Keith Hennessey, a former top economic adviser to President George W. Bush, saw this one coming. He rightly predicted that the Group of 20 would drop a key word from its communique at the conclusion of the London Summit: Free.

Here is my original post from Wednesday:  A quick guide to the G-20 summit.

Unfortunately the problem is even bigger than just dropping the word “free” before “markets.”  Let’s compare the text of the November G-20 leaders’ declaration and the April G-20 leaders’ declaration.

Here is the key paragraph from the November summit, hosted in Washington by President Bush.  Thanks to President Bush’s negotiators, led by his “Sherpa,” Dan Price, and Treasury Under Secretary for International Affairs Dave McCormick, the following text is incredible.  Last November, I wrote about this paragraph:  “Let’s look at some important wins in the actual text of the declaration.  Formerly Communist China and Russia (along with all the other participating nations) agreed to the following text.”

12. We recognize that these reforms will only be successful if grounded in a commitment to free market principles, including the rule of law, respect for private property, open trade and investment, competitive markets, and efficient, effectively regulated financial systems. These principles are essential to economic growth and prosperity and have lifted millions out of poverty, and have significantly raised the global standard of living. Recognizing the necessity to improve financial sector regulation, we must avoid over-regulation that would hamper economic growth and exacerbate the contraction of capital flows, including to developing countries.

Let’s parse it a bit:

1. “… a commitment to free market principles …”
2. “… rule of law …”
3. “… respect for private property …”
4. “… open trade and investment …”
5. “… competitive markets …”
6. “… and efficient, effectively regulated financial systems.”
7. “… we must avoid over-regulation that would hamper economic growth and exacerbate the contraction of capital flows …”

Now let’s examine yesterday’s text:

3.  We start from the belief that prosperity is indivisible; that growth, to be sustained, has to be shared; and that our global plan for recovery must have at its heart the needs and jobs of hard-working families, not just in developed countries but in emerging markets and the poorest countries of the world too; and must reflect the interests, not just of today’s population, but of future generations too. We believe that the only sure foundation for sustainable globalisation and rising prosperity for all is an open world economy based on market principles, effective regulation, and strong global institutions.

Parsing this new language:

1. “… a commitment to free market principles …” has been replaced by “… based on market principles …”.  Note that the word “free” is nowhere in the document.
2. “… rule of law …” is nowhere in the document
3. “… private property …” is nowhere in the document
4. “… open trade and investment …” has been replaced by “… open world economy …”  (This one is fine, I think.)
5. “… competitive markets …” and the word “competitive” are nowhere in the document
6. “… efficient, effectively regulated financial systems” has been replaced by “effective regulation, and strong global institutions.”
7. The over-regulation caution is gone.

What makes this so disappointing is that all G-20 nations agreed to the November text.  It should have been an extremely easy lift for negotiators from capitalist countries to insist that this leaders’ declaration merely repeat what the leaders agreed to last November.

Wednesday I wrote, “In the short run, it is easy to see how a negotiator might give this up for a more concrete immediate objective.  In the long run, few things are as important.”

What happened to FREE markets in London?

© 2010 Keith Hennessey - Your guide to American economic policy

Related posts:

1. What was accomplished at the G-20 Summit?
2. President Bush’s speech on financial markets and the world economy
3. A quick guide to the G-20 summit

I wrote last November about the first G-20 Economic Summit, initiated and hosted by President Bush.  You can see some neat behind-the-scenes photos of the gorgeous National Building Museum and read about the accomplishments of that summit.  Last November the press tried to write the story “Lame duck President … not much accomplished.”  That storyline was incorrect.  Now we have a new American leader and one fundamental policy shift, but much of the agenda remains consistent.

There is a symbolically important change to watch for in the text of the leaders declaration, compared to that in the November text.  I fear that the word “free” may be absent in the successor statement to this sentence from the November leaders declaration:

12.  We recognize that these reforms will only be successful if grounded in a commitment to free market principles, including the rule of law, respect for private property, open trade and investment, competitive markets, and efficient, effectively regulated financial systems.

