Term paper written for graduate economics course covering the causes of the 2008 global financial crisis and outlining the September 2009 G-20 meeting as it related to addressing the issue.

1. THE GLOBAL FINANCIAL AND ECONOMIC CRISES AND THE ROLE OF THE G-20<br />By:<br />Matthew J. Maul<br />Course: ECON 4033 – Current Economic Issues<br />Instructor: Kadir Nagac, Ph.D.<br />Submitted: 1 December 2009 <br />© Matthew J. Maul, 2009<br />Introduction to the G-20<br />The Group of Twenty (G-20) Finance Ministers and Central Bank Governors was established in 1999 to bring together systemically important industrialized and developing economies to discuss key issues in the global economy. The inaugural meeting of the G-20 took place in Berlin, on December 15 -16, 1999, hosted by German and Canadian finance ministers.<br />The G-20 mandate is as follows: The G-20 is an informal forum that promotes open and constructive discussion between industrial and emerging-market countries on key issues related to global economic stability. By contributing to the strengthening of the international financial architecture and providing opportunities for dialogue on national policies, international co-operation, and international financial institutions, the G-20 helps to support growth and development across the globe.<br />The origins of the G-20 are as follows: “The G-20 was created as a response both to the financial crises of the late 1990s and to a growing recognition that key emerging-market countries were not adequately included in the core of global economic discussion and governance. Prior to the G-20 creation, similar groupings to promote dialogue and analysis had been established at the initiative of the G-7. The G-22 met at Washington D.C. in April and October 1998. Its aim was to involve non-G-7 countries in the resolution of global aspects of the financial crisis then affecting emerging-market countries. Two subsequent meetings comprising a larger group of participants (G-33) held in March and April 1999 discussed reforms of the global economy and the international financial system. The proposals made by the G-22 and the G-33 to reduce the world economy's susceptibility to crises showed the potential benefits of a regular international consultative forum embracing the emerging-market countries. Such a regular dialogue with a constant set of partners was institutionalized by the creation of the G-20 in 1999.” CITATION G2009 1033 (G-20, 2009)<br />The Pittsburgh G-20 Summit: September 24, 2009<br />“G- 20” (Group 20) refers to a conglomeration of the world’s top 20 economies, representing 85 percent of the global economy. The group has been on the forefront in taking actions to assure a sustainable world economic recovery in the face of recent local financial market crises that are affecting the entire world. The G-20 was formed in 1999 to bring together the major developed and industrialized nations, as well as developing economies, in an effort to highlight key concerns in the current and future global economy. Member states are represented by their respective Finance Ministers and Governors of their Central bank. The G- 20 is made up of the European Union and 19 individual nations: the U.S., the U.K., Turkey, South Korea, South Africa, Saudi Arabia, Russia, Mexico, Japan, Italy, Indonesia, India, Germany, France, Canada, Brazil, Australia, and Argentina. A recent G-20 meeting held in Pittsburg, Pennsylvania September 24- 25, 2009 reviewed the progress on recommendations proposed in earlier Washington and London meetings. (Lloyds, 2009)<br />Due to the gravity of possible future global economic and financial crises, the leaders of the G- 20 member states held their first formal meeting in Berlin in 1999. The summit was further attended by the leaders of global top financial institutions including the World Bank, International Monetary Fund (IMF), and United Nations. At this summit, the German and Canadian Finance Ministers unveiled an action plan to deliver the world from economic crisis. A consecutive meeting organized in London reviewed and renewed the action plan whose aim was to restore growth, increase employment opportunities, and restore lending by reconstructing the fallen financial system as well as stiffening financial regulation .(Rebecca, 2009)<br /> The Pittsburgh meeting was held September 24-25 2009, where the progress on the earlier resolved action map was to be assessed. The summit offered yet another chance for member states to discuss any other necessary courses of action to attain sound economic and financial revival. (Rebecca, 2009)<br />Background causes of the global financial and economic crisis<br /> The global financial meltdown of 2007 to 2009 has been termed as the worst financial crisis to occur since the Great Depression in the early to mid 1930s. The crisis has been marked by failure of key international businesses, decreased consumer wealth, and a general reduction in economic activity in both the public and private sector. Government and market based regulatory measures have been implemented, or are being considered for implementation; but the crisis still poses a significant risk to the world economy. (Krugman, 2009)<br />The immediate causes of the crisis include the collapse of the U.S. housing and mortgage sector during the period of 2005 to 2006. This led to the disintegration of the United States housing bubble. The bubble