26 November 2010
Paola Subacchi

Dr Paola Subacchi

Senior Research Fellow, Global Economy and Finance


Cooperation appears to be the magic word in a world of increased economic and financial interdependencies and where national policy interventions have international ramifications. The financial and economic crisis emphasised the need for cooperation. After all, it was cooperation that prevented countries from embracing protectionist measures in the aftermath of the banking collapse. And it was the willingness to provide a financial safety net to countries in need that helped restoring confidence after the London G20 summit in 2009.

Cooperation is also the principle that underpins and justifies the existence of multilateral fora such as the G20. But there is a widening gap between theory and practice. The G20 and similar organisations seem increasingly unable to generate tangible measures to rebalance the world economy and engineer 'strong, balanced and sustainable growth'.

Undoubtedly cooperation was easier when all countries were 'diving' together than at present, where some countries and regions are performing much better than others. Now that the recovery path seems to significantly diverge between advanced and developing economies, and the imbalances are threatening stability of the world economy again, the urgent issue is how countries can, and should, cooperate in order to engineer some rebalancing. Because of these difficulties the recent Seoul summit was unable to repeat the 'magic' of the London summit where the G20 leaders sent the clear message of being able and willing to work together to pull the world economy out of crisis.

While the rhetoric about 'assessing the collective implications of our national policies on global growth and development' and 'achieving our shared objectives remains strong, the reality is that countries have goals which are not necessarily convergent: national interests and international public goods are not aligned.

The objectives of the main players

For the US the main goal is job creation. For China the concern is to avoid overheating while maintaining robust economic growth. Germany and Japan are mainly preoccupied with sustaining export growth and bringing public finances to a more sustainable level - the latter being a relative concept, given their very different debt position. At the national level these goals make sense, but what happens when all major economies try to push exports in order to support weak domestic demand and/or improve their fiscal positions? In this context do governments have a reason to cooperate or even coordinate their policies?

Countries cooperate when they can either maximise their gains or minimise losses. Exchange rates are an example of a policy area where cooperation is better in the long run, even if unilateral interventions may bring temporary advantages. As it has recently become evident unilateral interventions in the FX market are not sustainable over the long run: the costs are too high, leading to sub-optimal results. For instance, despite cumulative intervention totalling nearly $ 200bn, the Swiss franc has gained almost 20% against the dollar since March 2009 when these measures were unveiled (although the rise may have been even steeper if no intervention had taken place).

Many interventions are often defensive measures by vulnerable economies - by size and/or level of development - in response to policies undertaken by countries in a more dominant position. For instance, the recent round of quantitative easing in the US can potentially spillover into excessive liquidity in other countries, especially emerging market economies. This leaves the door open for tit-for-tat reactions, with the risk of leaving all players worse off.

Policy uncertainty

The picture is complicated by the fact that the decision to cooperate is not based on a single policy dimension. Because of the numerous choices and outcomes policymakers are less certain about the effectiveness of any international agreement. Moreover, there is a time inconsistency between political (short term) and economic (long term) horizons. Politicians prefer policies that deliver economic gains that parallel short term political cycles. Such time inconsistency makes it difficult for political leaders to stick to, and implement, international agreements.

What is the solution? Along with the existing tools to enhance and monitor cooperation - from mutual assessment to peer review - multilateral fora such as the G20 and international financial institutions such as the IMF should consider incentives to cooperate. Would countries gain from cooperation? And would these gains be compatible with national interests? Ultimately willingness to cooperate depends on the existence of credible policy tools to enforce the desired outcome. Otherwise individual countries will always be confronted with the option to defect if this will deliver a higher gain - despite being unsustainable in the long run.