Losing “free” would be an enormous step backward.  All G-20 nations agreed to the above statement last November, so there is no good reason to change it if the U.S. objects.  In the short run, it is easy to see how a negotiator might give this up for a more concrete immediate objective.  In the long run, few things are as important.  I hope the American team will insist on repeating this language, and in particular keeping the phrase “a commitment to free market principles,” as our negotiator did last fall.

Four of the five major topics of discussion at the summit are extensions and continuations of the November efforts.  There is one big difference, influenced greatly by our new President.  After reviewing the available press and talking with Dan Price, President Bush’s “sherpa” for the first G-20 summit last November, here are my expectations for the London G-20 summit.

1. Global macroeconomic stimulus — The big difference is the new #1 agenda item for the G-20, global macroeconomic stimulus.  President Obama’s first domestic economic policy effort was the enactment of a law that he argues will stimulate near-term macroeconomic growth.  He is pushing other nations to take similar actions, and for the G-20 as a whole to support similar global efforts.

   I expect the final G-20 statement will broadly support national actions for macroeconomic stimulus, but will not include any numbers.  It will say something like “Nations should do what is necessary…”  It may also emphasize the fiscal actions already taken by a large number of nations.  Reading between the lines of President Obama’s answer to a question in a press conference this morning confirmed this expectation.

2. Financial market stabilization — I expect this will be a continuation of efforts in November, but with some details fleshed out.  The final statement will likely highlight three subgoals to financial stabilization: restarting lending, enhancing the capital structure of financial institutions (aka recapitalizing banks), and dealing with toxic assets.  This is consistent with discussions from last fall, but I expect a greater American emphasis on the last item from the new team.

3. Regulatory reform – While financial market stabilization focuses on short-term actions the G-20 nations need to take, the regulatory reform section will focus on longer-term reforms to reduce the chance that these same problems recur in the future.  The negotiators and their staffs have spent a lot of time on these issues, and I expect the final product will continue to flesh out the construct created last November, with a lot of details now filled in.

   I expect an emphasis on improving oversight and greater cooperation among national regulators.  To my delight, I do not anticipate any mention of any sort of “single global regulator.”  There is a so-called “college of supervisors” that was part of the November and prior efforts, but my expert advisors on this subject assure me that this group is about coordination, not the creation of a supra-national sovereign group.  Participant nations appear interested in coordination of national efforts while maintaining national sovereignty.  This is a big deal for me.  Let’s work together, but Americans should have the final say in what America does.

   There is an interesting debate about “convergence” of national regulatory structures that underlies this question.  I expect the statement will emphasize the goal of “convergent” regulatory structures.  A tension exists between two goals.  We want a level playing field across nations so that government policies distort capital flows as little as possible.  In this respect, convergence of national regulatory structures can be a good thing.  At the same time, if they converge to a consensus position that is unwise, then that’s a bad thing.  My own instinct is to worry that, in a politically governed process negotiated by national governments and regulators, there will be a tendency to converge to a structure that is overly restrictive and burdensome.  This is a tension that will play out in obscure international regulatory fora over months and years, and can have long-lasting and important consequences on the international flows of capital.  I could be OK in theory with “convergence” language, if I knew what the final details would look like.  Since no one can know that in advance, “convergence” language makes me nervous now, as it did last November.

   I further expect that the regulatory reform section will talk about the importance of better oversight of “systemically important institutions” (read:  too-big-to-fail) in ways that parallel how Secretary Geithner, and Secretary Paulson before him, and Chairman Bernanke, have spoken about the issue.  This will send an international signal that the problem of regulation of institutions that are deemed to be too big to fail is a critical area for future policy development.  My own view is that this is the big enchilada.  I trace back much (most?) of our current financial pain, as well as almost all of the tension between Wall Street and Washington, to consequences from being on the back end of a too-big-to-fail problem, where all options are terrible.  I think it’s our primary long-term financial policy challenge.  I wrote about the causes of the financial crisis last October, following a speech by President Bush.

   There is an important follow-on question about the relative importance of strengthening the oversight of huge banks and insurance companies on the one hand, versus expanding regulation into hedge funds and private pools of capital on the other.  I am absolutely convinced that the former needs major reform.  I am far less certain that the second is as large of a problem.  I am in the minority in this view.  This is a topic for further discussion.

