A repository of solutions to global problems

For two years now, leading policy makers, academics and businessmen have been meeting for intensive discussions in the Global Economic Symposium, set up by the Institute for International Economics at the University of Kiel. The goal of the GES is provide concrete solutions for the most pressing global governance issues the world will be facing this century. The GES compiles these solutions in a document which we would like to make available on Eurointelligence, as some of many of the  subjects are of direct relevance to our readers, and also because we have directly contributed to the debate, specially on global policy co-ordination, and on post-crisis exit strategies. We are attaching a full version of the document for download below, and summarising the main conclusions on two important aspects of direct importance to us – financial regulation and global imbalances.

        I.            Balancing Risk-Taking and Financial Regulation

The challenge: Many blame excessive risk-taking and inadequate regulation as the core causes of the global financial crisis. Consequently, in the aftermath of the massive government efforts to rescue financial institutions that were hard hit by the crisis, the re-regulation of global finance has been a central focus of policy discussions.

There are many questions, including:

• How far should re-regulation of global finance go without stifling healthy

risk-taking and financial innovation?

• Should tighter regulation be across-the-board or case-by-case?

• Which regulatory instruments require multilateral coordination?

Proposed policy solutions:

1.       Consider the creation of “solvency-convertible debt” for systemically relevant financial institutions, ensuring that if such institutions become insolvent, their debt would automatically be converted into equity, on predetermined terms.

2.       Create an internationally harmonized and countercyclical set of capital requirements for financial institutions.

3.       Create new retail financial instruments to insure consumers against risks, such as home equity insurance and house price futures.

4.       Introduce incentives for “patient capital,” giving more voting rights to investors who commit themselves to companies for longer periods.

5.       Establish an European Deposit Insurance Agency to insure deposits in banks.

6.       Consider establishing an institution with the power to approve or reject new financial products in accordance with their forecast systemic risks.

      II.            Managing New Global Imbalances

The Challenge: The current crisis was preceded by a huge build-up of global imbalances in terms of current account balances. While several industrialized countries, notably the United States, ran excessive deficits, some emerging economies experienced remarkable surpluses.

These imbalances were connected to the asset price bubbles in the developed countries. The steady capital supply from emerging economies lowered interest rates in industrialized countries and supported the emergence of asset price bubbles. As the financial system transformed the savings from abroad into credit and mortgages and thus consumption within the industrialized countries, imports increased. This fueled export revenues in surplus countries and enabled them to increase savings further.

The financial crisis and the recession have unwound some of the old global imbalances. For example, US household consumption as a proportion of income has fallen, and Chinese government spending relative to GDP has increased. Nevertheless, the economic turmoil may give rise to new patterns of global imbalances.

Governments’ ability and need to provide bank bailouts and fiscal stimuli have depended on the size of their financial industry and the size of the national debt, rather than on the magnitude of previous global imbalances. The severity of national recessions—along with the associated changes in trade flows and capital movements—have depended in part on countries’ different degrees of export dependence, energy production capacities, and past financial regulations.

These differences may generate new imbalances—between countries with relatively large and relatively small financial sectors; between countries that are producers of raw materials and those that are consumers of raw materials; and between relatively open and relatively closed economies.

How should countries, both individually and collectively, respond to the prospect of new imbalances? And what exchange rate regimes would be useful to prevent the new imbalances from emerging?

Proposed policy  solutions:

1.       Reduce global imbalances through an internationally harmonized reduction in financial institutions’ leverage ratios, elimination of their off-balance sheet activities, and tighter monitoring of financial products.

2.       Monetary policy should monitor asset prices and be prepared to prevent the emergence of asset price bubbles.

3.       Conduct international negotiations on exchange rates through the G20, using the IMF as intellectual backbone.

4.       Promote international cooperation between deficit and surplus countries, to induce deficit countries to reduce restrictions to foreign investments and improve the quality of their assets and to induce surplus countries to encourage procurement from and investment to deficit countries.