliberations to address the crisis were made, and during the subsequent phase, when the G20 proved less effective than had been hoped.

Notes 1 The text of the communiqué can be accessed at www.g20.utoronto.ca/2008/ 2008washington1011.htm. This website collects all G20 and G7/8 communiqués quoted in the text. 2 The formal expression for meetings at the very top level is “Heads of State or Government”. 3 Alan Greenspan (1996) coined this phrase in a televised speech in December with reference to the dot-com stock bubble. Shiller (2000) used it as the title of his book on the US housing bubble. 4 This Time is Different by Reinhart and Rogoff (2009). 5 Eichengreen and O’Rourke (2010, 2012), Almunia et al. (2010). 6 Eichengreen’s (2015) eminently learned and enjoyable book analyses uses and misuses of history in the process of making policy decisions and shaping public perception during the response to the 2008 financial crisis. 7 Stock and Watson (2002) introduced the expression “great moderation” to label the reduction in the amplitude of business cycle fluctuations, starting in the mid-1980s. Soon after, Ben Bernanke brought it to the attention of the general public and, by vindicating the merits of improved monetary policy management, triggered the academic debate on its causes. 8 The episode, which took place in November 2008, was widely reported on by the British media. 9 In a fascinating, non-technical narrative turned into a movie, Lewis (2010) explains how poor-quality loans were repackaged in securities to obtain the top (triple-A)

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10 11 12 13 14

15 16 17 18 19

20 21 22 23 24 25 26 27 28 29 30 31

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evaluation from credit rating agencies, in complete defiance of common-sense that was accepted by virtually all the financial establishments. US Treasury Secretary Paulson famously kneeled before Nancy Pelosi, then Speaker of the House, to beg for her support for the rescue plan. The G10 refers to the group of countries that have agreed to participate in the General Arrangements to Borrow. More information on the G10 is available at www.imf.org/ en/About/Factsheets/A-Guide-to-Committees-Groups-and-Clubs#G10. Saccomanni (2010) puts forward this argument very forcefully. On the role of macroeconomic policies in causing the crisis, see Visco (2010), Catte et al. (2011), and the other papers there referenced. The concepts from evolution theory, such as those in Dawkins (1986, 1997), come in very handy when accounting for the piece-meal and haphazard yet functional process of progressive transformation in global economic governance, with one significant exception: the absence of extinctions among the institutions that form the international architecture. New institutions are periodically set up, without closing down the existing ones. Of the more than twenty international institutions in the economic and financial field that have been created since 1950, only the G10 has been discontinued (in 2009). And even this event, rather than a deliberate decision, was the result of the overloading of the agenda at international meetings, as none of the rotating chairs wanted to take the responsibility of declaring that the G10 had long outlived its usefulness. Rey (2015). For example, Drezner (2014a, 2014b). Episodes of successful policy coordination are recalled, for example, in Bayne (2000), Kirton et al. (2000). The importance of networks in international economic relations is stressed by Slaughter (2004). Besides finance and foreign affairs ministers, always involved in the preparation of summits since the first one, regular parallel processes were over time established for the ministers of trade, environment, labour, interior, and justice, in addition to innumerable groups of experts. Franchini Sherifs and Astraldi (2001) chronicle the process in detail. The sources of these data, as well as the other GDP figures quoted in this chapter, are the IMF World Statistics and Maddison (2010), in some cases as elaborated by Baldwin (2016). Baldwin and Martin (1999), however, warn that these two waves of globalization have fundamental differences and that the analogy should stop at the intensity of economic dislocation and social distress. Following the analysis by O’Rourke and Williamson (2002), this is the period typically indicated by economic historians as the beginning of the 19th-century globalization wave. Pritchett (1997). This is the title of James (2001). Here again we follow the analysis of Baldwin (2016). China, India, Brazil, Russia, Indonesia, Mexico, Poland, Turkey, Korea, Australia, Venezuela, and Colombia. Morris (2010, 2013). Stiglitz (2003), Bhagwati (2006), Rodrik (2012). Hamada (1974, 1976). The non-cooperative policy interaction with a recognized leader is modelled with reference to the notion of Stackelberg equilibrium, different from the usual Nash equilibrium, recently popularized by the movie A Beautiful Mind, which recounts the life of John Nash. For an introduction to game theory, see Tadelis (2013). Rogoff (1985), Kehoe (1989), Canzoneri and Henderson (1991) put forward gametheoretic analyses showing that international cooperation can be worse than useless.

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Despite their rigour and appeal, the models of counterproductive international cooperation do not seem to capture situations that often occur in practice. A search for Prisoner Dilemma on the internet provides innumerable links to sites describing the original game and illustrating possible applications. The rate of time preference, in game-theoretic jargon. In game theory, the analytical proof of this result is known as Folk’s Theorem. The first efforts to measure the benefits from cooperation on the basis of international economic models date from the 1980s, with the path-breaking paper by Oudiz and Sachs (1984). Bryant et al. (1988, 1993) collect several estimates. Subacchi and van Den Noord (2012). Faruqee and Srinivasan (2012). For example, Corden (1994, 2012). As Fearon (1998) points out, international bargaining always involves elements of both “coordination” and “cooperation” as negotiations are framed by the possibility of enforcing the agreement, which is itself part and parcel of the bargaining process. Kenen (1990). In his seminal book on the G20, Kirton (2013) provides a detailed account of this process. The initial membership of the FSF and its evolution when the group was upgraded from Forum to Board in the aftermath of the crisis are discussed in Chapter 5. Wade (2009). Argentina, Australia, Brazil, China, India, Indonesia, Korea, Mexico, Russia, South Africa, Saudi Arabia, and Turkey. Here is an example worth recalling: the first G20 ministerial meeting took place in Berlin in December 1999 to pacify the dubious Germans, but was chaired by the staunchest G20 supporter in the G7, the Canadian Martin. In the spirit of symmetric compromise, the meeting was chaired by Germany and held in Canada. These ambitions are evident from Canada (2000), the “backgrounder” prepared for the press by the department of finance, available at www.g20.utoronto.ca/g20back grounder.htm. Most notably, Kirton (2013), who also thoroughly reviews scholarly positions on the G20. The G14 consisted of the G8 plus Brazil, China, India, Mexico, South Africa, and Egypt, which is equivalent to the G20 format with the addition of Egypt and the exclusion of Argentina, Australia, Indonesia, Korea, Saudi Arabia, and Turkey (note that the two formulations do not seem to be algebraically consistent because both the G8 and the G20 include the EU, but the former does not count it in the number of the group’s name, while the G20 does). The Major Economies Forum format is equal to the G14 with the addition of Indonesia and Korea and the exclusion of Egypt. The G14 and the Major Economies Forum. Helleiner (2010a). Helleiner (2010a). Quoted in www.nytimes.com/2008/11/16/business/worldbusiness/16summit.html. For example, Duncan (2008); for a review of the comments, see Kirton and Guebert (2009), Kirton (2013, pp. 228–30).

2 SUCCESS AND FAILURES OF THE G20

“No, I am not going to Muskoka, I am staying – there is much more important stuff to negotiate here”. This was the answer that another G7 finance deputy gave to this author in the Toronto Convention Centre, where G20 officials had been locked up for two days, drafting the communiqué to be adopted at the fourth G20 summit, on 26–27 June 2010. Muskoka was the resort in North Canada where, on the 25th, the G8 summit would take place. This matter-of-fact exchange crystallizes the perception at the time, shared by the international official community and the general public, that indeed the G20 had eclipsed the G8 in terms of decision-making relevance. Canada, holder of the G8 rotating presidency and staunch supporter of the G20 well before the crisis erupted, had insisted on hosting a G20 summit. This demand was accommodated on the condition that Korea too could have one, as the country holding the G20 presidency according to the rotation. As a result, two G20 summits were held in both 2009 and 2010. For practical reasons more than out of a deliberate plan, the Muskoka G8 summit took place just before the G20. It thus came to be portrayed as a “preparatory” meeting, furthering the notion that the G20 was the only forum where international decisions that mattered in the economic and financial sphere were made. In the acute phase of the crisis, the G20 had rapidly come of age and was hailed as a sort of world-saver. It had come up with the policy actions that staved off the collapse of the global economy – a joint fiscal and monetary expansion with no precedents in history for size and geographical coverage, together with the rejuvenation of the IFIs’ role accompanied by a massive injection of resources. These achievements spurred the Canadian presidency’s ambition, shared by Korea, to consolidate the G20’s central role in global economic governance. The emergency function of devising urgent common actions was to morph into the permanent

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status of agenda setter – From Crisis Committee to Global Steering Committee, as the title of a symposium organized in Seoul that year very eloquently put it. This transformation was not as straightforward and unavoidable as it appeared at the time. It is indeed debatable whether the G20 in its present composition has achieved these ambitions and has become the “Global Steering Committee”, as effective as the interconnectedness of the world economy and finance would badly require. Before addressing this question, the unfolding of the different phases of the G20 has to be reported and analysed. This is the purpose of the present chapter, which covers the success of the two 2009 summits, underpinning the optimistic mood in Toronto described earlier; the ambition to overhaul the international financial architecture in its monetary and institutional foundations; and, later, the disappointing years of low growth and renewed financial instability, when the G20 struggled to deliver the objectives it had set for itself. Many authors have persistently challenged the G20 as the appropriate basis for global economic governance, even after the communiqué of the third summit in Pittsburgh anointed it as “the premier forum of international economic cooperation”. There was no repetition of the multiformat experimentation that took place in 2009, but several academics have been pointing out the insufficient legitimacy of the G20,1 proposing alternative groups and arrangements – in particular, suggesting assigning (some of) the seats of the agenda-setting group to constituencies of a geographical nature.2 For better or for worse, this debate has never gained traction in the international official community. Policy makers have been afraid to initiate contentious negotiations about format and composition, which would have interfered with more pressing matters. One should not underestimate the conservative attitude of incoming and prospective G20 presidencies, which are keen to get the attention guaranteed by hosting the summit and do not want to have a different forum reduce their visibility. Despite the questions raised about its legitimacy and its mixed success, since the upgrade to the leaders’ level, the G20 has unfailingly proven to be the laboratory where the key changes in global economic and financial governance have taken place, have been decided or initiated, formally or informally. Indeed, since 2009, when the major decisions that averted the collapse of the global economy were made in London and Pittsburgh, the G20 has really been the only “G” in town. Even though it has regained some importance in the most recent years, the G7 could no longer rival the G20 for scope of decision or capacity to steer the debate among all the relevant global players. At the same time, the undeniable flaws of the G20 in providing adequate responses to the demand for international policy coordination – a demand arising from ever-increasing interconnectedness – raise legitimate doubts about its longevity as the hub of global governance.

The crowning of the G20 as the world-saver With the success of the Washington meeting, the G20 had proven itself to possess the potential to become the hub for the international coordination of policy

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responses to the crisis. It could not possibly have become the key forum of international economic cooperation without the important decisions made at the London and Pittsburgh summits in 2009. On these two occasions, under the enormous pressure of rapidly shrinking economic activity and a collapse in trade flows harsher than during the Great Depression,3 the G20 marshalled a comprehensive response, resorting to a wide spectrum of policy and institutional levers, domestic and international. Even more importantly, the G20 acknowledged the need for reforms in various areas, starting with financial regulation. Actions to address urgent situations had to be accompanied by bold reforms that would prevent the next crisis. Spurred by the gravity of the situation, which had started to show its dramatic intensity in the rapid rise in unemployment, the G20 gathered the political determination to take resolute actions. As in Washington, advanced countries felt more than the other members of the G20 the urgency to achieve an agreement on a robust policy package. To secure the support of emerging countries, the decisions in 2009 included significant steps in the direction of a more inclusive global governance. Moreover, in contrast to what had happened at the Washington summit, both 2009 reunions were preceded by ample time for technical and political negotiations, so that adequately prepared options were available to the leaders. Throughout 2009, the lead of the G20 process rested firmly with the G7, in particular with the two countries where the financial disruption was the most intense and the interventions to rescue the financial system were the most radical: the UK and the US, which hosted the two summits of the year. All the other countries were receptive and open to considering innovative measures in a situation where the global economy was deteriorating so fast and deeply as to leave hardly any room for timidity on the part of policy makers. Another major drive of the G20 process was intertwined with the common appetite for bold and effective measures: the determined, unrelenting demand from the new economic powers for more influence in global governance. The upgrade of the G20 at the leaders’ level had already strengthened their role in that forum, receiving unambiguous recognition both within the G20 itself and in the public profile. Yet this was not – and could not be – enough. The new powers intended to exploit as much as possible the special bargaining force granted by the ravaging crisis “caused by advanced countries”. To elaborate a more precise formulation of their requests, they organized assiduous consultations among themselves – most notably in the format of BRIC (Brazil, Russia, India, and China) meetings, giving momentum to this group that, as discussed later in the chapter, has played a relevant role in the reform of global governance. This process resulted in the demand for more participation and influence in a very wide spectrum of international institutions, fora, conventions, interactions – demand which was then relentlessly advanced both in institutional settings, such as the IMFC, and in the G20, as the forum with an overarching view of the key negotiations in progress.

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The London summit delivered the first results of this strategy with, for example, the decision to broaden the membership of the FSF, although the new powers only considered this a down payment for the more substantive power rebalancing to which they felt entitled. Most importantly, the process of international crisis management, which came to have the G20 as its centre, marked the beginning of the strategy that is one of the defining features of the transformation in global economic governance. On every possible occasion, the new powers exert an incessant pressure for more influence in the existing system of governance, without, however, escalating to the open threat of overthrowing the existing architecture, since an alternative was not (and is still not yet) available. Before turning to the key results of the two summits, a brief detour is needed to dwell on the special role of Gordon Brown in the preparation and then management of the London summit, both because of his determination and because of the specific economic and financial competence he acquired during his long tenure as Chancellor of the Exchequer. Brown’s expertise, unrivalled by any other G20 leader, provided him with a remarkable advantage, which he fully exploited through countless one-on-one calls with his peers. Whenever some country expressed stubborn doubts on a specific measure (such as the increase in the IMF Special Drawing Rights [SDRs]) in the technical negotiations, Brown would directly call his counterparty. He purposefully bypassed recalcitrant officials and ministers, confronting his fellow leader with a barrage of technical arguments before coaxing him/her into agreeing with the objective that the announcement of specific measures at the summit was indispensable to restore confidence. Although resorting to bilateral calls from the Chair to secure support before an international meeting is standard practice, it had never been used to such an extent, especially on such technical issues. The culmination of Brown’s daring departure from the well-established protocol of international meetings was reached in the communiqué negotiation. The drafting of the text had been particularly long and complex, given the numerous decisions to be approved and their political sensitivity. In the wee hours of the morning when the summit began, at the end of exhausting discussions in the socalled jumbo session with both sherpas and finance deputies, baffled officials were told that the first part of the text that they had so painfully agreed upon would not be circulated to leaders. Brown had found it dull and decided to try his own hand at it, as the G20 could not risk issuing an uninspiring communiqué. Infuriated protestations and threats to escalate the procedural question up to leaders4 led to nothing. The leaders had to work on and approve a text that neither they nor their teams had seen before. Gordon Brown’s stamina added to the pressure from dire economic conditions that led the G20 to agree, in both London and Pittsburgh, on many momentous decisions, which it is useful to overview briefly. G20 deliberations of that year, and the initiatives and processes they started, gave rise to many of the threads in the transformation of global governance that are analysed in this work. They can be grouped into four areas.

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The first line of action was macroeconomic policies. The Washington commitment to take aggressive expansionary measures was honoured through drastic reductions in interest rates by central banks and large increases in public spending in all countries with available fiscal space. In order to buttress the notion that macro policies had to follow a common approach, a new process of peer review was launched in Pittsburgh. The second area of intervention was specifically targeted to revive international trade, which was rapidly shrinking and acting as a powerful contagion channel for the crisis. The pledge to avoid protectionism was made operational in the London communiqué, which assigned an explicit mandate to the World Trade Organization (WTO) to monitor the possible adoption of protectionist measures, and which stated the equally explicit engagement to remove any such measures detected by the WTO. Most importantly, the G20 decided on a US $250 billion increase in trade finance from various sources – a crucial measure that deserves more credit than it has received, since it facilitated the thaw in the trade-finance freeze that was the immediate cause of the collapse in international commercial transactions. The repair of the financial sector was the third area of major action. The London and, in particular, the Pittsburgh communiqués have very detailed action plans as attachments. Somewhat pedantically, they list the types of measures necessary to restore the viability and robustness of the financial sector so that it can perform its function of providing credit to economic activity, avoiding the prolongation of the credit crunch, which is always the most powerful channel of propagation of financial crises to the rest of the economy. The injection of fresh capital, mostly public although in different forms, was particularly important. The fourth area regarded the massive increase in the resources of the IFIs, most notably the IMF, which saw its available funds triple through bilateral loans and a substantive increase in SDRs, the reserve asset issued by the IMF. These resources allowed the IFIs to stand ready to extend financial support should the crisis deteriorate further and prevent weak countries from accessing the markets for their financing needs. However, the G20 went further than devising immediate responses to the crisis, no matter how effective and mutually consistent they were intended to be. In the two summits of 2009, it resolved to exploit the political momentum of the emergency situation to launch a radical reform process in order to redress the root causes of the crisis. This ambitious objective required deep institutional changes with important consequences for the balance of power within the various institutions, national and international; between them and their stakeholders; and more generally in the global financial architecture. The political sensitivity of the reform process and its importance in shaping international relations for years to come was apparent to all G20 participants and attracted commensurate focus and energies, both in the negotiations for the two summits and in the following years, when the reform process launched in London and Pittsburgh would be implemented and forged out.

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The two major reform processes launched in London have to do with the financial sector regulation, as befitted the crisis in progress, and the IFIs, whose usefulness had been seriously questioned before the crisis. In both cases, the new powers demanded and obtained concrete and immediate steps towards the suitable recognition of their enhanced role. The G20 deliberated to transform the FSF into the Financial Stability Board (FSB), to assign a reinforced mandate to the newly established body, and to broaden its membership to all G20 countries, as discussed in Chapter 5. Second, in return for the massive increase in resources, the G20 required the IFIs “to strengthen their longer term relevance, effectiveness and legitimacy” – where the crucial word here is legitimacy, coded term for a shift in voting share and influence in favour of the new powers. In addition to these two reform threads, in the two summits of 2009 the G20 decided to launch other work streams, most notably on tax cooperation and anti-money laundering. With all these achievements, actual or pretended, it is no wonder that the G20 was hailed as the new “committee to save the world”, revamping the sobriquet that the famous cover of Time magazine had bestowed upon the Rubin-GreenspanSummers trio ten years earlier5 – a committee that, reassuringly for non-US citizens, this time had a more assorted national composition. Leaving hyperboles aside, in the span of one year, the G20 had become the focus of international economic relations. Assessments about its effectiveness and legitimacy, to echo what the G20 demanded of the IFIs, varied, even among G20 members, but the perfectible G20-based governance was by then the starting point of any plan to improve the way the world economic and financial system was managed. And it could not be any different, given that the G20 was the forum where the policy decisions to avoid another Great Depression had been made. Subsequent events tempered the initial enthusiasm about the G20. What about the G7/8? After the 2009 events, the G7 concluded that keeping a low(er) profile was the best contribution it could make to smooth international economic relations. Quite some time later, the G7 would experience a rejuvenation, but at the end of that year, the G7’s mood about its own role was definitely sombre, as epitomized by the final sentence of the communiqué issued after the usual gettogether of G7 finance ministers and central bank governors at the margin of the IMF annual meetings: “We pledge to lead by example in adhering to the commitments agreed by G20 leaders in Washington, London and Pittsburgh”. The baton had passed on to the G20, as evoked at the opening of this chapter.

Revamping macroeconomic coordination One of the most significant and ambitious pledges taken by the new G20 was to adopt a shared approach to the setting of macroeconomic policies. This was the dutiful implication of the acknowledgment that poor coordination and global imbalances (a.k.a. as we have seen, “unsustainable global macroeconomic outcomes”) had been a key factor of the crisis. The text of the Washington

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communiqué had been very explicit about that: “major underlying factors to the current situation were, among others, inconsistent and insufficiently coordinated macroeconomic policies, inadequate structural reforms, which led to unsustainable global macroeconomic outcomes”. Such a candid admission of failure called for an improvement of a structural nature in the peer-pressure mechanism that had proved so wanting in the precrisis G7-based global governance. Delivering on this front, with a process fostering consistent policy actions, was a crucial element in the G20’s aspiration to become the lynchpin of renewed governance. This was a tall order, as an effective coordination mechanism required an agreement on the common objective to be pursued, the method to assess the consistency between policies, and the arrangements to exert peer pressure. Yet there was no way to duck the issue. After particularly lengthy and difficult negotiations at the Pittsburgh summit, the G20 announced the adoption of the Framework for Strong, Sustainable and Balanced Growth. Even though the coordination process has undergone several modifications, the name has stuck and the G20 still relies on the Framework and the homonymous working group, which is charged with the preparation of a periodic report for the principals. The persistence of the name is the legacy of the strenuous efforts needed to reach a consensus at the launch of the exercise. Views differed on its scope, particularly with regard to the importance accorded to the need to adjust global imbalances. As on many other occasions, constructive ambiguity solved the standstill and allowed agreement on a text – although the fundamental differences remained and would systematically re-emerge in the efforts to coordinate policies. Sustainable was interpreted to imply absence of both fiscal and financial imbalances, so the contentious reference to financial stability was left out, accepting the request of the US not to be “finger-pointed to” (even though that evocative expression this time was not used). Balanced too was accorded a double meaning. It had a geographical interpretation, in that strong economic growth should be broad-based, involving all regions of the world. It also had a reference, for each and every country, to domestic and external demand, which should be balanced, preventing the persistence of large trade surpluses or deficits. The reluctance of the G20 in Pittsburgh to be more explicit on the importance of reducing external imbalances in the commonly agreed objective of the coordinated approach should not be surprising. Throughout the history of international relations, the sharing of the burden of adjusting external imbalances has always been bitterly controversial. Finding concrete agreements on the matter – and on a system that would foster such agreements – has long been the holy grail of cooperation. The economic reasons for this are easy to appreciate. If neither the surplus nor the deficit countries take any policy action to restore the balance in the external position, it will always be the deficit countries that are forced to adjust. The external sources of finance that are necessary to continue accumulating trade deficits – the “nation-wide” version of living beyond one’s means – will sooner

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or later dry up, forcing an abrupt rebalancing of external accounts. With respect to a smoother and more symmetric adjustment, this process implies a reduction in income in both the deficit country, which must spend less, and the surplus country, whose exports to the other country accordingly decline. In a nutshell, limiting the fall in income in both surplus and deficit countries is the common interest that can ultimately motivate a cooperative division of the burden of adjustment. There is no need to invoke solidarity or political altruism, just enlightened self-interest. Enlightenment, particularly in the form of a forward-looking attitude to setting policies, is however necessary. Domestic political incentives tend to push for the continuation of the prevailing course of action and the unsustainable accumulation of imbalances. Deficit countries enjoy their higher living standard, irrespective of whether it depends on mounting fiscal or financial disequilibria, and prefer to delay the structural reforms, such as a more flexible labour market, which are capable of improving their insufficient competitiveness – “give me continence, but not as yet”, as young Saint Augustine candidly prayed. Surplus countries feel that their accumulation of external wealth is the righteous reward for their competitiveness. They believe that saving more than they invest (which is the accounting implication of running a trade surplus) helps to adjust for past imbalances, for example high public debt, or preparing to cope with future ones, such as those deriving from the aging of the population. And they certainly do not want to modify their policies to help the continuation of unsustainable trends in deficit countries – the moral hazard argument that gained so much prominence in the European sovereign debt crisis. The structure of the international monetary system, with the dollar as its pivot currency, also plays an important role in the determination of burden sharing in the adjustment of external imbalances. This was another long-standing topic of international economic cooperation, which could not possibly be omitted in the debate underlying the change in global governance that the explosion of the crisis had unleashed. Indeed, this issue featured prominently in the G20 debate under the French presidency in 2011 (as discussed later) – not in Pittsburgh, though, when the new format for the coordination of macroeconomic policies was launched. The disappointing performance in later years should not lead us to overlook the important innovative elements of the coordination exercise, which the G20 agreed to, marking a turning point in international economic relations. First, an informal group explicitly and publicly put forward the definition of a shared objective of a long-term, encompassing nature, rather than focusing on the specific economic or financial circumstances. As we have seen, the agreement required some ambiguity, but still, the G20 definitely recognized that cooperation could generate common benefits and that these had to be shared broadly – that is among all members. Quite a change with respect to the G7, which had unilaterally taken for granted that the results of the cooperation among them would benefit the world. Second, the need for peer pressure was explicitly recognized and attributed to the group itself with the establishment of the “Mutual Assessment Process”,

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where G20 members themselves would periodically assess the consistency of their own policies and demand from each other any required policy change. This was another symbolic milestone. All G20 members were put on an equal footing, as each of them had the faculty to demand other countries’ policy actions in the pursuit of the shared goal. To sustain a cooperative approach, the US emphasized that every single country at the table had to contribute to the growth revival through appropriate policy adjustments. Everybody had to “eat spinach” was the metaphor used in the preparatory sessions – although, quite palpably, opinions differed on those who were more in need of a dietary change. In Pittsburgh, the focus was almost solely on macroeconomic policies. The passing of time, with the failure of global growth to return to a satisfactory (precrisis) pace, exposed the need for extending the peer-review process to structural policies and their interaction with macroeconomic policies. The cooperation endeavours of the Framework Working Group increasingly involved considerations and recommendations in this area. The debate on secular stagnation and the deep-seated causes of lower growth6 that thrived in more recent years also pushed in that direction (although policy circles refrained from even considering the irreversibility of this trend that some academics entertain7). However, international peer-review and cooperation on structural policies always encounter additional difficulties, as reforms typically have important country-specific aspects and are politically even more sensitive. Political costs tend to be immediate and well understood, while the economic benefits appear to accrue with “long and variable lags”, to use the expression Milton Friedman coined for the effects of monetary policy. The third novelty was the explicit recognition that the evaluation of mutual compatibility is a technically difficult exercise and that policy options had to be prepared by adequate analysis. The G20 lacked the necessary resources, and the task was assigned to the IMF and the World Bank. For this reason, their profile in global governance was heightened through the G20, as discussed later. Yet, it should be noted here that the Fund’s role in the coordination exercise was not easy to reconcile with its own view that the Fund itself should be the sole repository of the surveillance function at the global level.

The old issues of international coordination confront the G20 The defining of the next concrete steps for the Mutual Assessment Process could not be finalized at the time of the exercise launch in Pittsburgh. It was left to the upcoming meeting of ministers and governors in St Andrews, which, in November 2009, marked the last act of the UK presidency, and involved an unexpected visit from Gordon Brown to promote a global tax on financial transactions before an unashamedly sceptical audience. There, a very tight calendar was envisaged. Countries were expected to fill in submissions detailing their policies and projections at short notice so that the first Assessment exercise could present concrete policy options for the Toronto summit, due to take place within six

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months, and more specific recommendations for the Seoul summit, planned for November 2010. This ambitious calendar was not respected. Most national submissions, in particular the one from China, were late, such that the IMF simulations could only be sketchy. The indicators proposed for the assessment of mutual policy compatibility turned out to be controversial within the Framework Group, with evaluation of external imbalances as the major sticking point. The G20 did not deliver what it had promised. No precise policy options could be fleshed out for the leaders’ consideration in Toronto, with the result that, on the macroeconomic front, the summit communiqué only focused on a half-hearted agreement on the need for putting public debt back on a sustainable path. The plea for the reduction of fiscal stimulus was not accompanied by an agreement on compensating measures to sustain global demand, particularly with regard to commitments by countries with a trade surplus to reduce it by boosting their domestic demand. The appearance of a consensual, joint policy response to support global growth was difficult to maintain. On this score, Seoul was not any better. The “specific recommendations” promised in Pittsburgh did not even reach the level of being submitted to ministers and leaders, as political divergences stymied their preparation at the technical level. In contrast to the multilateral, common approach enshrined in the Assessment process, the bilateral confrontation between China and the US dominated the G20 discussions on macroeconomic policy in 2010. In the US political debate, the accusation at China as currency manipulator because of its reluctance to allow an appreciation of the renminbi and a reduction of its external surplus gained significant relevance – for neither the first nor the last time, as the 2016 US presidential campaign for example demonstrated. China insisted on its defiant rejection of external interference, undermining the very idea of mutual surveillance on an equal footing, which was meant to be a key tenet of the power rebalancing within the G20. The positions of other G20 members were fragmented in national concerns without an encompassing vision. The BRIC front, so determined and compact in its claim for a stronger role in the IFIs, was certainly not united in supporting China. India as a deficit country was a fence-sitter in the dispute between the US and China. Russia, with the sole support of Saudi Arabia, focused on the vain effort to make the stabilization of the falling oil price an objective for the G20. Brazil loudly lamented the strong appreciation of its currency – in a celebrated interview to the Financial Times,8 its finance minister Mantega (the one who chaired the meeting marking the birth of the new G20) denounced the “currency war”, following unilateral currency interventions by Japan and Korea to make their exports more competitive. Advanced countries were no less divided. Canada and Australia, as earnestly as unsuccessfully, tried to steer the discussion back towards a multilateral approach. European members of the G20 were more sympathetic in their support of the cause of the renminbi appreciation, with the important exception of Germany,

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which denied that trade surpluses should be regarded as disequilibria to be corrected. The carefully crafted compromise on a common position agreed upon in the preparatory gatherings among the European members, which routinely take place before the G20, typically did not stand the test of the actual G20 meetings. European disaccord became increasingly apparent as the worsening of the situation in Greece (which accounts for less than 2 per cent of the euro-area GDP!) paved the way for the outbreak of the European sovereign crisis. The problematic arrangement of the first rescue package for Greece in May 2010 revived long-standing divisions in Europe on fiscal discipline and, more fundamentally, on the economic and political underpinnings of the euro-area. The initial success of the measures, blessed by the European Central Bank (ECB), rested on widespread belief that no sovereign debt repudiation would ever take place in the euro-area – the risk that contagion effects could jeopardize the survival of the Monetary Union was thought to be too large, forcing other euroarea governments and the ECB to come to the rescue. German Chancellor Merkel and French President Sarkozy dispelled this illusion in a memorable walk on the shores of Deauville on 18 October 2010, where they affirmed the principle that investors should bear the brunt of their careless lending to unreliable States. Bonds issued by troubled euro-area countries started to sell off, as fears of total or partial (the so-called haircuts) default mounted. The European crisis had started and, with its intricate convulsions,9 would occupy the centre stage of international macroeconomic debate for the following two years. With the meagre results of both the Toronto and Seoul summits, 2010 was very sobering for the effectiveness of the G20 as promoter of international macroeconomic coordination. The great expectations triggered by the results of the previous year and the ambitious Framework launched in Pittsburgh were disappointed. The difficulties faced by the G20 as soon as the emergency abated would later be interpreted as proof that the G20 coordination, even in the most acute phase of the crisis, was nothing more than an optical illusion: every country had just run countercyclical, expansionary policies, as they would have done regardless. The comparison in vogue was with the simultaneous opening of umbrellas when it starts raining. Individuals do not coordinate their actions, as a superficial observer might surmise. Everyone simply avoids getting wet when the rain comes. Within the G20, the mood at the time was very different. That same year, 2010, the G20 reached important agreements on other issues, such as the governance reform of the IMF discussed in the next chapter. Growth prospects appeared rosy – or at least much rosier than what would later materialize during a prolonged period of stagnation and diminishing expectations, with economic forecasts revised downwards one year after the other. Substantive progress on macroeconomic policy coordination to bolster global growth and adjust global imbalances appeared smoothly within reach. The incoming French presidency was determined to push on this issue and, even more ambitiously, to press forward a more general reflection on the international monetary system.

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Overhauling the international financial architecture? The coincidence that, for the first and thus far the last time, the same country held the presidency of both the G7 and the G20 for a whole year granted France a special agenda-setting power. Well aware of this, France very early on announced its intention to maintain the G20 momentum as a spur for major reforms in international economic relations. Even before the Seoul summit took place, a highprofile international working group, chaired by a trio of well-known gurus of international cooperation,10 was set up to provide bold proposals – ballons d’essai – to test the waters without committing the French authorities. The Palais-Royal initiative,11 which was the name of the group, carried out its mandate with zeal, without shying away from any contentious issues. It explicitly acknowledged that the lack of effective governance had resulted in persistent global imbalances, financial excesses, destabilizing capital flows, excessive exchange rate fluctuations, and over-accumulation of foreign exchange reserves, mostly denominated in dollars. From this premise, it derived the need for urgent action not only in the form of adopting immediate policy measures but also, most importantly, of introducing institutional changes conducive to the prevention of domestic and external imbalances, and to a more symmetrical adjustment of the existing ones between surplus and deficit countries. The final report presented eighteen specific suggestions to improve international surveillance, to better monitor and control international liquidity, to contain exchange rate volatility, and to strengthen the role of the IMF. Three key themes for the evolution of global governance emerged from this exercise and percolated in the debate within the G20. First, many ideas of the Palais-Royal initiative hinged on assigning a stronger role to international institutions, in particular the IMF. The perennial tension between institutional and inter-governmental approaches to international economic cooperation came again to the fore. This time, with an unprecedented twist. The informal group vying for the global agenda-setting role had a much broader representation. Moreover, the G20 was the forum where the overarching decisions on changes in the governance of international organizations were prepared and substantively agreed upon before their formal adoption. As a result, the G20 members saw any proposal for strengthening the IMF enforcing capabilities in surveillance as part and parcel of the IMF governance discussions, which were in turn a central element of power rebalancing in global economic and financial architecture. While these negotiations were underway, any concrete progress in economic policy coordination had to rely on the G20 peer-pressure framework, already supported by the analysis and, possibly, the honest-broker services of the IMF. Second, despite the fact that containing excessive and protracted fluctuations of exchange rates was a unanimously shared objective, the G20 did not seriously consider even the soft definition of exchange rate norms proposed by the PalaisRoyal Initiative, let alone the formalization of more structured systems, such as the establishment of target zones.12 Several reasons underpinned the shared

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assessment that a general exchange rate arrangement, even of a non-binding nature, was unattainable and hence not really worth discussing. From an institutional point of view, the management of any exchange rate arrangement would have to involve the IMF – and thus the same objection related to the IMF governance applied. Daunting political economy obstacles also stood in the way. The international ones are exemplified by the tussle on the renminbi then (and now) in progress between the US and China. The domestic ones are due to the political tensions that arise from the internal distributional effects of exchange rate policies.13 Likewise, there are the unresolved analytical problems in calculating sensible and reliable exchange rate norms, and the practical difficulties in managing the exchange rate or sustaining a peg with success. The third theme attracted more attention: enhancing the role of the SDR – a bookkeeping claim issued by the IMF, with the value determined by a basket of major convertible currencies,14 which has the potential to be used as a reserve asset and, at least in principle, to replace the dollar as the pivot currency of the international monetary system. This function of the dollar has always been politically sensitive, if not outright controversial, starting with the negotiations in Bretton Woods, when Keynes advocated a supranational currency called bancor, and continuing over the years, with France being particularly active on this front. Political sensitivity is grounded in very concrete economic and financial motivations in addition to grandeur or national pride. The pivot role of the dollar in the international monetary system makes it much easier for the US to run its external deficit – a situation that, in the 1960s, France’s minister of finance Valery Giscard d’Estaing labelled “the exorbitant privilege”15 of the dollar. It gives scope to conflicts between the domestic monetary policy objectives of the US and the needs of the global economy, with the possibility of very destabilizing effects. Likewise, there are inherent tensions between the maintenance of the real value of the dollar and the expansion of international liquidity in line with the growth of international economic and financial relations (the so-called Triffin dilemma16). All these arguments in favour of an international currency (or reserve asset) have taken renewed vigour and relevance during times of international financial instability. They motivated the very creation of the SDR in 1969 just before the collapse of the Bretton Woods system and the recurrent demands for the strengthening of its role as an instrument for, or perhaps only a symbol of, rebalancing the US hegemony in world finance. The rehashing of the SDR theme had a profound political significance, because this time France championed it again with the vocal alliance of a new, important partner: China. Indeed, in March 2009, in the midst of the crisis, China17 strongly chastised a system based on nationally issued reserve currencies (“the frequency and increasing intensity of financial crises . . . suggest the costs of such a system to the world may have exceeded its benefits”) and advocated an SDR-based system. As a quaint token of oriental diplomacy, the dollar is never explicitly mentioned in the paper, which also admits that “the crisis may not

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necessarily be an intended result of the issuing authorities”. This gentle touch does not dilute the substance of the criticism towards the US hegemony. To signal its alliance with China in the pursuit of a reform of the international monetary system with substantive institutional implications, France organized yet another informal initiative. A “seminar” on the international financial architecture was held in Nanjing for the G20 (plus some other) finance ministers and central bank governors, with a sprinkling of academics and basically the same broadranging agenda of the Palais-Royal initiative, including the role of the SDR. Unsurprisingly, the top US officials did not attend.18 Despite the refreshing contribution of the seminar and its influence in promoting more wide-ranging discussions in the G20 meetings, no concrete proposal for a drastic redesign of the international financial system, including a significant role for the SDR, took off in official circles. China itself had become more lukewarm about the immediate pursuit of the SDR cause – a circumstance that can be interpreted as revealing that its 2009 proposal was mostly motivated by the protection of the value of its huge stock of dollar-denominated reserves.19 As the risk of a dollar collapse appeared less imminent, the push in favour of the SDR could be more gradual and in any case could wait for the stepping stone of the addition of the renminbi in the SDR (which in fact happened in December 2015 as part of the regular basket review). The other emerging economies in the G20 were mostly focused on increasing their influence in the IMF and other IFIs, rather than on radical transformations in its institutional set up, including a central role for the SDR. And apart from France and Italy, advanced countries too were wary of venturing into any major institutional renovation. For all these reasons, at the Cannes summit, the G20 did not launch any overhaul of the international monetary system. And yet, no one should be misled in equating this to an acceptance of the status quo. At the insistence of emerging countries, the Cannes communiqué stated: “We commit to continue working to ensure . . . an appropriate transition towards an IMF which better reflects the increased weight of emerging market economies”. The rebalancing of power in global governance in the emerging countries’ favour that the crisis had unleashed was continuing, pushed by their relentless determination. However, it did not take the form of promoting a complete redesign of the system. Rather, emerging markets were fighting, and fighting hard, for a shift in power within the existing structure of a dollar-based, IMF-centred architecture, making the power rebalancing within the IMF their top priority. A viable alternative plan was not immediately available. Elaborating one has not yet become an explicit pursuit, although many of the initiatives of emerging markets in international economic relations are meant to serve, in addition to their immediate purpose, as building blocks of a more multipolar system. Even after the French presidency, the rebalancing of the international monetary system maintained its relevance in the G20, although it was cast in terms of emerging economies’ key priorities and thus centred on the IMF. At the very beginning of its term, the following presidency, held by Mexico, established a

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new working group on International Financial Architecture, with an IMF-based mandate: implementation of its reform, strengthening of its resources and improvement of its surveillance, with the added element, once again chosen by emerging powers, of developing local currency markets. The evolution of the group followed the ebbs and flows of the debate on IMF governance, with a long period of oblivion and inactivity due to the delay in the approval of the 2010 reform, discussed in Chapter 3. With the Chinese presidency of 2016, the group acquired renewed momentum and scope, reflecting emerging market countries’ dissatisfaction with the transformation in international financial architecture, which, in their view, had been far too modest. To provide an outlet, if not an accommodation, to these concerns, in 2017, Germany, as a chair of the G20, rehashed the approach of the Palais-Royal Initiative and set a high-profile international working group – the G20 Eminent Persons Group on Global Financial Governance – presided over by Tharman Shanmugaratnam, the finance minister of Singapore and former IMFC chair. The Group’s report (Shanmugaratnam et al., 2018) was released in October 2018 at the IMF and World Bank annual meetings. It presents a set of eminently sensible and politically viable proposals for the amelioration of the international financial architecture. The proposals, however, are far less ambitious than those of the Palais-Royal Initiative and fall short of addressing certain crucial issues, such as the orderly adjustment of the huge outstanding global imbalances, especially in terms of financial stocks.20

Cannes (and Los Cabos) hijacked by the European crisis The ambition of the French presidency was not confined to the issue of the international monetary system but extended to other areas, in particular macroeconomic policy coordination – “choosing an agenda with no ambition would be imprudent [in a risky world]”,21 as President Sarkozy put it when he addressed G20 governors and ministers at their meeting in February 2011. Efforts focused on overcoming the stumbling block left from the previous year: the definition of the indicators to be used in the mutual assessment process of macro policies, in particular with regard to external positions. During a memorable drafting session that ended the following morning, after the beginning of the ministerial meeting, a compromise was found and “the external imbalance composed of the trade balance and net investment income flows and transfers, taking due consideration of exchange rate, fiscal, monetary and other policies”, was publicly announced as one of the key indicators. This was the first step in defining guidelines (agreed at the following G20 meeting in April) that specified thresholds for triggering a more in-depth assessment of the countries exceeding them. It was a convoluted definition for a convoluted process, reflecting the unresolved differences among G20 countries. Yet it was real progress. The agreement buttressed the rebalancing of China’s external surplus, also through a gradual appreciation of the renminbi.

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In spite of this result, which is even more remarkable when contrasted with the lack of any relevant adjustment in Germany, the other major surplus country, the G20 did not receive any credit for it, neither did the mutual assessment process gain any extra confidence or momentum. Why? The peer pressure within the G20 did not work as expected. The multilateral aspect of the process was obfuscated by the US bilateral approach to the issue of China’s surplus and renminbi appreciation. The contentious profile in the US debate excluded the possibility of giving China any credit for the adjustment, both in public and within the G20. This attitude deprived the G20 process of the possibility of granting some form of soft rewards, which are an essential component of any incentive structure in a cooperative process lacking the institutional basis for enforcing deviant behaviour. With neither stick nor carrot, how could the G20 peer pressure possibly work? More generally, once the acute phase of the crisis had passed, countries perceived only weak short-term benefits from taking international spillovers into account when setting their policies – and long-term gains were dwarfed by present tensions in domestic politics. Other areas of negotiation within the G20 did not offer scope for quid pro quo exchanges as the alliances on the issue of IFIs’ reform differed from the country groupings about macroeconomic contentions, in particular the adjustment of fiscal and external imbalances. All in all, there was not much demand from the G20 members for the candid mutual assessment necessary for peer-based surveillance to work. When filling out their questionnaires, input for the coordination exercise, countries showed little appetite for changing their policies and systematically argued that their own policies were anyhow pursuing “strong, balanced, and sustainable” growth for the whole world. They were not any more eager to pay attention to the IMF analysis, which was systematically showing that a more cooperative course of action could lift global growth and employment. In spite of what the French G20 presidency had hoped for, the favourable growth outlook, much more benign than actual developments turned out to be, seemed to discourage rather than promote a cooperative attitude – a timehonoured paradox in international relations and, most importantly, a missed opportunity in light of the disappointing growth and renewed financial instability of the following years. The other major reason for the poor performance and recognition of the G20’s mutual assessment process was the outburst of the European sovereign crisis – a crisis so acute that it questioned the very survival of the euro and became the most dangerous threat to global financial stability. For this reason, it was the focus of the macroeconomic debate within the G20, although in quite a different way from the 2008 global emergency. Back then, it was the G20 that was expected to find a solution, as all the G20 members had to take policy measures to address the crisis. This time, on the contrary, everybody agreed that the responsibility for action lay with Europe, or more precisely, with the euro-area countries and the relevant EU institutions. The non-European G20 members expressed concern, offered advice

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and political support, volunteered honest-broker services, in particular the US, and voiced the expectation of a rapid return to orderly conditions. With the unfolding of the European crisis, the tone of the discussions within the G20 changed more than what the language of the official G20 declarations of support suggests. The harsh divisions in the European camp long delayed a solution of the crisis that was (and was perceived as) viable from a financial, economic, and, even more importantly, political point of view. As the outlook for global growth remained fragile, uneasiness about the ineffective policy response in Europe mounted among non-European G20 members. Politely expressed irritation at the European inability to find a common position began to appear. The complexity of the euro-area institutional set-up was poorly understood within the G20. Certainly, it was not regarded as a good reason for the failure of European institutions to exert leadership in marshalling a common position. The limits posed by the ECB mandate to the proactive support it could provide dismayed many non-European G20 members, particularly when the ECB increased rates in 2011 also, some claim mainly, with the intention of signalling to divided European politicians that monetary policy by itself could not fix the problems of the euro-area in their stead. For their part, Europeans were at first surprised and then aggravated by the pressures they received in the G20 meetings to get their act together and restore stability. Each of the European actors, be they countries or institutions, was convinced of their own righteousness and that it was making the best possible contribution to a solution for the crisis. Despite the declared intention to show a united front and regular preparatory reunions among European members, the G20 meetings became the occasion for each of them to vindicate its position, paying little attention to the discord this attitude projected. As discussed in Chapter 6, this disunity over the management of the crisis prevented Europe from exerting an influence in the reform process of global governance commensurate to its economic and financial size as well as to its potential role in a multipolar system succeeding the US hegemony. The interference of European disputes about the way to handle the euro-area crisis with the workings of the G20 reached its iconic manifestation at the G20 summit in Cannes. The leaders’ timetable had to be adjusted at the last minute to make room for a meeting of some22 of the European leaders attending the G20 with Mr Papandreu, the Greek prime minister who, uninvited, had decided to come to Cannes. Papandreu’s objective was to exploit the international attention of a G20 meeting to renegotiate the conditions of the financial support the euro-area had painfully agreed to grant Greece a few months before. The tactic was to inform, in person and with maximum visibility, the key European leaders of his intention to call a referendum on the austerity measures Greece had to implement. The plan did not work to Greece’s advantage, since the deal was not changed and the referendum did not take place (both things would in time happen, but that is

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another story). Yet it was very effective in hijacking media attention and the G20 focus from global to European matters. The inordinate attention paid to European affairs in the G20 discussions continued in the following months, when the G20 presidency passed to Mexico, which decided to hold the summit in June 2012 to accommodate its election calendar. In a little more than the six months that separated the Los Cabos from the Cannes summit, the euro-area crisis continued unabated and led to a host of further measures at the national and European level, including the agreement on two new international treaties.23 The first is the Fiscal Compact, which commits the signatories to enshrine the objective of fiscal discipline at the constitutional level. The second one establishes the European Stability Mechanism, a sort of European IMF to provide financial support to euro-area countries for up to €500 billion. Both treaties would have been politically inconceivable just one year earlier and were (and still are) regarded by Europeans as major improvements to the institutional architecture of the euro-area. Yet, their negotiations, like those for many other measures to address the crisis, were divisive and acrimonious, even in public. As a result, none of the several packages of measures agreed upon over time24 was perceived as decisive (“game changer” was the expression fashionable at the time), and none succeeded in stopping the euro-area turmoil. The G20 increasingly regarded European action as insufficient and inconclusive – “behind the curve” became a recurrent phrase and the break-up of the euro-area (euphemistically called “redenomination risk”) was seriously entertained as a possible outcome. The public disagreements within the Troika did not encourage the G20’s confidence in European policy action. The Troika was the nickname given to the group of three institutions (the European Commission, the ECB, and the IMF) that negotiated the conditions for the support of the euro-area countries in need of financial help, often with the IMF openly criticizing European decisions, in a very troubled relationship, discussed in Chapter 6. In Los Cabos there was no portentous European surprise as in Cannes, but, once again, European affairs dominated the summit, with an unprecedented and thus far unmatched intensity of peer pressure exerted by the G20 on some of its members. Accents and approaches varied. Some, like the Canadian finance minister at the plenary meeting, resorted to unusually strong language. Others, like the US delegation, opted for a coaxing approach in several ad hoc side meetings, where, most notably, the role of monetary policy in ensuring the survival of the euro came again to the forefront. Indeed, it is no coincidence that the following month the ECB president Mario Draghi,25 at a conference in London, declared that “the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough” – a statement that marks a watershed in the solution to the European crisis. The focus of the G20 on European matters, which was, however, the responsibility of only the Europeans to solve, provided a good excuse for stalling progress in the other areas of policy coordination. The discussion on what should

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be done to save the euro facilitated in postponing, yet again, a substantive agreement on the pace and distribution across countries of the adjustment of fiscal and external imbalances so as to buttress global growth.26 This inertia, motivated by the widespread desire to avoid unsettling domestic political equilibria, was a disconcerting contrast to the delicate economic juncture. The US economy slowed down and led the Federal Reserve to relax monetary conditions further with the QE2 programme, nourishing the view that only central banks have room for policy manoeuvre.27 The Mexican presidency, much to its credit, did try to revive policy coordination and to strengthen the G20 peer-review mechanism. It launched the Los Cabos Growth and Jobs Action Plan to marshal consensus on common actions stemming from the premise that “cooperation and coordination will result in better economic outcomes”. In line with the discussions, the first item of the Plan’s commitments is “to address decisively the euro-area crisis”. Several other policy prescriptions addressed to individual countries then follow, none of which, however, is materially different from previous (poorly followed) G20 engagements. The Action Plan proposes a new monitoring procedure, the Mutual Accountability Framework, with the purpose of focusing the G20 surveillance on the actual implementation of the commitments made by each country in the previous exercises – country prescriptions had basically remained the same, as the IMF tirelessly recalled at G20 meetings. The new procedure provided for more specific questionnaires for the G20 members, a more thorough analysis by the international organizations, and annual reporting of the mutually endorsed assessment to the leaders. This was, and still is, the state-of-the-art machinery in international coordination to foster genuine negotiations on the mutually desirable and mutually consistent policies. Yet it is insufficient by itself to generate the goodwill to cooperate. The events just recounted show that the toll of the divisive management of the euro-area crisis went beyond the cost that Europe had to pay in terms of lost economic growth and unprecedented spreading of anti-European sentiment among its citizens. As discussed in Chapter 6, the lack of a common European position on international matters and the inadequate political and institutional backing of the euro undermined the immediate prospects of an evolution towards a multipolar alternative to the US hegemony.