   I also anticipate that the final statement will say something on tax havens.  My views here on international convergence of taxation differ significantly from those expressed in the past by those who are now senior American officials.  I will refrain from commenting while they are overseas negotiating.  They have the ball for America.

   I expect the regulatory reform section will talk about the importance of moving the trading of Credit Default Swaps (CDS) onto organized exchanges, which parallels efforts that Secretaries Paulson and Geithner have pushed here in the U.S.  This is a good and important thing.

   I expect the statement will continue to flesh out work to harmonize accounting standards.  This is simultaneously mind-numbingly boring and incredibly important.

   There will also be some structural changes to the Financial Stability Forum – they will change the name to the Financial Stability Board and add more members from the G-20.  They will also have language, I think, similar to that in the November document on executive compensation.

4. Increased resources for the IMF and restructuring of the World Bank and IMF – One of the advantages of being Treasury Secretary is you get some leeway to push issues that are important to you.  Secretary Geithner has spoken of tripling the IMF’s budget, and Prime Minister Gordon Brown has spoken of doubling it.  We will see where the number ends up, but it’s clearly going to increase.  I am interested to see how willing Congress will be to fund the increased U.S. contribution.

   They will also change the governance structure of the IMF and World Bank.  I anticipate that China and other developing countries will get more weight in decisions of these international bodies, but only if they pay their share of the budgets.  There is an important thematic here for China and India that crosses a range of international economic policy issues.  In international negotiations, China and India sometimes try to have it both ways.  Their negotiators argue they should have the same say in international economic policy questions as major developed economies like the U.S., Japan, and major European economic powers.  At the same time, they plead poverty and argue that they cannot possibly sacrifice economic growth for the global good.  My view is:  in or out.  You decide.  If you want to be a first-tier economic nation, that’s fantastic.  You play by the same rules as everyone else, and you make the same sacrifices for the global good.  You cannot have it both ways.

   Finally, I anticipate the U.S. and Europe will give up what some call the “knightship rights” of choosing the leaders of the World Bank and the IMF.  I expect one result will be some kind of new (supposedly) merit-based selection process.

5. Fighting protectionism – This is the topic that I hope will make almost all of the G-20 leaders uncomfortable.  In November the G-20 leaders agreed to a fantastic strong statement that opposed protectionism, in which they said,
   

   We underscore the critical importance of rejecting protectionism and not turning inward in times of financial uncertainty. In this regard, within the next 12 months, we will refrain from raising new barriers to investment or to trade in goods and services, imposing new export restrictions, or implementing World Trade Organization (WTO) inconsistent measures to stimulate exports. Further, we shall strive to reach agreement this year on modalities that leads to a successful conclusion to the WTO’s Doha Development Agenda with an ambitious and balanced outcome. We instruct our Trade Ministers to achieve this objective and stand ready to assist directly, as necessary.

   And yet on March 17th the World Bank reported that 17 of the G-20 nations “have implemented 47 measures that restrict trade at the expense of other countries.”  The U.S. is one of the 20, and the World Bank highlighted “the US direct subsidy of $17.4 billion to its three national [auto] companies.”  President Obama’s Monday announcement extending the auto loans make this a challenging topic for him in London.

   I’d like to praise World Bank President (and former U.S. Trade Representative and Deputy Secretary of State) Bob Zoellick for this excellent and well-timed study.  We need more “name and shame” tools to highlight protectionist actions by governments.  The fragile world economy makes it even more important that everyone push for free trade and open investment.

   Dan Price was President Bush’s international economic advisor in the White House, and also the President’s “sherpa” for the November G-20 summit.  Dan suggests that President Obama could demonstrate U.S. leadership with a move that promotes both free trade and his clean technology agenda, by getting the G-20 nations to agree to eliminate tariffs on clean energy technologies.  President Bush launched this effort last November, and it would be a huge win on multiple fronts for our new President if he could bring this to a successful closure.  I strongly agree with Dan.

   I conclude with a warning from Dan Price, who says, “In the process of needed reform, there is a risk of political demonization of particular products or services, like CDS or securitization, that in fact perform a very useful function.”