affected major states such as California, Nevada, Oregon, and Colorado; with housing costs taking an all time high in 2005 but showed some decline in 2006. The bubble was not only felt by homeowners, but also the entire building and housing sector stakeholders such as real estate agencies, homebuilders and home retail outlets. (Ravallion, 2009)<br />Prior to the onset of the crisis in 2007, the U.S. economy received a massive inflow of money from fast developing economies of Asia. Borrowers were encouraged to seek both short and long- term loans to cushion the rising housing costs while hoping to cash in more quickly at more friendly terms. This cash inflow facilitated the Federal Reserve Bank in its quest to keep low interest rates. The crisis led to increased unemployment levels and price reduction in essential assets and commodities. (Gjerstad et al 2009)<br />The U.S. crisis later degenerated into a full-blown global crisis in 2007; with failures of major European banks, reduced stock indexes, and major equity market value decline. In an attempt to refinance the frozen credit market, assets were sold out; however, this only complicated the situation. Ultimately, this culminated in a decline of international trade. The crisis continued despite actions by major world leaders to prevent the possibility of a recession. Non-performing mortgages infected the global financial system; destroying trust in financial institutions. This led to depositors withdrawing their money out of banks, thus further fueling the crisis. To curb further damage, the Federal Reserve restricted normal credit flows and injected liquidity to majorly affected corporations. (Chen, 2009)<br />By 2008, most of the United States’ big financial institutions had collapsed or were being sold out, thus compelling governments of rich nations to consider programs of bailing out such companies using public financial systems. However, many people believed that the institutions that were being bailed out were the same institutions responsible for the crisis. It seemed also that the government was only socializing the companies’ liabilities and allowing them to privatize their profits. The crisis likely would have been avoided if certain proposed economic strategies had been put in place according to economist Paul Krugman. (Krugman, 2009)<br />The effects of the global financial crises were experienced by governments and various economic sectors throughout the world. For example, the rapid changes in economic fortunes were experienced dramatically in the Arab counties. Oil, being the price-export commodity from the region, experienced a rapid price increase leading to huge benefits for oil-producing nations. Since most of these nations are net food importers, their economies were greatly threatened by rapidly rising food prices and a possible drop in oil prices if the world experienced slow economic growth. The period between July and December 2008 saw a 70 percent reduction in oil prices from $130 to $40 per barrel. Stock markets worldwide also suffered due to the turmoil on Wall Street and the US stock market. Although Arab banks were not directly affected by the U.S. mortgage crisis, large losses were experienced in the other equity holders and sovereign wealth funds. Take for example the period of one year ending in February 2008, where the Saudi market experienced a 49 percent drop, while Dubai’s declined by 72 percent. (Ravallion, 2009)<br />The International Monetary Fund (IMF) urged the countries to evaluate their long-term expectations on oil price, to avert the possible negative effects. This suggestion was primary of those brought about by the G-20. The entire region was facing an increase in food prices as well as other consumer costs, which created tension and anger within the population; for example, in Egypt riots broke out in major cities due to the populations’ lack of financial resources. The Arab tourism sector was greatly affected and the governments could do little to salvage the situation. The Moroccan government boosted their spending on social projects to cushion on the effects of the economic crisis, as inflation was at 14 percent. This hyperinflation in Morocco was another situation the G-20 sought to resolve and prevent from occurring elsewhere. (Ravallion, 2009)<br />The Effects on Africa<br />Economic analysts had downplayed the possible effects of the global economic crisis on sub-Saharan Africa. They believed that African banks did not possess the “toxic assets” like those that triggered the crisis. However, as the recession deepened, increased harm was felt by these economies as well. The IMF projected a decline in Africa’s economic growth from 6 percent in 2004 to an average of 1.5 percent in 2009. Due to this, some Africans economies required extra resources to recover amidst rising population and poverty levels. The effects were mainly realized as the crumbling of basic and primary commodity exports that these economies depend on. Secondary to the greater effects in developed Western countries, these Third-World countries suffered great decreases in foreign investment. (Ismail, 2009) <br />As developing nations, these countries played no part in the creation of the crisis, but suffered heavily due to the lack of resilient economic systems. These nations could not afford to bailout their institutions through rescue packages like the Western nations. <br />African nations, unlike other developing countries, are still dependant on less diversified primary commodities that are highly susceptible to external shocks, such as agricultural products. Wealth creation and drawing of external investment is riddled with labor exploitation, massive corruption, and internal instability as well.