Against significant odds, the Group of 20 is moving closer to its goal of rebalancing the global economy.
In a surprising show of faith in an institution that has met only four times, leaders from countries as disparate as Germany and Saudi Arabia agreed Sunday in Toronto to subject their domestic economic programs to peer review within the G20.
By this fall's Seoul summit, countries have promised to explain in some detail how their domestic policies are helping to achieve the G20's goal of reducing the excessive mismatches in spending and saving that exacerbated the financial crisis. Then, with the help of the IMF and its expertise in economic modelling, the other members will assess whether each partner is doing enough.
The commitment is historic.
The promise by each leader to agree to put his or her cards on the table adds a level of transparency and credibility that the process lacked until now. While economic co-ordination has been tried before, it has been with lesser officials or the International Monetary Fund as the arbiter. Now, the accountability rests at the highest levels. Where previous failures could be blamed on bureaucratic deadlock, global economic co-operation is now a political imperative in the hands of presidents and prime ministers.
The increased transparency could even encourage competition among members to implement policies that curry favour with investors.
Since the review remains a voluntary exercise without penalties, success will depend on G20 members taking the process seriously, both by submitting credible policies and showing the courage to offer tough, but fair, criticism. Given how these countries allowed the global economy to get so out of whack in the first place, there is reason to be skeptical they have what it takes to deliver, especially as the economy improves.
Still, "it's a pretty significant step," said Tim Adams, managing director at the Lindsey Group consultancy in Fairfax, Va., and a former undersecretary of international affairs at the U.S. Treasury Department. "It creates the potential that this will become a serious exercise."
Going into Toronto, it was unclear whether the G20 was fully committed to their September pledge at the summit in Pittsburgh to create a forum in which they would shape their domestic policies in way that would ensure "strong, sustainable and balanced" global economic growth.
In Pittsburgh, the G20 acknowledged that self-interested policy making had created the conditions for the global recession that was sparked by the 2008 credit crisis.
U.S. consumers spent too much borrowed money, an unsustainable circumstance that the world's major exporters were all too happy to exploit.
In fact, China underwrote the spending by purchasing U.S. debt in an effort to keep its currency low against the dollar, a policy that had the effect of lowering American interest rates. Big oil exporters run up surpluses of their own by using their wealth to buy U.S. bonds instead of investing in their domestic economies. Continental European countries refused to confront rigid labour markets that constrained investment and productivity.
The Framework for Strong, Balanced and Sustainable Growth was launched to correct this policy mismatch.
Few gave it much chance for success. Noting previous failures, academics, economists and former policy makers said they doubted sovereign nations would ever tailor domestic policies for the sake of the greater good. Going into Toronto, some countries, including China, were balking at accepting country-level reviews under the framework, saying instead that G20 members should simply be grouped under headings such as "surplus countries" and "deficit countries."
Daniel Schwanen, an award-winning economist at the Centre for International Governance Innovation, earlier this month published an analysis of the framework effort that was laudatory of the concept, but skeptical that national self-interest would allow the process to work.
"It is, of course, conceivable that the framework introduced at the Pittsburgh summit will prove only a passing phase, a temporary political convenience that usefully helped leaders' intentions to coalesce at a time of global crisis," Mr. Schwanen wrote in his paper.
But in Toronto, the reluctance to embrace a transparent process faded.
That might have had something to do with convincing evidence of what co-operation could achieve. The IMF and World Bank submitted studies that showed the G20 could generate GDP of $4-trillion, create tens of millions of jobs and lift even more out of poverty if countries actually made the changes necessary to achieve more balanced growth.
"We concluded that we can do much better," the G20's final statement said.
To be sure, the G20 is far from reaching its goal of a balanced global economy.
The IMF warned recently that trade imbalances, which narrowed after the financial crisis, are starting to move back to pre-crisis levels. The U.S. still has a current-account deficit that is more than 3 per cent of GDP, while China and Germany run current-account surpluses that are about 4 per cent of GDP and 5 per cent of GDP respectively.
Also, G20 countries must be tough critics of their fellow club members. Any boost in credibility the G20 gets from embracing country-by-country peer review will be lost if the promises the process accepts lack ambition or commitment. Because the threat from global imbalances is present, the framework process must result in national programs that are implemented over the next three to five years, Mr. Adams said from Washington.
The G20 took another step toward credibility by describing the kinds of policies that various members should strive to implement.
In the statement, the G20 said advanced economies in the group already have committed to fiscal programs that will at least halve deficits by 2013 and "stabilize or reduce" debt levels by 2016. Those countries also must take steps to boost national savings and avoid protectionism.
The G20 said that some emerging markets need stronger social safety nets, enhanced corporate governance, further exchange rate flexibility and more vibrant financial markets – a prescription for increased domestic demand in the world's fast growing emerging markets such as China and India. These nations also will lessen their reliance on exports and focus more on domestic sources for growth, the G20 statement said.
Mr. Schwanen admitted surprise with what the G20 accomplished, especially the agreement on peer review. "If you have a scorecard, the targets look a lot more serious," he said.