   I wish President Obama and his team the best in their efforts to represent America at the G-20 summit.

A quick guide to the G-20 summit

© 2010 Keith Hennessey - Your guide to American economic policy

Related posts:

1. What was accomplished at the G-20 Summit?
2. The G-20 Summit in pictures
3. President Bush’s speech on financial markets and the world economy

This is the second of a two-part note.  Here’s the first part.

A fair amount of the press coverage followed a ready-made storyline:  “Lame duck President … not much accomplished.”  This storyline is incorrect.  Let’s look at some important wins in the actual text of the declaration.

• Formerly Communist China and Russia (along with all the other participating nations) agreed to the following text:

12.  We recognize that these reforms will only be successful if grounded in a commitment to free market principles, including the rule of law, respect for private property, open trade and investment, competitive markets, and efficient, effectively regulated financial systems. These principles are essential to economic growth and prosperity and have lifted millions out of poverty, and have significantly raised the global standard of living. Recognizing the necessity to improve financial sector regulation, we must avoid over-regulation that would hamper economic growth and exacerbate the contraction of capital flows, including to developing countries.

• All 20 nations agreed to reject protectionism, to refrain from raising new trade barriers for a year, and to continue working toward a global free trade “Doha” agreement:

13.  We underscore the critical importance of rejecting protectionism and not turning inward in times of financial uncertainty. In this regard, within the next 12 months, we will refrain from raising new barriers to investment or to trade in goods and services, imposing new export restrictions, or implementing World Trade Organization (WTO) inconsistent measures to stimulate exports. Further, we shall strive to reach agreement this year on modalities that leads to a successful conclusion to the WTO’s Doha Development Agenda with an ambitious and balanced outcome. We instruct our Trade Ministers to achieve this objective and stand ready to assist directly, as necessary.  …

• All 20 nations agreed on the “root causes of the crisis.”  It’s not as clear as the President’s explanation, but it’s quite close, especially given that this is the result of a 20-nation negotiation.

3. During a period of strong global growth, growing capital flows, and prolonged stability earlier this decade, market participants sought higher yields without an adequate appreciation of the risks and failed to exercise proper due diligence. At the same time, weak underwriting standards, unsound risk management practices, increasingly complex and opaque financial products, and consequent excessive leverage combined to create vulnerabilities in the system.  Policy-makers, regulators and supervisors, in some advanced countries, did not adequately appreciate and address the risks building up in financial markets, keep pace with financial innovation, or take into account the systemic ramifications of domestic regulatory actions.

4. 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. These developments, together, contributed to excesses and ultimately resulted in severe market disruption.

• All 20 nations agreed on five key principles:
  1. strengthening transparency and accountability;
  2. enhancing sound regulation;
  3. promoting integrity in financial markets;
  4. reinforcing international cooperation; and
  5. reforming international financial institutions.

• The document never talks about a “single global regulator” or anything approaching that.  Instead, it emphasizes coordination and cooperation among national regulators.

Regulation is first and foremost the responsibility of national regulators who constitute the first line of defense against market instability. However, our financial markets are global in scope, therefore, intensified international cooperation among regulators and strengthening of international standards, where necessary, and their consistent implementation is necessary to protect against adverse cross-border, regional and global developments affecting international financial stability.

• The document emphasizes strengthening transparency and accountability, thus allowing well-informed market forces to provide market discipline:

We will strengthen financial market transparency, including by enhancing required disclosure on complex financial products and ensuring complete and accurate disclosure by firms of their financial conditions. …