<br />Proposed solutions to the problem<br />On September 4th and 5th, the Chief Bank Governors and Finance Ministers met in London prior to the Pittsburgh Summit to evaluate the progress achieved from the earlier summits in Berlin and London. They realized that further reforms were necessary in order to arrive at a firm and strong financial system. They acknowledged, however, that the situation was currently under control. G-20 leaders concluded that the future is to be built on the steps already undertaken, thus providing a platform to tackle new emerging challenges. To realize growth, it is imperative to support lending and implement structural policies that facilitate employment. The Pittsburgh Summit discussed ways of addressing increased product price volatility through improvement of the fiscal and financial markets and promoting closer relationship between consumer and producer nations. <br />The member states realized the importance of enhancing energy security and combating climatic changes. Poor fossil fuel subsidies promote uneconomical consumption; inhibiting efforts of harnessing clean and renewable energy sources and efforts to combat climate change. The G-20 promised to remove fossil fuel subsidies by 2020, with the aim of decreasing greenhouse gas pollution by 10 percent in 2050. (DeCapua, 2009)<br />Member nations also promised to assist the developing and emerging nations, whose poor and vulnerable economies could not withstand the tenacity of the global crisis. The G-20 proposed support in areas of education, health, and infrastructure; thus reinforcing and reforming the world financial architecture to combat the long-term challenges of the crisis. (Thomas, 2009)<br />The world economy was facing serious challenges and the severity of the crisis demonstrated the need for quick action. In the London summit, the G-20 members agreed on prioritizing agreements that will enhance coordinated international action beginning immediately. They stressed the need to take all possible steps to restore confidence, build jobs, and facilitate sustained, sound economic growth. The G-20 Pittsburgh Summit was held at a time when the global economy was just recovering from the verge of total collapse. The recommendations and pledges in the earlier summit were now bearing fruits to the governments, businesses and individuals. By 2009, it was clear that the Summit’s actions had saved approximately 10 million jobs that were earlier at risk; with over one million U.S. jobs saved by the ambitious American Recovery and Reinvestment Act (ARRA). Although much is yet to be done, the efforts by G-20 member nations and other global economic leaders have stopped further recession and laid the foundation for total recovery. (Lloyds, 2009)<br />The Pittsburgh meeting was also convened at a critical time when the world economy was at a transition period, rising from decline. Leaders evaluated the commitments given by the individual nations at the earlier London summit. The proposed recommendations allowed the different nations to participate in the largest and the most coordinated financial and monetary stimulus to have ever been carried out jointly in restoring normalcy to the global economy.<br />Summit leaders emphasized the need to change dependency from public to private sources, thus creating a pattern of more sustainable and balanced growth; eliminating developmental imbalance. To promote adequate and stable global demand, the governments agreed to stabilize busts and booms in credit and assets prices, adopting economic policies aimed at price stability. At the same forum, the leaders pledged to create key advancements on economic structural reforms that will strengthen perpetual growth potential and promote private demand. (Lloyds, 2009)<br />As a show of unity that arose from the common objective of combating the recession, the governments pledged to work together in assessing collective policies that promote sustainable and balanced growth and development. To promote over-the-counter market strategies, curb high-risk taking, and creating strong mechanisms of holding major global firms accountable; the summit resolved to implement firm international compensation benchmarks by raising capital standards. However, the standards should be proportionate with the cost of their failure. (Thomas, 2009)<br />The leaders recognized that about four billion people living in Third-World underdeveloped nations faced great challenges in terms of food, security, education, and technological advancement; and an insufficient contribution to the world economy. Member nations pledged to offer support to the concerned nations in promoting the living standards and productivity to the levels of progressed economies. This was to be preceded first by the implementation of the World Bank support program for Food Security Initiative for low-income underdeveloped countries proposed in 2008. On voluntary grounds, they resolved to move up deadlines regarding programs meant to provide clean and cheap energy for the nations, such as the Scaling up Renewable Energy Policy proposed in the earlier summit.