Russia and the overbearing return of high politics Vladimir Putin returned as President of Russia in May 2012 and viewed the upcoming G20 presidency as a good opportunity to enhance his profile. To this end, the approach chosen for setting the G20 programme for 2013 was straightforward: to emphasize the encompassing theme of growth, to insist on continuity with the issues under discussion without opening new contentious fronts, and to maintain a broad agenda with ample space to accommodate the various items that had been added to the core mission of the Group.28

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With the same rapidity that had marked its evolution after the crisis, the G20 process replicated the transformation that had occurred in the G7 and then the G8. Over the years, the leaders’ discussions had broadened from the practically exclusive focus on global economy and finance to a much wider spectrum of issues. These progressive extensions led to the creation of increasingly permanent processes, with technical meetings, working groups, and ministerial meetings, meant to serve as an input to the summits’ deliberations. The broadening in scope can be interpreted in various ways. It can be viewed as an effort to enhance the scope of reaching a comprehensive agreement. A broader negotiation space should allow for compromise across different questions through the creation of packages that offer some concessions to everybody. In practice, especially within the G20, coalitions tend to be different for various matters, severely restricting the margins for cross bargaining. Another interpretation considers the extension of themes as an offspring of bureaucratic forces. Officials and diplomats, not to mention ministers, are keen to create opportunities to attract attention to their work and to partake of the visibility offered by international meetings. The proliferation and persistence of side initiatives to the summits gives credit to this view, even though it would be unfair to point only to events like the Y20 – the emblematic case of a G20 summit of teenagers convened to discuss an international agenda and generate photo opportunities. A third view is more positive in that the broadening of the themes discussed in the G20 is considered as functional to its transformation into a global steering committee.29 The discussion on all key international issues stands to benefit from the political momentum of a group that has no comparison for representativeness of the global economy, matched with flexibility in scope and methods for effective deliberation. Each of the views offers some valid insights, as reflected in the very mixed results obtained in the areas outside the immediate macroeconomic and financial scope of the original G20. The extension to tax issues, to name one, was very successful and allowed substantive progress on three important fronts: increased transparency in the legislation of many tax havens, more intense and widespread automatic exchange of information to fight tax avoidance, and concrete steps to increase cooperation to combat the multinational firms’ exploitation of differences in national rules.30 Formally, the relevant decisions were taken by the Global Forum on Transparency and Exchange of Information for Tax Purposes, a body organized by the Organization for Economic Cooperation and Development (OECD), with more than 140 member states. In substance, the progress was due to the agreement reached within the G20 in an area with a long tradition of poor and ineffective cooperation even among advanced countries. This is a truly remarkable achievement of the G20, which does not typically get the credit and visibility it deserves. The involvement of the G20 on the issue of climate change stands at the opposite side of the spectrum, with no agreement of note, except for clever drafting. Many communiqués have repeated the commitment “to phase out over

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the medium term inefficient fossil-fuel subsidies that encourage wasteful consumption” – a sentence that sounds good but has very little, if any, substance. This outcome should not come as a surprise. The G20 members have long held very different positions on climate change, and none has any incentive to agree within the G20 on anything that could compromise their bargaining stance in the forum where the real negotiations take place: the UN-based Conference of Parties.31 Yet much time and attention were devoted to climate change discussions, lengthening the communiqués and diluting the Group’s energy and resolve to make progress in other areas, more central to its core mandate and possibly with more scope for substantive advancement. Several other G20 non-core processes32 stand in between these two extremes, with a variety of themes, accomplishments, and failures that make any meaningful generalization impossible and any exhaustive description tedious. Suffice it here to recall just another area of debate: employment. This process was launched in 2011 by the French presidency with a meeting of labour and employment ministers and received particular prominence under the Russian presidency, which arranged the first, and thus far the only, joint meeting of ministers of finance and ministers of labour and employment. The special attention paid by Russia to labour market issues was in line with the approach of choosing “growth and jobs” as a non-controversial and inclusive focus for a presidency mostly content with running the G20 process smoothly. The overriding concerns of Russia were recognition as an international power capable of being at the helm of the most relevant international forum and, even more importantly, the domestic appreciation of this role. Two new items were added to the G20 agenda to signal specific national interests: public debt management and energy security. The typical ambition of presidencies and the pressure they exert on other countries to obtain concrete agreements, however, were absent so as not to compromise the atmosphere of the summit with tensions and discord. Persistent divisions on the appropriate policies and macroeconomic developments took care, in any case, to enliven the discussions. At first, there was the recurrent confrontation about the role of fiscal policy. Germany and the UK led the faction in favour of discipline and debt reduction as the best strategy to strengthen growth. With great determination and no success, Germany even tried to push the G20 to endorse the euro-area notion of a threshold for public debt as a general approach to ensure fiscal sustainability. The US was the most vocal proponent of a different view that, while preserving a framework ensuring sound public finances, budgetary flexibility was needed to sustain global demand, especially in countries with a trade surplus. Unsurprisingly, the debate did not achieve a breakthrough in an environment of global growth weaker than desired but with no crisis demanding urgent action. The other major issue during the Russian presidency revolved around the socalled taper tantrum – that is, the abrupt bout of volatility in financial markets

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triggered by the Federal Reserve declaration in June 2013 that it would start reducing the intensity (tapering) of its asset purchases in its quantitative easing programme. Although the announced reduction was relatively modest in size, it was interpreted as a turning point in monetary policy, bringing about intense turbulence, especially in emerging markets. India took the lead in voicing the complaint of wanting international coordination. The US authorities should have paid more attention to the external spillovers in their action and communication. Other emerging economies supported India, but with not much conviction, while other advanced economies were fence-sitters. The point about communication was in some sense accepted, leaving a tenuous mark on the St Petersburg summit communiqué. The paragraph on monetary policy contains the reference to “[having monetary policy] carefully calibrated and clearly communicated”. On the substance of the decision, the rejection of the criticism on the part of the Federal Reserve was instead very firm. The normalization of an extraordinarily accommodative monetary policy stance was beneficial to the whole global economy, as too much liquidity would fuel imbalances and excessive risk taking – a classic argument based on an optimistic assessment of the US recovery that was quickly revised: the first increase in US official rates would have to wait three more years. More fundamentally, the Federal Reserve argued that the mandates of independent central banks are strictly domestic, and international spillovers can only be taken insofar as they have a bearing on domestic objectives. This is why the same paragraph of the summit communiqué recalls that “monetary policy will continue . . . [to be run] . . . according to the respective mandates of central banks” – a sentence that was also much supported by the ECB, which tirelessly recalled that its own mandate provided less scope to support growth than the one of the Federal Reserve. This exchange on the scope of central banks’ specific mandates is related to the more fundamental issue of the legitimacy and accountability of “unelected power”, which was brought to the fore by the question of central bank independence but has a much more general relevance to the delegation of power to independent agencies.33 The Russian chair made sure that these controversies would not spoil the family-photo atmosphere that they hoped would pervade the St Petersburg summit. In the same vein, it coaxed the US to go along with Chancellor Merkel’s last-minute request to insert a section in the communiqué on “the risks of shadow banking”. Two weeks before the general elections that led to her re-appointment, Merkel wanted to impress her domestic audience with her capability to steer the G20 discussion on the dangers of non-bank intermediaries, particularly hedge funds – an issue that was featuring prominently in the German electoral campaign. The power of the G20 as an instrument for affecting domestic public opinion, particularly for the host country, was also quickly recognized by Tony Abbott, who was elected Australia’s prime minister just two weeks after the St Petersburg

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summit. As a result, Australia’s G20 presidency for 2014 once again followed the track of avoiding the advancement of controversial objectives and picked growth – “strong, sustainable and balanced”, in tune with the G20 mantra – as the overriding theme. The machinery for promoting policy coordination to lift global economic activity was already in place and put to work: the Framework Group, the Mutual Assessment Process, and the prospect of crowning the Brisbane summit with yet another Action Plan named after the town hosting the summit. The communiqué of the first meeting of finance ministers and central bank governors under the Australian chair boldly declared, “We will develop ambitious but realistic policies with the aim to lift our collective GDP by more than 2 per cent above the trajectory implied by current policies over the coming 5 years”. The Brisbane summit delivered the eponymous Action Plan, and the IMF indeed validated that the implementation of the policy commitments by the G20 members would increase global output by 2.1 per cent34 in five years. Even if successful, though, this self-declared ambitious strategy would not have been able to make up for the downward revision in expected global GDP that had occurred the previous year. Actual growth would be even more disappointing, in turn leading to further curtailments in projections. This was the age of diminishing expectations, vividly illustrated in Figure 2.1, which reports different vintages of IMF forecasts for the global economy as published in successive issues of the World Economic Outlook. Despite a focused strategy and an impeccable organization that, at a considerable carbon footprint, brought G20 meetings throughout the country, Australia had its thunder stolen in large part. Compelling political developments took the

Global growth forecasts in successive issues of the IMF World Economic Outlook (WEO) 4.8

IMF WEO (Apr. 2011) IMF WEO (Oct. 2012)

Expected global GDP Growth, constant prices (% change)

4.6

IMF WEO (Apr. 2013)

4.4 4.2

IMF WEO (Oct. 2014)

4.0 IMF WEO (Oct. 2015)

3.8 IMF WEO (Apr. 2016)

3.6 3.4 3.2 3.0 2.8 2013

2014

2015

2016

2017

2018

2019

2020

The age of diminishing expectations: global growth forecasts in successive issues of the IMF World Economic Outlook

FIGURE 2.1

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upper hand as Putin was no longer content with the benevolent aura of the G20 convener and moved to a profile of homeland defender with a belligerent attitude towards the international community. The escalation of political tensions interweaved through the G20 and G8 processes. On the same days of February 2014 during which G20 ministers in Sydney approved the statement just recalled, Putin in Moscow resolved to invade Crimea as a reaction to the Ukraine revolt and the ensuing change in regime. A few days after the invasion, Russia annexed Crimea following a referendum, convened by the occupying troops, which the international community did not recognize as legitimate. In an increasingly harsh dispute, the G7 and European countries (plus Australia) imposed economic sanctions against which Russia retaliated with a total ban on food imports. All G7 countries deserted the G8 meetings, forcing Russia, which held the rotating chair, to cancel the summit planned to take place in Sochi. As a further reprisal, a G7 summit was organized in June in Brussels, ending the G8 experience and offering a new lease of life to the old format with a renewed focus on geopolitical issues and, for the finance track, on cyber security and anti-money laundering. The diplomatic crisis exacted a heavy toll on the Russian economy, already hit by a fall in oil prices that curtailed a precious source of foreign reserves. International tensions ushered in a financial and foreign exchange crisis: in December 2014 the value of the rouble collapsed, forcing the central bank to hike interest rates, further aggravating the recession. Although monetary and financial conditions subsequently normalized, growth prospects deteriorated permanently, underpinning a declining influence on global economic issues. The worsening economic outlook and the shift towards a more bellicose attitude in international politics severely weakened Russia’s role in the G20 discussions and negotiations. Even though, fortunately, the confrontation never reached a level that made it impossible for Russia to attend the G20 meetings, including the summit, its capacity to sway consensus building significantly eroded in all international economic and financial fora, including the IMF. This episode reminds us that – as in many other times in history, most tragically between the two World Wars – when international political tensions escalate, they have the upper hand on the setup of global economic governance and directly shape its evolution. Geopolitical confrontations (so far) have not been as acute and persistent as to become the dominant factor, except in the case of the role of Russia. However, the Ukrainian crisis is a powerful reminder of the potential role of high politics in global economic governance. In particular, by intention or accident, China’s unconcealed ambitions to become a military superpower could derail the evolution towards a new international financial architecture.

The BRIC(S) and the G20 Although Russia’s confrontation was mainly directed at Europe and the US, it also had far-reaching implications for the relations between emerging countries,

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straining their fragile cohesion around the objective of defying the US (and G7) dominance. As shown in the negotiations within the G20, the position of emerging countries was shaped by the tension between the centripetal pull of the awareness that a united front would greatly strengthen their common vindications, and the centrifugal forces of their different geopolitical priorities. This clash was particularly important in the evolution of the so-called BRIC, the group of emerging countries which organized the most articulated and high-profile counterbalance to the G7.35 The acronym BRIC was coined in 2001 by the Goldman Sachs economist Jim O’Neill to bring together the most important emerging economies (Brazil, Russia, India, and China) and to present their increasing share of world GDP. The term was a huge success, as it became the popular reference for expressing the upheaval in the relative weight of the world major economies that started in the 1990s. Five years after its birth as a statistical aggregate, the group became a political reality with the first informal meeting of the four countries at the margins of the UN Annual Assembly in 2006 under the initiative of Russia. Given the political differences among its members, the real-life group remained subdued and ineffectual, with only occasional, low-key meetings, while the popularity of the acronym continued unabated. With the outbreak of the crisis and the emergence of the G20 as the premier forum of international economic cooperation, an explicit alliance of the major emerging economies acquired a new scope. BRIC countries immediately realized the potential function of the dormant group and remodelled it in ambition and political profile, both in public and within the G20. Emerging markets were keen to be (and keen to be perceived as) an essential part of the G20 response to the emergency situation, but they also wanted to signal that they bore no responsibilities for the crisis and that they could advance innovative approaches and proposals with a view to changing the balance of power in economic governance. BRIC meetings appeared as a convenient tool for performing this function. The budding role of the BRIC group as a catalyst of the demand for a drastic change in global governance made joining it very attractive from a political point of view, especially for the other emerging economies in the G20. Argentina, Indonesia, Mexico, and South Africa, but also Turkey and South Korea, all made some moves to be a part of it, although with different degrees of publicity and determination. Eventually, only South Africa succeeded: it boosted the representativeness of the group by one continent, while having reassuringly mild geopolitical ambitions. Starting from the third summit in 2011, South Africa became a full member and the acronym changed from BRIC to BRICS. The revamping of the BRIC group was initiated just after the path-breaking G20 meeting attended by President Bush, which was described in Chapter 1. At the margins of the “regular” G20 meeting in São Paulo, just a few days ahead of the first G20 summit of November 2008, BRIC countries started the practice of convening regularly, back-to-back with the G20. They issued a public statement to publicize this intention and its goal: to provide a key input

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to the G20 process and to advance “proposals . . . on reforming the global financial architecture”.36 The tactical motive to have a show of unity ahead of the Washington summit allowed only agreement on broad political messages at that meeting. The critique of the prevailing order and the demand for more influence would then became familiar in the G20 debate, as we have seen. The other key element, loaded with symbolic significance, was instead meant to remain in the domain of the BRIC countries’ initiative: the objective to create a new international institution which would be independent of the hegemonic powers and be useful in the construction of an alternative economic order. The success of the G20 in marshalling the response to the crisis further enhanced the motivation to give visibility to the leading group of emerging economies. The symbolic element of building a counterbalance to the G7 within the G20 (just at a time when the G7 was lowering its profile) provided yet another reason to upgrade the BRIC process with the organization of an annual summit of the leaders, separate from G20 or other international meetings. Under the initiative of Russia, particularly attracted by a more explicit defiance to the US hegemony, the BRIC held their first formal summit in Yekaterinburg, in June 2009. The summit gave further visibility to the demand for more power in global governance and the challenge to US hegemony, using the same rhetoric as that of the pax Americana: “The dialogue and cooperation of the BRIC countries is conducive not only to serving common interests of emerging market economies and developing countries, but also to building a harmonious world of lasting peace and common prosperity (emphasis added)”.37 The BRIC leaders were fully aware that their endeavour required setting up a more systematic process, so that they explicitly agreed “to promote dialogue and cooperation among our countries in an incremental, proactive, pragmatic, open and transparent way.” As the host of the first summit, Russia confirmed its eagerness to promote the BRIC group, particularly with a view to defying the US hegemony. Yet Russia was in an awkward position with respect to the other members. It had been admitted to the G8, the ruling club, although half-heartedly by financial circles. Moreover, Russia was in a different condition from the others with regard to the issue around which they rallied in the G20 negotiations: it was overrepresented, rather than underrepresented, in IMF governance. Its acquiescence to the claims of the other BRIC countries on IMF quota shares eased the difficulties on this front, but its confrontational attitude in global geopolitics, which exploded with the Crimean crisis, was much more problematic to cope with. The break-up of the group was avoided, however, due to two main reasons: the strong interest in showing a common stance with respect to advanced countries and Russia’s much weaker position resulting from the economic and financial crisis which followed the Crimean events. As a follow-up to their first summit, BRIC countries initiated a thorough search for areas of viable cooperation, with regular meetings of the ministers of

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foreign affairs, agriculture, and trade.38 As in the G20, however, the economic and financial sphere was the focus of BRIC cooperation, lobbying for common positions on current developments and the IFIs’ reform, while taking the opportunity to invite advanced economies to adopt “responsible policies”,39 in the same way that they themselves had been patronizingly advised in G7 statements and IMF analyses. In parallel, the idea of building a new institution continued to advance, spurred by the mandate to this effect given at the Brasilia summit, in April 2010.40 The concrete negotiations on the definition of proposals for a new institution immediately exposed the lack of cohesion among the BRICS on the strategic objectives of their action, beyond defiance to the established global governance.41 The absence of an accepted hegemon that could mimic the leadership role of the US in the G7 made differing priorities even more difficult to reconcile, especially when considering the broad spectrum of areas where the new institution could advance alternatives: development policy, safety nets, conditionality, global financial stability, trade integration, and so on. India was more interested in elaborating a new vision of development;42 Brazil and Russia in a mechanism to obtain financial support without resorting to the IMF; China would not want to compromise its ambitions of dominance in Asia and its aspiration to a prospective superpower role; and South Africa, when it joined the club, supported India on development, though its smaller economic size reduced its influence in the group. The recurrent issues involved in setting up new international institutions complicated the negotiations further: the sharing of the financial burden, the allocation of voting power, the governance structure, the location of the headquarters, and the nationality of the president and the senior management. Two events in 2012 gave renewed momentum to the process of setting up a new institution. India, which hosted the fourth BRICS summit, publicly advanced the idea of a development institution and coaxed partners into agreeing to mention it in the communiqué.43 The BRICS leaders informally met at the margins of the G20 summit, held in Los Cabos in June, and jointly announced their intention to contribute to shoring up the IMF with bilateral loans for a total of US$70 billion and to explore “swap arrangements among national currencies as well as reserve pooling”44 – that is, safety nets not involving the IMF. It took a year of intense negotiations for the BRICS to sketch out a compromise, which was announced at the following summit in Durban, in March 2013. Diverging priorities could only be accommodated by the solomonic accord to establish both45 the New Development Bank and the Contingency Reserve Arrangement (CRA) – a framework for the mutual provision of financial support in the event of a crisis. In spite of this, reaching the final agreement turned out to be extremely laborious, both because of the bargaining over the final, all-important details, such as the location of the headquarters, and because of two major political developments. First, the eruption of the Crimean crisis perturbed the interaction with Russia within the BRICS and risked obfuscating

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the group’s key objective in the relations with advanced economies. Second, China did not want to close the deal without making defiantly clear to both its BRICS partners and the world at large that it ranked its Asian ambitions as high as the establishment of would-be rivals to the IMF or the World Bank. Choosing the symbolic venue of the forum for Asian Pacific Economic Cooperation (which includes Australia, Japan, Russia, and the US), President Xi Jinping unveiled, in October 2013, the project to create a novel international financial institution to support the huge infrastructure needs of Asia. This announcement was purposely directed to affect ongoing BRICS negotiations by signalling China’s superior status in both financial strength and geopolitical ambitions. The other BRICS countries were reluctant to tolerate this stance and reacted by stiffening their positions in that long-term political rivalry combined with the perception of China’s insufficient commitment to the BRICS common agenda.46 Negotiations experienced severe tensions and many times stalled so that publicly announced deadlines could not be met. However, they never broke down, as they were sustained by the overriding political consideration that a common stance vis-à-vis the advanced economies was necessary to obtain concrete results in the transformation of global governance. In addition to its practical implications, an agreement on setting up a new institution was a powerful symbol of unity that simply could not be missed. Financial power, as well as the difficult economic conditions of Russia and Brazil, gave China the upper hand in many aspects, such as setting the headquarters of the New Development Bank in Shanghai. However, it had to make important concessions, such as agreeing to a sizeable commitment into the CRA. After the customary eleventh-hour bargaining, the treaties establishing the novel BRICS institutions were signed at the summit in Fortaleza, Brazil, in July 2014, so that they could be formally launched at the subsequent summit in Ufa, Russia, following national ratifications. Notwithstanding the difficulties resulting from lack of cohesion on the strategic goals of their alliance, the BRICS countries did manage to meet the objective of establishing new international institutions. As discussed in Chapter 4, these institutions can be regarded as useful building blocks of a new economic order still to be defined in its architecture. It is unlikely, however, that the BRICS group itself can be regarded as a component of the global governance in the making,47 given the diverging geopolitical interests and political visions of its members beyond the shared view that they themselves should be more influential. At the same time, the achievements of the BRICS process as such should not be underestimated. It not only provided a platform for new views and interests that remains unmatched in visibility and political profile (as well as in effectiveness, when there is an actual common purpose). Its meetings and the preparatory work leading to the summits launched an intense process of dialogue and cooperation that required the building of personal and institutional capacities

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that are certainly necessary for these countries to play a more relevant role in global governance.

Conclusions In the span of a decade since its upgrade at the leaders’ level, the performance of the G20 has been extremely varied even by the standards of a practically new international group during a very turbulent period for the global economy. The G20 achieved the consensus to implement bold and internationally coordinated measures that staved off the implosion of the world’s financial system and contained the ensuing collapse in trade and economic activity. It marked the active inclusion of a new set of actors at the core of international policy interaction. It initiated a major reform process in several areas, with many important achievements. In particular, it addressed two issues at the centre of global governance: the revamping of macroeconomic policy coordination and the reform of the international financial architecture, reviving the debate on the role of the SDR. The broad scope of the G20 initiatives and decisions, together with the resolve spurred by the acute phase of the crisis, raised huge expectations about its effectiveness and its imminent upgrade as the lynchpin of a radically new arrangement of global governance. Some expectations were unrealistic, coloured by wishful thinking. Other views were more solidly grounded in the shift in the balance of global economic power that the crisis had unleashed, and in the assessment that the benefits of cooperation and the shared objective of avoiding another crisis would continue to catalyse common actions and positions. As global activity rebounded and financial disruptions eased, the traditional obstacles to international coordination became pre-eminent again, notwithstanding the major improvements achieved in the coordination process, such as the explicit definition of objectives and better procedures for exchange of information between countries. Neither did any radical reform in the international financial architecture take off. Emerging countries opted to fight for a rebalancing of power, while preparing the building blocks of a new order with the establishment of novel international financial institutions. The G20 failures are epitomized by the poor performance of the global economy and the persistence of major imbalances. The objective of strong, sustainable, and balanced growth was sorely missed. Productivity and investment stagnated in a widespread economic malaise that lasted long after the recession. The G20 show of unity in the urgent response to the crisis was overshadowed by later fragmentation, which also affected each of the camps of advanced and emerging economies. Major emerging economies gave birth to their own club, the BRICS group, to make more visible and effective their common claim to a more prominent role in global governance and to greater power within international financial institutions. As soon as the group ventured beyond this agenda, it exposed a lack of

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cohesion over its members’ strategic objectives and overarching political values. The BRICS is thus unlikely to remain a central element of the new order, although some authors maintain a more optimistic view of its prospects.48 The mixed record of the G20 is a reflection of the incompleteness of the ongoing transformation in global governance. It should not be mistaken for an indication that other existing international fora are more relevant or effective – certainly not the G7, despite renewed visibility after Russia’s exit following the Ukrainian crisis, nor the BRICS group. The G20 is the forum where all the key international decisions were, and still are, formally made or informally initiated and negotiated. It is the laboratory where new proposals, ideas, and arrangements towards a different international financial architecture are flagged and undergo the first relevant test of technical and political viability. It remains the ultimate forum for debating and searching for a political consensus over the issues regarding the other institutions and processes that are part and parcel of the reform in global governance. The next three chapters are devoted to them, starting with the IMF.

Notes 1 Questions about the relevance and legitimacy of the G20 had been raised well before the crisis, for example by Kenen et al. (2004). 2 For example, Vestergaard and Wade (2012). Others focused on the question of “whether the challenge . . . to global governance . . . [would] lead to an increase in democracy and social justice for the majority of the world’s peoples” Gray and Murphy (2013, p. 183). 3 Eichengreen and O’Rourke (2010, 2012). 4 Although many leaders promised that they would complain about Brown’s unorthodox behaviour, only Kirchner mentioned the issue in one of her interventions in the plenary session. 5 On 15 February 2009. 6 The term “secular stagnation” regained popularity with reference to the present predicament of the world economy after Larry Summers put it forward at the annual IMF research conference in November 2013. 7 Gordon (2016) provides the most influential analysis of this view with reference to the slowdown in the productivity growth of the US economy. 8 27 September 2010. 9 Bastasin (2015) offers a vivid chronicle of the European crisis. 10 Michel Camdessus, Alexander Lamfalussy and Tommaso Padoa Schioppa. 11 The final report of the Group was published as Camdessus et al. (2011). 12 The best-known advocacy of a system of target zones is Williamson (1987). 13 As Frieden (2014) convincingly argues, in each country, political economy issues play a crucial role in the setting of exchange rate policy. Domestically oriented actors prefer a flexible exchange rate regime and non-tradable producers prefer an appreciated exchange rate, while the opposite applies for groups relying on international economic and financial relations, and for tradable producers. 14 The composition of the basket has varied over time with periodic reviews since its creation. At the time of the eruption of the crisis, the currencies in the SDR basket were the US dollar, the euro, the yen, and the British pound. As discussed later in the chapter, China forcefully lobbied for the addition of the renminbi to the SDR basket, which in fact happened in December 2015.

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15 Another way to define the exorbitant privilege granted to the US by the role of the dollar in the international monetary system is due to Eichengreen (2012, p. 3): “It costs only a few cents for the Bureau of Engraving and Printing to produce a $100 bill, but other countries had to pony up $100 of actual goods in order to obtain one”. 16 Triffin (1947). 17 Zhou (2009, p. 1) for both quotes. 18 The defence of the US views was delegated to the famed stamina of Ted Truman, a former official who had moved to a think tank. 19 The transition to an SDR-based system could contemplate an off-market transformation of dollar-denominated reserves into SDR-denominated reserves avoiding large capital losses. 20 The timidity of the Eminent Persons Group’s report in addressing some of the crucial issues of global financial governance is accounted for by two complementary reasons: i) the sharp disagreement among the Eminent Persons themselves on the desirable reforms of the international financial architecture; and ii) the Chair’s deliberate strategy – which, by the way, he explicitly stated responding to one of this author’s questions at the public presentation of the Group’s report – to avoid that the widely agreed, politically viable proposals of the Report be ignored and not be implemented as they would be eclipsed by the dispute over other issues, possibly more fundamental but certainly more controversial and politically sensitive. Time will tell whether this approach to advance the reforms proposed in the Report will actually pay off. 21 Non-literal translation of the passage, “C’est en choisissant un agenda sans contenu et sans ambition que la France aurait choisi la voie la plus imprudente”. The transcription of Sarkozy’s address is available at www.g20.utoronto.ca/2011/sarkozy-g20finance110218.html. 22 Cameron and Berlusconi were not involved in the meetings with Papandreu. The former did not participate as the UK desired to be as distant as possible from euro-area disputes, the latter because Italy was itself hit by the crisis and at the time it was considered, unfoundedly as it turned out, to be a potential recipient of financial support. 23 Both of them were signed in 2012 (the Fiscal Compact in March, the European Stability Mechanism in September) and subsequently ratified by national parliaments. 24 For more details, see the many histories of the euro-area crisis, such as Bastasin (2015). 25 Par. 19 of the “Verbatim of the remarks made by Mario Draghi” on 26 July 2012 at the Global Investment Conference in London, available at www.ecb.europa.eu/press/ key/date/2012/html/sp120726.en.html. 26 Frieden et al. (2012) stress the importance of an effective global governance to address macroeconomic disequilibria and foster the orderly adjustment of global imbalances, while pointing to the major political economy obstacles to the success of this endeavour necessary to the stability of the world economy. 27 As El-Arian (2016) puts it, central banks are (often seen as) “the only game in town”. 28 The opening page of the presidency website http://en.g20russia.ru/docs/g20_russia/ priorities.html prominently states: “Address all the issues through the lens of growth, ensuring continuity giving extra impetus to the currently undertaken activity”. 29 Kirton (2013) champions this view. Eccleston et al. (2015) instead stress the G20’s “endorsement” function, promoting the legitimacy of specialist agencies and enhancing their efficacy, as in the OECD’s tax transparency agenda. With disputable optimism, contributions in Larionova and Kirton (2015) stress the complementarity between the G8, G20, and BRICS summits. 30 The exploitation of different national legislations by multinational firms to reduce their tax bill is known as “Base Erosion and Profit Shift”. 31 The Conference of Parties is the supreme decision-making body of the UN Framework Convention where both objectives and financial means to achieve them are decided. 32 For more information on the different G20 processes and working groups, see Kirton (2013) and the website www.g20.utoronto.ca/.

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33 Tucker (2018). The implications for international cooperation among independent agencies stemming from the constraints posed on each one’s modus operandi by the national requirements of transparency and accountability is an interesting area for future research. 34 The unrealistic precision of this point estimate is difficult to account for without noticing that 2.1 is the smallest number that does not belie the “above 2 per cent” commitment of the February communiqué. 35 Cooper (2016) provides a brief history of the establishment of the group and its functioning. 36 Communiqué of the BRIC finance ministers joint meeting, São Paulo, Brazil, 7 November 2008, available at http://brics.utoronto.ca. All BRIC(S) communiqués quoted in the text are available from the same source. 37 Communiqué of the BRIC Summit, Yekaterinburg, Russia, 16 June 2009. 38 Since 2009, these formations have met more regularly, but others were explored, such as the meetings of the BRICS ministers of labour, environment, and energy. 39 For example, the statement of the meeting of the BRICS finance ministers and central bank governors held at the margins of the 2011 IMF annual meetings stressed, “It is critical for advanced economies to adopt responsible macroeconomic and financial policies, avoid creating excessive global liquidity and undertake structural reforms to lift growth, create jobs and reduce imbalances”. 40 “We have asked our finance ministers and central bank governors to look into regional monetary arrangements and discuss modalities of cooperation between our countries in this area”, from the communiqué of the BRIC summit, Brazil, 15 April 2010. 41 In an unorthodox analysis on the role of the BRICS group, Stephen (2014, p. 912), notes that “it is not the global governance order itself, but its most liberal features that are contested by the rising powers”. 42 Narlikar (2017) provides an updated analysis of India’s ambitions on the world stage. 43 The communiqué of the BRICS summit, held in New Delhi on 29 March 2012, states: “We considered the possibility of setting up a new Development Bank for mobilizing resources for infrastructure and sustainable development projects”. 44 This quote is from the “Media Note on the Informal Meeting of the BRICS Leaders Ahead of G20 Summit in Los Cabos”, 18 June 2012. 45 The Summit communiqué states “we [the BRICS leaders] are satisfied that the establishment of a New Development Bank is feasible and viable” and “we are of the view that the establishment of the CRA with an initial size of US$100 billion is feasible and desirable”. 46 As Armijo and Roberts (2014) put it, China regarded the BRICS as a ready “outside option” to exercise leverage on the G20 and the IFIs. 47 Unsurprisingly, opinions differ on the prospects for the BRICS group, with Stuenkel (2015, 2016) and Nayyar (2016), for example, more optimistic than Carey and Li (2016). 48 For example, Stuenkel (2015, 2016) and Nayyar (2016).

3 THE REFORM OF THE INTERNATIONAL MONETARY FUND

“With the leaders, are you sure?” “Yes, with the leaders, the White House decided so”. This type of exchange between US Treasury officials and their counterparties in the finance ministries of several countries took place as soon as the programme for the Washington meeting was circulated in the early days of November 2008. It reflected surprise at the fact that, in spite of the existing protocol, the heads of the World Bank (WB) and the IMF (as well as of the FSF) had been invited to the leaders’ restricted lunch, which finance ministers were not expected to join. In contrast to the definition of “informality” reserved for inter-governmental groups, the “Gs” – G7, G8, G20, and the like – have very precise and strict rules of attendance at their meetings, especially when leaders are present. Overriding of the protocol occurs only under exceptional circumstances and for a specific purpose. This time, the objective of the G20 leaders was to summon the IFIs’ intervention to contain the crisis and to vow renewed confidence in the role that IFIs could play in the global economy. The newly found support marked a turning point for the Bretton Woods institutions, after many years of radical questioning of their function, which had even led to the initiation of a process of downsizing. Challenges and criticism had been insistent and fundamental, disputing the relevance of the IFIs, in particular of the IMF: lending volumes had decreased and surveillance was based on a paradigm judged inappropriate in many quarters, especially in emerging economies. IFIs’ legitimacy was also called into question, as the balance of voting rights had not adapted to reflect the upheaval in the relative size of the world major economies. And a stigma came to be attached to borrowing from the IMF, further denting its relevance: countries tried to avoid it at all costs, as suggested by the massive accumulation of foreign exchange reserves as a selfinsurance for crisis times.

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With the crisis raging, the contribution of IFIs, starting with the IMF, to sustaining the global economy was deemed indispensable. G20 members put their money where their mouth were and, at the 2009 London summit, they decided on a substantive increase in the resources available to all the IFIs. The questions about relevance and legitimacy, however, were not forgotten. Responding to them with a profound and wide-ranging reform was an imperative condition for the G20 to find agreement and provide resources. The reform of the IFIs is an integral part of the transformation in global governance unleashed by the crisis. It is a multifaceted process with many implications, going beyond the most conspicuous aspect: the shift of voting rights in favour of emerging economies. Extensive negotiations were necessary to reach an agreement on this shift, which, however, was and still is regarded by emerging market economies only as a first step, a sort of down payment for a much larger rebalancing. The key negotiations took place in the G20 and for several years constituted one of the central items on its agenda, absorbing a very substantial portion of its time and energy. Indeed, the very fact that the G20, rather than the G7, was the forum where changes in voting power within the IMF were debated can by itself be regarded as a significant change in global governance. The role of the G7 in steering the IFIs and its informal but decisive involvement in their financing decisions at times of crisis had been one of the defining features of the G7-based governance. This time the shots were called in a different forum and the G7 did not even manage to converge on a common position during the bargaining. Once agreed upon, the rebalancing in voting power within the IMF took five years to become effective. That inordinately long time was necessary for the US Congress to approve the appropriation of the financial resources to pay in the US share. The world was forcefully reminded that the US still had veto power over crucial decisions in the IMF and, as a result, the US domestic policy debate would continue to have an unrivalled influence on its affairs. In this area, as in others, the transformation in global governance has not yet resulted in a radically new international financial architecture. Yet it would be wrong to jump to the conclusion that nothing of substance has changed. The shift in voting power from advanced to emerging economies equalled more than 8 percentage points.1 And the rebalancing of influence on the strategy, economic views, and day-to-day operations of the IMF, and more generally of the IFIs, has gone much further than even that sizeable number per se would imply. Moreover, the stronger clout of emerging countries is only part of the story. IFIs’ reform and the ongoing transformation in global governance intertwine in more dimensions than typically recognized. IFIs’ policies and strategies are not the straightforward reflection of their shareholders’ instructions, weighted by their respective voting rights. As in many other institutions and bureaucracies, management2 tries to stretch the margins of its statutory independence to play as autonomous a role as possible – and the IFIs’ scope spans a bafflingly wide spectrum of issues, from education to pensions and health, to name just a few.

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IFIs exert a direct influence on individual member states through the conditions they require for granting loans and the advice they offer in the framework of their surveillance and development functions. In addition, they play a pervasive role through their contribution to defining the economic paradigm that underpins both IFIs’ own intervention and their members’ domestic policies as well as their international economic relations. IFIs perform consultative functions in all the inter-governmental fora and exploit this privileged channel to sway the evolution of the international financial architecture. They also interact directly with different branches of the national administrations, consult with various interest groups and maintain a direct channel of communication with public opinion. In this way, IFIs influence what their shareholders demand of the IFIs themselves. The interaction between IFIs and their members is further complicated by the fact that countries can host different views on IFIs, as the US has most conspicuously illustrated in recent congressional debates. The reform of the IMF, in particular with regard to the relative voting powers of its shareholders, has had special prominence in G20 discussions. This is not surprising. Its role as lender of last resort at the international level and issuer of SDRs, the embryo of a possible international reserve currency, grants the IMF an unrivalled systemic function in the international financial architecture. The IMF is in a league of its own among IFIs, also from a symbolic point of view. Vying for more influence on its policies, decisions, and economic views was an intentional challenge to the G7-based governance that deserved top priority and commensurate investment of political capital, also because of the expected knockon effects on the balance of power in the other IFIs, starting with the WB. For all these reasons, the IMF reform is the first to be discussed and analysed: the next chapter will deal with the other IFIs in more detail. Before entering into an analysis of the transformation in the IMF triggered by the 2008 crisis, this chapter discusses some of the salient features of the role in global governance that are common to the IMF and the other IFIs. The natural starting point is the establishment of the IMF and the WB as the lynchpin of the post-World War II international economic order.

IFIs, their shareholders, and global governance: a multifaceted interaction IFIs – institutions that are owned by several sovereign states and extend loans, typically to governments or their agencies – are a relatively recent invention, conceived at the Bretton Woods conference. They responded to the need to have a worldwide framework of exchange rate stability and a reliable source of finance to foster growth and trade in the new international economic environment that followed World War II.3 On countless occasions, experience had shown that macroeconomic imbalances caused harmful exchange rate volatility and that private finance dries up at times of crisis, forcing disruptive adjustments. An institution with sufficient public capital and access to the reserve

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currency(-ies) could prevent balance-of-payment crises from precipitating painful contractions in economic activity and drastic falls in international trade. Together with the promotion of sustainable growth, this remains IFIs’ common mission, given that markets still fail to provide adequate financing in times of crisis despite the enormous expansion in international financial flows. The prominence of the IMF in global governance stemmed from the combination of its role as guardian of exchange rate stability with its financing function.4 In the system of fixed exchange rates, changes in parities required IMF consent, which was granted only in the case of fundamental disequilibrium as assessed by the IMF itself.5 The IMF also determined the policy adjustment that the country had to undergo in order to receive both the permission to modify its exchange rate parties and, typically, an accompanying loan (which is usually disbursed in several tranches to ensure that the required policy actions are implemented). Bretton Woods negotiators were lucidly aware of the high stakes, as shown by the views articulated in two different blueprints of international financial architecture championed by the towering personalities of John Maynard Keynes and Henry Dexter White, heads of the UK and US delegations, respectively. Some of these contrasting opinions had to do with the situation at the time, characterized by two key features that are no longer relevant: the scarcity of international means of payment, and the prevailing view that an orderly international system could only hinge on fixed exchange rate parities. Much of the debate, however, expressed fundamental issues that are still at the core of international economic relations, as they reflect the extent and modus operandi of the US economic hegemony: the role of the dollar; the intensity of the desired regulation of the international movements of private capital; the division of the burden of adjustment;6 and the relative voting power of member states. Negotiations were embedded in war politics.7 Their result, the Articles of Agreement which established the IMF, reflected the overwhelming military supremacy of the US and replicated the central aspects of the White plan. In particular, gross international positions had to be settled in US dollars,8 rather than having net positions settled in an internationally issued currency as Keynes advocated. Moreover, the resources of the IMF were determined by the pooling of its members’ quotas.9 To put it simply, the IMF was set up according to the framework governing credit unions: to join the union, members must subscribe deposits (quotas) that provide the resources to lend to members in difficulty (loans granted, in turn, in relation to the recipient members’ quotas). Although a formula based on economic factors10 provided some guidance, the allocation of quotas and voting power was decided on political grounds.11 It granted an overwhelming supremacy to the US, crowned by the veto power on key decisions such as changes in quotas, which require a qualified majority of 85 per cent. But even then, it was widely recognized that there is more to each member state’s influence on the IMF than the sheer size of its voting power. Two examples in this regard are very telling. The US and the UK disagreed on whether the components of the board of directors representing the IMF

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members – who are in charge of the main day-to-day decisions, most notably loan approvals – should reside in Washington or convene periodically in the capitals. The UK feared that a resident board would become captive to the institution and be insufficiently accountable to national parliaments. The US again had its way, this time possibly just because of the undeniable difficulties in transport and communications at the time. The other example is the insistent practice, in the early times of the IMF, of arranging frequent exchanges of staff with the US Treasury, including at a very senior level, in order to spread the US vision within the organization. The International Bank for Reconstruction and Development, better known as the World Bank, is the other institution established at the Bretton Woods conference. Its business model proved very successful and led to the establishment of several other Multilateral Development Banks, which, as discussed in Chapter 4, have also played an important role in global economic governance and its reform. The mark of the US supremacy, most significantly embodied in its veto power, has remained a paramount trait of the strategic directions and the day-to-day activity of the two Bretton Woods institutions throughout their lives. Whenever major economic or geopolitical interests of the US were at stake, the position of the US Treasury carried a crucial weight in the deliberations. However, many other factors and influences have always been at play, increasingly so over the years. The representation of the Bretton Woods institutions as passive instruments of US imperialism, which periodically surfaces in the debate in more or less extreme versions,12 is both simplistic from an analytical standpoint and inadequate to account for their relations with their members and their function in global governance. First, other large shareholders wanted to have not only their voice heard but also their geopolitical and economic interests considered. Although this theme has always been present in the IMF experience,13 it became more prominent with the demise of the Bretton Woods system of fixed exchange rates, which led to the creation of the G7. The function of the latter as hands-on steering committee of the IMF was a central aspect of the G7-based global governance and reflected the commonality of the strategic interests of the G7 members in the IMF’s function as a pillar of the liberal order they desired for the world economy. Alongside common objectives, however, conflicting national interests have systematically emerged. Their pursuit animated G7 meetings and conference calls, and led to direct confrontations within the IMF board and informal but nonetheless momentous clashes within the IMF administration. The duality of the IMF as both instrument of its shareholders’ commonly agreed intentions and bone of contention for exerting national influence was a constant feature of the G7 period. It has also unmistakably marked the fight for the rebalancing of power that lies at the centre of the IMF reform following the 2008 crisis. Second, the relations between the IMF, and the IFIs in general, and their members have always been two-way. IFIs’ capacity to influence their members is hard to overestimate, as it takes place through multiple channels. Conditionality attached to lending is the most direct route, covering a bafflingly broad range of

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policies. The memoranda of understanding – the instruments used to express the policy commitments of the borrowing authorities – are not confined to setting the aggregate indicators of monetary and fiscal policies, such as the size of the public deficit. They enter into details about the specific measures required to attain the macroeconomic objectives, and typically extend to structural policies, including any issue deemed relevant, from civil servants’ wages to education and pension reforms. The Article IV reports14 – the yearly analysis of the economic conditions of each country carried out in line with the IMF’s surveillance mandate – are equally broad in scope. Their immediate impact on policy decisions is much weaker, as member states are not compelled to follow the IMF’s advice to obtain a badly needed loan. Further, they have long been criticized for their unfair benevolence towards major countries, in particular the US. Yet these reports, the regular publications, such as the World Economic Outlook, and the research papers contribute to shaping the mainstream views on economic issues, exerting an influence so powerful that the term Washington Consensus15 was coined to describe its sway. The IMF’s capacity to leave a clear mark on prevailing views is rooted in its direct policy experience combined with mighty intellectual firepower, coming from the highest concentration of economics PhDs of any other academic or policy institution. IMF economic thinking is embedded in the mainstream economics of top world universities, US ones in particular, as evidenced by the education background of its recruits and by the fact that, irrespective of their nationality, all the Economic Counsellors in the last thirty years have joined the IMF from prominent positions in US academia.16 Notwithstanding the shared roots and frequent interactions with top schools, a distinct house view has blossomed, with an autonomous role in the policy debate. The influence of the IFIs on their members gains further traction from their roles, both institutional and informal, as instruments of international economic and financial cooperation. They host meetings, produce essential background analyses, advance detailed policy proposals, provide technical assistance, contribute to the shaping of many national institutions, and assist with the formation of the ruling classes of developing and emerging economies. In short, IFIs have provided an essential impetus to the globalization of the world economy, promoting, sometimes forcing, policies that have opened up nations to global trade, investment, and capital. They have been successful globalizers, as Ngaire Woods17 convincingly put it. Both the economics and the politics underpinning this function, however, have been bitterly controversial, especially with regard to crisis management. Emerging economies considered that challenging this approach – which they rightly or wrongly perceived as subservient to US and G7 interests – was an essential component of reform to redress the balance of power in both IFIs and global governance. IFIs have meticulously nourished their public profile and capacity for influence with their mastery of the technical intricacies of international economic and financial affairs, diplomatic acumen, their ability to interact with different branches of national administrations, and their proactive attitude towards

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the media coverage of their activity. They have become powerful bureaucracies, and, as such, they have developed an independent agenda of ever-increasing power. The range of implications is very broad, spanning from the unnecessary inflation of their lending activity, to the self-serving bias in setting the conditionality attached to their loans,18 to securing above-market conditions of employment.19 Even more significantly, IFIs’ flexibility in responding to the evolving needs of international cooperation and their members’ mutable demands has combined with ingenuity and persuasion in proposing new functions and mandates, leading to wider goals and responsibilities. Shareholders have long been aware of the IFIs’ self-promoting mission creep. Although they castigate and try to limit it, they have ultimately accepted it as a necessary cost of preserving IFIs’ capacity to adapt to a changing world and to respond to its evolving challenges as well as to their own fickle demands. Particularly since they became the target of unceremonious public protest, the IFIs have developed a painstaking attention to their communication policy. They dedicate considerable resources to trying to shape their media coverage – including social media, of which they were early users in the public sector. IFIs actively try to raise their public profile, present their successes, and argue their case directly towards public opinion, sometimes with the deliberate purpose of influencing governments. Often, the objective is to give more traction to their surveillance function when their policy advice need not be heeded because it is not embodied in the conditionality associated with a loan. In general, great care is devoted to targeting communication towards specific audiences, both national and international. Indeed, another facet of the interaction between IFIs and their members has to do with the fact that different views and influences are expressed by different interest groups even within the same country, particularly large ones. There is a formal line of command running from the head of the national institution formally holding the IFIs shares (typically the Treasury, but with some exceptions20) to the member of the board representing the country. However, parliaments, in their institutional prerogatives with regard to IFIs, political parties, specialized think tanks, NGOs, an assorted array of actual or self-appointed stakeholders, and public opinion in general, all voice their concerns and are capable of swaying the country’s official position, directly influencing the IFIs, especially on specific projects and actions. Bearing in mind the complexity of IFIs’ relations with their members is essential to understanding the way their role in global governance is evolving as a key component of the rebalancing of power towards emerging economies. This evolution, which required a thorough reform process, has restored relevance and authoritativeness to the IFIs after a period during which they were “withering” and “slipping into obscurity”.21

The withering of IFIs The timespan between the Asian Crisis of the late 1990s and the outburst of the global crisis in 2008 was the most difficult period in the history of the IMF, and

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the IFIs in general, as their very raison d’être was radically questioned from different points of view. The financing function of the IFIs reached a historically low ebb. The phenomenal expansion of international finance offered developing and emerging economies ever-growing opportunities to obtain credit from banks or by tapping markets directly. IFIs seemed an obsolete instrument of the past. The WB accumulated a significant capital headroom – meaning that its outstanding loans were less than its capital endowment would allow, indicating difficulties in attracting borrowers. Other multilateral banks had to explore new regional niches of investment projects to find clients. Most significantly, IMF loans were at record lows. Russia, Brazil, and the large borrowers from the Asian crisis had hastened to repay their debt as soon as economic conditions permitted, well before schedule. Apart from the large loans to Turkey and Argentina in 2002, which were in any case considered “special episodes”, for quite a while no major intervention was required of the IMF in a situation of relative global stability, fostered by ample liquidity and the presumption that central banks would offer a safety net if necessary. That period was a lull during which the imbalances that led to the 2008 crisis were building up, but the perception at the time was different. In addition to the copious availability of private finance and a spell of good times, the drastic fall in the resort to international official finance had further reasons. It was also the result of a widespread and radical dissent from the fundamental approach underpinning IMF operations and policies. Austerity measures, always a component of the policy adjustment typically required by IMF conditionality, had never been popular. Yet, they had always been accepted as an inevitable component of the deal and were rooted in the prevailing orthodoxy that was buttressed intellectually by the Bretton Woods institutions. This was no longer the case and the traditional creed came under dispute. General dissent from the Washington Consensus started to mount during the so-called tequila crisis that hit Mexico in the early 1990s. The conventional policy responses championed by the IMF through the conditionality associated with its financing were blamed for neglecting essential institutional features,22 thus resulting in unnecessarily harsh conditions for the weakest parts of society. With the Asian crisis of a few years later, criticism intensified and spread, as the Structural Adjustment Programmes that accompanied IMF loans extended the scope of conditionality as never before,23 resulting in austerity measures that caused intense popular protests. Similar outcry and demonstrations were directed against the policy recommendations that the IMF offered Russia and then Brazil when it provided loans to cope with the crises triggered by the massive devaluations of the rouble and the real – devaluations caused by major imbalances in the financial sector and external accounts. The disapproval of IMF policies and policy framework came not only from left-wing politicians and populist protesters in the countries that had to undergo draconian adjustments, but from many other quarters as well: borrowing governments and even the moderate public opinion in their countries; NGOs from

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advanced countries; and, most poignantly, from academics, columnists, and officials from international institutions with full credentials as supporters of mainstream economics. But the most significant criticism came from the twin Bretton Woods institutions. At the annual meetings in 1998, James Wolfensohn, then WB president, prompted a radical rethinking of the IMF approach, famously addressing Michel Camdessus, then IMF managing director: “we cannot close our eyes to the fact that the crisis has exposed weaknesses and vulnerabilities that we must address”.24 Nineteenth street, the road that separates the IMF and WB headquarters in Washington, appeared deeper than the Grand Canyon. At the same time, no lesser intellectual calibres than Larry Summers, Stan Fischer, and Ken Rogoff, to name just a few, mobilized in defence of the IMF. Criticism of the IMF also came from the opposite side of the spectrum. Many academics and observers blamed IMF financing for unduly relaxing market discipline, delaying necessary policy adjustments, and rescuing banks from their unwise lending to reckless countries. In November 1998, the US Congress set up a commission, chaired by Allan Meltzer, to investigate the future of the major IFIs.25 The commission’s report lamented the broad scope of IMF intervention and conditionality, and advised a radical refocusing of its activities and an attendant drastic downsizing. The street protests and riots that accompanied both the spring and annual IMFWB meetings made news headlines worldwide, epitomizing the angry distrust of the IFIs, and the IMF in particular, within a vocal portion of public opinion. Misgivings extended to IMF members and were forcefully vented in the IMF statutory organs, starting with the board of directors. Several former borrowers explicitly complained about the mishandling of the crisis and solemnly declared that they would not repeat that experience. The two-fold stigma associated with borrowing from the IMF – the limitation on sovereignty in bending to conditionality and the counterproductive signal of distress vis-à-vis financial markets – was not entirely new,26 but it became preponderant. Many countries actively started to take precautions in order to be able to avoid resorting to the IMF at times of crisis. The action with the highest political profile was the establishment, in May 2000, of the Chang Mai Initiative – an agreement of economic and financial cooperation between South East Asian countries and China, Japan, and South Korea. More mundanely, countries, particularly in Asia, began to accumulate official foreign exchange reserves that progressively reached levels previously unthinkable, with non-negligible costs in terms of growth, given the scale of resources diverted from productive investment. The surge in official reserves27 also had reasons other than self-insurance, but the wish to avoid IMF financing and conditionality undoubtedly played an important role. Bitter complaints, both in public and within the IMF institutional fora, targeted the surveillance function too. Many loud and resentful voices lamented that it was uneven and unfair. It was too lenient towards advanced economies, the US in particular, and it often ignored conspicuous imbalances and inappropriate policies. It was too harsh, sometimes unnecessarily so, towards emerging and

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developing countries, and it put forward the same kit of policy recommendations, which were appropriate to the commercial and financial expansion of advanced economies but were oblivious to emerging and less-developed economies’ specific conditions and concerns. Many non-advanced countries emphatically demanded even-handedness and a fresh pair of eyes in surveillance. At the same time, many US voices, including the Treasury, accused the IMF of “sleeping at the wheel”, as it allegedly failed to rebuke China about its exchange rate policy, which exacerbated global imbalances. The dispute over voting power did not augment the reputation of the IMF as a fair and inclusive institution. After long and divisive negotiations, in March 2008 the IMF board passed a reform to increase the relative share of emerging and developing countries, without succeeding in restoring the legitimacy of the IMF. At the 2008 spring meetings, India took leadership, expressing discontent and voting against the proposal. In a memorable intervention, the Indian finance minister Chidambaram quoted The Economist – “which should be of interest to this audience”, he ironically added – to convey the notion that IMF quota shares still poorly reflected the importance of emerging markets in the global economy. In sum, the IMF had only few and lukewarm supporters. Its cost-to-income ratio was worryingly on the rise since the stock of outstanding loans had shrunk with little prospect of a sizeable rebound (with the privilege of hindsight, it is hard to believe that this was the perception at the time!). The only sustainable solution appeared to be downsizing and moving to a business model in which a substantial part of current expenditure would be financed by an endowment obtained by selling part of the original gold reserves.28 The newly nominated managing director Dominique Strauss-Kahn lost no time in addressing this issue point-blank. With his characteristic matter-of-fact style, he pleaded, in an informal dinner speech, for ministers’ support for this solution – a speech that, by an awkward coincidence, he gave in November 2007 at a meeting of the G20 finance ministers and central bank governors in Johannesburg – the very last one of the “old” G20. Once he obtained the green light, the project went ahead29 and IMF staff were offered attractive early-retirement packages, which however did not improve their battered morale. The IMF started to reduce its personnel just a few months before the eruption of the crisis.