• While agreeing on the need for financial sector reform, the leaders sounded a cautionary note against over-regulation warning that it would “hamper economic growth and exacerbate the contraction of capital flows, including to developing countries.”  This is similar to what the President said last Thursday.
• The leaders committed to continue to work to alleviate poverty and address the needs of the most vulnerable.
• The leaders agreed to meet again by April 30^th of next year “to review the implementation of the principles and decisions agreed today.”
• You’ll note that pages 6-10 of the declaration are an “action plan” of 47 specific to-do’s.  The list addresses:
  • accounting standards;
  • addressing the valuation of complex illiquid securities, especially during times of market stress;
  • requiring financial institutions to disclose more information about their risks and losses on an ongoing basis;
  • looking for opportunities to better coordinate among national financial regulators;
  • improving bankruptcy laws to allow for an orderly wind-down of “large complex cross-border financial institutions”;
  • reforming the regulation of credit rating agencies;
  • strengthening capital standards “in amounts necessary to sustain confidence”;
  • actions to reduce risk in the markets for credit default swaps;
  • enhancing regulatory guidance “to strengthen banks’ risk management practices”; and
  • steps toward reforming international financial institutions like the International Monetary Fund and the World Bank.

Skim the document and judge for yourself.  We think this summit was a big success, both in the good things that were agreed to, and the bad things that were not.

What was accomplished at the G-20 Summit?

© 2010 Keith Hennessey - Your guide to American economic policy

Related posts:

1. A quick guide to the G-20 summit
2. What happened to FREE markets in London?
3. The G-20 Summit in pictures

This speech is a prelude to the financial summit the President will host this weekend.  I’ll write separately about the Summit, and about the elements of today’s speech that talk about principles for reform.

I want to draw your attention to two parts of the speech.

The first is where the President reprises his explanation for the economic causes of our current situation.

Over the past decade, the world experienced a period of strong economic growth.  Nations accumulated huge amounts of savings, and looked for safe places to invest them.  Because of our attractive political, legal, and entrepreneurial climates, the United States and other developed nations received a large share of that money.

The massive inflow of foreign capital, combined with low interest rates, produced a period of easy credit.  And that easy credit especially affected the housing market.  Flush with cash, many lenders issued mortgages and many borrowers could not afford them.  Financial institutions then purchased these loans, packaged them together, and converted them into complex securities designed to yield large returns.  These securities were then purchased by investors and financial institutions in the United States and Europe and elsewhere — often with little analysis of their true underlying value.

The financial crisis was ignited when booming housing markets began to decline.  As home values dropped, many borrowers defaulted on their mortgages, and institutions holding securities backed by those mortgages suffered serious losses.  Because of outdated regulatory structures and poor risk management practices, many financial institutions in America and Europe were too highly leveraged.  When capital ran short, many faced severe financial jeopardy.  This led to high-profile failures of financial institutions in America and Europe, led to contractions and widespread anxiety — all of which contributed to sharp declines in the equity markets.

These developments have placed a heavy burden on hardworking people around the world.  Stock market drops have eroded the value of retirement accounts and pension funds.  The tightening of credit has made it harder for families to borrow money for cars or home improvements or education of the children.  Businesses have found it harder to get loans to expand their operations and create jobs.  Many nations have suffered job losses, and have serious concerns about the worsening economy.  Developing nations have been hit hard as nervous investors have withdrawn their capital.

The second is the last two pages of the speech.  I tried to summarize and excerpt from this, and instead have concluded that the best thing I can do is allow the President’s words to speak for themselves.

All this leads to the most important principle that should guide our work:  While reforms in the financial sector are essential, the long-term solution to today’s problems is sustained economic growth.  And the surest path to that growth is free markets and free people.  (Applause.)

This is a decisive moment for the global economy.  In the wake of the financial crisis, voices from the left and right are equating the free enterprise system with greed and exploitation and failure.  It’s true this crisis included failures — by lenders and borrowers and by financial firms and by governments and independent regulators.  But the crisis was not a failure of the free market system.  And the answer is not to try to reinvent that system.  It is to fix the problems we face, make the reforms we need, and move forward with the free market principles that have delivered prosperity and hope to people all across the globe.

Like any other system designed by man, capitalism is not perfect.  It can be subject to excesses and abuse.  But it is by far the most efficient and just way of structuring an economy.  At its most basic level, capitalism offers people the freedom to choose where they work and what they do, the opportunity to buy or sell products they want, and the dignity that comes with profiting from their talent and hard work.  The free market system provides the incentives that lead to prosperity — the incentive to work, to innovate, to save, to invest wisely, and to create jobs for others.  And as millions of people pursue these incentives together, whole societies benefit.

