Policymakers have made some progress reforming financial services, but a recovery in the wider economy has yet to take hold
When leaders of the world's major industrial nations met in London last April to hammer out a response to the global recession, the economic landscape was an ugly sight. The world's manufacturing output had plunged, capital markets were frozen as banks refused to lend, and there were signs of creeping protectionism that could prolong the downturn.
On July 8 politicians from the Group of Eight (G-8) countries, along with counterparts from the largest emerging economies, will gather in central Italy for a three-day summit to check on their progress. The conclusion so far? Some policy reforms, particularly those aimed at financial services, are taking shape around the world. But a recovery in the wider economy has yet to take hold, despite the infusion of hundreds of billions of stimulus and bailout dollars into countries and industries. The lack of a clear turnaround could force politicians at the G-8 to promise further steps to revive global growth.
"The situation is certainly getting less bad, but we aren't out of the woods just yet," says Jonathan Loynes, chief European economist at London-based consultants Capital Economics. "The G-8 can make encouraging noises, but most policies will be carried out at a country or regional level."
Since global leaders parted company three months ago, many have been doing just that. At the top of the agenda has been financial regulatory reform. Last month, U.S. President Barack Obama unveiled wide-ranging changes to America's financial-services industry, mirroring proposals outlined at the London summit. They included the creation of two new regulatory entities—a Financial Services Oversight Council and a Consumer Financial Protection Agency—as well as two new overseers of banks and insurance firms. The U.S. Federal Reserve will also receive new supervisory powers to police institutions that could pose a threat to overall financial stability.
The European Union has also gotten into the act, approving legislation to boost the transparency of securitized financial instruments and to increase oversight of credit rating agencies—both key objectives discussed at the April London summit. Next on the agenda: plans to force hedge fund managers to register with authorities and a proposal to move the trading of complex derivatives contracts, such as the credit defaults swaps that got U.S. mega-insurer American International Group (AIG) into such hot water, out of the back room and onto regulated exchanges.
"The regulators have been tightening the net around financial services," says Rym Ayadi, senior research fellow at the Center for European Policy Studies, a Brussels-based think tank. "They're adding layers of new supervision, which is a step in the right direction."
But while increasing financial controls could help prevent future crises, policymakers' attempts to jump-start economic growth now have been less successful. Last April global leaders promised an additional $750 billion of funding for the International Monetary Fund to help developing countries tackle the global downturn. That came on top of domestic efforts, including so-called quantitative easing, in which countries' central banks buy high-quality but illiquid public and private assets, such as corporate bonds, to increase capital flows. The Fed and the Bank of England both have purchased billions of dollars worth of such assets, while the European Central Bank, which oversees the 16-country euro zone, has offered short- and medium-term financing to fill the void of the frozen capital markets.
Huge Job Losses
Yet despite these and other measures, the economic outlook remains cloudy. According to the World Bank, global gross domestic product will contract 2.9% annually in 2009, then rise a mere 2% next year. Much of the blame falls on a steep drop in global trade, down 10% annually in dollar terms, and a near-halving in foreign investment this year, to $363 billion worldwide. These declines have fed huge job losses: The U.S. unemployment rate, for instance, rose to 9.5% in June—the highest figure in more than 25 years—while in the EU it reached 8.9% in May, the latest data available.
At the G-8 summit in Italy, new approaches to reignite growth will be a high priority. Analysts predict the European Central Bank could well take the unprecedented step of quantitative easing, buying up illiquid assets to increase European capital flows. Others say Western countries may call on developing countries such as India and Brazil, which are also attending the event, to use their vast cash reserves to take some strain off the U.S. and Europe. In response, China is expected to continue pushing its plan to lessen the role of the U.S. dollar as the world's reserve currency—an idea that elicits some support from other emerging economies but isn't likely to make headway among the world's richest countries.
To be sure, other topics, such as increased aid for Africa and cuts to carbon dioxide emissions, will be on the G-8 agenda. But with the recession still dominating the attention of leaders, Africa and global warming could take a back seat in the discussions. Since the last meeting in London, policymakers have made huge progress on reforming financial regulations. But if they don't get the economy back on track soon, some of them may not be around for many more G-8 meetings.