Palingenesis The pervasive sense of the incipient collapse of the international financial system that followed the bankruptcy of Lehman Brothers completely changed the temperament surrounding the IMF and the IFIs in general. In the mood of prevailing panic, financial markets could no longer be relied upon to provide even the routine credit flows necessary for the normal functioning of international trade, which in fact plummeted to a virtual freeze. The importance of official finance in avoiding unwarranted contractions in economic activity and in

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limiting the risk of contagion to economies with sound fundamentals came forcefully back to the fore. The IMF and the other IFIs were recognized as indispensable instruments for an effective policy response. The invitation to the leaders’ restricted lunch at the 2008 Washington summit, recalled at the opening of this chapter, was the symbolic expression of renewed confidence in those institutions. Fresh vows of confidence alone were not enough. A substantive scaling up of IMF resources had to follow in order to build a safety net commensurate to the intensity and scope of the turmoil. And, in a crisis situation, penny-pinching in devising financial firewalls, both at the national and international levels, was illadvised: its precautionary and deterrent function would be impaired by the perception of insufficient size, which would in turn suggest half-heartedness in their deployment. This argument, which was put forward innumerable times before reluctant parliaments and perplexed public opinions, was commonly evoked with reference to the bazooka – a weapon that is so large and intimidating as to reduce the need for its use. It was along this line that the US Treasury secretary Paulson had argued in his July 2008 testimony to motivate the very generous size of the appropriation by Congress – a size he was advocating to save the mortgage giants Freddie Mac and Fannie Mae: “If you’ve got a squirt-gun in your pocket you may have to take it out. If you’ve got a bazooka, and people know you’ve got it, you may not have to take it out”.30 The bazooka argument carried the day. As we have seen in Chapter 2, at the London summit G20 leaders decided on a hefty amount of resources to be delivered through the IFIs. The summit communiqué included a special declaration on IFIs, indicating the great importance attached by the G20 to their contribution to the policy response to the crisis. If size was critical, time too was of the essence. Large-scale financing by the IMF could be urgently needed if conditions deteriorated further, while increasing quotas would take an insufferably long time because of the complex procedure and the difficulties of negotiating the entailed changes in voting power. Two instruments were then used to strengthen the resilience of the international financial system quickly: loans to the IMF from its members, as a bridge to the increase in quotas, and a general allocation of SDRs to complement it. Unsurprisingly, the pre-summit negotiations about both were not easy. Loans from financially strong countries had long been used as a means to supplement the IMF’s fire power. In 1962, the first standard arrangement regulating loan conditions and IMF access to the resources was formalized in the General Agreement to Borrow (GAB).31 In the aftermath of the Mexican crisis, prompted by a G7 initiative launched in 1995, the New Agreement to Borrow (NAB) was established, doubling the GAB resources and providing for a much wider participation of lenders: 38 countries, including all the emerging economies. In both cases, however, long negotiations were necessary to overcome tricky technical hurdles32 and to address sensitive political issues, such as the burdensharing among lenders.

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In the preparation of the London summit, the same difficulties were present, possibly in an even more acute form, since emerging countries, with China in the lead, demanded a rebalancing of power in global governance. Furthermore, many countries participating in the NAB were not G20 members. It soon became apparent that an agreement for a meaningful increase in NAB resources could not be concluded in time for the summit. Diplomatic ingenuity, the activism of the IMF managing director Strauss-Kahn, the stamina of Gordon Brown as G20 chair, and the pressure from the crisis helped to find a viable solution. IMF resources were immediately expanded by bilateral financing agreements with member states for US$250 billion, which would then be incorporated “into an expanded and more flexible New Arrangement to Borrow, which will . . . be increased by up to $500 billion”, as stated in the official communiqué.33 Against the backdrop of this approach, a flurry of bilateral and multilateral talks on the size of each country’s loan (and the modality of its announcement) took place both before and well after the London summit, often mingling with other hot issues of the moment, such as the handling of the European sovereign crisis. The renewed NAB, which incorporated the bilateral loans, came into effect in May 2011. A general34 increase in the allocation of SDRs had two very attractive features: it could augment IMF members’ official reserves at the stroke of a pen and it could inflate the resource tally in the summit communiqué at no extra cost to G20 members. Also, it non-committally hinted at a strengthening of the role of the SDR in the international monetary system, which China and other emerging countries appreciated. Although these arguments in the end prevailed, they had to face a host of often conflicting objections. The strenuous opposition reflected a wide-spread uneasiness, especially within the most conservative central banks, about a policy step that had technical and political implications that were uncertain and not completely understood. The perils of worldwide inflation and potential loss of monetary control were invoked, together with the risks that abundant SDRs could became an excuse not to increase quotas adequately or could help countries avoid IMF conditionality. As recalled in Chapter 2, it took the intervention of Gordon Brown directly with his peers to break the deadlock at the technical level. Following the decision made by the G20, SDRs were increased by nearly tenfold, with the total exceeding US$300 billion. This is an extraordinary figure that in fact did not fail to impress, allowing the total of the mobilized resources to surpass the totemic threshold of US$1 trillion. However, there is no manifest evidence of equally impressive benefits from the new SDR allocation for the smooth functioning or resilience of the international monetary system. SDRs were distributed in proportion to the IMF quotas, thus mostly going to countries which did not need a boost in their international reserves. More fundamentally, to be deployed as a proper reserve asset, SDRs continue to require a willing counterparty35 to exchange them for convertible (hard) currencies. Accordingly, they have only been utilized in negligible amounts. The grandiose increase in IMF resources could in any case strengthen the resilience of the global economy only insofar as countries were (and were

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perceived to be) willing to use them. This condition did not need to be taken for granted given the stigma that had come to be associated with resorting to IMF finances. The reluctance to access the IMF was particularly conspicuous in the case of the so-called precautionary facilities – that is, instruments specifically designed to minimize the stigma and contain crisis contagion to countries with sound fundamentals:36 the first one, the Contingent Credit Line, was established in 2000 and had never been used. The crisis and the renewed support for the IMF by the G20 broke the spell. Mexico started negotiating a precautionary arrangement just days before the London summit (so that this decision could be welcome in the communiqué). With the unfolding of the crisis, several countries followed suit, applying for both precautionary arrangements and standard loans. The criticism and disaffection that had triggered the plan to reduce staff started to fade away. The IMF regained its prominence as provider of official finance and competent analyses. Its house view recovered its appeal, and its intervention in the European sovereign crisis was expressly invoked by several countries, led by Germany, as a bulwark of analytical and policy integrity. Multilateral Development Banks (MDBs) fully partook in the renewed confidence and augmentation of resources decided upon by the G20. At the London summit, only the threefold increase in the capital of the Asian Development Bank could be decided, because the preparatory work to this end had already started before the eruption of the crisis, though for a smaller amount. For the other MDBs, the G20 agreement could only cover “the reviews of the need for capital increases”, which invariably resulted in substantive increments in resources, including for the MDBs that were not explicitly mentioned in the communiqué. The G20 decisions also put an end to the pre-crisis soul-searching mood of the MDBs, as they were curtly summoned to make “full and exceptional use of [their] balance sheets, to create further capacity for lending to meet crisis needs”. The capital headroom the WB had accumulated during the years of discomfiture allowed it to respond vigorously, nearly doubling its loan issuance between 2008 and 2009. With a fresh sense of common purpose, the rift between the Bretton Woods twins eventually came to a full end and they both felt united in the common mission to fight the crisis. The other MDBs’ response was equally powerful, stretching the available capital and finding new ways to deploy it so as to attract co-financing from private sources while deliberating new capital injections.37 The revival of MDBs’ countercyclical function, which soon translated into the objective of supporting infrastructure investment, greatly enhanced both their profile and functions in global economic governance. Recognizing the crucial contribution that the IFIs could make did not mean consigning to oblivion the radical questions that had been raised on their relevance and legitimacy. Emerging countries, in particular, felt that only deep and wide-ranging reforms could address their grievances. They firmly demanded a radical reform of the IFIs as a precondition for their consent to the massive increase in resources. Not only that: during the drafting session, they requested

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that the text of the communiqué explicitly put the two concepts in relation to one another. And so it did. Paragraph 20 reads: “alongside the significant increase in resources agreed today we are determined to reform [. . . IFIs’] mandates, scope and governance”. The rest of the paragraph consists of a series of bullet points indicating specific actions to this end, starting with the issue that was regarded as the most crucial: the IMF quota reform.

The (latest) IMF quota reform Emerging economies viewed the increase in their voting power within the IMF as necessary to restoring the legitimacy of the institution. Even more importantly, they thought that their enhanced weight in IMF decision making was an essential element of the reform in global governance. They pursued this objective with adamant consistency and tenacious determination, exploiting the opportunities opened by the crisis for stronger bargaining power. They even used this endeavour as a catalyst to define a unitary position within the G20 and other fora, as their opinions on other issues were less clear and consensual. Since the voting power within the IMF is based on quotas, the ultimate purpose of the quota negotiations is direct and it is in essence a zero-sum game: any country’s gain in relative voting power must be compensated by some other country’s loss. Despite the clarity of the final stakes, discussions about IMF quotas are fraught with technicalities and oddities, making it an esoteric topic almost impenetrable to outsiders. Here are some of the reasons. First, since countries have a veto power on the reduction of their quota, the rebalancing of voting power can only take place through increases (non-proportional to existing quotas). As a result, when large shifts in voting power are contemplated, the negotiations on relative quotas intertwine with those on the overall size of the increase in IMF resources. Second, relative quota shares and voting power differ because of so-called “basic votes” – voting rights that are periodically assigned to members irrespective of their quota in order to inject an element of one-man-onevote democracy in the system, thus protecting the smallest (not necessarily the poorest) countries. Third, the formula used to calculate “ideal” quota shares (then corrected on the basis of sheer political considerations) is quite complex and has changed many times over the lifetime of the IMF. It includes several variables to capture the different criteria for quota allocation that stem from the multiple functions of the quotas inherent in the credit-union framework of the IMF: a yardstick to determine contribution, maximum borrowing limit, and voting power of each country member. Further, the importance to be attached to each of these functions, with the attendant implications on the specification of the formula, is arbitrary. And even the consensus that has built up in recent years to increase the weight attributed to economic size in the formula provides only partial comfort, because its implications differ markedly according to whether GDP, the standard measure of income, is calculated at market or PPP exchange rates.

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Even this cursory and partial list is sufficient to explain why the very long tradition of attempts to improve and simplify the formulas at each statutory quota review has produced “limited or no results”, as the report38 of the Quota Formula Review Group, formed by eight eminent external experts, candidly admitted in 2000. Its own proposals for simplification were only partially followed, but they provided an important backdrop to the decision to match the 2008 quota reform with the adoption of a new formula – a formula which is still in force. The new formula is somewhat simpler than before, but it still has to be tweaked to accommodate conflicting opinions and interests. For example, the GDP measure included in the formula is a blend of PPP exchange rates (40 per cent), favoured by emerging economies, and market exchange rates (60 per cent), desired by advanced countries; quotas are raised to the power of 0.95 and then re-normalized, so as to boost the share of the smallest countries.39 Although compromise and political accommodation have been crucial factors in the definition of the formula since Bretton Woods, actual quotas have always departed from calculated ones because of (further) adjustments, which are sometimes quite significant.40 The systematic overruling of the results from the agreed formula makes one question the need for invoking a formula in the first place, rather than directly applying political discretion and negotiation. However, IMF members have constantly shown their unwillingness to jettison the notion of fairness and objectivity that a formula, no matter how tweaked or complex, conveys. In addition, from a practical point of view, an automatically calculated yardstick as a starting point for discretion is needed when there are so many countries, with countless and disparate political sensitivities, as regional and sub-regional considerations come into play. Against this background, the negotiations on IMF quotas that followed the London summit involved three different but intersecting aspects: i) the discussion on the formula itself, with various proposals to change it, modifying the variables and/or their importance; ii) the size of the shift in voting power in favour of the “dynamic emerging markets and developing countries” (the group of beneficiaries of the increase in quota shares was also the subject of a long debate);41 and iii) the criteria to be followed in adjusting actual quotas towards the newly calculated ones – which, by the way, also reflected the update in the macroeconomic data that were per se enhancing the weight of emerging countries. In addition, the G20 also had to agree on the amount of the overall increase in the value of quotas, which determines the IMF’s available resources, and on the increment in basic votes for safeguarding the voting power of the smallest countries.42 The broad political agreement reached in London to increase the voting power of emerging countries had to be translated into precise technical decisions, each capable of significant effects, sometimes with very large idiosyncratic implications for this or that country. Several international groups, in formations of different seniority, were involved, even though it was the G20 that maintained the lead on the strategic directions. To navigate the daunting maze of open options, each country’s delegation followed a trusted polar star: whether the particular variant debated at the

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moment, such as the addition or deletion of a certain variable in the formula, would make its quota share higher or lower. Statements at the meetings tended to be as predictable in their bottom line as they were creative and astute in the argumentation, especially in the micro confrontations on specific, minute issues. Some topics, such as the possible inclusion of population as a factor to determine the quota share, offered the opportunity for more philosophical contentions. In general, however, the debate was aridly technical and prone to deadlocks on each specific topic, as mutual concessions and compromises could be attempted only by reference to complete packages involving many details. IMF staff were the only party with the technical capacity, stamina, and institutional role to elaborate comprehensive proposals, arranged as scenarios. Larger and more active countries built their own machinery to simulate the effects of alternative hypotheses and influence the negotiation through bilateral informal talks with the IMF, suggesting alternative solutions or venting their imperative red lines. Only a few external observers dared to enter into the nitty-gritty of the debate.43 The repeated involvement of G20 ministers and leaders allowed the overcoming of the logjams in such a thorny technical negotiation and the reaching of an agreement on a major rebalancing of voting power within the IMF in just eighteen months, the period spanning the G20 summits of London (April 2009) and Seoul (November 2010). This was a quick process when compared to the complexity of bargaining or to other major changes in the IMF. The Pittsburgh summit (September 2009) decided upon the first important steps towards securing a deal.44 The existing formula should be maintained, at least for the time being, as initial exchanges had shown that it would have been impossible to find a consensus on any alternative within a reasonable time. The ambition to change the formula, however, was not abandoned by emerging countries, led by Brazil on this particular issue, and the package finally agreed upon did include the commitment to review it by January 2013 – a commitment that would periodically resurface in G20 communiqués but which has thus far remained unfulfilled. The other breakthrough was an indication of the magnitude of the shift in voting power in favour of emerging countries: “at least 5 per cent” was not the final figure, yet it proved sufficient to frame expectations and foster convergence. In Toronto45 (June 2010), G20 leaders pressed to accelerate the negotiations that were stalling and confirmed the Seoul summit as the final deadline for an accord.

The Seoul package and its implementation As is customary in international negotiations, the final deal was cut at the last moment at the G20 finance ministers and central bank governors’ meeting in Gyeongju, which took place just a few days before the Seoul summit. There, G20 leaders were put in the position to “welcome the ambitious achievements . . . reached in Gyeongju” and confirm “the shifts in quota shares to dynamic emerging market and developing countries and to under-represented countries of over 6 per

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cent, while protecting the voting share of the poorest”. The G20 also deliberated the doubling of the IMF quotas together with a corresponding reduction in the size of the NAB commitments when the quota increase came into effect.46 The breakthrough in the negotiations owed much to US determination, tactical skills in arranging a comprehensive package, and leadership in convincing the key actors to accept it. Alongside the immediate reallocation of quota shares towards emerging economies and an increase in basic votes, the package included commitments to an acceleration of the forthcoming quota review (with a reassessment of the quota formula) and a reform of the IMF board. A key point of this reform, however, has to be highlighted here since it was essential to closing the deal in Gyeongju: the understanding that advanced European countries would relinquish two of their seats on the IMF board. The reluctant European members of the G20, including the European Commission, were convinced to assent to this reduction in a memorable side meeting with the US treasury secretary and the IMF managing director. Tim Geithner and Dominique Strauss-Kahn put forward very pressing political arguments, in particular outlining that Europeans would be harshly blamed for resisting the modernization of the IMF only to secure the conservation of their outdated privileges in representation, some still stemming from post-war arrangements. Counterarguments by European representatives were defensive and, as discussed in Chapter 6, were not supported by a common strategic vision. At that critical juncture, the traditional European reluctance to take a strong unitary stance in external matters was exacerbated by the mounting strains over the sovereign crisis. Europe missed a crucial opportunity to exert influence over the reform of the IMF commensurate with the size of its aggregate quotas (about 30 per cent) and the potential role it could play in shaping the transformation of global governance. Another essential element for the conclusion of the deal was the painstaking elaboration by the IMF staff of the minute details of the quota allocation that implemented the general guidelines deliberated at the Pittsburgh summit in a way acceptable to all members. To reach this result, formula calculations had to be complemented with eight different ad hoc adjustments, which as a whole account for the allocation of 40 per cent of the quota increase, with three of them applied with further specific tweaks.47 Indeed, the final compromise is so complex as to rival the legendary obscurity of international trade agreements. Despite these contortions, the rebalancing of voting power within the IMF agreed upon by the G20 in Seoul marked a major step forward in the transformation of global economic governance. Europeans begrudgingly accepted the reductions in quota shares and board seats, while emerging countries continued to lament the remaining flaws in the formula and a still inadequate recognition of their role. But these elements of discontent seemed simply to confirm the time-honoured adage that the distinctive sign of a good compromise is when nobody is satisfied, but everybody can live with it.48 The US even had reasons to be definitely pleased: its successful leadership in the final stage of the negotiations boded well for its capacity to guide the future evolution of international economic and financial

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relations. The further steps of the 2010 IMF reform, however, reversed this benign assessment. Given the veto power assigned to the US by the qualified majority rule, the IMF quota reform required the ratification of the US Congress to come into effect, even if all other members had approved it. In spite of the key role of the US in shaping the salient features of the reform, the US administration failed to deliver a swift endorsement by Congress, thus blocking its implementation for several years. US lawmakers approved the IMF reform only on 18 December 2015, much to the dismay and irritation of the international community. US politics accounts for this inordinate delay. At first, the Obama administration chose to wait for the inauguration of the new Congress in 2013 to submit the IMF reform, presumably to avoid the reform’s involvement in the political fights linked to the presidential election of 2012. Embroilment of the reform in US domestic political struggles, however, became inevitable when the election results confirmed President Obama into office but failed to give his party control of Congress. As several attempts to secure legislative approval failed, the world had to confront the unpalatable reality that the US political system was no longer capable of delivering the traditional bipartisan support for the international arrangements US negotiators had agreed to – an implicit arrangement that had underpinned the US hegemonic role in international cooperation. Instrumental opposition to specific pieces of legislation based on transient political calculations is a staple of parliamentary democracy in every country. In the case of the US, however, domestic parliamentary confrontation held hostage a key component of the transformation in global governance, even though no party explicitly opposed the goal of granting a more significant role to emerging markets in the IMF. As the quota reform became a bone of political contention beyond its own intrinsic content, the debate was shaped by domestic sensitivities rather than actual relevance: for example, budgetary implications of the increase in the US quota commanded huge attention, although they were negligible in size and merely due to dubious provisioning requirements.49 Congress resistance to the IMF reform also provided new strength to a long-standing US streak of criticism of the IMF as a source of harmful interference with market discipline: IMF financing delayed, or avoided, necessary debt restructuring, thereby rewarding imprudent investors and extravagant governments while jeopardizing (US) taxpayers’ money.50 The administration’s efforts to win Congress approval crashed against incommensurate requests for political compensation or demands to modify a reform that in the meantime had been voted upon by more than 100 parliaments across the world. The standstill appeared so desperate that it prompted Christine Lagarde51 to declare with purposeful irony that she would “do belly-dancing if that’s what it takes to get the US to ratify”. Rather than by the managing director’s artistic performance, Congress approval was secured by conceding two conditions. The first one, pertaining to domestic decision making, was the introduction of the obligation of the treasury

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secretary to consult Congress on key IMF operations.52 The second one concerned the IMF financing policy and, given the stage in the ratification process, had to be within the powers of the IMF board, without involving the other national parliaments, which had already approved the reform. A delicate balancing act was required as the change had to be sufficiently significant and related to the Republican stance in Congress to provide a meaningful motivation for putting an end to the veto, while also being acceptable to the rest of the membership. The substance of the deal was the abolition of the so-called “systemic clause”. This provision was introduced on the occasion of the IMF intervention in the Greek crisis and allowed the IMF to raise the maximum limit for its lending to a single country well above the statutory “exceptional access” if the country situation caused a systemic risk to financial stability. As the systemic clause had been criticized for granting unwarranted leeway to the IMF management with attendant risks for IMF resources, its abolition could be considered (and portrayed) as a major policy change.53 The other IMF members were so glad to end the unbearable impasse that they raised no objections, even though, to all practical purposes, the US had used its veto power to impose an extra round of negotiations for an agreement they had not only accepted but emphatically championed. Europe’s acquiescence was yet another testimony of its inability to stand its ground on global issues. Emerging markets’ quiet endorsement is very telling too, especially on the part of China. It shows that, in the transformation in global governance, emerging powers are unwilling to invest political capital on questions of principle about the configuration of international financial relations unless they have a direct interest at stake. All that ended well, however, was not well. Given the actual and symbolic importance of the rebalancing in IMF voting power, the extraordinarily long time it took for it to come into effect once agreed upon had major repercussions. Urging the implementation of the 2010 reform absorbed countless hours of G20 meetings, diverting political attention away from further steps in the reform of the IFIs and more fruitful exchanges in other areas of international economic cooperation. This was inevitable. The entry into force of the 2010 reform was a precondition of initiating the process of the subsequent quota review and further rebalancing, already agreed upon by the G20. It was also key to preserving the reliability of the G20 as the central decision forum for international economic and financial relations. The repeated inclusion in G20 communiqués of deadlines for the US ratification of the reform revealed the growing sense of irritation and frustration, which could not be assuaged by the soft-spoken reassurances offered by the US delegation at G20 meetings. As deadlines went disregarded, the aggravation mounted such that G20 leaders, at the Brisbane summit in November 2014, assigned the mandate to the IMF to study alternatives54 – a genuine mission impossible given the veto power of the US enshrined in the Articles of Agreement. The situation unavoidably fostered uneasiness, particularly in emerging countries, about the US hegemonic role in world economic affairs. The disproportion

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between the severity of international repercussions of US veto power in the IMF and the short horizon of the US domestic political stakes that caused it did not go unnoticed, and it provided yet another reason for emerging economies to accelerate the evolution of global governance towards a more multipolar system.

There is more to influence than quotas The rebalancing of relative quotas towards emerging countries is only part of the story. There is more to exerting influence on IMF decisions than the sheer size of the quota, as all members have always well understood and, whenever possible, embodied in their negotiating positions. Already in 2008, changes in IMF governing arrangements were labelled quota and voice reforms, where voice referred to two elements: the increase in basic votes, which was meant to protect the voting power of the smallest countries, and a slightly greater access to the board, as numerous55 multi-country constituencies were given the possibility of appointing a second alternate executive director. The issue of voice continued to be associated with the IMF quota reform in the communiqué of the London summit, and the package agreed upon in Seoul contained important elements to this effect. The G20 agreed both to another increase in basic votes, to avoid the dilution of their position due to the doubling of quotas, as well as to further changes in board representation, which were essential to closing the deal: i) G20 members committed to enlarging the board to twenty-four seats systematically,56 with a review of its composition every eight years; ii) the possibility of appointing a second alternate executive director was extended to all multi-country constituencies; iii) the board would consist of all elected members, abolishing the post-war provision that five countries had the right to appoint a director;57 and iv) as noted earlier, European countries committed to relinquish two of their seats. The attention paid to the details of country representation on the board, alongside the struggle to increase formal voting power – which, by the way, is common to all IFIs – is not difficult to understand. It is a reflection of the way the decision-making process works in practice – with a fundamental reliance on consensus. Occasions on which votes are formally cast and counted are relatively infrequent, and, apart from the US veto power (on a limited range of issues), countries, including large ones, practically never happen to be swing voters. Indeed, in most cases, vote-counting is requested and carried out rather to record discord formally than to reach a decision through the voting procedure, whose outcome is typically predictable through the informal consultations that take place before board decisions. This state of affairs accords crucial importance to active, direct participation in the board discussions and informal contacts with the other constituencies and IMF staff and management. This is the way to have a voice in decision making. In the day-to-day activities of the institution, directors, their alternates, and their collaborators are considered by their peers and IMF representatives more for their

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personal credibility and capacity for persuasion than for the exact weight of the country (or group of countries) they represent. Directors try very hard to avoid split constituency votes (that is, when they receive contrasting voting instructions from the countries they represent that have to be recorded formally) in order to preserve their personal credibility as opinion leaders within the constituency. Therefore, split votes occur very rarely and only by reference to special cases and sensitivities. Informal interaction with the staff is crucial to receiving advance information on IMF views on broad policy approaches, specific issues, and country analyses – among the latter, growth forecasts and Article IV reports are traditional favourites because of the attention they can command in national political debates. The time when ideas are in the making, or even the earlier stage when their conceptual underpinnings are elaborated, is also when IMF staff are more prone to assimilating influences, paying attention to country concerns, and taking note of local political constraints. Informal dialogue is useful to the IMF too, as explaining the rationale of its approach can facilitate the acceptance of its policy advice. Against the backdrop of the informal consultations that are so important in the actual decision-making process, the perennial bone of contention over the nationalities of both the staff and the leadership of international organizations became an even more explicit and pressing demand by emerging countries. At their inescapable request, the communiqué of the London summit openly declared that “the heads and senior leadership of the international financial institutions should be appointed through an open, transparent, and merit-based selection process” – an intention that echoed the 2008 recommendation of the Internal Evaluation Office of the IMF58 and the condition explicitly advanced by emerging markets in 2007 to support the election of Tommaso Padoa Schioppa as a chair of the IMFC. Although the heads of both Bretton Woods institutions have changed since then, the promise has not (yet) translated into a change in their traditional geographical origin, with a European at the helm of the IMF and US citizens as head of the WB and number two at the IMF (First Deputy Managing Director is the official title). However, after Padoa Schioppa, the IMFC presidency has systematically rotated across geographical areas.59 For the first time in the IMF’s history, a Chinese national, Min Zhu, was appointed IMF Deputy Managing Director in 2011, and when his five-year term expired, he was replaced by another Chinese national. Even more impressive and relevant has been the quick and widespread increase in staff from emerging countries at all levels of seniority.60 The more diffuse presence within IMF staff, the higher profile and eloquence in board discussions, the broadening of policies and issues attracting an active interest, the coming of age of the G20 as the steering forum of the IMF: all these factors have combined with the increase in voting power to give emerging countries recognition and influence in the IMF decision-making process, which would have been simply unimaginable before the 2008 crisis. Now, the views of

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key emerging countries, just like those of G7 countries, are garnered before any major decision is submitted to the board. Their concerns and political constraints are factored in during the elaboration of important proposals, even without the need for a specific démarche, as it is widely understood that they are key to defining the viable policy space. As for the shift in relative voting power towards emerging countries, China took the lion’s share of enhanced influence in IMF decision making. In the absence of a strong and united European position, only China can rival the US in its capacity to attract attention and to elicit responses to its specific demands or general policy stances. China always joins forces with the other emerging economies in asserting the need for a further rebalancing of power in their favour and often seeks their support in swaying IMF positions. However, as in the G20, China is wary of taking an explicit and systematic role of leading emerging economies within the IMF, keen as it is to stress its one-of-a-kind status and being unwilling to invest political capital in issues about which it has no direct interest. One example may be useful to illustrate the depth of the transformation that has taken place in the IMF. In June 2006, much to the reluctance of China, the IMF launched “the first multilateral consultation . . . [to] focus in a comprehensive and collective way on the issue of global imbalances”, directly involving China, the euro-area, Japan, Saudi Arabia, and the US. The procedure turned out to be divisive in both method and results, and not particularly useful either, as the IMF itself had to admit.61 After some preliminary conclusions were presented to the IMFC at the spring meetings, the report of the consultation was submitted to the board in July 2007 and approved, notwithstanding the opposition of China, which felt “finger-pointed to”. Such a course of action would now be inconceivable, as anybody familiar with IMF internal process would candidly admit. The abolition of the systemic clause without securing in advance the informal endorsement by China would have been equally inconceivable. The much more pervasive and influential role in IMF decision making of emerging markets, China in particular, was apparent even before the quota and voice reform became legally effective at the end of 2015, and it is one of the major elements of the transformation in global governance set in motion by the eruption of the crisis in 2008. This is a genuine sea change both in practice, as IMF deliberations are palpably different from what they would have been otherwise, and from a symbolic point of view, as the stigma associated with the IMF and the disputes over its legitimacy have been largely, albeit not fully, overcome. Despite its relevance, and for two sorts of reasons, this momentous change has not received adequate recognition by those lacking a direct involvement in IMF decision making. First, the visibility and relevance of the change are masked by the persistence of the US veto power and the substantial continuity in the economic paradigm underpinning IMF policies, as discussed in the next section. Second, notwithstanding the recent progress in transparency and public accountability, the actual IMF decision-making process remains only partially known and understood outside official circles, as discussion details and voting records within

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the board remain confidential. Effectively, the same confidentiality pertains to the informal interactions, unrecorded by definition, which have been a key channel of the strengthened influence of emerging markets. Scholars of IFIs are in fact used to interviewing insiders as one of their main sources of information.62

Paradigm regained: the persistence of the Washington orthodoxy Blaming the framework underpinning the policy prescriptions of the IMF and the other IFIs, and radically questioning their relevance and legitimacy, lay at the heart of the poignant criticism to which they were subject before the 2008 crisis. For this reason, one would have expected the reform of the IFIs, and in particular the increase in the voting power and influence of emerging countries, to bring about drastic changes in their policy approach. Instead, such an overhaul simply did not happen. The IFIs’ prescriptions are characterized by an unmistakable paradigm continuity. Several reasons account for this persistence, but before discussing them, it is useful to recall the evolution undergone by the IFIs’ policy vision. The debate on the IFIs’ policy approach is typically conflated with the contention over the Washington Consensus – the expression coined by John Williamson in 1989 to summarize the set of principles that the Bretton Woods institutions followed when elaborating their policy advice and, most significantly, when determining the conditions countries had to fulfil to receive their loans. This is an unfortunate source of confusion because several contrasting meanings have been given to the expression. In Williamson’s mind, Washington Consensus was meant to be a descriptive label for the practice of Washington-based institutions, which was firmly based on mainstream economic thinking and, as such, widely accepted – “for the most part they are motherhood and apple pie, which is why they commanded a consensus”, to use his own words.63 However, the expression immediately acquired a life of its own, becoming a synonym for a general orientation based on market fundamentalism or an umbrella term for the one-size-fits-all neoliberal policies imposed on the countries that had the misfortune of needing IFIs’ money. At first this ambiguity generated controversy with reference to the fiscal austerity and anti-inflationary monetary stances that have always been standard elements of IFIs’ prescriptions. Defending the IFIs and the Washington Consensus was seen as dutiful support in the fight against populist policies that cause crises and that hurt the weaker part of the population they claim to benefit.64 The orthodoxy encapsulated in the Washington Consensus was in any case richer than the requirement of a balanced macroeconomic stance; it encompassed the protection of property rights, fiscal discipline, deregulation, and privatization, together with external openness ensured by trade and financial liberalization, market-based exchange rates, and the acceptance of direct foreign investment. With the tequila and Asian crises of the 1990s, the criticism of IMF policies was so fierce and widespread that it could not be ignored. The IMF had to acknowledge

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that too much reliance on a standardized approach in policy design across countries had led to insufficient attention on crucial factors, such as institutional features, social implications, or the appropriate sequencing of reforms – for example, insisting on the liberalization of the capital account before the financial sector could withstand the associated volatility. The IMF conceded no generalized repentance but took important corrective action in designing concrete policy prescriptions. Suggested policies became less rule based, with greater attention paid to institutional aspects, such as corporate governance, anti-corruption, flexible labour markets, central bank independence, financial codes, and standards. Policy discourse included more substantive elements of equity considerations and frequent references to social safety nets and targeted poverty reduction. In short, the orthodoxy embodied in the Washington Consensus, as originally defined by Williamson, was neither repealed nor abandoned, but it was integrated with pragmatic additions, combined with a more open attitude towards the flexibility and relevance of country- and situation-specific factors. “Goodbye Washington Consensus. Hello Washington Confusion”65 is the title of the paper that first codified the “Augmented” Washington Consensus, adding ten new principles to the original ones, with much more sympathy for the open-minded eclecticism of the new approach than the title of the paper would suggest. In addition to the changes in policy framework, in 2001, the IMF created the Independent Evaluation Office (IEO) to respond to its members’ criticisms and demand for a fresh pair of eyes in assessing policies. Its establishment was difficult and half-hearted, as management was wary of a body with an oversight function that could become an internal source of criticism. The IEO has become a precious source of public information about the IMF internal process, promoting accountability. Its evaluations have provided valuable suggestions for improving effectiveness, fostering openness on the part of the IMF to consider policy alternatives. Yet, IEO influence has remained limited: to have an impact, its proposals must be implemented by staff and management, who have instead shown enthusiasm more in praising the independence and quality of IEO’s analyses than in heeding its advice. Despite all these efforts, the IMF had failed before the crisis to regain the confidence and ownership of many of its members, which continued to deplore its insufficient legitimacy. Yet the expectation that the reform and the greater role of emerging markets would result in a radical overhaul of the pre-crisis policy framework proved wrong. IMF prescriptions adhered to paradigm continuity, as evidenced in various analyses66 and confirmed by the tone of board discussions: critical remarks on a single programme or a particular paper remained focused on the issue at hand without becoming an opening for advocating a radically new approach. Neither did emerging economies systematically take side with borrowing countries, thus suggesting lenient conditionality or generous financing: they voiced concerns about protecting IMF resources – and they did so very noticeably when expressing their worries about the very large exposure of the IMF to European countries during the sovereign crisis.

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Paradigm continuity has several complementary explanations. The first one, obviously endorsed by the IMF itself, is that the policy framework followed by the IMF is “motherhood and apple pie”, but seasoned with abundant doses of pragmatism. Although the IMF house view is firmly rooted in liberal orthodoxy, it is not immutable and dogmatic. It remains open to the evolution in mainstream economic thinking and, most importantly, ready to incorporate lessons from experience, including mistakes, even if they are rarely given that name. Several taboos in policy prescriptions have been broken since the crisis, such as the acceptance of capital controls or a more receptive attitude towards the countercyclical use of budgetary policy.67 Indeed, this flexibility can even be interpreted as a direct result of the greater attention paid to the concerns of emerging countries. Paradigm continuity results from the seamless, experience-based, pragmatic transformation of the way the fundamental principles underlying the market-based, liberal view of economic policy are applied. Paradoxically, it is also the diversity of crisis situations and political economy constraints that works as a powerful force in preserving paradigm continuity.68 Substantial departures from the standard approach when devising policy prescriptions would give rise to issues of consistency and fairness that would be impossible to manage. If the conditions requested of borrowers were not perceived to originate from the same set of standard principles, the burden of adjustment across countries would appear arbitrary and unjustifiable from a political point of view. Abandoning the traditional approach would raise issues of consistency and coherence that the IMF and its members do not seem to be willing to address. Uncertainty about the impact of policy measures – especially on the ultimate engine of prosperity, productivity growth – also favours paradigm continuity. Policy mistakes stemming from the usual paradigm are intellectually more justifiable and politically more defensible than errors from new models and approaches, especially when the latter are not derived from a broad, encompassing view of economic policy and development. Despite the fundamental differences of their economic systems and policy frameworks with respect to the liberal orthodoxy, emerging economies have not yet developed an alternative economic doctrine or model of development. It is too early to tell whether they will ever develop a global alternative to the liberal order, but the overall support of the IMF is consistent with the key argument of this work: emerging economic powers shun open confrontation in the absence of an immediately available alternative, while exerting pressure to pursue their immediate objectives and to weaken the influence of the US and the G7 in global governance. The last remark on continuity regards the even-handedness of IMF analyses. Before the crisis, emerging, developing, small, and weak countries had long been complaining about the double standards applied by IMF in its surveillance, deploring the indulgence reserved for large advanced countries. They felt criticized in an unfair and unnecessarily harsh way in comparison with the cavalier attention paid to the imbalances and wrong policies of more powerful members. Post-crisis efforts to strengthen surveillance69 improved the quality of the analysis

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and made it more candid in exploring risk scenarios. Yet they fell short of transforming the IMF into the “ruthless truth-teller” Keynes advocated, universally tough and fair. Rather, the new balance of power within the IMF has resulted in a wider range of countries that are able to obtain soft tones and mild expressions of concern from the IMF.

Conclusions Since their establishment at Bretton Woods, IFIs have been part and parcel of global economic and financial governance, with multifaceted, two-way interactions with their shareholders: instruments to pursue the objectives of their members, proactive bureaucracies striving for independence and capable of enormous clout on their owners’ policies, terrain of conflict for the acquisition of power and influence in the global economic and financial arena. Among the IFIs, the IMF has always had special prominence due to its function as lender of last resort at the international level and lynchpin of the international financial architecture. The decision of the G20 to use the IFIs as the key instrument of the policy response to the crisis put them back at centre stage, after many years during which their function and legitimacy had been radically questioned. At the London summit in 2009, the G20 decided upon a massive expansion of IFIs’ resources, tripling the lending capacity of the IMF. Such an impressive increase in resources was possible only because at the same time, the G20 launched a major reform process focused on transferring relative voting power towards emerging countries. The latter made the struggle to gain more influence within the IMF one of the defining elements of the change in global governance they championed in the G20. Negotiations resulted in a deal that provided for a substantive shift in power in favour of emerging markets, as well as a reduction of the European seats on the IMF board. The agreement took nearly five years to become effective because its ratification by the US Congress, which was necessary given the US veto over major IMF decisions, was embroiled in US domestic politics. The situation cast new doubts on the economic benefits and the political appropriateness of centring global governance around the US’s hegemonic role. Even more important than the gain it gave to their voting power, the IMF reform led to a major boost in emerging countries’ influence on the actual IMF decision-making process – an influence that was acquired through greater recognition by both IMF staff and other members in the informal contacts that shape IMF decisions. The weight of informal interaction in IMF deliberations and the confidentiality, if not opacity, of the way the IMF operates explain why this major change has not been adequately appreciated despite it being one of the key elements of the transformation in global governance. In spite of its intensity, the rebalancing of influence over IMF decision making has been accompanied by continuity in the paradigm underpinning IMF interventions and policies. It is instead the reform of MDBs, discussed in the next chapter, that has been marked by more important changes.

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Notes 1 This is the total result of both the 2008 and 2010 quota reforms, as discussed later in the chapter. 2 For the reader unfamiliar with the internal organization of IFIs, it may be worth recalling that management refers to the top echelons of the organization which are appointed directly by the shareholders either formally or informally: for example, in the IMF, management consists of the managing directors and his/her deputies; in the WB, the president and the managing directors. Staff members (who carry out the analyses underpinning the decisions and do not always fully agree with the policy directives of the management) are employed under the management’s responsibility, even though for senior members, such as department heads in the IMF or vice-presidents in the WB, major shareholders are informally involved in the process and, in general, management tries to maintain a nationality balance in the staff. 3 James (1996) emphasizes the acceptance of limitations to sovereignty on foreign exchange and macroeconomic policy as the key innovation of the Bretton Woods system. In the 1920s, the League of Nations granted loans, subject to conditionality, to some Central and Eastern European countries in financial distress. Political developments that led to World War II limited the scope of these interventions, the relevance of which has however been reassessed by Decorzant and Flores (2012). 4 Yago et al. (2015), however, warn not to overdo it with an IMF-centric view of global governance: “Although very important, the IMF was just one of the actors in the post-war international financial order” (p. ix). 5 The IMF never formally defined the notion of “fundamental disequilibrium”, with the obvious scope for policy (and political) interpretations that this afforded. 6 At the time, the US had the largest international credit position in the world, which, in the following decades, turned into the largest debit position. Over time, the US views on the onus of adjustment that surplus countries should bear changed accordingly, irrespective of the fact that the function of the dollar as the key reserve currency grants the US a special status in the adjustment process of external imbalances. 7 Steil (2013) emphasizes this aspect. 8 An initial draft of the White plan also provided for the use of an international numeraire, the unitas, which however was never thought to become a fully fledged currency; for more details, Bordo and Schwartz (2001). 9 The Articles of Agreement allow the IMF to tap international markets directly by issuing bonds like the WB and other IFIs do. Yet major shareholders, starting with the US, have always been afraid that this would give undesirable leeway to the IMF and have never given their permission, so that in practice, the IMF can only borrow from treasuries and central banks. Throughout its history, the IMF has periodically tried to obtain the green light to borrow from private sources, always without success. Indeed, when the issue of IMF resources became urgent in 2009, the staff, considering various options, had to admit that “private sector borrowing would raise a broader range of policy, financial and legal issues . . . which could limit the immediate utility of this option in addressing the current crisis” (IMF, 2009, p. 19). 10 The variables in the formula were: national income, reserves, external trade, and fluctuation of exports. 11 According to Mikesell (1994), who was directly involved in the negotiations, the final decision was made directly by the US president. 12 Broz and Hawes (2006) and Wolff (2013), for example. 13 This clearly emerges even in the official histories of the IMF: De Vries (1986) and Boughton (2001). 14 As one can expect, they take the name from the Articles of Agreement, the treaty that established the IMF and stipulates its surveillance function in its fourth article. 15 Williamson (1990, 1993). The significance and evolution of the Washington Consensus is discussed later in this chapter.

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16 After a thorough examination of the IMF recruitment records, Momani (2005, p. 283), notes that “despite the executive board’s calls for greater diversity of the Fund staff economists’ educational backgrounds, there were no calls per se for alternative economic policy prescriptions”. 17 Woods (2006). 18 Noteworthy analyses of IFIs’ behaviour based on the theory of bureaucracies include Vaubel (1986), Easterly (2002), Vaubel (2004), Copelovitch (2010). 19 In addition to high salaries and fringe benefits, the IFIs’ double standard of insisting that countries introduce draconian pension reforms while themselves granting profligate pension benefits to their own staff is notorious. 20 For example, the Bundesbank is the holder of the IMF shares of Germany. The institution formally holding the IMF shares is generally immaterial. In certain critical times, however, it can make a difference, as, for example, in the case of the idea, informally discussed at the margins of the G20 summit in Cannes, of pooling the SDRs of the euro-area countries as a measure to buttress confidence in the face of the European sovereign debt crisis. The Bundesbank, in its institutional independence, was fiercely opposed and blocked it, irrespective of the government’s views – at least so the German government said. 21 From the titles of the papers by Krueger (1998) and Helleiner and Momani (2007), respectively. 22 For example, Mishkin (1999). 23 Allegret and Dulbecco (2007). 24 Wolfensohn (1998, p. 4). 25 Meltzer (2000). The commission’s mandate also included the analysis of the World Trade Organization and the Bank for International Settlements. 26 Vreeland (2006). 27 In spite of the general surge, many countries still held insufficient foreign exchange reserves, for example in Central America (Magnusson Bernard, 2011). Moreover, evidence suggests that higher reserve accumulations before the crisis are associated with better post-crisis growth performance (Dominguez et al., 2012). 28 The attractiveness of this solution also stemmed from the fact that, in the IMF balance sheet, gold still had the original book value of US$35 per ounce, some twenty times lower than the market price prevailing in 2007. 29 The plans for staff reductions came to a halt with the crisis. However, the sale of gold reserves went ahead, reducing the dependence of the IMF’s income upon loan business (the board passed a resolution to this effect) and strengthening its capacity to provide concessional finance to low-income countries. 30 Much to the irritation of the lawmakers, secretary Paulson added: “if you’re not used to thinking about these issues, it seems counterintuitive”, as reported by the Wall Street Journal Blog, http://blogs.wsj.com/economics/2008/09/24/paulsons-bazooka-aweapon-to-be-remembered/. 31 The signatories of the GAB launched an informal body of international financial cooperation, the G10, which played an important role in global governance until the creation of the G7. Afterwards, G10 activities were mostly confined to central bank cooperation, until the establishment of the G20, which led to an unavoidable petering out. The G10 legacy still remains in the country composition of several international fora, still active, such as the Working Part n. 3 (WP3) of the OECD or the Bellagio Group. 32 For example, defining the procedure for the activation of the Arrangements proved quite difficult. 33 All quotations in this section are from the London summit communiqué. 34 The London summit also urged members to finalize the process of approval for a selective allocation of SDRs, decided in 1997, in order to increase the SDR endowment of countries that had joined the IMF after previous SDR general allocations. This required an amendment to the Articles of Agreement (the fourth).

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35 Strictly speaking, there exists a mechanism, acting as a backstop to the failure of voluntary arrangements, whereby the IMF can designate members with a sufficiently strong external position to buy SDRs with freely usable currencies up to countryspecific thresholds. The low limits of the designation mechanism, however, make it relevant only in rare circumstances. 36 Precautionary facilities consisted of credit lines which, once granted by the IMF on the basis of due diligence on the country’s solidity, could be activated without any (further) conditionality. The Contingent Credit Line was the first facility to be established with an explicit precautionary purpose. As it received no application, its technical features (most notably, conditions for access and eligible amounts) were changed several times until in 2008 it was discontinued and replaced by a new facility: the Flexible Credit Line. 37 The capital of the WB was increased too. 38 Cooper et al. (2000, p. 3). The IMF Articles of Agreement provide for a review of the quotas every five years. 39 More precisely, this procedure reduces the dispersion of quota shares without altering the ranking. 40 The long-standing over-representation of Russia and Saudi Arabia is one of the most conspicuous examples. 41 For example, the definition of “dynamic” had to be tweaked to ensure that India could be part of the group. 42 It may be worth recalling that, arithmetically, an increase in quotas dilutes the rebalancing effect of basic votes on the relative voting power of countries with the smallest quota shares. 43 Bryant (2010) and Truman (2013) are two examples, although they can hardly be regarded as outsiders from official circles. 44 The relevant part of the communiqué of the Pittsburgh summit reads: “we [G-20 leaders] are committed to a shift in quota shares to dynamic emerging market and developing countries of at least 5 per cent from over-represented to underrepresented countries using the current IMF quota formula as the basis to work from. We are also committed to protecting the voting share of the poorest in the IMF”. 45 The relevant part of the communiqué of the Toronto summit reads: “we [G-20 leaders] call for an acceleration of the substantial work still needed for the IMF to complete the quota reform by the Seoul summit”. 46 The accompanying reduction in the NAB commitments was in line with the expansion of the IMF resources decided at the London summit and the objective to maintain the IMF as a quota-based institution. 47 The specific details are described in IMF (2010, 2012a, 2012b) and, in a more digestible form, in Truman (2013). 48 Some authors, however, argued that the shift in power towards emerging market economies had been far too small, for example Malkin and Momani (2011) and Vestergaard and Wade (2012). 49 Truman (2013, p. 1) precisely explains the budgetary implications in the US and argues that the approval of the IMF reform involves “zero true cost to the US taxpayer”. 50 For example, Lachman (2015). 51 Reported for example in www.business-standard.com/article/pti-stories/imf-chief-pro mises-belly-dance-if-us-endorses-reforms-114101000085_1.html. 52 The text of the bill (US Congress, 2015) specifies that the Committees on Appropriations and Foreign Relations of the Senate and the Committees on Appropriations and Financial Services of the House of Representatives should be consulted. 53 In his testimony to Congress, Taylor (2015) presents the arguments against the systemic clause. His personal involvement, strength of his academic credibility, and experience as Treasury undersecretary for international affairs in the Bush administration, was decisive to convince Republican lawmakers to ratify the reform on the

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condition that the systemic clause be abolished. It may be worth recalling that the “exceptional access” policy still in force in any case provides for the granting of very large loans if the country’s debt sustainability is ensured. The communiqué of the Brisbane summit reads: “we [G-20 leaders] urge the United States to ratify [the 2010 IMF reform]. If this does not happen by year-end, we ask the IMF to build on its existing work and stand ready with options for next steps”. Anyway this was a political signal rather than a credible threat. Short of changes in the Articles of Agreement, which would have required the approval of the US Congress in any case, the only meaningful next step was an ad hoc quota increase by the other countries bringing forward some of the rebalancing of the 2010 reform. In order to produce the same changes in relative quotas as those provided by the 2010 reform, the rebalancing through this very laborious process would have required a reduction in the absolute value of the existing size of the US quota, again conditional on Congress approval. Constituencies consisting of more than seven countries. The Articles of Agreement provide for twenty seats; the enlargement to twenty-four is voted by the board every two years, just before its renewal. Although the US, the UK, Germany, France, and Japan had the right to appoint an executive director, it should be recalled that China, Russia, and Saudi Arabia systematically elected one representing their country only. Given the distribution of voting power, in principle multi-country coalitions could have formed to avoid this privilege by forcing a situation in which all elected executive directors represented more than one country. This possibility was never considered in practice, confirming the importance of political considerations underpinning representation on the IMF board. Peretz (2008). In chronological order: Youssef Boutros Ghali (Egypt), Tharman Shanmugaratnam (Singapore), Augustin Carstens (Mexico), and Lesetja Kganyago (South Africa). Impressive statistics on the increase in IMF staff from emerging countries, particularly from Asia, can be found in the Report on Diversity and Inclusion the IMF publishes each year. On the appointment of a Chinese national as deputy managing director, and more generally on the influence of China, see Momani (2015). The relevant public information notice, available at www.imf.org/external/np/sec/ pn/2007/pn0797.htm, is quite explicit. See also Momani and English (2014). See, for example, Woods (2006). Copelovitch (2010) and Breen (2013) offer a valiant attempt to provide quantitative evidence on the influence exerted by a group of countries on IMF decisions. The quotation is from Williamson (2002, p. 1). Williamson (2004) describes the origin and intended meaning of the phrase as well as the subsequent interpretations, which he has never shared. The Washington Consensus was “not the righteous assertion of conservative economics, but rather a warning that populist policies do ultimately fail; and when they fail . . . it is always at a frightening cost to the very groups they were supposed to favour”, as Dornbush and Edwards (1991, p. 9), put it. Rodrik (2006). Burki and Perry (1998) also stress the importance of institutional aspects for the success of IFIs’ policies. For example, Gabor (2010, 2011), Loxley (2011), Güven (2012). Ban and Blyth (2013), as well as the other papers in the special issue of the Review of International Political Economy, instead argue that emerging market countries promoted “institutional and ideational hybrids” to adapt the IMF orthodoxy to the specificities of domestic contexts, starting with their own. For example, Blanchard et al. (2010) on countercyclical fiscal policy; Grabel (2011), Ostry (2012), Chamon and Garcia (2016), Blanchard (2016), Ghosh et al. (2018) on capital controls. Güven (2012) forcefully argues this case. Oatley and Winecoff (2014).

4 MULTILATERAL DEVELOPMENT BANKS IN FASHION AGAIN

“One meeting in New York [at the UN headquarters] each year is a red line for us”, said the G77 representative in the most crowded drafting session for a communiqué this author has ever attended. This dry statement was the kiss of death to the compromise that the Like Minded (i.e. advanced) countries put forward about the frequency and venue of the meetings of the Committee of Experts on International Cooperation in Tax Matters – a body of experts reporting to the United Nations (UN) Economic and Social Council, the relevance and effectiveness of which are commented upon in very politically incorrect terms in (advanced countries’) official financial circles. The Ethiopian presidency ensured an agreement on the text, omitting any reference to this controversy and papering over many other divisive issues, which continue to be discussed to date, even in terms of process. These events took place in July 2015 in Addis Ababa, at the third international conference on financing for development, which prepared the conference that on the following September, at the margins of the UN General Assembly, would set the strategy for development policies for the following fifteen years.1 Like the other two development financing conferences, the Addis gathering drew a copious participation, resulting from both the large number of national delegations2 and the multiplicity of stakeholders involved: from MDBs to “civil society”, a magmatic conglomeration of actors, with disparate objectives and attitudes, and more or less tenuous links to governments.3 In the official sector, too, representation was variegated, with participants from finance ministries, development agencies, and diplomatic corps.4 Even this cursory list of participants is sufficient to illustrate the intricate interaction of broad-ranging visions and the complex overlap of institutional powers that forge the development discourse and shape the traditionally neglected role of MDBs in global governance. Indeed, on development policies, the official

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lines of reporting and command are notoriously entangled, with many institutional actors that have intersecting but distinct prerogatives, competencies, and interests. This situation fuels the perennial confrontation between two different visions of development. The consensus that the expansion of economic activity is the key driver to defeating poverty and disease – since “growth, like tide, lifts all the boats” – masks two diverse views on the key triggers of economic growth and the attending policy priorities. One view focuses on the importance of private-sector initiatives, implying that supporting infrastructure investment and light regulation have priority over interventions to immediately alleviate poverty and promote social cohesion. The other maintains that the primary objective of development policy is to take care of the weakest part of society and support institutional capacity (and democracy), as they are necessary conditions for sustainable economic activity, which is in turn a precondition for growth to be inclusive and hence effective in overcoming poverty. These two views, in turn, underpin different approaches to the key function that MDBs are expected to perform. There is consensus that MDBs’ ultimate objective is to overcome the impediments and market failures that prevent a stable flow of resources into poor countries. One view, however, holds that this objective is best pursued if the MDBs are providers of affordable finance for large infrastructure projects, indispensable to private-sector-led economic growth, as well as facilitators of international integration in trade and finance. The other view, instead, is that MDBs should be mainly the granters of cheap, possibly concessional, finance and technical assistance to projects improving life conditions of the most vulnerable and sustaining the institutional framework, which are prerequisites for a balanced and inclusive economic growth. In reality, the two approaches are not necessarily at odds, since “ending extreme poverty and boosting shared prosperity are Twin Goals” as the World Bank (WB) put it,5 and throughout their history MDBs have been guided, with varying intensity, by both. Still, it is a useful characterization for understanding how MDBs’ policies and their role in global governance have evolved across time and space. Moreover, it helps our understanding of the reasons for the ambiguity in the MDBs’ attitude, which has resurfaced time and again. MDBs have been both energetic globalizers, aligned with the IMF in spreading and enforcing the orthodoxy of the liberal order (grants and concessional financing also come with strings attached), and active promoters of dissent from the Washington Consensus, as epitomized by the open dispute between the WB and the IMF in 1998. The uneasy coexistence of differing views on development and the attendant visions on the function of MDBs in global governance has always been a defining feature of their modus operandi. Indeed, the ambiguity about the WB’s fundamental mission marked its very establishment at Bretton Woods and extended to the many other MDBs that over the years have been set up in all continents, with regional and a sub-regional focus. The proliferation continues to date and is proof of the success of the MDB business model, notwithstanding the unrelenting criticism by many economists who consider them an unwarranted interference with markets.