Free market capitalism is far more than economic theory.  It is the engine of social mobility — the highway to the American Dream.  It’s what makes it possible for a husband and wife to start their own business, or a new immigrant to open a restaurant, or a single mom to go back to college and to build a better career.  It is what allowed entrepreneurs in Silicon Valley to change the way the world sells products and searches for information.  It’s what transformed America from a rugged frontier to the greatest economic power in history — a nation that gave the world the steamboat and the airplane, the computer and the CAT scan, the Internet and the iPod.

Ultimately, the best evidence for free market capitalism is its performance compared to other economic systems.  Free markets allowed Japan, an island with few natural resources, to recover from war and grow into the world’s second-largest economy.  Free markets allowed South Korea to make itself into one of the most technologically advanced societies in the world.  Free markets turned small areas like Singapore and Hong Kong and Taiwan into global economic players.  Today, the success of the world’s largest economies comes from their embrace of free markets.

Meanwhile, nations that have pursued other models have experienced devastating results.  Soviet communism starved millions, bankrupted an empire, and collapsed as decisively as the Berlin Wall.  Cuba, once known for its vast fields of cane, is now forced to ration sugar.  And while Iran sits atop giant oil reserves, its people cannot put enough gasoline in its — in their cars.

The record is unmistakable:  If you seek economic growth, if you seek opportunity, if you seek social justice and human dignity, the free market system is the way to go.  (Applause.)  And it would be a terrible mistake to allow a few months of crisis to undermine 60 years of success.

Just as important as maintaining free markets within countries is maintaining the free movement of goods and services between countries.  When nations open their markets to trade and investment, their businesses and farmers and workers find new buyers for their products.  Consumers benefit from more choices and better prices.  Entrepreneurs can get their ideas off the ground with funding from anywhere in the world.  Thanks in large part to open markets, the volume of global trade today is nearly 30 times greater than it was six decades ago — and some of the most dramatic gains have come in the developing world.

As President, I have seen the transformative power of trade up close.  I’ve been to a Caterpillar factory in East Peoria, Illinois, where thousands of good-paying American jobs are supported by exports.  I’ve walked the grounds of a trade fair in Ghana, where I met women who support their families by exporting handmade dresses and jewelry.  I’ve spoken with a farmer in Guatemala who decided to grow high-value crops he could sell overseas — and helped create more than 1,000 jobs.

Stories like these show why it is so important to keep markets open to trade and investment.  This openness is especially urgent during times of economic strain.  Shortly after the stock market crash in 1929, Congress passed the Smoot-Hawley tariff — a protectionist measure designed to wall off America’s economy from global competition.  The result was not economic security.  It was economic ruin.  And leaders around the world must keep this example in mind, and reject the temptation of protectionism.  (Applause.)

There are clear-cut ways for nations to demonstrate the commitment to open markets.  The United States Congress has an immediate opportunity by approving free trade agreements with Colombia, Peru*, and South Korea.  America and other wealthy nations must also ensure this crisis does not become an excuse to reverse our engagement with the developing world.   And developing nations should continue policies that foster enterprise and investment.  As well, all nations should pledge to conclude a framework this year that leads to a successful Doha agreement.

We’re facing this challenge together and we’re going to get through it together.  The United States is determined to show the way back to economic growth and prosperity.  I know some may question whether America’s leadership in the global economy will continue.  The world can be confident that it will, because our markets are flexible and we can rebound from setbacks.  We saw that resilience in the 1940s, when America pulled itself out of Depression, marshaled a powerful army, and helped save the world from tyranny.  We saw that resilience in the 1980s, when Americans overcame gas lines, turned stagflation into strong economic growth, and won the Cold War.  We saw that resilience after September the 11th, 2001, when our nation recovered from a brutal attack, revitalized our shaken economy, and rallied the forces of freedom in the great ideological struggle of the 21st century.

The world will see the resilience of America once again.  We will work with our partners to correct the problems in the global financial system.  We will rebuild our economic strength.  And we will continue to lead the world toward prosperity and peace.

President Bush’s speech on financial markets and the world economy

© 2010 Keith Hennessey - Your guide to American economic policy

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