<br />Inadequate, or lack of, state supervisory and regulatory mechanisms and the uncontrolled and negligent risk behaviors by financial institutions such as banks were to blame for the crisis. The leaders at the Pittsburgh Summit resolved to unearth the core causes of the financial crisis and change the individual countries and the collective regulation mechanisms for financial institutions through strengthening transparency and accountability and creating market oversight and integrity; thus improving management of risks and international cooperation. (DeCapua, 2009)<br />Through promoting strong quality standards, the governments would be able to safeguard their consumers, investors, and depositors; while avoiding protectionism, regulatory arbitrage, and market fragmentation. The Summit advised banks to plow back their profits in order for them to boost their capital base necessary for lending; as well as cushioning them against losses that may unavoidably arise. However, care is required in supporting business and household lending, as these were among the primary practices that led to the original crisis.<br />It became apparent that the effect of the crisis on developing countries could have been controlled through technological innovations and improvements, according to some economists such as Paul Krugman. (Krugman, 2009) The respective countries could cushion themselves from the effects of the crisis by applying the scientific and technological knowledge to the production of goods and services; thus fostering and tapping the opportunities in the manufacturing sectors. (Rebecca, 2009)<br />The Member states agreed to implement certain international standard rules on banks’ capital base by the end of 2010. The rules will be implemented as more economic recovery is assured. This will involve reinforcing the liquidity risk requirement and minimizing bank eagerness to take overrated risks; thus creating a well prepared financial system to hold up under undesirable shocks.<br /> Following the crisis, the U.S. government embarked on a recovery program of bailing-out large financial institutions, such as AIG. However, the G-20 resolved that excessive compensation policies only increased the risks. The G-20 encouraged reformation of the policies and practices used in compensation. This should be done from a long- term point of view rather than excessive risk-taking. Any compensation should be consistent with the company’s total net revenues and be in-line with its financial performance. (DeCapua, 2009)<br />The countries agreed to support poor countries in overcoming their financial problems through reforming the international financial management and modernizing the countries’ infrastructures. A 5 percent proportion of the over-represented countries share in the International Monetary Fund (IMF) quota will be directed to the underrepresented nations. They also agreed increasing the nations’ voting power within the World Bank. (Ravallion, 2009)<br />Conclusions<br />Many countries relied on borrowing for development and subsequently built-up international deficits and debt; while others heavily relied on primary commodity exports. A decision to encourage saving and lessen spending was determined appropriate in fighting a possible crisis in the future. The concerned countries should build up local economic resources and depend less on external assistance. In an effort to ensure future stability, the G-20 installed macro-prudential regulatory and supervisory mechanisms to protect asset and credit- price cycles. Since lightly supervised entities could jeopardize the confidence in the financial markets, the proposals suggested will not only reinforce the international collaboration in the supervision of international institutions, but will also strengthen arrangements by individual nations’ authorities in organization and resolution of cross- border financial problems, thus bringing back the confidence and financial stability of before. (DeCapua, 2009)<br />Bibliography<br />The Global Economic Crisis, the G-20 Summit and Africa. Retrieved 11 November 2009, from http://ictsd.net/i/news/bridges/48563<br />Chen, W. (2009) Interview: Financial crisis tells us global economic challenges need global solutions. 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(2009). “G-20 Pittsburgh summit vauge on plans, symbolic of unity.” Retrieved 08 October 2009, from http://www.newpittsburghcourieronline.com/index.php?option=com_content&view=article&id=460: g-20-pittsburgh-summit-vague-on-plans-symbolic-of-unity&catid=38:metro&Itemid=27.<br />Stewart, J.B. (21 September 2009). “Eight Days: the battle to save the American financial system.” The New Yorker, September 21, 2009<br />Thomas, P. (2009). “The future of the financial industry.” New York University: Finance Department of the New York University Stern School of Business.<br />Woods, T. (2009). “Meltdown: A free-market look at why the stock market collapsed, the economy tanked, and the government bailouts will make things worse.” Washington, Retrieved 19 November 2009, from http://www.voanews.com/english/archive/2009-03/2009-03-30-voa35.cfm<br />Much inspiration and insight for this paper came from daily readings of current print versions of The Wall Street Journal and The Economist. Without the insight provided by these journals, this paper would not have been possible.<br />