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In the late 1990s and early 2000s, MDBs, and especially the WB, suffered from the malaise discussed in the previous chapter. Their role was radically questioned, both as sources of loans in a world of abundant finance and as champions of development policies whose appropriateness came under a crossfire of criticism from different sources and perspectives in conjunction with a radical rethinking of aid flows. The WB influence on policy making in middle-income countries and less-developed countries (LDCs) declined and so did the volume of its loans. The G20 London summit in April 2009 put the MDBs back at centre-stage, assigning them the task of providing essential financial flows and badly needed support to aggregate demand in a world of frozen capital mobility, imploding trade, and collapsing production. The available capacity to lend in the MDBs’ balance sheets – testimony to their flagging activity – became an expedient asset that could be immediately and heftily deployed. The London decisions were then implemented through each institution’s specific procedures under the aegis of the G20. Compared with the IMF reform, however, the process was much quicker and far less divisive, both in the G20 and at the national level. Even the debate within the US Congress was uneventful when compared with the never-ending saga about the IMF, with a quick approval of MDBs’ capital increases. The agreement in the G20 on the recapitalization and reform of MDBs should not obscure the intensity of the power struggle involving them: MDBs have been both instruments and battlefields of the change in global governance. In much the same way as the IMF reform, the WB reform provided the opportunity for a substantive transformation in the internal balance of power in favour of emerging economies, in terms of an increase in both their voting rights and their influence on daily working practices. In the field of the MDBs, emerging economies went further in their defiant challenge to the status quo and controversially set up two new institutions: the New Development Bank and the Asian Infrastructure Investment Bank. The participation of many advanced countries in the capital of the latter is a particularly significant indication of the rebalance in global power. Both the US and Japan tried very hard to boycott the initiative, putting pressure on the other G7 and advanced countries not to join the new institution. They miserably failed, as advanced countries, after some hesitation, resolved to pursue their immediate interest by demonstrating their openness to dialogue with China about the transformation of global economic governance. The establishment of MDBs remains as intertwined with the evolution in international financial architecture as it was in Bretton Woods, to which it may be useful to return briefly in order to appreciate MDBs’ role in global governance.

The birth of the MDB business model Through its support of economic development, the WB would have the task of targeting equity in an ideal world, where international institutions are created to pursue, at a global level, the three objectives of government intervention in the

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economy that Musgrave famously rationalized: stability, equity, and efficiency.6 Real-world agencies hardly ever adhere to such a tidy allocation of tasks, and it certainly was not intended for them to do so by delegates at the Bretton Woods conference. The establishment of the International Bank for Reconstruction and Development (IBRD) – or WB, as it came to be known – was meant to pursue the same objectives assigned to the IMF: promoting international stability and the expansion of trade. The instruments were different, as the WB financed specific projects with resources borrowed in the market while the IMF lent to governments using its own funds, but both shared the same strategic function in a world with acute scarcity in international means of payment. And both were meant to be pillars of the new global financial architecture. The issue of international development – and more broadly, the compatibility of the new financial order with the aspirations of poorer countries – did not feature prominently in the definition of the IMF and WB mandates. The attention paid to development by the WB in large part resulted from the need to refocus the priorities of its actions when, soon after its foundation, the US government launched the Marshall Plan.7 Indeed, the field trip to Colombia – arranged in April 1948 by the second WB president, John McCloy – led to a comprehensive report on the growth prospects of the country, and stands as the symbolic beginning of the (initially self-assigned) global development mission of the WB.8 This view has recently been challenged:9 Bretton Woods preparations saw the active participation of delegates from India, China, Brazil, and other Latin American countries, who stressed the importance of global development goals and put forward proposals to this end. Although these suggestions are neglected in mainstream analyses of Bretton Woods,10 they had some bearing on the final outcome and marked an important precedent to future debates. They made the international financial architecture more development friendly than it would have been otherwise, inserting a development gene into the DNA of both the IMF and the WB. The WB has never had full monopoly of development issues, even in Washington, notwithstanding its undisputed intellectual leadership in this area, which it has built over the years thanks to an unrivalled reservoir of development experts on its payroll. The IMF has always maintained an active interest in assuming responsibilities in the setting of development policies,11 while perfecting its own financing instruments dedicated to poor countries.12 The fuzziness in the division of labour between the two institutions has worked in the other direction too. The WB has systematically provided its financial support to IMF-led rescue packages (including during the 2008 crisis) and its analytical input into defining the conditions attached to financing. The tensions and inconsistencies in policy advice that resulted from the turf wars between the staff of the Bretton Woods twins on conditionality, and more generally on medium-term growth strategies, are a legend in the official international community.

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The need for a more precise mutual understanding about the allocation of responsibilities and procedures for practical coordination very soon became apparent.13 In 1966, the IMF and the WB agreed on the first formal concordat, which was revised countless times over the years. These bottom-up efforts for more effective cooperation received a further boost from the establishment in 1974 of the Development Committee14 – a joint ministerial meeting of IMF and WB boards which regularly meets twice a year as a part of the spring and annual meetings and remains the key high-level international forum on development issues. The blurred borders among the responsibilities of the WB go hand-in-hand with more fundamental ambiguities that have always marked the evolving views on the most effective polices for supporting growth and on the role of the measures specifically addressed towards poverty eradication. Conflicting opinions and ambivalent sentiments on the importance to be attached to the fight against poverty in development strategies are reflected in the perennial debate on the kinds of investments that deserve priority; they underpin the contrasting visions, evoked in the Introduction to this chapter, of the MDBs’ key function. These tensions were present in Bretton Woods negotiations, became immediately apparent in the functioning of the WB and have since marked the life of every single MDB subsequently established. The precise mandate of the WB might not have been fully clear or universally agreed upon, but its establishment was a remarkable innovation from an institutional point of view. A brand new model of international financial institution was launched and proved successful, as shown by its diffusion: several MDBs have since been founded, with the latest in 2015 at the initiative of emerging countries. The strength and resilience of the MDB business model stems from its simplicity, coupled with its capacity to offer an efficient use of its members’ resources. Member states subscribe MDB capital and typically only pay in a small proportion of the amount, while committing, through appropriate legislation, to confer the rest on demand by the MDB, should the need arise. The paid-in capital and this commitment15 allow MDBs to tap international financial markets at the conditions granted to the most creditworthy borrowers, which are better, often much better, than those faced by most MDBs’ members, in particular middle-income and poor countries (assuming that they do have access to international financial markets). In contrast to private financial intermediaries, MDBs’ capital need not be remunerated from a financial point of view, so that the margin between the interest rate they charge to their borrowers and the one they pay to their bond holders can only serve to cover running costs.16 This creates a situation that marketing pundits would rejoice in calling win-win: on the one hand, borrowers have access to cheap credit, provided the projects are eligible (which in turn depends on a combination of micro and macro conditions set by the MDB); on the other hand, advanced countries can promote (and steer) the development of borrowing countries with an efficient use of their resources, which are leveraged through financial markets.

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The sustainability of this business model obviously requires that loans be repaid, notwithstanding the fact that the MBDs’ mandate entails lending to countries that are particularly risky.17 The quality of the projects financed and their alignment with the borrowing governments’ priorities help to ensure repayment, but they would certainly not be enough when political upheavals or severe financial crises lead to sovereign default. This is the time when the special nature of the MDBs and, of course, of the IMF too, comes into play with their “preferred creditor status” – i.e. the practice of loans granted by the IFIs always being paid back in full even in cases when a country defaults on its sovereign obligations. The “preferred creditor status” is an essential component of the MDBs’ business model as it allows them to tap capital markets in a cheaper manner than they would do otherwise, benefitting their borrowers and shareholders alike.18 This is the reason why, even though the principle has no formal legal foundation, it has been defended at all costs: by exerting political pressure on sovereign borrowers to pay back; by extending arrears for a very long time (Cambodia’s arrears to the IMF lasted from 1975 to 1992, for example); even by having advanced countries repaying the debt of poor countries, as in the debt-relief initiatives of 1999 and 2005 promoted by the G7.19 Perfected over the years with the affirmation of the preferred creditor status, the MDB business model introduced at Bretton Woods provided an important new component to the international financial architecture, particularly attractive because of its flexibility. Its capability to provide inexpensive finance has been directed at pursuing a wide range of objectives: to address market failures hindering infrastructural investment necessary for development; to promote policies to alleviate poverty; to facilitate the integration of countries in the global economic system; to join forces with the IMF in coping with financial crises; to assist, as critics and detractors would add, the power games of the US and their allies; and to allow an international bureaucracy20 to be more numerous and better paid than necessary. WB operations in the late 1940s and 1950s provided confirmation that the MDB business model could indeed work in practice. This success prompted its refinement and diffusion such that its potential in both size and scope could be better exploited.

More development (and more MDBs) in global architecture In the 1960s, the MDB business model blossomed against the backdrop of the growing attention given in world politics, and in particular in the UN fora, to the issue of development, with the attendant notion of an imperative need for significant resource transfers from the “North” to the “South”. The process of decolonization, the tensions between the communist bloc and the western world, and the growth of the non-aligned movement are the major political forces that conditioned both the WB and the new MDBs that were established in these years. Unsurprisingly, it was the WB that took the lead in introducing two major changes in the MDB business model, both of which would become part and

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parcel of the model itself. Equally unsurprisingly, considering the predominance of the US at the time, the innovations followed proposals originating in the US. In 1956, the International Financial Corporation was set up as a facility explicitly dedicated to financing private sector, for-profit projects fostering development.21 The extension of the MDB model to the private sector responded to the need to relax the constraints that a limited fiscal space could pose to much-wanted capital inflows, as well as to the US desire to affirm the essential role of the private sector in development. In 1960, yet another branch was added to the WB,22 following a debate in the US Congress which led to the approval of the Monroney Resolution, named for the senator who, together with the WB president, had advanced the idea of a soft loan fund offering very long-term, inexpensive loans to poor countries. The International Development Agency (IDA) was created to meet the exigencies of the countries unable to afford even the low interest rates and convenient repayment schedule of standard WB loans, by offering very advantageous terms, such as long grace periods and a zero interest rate. Notwithstanding the gift element of IDA soft loans, they remained loans, not grants (always a minor proportion of IDA financing), providing better scope for the conditionality and monitoring that were the indispensable pillars of the functioning of the Bretton Woods institutions. Yet, at the same time, the subsidy component resonated very well with the notion of a transfer of resources, both financial and technical. Former colonies and a growing part of public opinion in the advanced countries viewed this transfer as an essential lubricant of decolonization, then a prominent feature of the development debate. They also entertained the idea that, like the Marshall plan, aid could be an antidote to the spreading of communism. LDCs23 obviously welcomed the IDA and the burgeoning vocation of the WB as a provider of technical assistance. However, they felt that the WB was too close to the interests of (former) colonial powers and not sensitive enough to their needs, in terms of both immediate relief to the poor and promotion of an economic model not based on commodity exports. For these reasons, they pursued two other routes: the first, insisting that the debate on development be held in UN fora, to stress its link to broader political issues; the second, establishing “their own” regional MDBs. LDCs felt their needs and views squeezed by the contraposition of eastern and western blocs, and reacted by founding the Non-Aligned Movement at the Belgrade summit in 1960.24 The Movement was the origin of further initiatives to give LDCs more “voice”25 in global governance. Two of them are the most notable: the G77, a group which is still very active, as we have seen in the episode at the Addis conference that opens this chapter;26 and the G24,27 which has had an observer status at both the IMFC and the G20 since their respective inceptions. Retracing the fascinating history of the Non-Aligned Movement and these groups would lead us astray.28 However, it is important to bear in mind that their

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long tradition of radical criticism of the dominant economic paradigm underpinning the liberal order has provided an important source of inspiration for the role of MDBs in the current rebalancing of global governance in favour of emerging economies. The establishment of new MDBs, one on each continent, was motivated primarily by the desire to exploit the effectiveness of the MDB model in service of specific aspirations of the region, bypassing the bias perceived to be coming from the balance of power within the WB. Each MDB reflected the political equilibrium of the respective continent in a different way. They all shared the same feature of connecting the promotion of regional development objectives to the broader political issues that surround development policies and intersect with global governance. The start of regional MDBs was slow and in some cases quite problematic, but over the years, they have experienced a remarkable growth, so that now the size of their balance sheet is at least of the same scale as the WB loans in the corresponding continent.29 For obvious economic reasons, Europe was the first continent to establish a regional MDB. Following the signature of the Treaty of Rome, which launched the process of European integration, the European Investment Bank30 (EIB) was founded with the purpose of accelerating investment to support economic growth. By the Treaty, its shareholders always coincided with the members of the European Community, which then enlarged and became the European Union.31 In terms of the expansion of its balance sheet and, until the eruption of the European sovereign crisis, limited controversy over its policies, the EIB has been the top achiever among its peers and is now the largest MDB in the world. In 1959, the Inter-American Development Bank (IADB) was the second regional MDB to be established. It was founded in the wake of a very long tradition of commercial and financial cooperation (the first Pan-American conference was held in Washington in 1890), which the US has always promoted and overseen to buttress its hegemony in the region. Given this background, it is not surprising that the US agreed to be the largest shareholder, with nearly one-third of the capital, but to leave both presidents and the majority in the hands of borrowing countries. Membership, initially restricted to the American continents, was open to non-regional countries in 1976, as an instrument to attract foreign investment. A first wave of non-regional members entered immediately,32 others countries over the years. Most notably, China joined in 2009 – a further testimony both to China’s determination to spread its influence and the role that MBDs have played in this strategy. The political impulse for an African Development Bank (AfDB) originated in the United Nations Economic Commission for Africa, which was the key forum African countries chose to seek empowerment in the political process of decolonization, in order to promote the Pan-African movement and advocate a model of development not hinging on the relations with former colonizers. The AfDB was founded in 1964 by African countries only, with the radical mission of

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championing an “African way” to development. The exclusion of non-regional members led to insufficient capital, both financial and human. The AfDB could only operate on a negligible scale and did not elaborate any of the innovative strategies that had motivated its foundation. In 1982, the Bank charter was amended to allow non-regional participation, while maintaining African leadership and focus. The fresh resources that followed did not improve the situation, which continued to deteriorate as the bank was lacerated by harsh internal fighting reflecting inter-African tensions and the crash of the Pan-African project. The AfDB was eventually on the verge of collapse.33 It was only the public outrage voiced in international media that led to drastic reform under the leadership of President Kabbaj. With the launch of the New Partnership for Africa’s Development in 2000 and the renewed African ownership it promoted, the mission of the AfDB was modernized and its action became more focused. In 1966 the Asian Development Bank (AsDB) was launched on a continent divided into two blocs clashing in the Vietnam War. Following the directives of its major shareholders, Japan and the US, the AsDB stayed studiously clear of that conflict and the subsequent political tensions, and pursued an explicit strategy of regional economic integration under the leadership of Japan.34 This approach was tacitly accepted: all countries in the region, as well as many European countries, joined the bank at its inception – only China delayed its participation until 1986. Over the years, Japan further increased its contribution and influence in the AsDB, albeit without demanding stronger voting rights. The other regional powers acquiesced and never sought a prominent role within the organization, as tellingly indicated by the fact that Bangladesh and Pakistan were the main beneficiaries of the concessional arm of the AsDB even though the vast majority of poor people on the continent lived in India and China. After the breaking up of the Soviet Union, its Asian Republics, such as Azerbaijan and Kazakhstan, hastened to join the AsDB, which readily extended its well-established approach to the new members. Moulded by decades of benevolent but determined Japanese rule, the AsDB was ill suited to accommodating China’s ambition to have an MDB supporting its economic expansion. This provided yet another reason for the foundation of a brand new regional MDB in Asia. Even these sketchy descriptions of the regional MDBs are sufficient to convey the diverse roles they played on the different continents, particularly in relation to the evolution in regional politics, which has offered varying scope across time and space for using the MDB business model so as to provide an impulse to economic development. With the exception of the EIB, however, they all share a common feature: they have acted as an interface between the globalizing mission of the Washington-based IFIs and local politics, in particular with regard to the objectives of regional integration and the investment priorities of borrowing countries.

Defending and enriching the mainstream view of development The yearly flow of total Official Development Aid (ODA) can be considered a rough but telling indicator of the importance attached to development issues in

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world politics and public opinion in rich countries. Its rapid growth in the 1970s and acceleration in the 1980s ostensibly point to the persistence of the trend that sustained the diffusion of the MDB business model – indeed, that trend continued uninterrupted until the early 1990s, when global ODA declined in relation to the demise of the communist bloc. Although the bulk of ODA was, and remains, bilateral (that is, from a donor country directly to a recipient country), the increase in WB disbursements was equally rapid, in both non-concessional loans and IDA (the WB soft window) finance. The ascent of the WB as the hub of the world development community was even more remarkable than the enlargement of its balance sheet. Many aspects underpinned this rise: the broadening of the sectors where the WB could offer competent technical assistance; the expansion of its network of resident missions; the increasing attention paid to development strategies and poverty alleviation in IMF-WB programmes; the promotion of global public goods; the proliferation of trust funds conferred to the WB in the pursuit of specific objectives. The special role of the WB in the development debate and global economic governance, however, did not only originate from its technical proficiency, which came from its hands-on involvement in projects and policies that have remained unrivalled for scope and geographical diversity. It was also the result of the task the WB courageously and doggedly embraced: responding, from an intellectual point of view, to all critiques of the mainstream approach to development issues embedded in the post-war liberal order. Whereas a widespread critique to the Washington Consensus had to await the experience of the Asian crisis in the late 1990s, radical dissent from the conventional wisdom about development was voiced much earlier. It basically took two major avenues: defying the liberal order itself and challenging the effectiveness of development aid and policies. On both fronts, the WB played a key role in organizing advanced countries’ reactions, both through its direct contribution in terms of ideas and policy proposals, which often took on board some of the critical remarks, and through the mediation of the related contrasts in the meetings it hosted, most notably in the Development Committee. Starting with the New Delhi conference in 1968, the New International Economic Order has been the policy platform that LDCs put forward in the UN, and in particular in the United Nations Conference on Trade and Development, to challenge the arrangements of the liberal order, viewed as harmful to their legitimate development objectives. In particular, it advocated a stronger control of LDCs’ natural resources, including through the expropriation of multinational companies and a more balanced tariff system to improve their terms of trade. The WB and the advanced countries could not possibly find an encompassing compromise with such radical views,35 especially in a context where US foreign policy interests and sensitivities were exacerbated by the Vietnam War and, later, by the turmoil following the inconvertibility of the dollar and the oil shock. Yet, while scrupulously respecting the most stringent political red lines of the US, the

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WB relentlessly explored openings, technical solutions, and policy approaches that could somewhat accommodate the LDCs’ demands. The WB did not shy away from a protracted tussle with the US administration and Congress, which on numerous occasions and in high-profile hearings complained about the insufficient accountability of WB – the US way of putting it when the WB was felt not to toe their line. A significant example is the so-called pro-rata rule, which was introduced in the 6th replenishment of IDA (1980) with the unconcealed support of the WB management. It gave each IDA donor the faculty to retard the disbursement of their contribution in proportion to the other donors’ actual payments with the purpose of responding to the US strategy of systematically delaying the payment of their contributions in order to put pressure on the WB.36 Over the years, radical critiques of the mainstream model of development progressively tended to focus more on environmental concerns and the protection of the rights of people directly affected by development projects and policies. An increasing proportion of the developed world’s public opinion expressed its support for these causes through NGOs. On this front too, the WB played a leading role in establishing a dialogue, searching for compromises and remedies, addressing specific cases, and establishing permanent corrective mechanisms. The protests over environmental damage, violated human rights, and corruption connected to the huge Yacyretá dam in Argentina and Paraguay attracted worldwide attention and support, leading the WB37 to taking corrective action and, in 1993, establishing the Inspection Panel. The latter is an independent complaints mechanism directly open to people who believe they have been damaged by projects financed by the WB and was a path-breaking innovation in international law.38 As a broader response to the concerns about its operations, the WB strengthened the independence and scope of action of its evaluation unit, originally created in 1970,39 which now covers the whole WB Group under the name of Independent Evaluation Group. More generally, the WB took important actions to enhance its transparency, accountability, and involvement with a broad spectrum of stakeholders.40 Irrespective of whether these measures are judged appropriate and sufficient, it was the WB which marshalled the intellectual resources and put forward concrete action and policies to react to the critique of the mainstream development approach in a constructive way. Performing this self-assigned task gave the WB a central role in global governance well beyond the one warranted by the size of its balance sheet. For their part, regional MDBs failed to deliver on the mission that was one of the reasons why they were established in the first place: elaborating an alternative model of development which radically challenged the global hegemony of the US and its collusion with the interests of former colonial powers and multinational companies. Like the unhappy families in the opening lines of Anna Karenina, each MDB had its own reasons for being unable to succeed in this important aspect of its original mandate, while nonetheless achieving others. However, the idea that

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an MDB was necessary, or at least could help, to advance a “different” approach to development was not forgotten: it would resurface again, promoted by the BRICS.

More than affordable finance The key role of the WB in global governance stemmed also from its intellectual leadership in responding to the other major line of critique to the mainstream model of development: the challenge to the effectiveness of aid. Projects in support of direct poverty relief (such as the provision of water) and, more generally, economic growth (such as energy infrastructure), yielded conspicuous benefits, improving the life conditions of millions of people. In spite of this, it became apparent fairly soon that the correlation between the volume of aid (and MDBs’ financed projects) and the growth of per capita income was at best tenuous, most likely inconsequential, and possibly perverse, as some41 would argue at a later stage. This discomforting evidence was initially put to the fore as the “micro-macro paradox”42 and then confirmed by a large body of empirical investigations, as reviews and meta-analyses of these studies have disappointingly shown.43 More poignantly, one can flag the example of Kenya and South Korea. In the 1950s, Kenya’s per capita income was higher than South Korea’s, whereas now it is only a twentieth, despite the fact that over the years, Kenya has received a large multiple of the development aid that went to South Korea in both absolute and per capita terms. Accompanying conditions proved crucial to determine aid effectiveness, in particular peace and the rule of law, providing an overarching rationale for the dismal persistence of aid ineffectiveness in Africa and leading to increased aid efforts in capacity building.44 The establishment of the working group on aid effectiveness by the Development Committee in 1984 marked the beginning of the institutional response to these disquieting findings. Countless initiatives would then follow to define best practices, hone monitoring tools, improve donors’ coordination, and foster recipient countries’ ownership of aid and development policies.45 Once more, the WB was at the forefront of the debate on improving aid effectiveness, which became one of the recurrent themes surrounding IDA replenishments. The WB increasingly asserted its role in world development policy and global governance not through its financial impact but through its analytical stature on development issues and its capacity to connect the G7-based policy debate to the UN processes, where the LDCs felt more at ease in advocating their aspirations. Wolfensohn’s arrival at the helm of the WB in 1995 accentuated this trend. The WB rebranded itself as the “knowledge bank” and started to distance itself more openly from the Washington Consensus. The “non-financial” profile of the WB was further raised by its active involvement in both the definition and the pursuit of the Millennium Development Goals (MDGs). Solemnly adopted in September 2000 at the special UN Millennium summit, the MDGs catalysed the renewed attention paid in world

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politics to development issues: the global amount of ODA returned to expand rapidly, after the stagnation of the 1990s, while rock stars Bono and Geldof showed up at G8 summits to advocate ever additional aid pledges.46 The precise definition of the MDGs47 allowed a reliable monitoring of the progress towards their attainment and provided additional momentum to increase accountability of development policies. Again it was the WB that had a proactive role in promoting initiatives to respond to the demands of civil society and NGOs – which, by the way, were themselves attacked by some for pursuing their own notoriety agenda and hurting those they pretended to defend.48 Another important dimension of the WB’s special role in global governance is its success as “globalizer”, to use the sobriquet coined by Ngaire Woods.49 Indeed, the WB effectively promoted the adoption of policies that were crucial to integrating many developing and middle-income nations in global trade and investment flows. This influence came from both loans (typically with some form of conditionality attached50) and policy advice, combined with technical assistance, support for capacity building, and input to institutional reforms. Like the IMF, the other major globalizer, the WB was subject to harsh criticism that questioned the impartiality and usefulness of its policy advice. There is one important difference between the two, though, which stems from the WB’s longdated and painstaking efforts to bridge conflicting views on development. Notwithstanding the abundant doses of flexibility, pragmatism, and diplomatic ingenuity, the accomplishment of these efforts in providing balanced and effective policy prescriptions was hotly disputed. In any case, it provided at least a partial shelter of authoritativeness to the development mission of the WB in the difficult years before the outburst of the 2008 crisis, when IFIs’ relevance was questioned. The push towards economic and financial integration – especially through the financing of infrastructure projects and large private-sector investments in middleincome countries – is one of the fields where regional MDBs achieved important results that account for their often-neglected role in global governance. In a mix of rivalry against and cooperation with the WB, regional MDBs have both assisted its function as globalizer and acted even more successfully as “regionalizers”,51 pursuing regional integration with a wide array of initiatives. Regional MDBs supported the IFIs’ globalizing mission by helping to ease tensions between global and regional integration, and by accommodating particular investment needs that the WB was unwilling or unable to finance, while also co-financing many strategic projects with the WB itself. The combination of partnership and competition between regional MDBs and the WB marked both the financing of projects and the definition of local development policies. Building on their tighter cultural and political links with local societies and governments, regional MDBs could appreciate and pay more attention to idiosyncratic sensitivities and objectives, both on specific issues and broader strategies. For example, it was the IADB, co-lender with the WB, which was the key mediator with the local population in the major dispute, noted earlier, over the Yacyretá dam, even though the initiative to establish the Inspection Panel

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originated in the WB. It was Enrique Iglesias, president of the IADB for nearly 20 years, who put forward the notion of a “Latin American Consensus”52 as the desirable adaptation of the Washington Consensus to Latin American ways. Moreover, regional MDBs were always active supporters of all the processes of regional trade integration, as in the case of the Association of Southeast Asian Nations Free Trade Area and the Latin American Free Trade Area, just to quote two of the best-known cases. The success of MDBs as “regionalizers” often hinged on their effort to be (and/or to present themselves as being) different from the WB, while still cooperating with it. Although confused and politically ambiguous, in particular with regard to development strategies, these efforts paid off, at least from the business point of view: contrary to the WB (and the IMF), regional MDBs’ loan books continued to expand in the years before the 2008 crisis.

Malaise and revival of the MDBs The authoritativeness that the WB gained over the years as the hub of the global development debate was not sufficient to immunize it from the malaise which pervaded the IMF in the late 1990s following the Asian crisis. Some of the reasons for the widespread discontent about the IFIs and the unprecedented feebleness of their financing function were common – most notably, the presence of abundant sources of alternative financing in the private sector and the radical criticism of the Washington Consensus, with which the WB continued to be associated notwithstanding its efforts to maintain its distance from it. Others were particular to the WB and, at least in part, originated from the fact that its pivotal function in the development debate made the WB the obvious lightening rod for any radical complaint in this matter. First, the fundamental questioning of aid effectiveness continued to loom large and to taint the WB’s image, as well as to discourage loan applications, despite its efforts to respond proactively in both the policies it controlled directly and those that it influenced. Analytical studies continued to churn out results confirming the “micro-macro paradox”, while the argument gained traction that aid was intrinsically counterproductive as it distorted incentives to sustainable growth in both the private and the public sectors.53 Moreover, the excellent progress in the pursuit of MDGs, many opined, was a further challenge to aid effectiveness, since it was for the most part due to the extraordinary economic growth of China and India, which, given the size of the two countries, had lifted a large proportion of the world’s poor out of poverty. Their extraordinary economic expansion could hardly be credited to the flow of development aid or the massive financing they received from the WB – even though this circumstance would be a non-negligible factor in the negotiations for the rebalancing of power within the institution. Second, the appetite for WB loans was dampened by the specific requirements linked to project execution, especially for large infrastructures, that were typically

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added to the large-scale conditionality covering macroeconomic and development policies.54 Many potential borrowers found these conditions tediously taxing on their scarce administrative capacity, which was often already encumbered by the reporting requirements attached to aid flows. For their part, donors came to realize that their demands to improve the accountability of their transfers led to cumbersome procedures and unnecessary duplications, if not contradictory directions. The WB and the OECD led a process of coordination among donors to harmonize and streamline aid dispensation and monitoring, which achieved many important results. Yet many potential borrowers still preferred to avoid the burden linked to WB loans altogether, also given the availability of a new and convenient source of finance: Chinese banks that, since the early 2000s, had massively increased their loans to Africa. They did not require IFI-type conditionality and safeguards but rather relied on commodities, such as oil, as collateral and imposed the resort to Chinese firms for procurement – as most famously illustrated by the case of Angola, the single largest recipient of Chinese funds. Much controversy55 surrounded these developments, further fuelled by the notorious opaqueness of Chinese banks and the non-participation of China in the international exercises of data collection on development finance, such as those organized by the OECD. Concerns also arose in the G7 as the rise in Chinese lending to Africa overlapped with the two major debt cancellation initiatives56 that the G7 had launched and which were in large part financed with the objective of providing a durable debt relief in support of development. In 2007, the G7 agreed on a position paper putting forward “Principles of Responsible Lending” meant to lead by example and exert moral suasion on Chinese lending practices in Africa (although China was not even mentioned). The timid attempt to have the paper discussed within the G20 (under the presidency of South Africa) did not have any success. Your author had the misfortune of bearing the brunt of the irritation of the Chinese representatives when, at an informal G20 seminar, he flagged the idea that the topic might deserve a formal discussion by G20 deputies and then, possibly, by ministers and central bank governors. G7 countries and other G20 members preferred to devote their political capital to other controversies with China and the issue was dropped.57 China’s infrastructure financing to Africa, nourished by its desire to control the continent’s natural resources, kept on increasing and sparking dispute, although recent analyses have shown that many concerns may be unfounded.58 While not displacing the WB as the hub of the global development debate, these events led to a decline in both its yearly disbursements and influence in policy making, particularly in middle-income countries. Regional MDBs were partly sheltered from this decay in function and profile by their milder involvement in the confrontations over development policies and their capacity, due to their affinity with borrowing countries, to accommodate specific investment needs. Their loan book continued to expand, albeit at a subdued rhythm. In April 2009 the G20 London summit set in motion a profound and lasting reversal to the IFIs’ dwindling role, as the increase in their resources was one of

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the key elements of the policy response to the crisis. Whereas the IMF’s renewed importance and firing power could stem the spread of financial distress, the MDBs could offer immediate support to a shrinking aggregate demand in a situation where international capital flows were frozen and trade was collapsing. The room for manoeuvre in the MDBs’ balance sheets, which was a symptom of their fading relevance, turned into an expedient asset, as it allowed MDBs to increase their disbursements massively and promptly, as G20 leaders demanded. Their message arrived loud and clear. Perhaps too much so. While commending the quick response to the crisis (the WB doubled its loan issuance in one year), the Independent Evaluation Group’s post mortem59 lamented an insufficient selectivity, both geographical and sectorial. Rather than choosing the countries that were most in need of a boost to aggregate demand or the projects with the highest developmental impact, the WB had mostly financed projects already in the pipeline or in countries where operational relations were easier. Although indisputably accurate, this judgement does not do full justice to the palpable sense of urgency and renewed enthusiasm for their mission that pervaded the WB and the other IFIs during the crisis. Indeed, the frantic situation and the need for enhanced policy coordination led to a marked and durable improvement in the relationship between the WB and the IMF. The persistent legacy of the bitter dispute over the “right” policy interpretation of the Washington Consensus – exposed in the public confrontation at the 1998 Annual Meetings – was eventually forgotten. Cooperation on strategic matters between the Bretton Woods twins significantly strengthened, while rivalry returned to the ineradicable tugs-of-war between proud staffs of proud institutions. The relations between regional MDBs and the WB improved too. The massive expansion in business opportunities and the common mission assigned to all MDBs by the G20 leaders reduced the scope for competition, facilitating more effective relations. The G20 agreement at the London summit, however, not only commanded an immediate countercyclical support through the “full and exceptional use of [their] balance sheets” but also ordered “the reviews of the need for capital increases”. All MDBs, including those unmentioned in the communiqué, exploited this unprecedented opportunity to obtain fresh resources. The formal processes60 to augment capital were further facilitated by the circumstance that in many countries, the appropriation of the necessary funds for each MDB went to parliament for approval with a single piece of legislation. The extraordinary injection of new resources allowed MDBs not only to deploy the sizeable emergency response but also to sustain a persistent increase in their loans. After 2010, the urgency of the countercyclical mission morphed into a lasting, structural support to investment that rejuvenated the MDBs’ financing function. As discussed in Chapter 2, the joint fiscal and monetary stimulus coordinated within the G20 had avoided reproducing a Great Depression, but the recovery continued to be weak and repeatedly disappointed expectations. Wide investment gaps persisted throughout the world, severely hindering the development prospects of middle-income countries and LDCs.

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Against this backdrop, it is not surprising that the promotion of investment was one of the central themes of the G20. One presidency after another eagerly embraced it as one of its priorities, leading to the establishment of the G20 Investment and Infrastructure Working Group.61 Political reasons added to the macroeconomic rationale for the special focus on investment, especially in public communication. After the initial success in responding to the crisis, macroeconomic policy coordination was making little progress, as it was fraught with the difficulties linked to the evergreen issue of the symmetry of adjustment. For this reason, the whole G20 membership found it expedient to send a message of strong agreement on the need to reinvigorate investment as the key engine of economic growth – even though the use of public investment by surplus countries as a tool for evening out the burden of adjustment remained as contentious as ever behind the closed doors of G20 meetings. MDBs turned the page on the forlorn days of faltering business opportunities, eagerly supported G20 work on investment and came up with countless initiatives to promote investment, such as the Africa 50 Investment Fund, launched by the AfDB, or the so-called NewCo, established by the IADB. Although in 2010 the Toronto summit established the G20 Development Working Group that reported to the leaders’ sherpas,62 the key negotiations on MDBs’ capital increase, the accompanying reforms, and their evolving role in global governance did not take place there. Rather, the debate, to which we now turn, was held within the group of finance ministers. This was due to the debate’s financial implications and the fact that in many countries, the functions of shareholders in the MDBs are tasked with the ministry of finance, even when the general responsibility for development policy lies with the ministry of foreign affairs or another agency.

The reform of the MDBs As discussed in Chapter 3, the reform of international financial institutions was the inescapable prerequisite for emerging economies to agree to the increase in resources that was decided upon at the G20 London summit in April 2009. For the IMF, the quota increase and the resulting shift of voting power in favour of emerging economies were not only very difficult to negotiate within the G20 but also then took many years to come into effect because of the veto of the US Congress. For the MDBs, the capital increase and the transformation in governance were less controversial, as indicated by the negotiations within the G20, and they had a far quicker implementation, as the US Congress passed the necessary legislation smoothly. This, however, does not mean that the change in MDBs and their role in international financial architecture was any less momentous. Quite the contrary: MDBs are one of the areas where the ongoing transformation in global governance has been deeper and faster. Several reasons account for this apparent contradiction and they concern both the economic and institutional frameworks, as well as the political economy of the negotiations.

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An initial consideration regards timing. In the acute phase of the crisis, the IMF and the MDBs needed to obtain the increase in resources urgently in order to fulfil the fire-fighting mandate they were assigned by the G20. While the IMF could borrow from its members63 as a bridge arrangement pending the augmentation of the quotas, a similar opportunity was in practice not available to MDBs, given the way they operate. They could immediately deploy a massive increase in their lending by resorting to the spare capacity in their balance sheets derived from the previous years of weak activity. Yet, sustaining their countercyclical function required the increase in capital to be agreed upon and implemented within a short time, thus constraining the dynamics of the negotiations on the changes in voting power – changes that the emerging economies vehemently demanded to reflect their larger weight in the world economy and, as they put it, to restore the legitimacy of the Bretton Woods institutions. As in the case of the IMF, negotiations of the capital increase in the WB revolved around the voting power (mostly64) determined by capital shares. Historically, the WB had not had an explicit formula for guiding the distribution of quotas, but it had relied on the IMF approach, virtually mirroring the latter’s quota share allocation with all its vagaries – as we have seen, the IMF formula determined an “ideal” distribution, which was implemented with plenty of ad hoc adjustments dictated by political considerations. Since the 1990s, in particular with the 1998 capital increase, the WB had abandoned the parallel with the IMF, informally adjusting quotas to recognize its members’ contributions to IDA replenishments. This change in the criteria for assigning voting power was consensual. It was widely perceived as useful to sustaining “the financial capacity of the WB Group to carry out its development mission . . . in the unique governance structure of the WB Group”, as the Development Committee put it.65 The same board, consisting of the same executive directors, is the decision-making body for IBRD (usually called the WB), IFC (the private sector arm), and IDA (the concessional arm), although decisions for each of the three are legally made on the basis of the members’ voting power in that institution. These peculiar institutional features combined with a situation where the strongest advocates and potential beneficiaries of the rebalancing in voting power that the WB reform was intended to achieve were among the largest borrowers. Moreover, they also directly benefited from a sizable proportion of the massive increase in the WB lending as an emergency response to the crisis. In addition, India still had access to IDA at concessional rates.66 Against this backdrop, the process for finding an agreement on capital increase in the WB was much quicker and smoother than for the IMF, in spite of the fact that both had the objective of a shift in voting power towards emerging economies. The contrast is particularly striking with regard to the negotiations on the formulas for the distribution of capital shares. A deal for the WB so-called “framework” was already struck at the 2009 annual meetings.

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The WB “framework” was based on three elements: i) economic importance, with the largest weight (0.75), indeed larger than in the IMF formula (0.5); ii) IDA contributions, both disbursed and pledged, (0.20); and finally iii) the socalled development contribution, which provides for a distribution of some votes to small, non-advanced borrowing countries. The negotiations predictably encountered difficult moments because of the conflicting interests of advanced, emerging, and less-developed economies, such as in defining the appropriate measure of economic importance (the same compromise as for the IMF was adopted67) and contributions to IDA. The ingenuity of WB staff came to the rescue, proposing compromises on specific technical points, various ad hoc adjustments, and the addition of one chair on the board for Sub-Saharan Africa. The package was already approved by April 2010, without the need for any of the drama and arm-twisting necessary to strike a deal on the IMF in the G20.68 An agreement on a capital increase was urgent for the WB to be able to continue its countercyclical action and support investment, particularly in infrastructure. These objectives were unanimously endorsed by the G20, which was also quite content to enhance the legitimacy of the WB by strengthening the voice of LDCs through an increase in basic votes and the addition of an executive director. At the same time, the very sizeable contributions to IDA from European countries deflated the issue of their overrepresentation, which was such a sticky point in the IMF reform. All of these factors made the proposed WB reform package attractive to the US, which championed the countercyclical role of the MDBs for the global economy. In addition, the renewed emphasis on the role of the private sector in development, which accompanied the reform, was particularly close to the heart of the US Congress. Even more importantly, the timing of the submission to Congress helped to avoid the embroilment of the WB reform in the US political struggle. As a result, the appropriation of the resources to subscribe the US capital increase in the WB (and all other MDBs) was swiftly approved in December 2011. Emerging economies too had motives for supporting a rapid acceptance of the compromise which the WB staff orchestrated by sounding out key shareholders. As major recipients of WB loans,69 including those swiftly granted in response to the crisis, they felt some restraint in the negotiation and opted for reserving their more pugnacious attitude for the IMF front. Moreover, it was clear that pushing further for voting power in the WB should come with larger contributions to IDA, which emerging economies were unwilling to commit to.70 The relative ease in reaching an agreement should not lead to the belittling of the rebalancing of power within the WB, which was as momentous as the one within the IMF. The WB reform resulted in a shift of 4.59 percentage points in voting power in favour of “dynamic and transition economies”,71 with 1.64 points going to China, which became the third largest shareholder, after the US and Japan. Most significantly, emerging countries, in particular China, acquired a more pervasive and consequential influence on everyday affairs. Major emerging

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economies became additional members whom the staff would consult before putting forward any important policy or controversial project. Their official representatives and nationals in the WB staff acquired a more assertive attitude in the internal processes. It is no coincidence that in 2012, a Chinese national (formerly of Goldman Sachs) became president of the IFC. In the other MDBs, the main bone of contention in the review of capital adequacy mandated by the G20 at the London summit was the size of the increase, rather than its distribution among shareholders to engineer a shift in voting power. The role of regional MDBs in global governance, as “regionalizers” and mediators between the global policies of the WB and regional needs, was to be strengthened by the renewed importance of their financing function and the scaling-up of their activities. This enhanced role, which emerging economies forcefully supported, however, did not require any major rebalancing in the voting power among shareholders, as regional members already had the most substantive clout on MDBs’ policies and concentrated their efforts on obtaining more resources to support MDBs’ activity. The management of all regional MDBs inventively put forward old and new ways in which they could contribute to the countercyclical response to the crisis and support investment, with the objective of inducing already well-inclined shareholders to be even more liberal with their resources. Negotiations, then, typically boiled down to a confrontation between regional shareholders, which basically supported the scenarios72 of the most rapid expansion in activity requiring larger capital increases, and non-regional members, trying to temper these demands, which, for them, accumulated across institutions. The urgency dictated by the economic situation and the accord within the G20 led to agreements providing for the largest capital increase in the history of each MDB, although somewhat short of the most ambitious scenarios. Emerging economies scored a great success with the reform of MDBs, obtaining a major rebalancing in their favour of voting power and informal influence within the WB, as well as a massive injection of fresh resources in regional MDBs.73 This, however, did not exhaust the scope they saw for using the MDBs’ role in international financial architecture to challenge the status quo and to transform global governance to their benefit. They resorted to another, bolder move. They established two new institutions: The New Development Bank (NDB), often referred to as the BRIC bank, and the Asian Infrastructure Investment Bank (AIIB).

The brand new MDBs The decision to establish the new institutions was rooted in a long tradition that acquired new relevance once emerging economies had at their disposal the financial resources to set up an independent MDB, potentially significant at the global level. The radical challenge to the development model embedded in the liberal order had been a persistent component of global relations, periodically

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resurfacing in UN fora and underpinning the critiques of the WB in global governance as being an instrument of the US (and G7) hegemony. Moreover, experience had proven the success of the MDB business model both in enabling an efficient use of shareholders’ financial resources and in fostering global and regional integration. With this background in mind, it is not surprising that emerging economies decided to establish a new institution under their leadership, which could complement the rebalancing of power in their favour within existing IFIs and could reinforce the transformation of global economic governance. A new order would undoubtedly require changes in international financial architecture. Setting up a new institution that could serve as a building block of the new system combined the practical purpose of acquiring an additional instrument to influence the world economy with a powerful signal of defiance against the US and the G7-based order. But then, why two distinct institutions rather than one? The reason is that emerging economies waged their challenge against the monopoly of G7-dominated MDBs – and the prevailing governance system they were a part of – through the pursuit of two complementary but distinct objectives: i) creating an independent global institution that could be an alternative to the Bretton Woods architecture both in the supply of financial resources and in the setting of global policy standards; and ii) unsettling the regional monopoly of the AsDB as the champion of Japan’s economic leadership in Asia – a monopoly that had been supported by the US and accepted by the other advanced countries as an integral component of the post-war liberal order. China dominated the elaboration and the implementation of this agenda. Its resources were essential for the establishment of any new international financial institution. And the objective of challenging Japan’s role in Asia was mostly China’s priority, as it served its immediate economic interests and its ambition to become a superpower, rivalling the US from a military standpoint as well. At the same time, as discussed with reference to the negotiation dynamics within the G20, there was a convergence of interests among emerging economies in creating a common front to defy the prevailing order and weaken the US hegemony. China has paid particular attention to international development policy because of the support it can provide for the expansion of its trade and global value chains. The financial resources and political capital invested in this field have been commensurately large and deployed through many diverse channels. In addition to recapitalizing the “old” MDBs74 and establishing the new institutions, China has provided very large flows of external financing through its “private” banks, in particular Exim Bank and China Development Bank, even though information on this activity is wanting because of incomplete reporting to international organizations, such as the OECD.75 Most recently, China added yet another instrument to pursuing this design, launching the One Belt One Road initiative at an international summit held in Beijing in May 2017. The fame of the Silk Road was rehashed as a banner to promote infrastructure investment

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facilitating connectivity as a boost to trade, extending the targeted (land and sea) links well beyond the traditional Road. As a part of this strategy, China also marked its place in the archetypical window of concessional development finance, joining IDA in 2007 with a minimal contribution to the fifteenth replenishment. Although three replenishments later, in 2016, China’s pledge still remained below 2 per cent of the total, its active participation in the negotiations was certainly felt, reinvigorating the challenge, long pursued by the other advanced countries76 in IDA negotiations, to the US hegemony in international development. The comparison to the much vaster resources mobilized through other channels in any case leaves no doubt that China believes generous funding to IDA would be a cost-inefficient way to pursue its interests in both supporting its commercial expansion and tilting the balance of power in global governance. Large donors bitterly resent China’s small contribution to IDA burden-sharing; in particular because they see it as an outright defiance of the notion, embedded in the liberal order, that economic success involves solidarity obligations – a sort of dues paid to be part of the world leaders’ club. Direct pressure during IDA negotiations and broader moral suasion in other fora have obtained few results from China and other “should-be” new major donors, confirming the emerging countries’ preference for challenging the US (and G7) hegemony in development policy through the establishment of new institutions. China’s determination and overt geopolitical ambitions severely strained the relations within the BRICS group, adding to the tensions caused by the outbreak of Russia’s conflict on Crimea in early 2014. As we have seen in Chapter 2, the process that led to the establishment of the new MDBs, in the search of a delicate balance between each country’s particular priorities and geopolitical trade-offs, was long and difficult. Eventually the BRICS reached a compromise, as they realized it could not afford to miss the opportunity of sending a powerful signal of cohesion that would strengthen their common stance vis-à-vis advanced countries. To be viable, however, the package had to include both the two new MDBs and the Contingency Reserve Arrangement (CRA), a source of financial support in the event of a crisis. The establishment of an alternative to the IMF had high priority for Brazil and Russia, as they saw it as a key element of the BRICS’ strategy: it could challenge the IMF’s monopoly in the provision of emergency financing and pave the way to a novel approach to conditionality for granting financial support. China, the only BRICS country with the wherewithal to implement such a project, was at best lukewarm about it. Eventually, it had to accept the creation of a BRICSbased financing mechanism, but it obtained the condition that the CRA provided adequate safeguards for lenders and involved no ex-ante transfer of resources. As set out in the treaty establishing it, the CRA is only a web of reciprocal commitments (denominated in US dollars!) and conditions for assistance rely heavily on IMF surveillance procedures.77 Despite its non-negligible size of US$100 billion, the CRA falls far short of the initial ambitions of some of the

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BRICS, and, unless the treaty is modified, it can only function as a complement to the IMF. The CRA has neither the mandate nor the human nor financial resources to become an independent alternative to the IMF, even restricted to the BRICS themselves.78 For the BRICS, the establishment of the CRA is undoubtedly an accomplishment both as an instrument for striking a deal on the creation of the new MDBs and, in itself, as a complementary safety net that enhances the cohesion of the group. However, in its current form, which ultimately depends on the reluctance of China to commit more resources and accept more risks, the CRA certainly does not have even the potential to be the alternative to the IMF that some of the BRICS had envisaged when sponsoring its establishment. More generally, none of the regional agreements of mutual support has so far developed the capacity to live up to the ambition to be substitutes for the IMF, even at the regional level, as they all lack both sufficient financial resources and analytical calibre. Nonetheless, the rise of regional financial arrangements should not be disregarded, as it is yet another expression of emerging markets’ challenge to the prevailing global governance, and in particular to the preponderant role of the IMF in crisis resolution. The relevance of regional arrangements was also voiced within the G20, particularly in the framework of the debate about the strengthening of the so-called “global financial safety net” – that is, the system of crisis prevention and resolution resulting from the network of bilateral swap lines between central banks, regional financing arrangements, and the IMF.79 In spite of the persistence of the theme,80 no major breakthrough in terms of the integration of its components has ever been achieved, so that the safety net has remained more a patchwork than a consistent system.81 Without a substantive increase in their resources, which is definitely not on the horizon, regional financial arrangements are thus unlikely to develop into one of the key building blocks of global governance. The two new MDBs, instead, do have this potential in terms of structure, mandate, and the commitment of their founders. Institution-building and the honing of operational capacity are lengthy processes so that, at the time of writing, it is not yet possible to assess their success in challenging the incumbent MDBs. Questioning the pivotal role of the WB is a very tall order, because its position being buttressed by decades of policy advice and financing activity combined with a global intellectual leadership in elaborating, defending, and adapting the mainstream view of development. And, as we have seen, emerging countries have actively and effectively vied for more formal and informal influence with the WB. Yet, the institutional and political achievements already attained by the two MDBs, starting with the very fact they were established in spite of the scepticism and obstruction of advanced countries, point to a burgeoning role in the coming years. They stand as important elements of the rebalancing of power in global governance that has already taken place. Within the BRICS, India was the first and most resolute promoter of a new institution, building on the tradition of a radical alternative to the mainstream

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development model (the notion of a “New International Economic Order” was launched in New Delhi in 1968). When the Indian chair of the fourth BRICS summit in 2012 convinced the other members to mention the idea in the communiqué, the name New Development Bank, loaded with this background, was chosen. This name survived the long negotiations that led to the formal launch of the NDB at the BRICS summit in 2015, following national ratifications of the relative treaty. The governance structure carefully ensured a balance among the five founding members: an Indian president; four vice-presidents, one for each of the remaining countries; a Russian chair of the Board of Governors (which consists of finance ministers, as usual for IFIs); and a non-resident Executive Board, in charge of approving operations and policies and composed of senior officials from the capitals. The headquarters are in Shanghai and the only other office is in South Africa. Most significantly, the capital of US$50 billion is equally divided among the BRICS, which thus enjoy the same voting power. This feature, with all its symbolic connotation, was advocated by India and South Africa and accepted by China as a concession to securing the agreement about its demands on the financial structure of the CRA. The treaty opens NDB membership to all countries belonging to the UN,82 confirming the global mission intended for the NDB, but, at the time of writing, no other country has joined it. The frantic Chinese activism to widen AIIB membership stood in the way of any meaningful outreach, although the approval at the 2017 annual meeting of the explicit procedure for new admissions83 indicated the intention to move in that direction. At that meeting, the strategic plan 2017–21 was also approved, paving the way for an increase in the scale of operations, started in 2016, with loans for a total of US$1.5 billion and an expansion of the scope of activity, with particular reference to SDGs. The element of defiance against the status quo was even more evident in the establishment of the AIIB, which replicated the model of the AsDB (focus on Asia, but global membership) under the leadership of China.84 Indeed, China’s vast foreign exchange reserves and massive volume of external financing through the Exim Bank and the China Development Bank clearly indicated that the initiative did not have a financial motivation, but rather the goal of advancing its economic expansion and geopolitical ambition by resorting to an MDB, just as Japan had done before. The message was intended for both the other BRICS (the negotiations on the NDB were in progress) and advanced countries (the venue chosen for the announcement was the forum for Asian Pacific Economic Cooperation, which includes the US and Japan). The other BRICS did not conceal their displeasure with China’s initiative and stiffened their negotiating stance, but in the end they had no choice: its resources were indispensable to implement both the CRA and the NDB. At the same time, they did not fail to appreciate that they also stood to benefit from a challenge to the prevailing global economic governance, which included Japan’s economic leadership in the region as a long-accepted component.

