The crisis reveals the weakness of nation-based regulation

We Need Greater Global Governance. By Peter Mandelson
The crisis reveals the weakness of nation-based regulation.
The Wall Street Journal, Jun 19, 2009, p A13

Fingering the villain in the banking crisis of 2008 turns out to be tougher than it looks. Was it the banker with the skewed incentives and the poor grasp of risk? Was it the over-indebted consumer with the 125% mortgage? Was it the politicians and regulators who failed to see the risks in both?

The answer, of course, is that it was all three, and any number of other contributing factors. But what enabled the banking crisis to happen was a structural imbalance in the growth model of the global economy over the last two decades.

That model has produced unprecedented global growth, but it also developed a serious weakness at its center. Unless we address that weakness, any other counter-recessionary strategy is palliative at best. The risk is that as the global economy slowly returns to growth, the urgency to address this fundamental problem will recede.

Reduced to its crudest form the problem was this: Credit was too cheap in the developed world. It was kept cheap by a number of factors. The commitment of China to an export-led growth model, matched by a willingness from rich-world consumers to keep spending, created persistent surpluses in China in particular.

Those surpluses were invested in developed-world debt, particularly the U.S., pushing down interest rates. That encouraged investors to look for riskier and riskier investments to increase their yield. It also encouraged people to buy houses they couldn't afford with the help of people who probably shouldn't have lent them the money in the first place. That debt was sold around the world. The end of the housing bubble revealed the risk in the system.

The precise detail of this process matters less here than the simple problem it represents. The stability or otherwise of the global economy is the sum of sovereign national macroeconomic policies. There is no mechanism to mediate between those policies or insist on action that would counter systemic risk. Similarly, national financial regulators have a clear enough remit for national market stability, but financial markets are now regional and global. Nobody was asleep at the wheel of globalization because there is no wheel to speak of.

If these imbalances are to be unwound in an orderly way, China will have to build a social welfare system that reduces huge levels of precautionary saving and thus boost domestic demand. It will need to continue to move towards greater currency flexibility. The export-led growth models of other surplus economies such as Germany and Japan are also both going to have to give way to greater domestic demand. Both consumers and governments in the U.S. and Britain are going to have to repair their balance sheets. We are going to have to save and invest more and export more.

Is any of this actually possible? Is it possible to preserve the benefits of open trade and an open global economy, addressing macroeconomic risk while totally respecting the choices of sovereign governments?

The answer has to be: not really. No government in the global economy, and certainly not economies on the scale of the U.S., China, Japan and the European Union, can claim a prerogative over domestic action that entirely ignores the systemic affects of its policies. The only way forward is a totally renovated approach to international coordination of economic policy.

We need to strengthen and depoliticize the International Monetary Fund and give it a new surveillance role that covers all aspects of systemic risk. It needs to be mandated to make recommendations on weaknesses in the system, and countries should be obliged to take these recommendations extremely seriously. Peer pressure is going to be vital -- just as it has been in keeping trade barriers at bay over the last year.

We need much greater global coordination of financial regulation, facing up to systemic risk and ensuring that market participants are not able to play one regulatory jurisdiction against another. The Group of 20 leaders have taken the first steps down this road.

Free-market true believers will resist the conclusion, but the only way to preserve a global growth model based on the huge benefits of dynamic markets is to regulate it better. The bill for the benefits of an open global economy has arrived, and it can only be paid in greater global governance.

Mr. Mandelson is Britain's business secretary and was EU Trade Commissioner from 2004 to 2008.