Last weekend's Washington meeting of the G20 differed in two important ways from most international gatherings. First, it was warranted and urgent; and second, most of the relevant country representatives showed up.
These two factors speak to a silver lining of the current financial crisis: it is providing an opportunity to reform an international economic architecture that is outmoded, feudal and inconsistent with the promotion of global welfare. The big question now is whether the G20 meeting will be followed up on or, instead, fall victim to the bickering that has undermined so many other initiatives in recent years.
There is a reason to be more hopeful this time around: namely, the magnitude of the problem. The credit crisis has led to an unprecedented evaporation of trust among financial intermediaries. The absence of trust has blocked the stabilizing forces that normally kick in to smooth the functioning of global markets.
Typically, by this point in a crisis, new capital would be rushing in to buy up distressed assets. This time around, new capital is sidelined, credit is scarce and most lenders, borrowers and investors are paralyzed. No wonder the financial crisis has now morphed into widespread economic weakness. Witness the extent to which virtually every indicator of consumption and investment around the world has fallen off a cliff in the past four weeks.
The sharp economic downturn is accelerating a basic redefinition of the global landscape. Most visibly, the balance among private and public ownership that had been established over the past several decades is shifting, as governments take equity stakes in major institutions and industries in an attempt to offset market failures. Meanwhile, weak firms outside this official protection umbrella are struggling. Some are on the verge of failure while others are consolidating in order to better navigate the treacherous economic and financial scene. And, to top it all, even bigger questions are being raised about the sustainability of globalization as protectionist pressures grow to curtail the international free flow of goods and services. Against this background, it should come as no surprise that government officials are finally looking at ways to modernize the international architecture, bolster global policy coordination and increase information sharing. Last weekend's G20 meeting was an important, and overdue, start.
As they continue the process initiated over the weekend, officials will look to repeat the success of a similar exercise that took place in the midst of the Second World War in Bretton Woods, New Hampshire. Indeed, the current effort has already been labeled Bretton Woods II. But ultimately, the success of the G20 process boils down not to labels and words, but to whether four basic issues are addressed boldly and effectively in the weeks ahead.
First, there should be clarification of who is responsible and accountable for the delivery of global financial stability: this public good should ultimately be centralized in an international organization. The IMF is working hard to be that organization. It should be given the task, but only after it achieves a critical mass of reforms that allow the institution to be a legitimate, trusted and knowledgeable adviser. In the meantime, the G7 should be dismantled and the temporary role of international policy coordination should be assumed by a new "G10" grouping of countries consisting of the old G7 (minus Canada and Italy) and five systemically important emerging economies (Brazil, China, India, Russia and South Africa).
Second, we need to identify the political force that can ensure appropriate follow-up and arbitration. This function naturally resides with the United States. With the election of Barack Obama, America is now uniquely qualified for the task. The president-elect promises intellectually driven change in a world very much inclined to accept his leadership.
Third, we need new structures that recognize that economic well-being and financial stability are two sides of the same coin. For too long, these factors have been treated as distinct among policymakers and effectively pigeonholed in different international organizations (such as the IMF and the Financial Stability Forum).
Finally, there must be agreement on ways to manage the next crises: reform can reduce, but not eliminate, the probability of future crises. Accordingly, we need better clarification on how any future financial burdens of crisis resolution might be shared.
The financial crisis has given the world a rare opportunity to address some longstanding weaknesses. The outmoded multilateral framework can and should be modernized and rendered more legitimate, representative and accountable. Let us all hope that this opportunity is seized and that the outcome is judged in terms of clear performance metrics rather than wonderful speeches and nostalgic labels.
El-Erian is co-CEO and co-CIO of PIMCO. His recent book, “When Markets Collide,” won the Financial Times/Goldman Sachs 2008 Business Book of the Year award.