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Japan and the US were more outspoken in expressing their irritation and started an active campaign to stymie China’s project, flagging two arguments. The first was the claim about inefficient institutional duplication, which was not very convincing in light of the size of the infrastructure investment needs in Asia and the firm resistance they had posed to China’s insistent demands to increase its capital share and influence in the AsDB, after joining it in 1986. The second one was the allegation, flatly denied by China,85 that the new institution would not meet appropriate standards, in particular regarding procurement rules and environmental protection. Most significantly, they canvassed their G7 peers and other advanced countries such as Australia to secure their non-participation in the new bank. The boycott plan initially appeared to work. The issue was informally discussed at meetings of the G7 deputies and figured in the agenda of several bilateral ministerial meetings that took place at the margins of international financial events. In the first part of 2014, Japan and the US experienced a lull in their delusion that China’s project was bound to flop through endless postponements or meagre participation. China’s recruitment campaign then escalated with systematic outreaches at the margins of the G20 meetings, where an ad hoc delegation offered reassurances about the standards the new bank would follow and pointed out the advantages for founding members in terms of high-level positions in the organization. More effectively, contacts at the highest political level hinted at a link between participation in the new bank and easier access to the immense Chinese market. When, a few months later, the deadline for joining as a founding member was firmly set, the advanced countries’ front of non-participation simply crumbled. The UK was the first G7 member to suggest informally to the others that it might join the bank, although no decision had been taken yet. The rapidity of the European members of the G7 and other advanced countries in disclosing a similar attitude (and then in joining the AIIB) indicated that these decisions had been brewing for a long time. The draft statute prepared by China left little room for substantive deliberations at the five meetings of the Chief Negotiators Group, to which admission was granted upon the official signing of a specific memorandum of understanding. As one would expect, the governance structure reserved a special role for China: a share of about one-third of the US$100 billion capital (and voting power),86 headquarters in Beijing, and the understanding that a Chinese national would serve as president. For the other members, shares were to be apportioned using GDP as a key within the regional and non-regional groupings, respectively commanding three-quarters and one-quarter of the capital in order to preserve the regional character of the bank. Seats on the non-resident board of twelve directors were to be allocated in the same proportion, with China and India being the only countries to hold a seat not shared with other countries. The other features of the Statute reflected the standard international usage and opened the flank to no major dispute.

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After the opening ceremony in January 2016, the AIIB started its activity in earnest, focusing on the building of an institution which, from every operational point of view, conforms to the best practices of peer MDBs,87 while operations at the beginning were mostly projects co-financed with the WB. The establishment of AIIB and its prospects for expansion are a significant testimony to the importance of MDBs in the reform of global governance.

Evergreen tensions and dilemmas The renewed importance of the MDBs’ financing function boosted their profile within the G20. In the prolonged period of subdued growth and stagnating investment that followed the crisis, MDBs rapidly enlarged their balance sheet to shore up aggregate demand. In particular, they supported investment, which became a priority in the G20 agenda, also because this topic afforded the possibility to divert attention from the faltering progress on economic policy coordination. MDBs’ financing and assistance, especially in the field of infrastructure, returned to being viewed as a primary engine of development for both low- and middle-income countries, while also promoting trade. MDBs ingeniously exploited the appreciation they gained within the G20 so as to acquire further influence and expand their activity in both size and scope. Their inventiveness in devising new ways “to serve their customers” and finding novel areas of intervention seemed boundless. The WB revitalized its vocation as provider of global public goods, in particular within the realms of health and climate change, spearheading myriad initiatives. The availability of its own resources and easy access to finance ministers – the policy makers who are key to the allocation of public funds – provided an advantage which MDBs increasingly exploited to widen the scope of their interventions. As an example to illustrate this trend, one may recall the Pandemic Emergency Financing Facility, announced at the G7 finance ministers and central bank governors meeting in May 2016, in Sendai, with the objective of covering the “critical financing gap between the limited funds available at the early stages of an outbreak and the assistance that is mobilized once an outbreak has reached crisis proportions”.88 This was the end result of a process started, at the margins of the annual meetings in 2014, with an event jokingly dubbed “Ebola lunch”: in the presence of major shareholders, the chiefs of the WB and the IMF listened to the demands for financial help made by the leaders (some over videoconferencing!) of the West African countries hit by the epidemic. Although the World Health Organization participated, it was clear that the extra resources for the specific epidemic, and then for the creation of an ad hoc facility, would only become available because of the WB ingenuity, combined with its clout over finance ministers. Notwithstanding the cleverness deployed to widen the scope of their operations, the growth in MDBs’ activity mainly continued to originate from their “traditional” loan business. MDBs eagerly promoted their financing, both

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proposing advantageous financial terms and relaxing conditions regarding both the eligibility of projects and the attached policy requirements. Borrowing countries did not fail to exploit the opportunities opened by the MDBs’ eagerness to attract customers and engaged in what came to be known as “facility shopping”, i.e. the practice of exploiting the competition among MDBs to obtain better conditions and circumvent the conditionality the IMF imposed for financial assistance. MDBs rejoiced in their accomplishments and craved more. Not long after completing the capital increases originating from the London summit, they started to circulate projections on their future activity which suggested that a new injection of resources would soon be needed if “MDBs were to serve their shareholders as they demanded” – or at least, this was the narrative they put forward. Major member countries felt they were losing their grip on the institutions. In yet another example of the perennial dialectic between MDBs’ desire for independence and shareholders’ control, they took action to rein in MDBs’ financial ambitions and, as early as 2013, in the G20 they urged MDBs to use their capital more efficiently. The emerging versus advanced countries divide in the G20 surfaced on this issue too, as emerging countries were inclined to be lenient towards MDBs’ requests. At the same time, they realized that their enhanced influence in MDBs’ governance implied new responsibilities in reaching a compromise with the other major shareholders. The G20 thus agreed on an action plan for the optimization of MDBs’ balance sheets, which was attached to the conclusions of the G20 Antalya summit in 2015 and led to various operations89 that moderated MDBs’ demands for a capital increase. In addition, major shareholders, particularly advanced countries, repeatedly and determinedly called for a better coordination between MDBs and the IMF to ensure consistency across institutions in the conditionality imposed on potential borrowers. In spite of their shareholders’ reluctance, MDBs, led by the WB, kept insisting on a capital increase. Their main argument was that additional resources were indispensable to support the new, more ambitious, development agenda, which was adopted by the UN Assembly in 2015 and involved financial requirements of a much larger scale (see endnote 97). Proving, once more, their power of influence, MDBs reiterated their requests for fresh money until their shareholders eventually capitulated, including the US, in spite of the Trump administration’s unconcealed mistrust of multilateral institutions. At its 2018 spring meeting, the Development Committee, with the only opposition of Russia, gave its political endorsement to a very large capital increase90 for the WB, which, at the time of writing, was being finalized.91 The huge financial support that the WB managed to obtain confirmed its central role in global governance, which was further strengthened by the tactical positioning of its key shareholders. The US preferred to buttress the WB – the institution where, although declining, it still maintained a crucial clout and the top job – rather than risking the WB losing ground to the other MDBs in which

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it had no influence.92 For their part, emerging countries did not want to backtrack from their policy to vie for leadership in Bretton Woods institutions, dissipating the gains just obtained, at a time when the new MDBs they had established were not yet mature enough to be an alternative to the WB. European countries, as usual unable to take a common stance, went along with the capital increase in a mix of hope of obtaining more leeway for their individual priorities and fear of having their influence in the WB further eroded. The reshaping of the development agenda is the other major area where the MDBs, led by the WB, played a pivotal role thanks to their renewed strength and policy profile. Two major themes stood out in this respect. The first one was the return to prominence of the focus on economic growth as the key instrument to reducing poverty, fighting disease, and improving the living standards across the whole spectrum of development indicators. The renewed attention paid to this link was undoubtedly fuelled by the success, driven by the fast economic growth in China and India, in achieving the MDGs. Figure 4.1 illustrates this point by plotting the percentage of world population living in absolute poverty (MDG 1 was to halve it in fifteen years and was reached with a significant advance) together with China’s and India’s share in the world economy (in inverted scale, for ease of exposition). MDBs championed this approach, which the G20 was eager to endorse: “focus on economic growth” is the very first of the G20 development principles set out in the Seoul development consensus.93 The second major theme was the addition of the overarching objectives of sustainability and inclusiveness as an integral part of the development agenda. The WB provided key impetus for the definition of such a more ambitious and encompassing agenda, which translated into the specification of the Sustainable

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Development Goals (SDGs), solemnly adopted by the UN Assembly in 2015 to replace the MDGs. Even a cursory look at the list of the seventeen SDGs and the accompanying set of targets and indicators to monitor the progress towards their achievement94 is sufficient to indicate how much further than the MDGs they go in terms of comprehensiveness and ambition. They not only cover extreme poverty reduction (which should end by 2030 – SDG 1) but also aim at universal access to health coverage (SDG 3), quality education (SDG 4), and safe water (SDG 6). Even more significantly, they venture into territories that have highly controversial policy implications for all countries, including advanced ones, such as ensuring decent work for all (SDG 8), reducing inequalities within nations (SDG 10), promoting low-carbon energy systems (SDG 13) and managing ecosystems sustainably (SDGs 14 and 15). SDGs propose a holistic development vision that applies to all nations, not just to less-developed ones, and that accordingly calls for a global policy effort on many fronts. It is debatable whether this broader perspective is effective in catalysing more determined efforts to achieve “traditional” development objectives or, conversely, whether it is counterproductive in that it spreads political capital too thinly on too many and too highly controversial policy areas, some of which are already covered by other international processes.95 Whatever one’s assessment, SDGs were solemnly underwritten by the international community and have become the framework within which MDBs’ activities and narratives are cast. While providing the opportunity to extend the areas of MDBs’ intervention, SDGs again stress the need for the provision of basic public services, which, for the poorest countries,96 requires appropriate capacity-building strategies as well as the mobilization of a phenomenal amount of resources. In the run up to the Addis Ababa financing-for-development conference, the WB coordinated with all the other MDBs in the preparation of a paper with a title that very effectively conveyed the challenge: “From Billions to Trillions”.97 This financing gap cannot possibly be addressed only by raising ODA; it requires mobilizing additional private funds from multiple sources: from remittances to philanthropy and private investments. MDBs should play a crucial role in the renewed development challenge (would MDBs ever say otherwise?) both in the provision of global public goods and in catalysing the necessary private investment flows. This motivated their insistent requests for a capital increase, which, as discussed earlier, began to be accepted in the spring of 2018. As recent experience shows, the uneasy coexistence of the two different visions of development recalled at the beginning of the chapter (priority given to infrastructure investment versus poverty alleviation with capacity building) continues to pervade MDBs’ strategies and operations. It resurfaced in the reshaping of the global development agenda that led to the definition of the SDGs, which embody the effort to overcome it by stressing that both objectives are equally important. It also permeates the brand new MDBs. The NDB has not (yet) elaborated an alternative vision of development convincingly encompassing the

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two contrasting visions within a new synthesis.98 As for the AIIB, which is often portrayed as a catalyser of a south-south cooperation with a new character, it can be argued that it simply replicates for China the support to commercial expansion that the AsDB offered to Japan some decades ago, through infrastructure investment with a particular emphasis on connectivity.

Conclusions This chapter has explored the role of MDBs in global governance starting from the origin of their business model, with the foundation of the WB. Perfected over the years, the model proved very successful by virtue of its capacity to offer a flexible and efficient use of their member states’ financial resources. Building on this success, the WB became the hub of the world development community not only thanks to its involvement in projects and policies unrivalled in breadth of scope but also because of the mission it unsparingly embraced: to defend the mainstream view of development, which it actively contributed to articulating, enriching, and adapting through an uninterrupted dialogue with a wide range of stakeholders. Its leadership in the global community was crowned by its central role in the definition and pursuit of the Development Goals, approved by the United Nations at two special summits in 2000 and 2015. Regional MDBs were established in the wake of the WB, in some cases with the explicit mandate to elaborate an alternative model of development. Although they failed to accomplish this objective, they proved effective catalysts of economic integration at the regional level and useful interfaces between the two global IFIs, the IMF and the WB, and local politics, in terms of both regional objectives and investment priorities. Indeed, this function partly sheltered them from the malaise that the WB experienced in the years before the crisis, with a decline in financing activity and a decay in policy profile. That malaise was put to an end by the decision of the G20 to make the MDBs a central element in the policy response to the crisis, supporting global demand, particularly with regard to investment. To fulfil this mandate, MBDs received a massive injection of fresh resources on the condition that they embarked on a reform process, which emerging economies forcefully demanded to increase both their voting power and informal influence. Although at least as important as the one for the IMF, the capital increase in MDBs was far less controversial in the G20 and was approved by the US Congress far more easily. Several reasons account for this striking difference: first, resources had to be available urgently for the WB to be able to perform its countercyclical action; second, sizeable IDA contributions by European countries helped to diffuse the issue of European representation, which was so divisive for the IMF reform; third, emerging economies were among the largest borrowers from the WB and other MDBs; finally, the timing of submission to the US Congress helped avoid embroilment in US domestic politics. Emerging economies were keen to invest financial and political capital in a bolder move to defy the prevailing order: the establishment of two new institutions,

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challenging advanced economies’ monopoly on the mastery of the instrument of the MDBs, and preparing the building blocks for the new international financial architecture. Two new institutions rather than one reflect the pursuit of a twofold goal: challenging the mainstream view of development through a global MDB and unsettling the AsDB’s role as promoter of Japan’s economic leadership in Asia, which had long been accepted as an integral component of the post-war liberal order. China dominated the elaboration of this agenda, tilting it towards its priorities and geopolitical ambitions, much to the irritation of the other emerging economies. They went along, however, as they in any case stood to benefit: the establishment of new institutions was such an important step in the evolution of global governance also in their favour that the opportunity could not possibly be missed. Negotiations with China were harsh and led to various concessions on its part both on various features of the two new MDBs and on the supply of resources for the establishment of the CRA, a network of financial support in the event of a crisis reserved to the members of the club of the major emerging economies: the BRICS. The CRA has limited resources and insufficient analytical capacity, like all other regional financing arrangements that proliferated as yet another expression of emerging markets’ challenge to the prevailing global order. Notwithstanding this, for a period, regional arrangements were voiced within the G20 as potential key elements of a global financial safety net, which had to be developed through the integration of its components, including the IMF. No progress has been achieved in this direction and thus, without a substantive increase in their financial and human resources that is definitely not on the horizon, regional arrangements are unlikely to develop into one of the key building blocks of global governance. MDBs’ central function in global governance received further validation by yet another sizeable increase in resources which, after the MDBs’ insistent pressures, shareholders began the process to grant in 2018. Emerging economies were very effective in gaining formal power and informal influence in this crucial facet of global governance, both through their stronger clout over the “old” MDBs and through the establishment of two new MDBs. Indeed, in this, they were more successful than they were in the other new institution established after the crisis: the Financial Stability Board, to which the next chapter will turn.

Notes 1 It would define the Sustainable Development Goals replacing the Millennium Development Goals that had been set in 2000, with a fifteen-year horizon. 2 In contrast to many gatherings on economic and financial issues, the UN-style approach shuns constituencies and other forms of indirect national representation. 3 Despite their name, many Non-Governmental Organizations, best known as NGOs, are directly financed by official development agencies. 4 High-profile development meetings bring together the circles of international economic and financial governance and international relations with the official development community.

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5 This is the opening line of Development Committee (2017), discussed at the 2017 spring meetings, which echoes president McNamara’s foreword to the first World Development Report (World Bank, 1978): “The twin objectives of development are to accelerate economic growth and to reduce poverty”. 6 The popularity of the three functions of government intervention is due not so much to the original article (Musgrave, 1939) as to the widely adopted textbook (Musgrave and Musgrave, 1973). In the ideal transposition of this framework at the international level, stability would be assigned to the IMF and efficiency to the WTO. 7 Marshall’s speech at Harvard University on 5 June 1947 launched the notion of direct US aid to Europe, which was embodied in approved legislation within just one year. 8 Alacevich (2009) and Easterly (2013). 9 Helleiner (2014b). 10 For example, Steil (2013). 11 Boughton and Lombardi (2009). 12 The Structural Adjustment Loans and the Poverty Reduction and Growth Facility are the best-known examples. 13 For a detailed account of the evolution of the collaboration between the WB and the IMF, see Boughton (2001), in particular chapter 10. 14 The official name of the Development Committee is “Joint Ministerial Committee of the Boards of Governors of the World Bank and the International Monetary Fund on the Transfer of Real Resources to Developing Countries”. 15 In their most recent reports, credit rating agencies attach great importance not so much to the amount of callable capital per se (even though it is typically enshrined in legislation) as to their assessment of the main shareholders’ commitment to keeping each MDB adequately capitalized. 16 As Buiter and Fries (2002) argue, this is the source of the subsidies dispensed by the MDBs. Although the periodic transfers of profits to concessional facilities can be regarded as a sort of dividend, as they partly substitute for shareholders’ replenishments, the key point still holds that profits typically arise from the investment of the capital endowment and not from the interest margin. 17 MDBs’ mandate also limits the practice, followed by ordinary banks, of charging higher interest rates to less creditworthy borrowers. 18 For a recent discussion and a quantification of its effects, see Perraudin et al. (2016). 19 The two initiatives are the heavily indebted poor countries’ initiative and the multilateral debt relief initiative; see www.imf.org/external/np/exr/facts/hipc.htm and www.imf.org/external/np/exr/facts/mdri.htm. 20 Vaubel (1986, 2004). 21 It was Robert Gardner, a senior WB official, who championed the idea of a private sector facility and won the support of the WB president, the US administration and Congress, as chronicled in Mason and Asher (1973). 22 To be precise, what is normally called the “WB” is in fact the WB Group, consisting of IBRD (established at Bretton Woods), IFC (1956), IDA (1960), the International Centre for the Settlement of Investment Disputes (1965), and the Multilateral Investment Guarantee Agency (1988). 23 It may be worth noting that the LDCs’ acronym actually started to be used in the late 1960s (the first list of LDCs appears in the UN resolution 2768 of 18 November 1971), while in the early 1960s the term “Third World” was much more frequent even if it implicitly included China as a full member of the communist bloc, notwithstanding its very early sympathy for the Non-Aligned Movement. 24 India, Indonesia, Egypt, Ghana, and Yugoslavia were the initial leaders of the Movement. 25 The inverted commas are meant to recall that the expression “voice to LDCs” belongs to the jargon of the current millennium, not to the time of the events discussed.

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26 China, although it never formally joined the G77, always supported the NonAligned Movement. The initiatives within the UN framework have traditionally been labelled “G77 + China”, though not in Addis, where China behaved as a fence-sitter, thinking that a more balanced position would raise its profile as a forthcoming G20 chair. 27 The group membership is strictly limited to 24 countries, but any country of the G77 has the possibility of providing an input to the G24 discussions, typically held at the margins of the meetings of the IMF and WB. 28 Toye (2014) provides an excellent analysis of the role of the G77 on economic governance, also through its links with the United Nations Conference on Trade and Development. 29 The EIB, however, is much larger than the WB. 30 To be accurate, the first multilateral financial institution after Bretton Woods was a fund established in 1956 by eight countries to take care of the resettlement of refugees from World War II. This fund would then become the Council of Europe Development Bank (CEB). Its membership, now at 41 countries, has followed the history of the homonymous political institution, based in Strasbourg and best known for its European Court of Human Rights. Compared to its peers, the CEB has experienced a remarkably small mission creep, continuing to finance social investment and receiving a boost to the relevance of its original mission from the recent migrant crisis in Europe. 31 The UK will have to relinquish membership of the EIB through a settlement that was negotiated with the EU as a part of the exit arrangements. 32 Japan, Israel, and a few European countries joined early, while others, such as South Korea in 2006, did so over several years. 33 In August 1995, the Bank lost its triple-A rating, an unheard-of event for an MDB in the days before the 2008 crisis (Akonor, 2010). 34 Especially in the early years, AsDB loans mainly went to Japan’s key trading partners, such as Indonesia and South Korea, while Japan received the lion’s share of the Bank’s procurements and, between 1955 and 1977, paid the largest war reparations in history, providing much needed foreign capital to many Asian countries. 35 Opinions differ as to whether this radical stance was a bargaining attitude in the global power game (Rothstein, 2015) or the beginning of a fruitful dialogue between North and South (Bhagwati, 1977). 36 Xu (2016) provides a detailed account of the episode. 37 Although the IADB co-financed the Yacyretá dam, it was the WB that was questioned first and that then took remedial action. IADB was a follower on both scores, including the establishment of an Inspection Panel, but played a crucial mediating role with local authorities and the population, exploiting its greater cultural affinity. 38 Bissell (1997). The articulation by the WB management of “safeguard policies” in response to NGO concerns about the environmental and social impact of projects only came in 1997. 39 Evaluation of WB projects began in 1970 when President McNamara created an operations evaluation unit in the programming and budgeting department. 40 The issue of IFIs’ accountability to various stakeholders is discussed in the previous chapter. Woods (2006) analyses in detail the relations of the WB with NGOs and private-sector lobbies. 41 Moyo (2009) attracted widespread attention. 42 Mosley (1986, 1987). 43 The reviews and meta-analysis of the very vast literature exploring aid effectiveness, such as Doucouliagos and Paldam (2008, 2009, 2011) and Mekasha and Tarp (2018), basically confirmed the disappointing conclusion. 44 For example, Boone (1996), Artadi and Sala-i-Martin (2003), and Collier (2008).

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45 The launch of the New Partnership on Africa’s Development in 2001 and the Paris Declaration on Aid Effectiveness in 2005 can be viewed as the culmination of this process. 46 In the announcement game that surrounded G8 summits, vocal advocates of increasing aid insisted for the new pledges to be “additional” and often explicitly targeted to specific objectives, while government officials honed their skills at communiquédrafting to accommodate these demands for any given pledge. 47 For example, Goal 1, “eradicate extreme poverty and hunger”, is elaborated in several targets, the first one of which is “halve, between 1990 and 2015, the proportion of people whose income is less than $1.25 a day”. 48 Mallaby (2004). Organizations were set up with the aim of scrutinizing NGOs’ behaviour; ngowatch.org is the best known. 49 Woods (2006). The role of the WB and IMF as globalizers is also briefly discussed in Chapter 3. 50 Clegg (2013) argues that the conditionality attached to lending has also been an instrument for the major shareholders of the Bretton Woods institutions to exert a political influence on recipient countries. 51 Bull and Bøås (2003) introduce the label “regionalizing actors” and provide a thorough analysis of the impact of regional MDBs on regional cooperation with reference to both the traditional economic point of view and the political economy angle, which acknowledges that “the region is not an objective static entity” (p. 257). 52 Iglesias (1992). 53 Dead Aid by Moyo (2009) was the book that popularized that view. 54 In 2004, the WB tried to ease the burden on lenders by reducing the number of conditions and strengthening lenders’ ownership of policy recommendations by replacing “structural adjustment lending” with the so-called “policy-based lending”. The change was not sufficient to invert the declining trend in WB loans. 55 For example, Woods (2008) and Rotberg (2009). 56 For the two initiatives, see footnote 19. 57 In 2013, the Russian presidency of the G20 feebly tried to revive the issue of responsible lending, but, once again, G20 members felt that there were other more important issues to argue about with China. 58 Chen et al. (2015) and www.sais-cari.org/data-chinese-loans-and-aid-to-africa. 59 Independent Evaluation Group (2010, 2012). 60 The support for the threefold increase in the capital of the AsDB was decided upon at the London summit because the preparatory work had already started before the crisis, although for a smaller amount. The other MDBs followed suit, initiating the respective procedures. 61 At the Moscow summit in September 2013, G20 leaders endorsed the establishment of a study group on financing for investment, which was upgraded to a Working Group in 2014 during the Australian presidency. 62 Unlike, for example, the working group on international financial architecture, the development working group reported to the leaders’ sherpas rather than to the finance ministers through their deputies. This arrangement reflected the entangled lines of official command between member states and MDBs. In many countries, the responsibility for development policy lies with the ministry of foreign affairs or another agency, while the shareholder in the MDBs is the ministry of finance. As a result, several actors have intersecting competences and possibly competing priorities, often complicating international negotiations, although not in the case at hand, since the development working group refrained from entering substantive discussions on MDBs’ governance and reform. 63 As discussed in Chapter 3, bilateral financing arrangements, which would then be incorporated into an expanded New Agreement to Borrow, immediately increased IMF resources.

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64 As in the IMF, voting power was also determined by basic votes, which had been assigned to each member state irrespective of its quota and had been diluted over the years by successive capital increases. In line with the conclusions of the first international conference on financing for development (in Monterrey in 2002) that small and poor countries should be given a stronger voice on international development issues, basic votes were doubled in 2008, after a long process, which took place during the low-ebb phase of the MDBs’ life. After the London summit, this increase was interpreted as the beginning of the reform to rebalance voting power within the WB and was dubbed Phase I of the reform. Vestergaard and Wade (2015) provide full details. 65 Development Committee (2010a, par. 7). 66 India would be exceptionally granted the possibility of having access to IDA resources until 2017, though it breached the per capita income threshold to qualify for this support in 2013. 67 The compromise is a blend of 60 per cent GDP measured at market exchange rates (favoured by advanced economies) and 40 per cent GDP measured at PPP exchange rates (favoured by emerging economies). 68 In 2016, the board approved, with no major difficulties, a retouch of the “framework” (renamed “dynamic formula”) eliminating the variable “development contribution” and transferring its weight to “economic importance”, which reached a weight of 0.8. The variable “IDA contributions” kept its weight but had its definition slightly changed. The new formula also embodies the same compression factor present in the IMF formula (described in Chapter 3) with the aim of reducing the dispersion in voting shares. Details in Development Committee (2016). 69 The persistence of sizeable WB loans to China in spite of the accumulation of the largest net foreign asset position in the world and its massive development financing to other countries is testimony to the excellent quality of the technical services that the WB offers together with its loans. 70 Emerging economies’ participation in IDA is discussed in the next section. 71 By contrast, Wade (2013) and Vestergaard and Wade (2015) put forward the idea that the shift in voting power was smaller than desirable, as advanced economies deployed various techniques to manipulate the reform process and retain their power. According to the authors, one of the techniques is the choice of developing and transition economies as the group of countries to gauge the shift in voting power so as to overestimate it. (It may be added that the group is different from the one chosen for the IMF reform, i.e. “dynamic emerging market and developing countries and underrepresented countries”.) Their analysis includes a proposal for alternative methods for allocating voting power but does not consider the political economy factors that allowed for reaching an agreement on the WB reform more smoothly and more quickly than for the IMF. 72 According to the common practice of capital adequacy reviews, MDB management puts forward various scenarios for the evolution of loan-granting and other activities during the following three to five years. Different capital requirements for ensuring a sustainable balance sheet configuration are attached to each scenario. 73 The essays collected in Park and Strand (2016) provide an overview of the way regional MDBs reacted to the crisis and were instrumental in accommodating emerging market countries’ demand for more influence on global governance. 74 In the negotiations for the capital increase in the regional MDBs, China lost no opportunity to declare its desire to increase its financial participation in any way possible: from the subscription of the shares not opted by other shareholders to the generous contribution to new funds and windows, such as the NewCo in the IADB. 75 Sanderson and Forsythe (2013) claim that the activity of the China Development Bank has revolutionized global development finance, while Xu and Carey (2014) argue that,

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as a consequence, a radical renovation of the global reporting and monitoring systems is needed. Xu (2016) provides a fascinating history of the challenges to the US hegemony in international development through a detailed analysis of the negotiations that have accompanied IDA replenishments since its establishment. The treaty establishing the CRA (available at www.brics.utoronto.ca/docs/140715treaty.html) limits the amount of resources that can be released without a parallel arrangement with the IMF to 30 per cent of the maximum, which is in turn equal to the respective contributions for Brazil, India, and Russia (US$18 billion each), twice its value for South Africa (US$10 billion), and half that for China (US$20.5 billion). In addition, further requirements explicitly provided in the treaty include the compliance with IMF obligations on surveillance and disclosure, clearly suggesting that IMF reports are the most reliable source of economic and financial information that BRICS countries can have on each other’s conditions. Henning and Walter (2016) discuss the CRA in the framework of the proliferation of regional financial safety nets that has followed the crisis. The treaty establishing the CRA was presented at the BRICS summit in Fortaleza in July 2014. Following national ratifications, the CRA came into force in 2015 and, as of 2016, it can operate. At the time of writing, however, the CRA’s Standing Committee (a sort of non-resident board, with one member for each of the BRICS, mandated to decide on disbursement requests) has not yet decided upon the criteria it will follow for its decisions. Cheng (2016) presents a review of the literature on the global financial safety net “through the prism of G20 summits”. Since the Seoul summit in 2010, the global financial safety net has been mentioned in the communiqué of every single G20 summit with the exception of Brisbane in 2014. Henning (2015), Shafik (2015), Henning and Walter (2016), Scheubel and Stracca (2016), Weder and Zettelmeyer (2017). It stipulates, however, that 55 per cent of the voting power must remain in the hands of the founding BRICS members. The document is available at www.ndb.int/data-and-documents/policies/. Wang (2015) sees this in line with the widespread resort by China to what Brummer (2014) labels “minilateralism”, i.e. the accord of a subgroup of countries to overcome stalemates in multilateral institutions. Jin Liqun, the head of the negotiating team and who would then become president of the AIIB, had a long career at the WB. China’s share would be reduced to accommodate further new members once the initial provision for unallocated shares reserved for future members, both regional and non-regional, was exhausted. Malkin and Momani (2016) criticize the AIIB as it conforms too much to the traditional orthodoxy as a consequence of its “intellectual monocropping” which is a result of its conservative staffing policy. Detailed information on the Pandemic Emergency Financing Facility can be found at www.worldbank.org/en/topic/pandemics/brief/pandemic-emergency-facility-fre quently-asked-questions. The swap of exposures is an example of the techniques that can be employed to optimize the use of MDBs’ balance sheets. Two MDBs select a group of loans in their respective portfolios that present a similar level of credit risk and agree to share any loss resulting from the earmarked loans. The enhanced diversification resulting from this arrangement reduces the risk each MDB faces and thus decreases the amount of capital necessary to back up the loans, allowing a larger volume of activity for any given level of capital. The size of the capital increase which shareholders had agreed to in the preparatory negotiations was so high that, at the eleventh hour, the US Treasury secretary Mnuchin himself found it preposterous. Given that this assessment arrived so late in the process, the

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US accepted that it would be taken on board by maintaining the amount of fresh resources that member states would contribute but augmenting the proportion of paid-in capital above the traditional rate, so that the subscribed capital would be correspondingly reduced. Although many countries were irritated by the process that so blatantly confirmed the ascendancy of the US, they nonetheless welcomed the decision which reduced their commitments in terms of callable (that is, not paid in) capital. For the other MDBs, negotiations about the capital increases have not yet been concluded at the time of writing. Despite this rationale, the US decision to commit to such a large resource transfer to the WB remains somewhat perplexing. Not only it is at odds with President Trump’s rhetoric against multilateralism, but it was taken together with the decision not to participate in the concurrent capital increase of the IFC, the WB private sector arm, while allowing it to go ahead (the US could have vetoed it) on the condition to having a governance reform preserving such veto power in the IFC – a power that the US does not have in the WB. IFC regular financing to Chinese firms is a possible explanation for this behaviour, although it would be an essentially cosmetic motivation given the size of the WB loans to China. The website of the G20 Development Working Group (http://g20dwg.org/) reports the Seoul Consensus. It also provides a useful overview of the Group’s activities, which, however, as recalled in the text, reported to the G20 sherpas and, as a result, was not very active in the negotiations on MDBs’ capital increase and the attendant reforms. United Nations (2015) and United Nations Statistical Commission (2017). “Hot Air or Comprehensive Progress?” is the provocative title of a paper (Spangenberg, 2017) on this issue. Sachs (2015). “From Billions to Trillions”, Development Committee (2015), was presented during the 2015 WB and IMF spring meetings. However, Cooper (2017) is positive about the NDB’s prospective relevance because of “its creative design”.

5 RE-REGULATING FINANCE

“In all new matters one has to start somewhere. And this is what we did with the composition of the Steering Committee”. This purportedly candid admission was a masterly stroke of chairing by Mario Draghi at the very first meeting of the Financial Stability Board (FSB) in June 2009. It effectively diffused the tension that had mounted in the room after several members from emerging market economies had realized that none of them would be part of the Steering Committee – the group within the FSB that, as the name implied, had de facto agenda-setting power and would be the venue for key negotiations on controversial issues. The mood in the room returned to serenity and coffee breaks offered ample opportunities for conciliatory talks and soothing promises. Yet, all participants were fully aware that the composition of the Steering Committee remained a politically charged issue, linked as it was to the status of countries’ participation in that forum. Alongside stronger voting power within IFIs, membership of the FSB had been one of the key elements of the package that emerging economies had demanded in order to tilt the balance of power in global governance in their favour. Their concerns at the meeting reflected the sentiment that ensuring the implementation of the deals reached in the G20, possibly securing further advantages, was of the essence – and they certainly were not wrong, as the events discussed in the previous chapters attest. Fast forward one decade and the composition of the FSB Steering Committee is very telling: all BRICS are represented and so are Argentina, Mexico, and Turkey. This achievement is impressive and can be viewed as yet another indication of the transformation in global economic governance to the benefit of emerging countries. The assessment, however, is reversed if one uses, as a metric of success, their actual influence on FSB deliberations, or more generally on the reshaping of financial regulation after the crisis. Despite their presence in all the relevant

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international groups, bodies, and institutions, emerging markets’ clout over the directions of the major regulatory reforms of the financial sector has been, at best, modest. The contrast between the feeble influence of emerging countries on financial regulation and their increased weight in all the other areas of global governance is all the more puzzling given the importance attached to this issue by the G20. Starting from the very first G20 summit, concerns about the financial situation and the push for a major regulatory reform received sustained political attention, including in its detailed technical aspects, to an extent without precedent in the history of international relations at the leaders’ level. Regulatory inadequacies had been one of the root causes of the crisis. Addressing them was deemed to be as important as the urgent measures of financial repair, so that the objective of revamping financial regulation constantly featured with prominence in G20 communiqués, which tasked the FSB with high-profile mandates and provided detailed information on progress made on this front. In this narrative, the importance of international coordination in the reform efforts received special emphasis. Spillover effects of inadequate regulation in banking and finance were particularly damaging because of the interconnectedness of financial markets and the strength of the contagion of instability, as the crisis had brutally exposed. Harmful regulatory competition and the “race to the bottom” it generated, with the implied threats to global financial stability, had to be avoided through the effective implementation of international standards. Guaranteeing a level playing field was indispensable if international competition in the financial sector was to generate efficiency rather than distortions and instability. The FSB spearheaded the international coordination efforts, hosting consultations between national regulators and standard-setting bodies, and promoting accord on common lines of action. At the same time, the intensity of the financial crisis and the colossal size of public-sector interventions, often in the form of bailouts, captured public attention, becoming a prominent issue in political debate and arousing a revival of national focus. After all, the legal power to define and enforce financial regulation is national – leaving aside for a moment the exception of the EU, at least in some domains. Even more importantly, it is up to national parliaments to decide on the use of public resources for the measures to stave off contagion and financial implosion. The related strains in domestic politics were extreme, as the rage against bankers mounted. International cooperation risked becoming collateral damage, as it was often portrayed to be in conflict with national interests, even with no reason at all. Despite these tensions, the reform process of the financial sector under the aegis of the FSB continued well beyond the acute phase of the crisis and maintained its momentum for a long time. Crucial support came from the collective awareness within the G20 that financial stability was a global public good that required international cooperation in order to be achieved. Support also came from the resilience of the FSB’s technical work programme. The broad scope of

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the FSB’s activities spawned many working groups, streams of research, and consultation processes, which steadily carried on in their endeavours, regardless of the ebbs and flows of the political debate. The changes in financial regulation that directly or indirectly originated from this gargantuan effort were countless and covered every area that was identified as faulty or wanting. The assessment of this wave of re-regulation remains controversial. The comparison with the drastic regulatory overhaul that followed the crisis of the 1930s is often put forward as a significant indication that the recent regulatory reform was too timid and subservient to the interests of the financial sector. On the other hand, the G20 and the FSB, supported by many commentators, have stressed the international coordination of the newly introduced measures and the shared objective of preserving an open global system, which both stand in contrast to the uncoordinated, protectionist approach of the 1930s. These positive assessments have also flaunted the major improvements in the stability and resilience of the financial sector worldwide. The evaluation of the financial regulatory reform is unavoidably at the core of the assessment of the role of the FSB in global governance – in particular with regard to the impulse it provided for the discontinuity, in process and substance, in prevailing arrangements before and after the crisis. This appraisal reveals the very weak role of emerging countries in setting financial regulation, which stands out in comparison to the sharp increase in formal and informal influence they achieved in all other areas of global governance. In essence, emerging countries continue to be rule takers. This is at odds not only with the major increase in their relative importance in finance, as gauged by several stock and flow indicators, but also with the fact that they successfully vied for representation in the key international rule-making bodies. Several converging factors, of both an economic and a political nature, account for this peculiar outcome. They are all underpinned by the one feature of global governance that has changed little, if at all, since the crisis: the pivot role of the dollar in the international financial architecture, as represented symbolically by the fact that the balance sheet of the new institution which is the most conspicuous challenge to the US hegemony – the AIIB – is denominated in US dollars, even though the US is not even a member. Like the G20, the FSB was not established from scratch in the aftermath of the crisis, but rather involved the transformation of an existing group: the Financial Stability Forum (FSF).

The international standards regime and the creation of the FSF The Asian crisis of 1997–99 spurred the G7 to launch new initiatives to strengthen international economic and financial cooperation under their tutelage. In addition to the establishment of the G20, meant as a forum for dialogue with the most important emerging economies, the G7 deemed it necessary to set up a group explicitly focused on the promotion of international financial standards.

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Inadequate prudential regulation and poor supervisory practices (outside of advanced countries was tacitly understood) were commonly regarded as important determinants of the crises,1 motivating the intensification and extension to other domains of the standard-setting efforts initiated ten years earlier with the Basel Accord on bank capital adequacy. This line of action was promptly followed by the definition of many new international standards, as the G7 elevated existing international organizations of national regulators to a higher level of purposefulness and supported the creation of novel associations.2 The creation of the FSF was a central ingredient in the design of the “international standards regime” for its functions of proactive promoter of this approach and facilitator of the dialogue between the organizations defining standards – the Standard Setting Bodies (SSBs), as they came to be referred to. SSBs were full members of the FSF on their own, indeed so prominently that the FSF was dubbed “the club of clubs”.3 However, this was not the only innovation in membership that set the FSF apart from other international financial bodies. Each G7 country was represented by three institutions (the ministry of finance, the central bank, and the securities commission) with the purpose of coordinating the assessment of various types of financial vulnerabilities, catalysing agreement at a national level, and, more mundanely, trying to avoid disputes between agencies hampering FSF work. The participation of non-G7 countries in the FSF was limited only to the central bank of a very small set of countries hosting sizeable financial centres: Australia, the Netherlands, Hong Kong, and Singapore, to which Switzerland managed to be added in 2007, after years of relentless lobbying. The composition of the FSF by itself suffices to indicate the way the G7 intended to define international financial standards. The G7, the US, and the UK in particular, believed they simply knew better how to prevent crises, as they identified the universal application of their model of regulation and supervision to be the best possible way to ensure transparency and integrity in the financial sector. Although defined by various SSBs, international standards largely drew on AngloSaxon regulation and practices, which embodied key inputs from the private sector and underpinned the success of the most advanced financial centres in the world. In addition to promoting global financial stability, their dissemination would support the competitiveness of the financial industry already adopting them. The crisis modified the attitude of advanced countries, requiring the admission of inadequacies in their own regulation and practices as well as urging corrective actions in their own jurisdictions. Notwithstanding this novel disposition, the international standards regime has remained the core of the agenda of international cooperation in the regulatory and supervisory field. The post-crisis broadening of the geographical scope of its application (in particular, involving the “non-cooperative jurisdictions”, as tax and regulatory havens are called in official documents) is testimony to the fact that the standards regime remains one of the pillars of global governance. In spite of the undeniable trend towards more effective granular standards rather than high-level principles and more rigour in the monitoring of and public reporting on national implementation, the continuity in

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method and process stands in contrast to bolder changes that took place in other areas of global governance. Both political-economy reasons, discussed later, and the specific features of the cross-border cooperation in this field account for this continuity. Enhanced financial interconnectedness, particularly during crises, made clear that in financial regulation and supervision, more than in other areas of international cooperation, the perennial tension between the national basis of legal enforceability, on the one hand, and the need for cross-border consistency, on the other, is most effectively addressed by developing minimum international standards, rather than through detailed international agreements. Standards, which national rules and practices are expected to meet, have to be flexible in their implementation so as to be compatible with different country frameworks. Yet, to be an effective instrument of cooperation, they must be sufficiently ambitious, universal in their applicability, and transparent, in order to be assessable by market participants and national authorities. Legal and technical complexities, and the need to keep abreast of rapid innovation, account for the reliance on several SSBs, which have also strived to improve their legitimacy with more inclusive consultation processes.4 These factors explain the establishment of the standards regime and provide the rationale for its resilience during the crisis and the continuity in its overarching approach, which has been progressively extended to other aspects of financial regulation – for example, the principles on deposit insurance systems which were issued in 2009. The standards regime has become quite encompassing and now covers an ample set of principles that are worth recalling to illustrate the breadth of its scope. Conventionally, the international standards relevant to financial stability are grouped into three areas. The first one regards the transparency of macroeconomic policies and data. It includes principles that should be adhered to in: i) compiling and disseminating economic, financial, and socio-demographic harmonized statistics; ii) adopting practices so as to provide a clear picture of the structure and finances of government; iii) ensuring transparency in the conduct of monetary and financial policies; and iv) producing and disseminating information in order to access international capital markets.5 The second area focuses on financial regulation and supervision, and covers standards to define the framework for: i) the supervision of the insurance sector; ii) the sound prudential regulation and supervision of banks and banking systems; and iii) securities regulation protecting investors, reducing systemic risk, and ensuring that markets are fair, efficient, and transparent.6 The third area covers institutional and market infrastructure, and comprises standards defining: i) independent auditors’ responsibilities; ii) the legal, institutional, and regulatory framework that influences corporate governance; iii) benchmarks to assess the quality of deposit insurance systems; iv) the features of systemically important payment systems, central securities depositories, securities settlement systems, central counterparties, and trade repositories as well as the responsibilities of the respective supervising authorities; v) the legal, regulatory, and operational

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measures for combating money laundering and the financing of terrorism; vi) ways to evaluate and improve insolvency and creditor/debtor regimes; and vii) a single set of accounting standards to be applied on a globally consistent basis.7 On the other hand, if the international standards regime complemented by a pivotal forum bringing together the SSBs is still considered the state-of-the-art approach to international cooperation on financial regulation, why was it unable to prevent the worst financial crisis in nearly a century? Three complementary arguments can be advanced. First and foremost, as we have seen, the standards regime was initially based on the worldwide diffusion of standards largely drawn from Anglo-Saxon practices. Yet, the inadequacy and misapplication of these standards was one of the root causes of the crisis, which in fact originated from the very centre of the global financial system. As discussed in Chapter 1, prudential regulation had progressively become more lax and reliant on financial intermediaries’ own assessment, leading to excessive risk taking and insufficient capitalization, which in turn required many expensive bailouts with public funds. The international standards regime was developed during the progressive deterioration of the very national standards that were supposed to receive universal application. Although in principle compatible with stronger national rules, the setting of minimum international standards encouraged a “race to the bottom”, as countries sought to preserve the competitiveness of their national champions. The second argument concerns the inability of the FSF to monitor the quality of the standards and their implementation. The FSF had little clout over G7 countries and other jurisdictions because of the lack of political determination to make use of its potential peer-pressure capability. In substance, it soon became a talking shop that turned a blind eye to the inadequacy of regulation and supervision in advanced countries. Neither was it more effective, despite the creation of a specific working group and the explicit recommendation to consider using “positive and negative incentives”,8 in ensuring adequate compliance by off-shore financial centres with the core set of principles, including those relating to crossborder cooperation. The poor credibility of the regime at the time is epitomized by the fact that even some G7 members were reluctant to undergo a formal thirdparty scrutiny of their own compliance. When the IMF and the WB initiated, with mixed support from their members, the Financial Sector Assessment Programme9 to evaluate the compliance with the standards promoted by the FSF, the US refused to participate and many advanced countries successfully ganged up to ensure that the exercise (and the disclosure of its results) would be voluntary. Third, non-advanced countries did not recognize the legitimacy of the regime and were at best lukewarm in their efforts to comply with it. Standards were deliberately based on the experience of advanced countries, as conspicuously shown by the exclusive membership of both the FSF and the Basel Committee on Banking Supervision (BCBS).10 Their appropriateness for other countries was accordingly doubtful, not to mention the fact that costs of implementation could be unjustifiably high outside the framework of advanced

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financial systems, unless proportionality of implementation could be appropriately defined. In spite of these deficiencies, the international standards regime was not jettisoned after the crisis. On the contrary, revamping it became the key instrument of the G20 to push for the regulatory reform agenda, which was unanimously viewed as an indispensable component of the policy response to the crisis.

What’s in a letter? From the FSF to the FSB As we have seen, the eruption of the 2008 crisis provided the opportunity for emerging economies to demand a more effective representation in international fora and institutions. Participation in the FSF was one of the very first requests in this area, despite its dubious achievements, its inability to avert the crisis, and the scant knowledge outside its membership about its work. At a coffee break during the drafting session of the communiqué of the Washington summit in November 2008, one of the Chinese delegates, who in the meeting had just vehemently advocated for the enlargement of the FSF to include all G20 members, casually enquired of your author about both the substantive and prosaic aspects of its functioning. Three overlapping reasons explain the impassioned urge of emerging countries to be part of the FSF. First, there was the awareness that the crisis, as always, would be followed by important changes in financial regulation. The sensible assumption, even before one could venture hypotheses, that the FSF would play a central role, motivated a demand to be part of it in defence of one’s own interests. Second, despite its inability to prevent the crisis, the FSF had demonstrated that it could also be an efficient vehicle for international deliberations on financial matters, as shown by the April 2008 report On Enhancing Market and Institutional Resilience. Third, there was the more general issue of tilting the balance of power in global governance, which implied fighting for representation in any forum the G7 ran or influenced. In this respect, the composition and function of the FSF (and its transformation into the FSB) share with the G20 the serendipitous aspect discussed in Chapter 1. The FSF, much like the G20, was “already there” when the crisis erupted, and the broadening of global policy responsibilities to emerging economies had to find institutional and informal frameworks to take effect. Rather than starting from scratch with the establishment of new institutions and groups, it was convenient (and quicker in a crisis time) to transform an existing framework, adjusting its composition or modus operandi to the circumstances of the situation.11 In line with this approach, the pattern of extending participation to G20 members spread to other international groups in the financial field as a result of the pressure from emerging countries. In April 2009, China, Brazil, and India joined the Technical Committee, which is the leading internal body of the International Organization of Securities Commissions. In June 2009, the BCBS was extended to all G20 members, while the other SSBs followed suit.12

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The urgency of emerging markets to participate in the international fora where issues relating to financial regulation were discussed was consistent with the extraordinary attention paid by the G20 leaders to financial issues. Involvement from the top political level is quite standard in the domestic and international management of severe financial crises. What was unprecedented in the aftermath of the 2008 crisis was the persistent intensity of this involvement and the explicit consideration given to technical aspects. Starting with the Washington meeting, the statements coming out from every single G20 summit have had a long and detailed section devoted to the reform of the financial sector – even though, somewhat ironically, they do not seem to have had, per se, a statistically significant effect on asset prices.13 Leaders’ pressing concerns for the financial sector were dictated by the need to take immediate action to repair the financial system, most notably by rescuing systemic intermediaries with injections of public funds at a scale that dwarfed interventions in previous crises. There was no other choice, if the collapse of the global financial system – with the attendant misery, in President Bush’s words, for “many hard-working people who have done nothing to deserve that”14 – was to be avoided. Yet, such a massive resort to taxpayers’ money raised thorny political issues. Public opinion was incensed and further exasperated at learning that fabulous compensations were legally due, and scrupulously paid out, to the very bankers whose recklessness had caused the system’s breakdown. Parliaments were reluctant to vote for the appropriation of the resources necessary for the bailouts. Eventually, they had to bend to the urgency of the situation, but only under the condition that measures sanctioning past misbehaviour and reforming the financial sector would also be enacted. With the ill-concealed objective of containing the scope and incisiveness of the reforms, bankers protested their innocence and started to flag the negative implications for credit availability, vital to the prospects of economic recovery, of the stiffening of financial sector regulation. “Be careful . . . gentlemen. My administration is the only thing standing between you and the pitchforks”15 – President Obama’s famous retort, at a dinner with the CEOs of the major US banks, to the claims that the exorbitant salaries in the financial industry were motivated by international competition for talent. An international review of compensation practices in the sector was launched soon after, though its punch rapidly petered out. In addition to helping assuage domestic political concerns for the bailouts, international cooperation was necessary, in the words of G20 leaders,16 “to turn the page on an era of irresponsibility” and “implement reforms that will strengthen financial markets and regulatory regimes so as to avoid future crises”. Although rhetorically captivating, the goal of “avoiding future crises” could hardly be credible in light of historical experience – not to mention the view that considers financial instability an inescapable feature of capitalism.17 But this goal underpinned and gave momentum to the still very ambitious objective of “implement[ing] sweeping reforms to reduce the risk that financial excesses will again destabilize the global

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economy”.18 By explicitly proclaiming this goal, the G20 leaders set in motion a process that would consistently remain at the top of the agenda of international relations for a long period. Several reasons explain the persistence of this prominence coupled with the escalation to the highest political level of negotiations on quite technical aspects. First, there is the sheer complexity of the matter. The phenomenal expansion of finance had both bloated the stocks of assets and generated an intricate network of interconnections across markets and institutions, often through complex instruments, which created new menaces to stability. Reforming financial regulation involved a bafflingly wide array of laws, norms, and rules setting incentives that had proven difficult to assess at the time of issuing regulations. “To turn the page on an era of irresponsibility” with a consistent set of new rules was a tall order from a technical point of view, particularly because apparently minor regulatory details can have huge implications. Second, regulatory changes involved sensitive political trade-offs, since the financial industry had developed a resilient capacity to influence governments and parliaments.19 Though this capacity was dented in the acute phase of the crisis, it proved strong enough to require prolonged efforts to devise and implement new regulations. Third, at the international level, negotiations predictably encountered acute difficulties since re-regulation, with the definition of new standards (or new ways to implement old ones), would have critical implications for the competitiveness of the different countries’ financial industries – as well of specific market players. The more the “reforms to reduce the risk that financial excesses will again destabilize the global economy” had to be “sweeping”, the more the established market equilibrium in global finance could be potentially unsettled, challenging vested interests and opening new opportunities. It is not surprising, then, that the reform process set off long and harsh international disputes – particularly with regard to access to each other’s markets and equivalence of domestic rules – that absorbed significant political capital in international fora and triggered, for their management and eventual resolution, the active involvement of the transnational financial industry.20 Last but certainly not least, the US very actively promoted international cooperation in the effort to ensure that the post-crisis financial standards would be uniformly high, avoiding a competition across jurisdictions to attract financial business through lax regulation. Such a race to the bottom would jeopardize global stability and, crucially, would impair the competitiveness of the US financial industry, unable to join in the race after the crisis had made the stiffening of financial regulation a political imperative. This political economy motive was candidly put forward by the US administration.21 Together with the desire to prevent financial protectionism, harmful to US interests, it goes a long way in explaining the US staunch support for the FSB and its insistence that regulatory cooperation remain at the top of the international agenda. In one of the innumerable ironies of history, the arguments why the FSB and international cooperation on regulatory matters was in the US’s best interests had

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again22 to be elaborated in detail for the benefit of the incoming Trump administration. The prompt to do so, symptomatic of the new attitude to international issues, was the letter, written on 31 January 2017 by a Republican Congress member to Chairwoman of the Federal Reserve Board, Janet Yellen, which stated that “the Federal Reserve continues negotiating regulatory standards for financial institutions among global bureaucrats in foreign lands . . . [while it] . . . is incumbent upon all regulators to support the US economy”.23 This rhetoric, ultimately stemming from President Trump’s “America-first” mantra, is quite different from the emphasis on the shared objective to promote global financial stability that underpinned the ambitious objectives assigned to the FSB at the time of its establishment.24 Yet, they both share, together with all the post-crisis memoirs written by US leading figures,25 the very limited recognition of the fact that the regulatory flaws at the root of the worst financial crisis in nearly a century were part and parcel of the US legal and supervisory framework, which had been used as a model for the definition of the international standards regime. With this background in mind, one can appreciate why the move from the FSF to the FSB was a significant innovation in global governance despite the continuity of the international standards regime as the overarching approach to pursuing financial stability.26 With a single institutional arrangement, the creation of the FSB pursued several objectives, namely: i) to accommodate the demand of emerging countries for a stronger role in global governance in this domain too; ii) to give renewed impetus to the definition and implementation of more effective regulation; iii) to foster international cooperation striving for international consistency; iv) to revamp the monitoring of the implementation of the international standards regime (in both advanced countries and non-member jurisdictions, including non-cooperative ones); and v) to offer a convenient framework and venue for negotiating a viable compromise between conflicting interests across countries and sectors. These ambitious goals, together with US support, motivate the endlessly quoted declaration by Secretary Geithner27 that “[establishing the FSB] is to add, in effect, a fourth pillar to the architecture of cooperation we established after the second world war”. The IMF immediately spotted the potential for an international institution, no matter how small or informal, devoted to financial regulatory issues, and feared that its own role in global governance could be partially eclipsed. Already during the G20 Washington summit in 2008, tensions surrounding the separation of their respective tasks had emerged and were overcome through the direct involvement of the FSF chair and the IMF managing director. The establishment of the FSB in 2009 rekindled turf disputes, which, although persistent, have never escalated to the point of preventing an effective collaboration in promoting the implementation of standards. The most emblematic expression of this joint work is the preparation of the Early Warning Exercise – a restricted session during the “Washington meetings” where they candidly present what they see as the major threats to global financial stability.

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The daunting tasks of the FSB The regulatory reform that the FSB was mandated by the G20 to spearhead and coordinate covered a very broad set of issues. Some were the areas that the crisis had revealed to be glaringly faulty, while others were the subject of existing work by the FSF that the post-crisis reformatory momentum allowed to intensify and accelerate. This section provides a sketchy and unavoidably selective review of the key issues.

Capital adequacy Norms obligating banks to have a level of capital adequate to absorb the losses even in a stressful environment have always been at the core of bank regulation. The Basel Accord of 1988 on “International convergence of capital measurement and capital standards” was the first example of effective international cooperation on financial regulation. In 2004, that agreement was modified (in the so-called Basel II Accord). It accommodated the financial industry’s demand for more attention to be paid to its own assessment of capital adequacy, but the extent of this accommodation led many to regard it as a blatant example of regulatory capture.28 Insufficient quantity and quality of capital to absorb losses was immediately recognized as one of the key causes of the crisis. The need for more and better capital became the cornerstone of the regulatory reform promoted by the G20. In late 2010, the BCBS approved the Basel III Accord, whose official name makes explicit reference to “more resilient banks and banking systems” (emphasis added). This result was reached after intense negotiations with the financial sector, which spared no effort to limit its scope and stringency, and among regulators, who had markedly different preferences29 that could only be reconciled through the leaders’ informal mediation at the margins of the G20 Toronto summit in June of that year. Basel III unambiguously provides for higher capital ratios and a stricter definition of the assets that may count as capital for regulatory purposes. Whether this increase is sufficient has been disputed. Defenders are not uncommon,30 but argumentative detractors claim that regulatory capture by large international banks was again the overwhelming force31 behind the definition of capital standards, while others insist that they remain much lower than what banks themselves routinely demand from their borrowers in the course of their activity.32 The debate over the appropriateness of the new standards was eclipsed by the negotiations over their implementation.33 The timeline of the new regulation’s entry into effect was the subject of harsh disputes with the industry among regulators across the Atlantic and within Europe, as were two related issues that received particular attention: i) the pro-cyclicality of capital standards (banks are subject to more stringent requirements during difficult times, discouraging lending just when it is most needed); and ii) the focus on a broader concept that could be a better safeguard to financial stability – that is the “total loss-absorption capacity”, which, in addition to proper (Tier 1) capital, could include hybrid instruments, such as contingent convertible notes.

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The jury is still out on the success of the internationally agreed upon and uniformly applied capital standards, which are the ultimate kernel of banking regulation, as the deadline for implementation in all jurisdictions belonging to BCBS was only 1 January 2019. On both sides of the Atlantic, the perspective on this issue is that the other side had the upper hand, while emerging powers remain fence-sitters.34 As a measure to complement capital standards that are complex and prone to partial circumvention,35 the Basel III framework innovatively added requirements on banks’ liquidity: first, the liquidity coverage ratio, intended to ensure that banks have highquality liquid assets available to cope with short-term cash outflows; second, the net stable funding ratio, as a safeguard against liquidity mismatches.36 The short period since their implementation, and the environment of super-abundant global liquidity associated with the policies of quantitative easing, pursued by all the major central banks, prevent an assessment of the requirements’ effectiveness – assessment that is anyhow difficult because their interaction with capital standards is not obvious.37

Too big to fail The eponymous best-selling chronicle of the crisis,38 the outrage over the bailout of many large banks, and the trauma of Lehman’s bankruptcy all contributed to giving particular prominence to this perennial issue. In a nutshell, it can be summarized as the perverse incentive of large financial intermediaries to take excessive risks with the knowledge that they can reap extra profits if things go well, while, in the event of a mishap, authorities are bound to come to the rescue, fearing the catastrophic systemic implications of their bankruptcy. To complicate the matter further, at times of financial distress, Systemically Important Financial Institutions (SIFIs) tend to face difficulties at the same time because of shocks hitting the entire system, their interconnected exposures, and/or the herd behaviour of market participants.39 Moreover, as Bagehot famously contended in Lombard Street, only illiquid but solvent banks must be rescued, although in a crisis, it is quite difficult to separate them from insolvent ones. Following the G20 mandate to address “systemically important institutions”,40 the FSB initiated three parallel work streams to: i) devise additional capital charges for SIFIs so as to restrain excessive risk taking; ii) define criteria for enhanced prudential supervision; and iii) facilitate the resolution of SIFIs. It should be emphasized that for each of these issues, the cross-border dimension of the operations of the largest SIFIs involves an extra layer of complexity, due to the national legal basis of supervision and bankruptcy laws, as well as the specific political economy issues related to the protection of the respective financial industries.41 Even the necessary first step of identifying SIFIs – which should in principle directly descend from straightforward metrics of size, complexity, and interconnectedness – proved controversial. More granularity in the definition of SIFIs turned out to be the way to find an agreement, distinguishing between global and domestic SIFIs, between systemically important insurers and banks, and, for the

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latter, defining five different buckets, each associated with a distinct rate of capital surcharge.42 Once again, it is too early to reliably assess the effectiveness of the remedies introduced to cope with the too-big-to-fail issue.43 Yet it is quite remarkable that the obvious solution of a mandatory reduction in size for the “extra-large” banks (“if a bank is too big to fail, it is just too big”) was hardly ever proposed, even in a very intellectually rich debate,44 and was never considered a viable option in policy circles.

Transparency and integrity The outburst of the financial crisis was accompanied by frauds and accounting scandals45 that further tainted the reputation of the whole financial industry. Authorities had to take action and followed three main avenues. First, they promoted a tougher enforcement of regulation, insisting on the fit-and-proper requirements, more actively discouraging revolving-door practices,46 and, most conspicuously, levying fines of unprecedented size. The repetition of significant scandals, such as the rigging of the LIBOR index by major international banks, unavoidably casts radical doubts on the effectiveness of pecuniary sanctions, which seem to be considered by financial intermediaries more as an operating cost than a deterrent inducing honest behaviour. The second line of action was, in the US, to reintroduce the restrictions on proprietary trading activities that had characterized the post-1929 crisis regulation (and had progressively been lifted beginning from the 1990s) with the aim of eradicating the conflicts of interest between financial intermediaries and their clients. The so-called Volker rule (from the former Federal Reserve chairman who championed it) was introduced in the reform of US financial codes with the aim of reducing conflicts of interests and moral hazard on the part of banks.47 Third, at the London summit, the G20 leaders explicitly called on “the accounting standard setters to work urgently with supervisors and regulators to improve standards on valuation and provisioning and achieve a single set of highquality global accounting standards”, and in Pittsburgh, they even required the relevant bodies “to complete their convergence project by June 2012”. As a result, the FSB fostered the acceleration of work to implement the memorandum of understanding to this effect (Norwalk agreement), signed in September 2002 by the Financial Accounting Standards Board, the US standard setter, and the International Accounting Standards Board, promoted by the EU. In spite of this peremptory mandate, the harmonization project soon lost momentum and was, in substance, abandoned. The blatant disregard of the G20 injunction has several causes: from the complexity of certain technical questions, such as the evaluation of fair value in illiquid markets, which are addressed in very different ways on the two sides of the Atlantic; to deep-seated political economy issues, with their specific intra-European twists.48 Yet the inability to agree on a common set of accounting methods undermines the credibility both of the financial industry and

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of international cooperation, while remaining a source of fragility for the global financial system.

Excessive risk taking With the exception of a few financial operators who blamed the joint occurrence of very improbable circumstances, the consensus view considered the widespread recklessness of the financial industry to be one of the key causes of the crisis. Banks’ own risk-control procedures and market discipline had proven so inadequate that regulatory response in this area was deemed urgent. As early as their first summit in November 2008, G20 leaders gave a precise mandate to “develop enhanced guidance to strengthen [financial] institutions’ risk management practices, in line with international best practices”. The FSB, once again, spearheaded the pursuit of this mandate and initiated two main strands of work. First, supervisors agreed to take a more stringent attitude when assessing banks’ internal procedures on risk management, in particular within the framework of stress testing.49 With no dependable method for gauging risk exposure and discriminating between “reasonable” and “excessive” risks, supervision embraced a more hands-on approach to banks’ risk management, shifting away from the pre-crisis deference towards the expertise of market participants.50 The second thread regarded the elaboration of regulatory precepts to remove the incentives to excessive risk taking from compensation structures. Perverse motivations are simple to appreciate – if a trader’s bonus is linked to the success of a risky investment, s/he might as well make it as large as possible: if things go well, rewards are accordingly larger, while if the outcome is adverse, the bonus is zero irrespective of the size of the wager. Analogous perverse incentives arise in many other circumstances and apply to most decision makers on risk matters, including CEOs. Although the dangers of misaligned compensation practices had long been recognized,51 only the outburst of the crisis and public outrage at bankers’ earnings triggered concrete actions. Tense negotiations led to an agreement on principles for compensation structures meant to better align monetary rewards with sound risk management, also strengthening the link with long-term performance.52 These principles were introduced in regulation, and econometric analysis has proven their effectiveness in containing risk taking.53 The political pressure to reform compensations in the financial sector ultimately originated from the vehement indignation about their level, but regulatory action only pertained to their implications for risk management. Although all political leaders in public maintained some degree of ambiguity in the distinction between the two aspects, in the technical negotiations, a clash emerged between delegations, particularly the US one, who wanted to dispel this ambiguity, and those, most notably the French, who advocated regulatory leverage to moderate remunerations. The confrontation was short-lived, as the US position prevailed.

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Shadow banking This designation covers a congeries of financial institutions and markets that perform a variety of bank-like financial services without falling within the regulatory definition of banks that typically hinges on deposit taking. For this reason, shadow banks do not have direct access to public backstops, such as central bank liquidity, and are subject to lighter, if any, regulation, supervision, and reporting requirements. This reduces their costs, providing a competitive advantage that was been widely exploited through regulatory arbitrage. In the run-up to the crisis, the sector grew spectacularly, and in the US, it surpassed the traditional banking industry in size54 while its riskiest part remained little controlled and insufficiently known. The combination made it a perfect culprit, or at least accomplice, of the crisis. Although the damages shadow banks had allegedly caused lacked explanation and solid evidence, they stood out as a potential threat to be addressed: at the London summit, the G20 pledged “to extend regulation and oversight to all systemically important financial institutions, instruments and markets”. To follow up on this commitment, the FSB launched yet another work stream “to transform shadow banking into resilient market-based finance”, as its own website puts it.55 In spite of the fact that defining the boundary of financial regulation is fraught “with real and severe problems . . . [which] . . . have no easy answers”,56 in October 2011 the FSB managed to issue recommendations for strengthening the oversight and regulation of shadow banks and it has since monitored their implementation.57 The negotiations that led to this agreement conflated tricky technical issues, most notably the specification and use of the statistics to be gathered, with contrasting views over the role of non-standard financial intermediaries, in particular with the confrontation between the US laissez-faire attitude and the German distrust epitomized in the comparison to verminous locusts.58 As a result of the FSB initiative, the perimeter of the regulated financial sector was extended, although some argue that it was done so with only ineffective measures because of two mutually reinforcing factors: the regulators’ capture by interest groups and their inclination to promote national financial industries.59

Over-the-counter (OTC) derivatives This term indicates derivatives that are not traded in centralized platforms and that, in addition to hindering transparency and creating opportunities for market abuse, gave rise to a web of counterparty exposures of an inordinate size (some US$600 trillion in 2008). The crisis inevitably exposed the systemic risk associated with the situation and the by now familiar pattern was again followed: the G20 leaders set an explicit objective (“All standardized OTC derivative contracts should be traded on exchanges or electronic trading platforms, where appropriate, and cleared through central counterparties by end-2012 at the latest”60); the FSB instituted a work process ad hoc; difficult negotiations led to specific recommendations, whose implementation has been monitored regularly.61

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Progress in this field was arduous and the 2012 deadline, set by G20 leaders, was missed by several years. Three key factors account for the extreme difficulty of the process. First, the opposition of the financial industry was extraordinarily fierce, presumably motivated by the extra profits generated by OTC trades as opposed to transactions in more transparent market settings. To overcome this resistance, moral distinctions had to be mobilized in public discussions and parliamentary debates, emphasizing concerns over speculative behaviour and insisting on the questionable post-crisis legitimacy of the financial industry.62 The second factor was that clearing derivatives through central counterparties shifted the systemic risk onto these institutions, giving rise to novel issues that regulators were ill prepared to address. The third reason was the competition between the US and the EU to attract OTC derivative business, which generated harsh disputes over market access and a level playing field. Although the FSB assessment of the reform in 2017 is soberly positive, it points to the need for further efforts to complete it and the analyses to gauge its direct implications, while several researchers emphasize remaining challenges to ensuring that systemic risk is actually reduced.63 Finally, at the November 2010 summit in Seoul, the G20 tasked the FSB, together with the IMF and the Bank for International Settlements, “to do further work on macroprudential policy frameworks (emphasis added)” – that is, on the use of prudential tools to limit systemic risk by strengthening the financial system’s own defences in the face of shocks.64 Responding to a request from the G20 finance ministers and central bank governors at their February 2016 meeting, the three institutions have recently evaluated the international experience with these policies in a report that is so balanced as to sound lukewarm.65 The cautious assessment is shared by academic analyses.66

Halfway, half-empty, half-hearted, yet significant The broad scope of the regulatory reform, which even this sketchy overview has conveyed, resulted in practice in its fragmentation into many processes, with different institutions and actors involved in the various fields. Although they all shared the overarching mandate from the G20 leaders and the FSB as high-level hub and facilitator, the streams elaborating regulatory changes (and then monitoring their implementation and implications) faced different institutional frameworks and legal constraints. Even more importantly, they confronted diverse political economy incentives for both stakeholders and regulators, as well as veto players, at both the domestic and international levels. This fragmentation, which can be viewed as an example of a more general trend towards decentralization in financial governance,67 led to a variation in the dynamics of the regulatory process that was endogenous to the matter at hand with regard to both the intensity of the transformation and the speed of its implementation.68 The disparity among the achievements in the different issues and sectors is documented in detail in the yearly report on the Implementation and Effects of the G20 Financial Regulatory Reforms, which the FSB has been publishing since 2015.

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The executive summary of the first report69 openly admits that the “implementation progress has been steady but uneven” and introduces a colour-coded summary table to flag delays and failings. With equal candour, it also states that “G20 leaders’ support is needed to overcome implementation challenges involving legal powers and resources”, showing the fatigue of the G20 in maintaining the momentum for the regulatory reform after the economic and financial situation normalized even though in many areas the reform was only halfway. On this score, the turning point was the 2015 Australian presidency. It insisted on shifting the G20 narrative from “introducing sweeping reforms” to “finishing the job”. The relevant wording in the Brisbane communiqué, which the presidency managed to pass with minimal concessions to reluctant delegations, is clear: “The task now is to finalize remaining elements of our policy framework and fully implement agreed financial regulatory reforms”. Against this backdrop, most general assessments of the post-crisis regulatory reform70 carefully differentiate among the various key areas and are wary of passing overall evaluations, which otherwise could only be summarized by the stale analogy of the glass that is half empty and half full. Yet the pendulum swung back towards re-regulation far less than one might have expected given the intensity of the crisis and the experience following the 1929 collapse. Back then, the financial industry was subject to what now appear stringent and inefficient restrictions, which basically lasted for more than half a century during which no global crisis of comparable intensity took place – a fact that “commands respect, or at least curiosity”.71 This time around, continuity and incremental revisions have prevailed over rapid transformation and radical change.72 Although even a gradual process can lead to profound renewals, many have taken paradigm continuity and the lack of an overhaul in banking regulation to be the results of the resilient strength of the financial industry lobby and regulatory capture.73 In this, private finance has received further help from the technical complexity of the regulatory issues and public agencies’ difficulty in matching the private sector’s technical skills.74 Both circumstances are likely to persist, as is the industry’s capacity to offer very attractive jobs to regulators and to be a major bipartisan contributor to electoral campaigns, thus casting fundamental doubts on the possibility of regulatory capture ever being overcome. If the intensity of the regulatory reform was uneven, was the transformation in the international governance of financial regulation radical? In particular, has the FSB become the fourth pillar of global governance, as the US Treasury secretary Geithner famously maintained? Persuasive arguments can be advanced to support a flatly negative answer. Unlike for the IMF, the WB and the WTO, there is no international treaty establishing the FSB, which therefore has no legal clout nor formal or informal mechanism for enforcing its decisions – not even a panel of experts along the lines of the WTO model.75 The FSB has no full-time chair. Its staff is meagre and relies too much on seconded personnel from other institutions, especially to carry

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out its peer reviews, which are the key instrument for monitoring and fostering the implementation of the standards regime. As we have seen, it was not always successful in sustaining the momentum of the bold reform initiatives of its initial phase, often unable to reconcile political economy issues across stakeholders, and often challenged for its unfulfilled legitimacy. Despite the resilience of the technical processes it presides over, the FSB has been relying on the political support of the G20 and is thus exposed to its vagaries. For all these reasons, the FSB was called “a renamed and slightly souped-up version of the FSF”76 and presented as the most emblematic case of the contention, diametrically opposed to the thesis of this book, that the post-crisis changes in global economic governance were only cosmetic: The System Worked and the world experienced a “mere” Status Quo Crisis.77 Leaving aside the sweeping judgement on global economic relations, these analyses correctly point to the fundamental continuity in the post-crisis international governance of financial regulation. More specifically, your author submits that this continuity ultimately stems from the major countries’ attitude towards stepping up international cooperation, which has been half-hearted despite the advantages of regulatory consistency in a world of ever-growing financial interconnectedness. This ambivalence stems from two deep-seated political economy issues that survived the crisis virtually unscathed and heavily influenced policy responses. First, international regulatory cooperation has always been constrained by each country’s objective of defending the actual or perceived interests of its own financial industry, both in protecting the domestic market from foreign penetration and in favouring its expansion abroad.78 Thus, in parallel to their support for the G20 financial reform agenda based on the revamping of the international standards regime, major countries, and most notably the US and the EU as a bloc, sought in various ways to (re)assert their regulatory power towards other jurisdictions, which in turn typically followed the same logic. Efforts to strengthen cooperation and improve cross-country consistency in the implementation of regulatory standards went hand-in-hand with disputes about the terms of access to each other’s markets, the equivalence between domestic rules, and their extraterritorial implications.79 In these controversies, the US clearly maintained a pre-eminent role, which finds further validation in recent analyses based on network models: such models emphasize the hierarchical, as opposed to flat, structure of the network with the US as a pivot, enjoying advantages as a first mover and pace setter.80 Yet it should be noted that, while Japan and emerging economies always behaved as fencesitters in international disputes, on various issues, the US became a foot-dragger with respect to the EU’s post-crisis activism, so that transatlantic regulatory confrontation often acted as a catalyst to settling intra-EU disagreements.81 The second factor at play in shaping national authorities’ ambiguity towards international cooperation is the compelling influence of the transnational financial industry in the management and settlement of international clashes over standards and rules. In the “polycentric governance of international finance”,82 the industry’s lobbying power not only led to the regulatory capture recalled earlier but

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also acted as a key driver for finding politically and technically viable solutions to regulatory controversies. The industry objective was to avoid hampering crossborder business and disrupting the global network of private finance.83 Deploying substantial resources and political capital, the transnational lobby marshalled the support of other private-sector interest groups and achieved a “structuring power”84 that was even capable of shaping regulation so as provide exit options from a given jurisdiction. These political economy factors combine with the practical expediency of the international standards regime discussed earlier (flexibility in implementation; adaptability to innovation; conformity with the national basis of legal enforceability) to make soft law the key instrument of international regulatory cooperation.85 Soft law, as opposed to “hard” arrangements based on international treaties or fully fledged institutions, allows the coexistence of different institutional designs. Although comprised of different processes, it can nevertheless be viewed as an integrated system that determines the allocation of regulatory powers, their interaction, and their effectiveness at the global level in fostering financial stability and consumer/saver protection. Given its reliance on informal groups of “independent” agencies, the soft law architecture raises concerns of legitimacy and accountability in the absence of well-established international instruments of legislative and executive oversight, which the G20 cannot possibly surrogate given its nature and organization. In spite of the inherent limits to its enforceability,86 international soft law is not simply an articulation of regulatory networks; rather, it has acquired the status of a political resource in itself.87 As of now, it appears there to stay, since the evolution towards a treaty-based “World Financial Organization” is as impractical as unlikely, although some advocate it with good arguments.88 Within the framework of international soft law, transnational informal institutions have acquired a relevance that goes well beyond their provision of secretarial support to cooperation, becoming sources of policy feedback and transformations of the political landscape.89 The FSB is by far the most important among them and, though it did not become the fourth pillar of global governance (how could it in a context favouring soft law?), it has undoubtedly become a key new element in global financial governance. Since its inception, it has firmly stood as the hub for all international negotiations within its broad domain, promoted cross-border consistency of financial regulation and oversight, and spurred the G20 to maintain technical consistency in its pursuit of global financial stability. These facts are independent of one’s assessment of the adequacy of the reforms the FSB promoted and contributed to implementing. Paradigm continuity in financial regulation and oversight, the reliance on soft law, and the light legal and organizational underpinnings of the FSB should not lead to an underestimation of the major changes in global economic governance that have taken place in this field since the crisis. Most notably, regulatory issues have received great political attention, as vividly shown by the space devoted to them in G20 communiqués, and the implementation of international standards

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has become more stringent, with wider geographical diffusion, even on regulatory and tax havens. Above all, from the viewpoint of the global financial architecture, emerging countries now sit as full members in both the FSB and SSBs. Yet their influence in these groups has been minimal, disconcertingly feebler than in any other aspect of global economic governance. The next section addresses this issue.

Rule-taking behaviour The introduction of the international standards regime and the establishment of the FSF were framed, to use a crude analogy, as a sort of colonialist transfer of regulatory “civilization”, chiefly in its Anglo-Saxon rendition, to emerging and developing countries, which in the recent past had been the origin of financial turbulence. The universal application of advanced countries’ regulation and supervision was expected to foster domestic and global financial stability while promoting the worldwide predominance of their financial industry. The initial set-up of the standards regime contemplated hardly any channel through which emerging countries would provide feedback since they were part of neither the FSF nor the SSBs (with the exception of the IMF, of course). They were meant to be rule takers, benefitting from advanced countries’ superior experience and know-how, while modernizing their financial systems and opening up their capital accounts. Emerging countries did not fully accept the legitimacy of the system, were cautious in the implementation of standards not necessarily pertinent to their situation, and had other priorities in the definition of financial sector policies. Moreover, contrary to what the G7 and the IMF had expected (or claimed), financial markets did not seem to reward the adoption of international standards with lower interest rates, larger capital inflows, and the avoidance of market closure at times of stress. Markets were unwilling or unable to discriminate between actual compliance and the “mock” compliance at times adopted as a token of concession to peer pressure from advanced countries and the IMF.90 Meanwhile, financial development in emerging countries, especially in Asia, proceeded very rapidly. Particularly in the banking sector, since the 2000s, global finance has recorded changes in the relative importance of the major areas that are comparable to the radical transformation in the world GDP relative shares described in Chapter 1. At the beginning of this century, of the 100 largest listed banks in the world, only two were from emerging countries; fifteen years later, a third are. Since 2015, with US$32.1 trillion assets, China has turned out to be the largest banking jurisdiction, surpassing the euro-area (US$31.6 trillion) and the US (US$16.3 trillion). The growth in the size of emerging countries’ bond markets and listed companies’ capitalization has been impressive too, although in capital markets, nonbank intermediaries, and assets managers, the predominance of advanced countries has eroded far less, at least so far.91 All these factors underpin emerging countries’ resolute request, already discussed in detail, to become members of the club of international rule makers and standard setters in the financial field, as one of their utmost priorities in tilting the

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power balance in global economic governance. They were rapidly successful in this objective. Yet it did not take long to realize that, to use the words of the chief adviser to China Banking Regulatory Commission,92 “although there is a shift in the balance of economic power from the rich to the large emerging countries such as China and India, the basic rules of the [regulatory] game have not changed”. Notwithstanding their full membership in all standard-setting groups, emerging economies have only had a minimal clout and continue de facto to be rule takers. Some have somewhat tempered this assessment with various qualifications: there is no clear evidence that regulatory outcomes are biased towards NorthAtlantic interests;93 their participation in the FSB and other fora had a beneficial impact on their financial stability because of the resulting pressure to update regulation; there was some progress towards the compatibility of international standards with emerging economies’ regulatory preferences – indeed, had they not been members, the new regulation would have penalized them.94 And their active role in the G20 fostered the adoption and pursuit of the agenda of Global Partnership for Financial Inclusion, which is close to their hearts.95 These qualifications, irrespective of their relevance, do not alter the gist of the conclusion that in financial regulatory matters, emerging countries have persisted in behaving like rule takers, exerting hardly any influence, and with a basically defensive attitude and tepid engagement, as indicated, for example, by few interventions in the BCBS consultative exercises.96 This stance stands in puzzling contrast both to their very demanding approach and to significant achievements in practically all the other aspects of global governance. Various complementary reasons can be advanced to account for this anomalous situation. The first argument is straightforward. Emerging countries did not manage to behave like rule makers because the advanced ones just did not let them: financial regulation is a very powerful instrument to defend the incumbent position of the advanced countries’ financial industry, as shown by the acrimonious regulatory disputes between the EU and the US. This reason, however, cannot possibly be sufficient. In many other cases, advanced countries resisted emerging countries’ demands for more power, but the latter certainly did not take “no” for an answer, as the case of the AIIB vividly illustrates. The second argument is that emerging markets did not consider it necessary to enter into the regulatory disputes. The seat they had obtained in the key standardsetting bodies allowed them a vigilant presence that could prevent decisions detrimental to their strategic interests. Going further and trying to export their preferences, which would have required the investment of substantive political capital, was not one of their priorities. Such a muted appetite for playing a proactive role in the definition of new regulation is underpinned by various circumstances. Banking systems in emerging economies are more domestically focused than in advanced economies, and for them entering the competition for global financial services does not typically stand as an attractive area of business development.97 Even Chinese banks, whose foreign assets dwarf those of their emerging market

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peers, have an international activity linked to the state-guided strategy of support to China’s commercial penetration and south-south cooperation. As a result, emerging countries’ rule-taking behaviour was felt not to impair their financial industry interests. Neither were the implications of international standards for domestic activity strong enough to motivate the efforts to sustain an assertive attitude. One can cynically remark that, if international standards were felt to be inadequate, a tenuous domestic compliance could still be engineered – and this might be more expedient than negotiating an explicit exemption or fighting in the relevant committees in order to sway the decision. On a more positive note, standards drawn from the experience of a more complex and innovative financial system can actually prove useful in the modernization of emerging markets’ financial structure. Some argued that the attention and rapidity in the implementation of Basel III provide an unmistakable indication of the alignment of international banking standards with the policy preference of the early adopters – most significantly, China. For the latter, other factors have also been at play. China was weary of embarking on another front of confrontation with the US, when there were so many others with higher priority. Domestically, besides the intrinsic advantages, the adoption of international financial standards could become a highly visible and symbolic instrument for pursuing an agenda of modernization for the country – a necessary step to maintaining a competitive edge in a rapidly evolving world. This view was shared by the government and many Chinese scholars, who brought back into fashion the traditional phrase, “catch up with the modern world”, or 与国际接轨 (Yǔ guójì jiēguǐ).98 The third explanation is that even if emerging countries would have liked to be more influential, they were unable to be because they lacked the necessary expertise. The competence to (re)design the international regulatory framework, while being mindful of the interests of one’s own country, is very specialized and can only be acquired through long experience with sophisticated and rapidly evolving contractual usages, supervisory methods, and market practices. As a matter of fact, these skills are concentrated within a quite narrow elite of specialized regulators with an international profile. The standard-setting dialogue has taken place in a close-knit network, which over the years has shared knowledge and mutual understanding while elaborating its own communication and negotiation rituals. Emerging markets’ regulators were not only new to the club but also lacked in large part the required hands-on experience.99 Even ensuring the sheer proficient attendance of all the relevant groups was a challenge: international regulatory coordination is very labour intensive with a long list of committees, groups, and task forces that have further proliferated since the crisis. Similar considerations apply to the transnational financial network of large banks, key to finding solutions to international regulatory disputes. Bankers from emerging markets were simply not within this informal but powerful network, missing out on the shared practice of frequent high-level business interactions at the international level, the customary attendance at the lobbying

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and information-exchange events organized by associations like the International Institute of Finance, and often the education background marking the global banking elite.100 Beneficial as it may be to the incumbent transnational financial intermediaries, the persistence of a rule-taking attitude on the part of the “new powers” is not a good feature of global governance. It strains the legitimacy of the international standards regime in finance. It is unhelpful in safeguarding global financial stability, as it would hinder prompt regulatory action in a situation of mounting stress that might require diverse policies across countries. Proposed remedial actions to foster a more proactive involvement of emerging countries in deciding on international financial regulation typically start with vigorous domestic reforms, additional investment in the training of regulators, and a more assiduous participation in informal international regulatory events, such as conferences.101 They include providing for a larger participation in the standardsetting committees of international officials with a specific knowledge of emerging countries (in addition to the IMF and WB) and offering special assistance to the least-equipped members, as is done in the UN Security Council (which, for example, produces an extensive Repertoire of the Practice of the Security Council). More ambitious ideas of affirmative action for emerging countries propose setting the explicit objective of assigning chairmanships and the location of official events and institutions – for example, moving the FSB to Hong Kong or Singapore.102 Although creative and well meaning, these proposals are unlikely to have a significant impact without a major change in emerging markets’ rule-taking attitude, accompanied by the necessary investment in human resources and political capital. The predominance of advanced countries, and the US in particular, in the setting of international standards, however, has another key underpinning that has so far been neglected in the regulatory debate: the role of the dollar as the pivot currency of the international monetary system.

The exorbitant persistence As discussed in Chapter 2 in the context of the debate on the SDR in the G20, the pivot role of the dollar has always been very sensitive from a political point of view – and not for merely symbolic reasons. Issuing the global reserve currency provides tangible advantages: it facilitates the running of external and budget deficits, it provides a non-negligible source of fiscal revenue through seigniorage, and it enhances the leeway for monetary policy management, even with flexible exchange rates. The “exorbitant privilege”, as Valerie Giscard d’Estaing put it, covers other dimensions too: it fosters dominance in global finance and complements geopolitical supremacy, as the cases of both the dollar and the pound sterling demonstrated in different times and historical contexts. In other words, issuing the pivot currency grants “structural” power in global finance as opposed to “relational” power, which comes from a developed, outward-looking financial system, like that of Japan in the 1980s.103

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One implication of the structural power in global finance, which has so far been overlooked, is the ascendancy it warrants over international financial regulation. This specific type of influence can be traced to the capacity of the US and the UK to impose throughout the world the operating methods and legal approach of their major financial houses. This started with the financial globalization of the late 19th century, but it became deliberately explicit with the launch of the international standards regime in the aftermath of the 1997–99 Asian crisis. As we have seen, the regime was essentially based on the US regulation and practices, providing a competitive edge to its financial industry and helping to further consolidate its structural influence on global finance, all in a self-reinforcing loop. The link between structural power derived from the role of the dollar in the international monetary system and ascendancy over the global regulatory and supervisory environment unfolds through two main channels: i) the predominance of US banks within the transnational financial industry, which in so many cases has been determinant to settle international regulatory disputes; and ii) the priority for large international banks to gain access to dollar liquidity, directly tapping the Federal Reserve System. The importance of multinational financial firms in shaping the global regulatory environment has already been discussed and requires no further elaboration. The point here is that the supremacy of US financial intermediaries within that transnational elite is intimately linked to the role of the dollar as a pivot currency. These two circumstances strengthen one another. The cross-border commercial success of the US banks and the sophistication of the financial services they provide reinforce the attractiveness of the dollar as a reserve currency. The status of the dollar ensures an additional, incomparable advantage to US banks’ global franchise in terms of a further boost to their perceived creditworthiness, which is accompanied by a likely political succour from the world’s leading military power, should critical situations arise. This self-reinforcing combination is in turn an essential element of the US hegemony. The second channel through which the central role of the dollar in the international monetary system underpins US ascendancy over global financial regulation warrants a more detailed technical explanation. Given the pivot role of the dollar, every single financial intermediary intending to develop its activities on a global scale needs abundant and reliable access to liquidity in dollars as an indispensable requirement to running its business. In normal circumstances, the market provides the desired amount of liquidity, at a cost that is in line with market conditions and borrowers’ perceived creditworthiness. Shocks – including those so disruptive as to degenerate into outright crises – can unsettle the market supply of liquidity to the point of making it inordinately expensive or even freezing it completely, either for the single bank, or, as was the case after the failure of Lehman Brothers, for the whole system. In these situations, it is the Federal Reserve System that comes to the rescue with its capacity to create liquidity and offer funds to the single bank or to the market as a whole, as the case may be. In certain cases, because of the malfunctioning of the

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market, even an abundant supply of liquidity is able to reach the intermediaries that need it outside of the US so that central banks of other countries borrow dollars from the Federal Reserve through bilateral swap arrangements and on-lend to the banks in their respective jurisdictions. Indeed, the swap lines granted by the Federal Reserve to several central banks during the 2007–8 financial crisis are viewed by many as the most effective policy response in averting the collapse of the global financial system.104 From the point of view of the single bank running a global business, both systemic and idiosyncratic accidents could generate the need for dollar liquidity in a time span and fashion that only the Federal Reserve could satisfy. Moreover, given the pivot role of the dollar, direct participation in the US domestic financial market is a sine qua non of being competitive in the global financial industry. Access to the Federal Reserve’s facilities can really be considered part and parcel of the organizational infrastructure necessary to be a global player in the financial industry. Global banks thus need at least a subsidiary chartered in the US and to be in compliance with US domestic regulation – which, in turn, might have important spillovers in the management of the entire business, making it easier, other things being equal, to comply with international standards moulded after US regulation. The importance for international banks to maintain the licence to operate in the US and have access to the US clearing system and central bank liquidity is conclusively demonstrated by their willingness to pay the very stiff fines levied by US authorities. What is particularly noteworthy is that, in several cases, the fines were imposed for violations regarding activities carried on outside the US and pertaining to regulations motivated by US foreign policy (such as the ban on transactions with blacklisted countries) rather than by prudential objectives. The record-breaking fine of nearly US$9 billion imposed on BNP Paribas in 2014 was accompanied by the additional sanction of suspending participation in the dollar clearing – “a damaging blow to its international business”, as a news report put it at the time.105 It is impossible, even from a conceptual point of view, to precisely gauge the specific contribution of the pivot role of the dollar in sustaining US ascendancy over global financial regulation, and to disentangle this contribution from that of the size and sophistication of the US financial system, and, more generally, of the US status as geopolitical and military superpower. However, it is quite difficult to envisage a substantive rebalancing in favour of emerging economies of influence in shaping global financial regulation without a decline in the role of the dollar in the international monetary system. The erosion or the collapse of the pivot role of the dollar would have much deeper and pervasive implications for global economic governance than the rebalancing of the power of influence over financial regulation. It would trigger a radical rearrangement of the modus operandi of global finance, private and official, which in turn would require new institutional arrangements with a novel constellation of international power relations, presumably after a transition phase fraught with uncertainty and instability.

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Such a radical transformation in the international financial architecture has long been predicted as imminent: in the late 1950s, Triffin noted the intrinsic contradiction between the need for the US to run persistent external deficits so as to provide the world with the international liquidity required to develop trade, and the debasing of the dollar value that this implies. Since then, virtually every decade has had a cohort of pundits warn of the impending breakdown of the dollar-based system, adding new arguments based on the mounting disequilibria of the US economy, which do not need recalling here. Despite the severe imbalances, the dollar crash has never materialized and the dollar has maintained its function and symbolic position in world finance as well as its safe haven role.106 Its success as a reserve currency, which can be ultimately accounted for only by geopolitical reasons,107 even increased with the post-Asian crisis precautionary accumulation of large foreign exchange reserves and the global shortage of safe assets. Yet given the persistent imbalances in the US financial position, a major financial crisis originating within the US might have been expected to lead to a dollar crisis, questioning its pivot role and depressing its external value, which would have further aggravated global conditions. This was a widespread apprehension in the international official community, which was worryingly voiced in the post-Lehman G20 meetings and contributed to triggering China’s position in support of the SDR, recalled in Chapter 1. The dollar crisis did not happen. On the contrary, the dollar appreciated, as risk aversion rose during the crisis, leading to capital flights and repatriations in search of a safe haven, yet again identified in the reassuring greenback. Two types of explanation have been advanced to account for these developments, which are puzzling considering the severity of distress in the US financial sector, the persistence of US imbalances, and the fact that the crisis has acted as a catalyst for major changes in global economic governance. First, the structural power of the US in international finance is more entrenched and resilient than many had believed, rooted as it is in US geopolitical dominance, enduring military supremacy, and unrivalled financial markets.108 Second, the resilience of the dollar is mainly attributable to the absence of a viable alternative, as both currencies that stand as potential contenders present inadequacies making them unfit even to share the role of international reserve currency with the dollar, let alone to replace it. Given the size of the European economy, and the depth, liquidity, and sophistication of its financial markets, the introduction of the euro was seen as capable of altering the international financial architecture. Yet despite these features and some timid diversification in euros of official foreign exchange reserves, the international role of the euro has never taken off, as the ECB reports on this issue have confirmed over and over again with plenty of statistical evidence. The wanting institutional construction of the EU is universally regarded as the single most important reason why the euro is not perceived as a viable alternative to the dollar. The size of China’s economy and its unconcealed geopolitical ambitions underpin the potential of the renminbi as a global currency. However, its use as an

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invoice currency outside Asia remains very limited when compared to the size of China’s trade. Most importantly, China’s financial markets are still inadequate in their technical characteristics and legal framework, as neither the capital account nor financial services are liberalized – liberalization would open the flank to risks of financial instability and lead to political tensions, because the government would no longer be able to control interest and exchange rates. Thus, as of now, the renminbi does not stand as a realistic alternative to the dollar.109 In the case of both currencies, the impediments to their role as international currency could in principle be overcome by appropriate policy actions. China has clearly manifested its objective to boost the global role of the renminbi, as indicated by the intense lobbying to make sure that it became part of the SDR basket, the insistence on having the WB issue bonds denominated in renminbi, and the capillary promotion of its use for the transactions arising from Asian value chains. The moves towards the liberalization of the capital account and financial markets have been far less bold, if at all material rather than cosmetic. An acceleration on this front currently appears incompatible with the political regime, leading some to surmise that the future of the renminbi lies in playing only a regional role in Asia rather than a global one.110 The repeated warnings of an imminent demise of the dollar have been proving themselves wrong for more than half a century, and its predominance has just withstood the most testing ordeal. Insisting on a gloomy outlook may seem misguided or at best naïve. Yet fundamental factors undermining the dollar’s external value and its global role do remain, and the process of reform in global governance is proceeding in earnest. These arguments are too compelling to be ignored, and they conclusively imply that the diminution of the dollar is inevitable, posing new macroeconomic constraints on the US in exercising its hegemony. These constraints are similar in nature to the ones that the UK had to face in the 1960s in the management of the East of Suez crisis, when the difficulties in financing the budget deficit, which would have been inconceivable at the height of the international role of the pound sterling, forced the timetable for the withdrawal of the British troops from the region.111 Most arguments, however, point to a very slow and protracted process for the decline of the dollar. For starters, the actual availability of a concrete alternative seems quite distant, for the reasons just discussed. Second, the only concrete historical comparison, the demise of the pound sterling, had a very long evolution that lasted over thirty years. The most recent research contends that the length of the retreat was not due to the British efforts to protect the prestige of London as a financial centre. Rather, it was the international community that, given the weakness and uncertainty of the international monetary system, saw a collective advantage in the prolongation of the pound’s international role and supported the UK in managing its retreat also by decumulating official reserves held in pounds very gradually.112 In the case of the dollar, the outstanding amounts of official reserves and the stocks of financial instruments are incommensurably larger, even in comparison to

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world income, and exacerbate the risks of the transition phase. Moreover, a cautious and gradual process is also demanded by the paradoxical situation in which one of the most resolute contenders to complement the US as the issuer of the pivot currency is the very same country that has accumulated by far the largest stock of dollar assets. China thus faces the risk of enormous losses due to both the huge size of its dollar reserves and the enhanced exchange rate effect, because the appreciation of the renminbi due to its new international role would magnify the dollar depreciation accompanying its demise. This difficulty might motivate the resort to an SDR-based mechanism as a way to limit, or spread over time, the changes in the evaluation of official reserves, easing the transition to new international monetary arrangements.

Conclusions The re-regulation of the financial sector has been one of the key elements of the policy response to the crisis. It featured prominently in the agenda of the G20 with a persistence and an attention to technical details that have no historical precedent for international relations at the leaders’ level. The lynchpin of the renewed international cooperation on regulatory and supervisory matters was the establishment of the FSB, which strengthened, with a remarkable continuity in approach, the existing architecture of the so-called international standards regime. The regime essentially consisted of promoting the worldwide adoption of regulatory standards set by international bodies, such as the Basel Committee on Banking Supervision, which were basically mirroring the rules and practices of the Anglo-Saxon financial and banking industries. The G20 assigned the FSB the ambitious mandate to spearhead “sweeping reforms”. The ensuing agenda covered a very broad set of issues, the most important of which have been briefly reviewed here: capital adequacy, too big to fail, transparency and integrity, excessive risk taking, shadow banking, and over-thecounter derivatives. Such an extensive scope resulted in the fragmentation of international negotiations in many processes, each involving different institutions, stakeholders, and political-economy dynamics. The achievements of the reform efforts have been uneven, in many cases unsatisfactory, with continuity and incremental revisions prevailing over rapid transformation and radical change. Various factors account for this mixed success, many of which are specific to the particular issue. A common thread can however be traced in the ability of the financial lobby to continue capturing regulators by virtue of its superior technical prowess and its determinant role in finding technically consistent and politically viable solutions to international regulatory disputes. International financial regulation was also a major arena for the reform in global economic governance. The pre-crisis international standards regime was firmly entrenched in the power relations of the US-led liberal order, as shown by the features of the regulation, which largely drew on US rules and practices, and the absence of emerging economies from the FSF and the standard-setting bodies.

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The establishment of the FSB provided for the participation of all G20 countries. This enlargement was an important element of emerging countries’ objective of power rebalancing in economic governance, which, in this case, the US was prone to accommodate as a way of preserving the international competitiveness of its financial industry: the strengthening and wider application of international standards could prevent a race in laxity which, in addition to increasing the risks of financial instability, would outflank US banks, subject to the post-crisis stiffening of regulation. The FSB failed to grow into the fully fledged, treaty-based, international institution with enforcing powers that some advocated. International financial regulation has continued to be based on soft law, also as a result of each country’s objective of defending its own financial industry’s interests in international regulatory cooperation. Yet, the FSB has been a new important element in global governance. It has become the inescapable hub for the key international negotiations in its broad field, promoting consistent regulatory and supervisory policies in a world of ever-growing financial interconnectedness, and spurring the G20 to maintain the political momentum needed to promote international regulatory cooperation. Despite becoming members of the FSB and all the standard-setting bodies, emerging economies have been exerting remarkably little influence in the shaping of financial regulation. They have maintained a rule-taking attitude that stands in sharp contrast to the clout they have acquired in all the other aspects of global economic governance. In addition to the resistance of advanced countries in conceding leeway in an area they consider strategically crucial to defending their financial industry, other factors account for this puzzling fact. First, emerging countries were reluctant to take sides in international regulatory disputes because they thought they could benefit from international standards or duck them if necessary. Second, they lacked sufficient regulatory expertise and human capital to be active and effective in the negotiations. Finally, and thus far unnoticed as an explanation for advanced countries’ command over financial regulation, the dollar continues to be the pivot of the international monetary system. The dollar’s role assists the US supremacy in this domain through two main channels: the support it provides to the dominance of US banks in global finance, and the priority assigned by all large international banks, irrespective of their nationality, to gaining direct access to the Federal Reserve’s dollar facilities, which requires them to have a subsidiary chartered in the US and thus subject to US regulation. The global financial upheaval originating in the US was initially expected to lead to a dollar crisis, which did not happen. On the contrary, the dollar appreciated and reinforced its function as a safe haven. Although many structural weaknesses in the US position suggest that a diminution of the dollar is prospectively inevitable, this has not yet happened and it is unlikely to occur soon. The demise of a pivot currency takes a very long time, as the historical experience of the pound sterling has shown. Moreover, the two potential alternatives are not yet ready: the renminbi is not backed by deep and resilient financial markets,

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and China’s capital account and financial industry have not been liberalized; the euro, meanwhile, lacks adequate institutional background and political cohesion, a circumstance that is also a cause of Europe’s weak role in global financial governance – the theme of the next chapter.

Notes 1 Porter (2005), and Helleiner and Pagliari (2011). 2 The Basel Committee on Banking Supervision defined new international standards on banking supervision in 1997; the International Association of Insurance Supervisors on insurance supervision in the same year; the International Organization of Securities Commissions on securities regulation in 1998. The OECD contributed with the specification of standards on corporate governance in 1999. For example, the Committee on Payment and Settlement Systems was established in 2001 to define standards on payment systems. 3 Walter (2008) coined the phrase “international standards regime”; Drezner (2008) “club of clubs”. SSB members of the FSF also included the IMF, the WB, the OECD, and the Bank for International Settlements. 4 Regulators of the financial and banking industry, like central banks (see footnote 33 in Chapter 2), are one of those “unelected powers” whose legitimacy and accountability raise fundamental questions that have to be addressed by an appropriate institutional design, as discussed in Tucker (2018). 5 As detailed on the FSB website (www.fsb.org/), the usual denomination of the standards in the first area is: i) Enhanced General Data Dissemination System; ii) Code of Good Practices on Fiscal Transparency; iii) Code of Good Practices on Transparency in Monetary and Financial Policies; iv) Special Data Dissemination Standard. 6 For the second area: i) Insurance Core Principles: Standards, Guidance and Assessment Methodology; ii) Core Principles for Effective Banking Supervision; iii) Objectives and Principles of Securities Regulation. 7 For the third area: i) International Standards on Auditing; ii) G20/OECD Principles of Corporate Governance, which were renamed to take into account that some of the most relevant G20 members are not members of the OECD; iii) Core Principles for Effective Deposit Insurance Systems; iv) Principles for Financial Market Infrastructures; v) FATF Recommendations on Combating Money Laundering and the Financing of Terrorism and Proliferation; vi) Insolvency and Creditor Rights Standards; vii) International Financial Reporting Standards. 8 FSF (2000). See Helleiner (2010b) on the poor results of the FSF’s efforts on offshore financial centres. 9 In addition to this exercise, the IMF initiated the publication of the Reports on the Observance of Standards and Codes, which summarize countries’ compliance. 10 Porter and Wood (2002) insist on this aspect. The IMF and the WB were the only SSBs with non-advanced members, but their responsibility covered standards on the transparency of macroeconomic policies and data. 11 One may recall, as an example of the fortuitous factors determining membership in international groups, Spain, which, in contrast to the Netherlands, had managed to get its “special” invitation to the Washington summit confirmed for the London summit. For this reason, it was welcomed to join the FSB, like all the other G20 members. The Netherlands, like Switzerland or Hong Kong, were included in the FSB because they were in the FSF even though, despite their efforts, they did not manage to join the G20. 12 More details can be found in Helleiner and Pagliari (2009a).

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13 This is the conclusion of Lo Duca and Stracca (2015) who run an event study to test whether G20 meetings have had an impact on global financial markets. Although intriguing, this result should not be over-interpreted, as it pertains to the announcement effect, not to the impact of the policies influenced by the deliberations. 14 These were President Bush’s words during the episode narrated at the opening of Chapter 1. 15 Reported by ABS on 9 April 2009, see http://blogs.abcnews.com/thenote/2009/04/ obama-to-banker.html. 16 Quotations are from the communiqués of the G20 Pittsburgh and Washington summits, respectively. 17 Minsky (1982), and Roubini and Mihm (2010) are two classics. 18 G20 Pittsburgh summit communiqué. Viola (2015) argues that the prominent role thus assigned to the G20 is to be considered a state-initiated “orchestration” – a soft mode of governance used to enlist intermediary actors (in this case the FSB, the IMF, the regulators) on a voluntary basis and to address target actors (in this case the private financial sector). Orchestration was selected to gain influence over the financial regime complex without having to delegate extensive authority to supranational institutions. Although intriguing, this approach fails to consider the powerful influence of the private sector on both the regulators and their political masters. 19 Rottier and Véron (2010) stress the importance of national political economy factors in the setting of financial regulation. 20 Baker (2009), Verbruggen (2013) and Quaglia (2017a). One casualty of the international disputes around the post-crisis reform was “the considerable preference alignment between the two regulatory great powers, the US and the EU”, which, as Newman and Posner (2016a, p. 123) argue, marked the pre-crisis governance of finance. 21 Geithner (2009). As Helleiner (2010b) notes, this is in line with the analytical framework put forward by Singer (2007), which has to be extended to consider the incentives facing political leaders in addition to those affecting regulators. After the crisis, concerns loomed large that, if the US financial industry found ways to benefit from lax regulation in other jurisdictions, this would create a channel bringing vulnerabilities back onto US balance sheets. 22 Sheets (2017). 23 Letter from Patrick McHenry, Vice Chairman of the Committee on Financial Services, to Janet Yellen, available at https://ftalphaville-cdn.ft.com/wp-content/ uploads/2017/02/02104940/McHenry-letter-to-Yellen.pdf. 24 Whereas Geithner (2009) declared “We can’t do this [pursue financial stability] alone. If we continue to allow risk and leverage to migrate where standards are weakest, the entire US-global financial system will be less stable”, Mnuchin (2017) in his meeting with the FSB chair Mark Carney noted: “one of the administration’s core principles for financial regulation is to promote American interests in international regulatory negotiations and meetings”. 25 For example Paulson (2013), Geithner (2014), and Bernanke (2015). 26 As Helleiner and Pagliari (2009a) and Helleiner et al. (2009) stress, the agenda for regulatory reform discussed by G20 leaders at the 2008 Washington summit is practically indistinguishable from the FSF’s roadmap. 27 Geithner (2009). 28 For example, Underhill and Zhang (2008) and Baker (2010). 29 For example, Goldbach (2015), Howarth and Quaglia (2016), Quaglia and Spendzharova (2017a). 30 For example, Véron (2014). 31 Lall (2012) and Goldbach (2015), among others. 32 Admati and Hellwig (2014). 33 This is clearly apparent from the yearly progress reports (available at http://bis.org/ bcbs/implementation/rcap_reports.htm) on the adoption of Basel III prepared by the

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Regulatory Consistency Assessment Programme, which was established by the BCBS in 2012. Proposals for a radical revision of the bank capital regulation continue, however, to be advanced; see, for example, Fullenkamp and Rochon (2016). Examples of such European and US perceptions are Bieling (2014) and Sheets (2017), respectively. Haldane (2012) vividly expresses these concerns. The details of these two ratios are presented in BCBS (2013, 2014), respectively. Cecchetti and Kashyap (2016) argue that they are unlikely to be more binding than capital requirements. Sorkin (2010). Kallinterakis and Gregoriou (2017) thoroughly survey the theoretical and empirical literature on herd behaviour. Communiqué from the G20 Pittsburgh summit. Quaglia (2017b). Quaglia and Spendzharova (2017b) focus on the specificities of the debate within the EU. The list of SIFIs is available at www.fsb.org. Whereas Chinese authorities exerted informal pressures for their banks to be qualified as systemically important (and in the higher buckets) for prestige reasons, most authorities did the opposite. Some US insurers legally challenged their designation, as discussed in Dokic (2016). Poledna et al. (2017) argue that capital surcharges were ineffective, while The Economist (2016) claims that they caused the largest banks to stop growing and obtain smaller profits. Goldstein and Véron (2011) survey this debate. Johnson and Kwak (2010) are among the few who propose a compulsory reduction in size as the only effective fix for the too-big-to-fail issue. One may recall, as examples, AIG and Lehman Brothers, who altered their books for billions of dollars; Madoff, who defrauded his investors of around US$18 billion in a Ponzi scheme; the bonds, based on subprime mortgages, that were granted the highest grade by credit rating agencies and caused huge losses to their buyers. This is the name given to the habit, belonging to supervisors’ and regulators’ employees, of quitting their posts to take high-paid jobs in the financial sector, with the obvious potential effect of fostering captive regulation. Avci et al. (2017) provide an assessment of the Volker rule. Viñals et al. (2013) and the articles in Mayntz (2015) discuss the variants put forward by Liikanen (2012) with a view to European legislation. Posner (2010), Newman and Posner (2016a, 2016b). For the intra-European aspect, see Quaglia (2014) and Kudrna and Müller (2017). BCBS (2009). In the wake of Helleiner and Pagliari (2009b), Mackintosh (2014, 2015) considers this change a paradigm shift akin to the Copernican revolution, while Tsingou (2014) and Stulz (2016) stress continuity in both banks’ behaviour and regulation about risk management. Smith and Watts (1992), Houston and James (1995). FSF (2009). The issue of compensation was so politically sensitive that it could not wait a few days for the FSB. Yang (2017). A survey on the application of compensation principles can be found in FSB (2015a). Pozsar et al. (2010). In any case, as Gorton (2015) noted, the standard definition of the sector is not immune to pitfalls, with obvious measurement implications. www.fsb.org/what-we-do/policy-development/shadow-banking/. Goodhart (2008, p. 53). For a review of the literature on shadow banking, Adrian and Ashcraft (2016). For the recommendation see FSB (2011); for the monitoring www.fsb.org/transformingshadow-banking/.

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58 It was Franz Müntefering, then SPD chairman, who introduced this analogy in the debate (see The Economist, 2005). Together with the stigma it implies, the analogy stuck and has periodically resurfaced as a key political concern, as discussed in Chapter 2 with reference to the St Petersburg summit. 59 Rixen (2013). 60 Communiqué from the G20 Pittsburgh summit. Data on OTC derivatives exposures are from ECB (2016). 61 Information on the recommendations and their monitoring can be found in FSB (2010, 2017a). 62 Clapp and Helleiner (2012), Pagliari and Young (2014), Orban (2016). 63 FSB (2017b), Saguato and Ferrarini (2013), Markose et al. (2017), Cont (2017). 64 This idea was introduced in the policy debate by Crockett (2000) and Borio (2003). 65 FSB (2016). 66 Claessens (2015), Cerutti et al. (2016), Kahou and Lehar (2017), and Galati and Moessner (2013, 2017) review academic literature on macroprudential policies. Visco (2011) and Baker (2013) respectively discuss the macroeconomic and political economy constraints to their implementation. 67 Helleiner (2016a). Regional safety nets, discussed in Chapter 4, are another significant example of this trend. 68 Moschella and Tsingou (2013a) and other articles of the special issue of Regulation and Governance are devoted to analysing variations in the dynamics of the regulatory process across issues of the regulatory transformation. 69 FSB (2015b). 70 For example, Levine (2012), Véron (2014), Darrell (2017). Tooze (2018) and Boughton et al. (2017), instead, present a much more critical assessment. 71 As Lucas (2013, p. 43) puts it in his requiem of the Glass-Steagall Act. 72 Moschella and Tsingou (2013b). However, Baker (2010) contends that gradual processes can lead to major changes. 73 Young (2012) and Goldbach (2015), among others. 74 Helleiner and Porter (2009), Underhill (2015), Becker (2016), in the wake of Laffont and Tirole (1991). 75 This was the suggestion by Eichengreen (2009) and Blackmore and Jeapes (2009). 76 Helleiner (2014a, p. 137). On the shortcomings of the FSB, see also Helleiner (2013). 77 These are the self-explanatory titles of books by Drezner (2014b) and Helleiner (2014a). 78 Kapstein (1989). International standards unavoidably imply a redistributive element as different jurisdictions face non-uniform costs and benefits from their implementation; see Oatley and Nabors (1998) and Drezner (2008). 79 Rixen (2013) and Quaglia (2017a). Brummer (2015, p. 20) describes this acrimony in terms of “efforts to ‘overcomply’ with international standards”. 80 Posner (2010), Oatley et al. (2013), Quaglia (2017b). 81 Quaglia and Spendzharova (2017a), Quaglia (2017b). 82 Posner (2009), see also Avgouleas (2012). 83 Culpepper and Reinke (2014), Emmenegger (2015), Quaglia (2017a). 84 Pagliari and Young (2014), Farrell and Newman (2015). 85 This paragraph’s discussion of soft law draws from Brummer (2014, 2015). 86 Coffee (2013) insists that, because of the mobility of the financial industry, financial regulation should really be regarded as “extraterritorial” – that is, too often out of the reach of US and more generally national courts. 87 Newman and Posner (2016a, p. 123) also argue that soft law “may be employed by reform-minded agents dissatisfied with their domestic policy status quo”. 88 Kono (2017, p. 1) proposes “a treaty-based regulatory framework, while retaining sufficient flexibility at the national level”. 89 Newman and Posner (2016b),

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90 Simmons (2001), Mosley (2009), and Walter (2008), who introduced the expression “mock compliance”. 91 On banking, see Véron (2016); on other instruments, Drezner (2014b). 92 Sheng (2010, p. 196). 93 Véron (2016). 94 Chey (2014, 2016). BCBS (2017) show that Asian countries are more compliant than other emerging countries. Specific studies include Liansheng (2016) on China; Bandeira Martins (2016) on Brazil; Sane (2016) on India. 95 Magaldi de Sousa (2016). 96 Pagliari and Young (2014), Véron (2016), Chey (2016), Walter (2016). 97 McKinsey Global Institute (2013), Walter (2016). 98 Kempthorne (2015), Li (2011), He (2015). 99 Véron (2016), Chey (2016), Walter (2016). 100 Kempthorne (2015), Chwieroth (2008, 2009). 101 Liu (2010), Posen and Véron (2015), Walter (2016). 102 Véron (2016). 103 Kirshner (2016). For the notion of “relational power”, see Strange (1990). 104 For example, El-Arian (2016). 105 www.theguardian.com/business/2014/jun/30/bnp-paribas-fine-us-justice-department. 106 Eichengreen (2012), Prasad (2014). 107 Eichengreen et al. (2017, 2018) insist on this argument in the tradition of Kindleberger (1970), Strange (1988), Kirshner (1995), Cohen (2015). On the concerns for the global shortage of safe assets, see Caballero et al. (2017). 108 Helleiner (2014a, 2016b) uses this argument to support his thesis that global governance has changed little if at all. 109 Eichengreen and Kawai (2014). However, Ito (2017) is quite optimistic about the future role of the renminbi. 110 Eichengreen and Lombardi (2017). 111 Kirshner (2013, 2016). 112 Schenk (2010).

6 EUROPE AND GLOBAL GOVERNANCE

“Ok, we can conclude that all executive directors representing us will make a joint statement along the lines we agreed. Thanks so much for your cooperation”. These were the concluding remarks that your author pronounced as the chair of the group of European members of the AsDB, which convened in May 2013, at the margins of the annual meeting in New Delhi. The issue at hand was how to defend European financial and political interests in defining the terms of the merger between the AsDB and the Asian Development Fund (its concessional arm).1 The show of European unity proved effective: the conditions of the operation largely accommodated the European members’ requests, initially resisted by the US and Japan. The merger could go ahead to everybody’s benefit since it allowed a more efficient use of all members’ capital contributions. Prompt recognition of the strong commonality of interests and a proactive attitude combined with goodwill and determination were sufficient to secure the success of the single European position with no need for amendments in the European Treaty or convoluted inter-governmental negotiations. In comparison to the tectonic upheavals in global economic governance, the practical import of this particular episode is puny. Yet its symbolic significance and the pragmatic way forward that it suggests should not be lightly dismissed, particularly because this effective vindication of a European position occurred at a time when the continent was lacerated by its internal contrasts surrounding the sovereign crisis. The determinedly united front shown in New Delhi stands in striking contrast to the typical attitude of European countries in international fora. Usually, the positions expressed are national. When a European coordination is attempted, it tends to be clumsy and ineffectual. Even in groups where the EU has a formal direct representation, such as in the G20, the stance taken by EU representatives is generally constrained by the fragile compromise among diverging national positions that required long and painful efforts to be agreed upon and thus could

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not be flexibly adapted to the changing circumstances of the negotiations. Moreover, on frequent occasions the EU position is further weakened by the pronouncements in the same forum of European countries’ delegations which unashamedly try to tilt the “common” position towards their national views. The ineffectiveness of European representation in global economic governance is not a recent phenomenon. It has a long history that begins with the uneasiness of large European countries in accepting their essentially subordinate role in the Bretton Woods system – the economic embodiment of the pax Americana. Insistence on national objectives and specific issues was the chosen way to express discontent with this condition, with no attention paid to the possibility of a joint European response. The progress of European integration, driven by intra-European and mostly economic concerns, for a very long time provided little motivation to develop a common external position. Only with the Treaty of Lisbon, signed in 2007, did the (gradual!) development of a common action vis-à-vis third countries become an explicit policy objective, though with many reservations and safeguards for national sovereignty: foreign policy remains jealously guarded as a national prerogative. This persistent attitude is rooted in three entrenched convictions. The first one is the ambition, rekindled by a new powerful wave of nationalism, to continue playing a significant role in global economic governance as an individual country. The second belief is that economic and cultural differences across Europe are so deep that they cannot possibly be encompassed by a European position. The third idea is that, in external economic relations, national interests are overwhelmingly different and thus distinct from a common European interest. However, as discussed later, none of these arguments holds up to closer scrutiny. In addition to the countries’ reluctance to embrace a common stance, a further obstacle comes from the lengthy and cumbersome decision-making process within the EU. Procedures for defining a common position on external affairs, of an economic and financial nature too, are particularly ungainly and intricate due to the very little scope for majority voting and the extreme sensitivity about preserving national prerogatives. For all these reasons, Europe has been a far less relevant player in the reform of global economic governance than it could be in light of its economic and financial size – not to mention the political influence it could exert if it acted with unity. During the period of G7-based global economic governance, the clout of Europe over key matters was already well below its potential, despite holding the majority of seats around the table of G7 summits. The gap between the potential and actual influence of Europe widened further with the growing relevance of emerging economies and the ensuing changes in global governance. In particular, Europe had a very limited influence at two crucial junctures of this transformation: the reshaping of the G20 and the redefinition of the balance of power within the IMF. The sovereign crisis was in the end successfully managed and led to bold changes in the European architecture that would have been inconceivable before

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its eruption – think, for example, of the establishment of the European Stability Mechanism, the European institution for providing the financial backstop in the event of a crisis. Notwithstanding the benign outcome, public conflicts between EU members and the prolonged economic stagnation left a legacy of distrust and widespread anti-European sentiment, in turn fuelling the resurgence of nationalistic movements that culminated in the popular decision of Brexit. Scenarios of fragmentation, with the possibility of member states leaving the euro-area or the EU, had already surfaced, particularly with reference to Greece, and resonated with parts of public opinion. Yet they were thought to be ultimately unrealistic because of the exorbitant economic costs they would entail. Brexit broke a taboo and gave renewed strength to centrifugal forces in Europe. Even among countries with pro-European governments, views continue to differ on the way forward for correcting the institutional failings in euro-area governance and concluding the incomplete projects of banking and capital union. Against this backdrop, the perpetuation of a weak European influence on the world stage, just at the crucial time when the reform of global economic governance is being shaped, is generally considered the obvious outlook. Asia, emerging countries, and, above all, China are the future. Policy concerns and analytical attention focus on them, not on Europe. By contrast, it is contended here that there exist compelling economic, financial, and geopolitical arguments pushing European countries to converge to a unitary stance, which would have a much greater clout over global governance. These reasons are bound to become even more persuasive with growing public awareness of the chasm between the nationalistic illusions of relevance in the world arena and the hard reality of the inevitable decline of a fragmented Europe. Both Brexit and President Trump’s America-First mantra acted as catalysts for relaunching the stalling process of European integration. Yet it must be stressed that the rationale for a common European position in the reform of global governance is of a strategic nature, and it holds irrespective of vagaries in political mood. In the current legal architecture, many avenues to raising the European profile on external affairs – which necessitate a swifter decision-making process and a more effective representation in the relevant international fora – would require a reform of the Treaty. This endeavour is politically treacherous and institutionally complex, not least because it requires ratification by all members, many of which would hold a referendum. A more effective European stance in global economic governance, however, cannot afford to wait for a Treaty change. The most expedient way to strengthen European influence over world economic and financial affairs is to arrange a more effective representation in the G20 and the IFIs, which requires no changes in legislation. Appreciation of the commonality of strategic interests, ingenious initiatives associated with political goodwill and determination would be sufficient – as they were in New Delhi, during the episode that opens this chapter. To visualize the relevance of this

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approach, it is sufficient to imagine the implications of the credible agreement of a systematically common vote on the IMF board by European countries. This easy-to-implement arrangement would immediately grant Europe the same veto power on fundamental IMF decisions as the US, with no need to modify the Articles of Agreement. This chapter also argues that a stronger Europe in world economic and financial affairs would at once help defend its interests and improve the quality of global governance. It would diffuse the risk of an escalating confrontation between the US and China, which is harmful to the whole international community and not for economic reasons alone. It would foster the emergence of a more balanced international financial architecture, easing the daunting issues related to the accumulation of huge stocks of reserves denominated in dollars. It would promote the diffusion of democratic participation and social inclusion. It would advance the resilience of the global economic system, as more European responsibilities would be underpinned by the absence of major outstanding imbalances and fragilities. Before turning to the analysis, which starts by tracing the roots of the European reluctance to embrace a common stance on global governance, a clarification on what is meant by “Europe” is in order. Thus far, the discussion has basically conflated Europe with the EU, at times even with the euro-area – a confusion that is both institutionally inaccurate and likely to be viewed by some as inflammatorily incognizant of the entrenched political and historical reasons that make so many “geographical” Europeans proud outsiders to the EU or the euro. However, at the core of the case for a stronger Europe in world affairs lies a basic unity-is-strength argument that implies the relinquishing of (some) national sovereignty while maintaining cultural identity and basic democratic self-determination. It is obvious that many citizens and many countries simply have no desire to give up even a modicum of national power whose surrender is necessary for membership in a larger entity and a wider project. And even broad institutional houses with more modest ambitions of institutional cohesion struggle to withstand internal tensions, as the handling of the Crimean crisis by the Council of Europe vividly exemplifies.2 For all these reasons, no pan-European political project with precise structure can be realistically advocated for at this stage. Yet this is no excuse for tolerating the circumstance that Europe’s influence on world economic affairs remains far weaker than it could be.

The long tradition of punching below one’s weight Europe’s inability to effectively wield any potential influence over international economic affairs has its roots in the aftermath of World War II. The economic and military supremacy of the US left no choice (save joining the Communist bloc) but to accept the pax Americana and the Bretton Woods system. European countries had a fundamentally ambiguous attitude towards this state of affairs. For security and resource reasons, they wholeheartedly welcomed US predominance,

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eliciting the political and military projection of US power in Europe – “an empire by invitation”, as Ikenberry put it.3 At the same time, they resented their subordinate role and tried to blur this condition by managing the decolonization process so as to maximize the preservation of their influence over their former colonies. This approach remained strictly national for a long time, as shown by the fact that the Treaty of Rome, which established the European Community (EC) in 1957, contemplated no external representation whatsoever towards third countries or multilateral organizations. France was at the forefront of the European opposition to US supremacy in world economic affairs and especially to its materialization in the pivot function of the US dollar in the international monetary system. The Bretton Woods architecture was considered “abusive and dangerous”, as president de Gaulle put it in an acclaimed press conference in February 1965,4 before ordering the conversion into gold of a sizeable portion of French US-dollar reserves. Others5 attributed US supremacy to technological innovation and managerial skills rather than to monetary oppression, but still maintained the need for a national, as opposed to European, response. The idea of an external representation for the EC with the creation of the European Political Cooperation in 1970, as well as the greenlight to the negotiations that paved the way for the first enlargement of the Community, had to wait for the change in French attitude that followed the resignation of de Gaulle. The external representative function, very vaguely defined, was informally assigned to the rotating presidency of the EC, with all the vagaries in ambition, profile, and outright positioning on the hot issues of the moment that this informal and lowkey arrangement implied. In the 1980s, the mechanism of the troika – that is, the involvement of the preceding and succeeding EC presidencies together with the incumbent – was introduced in an effort to improve effectiveness. In spite of its ingenuity, this arrangement produced no noteworthy improvement in terms of efficacy, while at times generating slapstick-comedy situations at functions where, due to poor coordination, troika representatives did not really know what they were expected to do.6 With the acute financial turmoil that followed the oil shocks and the demise of the Bretton Woods system, the G7 emerged as the centre of the revamped global economic governance in the brave new world of flexible (and volatile beyond expectations) foreign exchange rates. The US felt that, under the new circumstances, the pursuit of the liberal order and its own supremacy required closer consultation with its key allies, who in turn welcomed the opportunity to have a more direct say on the coordination of macroeconomic policies and the modernization of the international financial architecture. The achievements and failures of the G7 were discussed in Chapter 1. Here it is important to recall that, although the precise format and working methods of the Group took several years to evolve, the involvement in the G7 summits of the president of the European Commission (hence forth Commission) was in place from the very beginning. The president of the European Council was invited, too, when one of the four European G7 members7 did not hold the rotating presidency. As a result, there

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were G7 summits, like the 1986 one held in Tokyo, where, much to the annoyance of Canada and Japan, six out of the nine leaders around the table were Europeans. The high number of European representatives, however, did not translate into a strong power of influence. This was in part due to the exclusion, at the time, of the Commission’s officials from both most of the finance ministers’ meetings and their deputies’ frequent consultations, where the bulk of the negotiations actually took place. However, the main reason for the low profile of the European view in the G7 was simply the four countries’ scarce appetite for developing and championing a common position. Participation in the exclusive club of the G7 was considered a national prerogative to promote national interests. When a convergence of European interests materialized, positions within the Group would be coordinated accordingly, but there was no presumption on the part of any of the G7 members that this would systematically be the case. The Treaties of Maastricht (1992), Amsterdam (1997), and Nice (2001) achieved substantive progress in the evolution of the European institutional architecture and the deepening of cooperation in several important policy areas. The strengthening of European external representation was part of this general trend but involved much more timid steps. The Maastricht Treaty explicitly assigned areas of external representation, such as trade, to the Commission, while foreign and security policy remained with the Council, continuing with the troika in spite of its inadequacies. The Amsterdam Treaty improved the troika arrangement, replacing the past presidency with a newly created job: the High Representative for the Common Foreign and Security Policy,8 who, in any case, had very narrow margins for initiating policy actions. He or she could represent Europe in multilateral contexts, such as the Quartet on Middle East, only after the Nice Treaty and if the Council president decided so. These unwieldy arrangements reflected the fundamental tension between the ambitions of a single European external representation and the widely shared conviction that foreign and security policies were essential constituents of national identity, resulting in a gap between expectations and capability in Europe’s international profile.9 Moreover, the competence of Europe’s representation in international fora and institutions was ambiguously left to the coordination between the Council and the Commission, with predictable turf wars between the two and the further complication that, within many crucial groups, the largest European countries enjoyed a national representation that they had no intention of relinquishing. The Treaty of Lisbon (2007) introduced major innovations in the EU’s external representation. It granted legal personality to the EU, absorbing the ones of the three existing Communities.10 Most visibly, it again changed the composition of the troika, displacing the EU rotating presidencies with a fully Brussels-based membership: the president of the European Council, the High Representative, and the Commission. The hope that the arrangement would end confusion in external representation was quickly disappointed. Controversies soon

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raged over the roles of the three actors, the interpretation that each of them gave to their revamped competences vis-à-vis the other two components of the troika and, even more contentiously, vis-à-vis member states.11 The organization of the EU representation on economic and financial matters (with the exception of trade) in international institutions and groups remained cumbersome, prone to triggering internal disputes, and certainly not helpful in encouraging a single European position. The problem of identifying an interlocutor empowered to represent Europe became understandably more acute with the introduction of the euro and the ensuing importance for the world of the European (in fact euro-area) economic and monetary stance. Several officials had some form of entitlement to performing this function: the president of the ECB, the commissioner for economic and monetary affairs, and the chair (at the time rotating with the Council presidency) of the Eurogroup (the assembly of finance ministers of the countries that adopted the single currency). In the absence of an institutional process for reconciling the views of the three potential “Mr Euros”, or at least for harmonizing their pronouncements, their differences of opinion were publicly exposed. Together with the declarations of the euro-area national central bank governors and cabinet members with economic responsibilities, they generated a confounding cacophony about fiscal and monetary policy that projected an image of litigious disarray – indeed, to such an extent that it was taken to be one of the reasons for the major depreciation of the euro in the period following its introduction. Confusion among public statements extended to the representation of the single currency in international economic fora, as each of the three institutions had a legitimate reason to vie for participation in key meetings. At the same time, somewhat paradoxically, countries that had indeed relinquished their monetary sovereignty were reluctant to abandon their prerogatives in representing the new currency. Countries that had not joined the euro – in particular, the UK, with its exemption from the in-principle obligation to adopt the single currency enshrined in the Maastricht Treaty – insisted that European representation should not be conflated with that of the euro. The December 1998 European Council in Vienna settled the discussions with a complex arrangement that provided for a further proliferation of European representatives at international meetings. This proposal was immediately rejected by the US, with the support of Canada and Japan, in the wake of the mounting feeling that the introduction of a single currency was complicating rather than easing relationships between Europe and the US, and more generally within the G7.12 As a conciliating signal, however, a few days later, the IMF board granted the formal status of observer to the ECB.13 In 1999, the US softened their opposition, paving the way for the search for an accommodation of European demands. Whereas there were no concessions about European participation at the summits, the G7 found a compromise regarding the meetings of finance ministers and central bank governors by the crafty arrangement of varying attendance according to the topics on

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the agenda. Its implementation, however, was a delicate balancing act that had to be repeated at each meeting, absorbing an inordinate amount of time and goodwill, partly because of the presidencies’ need to manage the insistence of euro-area central banks’ governors to take part in (at least be part of) the discussion in addition to the ECB president. In 1999, Germany held the presidency, when the G7, as discussed in Chapter 1, decided to form two new groups in order to foster international coordination in response to the 1997–99 Asian crisis: the G20 and the FSF. This circumstance helped ensure that the EU was a full member in both bodies from the date of their establishment. In the period before the eruption of the 2008 crisis, when both groups were basically more debating than deciding clubs, the lack of cohesion in defending a European view was hardly noticed. Why would Europe be more effective in these “derivative” settings when it was unable to marshal a united position in the key forum of global governance, the G7?

Missing a crucial opportunity: the G20 With upgrade to the leaders’ level, enhanced decision-making capability, and emerging countries’ stronger influence, the G20 became one of the key features of the upheaval in global economic governance set in motion by the 2008 great financial crisis. The radical transformation in the role and modus operandi of the Group, distinctly perceptible even in the hectic crisis-management mood, might have induced a change in attitude on the part of the European delegations, at least as a reaction to the erosion in their influence that was distinctly underway. This change simply did not happen, and, notwithstanding the critical juncture in global governance, European representatives continued to follow the time-honoured habit of emphasizing their respective differences rather than focusing on the pursuit of a common stance and the promotion of Europe’s role in the new circumstances. The participation in the G20 of a separate EU delegation, with full membership rights and comprising the representatives of three institutions (ECB, Commission, and presidency of the European Council), required the definition of a European position, if only for institutional etiquette. Even after 2008, this continued to be done through a process, discussed later in this chapter, that typically produced a fragile and insubstantial compromise, sweeping significant divergences under the carpet with clever drafting. The “European” position was adhered to by the EU representatives. The other European delegations, in their interventions, moved to a very national rendition of the common view, if not to an openly country-specific stance. Not much additional congruence was achieved by the polite gatherings of the five European delegations that were systematically convened just before each G20 meeting. During the phase immediately after the outburst of the crisis, intra-European differences surrounded the role of budgetary expansion in supporting economic activity, the symmetry in the adjustment of external imbalances, and the measures

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best fitted for the repair of the financial sector. In a way, there was nothing basically new in these divergences, just the reiteration of the Rhine divide on macroeconomic policy and the Channel divide on financial policy.14 Yet it is remarkable that while the traditional G7-based order was being uprooted, the impetus to set national differences aside so as to champion Europe’s role in the reform of global economic governance neither sprang spontaneously, incited by the circumstances, nor emerged as a result of deliberate strategy on the part of the European Council. In May 2010, at a memorable and extraordinary meeting – made even more dramatic by the several-hour delay of its start, caused by the sudden illness of the German minister Schäuble on his way to Brussels – EU finance ministers approved the first rescue package for Greece after a divisive confrontation. This controversial decision opened the sovereign crisis that absorbed the full attention of European countries, relegating all other international economic issues to distracted, secondary consideration for two years.15 Chapter 2 discussed the disruption the European crisis caused to macroeconomic policy coordination in the G20 and the intense irritation of the other members at Europe’s prolonged inability to manage its own crisis. The aspect to stress here is that the intensity of intra-European disputes escalated so much that European delegations in the G20 lost any restraint in exposing their differences. On the contrary, the G20 became a convenient venue for asserting one’s righteousness. This overt and cantankerous disunity undermined any possibility for negotiating with a common European stance the reform in global economic governance that was taking place in the G20. As a result of its revealed preference for the pursuit of internal power struggle over the investment of political capital in defence of its influence vis-à-vis the rest of the world, Europe missed a crucial opportunity to shape the global reform, despite having six delegations around the table.16 It also exposed an inward-looking attitude that stands in sharp contrast to the world-scale ambitions several European countries candidly maintain. The situation of patent and resentful discord caused Europe to be poorly influential on another key element of the transformation in global governance as well: the IMF reform, which emerging countries made their top priority in their pursuit of an overhaul of the international financial architecture.

Missing a crucial opportunity: the IMF At the time of the IMF’s establishment, Europe managed to secure an informal arrangement providing for its managing director to be a national of a European country. Although this agreement has always been honoured (half of the time with a French national at the helm), it should not lead one to infer any tradition of a cohesive European front within the IMF. Quite the opposite. Throughout its history, European countries hardly ever pursed a deliberately and declaredly joint position within the IMF board of directors, in line with their ambiguity towards

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the Bretton Woods system and their nationally centred behaviour within the G7, both of which have been discussed earlier. As a matter of fact, intra-European clashes within the IMF board, particularly during the decolonization period, were historically confined to programmes and policies involving countries that used to be European colonies. Later, legacies of these disputes lingered and added to differences on technical issues (such as the features of financing facilities) or administrative matters (such as staff salary increases). Yet the European presence in the IMF was characterized by a paradoxical situation. The very strong European representation both in terms of quotas (more than one-third) and chairs on the executive board (nine out of twenty-four) coexisted with a de facto convergence on virtually every single strategic issue and the firm assertion that positions had to be national, shunning a systematic European stance. No noticeable added coherence and assertiveness was brought about by the institution, in 1997, of the EURIMF, the group of European representatives at the IMF, and, in 2001, of the SCIMF, the Sub-Committee on IMF matters of the Economic and Financial Committee. As soon as emerging countries started their action to advocate for a major increase in their relative quotas and a reduction in the chairs on the board occupied by developed countries, Europe was immediately identified, with the support of the US,17 as the bloc that should bear the brunt of the adjustment. This direct and concerted offensive would have required a strategic response, breaking away from the tradition of a fragmented and ineffectual European representation. Given the circumstances, the way forward was quite clear, at least in broad terms – and indeed, it was voiced by several observers:18 to concede a reduction in quantitative representation in exchange for an enhancement of its effectiveness. Yet again, the change towards a forward-looking, common European position did not take place, and the bitter divisions about the way to address the raging sovereign crisis certainly did not help to foster it. In that moment, the Commission too was hesitant to push for a more cohesive European stance, wary of diverting its limited mediation power away from the even more pressing issues of the crisis. As a result, the “European” position ended up as a general defence of the constituency, with no overarching narrative to which international partners could relate. With the inability to find an intra-European agreement to absorb the unavoidable reduction in overall representation, European deliberations on this issue were trapped by the different country-specific situations as regards the quota share each European member should in principle receive according to the formula:19 some countries (like the largest) were underrepresented but prepared to relinquish any increase in their quota share; others (like Spain) were underrepresented and insisted on an increase; others still (like the Netherlands) were overrepresented and showed varying reluctance to accept a dilution of their share. In the final agreement on the IMF reform, Europe had to bear the largest brunt of the increase in emerging countries’ relative quotas and commit to a reduction of two chairs on the board held by “advanced European countries”.

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The lack of strategy that marked the negotiations was noted by other members, perceived more as “entrenchment” than accommodation to legitimate demands,20 and weakened Europe’s influence on all the other aspects of the reform in IMF governance – in particular, the change in the informal balance of power in everyday activities. Inattentive to these implications, Europe extended its hesitant and backward-looking attitude to the implementation of the deal on the board chairs. Whereas the cutback of one chair came from a clear move – the merger of the constituencies chaired by Belgium and the Netherlands – Europe resorted to a variety of stratagems to deliver the remaining part of the commitment: considering “fractional” chairs that result from the rotation between European and non-European countries in the same constituency; assigning some of the time in the chair rotation to countries, like Poland, that the IMF does not classify as advanced; and interpreting “Europe” in the widest sense in order to enlarge the base of the adjustment. In this way, a reduction of 1.6421 chairs has been attained. At the time of writing (just ahead of the October 2018 election of the board – the first one providing for the full implementation of the reform), no agreement has yet been reached on how to deliver on the missing “0.36” chair, under the ill-concealed European hope that 1.64 will suffice, as it can be rounded up to two. The way Europe conducted the negotiation about quotas and chairs was not the only major issue in the relations with the IMF that resulted in tensions with both the institution and its key shareholders while helping to impair Europe’s influence over the reform of global governance. The financial involvement of the IMF in the European crisis, and especially in the bailout of Greece, was the other key episode.

The IMF and the European crisis For a long time since the approval of the first rescue programme in 2010, the issue of Greece continued to be a sore spot. In 2018, pre-disbursement reviews for the third programme were still accompanied by drama and exhortations “to complete the outstanding prior actions as a matter of urgency”.22 The financial troubles of an economy that only accounts for well below 2 per cent of the euroarea GDP23 triggered such political and financial havoc for reasons that are related both to the incomplete institutional architecture of the single currency and to the still-unresolved flaws it implies in the management of the euro-area’s policies, as candidly admitted in the so-called Five Presidents’ Report.24 Although they are not analysed here, these flaws have to be kept in mind because they are at the root of the very peculiar modalities of the involvement of the IMF with Greece – and, more generally, with the European crisis. To the initial surprise, and later embarrassment and annoyance, of IMF staff and non-European shareholders, the financial and surveillance functions that Europeans asked the IMF to perform in the sovereign crisis significantly departed from its standard rules of engagement. Although cast in terms of

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benefitting from its experience in dealing with crises, European demands on the IMF neither reflected a strategy on its evolving role in managing regional crises nor originated from financial or analytical needs. They were instead driven by intra-European disagreements, especially on the role of the Commission, and, over time, they were steered by the evolution in the domestic political debate, especially in Germany. As a result, European positions on the IMF (and within the IMF) could only be rationalized in light of the intricacies of the intra-European institutional architecture and negotiations – an effort that the US and emerging countries were not always able or willing to make. The most emblematic case in point is the IMF sustainability analysis of Greek debt – an analysis that, over the course of the crisis, tumbled from the shrine of ultimate truth to the pit of tedious technicality. When the financial troubles in Greece became so acute as to render inevitable the arrangement of a rescue package, there was a brief phase during which Europeans considered IMF support to be undesirable,25 since it would imply the unpalatable admission of an inability to handle a situation of distress in the euroarea. With the surfacing of deep divergences on the way to address the Greek crisis, especially with regard to the size of the fiscal adjustment to be demanded of Greece, several countries, led by Germany and the Netherlands, insisted on the involvement of the IMF, which they portrayed as a guarantor of technical proficiency and independence from (Greek) political influences. In addition to increasing the pressure on Greece for a larger fiscal retrenchment (necessary to achieving debt sustainability, which is a condition for IMF financing), the call for IMF intervention was also meant to signal the mistrust of the Commission, considered too lenient, and to tilt the decision-making power of managing the crisis from European institutions to the inter-governmental process. In several countries, parliament passed bills providing that they would approve disbursements in favour of Greece only if the IMF would provide part of the financing. A new troika – comprised of the IMF, the ECB, and the Commission, and better known than the Troika in charge of external relations mentioned earlier – came into existence. Its purpose was to jointly define the conditions of the programme for Greece, monitor its implementation, and report to the two bodies formally in charge of approving the disbursements: the Eurogroup and the IMF board. Even though the IMF had already provided financial support to European countries (Hungary, Latvia, and Romania) after the 2008 outburst of the crisis, the involvement with a euro-area country was a major innovation, as it precluded the assessment of monetary and exchange-rate policy, in contrast to the standard IMF practice. The troika model became nonetheless popular with Europeans and the three institutions were collectively in charge of the other financial rescues during the sovereign crisis in the euro-area.26 Recent analyses have interpreted the troika as a clever artifice for pursuing the national interests of major countries, who cunningly elevated to the international level a well-known technique used by legislatures in overseeing executive agencies: “the complexity of [the troika arrangement] is the consequence of a

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strategy of key states to control their institutions, managing agency drift”.27 In spite of its intellectual appeal, this interpretation assumes a purposefulness and rationality behind the institutional arrangements for addressing the euro crisis, qualities that are in stark contrast to the actual short-termism and serendipity characterizing European decision making at the time. “Behind the curve” and “kicking the can along the road” were for a long time the defining traits of European behaviour, unable to bridge differences, much to the dismay of the international community.28 Relations within the troika were never easy, as the three institutions responded to different constituencies and had very diverse political sensitivities. Moreover, their interaction and public reporting forced them to make their reasoning more explicit than usual and thus to abandon the comfortable degree of ambiguity that had long been a fundamental ingredient in the modus operandi of international financial institutions.29 Differences within the troika economic policy recommendations and conditionality, however, did not always follow either the expectations of the European countries that had invoked the IMF intervention or any predictable pattern. Some even claim that the Commission was keener to defend the orthodoxy of the “Washington Consensus” than the IMF itself.30 In the case of Latvia, the Commission was significantly more hawkish than the IMF, which advocated the move to a floating exchange rate in order to reduce the cost of macroeconomic adjustment. The Commission, instead, supported Latvia’s resolve to maintain the peg with the euro and endure the resulting additional hardship so as to pave the way to the adoption of the single currency, which eventually took place in 2014. The hardest clash within the troika, however, regarded Greece – in particular, the mix of fiscal adjustment and debt reduction through restructuring that was necessary to ensure debt sustainability, allowing the concession of an IMF loan in line with its established framework for exceptional access, given the recordbreaking size of the loan. Europeans, with Germany exerting a direct influence over the negotiations, insisted on a size of fiscal adjustment that the IMF considered counterproductive for its implications on the economy, while the IMF suggested a debt restructuring that the Europeans regarded as too drastic. To overcome the stalemate and find an agreement within the troika on values acceptable to the Europeans, the IMF had to cave in and modify its framework to introduce the “systemic clause”. This was an exception that allowed the possibility of granting loans “when debt was sustainable, but not with high probability” in case “there was a high risk of systemic international spillovers”.31 This forcing was bitterly resented by both the IMF staff, which saw its illustrious analytical independence being trespassed upon, and non-European IMF members who felt that, since Europeans had adequate financial resources at their disposal, if they decided to resort to the IMF, they should accept its intervention framework. Throughout its brief existence, the systemic clause was perceived as a symbol of European overbearingness. When the US required its suppression to ratify the

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quota and voice reform, the other major (non-European) shareholders were eager to support this demand, unconcerned with the fact that the IMF would be deprived of an option possibly useful in different circumstances.32 The division within the troika about the policy recommendations to Greece continued well after the acute phase of the crisis, with the size of the fiscal adjustment and debt restructuring as perennial topics of contention. In particular, Europeans deeply resented the IMF call to cancel part of the European official lending33 as a necessary ingredient in the policy actions to put Greece on a sustainable growth path. Although the implied loss would not have been very large in net-present-value terms,34 loan cancellation would entail recording an explicit impairment for the nominal value foregone, with a resulting increase in public deficit. As the IMF was well aware, this was a political taboo that made Europeans, including Germany and the Netherlands, consider IMF debt sustainability an irrelevant technical detail. Even this succinct narrative of the involvement of the IMF in the rescue of the European crisis is sufficient for recognizing why it was so divisive vis-à-vis the IMF and its (non-European) key shareholders. The crucial aspect to be noted here is that these tensions occurred at the historical juncture at which the IMF – the very lynchpin of the international financial architecture – was radically transforming its governance, in terms of both formal voting power and informal influence in its internal decision-making process. Rather than joining forces to pursue a European position on global economic relations and the role of the IMF within them, European countries devoted their energies and political capital to steering the IMF participation in the troika so that it served the needs of the intricate evolution of the intra-European debate, often driven by the vagaries of German domestic politics. This attitude can be viewed as the result of the European crisis, which threatened the survival of the euro and set in motion the centrifugal forces underpinning Brexit and the diffuse resurgence of nationalism. It was also the symptom of Europe’s short-sighted inability to appreciate that its very role in global governance was at stake and its consequent inability to seize a crucial opportunity to mark its influence. The failure to pursue a joint strategy at that defining moment reflects a deep-seated reluctance to uphold a common position.

Three misconceptions The ultimate and unassailable origin of the difficulties in agreeing on and championing a single European position on international economic matters is the postulation of two absolute principles which, in their adamant formulation, allow for no wiggle room. First, foreign policy, together with security and defence, is the very essence of national sovereignty, since it sets the limits of admissible interference in a country’s Westphalian self-determination; thus, it can only be delegated with the safeguard of veto power. Second, the representation in international fora and institutions is part and parcel of foreign policy. Hence,

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Europe’s external economic relations also necessitate the protection of national veto power, and the delegation to any supra-national institution, such as the Commission, requires commensurate limits and safeguards. This argument always looms large in the background and it is invoked in critical situations by those who insist on the preservation of national sovereignty. Real life and politics are more nuanced and ductile. This line of reasoning is seldom applied strictly, leaving room for flexible arrangements in Europe’s external representation. As a matter of fact, albeit with ambiguities and afterthoughts, political and institutional arrangements have progressively moved towards the strengthening of a common external policy – and the innovations introduced by the Lisbon Treaty were conceived as a major step in this direction. Moreover, in the economic and financial field, specific factors lend special support to a common position. For starters, the Single Market within the EU required a common trade policy, which in turn left no other option than the delegation to a European representation. Then, in several international groups, most notably the G20, the EU has a dedicated seat at the table, which requires a common EU position. The euro, meanwhile, makes a single voice all the more compelling. And in some cases, the common European interest is so conspicuous and cogent that, by itself, creates an imperative push for a united stance, as in the example in New Delhi which opened this chapter. Yet, despite institutional progress and these particular factors, a single European position on economic and financial affairs has struggled, even at key junctures, to gain adequate traction and support. Instead, it has been hampered in its definition and defence by a fundamental obstacle: the notion that European external interests and best national interests are not the same. Rather, they are believed to be typically in conflict, so that the very concept of European interest is possibly not amenable to an internally consistent and practical interpretation. This view, which often airs in public as the basic argument of nationalistic movements, is based on three misconceptions. First, many believe that their own country can (and should) play a role on its own in global economic governance. This role – which is expected to entail national economic advantages and contribute to the dissemination, to the world’s benefit, of the country’s most cherished values – would be diluted, if not obliterated, in a common European stance. The ideological and emotional importance attached to championing one’s own country position in the world – which was one of the strongest forces underlying Brexit’s victory in the referendum – stems from the long tradition in European history of conflating national self-determination with the freedom to choose alliances in the conflicts that systematically ravaged the old continent until the end of World War II. For large European countries, empires stretching across different continents gave practical significance to the notion of a global role, whose glory is still revered and nostalgically evoked by many as an inspiration for foreign (and economic) policy. Small countries also aspire to a global role on their own, perhaps on the basis of the specific contribution they can make to governance (the Nordic

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exceptionalism in development policy,35 to quote an example), or perhaps simply to affirm vis-à-vis the international community the independence they have struggled to attain. In spite of its evergreen clout over citizens, invigorated by the post-crisis revival of nationalism, the idea that any single European country can play a global role on its own in the new economic environment is simply a delusion. The much-reduced relative weight of every single European country in world GDP makes it impossible for any country, including any of the large ones, to be pivotal on any major issue in global governance. This fact is merely a corollary of the upheaval in the relative wealth of nations, described in Chapter 1, that led to the radical change in the world balance of economic and financial power. The fall in the relative economic magnitude of the large European countries is astounding. It is even more so in light of current projections, which indicate that the next decades will put an end to a long economic supremacy (since the beginning of the 20th century, shared with the US and Japan). In 1960, the four largest European economies taken together were one-fifth of the world’s GDP in PPP36 terms. Over half a century, their share halved; over the next thirty years, it is projected to halve again. At market exchange rates, Germany, the largest European economy, was nearly 7 per cent of world GDP in 1990, 5.2 in 2010, 4.6 in 2015, and it is forecast to be 2.4 in 2050. Its ranking has fallen from third largest world economy in 1990, to fifth in 2015, and will be a meagre ninth in 2050.37 Sharper declines are recorded and expected for the other European economies, particularly the middle-sized ones, whose share in world GDP will become negligible. Like that of the US, the relative position in world GDP of Europe as a whole is going to be eroded, overcome by the nations that are giants in population and have returned to be giants in economic output too: China and India. Yet even without the UK, Europe as a whole continues to be pivotal in relative economic size, vying with the US for third place. Choosing different European countries, time horizons, or specific measures would not alter the picture. As crude and unpalatable as these figures might be, their basic purport is impossible to refute: there is no way any single European country can continue to be in the same league as the major economic powers, but Europe as a whole could. The second misconception regards economic, cultural, and political differences within Europe, which are perceived to be so profound and entrenched as to be insurmountable obstacles to any lasting confluence in a common European position. Against the backdrop of a century-old tradition emphasizing national diversity across Europe, countless studies have investigated and compared European economic and social systems, developing “models” to capture their salient features: the social-market model inspired by ordoliberalism versus the public-sector-driven capitalism with a Colbertist lineage versus the unfettered individualistic approach to economic enterprise; bank-based versus market-based financial systems; Nordic versus Anglo-Saxon versus Continental welfare models, marked by a varying mix

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of social protection, transfers to working-age population and retirement provisions – just to quote some evocative examples.38 These models are routinely complemented by the caveat that they mask further idiosyncratic specificities, conveying an idea of fragmentation that adds to the folklore of national stereotypes spanning from social organization to sense of humour. Pervasive national differences are real and continue to be passionately felt. The misconception arises when they are deemed to be in inevitable contradiction to sharing a common European position. Though intra-European differences along many dimensions are indeed important, they are dwarfed by comparison to differences with extra-European countries. The European social model admittedly encompasses varying features and performances in terms of efficiency and equity. Yet it does converge purposefully in its fundamental objectives of social inclusion, equity, and availability of safety nets for the vulnerable and disadvantaged – not to mention widespread participation in democratic life, as indicated by high voter turnout. Moreover, the contraposition of European and national identity that this misconception implicitly takes for granted is just as moot as the hypothetical contrast between one’s identity as a family member and as an active member of a profession. Individuals are defined by their “multiple identities”, which are normally neither exclusive nor mutually incompatible39 and which thus do not stand in the way of a European identity, culturally underpinning a common external stance. The third misconception concerns the allegedly conflicting economic interests between EU members in their economic relations with extra-European countries – a situation that would inevitably undercut the support for a common external position. Such a view can logically only rest on the assumption that the competition between European countries in third markets is harmful. This argument, however, is ultimately inconsistent with support for the Single Market and has dubious empirical foundations. The benefits of the Single Market in terms of growth and employment have been extensively documented40 and arise from the efficiency gains generated by enhanced competition among European countries. Exactly the same forces within Europe are set in motion by the competition of European firms in third markets and thus yield the same type of benefits. If the Single Market is fundamentally beneficial, how can each country’s national interest vis-à-vis third countries be fundamentally in conflict? Moreover, a sufficiently disaggregated analysis of the product mix of each European country’s trade flows shows that they are quite specialized.41 Hence, in third markets, European countries are less intensely in competition with one another than a coarse analysis would suggest, further eroding the factual premises of the view that national interests are in conflict. On the other hand, as trade patterns differ, each country’s preferred trade policy is in principle different too because reciprocal trade concessions entail diverse costs and benefits across EU countries. This is the ultimate reason for intra-EU disputes on the common trade policy, which have long been studied.42 However, this source of conflicting preferences has never been a strong enough

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concern to question the Single Market (and the single trade policy); neither is its relevance comparable to the common strategic interest of defending an open multilateral trade system, which is key to Europe’s prosperity, particularly in light of the increasing share of extra-EU trade in total EU trade.43 Europe’s commitment to an open system and its incentive to join forces to preserve it became all the more apparent in early 2018, with the eruption of the beggar-thy-neighbour tariff war between the US and China.

The European decision-making process does not help The European decision-making process is not conducive to overcoming the reluctance to embrace and advocate a common European position. It is tedious, cumbersome, and replete with intermediate steps, which are meant to offer opportunities to stop or at least to delay the procedure if national prerogatives are (suspected to be) put in jeopardy. Length and intricacy stymie consensus building, and stand in the way of the flexibility necessary to update the European stance in response to unfolding events – a precondition for its relevance. The complexity of European procedures has multiple layers and different motivations. The overarching theme is, of course, the “leadership paradox”44 – that is, the fundamental ambiguity in the attitude of European countries which, on the one hand, remain convinced that the legitimacy of an external position can only be embedded in national practices, while realizing, on the other hand, the importance of an effective European stance. The most conspicuous expression of this ambiguity is the “polycephalous” or “hydra-headed” nature of the external representation of the EU45 – nice euphemisms to express the rivalry in representation roles between national and European actors which invariably generated confusion, the appearance of litigious disunity, and, most importantly, ineffectiveness. The Lisbon Treaty’s renewed ambition to enhance Europe’s global stature hinged on the assignment of a broad-ranging representative authority to the Commission and more meaningful roles in external action to “supra-state” institutional actors, discarding or downplaying rotating presidencies.46 These steps were bold – or were at least perceived to be so by the Treaty drafters47 – but were tempered by the widespread persistence of veto powers for member states and the frequent practice of decision making by common accord or consensus. Although these two rules differ in strict legal interpretation and are rarely provided for in the formal decisions considered in the Treaty,48 they are relevant in the innumerable circumstances where no formal voting takes place, widening the scope for de facto national veto power and hindering, or at least delaying, the formation of a common position. The principle of conferral (that is, the powers not conferred upon the EU remain with the member states), the explicit cataloguing in the Lisbon Treaty of competences into national, EU, and shared, together with the case law of the European Court of Justice, set the legal framework for determining the decisionmaking powers on each specific question.49 In practice, as groups and institutions

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relevant to global governance cover a broad range of issues, external representation results in a mix, varying across circumstances and matters, of three different models, in the search for a “balance between delimitation and consistency”.50 The three models are:51 i) the “unconditional delegation” model, whereby representation is exclusively held by a European institution because of its competences set by the Treaty – for example, on trade matters; ii) the “supervised delegation” model, where member states’ oversight can take the form of a Council’s mandate or of constant monitoring by the member states, most typically followed in the negotiations for international agreements, such as some environmental accords and Brexit; and iii) the most frequent “coordination model” on matters with mixed competencies, whereby European institutions and individual countries share the representation, participating in the European delegation through the Council presidency or in any case having a seat in national capacity or both, with the G20 as the best-known example of the latter case52 in the economic and financial field. In principle, the unity of intent and action in European representation under the “coordination model” should be ensured by the duty of loyal cooperation,53 which is enshrined in the Treaty, that implies obligations for both member states and European institutions and has been explicitly asserted in specific rulings by the European Court of Justice.54 In practice, given the sensitivity and the broad scope of the issues at hand, the judicial enforcement of genuine loyalty is bound to get very limited traction and it cannot possibly be a substitute for political agreement. The overlapping application of these models and the attribution disputes they tend to generate have led to a complex governance: the so-called “intensive transgovernmentalism”, which is characterized by tortuous procedures and various functions delegated to EU institutions, not always in a consistent and dependable manner.55 This “informal division of labour” has sometimes proven effective in providing political steering and operational action.56 In general, though, the result has been an addition to the multi-layered intricacy of European decision making, often trapped in a self-reinforcing loop of ineffectiveness, complexity, and insufficient legitimacy.57 Enhancing the competencies of the directly elected European Parliament was meant to be the remedy that would boost democratic accountability. While Parliament’s success on this score is disputed,58 its increased influence in shaping the balance of power between the Council and the Commission is more widely recognized.59 Moreover, complexity in European decision making has long been recognized, following the “liberal intergovernmentalist” theory of international relations, as an instrument used by European states to anchor the Commission’s actions to their own objectives, limiting agency drift.60 Objectives, however, differ across countries, such that others have rationalized European decisionmaking processes in terms of the “Europeanization” of national policies – that is, the projecting of national interests at the EU level and the use of EU institutions, the Commission in particular, as an “influence multiplier” both in

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Europe and globally.61 More mundanely, complex procedures can also be viewed as a tool for resisting EU bureaucracy’s inclination towards the rent-seeking behaviour postulated by the institutionalist approach.62 The complexity of decision making in defining a “formal” European external position, with its underlying inter-European and inter-agency issues, is particularly prominent in the economic and financial field. This is because of the very large number of actors directly involved: in all key groups and institutions relevant for global governance, both the four largest countries and the EU have a seat, while in many others, like the IMFC or the FSB, even more European countries are present. Moreover, the wide scope of these groups implies an overlap in competencies not only across the national/European dimension but also across national agencies, which are often, in turn, involved in specific international groups.63 Meanwhile, the basis in the EU Treaty legislation for coordinating positions of euro-area and non-euro-area member states might be different.64 The process in place to overcome these tensions and to reconcile differing stances within a single European position revolves around the drafting of “Terms of Reference” (ToRs). These can be viewed as the best approximation to an “official” European position on economic and financial issues, since they cover the key issues in this field, are periodically updated, are endorsed by the Ecofin,65 and form the basis for the formal statements that the Commissioner of Economic and Financial Affairs delivers both at the G20 and at the IMFC. Their status, however, is more ambiguous than this factually correct description would suggest. And the process for their preparation is long and complex, with the involvement of so many “cooks” as to cause the infelicitous results predicted by the adage. For starters, the ToRs are not an official act of the Ecofin Council formally provided for by the Treaty, but rather a “language standard” to be followed by all EU representatives, including national ones, in their pronouncements and negotiations. Therefore, they are not per se legally binding; they only impose restraints stemming from the duty of loyal cooperation which, as recalled earlier, can hardly be enforced in the absence of a political accord. Moreover, given that ToRs are not official acts, their endorsement is conditional on Ecofin consensus, not formal approval, such that they are subject to the interdiction power of its members.66 Yet such a power has never been explicitly exercised or evoked, because ToRs are very rarely discussed in any depth, or indeed at all. On the other hand, the Ecofin has systematically exercised its prerogative to grant its more-symbolic-than-substantive seal of approval. It is not unusual for the Ecofin to resort to a written procedure to approve the ToRs when the calendar of Ecofin and international meetings renders it necessary. The attention paid to explicitly exercising the right to agree to the ToRs suggests the acknowledgment that, in principle, adopting a common position is a powerful instrument for enhancing the EU external profile. In practice, ToRs are not systematically published, neither do they receive much attention when they are, given that their content tends to be watered down in their preparation and, in a perversely self-reinforcing loop, that the process

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encourages the dilution of their content. The Economic and Financial Committee – the group that prepares all key Ecofin decisions67 – is in charge of negotiating the ToRs on the basis of a text prepared by the Commission services. It routinely delegates this task to its Alternates, which are in turn supported by two sub-committees: the Financial Services Committee and the Sub-Committee on IMF-Related Issues, with the latter also receiving inputs from the EURIMF, the informal group of European members’ representatives on the IMF board. At each stage, the procedure is by consensus. As peer pressure is the only instrument towards compromise, the sequencing of steps provides the incentive to postpone concessions because controversial points are marked with square brackets in the text, left open for the next step. However, experience shows that neither the Economic and Financial Committee nor the Ecofin, with so many difficult negotiations always under way, are keen to engage in a thorough dispute over ToRs. As ToRs are not binding, they do not seem to be worth the investment of political capital through the involvement in a negotiation, which would also imply making concessions.68 The compromise is then found by papering over substantive disagreements, which, in turn, reduce the relevance of ToRs and confirm the incentive not to make substantive concessions during their preparation. The result is a sort of suboptimal equilibrium in which every party seems to be trapped: large countries feel unconstrained, the Commission hopes to have its role enhanced, and small countries try to exploit the situation to pursue their objectives (at times with success, some claim69). As if the process were not complicated enough, this is only part of the G20 story, which in turn is only part of the European external representation in economic and financial matters; the preparation of European positions in other G20 work streams follows different procedures again. Despite the commonality of themes and the fact that the leader summit was added to the G20 to deal with the financial crisis, the European position in the “sherpa track” is prepared by a part of the Commission Services that is different from the one in charge of the “finance track”. Member states are informed about the European position by the sherpa during a meeting of the Committee of Permanent Representatives, who, however, are expected to take note rather than provide inputs, and are certainly not expected to express overall evaluations. The process for the other G20 work streams is different yet again. There, preparatory committees for the relevant EU Council formation are involved, with the Secretariat-General often playing a supervising role that many Commission directorates resent. The description of the intricacies of the processes followed in defining the European position at the various international fora on the different issues could continue with never-ending twists of overlapping competencies and tangled prerogatives, notwithstanding the periodic efforts to streamline the arrangements.70 However, not much further insight would be gained on the key contention of this section: the complexity of the European process, which has deep-rooted

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motivations, does not encourage stakeholders to overcome their resistance to agreeing on and championing a common European position.

The decline is not inevitable The analysis thus far has delved into the fundamental and accidental motives behind Europe’s inefficacy in marshalling consensus and advocacy for a common position on global economic and financial affairs. These arguments might lead to the unwarranted conclusion that Europe is bound to continue its slide into a secondary role in global governance, as it remains absorbed in its own internal disputes, unable to sway the reform of international financial architecture. Although this is a possibility, it is not the only one. Political developments have given mixed and volatile indications. The referendum outcome in favour of Brexit, the Italian electoral results of March 2018, the widespread support for various forms of sub-national separatism, most visibly in Catalonia, and not to mention even more scattered and radical movements, have provided powerful signals of nationalism, fragmentation, and anti-Europeanism. They seem to rule out any possibility of progress in the direction of a higher profile for a common European stance in the reform of global governance. On the other hand, the electoral outcomes in other European countries in 2017–8 – in particular, the election of President Macron, the re-election of Chancellor Merkel, and their renewal of emphasis on the process of European integration – rekindled the global ambitions of the old continent, most notably as paladin of free trade. The line of reasoning presented here, however, intends to abstract from the vagaries of political temperature in different European countries and rather move from the premise that, at this critical juncture in the reform of global governance, the case for Europe to enhance its common international stance is compelling. The economic and geopolitical reasons for this assertion are exactly those that have been put forward to refute the three misconceptions typically advanced against a European stance in international economic affairs. They ultimately boil down to the basic notion that only Europe as a whole has the economic size to aspire to be a major global player and to defend the common interest of its national (and subnational) members – a common interest that, as argued earlier, spans a very broad range of dimensions and is underpinned by a deeply rooted cultural and political affinity that is all the more apparent when compared to the culture and politics of other major global actors. The prevailing political mood is, of course, one of the crucial factors in the progress towards a common external stance. It shapes the resolve to combat nationalistic sentiments. Most importantly, it determines the appetite to pursue the institutional changes, particularly in the EU Treaty, that could significantly enhance the external European representation. A new wave of modifications in the Treaty, however, does not appear likely in the near future because views on the directions that further integration within Europe should take remain very different both across and within countries.71

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Against this backdrop, the most expedient way to enhance European influence in the reform of global governance is to arrange a more effective representation in international fora by systematically adopting, at the European level, the same approach that countries follow in IFIs when they share a director on the executive board. Although this strategy would not require any change in existing legislation, neither domestic nor international, it would be effective in strengthening European clout in decision making, even providing a de facto veto power in some cases. In all circumstances, it would convey a very compelling symbol of unity and common resolve. But what does this approach exactly consist of? When countries are not large enough (in that IFI) to have a seat on the board on their own, they congregate in a constituency to elect a common executive director who will represent them all on the board, expressing their joint positions and casting the vote for them. It should be stressed that the relationships between members of the constituency, including the appointment of its director, are regulated by either memoranda of understanding or by-laws, with no inclusion in national legislation or the institution’s statute. Membership of the IFI, with all the rights and obligations this entails, remains a national prerogative, and in principle, the executive directors can express split votes backed by split opinions when there are irreconcilably different views within the constituency. However, this hardly ever occurs, since it undermines the director’s credibility, impairing his/her effectiveness in defending the constituency members’ interests. In a wide range of matters across IFIs and constituencies, all arrangements include agreement on two fundamental features. The first one is the method for electing the executive director, which typically is simply the rotation between constituency members of the right to appoint him/her for a number of years roughly proportional to each one’s relative voting power. The second feature is the procedure for determining the director’s stance on the board, which normally relies on informal consultations with national representatives in the director’s office or, if necessary, with officials in members’ national administrations. Sometimes constituency arrangements provide for voting to decide on the director’s position (constituencies with Nordic countries have a reputation for that), but this is unusual: peer pressure normally proves sufficient for reaching a common understanding, since it is universally acknowledged that split voting works to every constituency member’s detriment. This brief description is sufficient to convey the key strengths of the approach proposed here. First and foremost, there is the possibility of an immediate implementation under the current institutional set-up on the basis of a goodwill initiative. Moreover, because of its informality, the approach is inherently flexible and its specific features can be adapted to each institution: the “European” executive director could be appointed according to a national rotation or, say, the same procedure followed for the chairperson of the Economic and Financial Committee. Even the method for consulting the stakeholders and reaching a consensus on the matters at hand might vary according to the institution, flexibly drawing on the network of officials in the relevant national administrations, the

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Commission, and the various groups with relevant expertise, such as the SubCommittee on IMF-Related Issues. These consultation practices could be strengthened, providing for voting procedures to settle disagreements and to avoid stalemates.72 The informality and flexibility of the proposed approach are its main weaknesses too: without a legal framework for enforcing the convergence to a common position, each country, being a member of the IFI in its own right, preserves the faculty to require the “European” director to voice its own national position and cast a split vote – a practice which, unless truly exceptional, would dissolve the single European chair. Without a revision of the Treaty, there cannot be any guarantee that this would not happen. Moreover, even without an official challenge by a member state, one can envisage a situation in which a specific issue, if not the arrangement in general, could be taken up by an anti-European movement as the topic of an inflammatory campaign complaining about the usurpation of a national prerogative. Notwithstanding these weaknesses, a single chair in IFIs is the most expedient way, under the current institutional set-up, to start redressing the decline in European influence on the reform of global governance. And recent experience has shown that it can be viable and not just wishful thinking: European countries have already begun to embrace it, though so far on a limited scale. The reference here is to the decision by euro-area countries to aggregate their representation in a single seat on the board of the AIIB, which, as discussed in Chapter 4, was one of the major events in the transformation of the international financial architecture. The AIIB’s governance framework allotted only two seats to European shareholders. Thus, if the latter had followed the customary practice of choosing constituency formation with the objective of maximizing the number of years during which each constituency member could appoint the executive director or a representative in the director’s office, the four large European countries would have paired off into the two constituencies while the others would have selected the constituency according to their relative size. Instead, euro-area countries deliberately decided to congregate into a single constituency, keenly aware of the commonality of the strategic objectives of their participation in the AIIB, and determined to signal their resolve through the symbolic choice of a single euro-area chair. The practical details of the procedures for the appointment of the director and the day-to-day decision making were arranged drawing on the experience of constituency life in other MDBs. This path-breaking implementation of a deliberately joint European (actually euro-area) representation within an IFI without embarking on a modification of the institutional set-up of either the IFI or the EU passed nearly unnoticed, overshadowed by geopolitical tensions in other domains and intra-European disputes over other matters, such as the banking union. Yet it worked smoothly and proved effective. Indeed, it could – and it is here contended that it should – become the springboard for extending the same arrangement to other IFIs.

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Most importantly, the single seat approach should be adopted for the IFI where it would matter most: the IMF, which, nearly eighty years after sparking the post-war liberal order, continues to be the lynchpin of the international financial system. Europe, the EU, but even the euro-area, if it acted as a single actor, would have a stronger voting power than the US, commanding veto power just as the US does and thus enjoying a comparable influence. Moreover, as the concerted efforts to weaken Europe’s role in the IMF were one of the salient features of transformation in global governance, a resurgence of a common European stance within the IMF would have a particularly strong significance in geopolitical equilibria. Given both the extraordinary symbolic value and the radical alteration of voting equilibria it would imply, it is not surprising that the idea of a single European seat on the IMF board has been long advocated by many authors and explored for its implications for coalition building.73 Somewhat paradoxically, the policy debate following the proposal was less intense than one might have expected, and it was very often side-tracked by the red herring of legal issues. Because of the set-up of the Articles of Agreement establishing the IMF, it was practically impossible for the EU (or the euro-area) to be formal members of the IMF, even if this is unnecessary to achieve the desired objectives. No matter how accurate, this legal argument obscured the key political point of the proposal: showing unity of intent on the IMF board by instructing national representatives to commit to the systematic expression of a common European position by joint statements. Technically, the possibility of delegation to a single European director had to await the removal of some formal restrictions on the appointment of executive directors that were lifted in the 2013 reform.74 This was a formality that would not in any case have stood in the way of expressing a unitary position through systematic joint statements and a consolidation of European representation into five chairs to respect the constraints then prevailing.75 Understandably, the introduction of the euro was the triggering factor for the proposal of the single “European” chair, although it is clear that competencies and responsibilities of the EU and the euro-area countries are quite different with respect to external representation too. Both groups have been quite jealous of their own prerogatives; non-euro-area countries, in particular, insisted that the Commission should not fail to represent their views too, even when not strictly necessary. The European obsession, at least perceived to be so by third countries, with offering the full palette of positions and representatives (Commission, presidency of the Council, rotating EU presidency, Eurogroup, ECB, etc. in addition to national positions) became a further factor of weakness in Europe’s external projection.76 In practice, the “single” European representation in the IMF has been discussed in terms of a euro-area chair and an EU non-euro-area chair, ignoring the rest of “Europe”. The proposal to have a single chair on the IMF board for the euro-area received new policy attention in the framework of the initiatives, spearheaded by the Five Presidents’ Report,77 relaunching the progress towards improving the

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institutional architecture of the Economic and Monetary Union. Shortly after the publication of the Report, the Commission specifically circulated a proposal “laying down measures in view of progressively establishing unified representation of the euro area in the IMF”.78 In addition to strengthening coordination procedures, the Commission suggested moving towards a single euro-area seat progressively, by a piece-meal aggregation of euro-area countries in a decreasing number of constituencies before reaching the final goal by 2025. The suggested gradualism attracted no additional support for the single chair, while the legal debate on national versus EU competencies continued unabated, once again focusing more on the quagmire of tangled institutional prerogatives79 than on the key policy point of sending a message of European unity. It is baffling to contrast the “enhanced cooperation by edict” of the Commission’s proposal with the “just do it” approach that was followed in implementing the euro-area chair in the AIIB during exactly the same months. This difference in approaches raises questions, certainly warranting further research, about what factors and circumstances foster the diffusion of goodwill underpinning the “just do it” approach. An answer could provide useful guidance for replicating the single-chair solution for the WB and the other MDBs, much to the benefit of Europe’s clout over global governance at this key juncture. The single-chair strategy could be easily adapted to the specificities of each IFI and, more generally, to the fact that in most countries, the institutional responsibility for MDBs lies with agencies different from those responsible for the IMF. Indeed, this circumstance has traditionally created difficulties, not only in applying an effective policy coordination to the WB and to the other MDBs but even in simply extending the basic information-sharing which has been achieved by the Sub-Committee on IMF-Related Issues. Finally, it should be emphasized that the single-chair approach advocated in this section could also be extended to situations where in fact there is no executive director, such as the G7 or the G20.80 This would, of course, require suitable variations – for example, by streamlining recurrent themes, defining an agile procedure for reaching consensus, and then expressing the common European position effectively, conveying a purposeful sense of unity (this, in turn, could be done by issuing and delivering joint statements by both the EU and national representatives, for example). It is, in any case, obvious that no formal act can substitute for the political determination and the active goodwill necessary to champion a single stance in the pursuit of common strategic objectives.

A more effective Europe is also good for the world A more united Europe, with a stronger influence over global economic governance and a greater capacity to mould its transformation, would be, quite understandably, beneficial to the promotion of Europe’s interests, both economic and geopolitical. This section contends that such a development would also be advantageous for the rest of the world. The reason is that a more united Europe

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would entail an improvement in the quality of global economic governance, which, in contrast to relative geopolitical power, is a public good and hence capable of boosting prosperity in the whole world, not just in Europe. The improvement in governance would potentially come through different channels and cover several aspects. First, a more prominent role for Europe in global governance would help the diffusion of some of the features of its socioeconomic model, which might assuage the backlash against globalization that underpinned the popular scepticism towards multilateralism and open international order. To appreciate this argument, one must recall that, as has long been known from economic analysis, gains and costs from international trade are unevenly distributed across countries, regions, sectors, type of workers, etc. History has repeatedly shown that the related tensions lead to political protests and a reversal of globalization unless ways are found to govern international integration, mitigate social strains, and somehow compensate losers. The latest wave of globalization, which led to the upheaval in the relative wealth of nations discussed in Chapter 1, was characterized by a very marked rise in inequality, both across and within countries. This was accompanied by the discomforting perception of lost control over one’s destiny, since neither national political mechanisms nor international cooperation proved able to govern markets.81 The resentment towards globalization, despite the unprecedented boom in economic growth it generated, is ultimately rooted in the “fundamental political trilemma of the world economy: we cannot have hyperglobalization, democracy, and national self-determination all at once”.82 In terms of policy response, the most urgent priority is to compensate losers from globalization via social welfare spending, which is a sort of “European speciality”: as Chancellor Merkel has become famous for tirelessly repeating, the old continent has 7 per cent of the world’s population, a quarter of its GDP, and half of its expenditure on social welfare. Although European countries face daunting challenges in preserving the viability of their systems in aging societies, the safety net they provide to their citizens can be viewed, notwithstanding their differences, as a point of reference for the other parts of the world. The model would become more relevant globally if Europe has a stronger international stance, and this, in turn, would help to buttress wider support for openness and multilateralism, while also contributing to the adoption of policies to mitigate the social costs of globalization. Along similar lines, it can be argued that a stronger Europe would make global economic integration more equitable and fair through the more effective promotion of instruments for fighting corporate tax avoidance. The Commission proposal for a common consolidated corporate tax base can be interpreted as one of the means for addressing the legitimacy crisis plaguing globalization.83 A stronger Europe would also improve global governance through its enhanced leverage on trade standards, making sure that consumer protection and fair competition are not compromised by openness in the wake of what has been

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labelled the “Brussels effect”: the significant impact on non-EU standards of the obligation for exporters to the EU to meet EU standards, which derives from the fact that the EU is the most important trading partner for more than 80 countries in the world.84 Even more broadly, the process of European integration – as a framework encompassing openness and free trade with a system for settling disputes and ensuring a level playing field – can be viewed as the instrument for European citizens to take back control of globalization. In spite of the fact that the elements of solidarity and sovereignty transfer of the European construction can hardly be replicated at the global level, the European framework is arguably a model for the social contract across countries that may be needed “to preserve social contracts within countries in the face of globalization”.85 This contention holds even though, as repeatedly recalled in these pages, a part of European public opinion holds the opposite view and blames European integration and the euro rather than globalization for the unrest and strains that beset European societies. The second reason why a stronger role for Europe in global governance would be beneficial for the world at large stems from classic analyses of international relations suggesting that multipolar systems are more stable than bipolar configurations.86 In multipolar systems, the risk of a destructive escalation of conflict is diffused and the “interaction opportunity” – that is, the possibility of crosscutting alliances – exerts a stabilizing function.87 The original theory was challenged, leading to further elaborations and refinements which still remained focused on geopolitical and military aspects.88 On economic and financial issues, no alternative to the US hegemony of the pax Americana, with the Bretton Woods system and G7 support, was realistically considered until the upheaval in global governance that was triggered by the financial crisis. Later, different options for the future have started to surface in some analyses. Even though the reference to multipolarity in economic and financial affairs has become less sporadic in international relations, it typically refers, with few exceptions, to the emergence of China as the only other sizeable economic bloc that, like the US, possesses significant military power and geopolitical ambitions.89 Moving forward, economic and demographic forecasts combine with military conjectures to project the potential for a global economic governance that hinges on a bipolar system, based on US and China. This configuration would present the well-known elements of instability, with all the attendant risks for the prosperity of the world economy. In this case, hazards would be compounded by the huge bilateral imbalances between the two economies – imbalances that are by far the major component of the global imbalances which were at the root of the financial crisis and which are for the most part still outstanding. Europe is the only other economic bloc with the size and the thus far unrealized political profile to have, at least potentially, a comparable standing even in the absence of a commensurate military force. Against this backdrop, a more united and determined Europe in international affairs would improve world stability and resilience, mediating between the two

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super blocs, spurring the involvement of other major partners towards a more inclusive multipolarity, enhancing global capacity to absorb shocks, given that Europe as a whole, contrary to China and the US, has no major imbalances either in stock or in flow terms. Moreover, a stronger Europe would have the credibility to select and define strategic partnerships with a narrow but crucial set of countries.90 This policy stance would contribute to providing resilience to multilateralism, which continues to stand as the ultimate instrument for ensuring sound global governance in a world where two powers exceed all others for economic and military might. The third channel through which a more united and determined Europe would benefit the global economic and financial system is the euro. As discussed in Chapter 5, the incomplete institutional architecture underpinning the single currency and the unresolved divergences on the future of monetary union have so far thwarted prospects for the euro to become a credible contender to the dollar as a global reserve currency. Until firm institutional improvements are achieved on that front, conjectures on the possible progress of the international use of the euro are of little consequence. Yet one cannot ignore the fact that the legacy of the huge imbalances between the US and China (for a large proportion, in the form of Chinese holdings of US public debt) is bound to be a key hurdle to any substantive evolution in the international monetary system, which would have to accompany further changes in global governance and financial architecture. A more prominent international role for Europe and the euro, possibly within the framework of an enhanced function of the SDR in the IMF, could offer crucial help in paving a smooth transition away from this severe disequilibrium. In the absence of a concerted arrangement providing for an ordinate unwinding of the imbalance, the risks for global financial stability are enormous. A more united Europe can be a key part of the solution.

Conclusions European countries are proud of their national cultures, identities, and individual capacities to leave special imprints on the world as they have done for centuries. They embarked on the most ambitious process of transnational integration in history, relinquishing substantive portions of national sovereignty and achieving the longest uninterrupted period of peace and prosperity in history. They (or at least some of them) also embraced an unprecedented experiment in monetary integration, sharing a single currency while retaining decentralized budgetary policies. In spite of all these achievements as Europe, European nations have remained jealous of their prerogatives regarding their relations with third countries. As a result, European external representation has always been weak, confused, divided, and derivative with respect to national positioning. “Who do I call when I want to call Europe?” Kissinger allegedly asked in the 1970s. After several revisions of the EU Treaty, he would now have a precise, legally sound answer.

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Yet it would be less straightforward than he had desired, since it would depend on the subject matter. The procedure to define the external European position and the composition of the exterior European representation remains complex, topic-dependent, and prone to safeguarding national prerogatives on the relationships with third countries and international institutions and groups, such as the IMF, the G7, and the G20. The complexity of the process of defining a common European position and the reluctance to champion it in practice in a convinced and synergistic way across actors and fora is not the result of shoddy bureaucracy or petty inter-agency disputes. It reflects the widespread idea that European and national external interests differ. This notion is based on three fallacious misconceptions that stand to be corrected: no European country can play a significant role on its own in global governance; intra-European differences dwarf in comparison to divergences from extra-European countries; and contrasts across European countries in extra-EU economic interests are not of any strategic significance. Intricate procedures for the definition of the single European external position, tepidity in defending it, and jealousy in preserving national status have resulted in a very clumsy and ineffective European stance. This disarmingly poor result stands in glaring contrast to the number of European representatives and the size of European voting power in the relevant IFIs and groups. The inadequacy of the European profile became even more conspicuous at the critical juncture of the transformation in global governance triggered by the crisis. At that decisive moment, Europe missed the opportunity to exert an influence on events commensurate to its economic size and potential geopolitical power. It was so engulfed in its own disagreements over the handling of the sovereign crisis as to be unable to act united in defence of its own interests both in the transformation of the G20 and in the long negotiations over the quota and voice reform of the IMF. Moreover, Europe badly mismanaged its relationships with the IMF during its involvement in the European crisis, alienating its management and key members. Europe’s declining influence in global governance is not inevitable. The process can be stopped and reversed. The most compelling and expedient strategy to this end is to arrange a more effective representation in international fora and institutions by systematically following, at the European level, the same approach that countries follow in IFIs when they are jointly represented by the same executive director. This approach requires no change in domestic or international legislation, only political goodwill. And, as the recent decision to form a euroarea constituency in the AIIB has indicated, it is no utopian wishful thinking. Flexible in its implementation and highly symbolic in the message of European unity it conveys (think of a euro-area executive director at the IMF!), this arrangement could be an important step towards a more effective role for Europe in the reform of global governance. A more united Europe, capable of exerting significant influence over global economic and financial architecture, would benefit not just Europe but world

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prosperity too. A more prominent Europe would promote the diffusion of some features of its social model, from consumer protection to welfare safety nets, which can mitigate the costs associated with globalization, thus helping to preserve an open multilateral system. Moreover, a stronger Europe could improve the resilience of the global economy, reducing the risks of a governance hinging on a US-China bipolar system towards which, as economic and strategic conjectures suggest, the world is likely being directed. Finally, a more united Europe could underpin the function of the euro as an international reserve currency, which would facilitate the ordinate adjustment of the huge imbalances between the US and China that pose a disquieting threat to the world economy.

Notes 1 In essence, the dispute regarded the (partial) preservation after the merger of the influence over concessional lending that countries, mostly Europeans, had obtained through contributions to the Asian Development Fund that were proportionally larger than their respective capital shares (and voting rights) in the AsDB. For the sake of accuracy, it should be mentioned that Canada too participated in that meeting because it belonged to one of the constituencies with European countries. Its assent, necessary for having a joint position by all the relevant directors, was not difficult to obtain because Canada was, on this issue, in a position similar to that of the European members. 2 When Russia, a member of the Council of Europe since 1996, eventually annexed Crimea in 2014, the Parliamentary Assembly suspended Russia’s voting rights. After some unsuccessful attempts to find a viable political solution, in 2016, Russia, contrary to standard practice, decided not to invite the Council to monitor its elections, and in June 2017 suspended the payment of its contribution to the Council’s budget until full and unconditional restoration of its voting rights, creating a major shortfall that other members showed little appetite to compensate for. For a detailed discussion see Casier (2017) and Guasti (2018). 3 Ikenberry (1989, p. 376). 4 The interview is available at www.youtube.com/watch?v=eYgnGAr3-kM. 5 Most famously, Le défi Américain by Servan-Schreiber (1967) which sold more than 10 million copies. 6 For an analysis of the European Political Cooperation in the 1970s and 1980s, see, for example, Allen et al. (1982) and Kirchner (1992). 7 The president of the Commission was first invited to attend the G7 leaders’ meeting at the third summit, held in London in May 1977. The eighth summit, held in Versailles in June 1982, was the first time that a president of the European Council, who was not from the four original European G7 members, participated in a G7 summit in addition to the president of the Commission. 8 The rebranding of the European Political Cooperation into the Common Foreign and Security Policy had already been decided upon in the Maastricht Treaty. 9 Hill (1993) introduced the concept of capability-expectations gap, which basically persists despite several institutional improvements to reinforce Europe’s external representation, as discussed in Hill et al. (2017). 10 De Schoutheete and Andoura (2007) show that this was no minor feat from both legal and political points of view, since Europe was “an international partner with troubled personality”, as Neuwahl (1998) says in the title of her paper. 11 Johansson-Nogués (2014). 12 Henning (1997), Everts (1999), Henning and Padoan (2010).

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13 The arrangement was an institutional innovation involving legal problems; see Horng (2004, 2005). 14 This is how Brunnermeier et al. (2016) label the traditional division on macroeconomic stabilization and public finance between the German ordoliberal and the French activist approach. Kattel et al. (2015) provide an overview of different approaches to financial regulation 15 The event marking the end of the acute phase of the crisis is the ECB president’s famous line “whatever it takes”, quoted in Chapter 2. Bastasin (2015) and Brunnermeier et al. (2016) provide detailed chronicles of the crisis. 16 Gowan (2012) identifies the failure to streamline European representation in the G20 as one of the key causes of Europe’s failure to influence the reform of the multilateral system it had contributed to initiate. 17 The US position in favour of the curtailment of European representation in the IMF predates the eruption of the financial crisis, as shown, for example, by Truman (2005). 18 For example, Ahearne and Eichengreen (2007) and the contributions in Jørgensen (2009a). 19 Chapter 3 explains the role of the formula in the negotiations in detail. 20 Kissack (2016). 21 Keeney (2017) provides a detailed explanation of the way this figure is reached. 22 Eurogroup statement on Greece of 22 January 2018, available www.consilium.europa. eu/fr/press/press-releases/2018/01/22/eg-statement-on-greece/. 23 Greece’s GDP stood at 2.52 per cent of the euro-area GDP in 2007, 2.42 in 2009, and 1.65 in 2016 – a fall which speaks volumes about the heavy toll paid by the country. These values are netted off the effects of the euro-area enlargement that took place in the period. 24 Junker et al. (2015). The report triggered a wide debate on the future of the Union that is still bourgeoning. Pisani-Ferry (2014), Matthijs and Blyth (2015), Fabbrini (2015), Stiglitz (2016), Elliott and Atkinson (2016), Caporaso and Rhodes (2016), and Nugent (2017), among others, offer diverse and insightful views. 25 Even Trichet, Junker (presidents of the ECB and the Eurogroup respectively), and Schäuble (the German finance minister) championed this view. They accepted the IMF involvement at the insistence of Chancellor Merkel in particular. More details are given in Blustein (2016) and Henning (2017). 26 Ireland, Cyprus, and Portugal. The IMF did not participate in the assistance to Spain, targeted towards banks. 27 Henning (2017, p. 239). Since Henning (2017) concurs with the conclusion that, to use his words, “the role of the IMF is inextricably bound up with the evolution of the institutional architecture of the euro area” (p. 248), the key difference between his interpretation of the troika and the view presented here lies in the degree of consciousness and premeditation in promoting such a complex arrangement: deliberate governance instrument, as he contends, or, more mundanely, haphazard organization to mediate between conflicting domestic and international objectives, often with blatant time inconsistency. 28 More structured policy responses and institutional innovations only came when further deterioration of the economic and financial conditions forced resolute decisions, which in any case remained controversial; for more details, including the political economy aspects, see the papers in Caporaso and Rhodes (2016). 29 Best (2005) and, with special reference to IMF conditionality, Best (2012). 30 Lütz and Kranke (2014). 31 At more than 3,000 times the value of its IMF quota, the stand-by arrangement for Greece is still the largest loan ever issued by the IMF in relation to the borrower’s quota. The extraordinary size and the need for a change in the IMF policy framework for exceptional access account for the irritation of the IMF’s key shareholders at Europe’s insistence. They also explain the special efforts put forth by the managing

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32 33 34 35

36 37

38 39 40 41

42 43 44 45 46 47 48

49

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director Dominique Strauss-Kahn to marshal an agreement within the IMF board in spite of the vehement opposition of the emerging markets and the lukewarm attitude of the US (details in Blustein, 2016; Henning, 2017). For a description of the systemic clause and the reasons for its abolition, see www.imf.org/en/News/Articles/2015/09/ 28/04/53/sopol012916a. Chapter 3 discusses the circumstances that led the US to request the abolition of the systemic clause. Official Sector Involvement, as it came to be known. Through successive decisions by the Eurogroup when programmes were renewed, official lending to Greece reached such a long maturity and favourable financial conditions that it had a very low net present value. Selbervik and Nygaard (2006). Elgström and Delputte (2016) suggest that the exceptionalism might have come to an end because of the “Europeanisation of Nordic development policies”, even though Delputte et al. (2016) warn that in the “Europeanisation of aid budgets nothing is as it seems” (titles of the respective papers). For a discussion of the PPP metric, see Chapter 1. For GDP data in PPP terms, figures are taken from www.rug.nl/ggdc/historicaldeve lopment/maddison/; for 2050 projections from www.pwc.com/gx/en/issues/econ omy/the-world-in-2050.html and https://data.oecd.org/gdp/gdp-long-term-forecast. htm for GDP at current exchange rates from IMF statistics. The reference list could be endless; just two examples: Vaughan-Whitehead (2015) and Allen et al. (2004). Padoa-Schioppa (2006) insists on the concept of “multiple identities” in his advocacy of European federalism. Mariniello et al. (2015), Micossi (2016), and Tache (2017) are recent works on the issue. Recent studies on EU trade specialization include Thissen et al. (2013), Leitner et al. (2016), Harte et al. (2017). Charts in https://atlas.media.mit.edu/en/visualize/tree_ map/hs92/export/deu/usa/show/2016/ offer an effective visual representation of trade patterns. Poletti and De Bievre (2014), Young (2017), Santagostino (2017), among others. Sousa et al. (2012) and Rueda-Cantuche et al. (2013). The share of extra-EU trade over total EU trade is increasing and likely to reach 50 per cent by 2030, as discussed in Gros and Alcidi (2013), Chateau et al. (2015). Aggestam and Johansson (2017). Cameron (2012) and Jørgensen (2009b) Johansson-Nogués (2014). Emerson et al. (2011) provide an overview of the status of the EU and the way it is represented in the multitude of international institutions and groups that deal with matters of interest for the EU. See, for example, McCormick (2014) and Yeşilada et al. (2018). Common accord is a reinforced unanimity rule that does not allow for explicit abstention (Bursens et al., 2016). Consensus is a vague term implying an imprecisely defined qualified majority that in any case allows indecision or silence, see Urfalino (2010, 2014) and Krick (2015). In European decision making, both require an appeasement of actual or potential dissenters, conferring them informal interdiction powers (Heisenberg, 2005; Novak, 2010; Häge, 2013). Maggi and Morelli (2006) provide a game-theoretic analysis explaining why the diffusion of unanimity in international organizations is related to the issue of the enforceability of decisions. Eeckhout (2011), Wessel (2011), Amtenbrink et al. (2015), Leino (2017). The modalities of external action are routinely assessed by the Commission Inter-service Group on EU External Competences, co-chaired by the Commission’s Secretariat General and Legal Service. As in the title of Van Elsuwege (2010).

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51 Jørgensen (2009b); see also Cœuré and Pisani-Ferry (2007). 52 Kaczyński (2011). 53 Also known as principle of loyal cooperation, or duty of sincere (or genuine or in-goodfaith) cooperation. For a discussion of its relevance in the Treaty, see De Baere (2008), and Van Elsuwege and Merket (2012). 54 Neframi (2010) and Casolari (2012). 55 Dijkstra (2013), Hayes (2013), Carta (2013), Wallace and Reh (2015), Bauer and Trondal (2015). 56 Delreux and Keukeleire (2017). 57 For example, Beetham and Lord (2014) and Hobolt (2018). Some influential analyses, such as Moravcsik (2002), find these concerns misplaced. 58 Ripoll Servent (2018). 59 Dehousse (2011), Bickerton et al. (2015), Pollak and Slominski (2015), Héritier (2017). 60 Moravcsik (1993, 2013). 61 Wong and Hill (2012), Wong (2017). 62 Dowding (2000) and Vaubel (2004) in the wake of Vaubel (1986). 63 For example, euro-area national central banks (including four directly involved in the G20) and the ECB meet periodically in the International Relations Committee and discuss, among other things, the G20 agenda. 64 More precisely, art. 138.1 of the Treaty versus art. 218.9, as discussed in Leino (2017). 65 Ecofin is the abbreviation for the Economic and Financial Affairs Council, which is the configuration of the Council of the European Union composed of the economics and finance ministers. 66 On consensus and common accord, see footnote 48. 67 It may be worth noticing that the Economic and Financial Committee consists of the very same people who are the deputies of the G7 and G20 as well as the FSB members for the Commission and the respective Treasuries. 68 By the way, granting substantive concessions would also create a precedent in accepting limitations to the autonomy of national pronouncements in multilateral fora, with which large countries would not be at ease. 69 Nasra and Debaere (2016). 70 For example, the arrangements on the delivery of EU statements in multilateral organizations, approved by the EU General Affairs Council on 22 October 2011, which, however, do not cover the ToRs discussed in the text. 71 See, for example, Fabbrini (2015) and Nugent (2017). 72 Formal voting procedures create incentives for strategic behaviour that can in principle be rigorously analysed. However, Kurz and Napel (2016) prove that procedures in the Lisbon Treaty are of an unprecedented complexity and thus intractable at the general level. Even analyses on specific issues, such as Monticelli (2003) on monetary policy on the ECB board, have to resort to numeric simulations to obtain definite results. 73 The best-known articles are: McNamara and Meunier (2002), Mahieu et al. (2003), Bini Smaghi (2004, 2006), Leech and Leech (2005), Cœuré and Pisani-Ferry (2007), Padoan (2008), Brandner and Grech (2009), Wouters and Van Kerckhoven (2013). 74 The restrictions that would have prevented all the European countries from being represented by only one chair were: i) the Articles of Agreement provided for the appointment of one executive director each to France, Germany, and the UK; ii) the Regulations approved by the executive board capped at 9 per cent the share of quotas that each elected director could represent. Both provisions were abolished. 75 The total quota share of European countries other than France, Germany, and the UK, whose board members used to be appointed, not elected, was well in excess of 15 per cent. 76 For example, Bini Smaghi (2006), Gstohl (2009), Woolcock (2016). 77 Junker et al. (2015).

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78 European Commission (2015). 79 See, for example, Lopez-Escudero (2016) and Leino (2017). 80 While arguing that Europe “has a lot to offer [to] global economic policy coordination”, Buti (2016, p. 126) stresses that Europe “should enhance its internal cohesion to project external strength”. 81 The academic and policy debate on globalization, its implications, and the actions to harness it more effectively is very vast. Suffice it here to recall the classic Wolf (2004), Bhagwati (2006), Stiglitz (2007) and the more recent Rodrik (2017), Mazzucato (2018); for the inequality aspect, Atkinson (2015), Bourguignon (2016, 2017). 82 Rodrik (2012, p. 200). 83 Morgan (2017). 84 Bradford (2012). 85 Cœuré (2018, p. 131). Less convincingly, Wouters and Ramopoulos (2012) argue that multi-level European governance, particularly the European Council, can provide useful lessons on improving global governance, especially with regard to decisionmaking dynamics within the G20. 86 Kaplan (1957). 87 Deutsch and Singer (1964). 88 For a critique, see, for example, Waltz (1964); for a refinement, Rosecrance (1966); for a review, Haas (1970). 89 For example, when Clegg (2010) says “multipolar world”, she in fact means bipolar, US and China. Conversely, Stuenkel (2015, 2016) is an exception because in his notion of a multipolar system, in addition to the G20, the other BRICS countries are expected to play a relevant role. 90 Renard (2011), and Renard and Biscop (2012) stress this point.

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INDEX

Abbott, T. 66–67 account balances, G7 25–26 Action Plans 63, 67 Addis Ababa conference on financing for development 107, 141n64 Adjustment, external imbalances: China 60; Germany 60; global 26, 208; symmetry 33, 52, 56, 80, 123, 185; US views 103n6 African Development Bank (AfDB) 10, 114–115, 123 aid effectiveness 119–120, 139n43, 140n45 aims: of development 108; Financial Stability Board 153, 154–159 Amsterdam Treaty 183 Arab Spring 6–7 Argentina 44n50, 69, 84, 117, 144 Article IV IMF reports 82 Articles of Agreement (IMF) 80, 95, 181, 202 Asian crisis 34, 84, 146–147, 185 Asian Development Bank (AsDB) 89, 115, 127, 130–131, 136, 137, 178 Asian Infrastructure Investment Bank (AIIB) 109, 130–132, 136, 146, 164, 201, 203, 207 austerity measures 84, 99 Australia 37, 54, 66–68, 131, 147, 160 Basel Committee on Banking Supervision (BCBS) 149, 150, 154–155, 175n36, 177n94; consultative exercises 164 Basel III framework 154–155, 165, 174n33 Berlusconi, S. 75n22

basic votes 90 bilateral loans 49, 71, 88 Birmingham Summit 26 BNP Paribas 168 Brazil 18, 28, 54, 71–72, 76n40, 84, 92 “Bretton Woods moment” 38–41 Bretton Woods system 23, 80–81, 103n3, 181–182, 205 Brexit 180, 191, 196, 199 BRICS 4, 8, 69, 76; CRA 128–130; Crimea 70; FSB 144–145; formation of 68–70; and G20 68–73; MDBs 126–132; see also Brazil; China; India; Russia Brisbane summit 66–68 Brown, G. 36–37, 48, 53, 88 Bush, G. W. 17–19, 37, 69, 151 Canada 24, 45–46, 68; G20 34–35 Cannes summit 58, 59–62 capital adequacy: AIIB 131; CRA 130; FSB 154–156; MDBs 111–112, 124–126, 133 Chang Mai initiative 85–86 China 5, 10–11, 40–41, 57–59; AIIB announcement 72; AsDB 195; IADB 114; IDA 128; IMF 98; lending to Africa 121; MDBs 126–132; renminbi 54–55, 169–170; time horizon 42 climate change 64–65 Cologne Summit 34 communiqués: Australia 67–68; G20 35, 40–41; London 49–51, 96; Pittsburgh

Index

49–53; Russia 64–65; vs. account balances of G7 26; Washington 40–41, 50–51 conferral, principle of (EU) 195–199 Congress (US), IMF reform 94–95 Contingency Reserve Arrangement (CRA) 71–72, 128–130 continuity, international standards regime 11–13, 159–171 control, of IMF 8–9, 79–83 cooperation 30–33, 45–55; and game theory 31–32 coordination: financial sector regulation 144–177; FSB 144–146, 150–163; FSF 146–153, 163; international 50–53; macroeconomic 50–53, 56–58 Crimean annexation 68 criticisms: of IMF 83–86; international standards 149–150, 160–171; WB 118–220; Washington Consensus 84, 122 Deauville 55 decision-making, EU 195–199 decline of G7 25–27 derivatives 21, 158–159 development: aims of 108; multilateral development banks 110–115, 126–132 Development Committee 111, 118, 133, 138n5, 138n14 dollar, persistence of 12–13, 166–171 Draghi, M. 62, 144 Early Warning Exercise 153 effectiveness: of aid 119–120; of EU 203–206 emerging economies: G20 7–8; GDP 28; international standards 12, 149–151; multilateral development banks 113–123; power imbalances 3, 144–145, 163–171; rule-taking 163–166; voting rights 9; World Bank framework 124–126 environmental damage 117 establishment: European Community 182; International Monetary Fund 79–81; multilateral development banks 79–81, 126–132; New Development Bank 71–72, 126–131 EURIMF 187, 198 euro 13–14, 169, 184, 206 European Central Bank (ECB) 55, 62–63, 189–191 European Community (EC) 182 European Court of Justice 195–196 European identity 194

239

European Investment Bank (EIB) 114 European Stability Mechanism 62 European Union (EU) 178–212; conferral, principle of 195–196; coordination 190–206; crisis 59–63, 185–186, 188–191; decision-making 195–199; effectiveness 203–206; foreign policy 191–192; future of 199–206; and G20 185–186; identity 194; and IMF 186–191; influence of 13–15, 181–188; International Financial Institutions 199–203; misconceptions 191–195; nationalism 192–193; Single Market 192, 194–195; support of Greece 55, 61–62, 186, 188–191; Terms of Reference 197–198; treaties 182–184 exchange rates: flexibility 23; Palais-Royal initiative 56–59; structural power 166–171 “exorbitant privilege” 57, 166 external imbalances 51–53 failures, global financial crisis 20–23 Federal Reserve: global financial crisis 20; international standards 153, 166–171; QE2 63, 65–66 financial architecture 56–59, 75n20, 145–146; G20 working group 59; Keynes and White 80 financial sector regulation 144–177; capital adequacy 154–156; Financial Stability Board 144–146, 150–163; Financial Stability Forum 146–153, 163; fragmentation 159–162; global financial crisis 22–23; integrity 156; legitimacy 149–150, 160–163; objectives 153, 154–159; OTC derivatives 158–159; outcomes 159–163; principles 148–149; reforms 49–50; risk 157; rule-taking 163–166; shadow banking 158; structural power 166–171; systematically important institutions 155–156; transparency 156 Financial Stability Board (FSB) 12, 50, 144–146, 150–163; capital adequacy 154–156; derivatives regulation 158–159; integrity 156; legitimacy 160–163; objectives 153, 154–159; outcomes 159–163; risk assessment 157; shadow banking 158; systematically important institutions 155–156; transparency 156 Financial Stability Forum (FSF) 48, 50, 146–150, 163; formation of 34; role of 41 financial support of Greece 61–62, 186, 188–191

240

Index

financial transactions tax 53 “finger-pointing” 40–41, 51, 98 Fiscal Compact 62 Five Presidents Report 202–203 Ford, G. 24 foreign policy, European 191–192 foundation, of G7 23–25 fragmentation: financial sector regulation 159–162; key features 4 Framework for Strong, Sustainable and Balanced Growth 51–53 “framework” of the World Bank 125–126 France 37, 56–62 FSB see Financial Stability Board FSF see Financial Stability Forum functions, multilateral development banks 108–109

Global Forum on Transparency and Exchange of Information for Tax Purposes 64 global growth forecasts 67 globalization: cooperation 30–33; EU 204–206; and interconnectedness 5–6; International Financial Institutions 82–83, 119; productivity 27–28; World Bank 119 governance: AIIB 131, 201; CRA 130; IFIs 79–83; MDBs 124–126; WBBank 109–120; see also international standards regime Greece 55, 61–62, 186, 188–191 Gross Domestic Product (GDP), of G7 27–28 Gyeongju meeting 92–93 hard law 162

G5 24 G7: Asian crisis 146–147; diminishment of 3, 7, 25–27, 50; and Europe 185–186; Financial Stability Forum 146–153, 166–171; foundation 23–25; global financial crisis 17–20; Pandemic Emergency Financing Facility 132; Purchasing Power Parity 27–28; relative wealth 27–30 G8 26, 37, 45–46, 50, 68–70 G14 36 G20 45–76; ascent of 7–8, 46–50; BRICS 68–73; emerging economies 7–8; and EU 185–186; Financial Stability Board 144–146, 150–166; formation of 34–41; global financial crisis 17–23, 86; international coordination 53–55; macroeconomic coordination 50–53; multilateral development banks 121–126; Mutual Accountability Framework 63; Mutual Assessment Process 52–53; Palais-Royal initiative 56–59; post-2008 3; taxation 64 game theory, and cooperation 31–32 GATT tariffs 27 Geithner, T. 35, 93, 153, 160, 174n21 General Agreement to Borrow (GAB) 87 Geneva-1 round 27 Germany 34, 54–55, 59–60, 65, 185, 193; Greek fiscal adjustment 189–191; IMF in Europe 89; IMF shares 104n20 Giscard d’Estaing, V. 57, 166 global financial crisis 17–23, 86–90 global imbalances 15, 17–19, 24–26, 40–42, 51–52, 75, 144–145, 163–171, 205

identity, European 194 inclusiveness, concern for 6 Independent Evaluation Office (IEO) 100 India 27–28, 54, 66, 71, 86, 105n41, 124, 129–130, 141n66; fall in absolute poverty 134 influence: of EU 13–15, 181–188; of IMF 82–83, 96–99 information, production of 6–7 information and communication technology (ICT) 27–28 Inspection Panel, World Bank 117 integration of Europe 182–184, 197–206 intensive transgovernmentalism 196–197 interaction opportunity 205 Inter-American Development Bank (IADB) 114, 119–120, 123, 139n37 interconnectedness: cooperation 30–33; financial sector reform 144–177; international coordination 53–55; key features 5–6; macroeconomic coordination 50–53 intergovernmentalism 196–197 International Bank for Reconstruction and Development (IBRD) 110; see also World Bank International Development Agency (IDA) 113, 117–118, 128 international financial architecture 56–59, 145–146 International Financial Institutions (IFIs): criticism of 83–86; EU 199–203; foundation 79–81, 126–132; G7 23–24; G20 25–26, 45–50; global financial crisis 86–90; globalization 82–83;

Index

legitimacy 77–79; paradigm 99–102; reform of 77–104; stakeholders 79–83 International Monetary and Financial Committee (IMFC) 29, 34–35, 97, 197 International Monetary Fund (IMF) 48–50, 77–104; Asian crisis 34; control of 8–9; criticism of 83–86; establishment 79–81; and Europe 186–191, 202–203; European crisis 188–191; G7 23–24; G20 25–26, 41, 53; global financial crisis 86–90; global growth forecasts 67; Greece 62, 188–191; influence of 82–83, 96–99; Palais-Royal initiative 56–59; paradigm 99–102; quota reforms 85–86, 90–96; Special Drawing Rights 5, 48–49, 57–58, 87–88, 169–171; stakeholders 81–83, 125–126; World Bank cooperation 110–111 International Organization of Securities Commissions 150 international standards regime: Asian crisis 146–147; continuity 11–13, 159–171; emerging economies 12, 149–151; Federal Reserve 153, 166–171; Financial Stability Board 144–146, 150–163; Financial Stability Forum 146–153, 163; global financial crisis 22–23; legitimacy 149–150, 160–163; outcomes 159–163; principles 148–149; quality 149; ruletaking 163–166; structural power 166–171 internet, social media 6–7, 83 Investment and Infrastructure Working Group 123 Italy 24, 37, 58 Japan 25–26 54; AIIB 109; AsDB 115, 129, 130–131 Jinping, X. 72 Kenya 118 Kissinger, H. 13, 206 Koch-Weser, C. 35 Korea 45–46, 54–56, 92–96, 118 Latin American Consensus 120 legitimacy 77–79, 149–150, 160–163 Lehman Brothers 17–18, 20 less-developed countries (LDCs): multilateral development banks 113–123; New International Economic Order 116; power imbalances 144–145, 163–171; rule-taking 163–166; World Bank framework 124–126; see also emerging economies

241

liberal intergovernmentalism 196–197 Library Group 24 Lisbon Treaty 183–184, 195 London summit 48–51, 96, 109, 156 Los Cabos summit 58–59, 62–63, 71 Louvre Accord 24 Maastricht Treaty 183, 184 McCloy, J. 110 macroeconomics: of EU 181–195; of G7 23–30; of G20 49, 50–53; of global financial crisis 22–23 macroprudential policy 159 Major Economies Forum 36 Mantega, G. 18, 54 market discipline 21–22, 51–53; see also Greece; international standards regime Marshall Plan 110, 113, 138n7 Martin, P. 34 memoranda of understanding (IMF) 82 Merkel, A. 55, 66, 199, 204, 209n25 Mexico 58–59, 62–63, 84, 87, 89, 144 Millenium Development Goals (MDGs) 118–119 Mnuchin, S. 174n24 Monroney Resolution 113 multilateral consultation (IMF) 98 multilateral development banks (MDBs) 9–11, 88, 107–143; business model 109–112; capital requirements 111–112, 124–126; development of 110–115; establishment 79–81, 126–132; functions 108–109; G20 121–126; Non-Aligned Movement 113–115; reforms 123–126; Sustainable Development Goals 134–135; tensions 132–136 Muskoka summit 45–46 Mutual Accountability Framework 63 Mutual Assessment Process 52–53 Nanjing seminar 58 nationalism 192–193 Netherlands 34, 37, 147, 187, 188–189, 191 New Agreement to Borrow (NAB) 87–88 New Development Bank (NDB) 5, 10–11, 71–72, 109, 126–131 New International Economic Order 116, 130 new order, key features of 4–7 New Zealand, G20 37 Nice Treaty 183 No Global Protest 29–30 Non-Aligned Movement 113–115 “non-cooperative jurisdictions” 147–148

242

Index

Obama, B. H. 94–95, 151 objectives, Financial Stability Board 153, 154–159 Official Development Aid (ODA) 115–116, 119, 135 O’Neill, J. 69 optimal policy 32–33 Organization for Economic Cooperation and Development (OECD) 64, 104n31, 121, 127 over-the-counter (OTC) derivatives 158–159 Padoa Schioppa, T. 74n10, 97, 210n39 Palais-Royal initiative 56–59 Pan-African movement 114–115 Pandemic Emergency Financing Facility 132 Papandreu, G. A. 61–62 paradigm continuity 99–102, 160–171; rule-taking 163–166; structural power 166–171 Paraguay 117 Paulson, H. 17, 43n10, 87 peer review 49, 52–53, 60–63 per capita income gaps 27–28 Pittsburgh summit 36, 46, 49–53, 92 Plaza Accord 24 power: relational 166; structural 166–171 preferred creditor status 111–112 prisoner dilemma 31–32 Pritchard, L. 27 production: of information 6–7; unbundling of 28 pro-rata rule 117 protectionism 49 Puerto Rico meeting 24 Purchasing Power Parity (PPP) 27–28, 90–91, 193 purposeful experimentation 5–6 QE2 programme 63, 65 qualified majority rule, IMF 80, 94–95 quantitative easing 63, 65 quota reforms, IMF 85–86, 90–96 redenomination risk 62 reform: financial sector regulation 49–50; IMF quotas 85–86, 90–96; International Financial Institutions 77–104 regional development banks: formation of 5, 10–11; multilateral 114–115, 119–120; see also AIIB ; AfDB; AsDB; EIB; IADB; MDBs; NDB

regulation, financial 22–23, 49–50, 144–177 relational power 166 renminbi 13, 54–55, 169–170; SDR 58 rescue packages, Greece 55, 61–62 reserve currency, dollar 12–13 “revolving doors” 22 risk management 17–18, 21–22, 154–157 Rogoff, K. 38 Rome, Treaty of 182 rule-taking, in finance 163–166 Russia 26, 63–66, 68; Crimea 65, 74 St Andrews 53 Sarkozy, N. 37, 55, 59 Schäuble, W. 186, 209n25 self-regulation 21 Sendai meeting 132 Seoul summit 54–56, 92–96 Seoul symposium 46 serendipity 4, 23–24, 34–35 shadow banking 66, 158 SIFIs see Systematically Important Financial Institutions Single Market 192, 194–195 social media 6–7, 83 soft law 162 sovereignty, of countries and EU 192–193 Soviet Union, collapse of 115 Special Drawing Rights (SDR) 5, 48–49, 57–58, 87–88, 169–171 stakeholders: AIIB 201; IMF 79–83 structural power 166–171 Sustainable Development Goals (SDGs) 130, 134–135 swollen finance 5 Systematically Important Financial Institutions (SIFIs) 17–18, 22, 155–156 taper tantrum 65–66 taxation: EU 204–205; G20 64 Technical Committee, International Organization of Securities Commissions 150 tequila crisis 84, 87 Terms of Reference (ToRs) 197–198 Tokyo summit 23 “too big to fail” 17–18, 22, 155–156 Toronto summit 54–55, 92 total loss-absorption capacity 154–155 toxic assets 21 transgovernmentalism 196–197 transparency 156 Treaty of Rome 182

Index

the Troika :in European crisis 62; in EU external representation 189–191 Twin Goals 108 United Kingdom (UK) 36, 53, 65, 80, 131, 170 Ukranian crisis 68 unbundling of production 28 UN General Assembly 107 United States (US): account balances 25–26; IMF reform 94–95; international standards financial reform 151–153 Volker rule 156 voting rights: Asian Infrastructure Investment Bank 131, 201; Contingency Reserve Arrangement 130; multilateral development banks 124–126 Washington Consensus 99–102, 106n64, 108, 122; Augmented 2-3, 100; EU Commission 190; WB 120

243

Washington summit 38–41, 50–51 Willard Group 34 Wolfensohn, J. 85, 118 World Bank (WB) 53; capital requirements 124–126; criticisms of 118–220; development 115–120, 133–135; foundation 79–81; framework 125–126; global financial crisis 89; IMF cooperation 110–111; intellectual leadership 118–120; MDB formation 109–115; pro-rata rule 117; responsibilities 110–112; Twin Goals 108 world GDP, shares of 27–28 World Trade Organization (WTO) 49 Y20 64 Yacyretá dam 117, 119 Yekaterinburg summit 70 Zhu, M. 97