The Centrality of the G20 to Australian Foreign Policy

The University of Queensland Annual Lecture in Politics and International Affairs

Brisbane, Qld

Speech, E&OE — Check against delivery

30 September 2011

Global economic stability is fundamental to Australia's foreign policy and national economic interests.

Those who argue that the current debates in Europe and the US are remote from our global economic reality should look carefully at this morning's reports of the downgrading of New Zealand's sovereign credit rating by international credit ratings agencies.

New Zealand remains one of our closest foreign policy and economic partners: what happens in New Zealand has an impact both here in Australia and more broadly across the South Pacific.

The truth is that, as we enter the last months of 2011, we stand again at a critical point in economic history.

A challenge the world will either respond to decisively.

Or a challenge that will be allowed to linger, becoming harder and harder to contain the longer it is left to grow.

With memories of the 2008 global financial crisis still fresh, we find ourselves living through a new global emergency.

Europe is hobbled by sovereign debt of enormous magnitude, banks with large-scale exposures and a crisis of confidence that has lasted for most of this year.

This comes together with a historic credit downgrade of the world's largest economy, the United States, and the world's 8th largest economy, Italy.

The global economy has entered the danger zone, as both sovereign and private financial institution's risk have increased substantially — reversing much of the progress that had been made over the previous three years.

The IMF's latest forecasts indicate that global growth will slow to four per cent this year, and next.

Advanced economies will manage what can only be called anaemic growth of 1.5 to 2 per cent.

Several shocks have buffeted the real global economy resulting in rolling volatility on the equity markets.

The situation in our region is vastly different from that facing the North Atlantic.

China's economy continues to grow strongly, as do the economies in the region more broadly.

Although China and the region are not immune from events in the US and Europe, they have the policy flexibility to respond and to place more reliance on domestic demand.

The strength of the Asian region is evidenced in the IMF's latest forecasts.

But while our region continues to grow strongly and has many underlying strengths, we will not be immune from the growing crisis of confidence in the North Atlantic economies, driven by weak growth, weak balance sheets and what is perceived to be weak politics.

This affects households, businesses and governments in these economies.

Businesses suffer through lower private and public demand.

Households suffer as jobs are harder to come by.

The slower pace of economic recovery, as well as half-finished policy actions, have stalled progress in the repair of both private and public balance sheets.

In Europe, sovereign risks have spilled over to the region's banking system and put funding under new strains and depressed market capitalisation.

The sovereign debt crisis is also threatening the core of the single European currency.

In the US, there have been concerns — and much debate — about the longer term sustainability of US government debt.

Furthermore if the US fiscal position is left unaddressed it could itself exacerbate sovereign risk.

US households are trying to repair their balance sheets too, but are still weighed down by a deep lack of investor confidence and high unemployment.

The bottom line is that policymakers, particularly in the US and Europe, have not yet generated broad political support for the policy actions they need — and markets have begun to doubt their resolve.

When the financial crisis began, it was fundamentally about market failure in the finance industry.

It has now evolved to become a broader lack of faith by markets in governments' capacity to deal effectively with the crisis.

Europe

Europe presents the greatest immediate danger to the global economy.

But in our interconnected world, what happens in Europe and the other advanced economies will affect every country, including Australia.

The clouds are darkest over Europe, where banks and financial institutions are bracing for a possible Greek default.

Their best hope is that Europe can erect firewalls that prevent contagion spreading to other eurozone countries — and fast.

There have been some positive developments. The German Parliament last night voted to expand the size and scope of the European Financial Stability Facility, endorsing Chancellor Merkel's handling of the crisis and taking a step towards a longer term solution for Greece.

The biggest fear is that a Greek default on its €366 billion loans — representing 166 per cent of GDP — would trigger widespread selling of eurozone debt, triggering a broader financial crisis.

Portugal and Ireland also face significant challenges.

Ireland's debt to GDP ratio is still at 109 per cent, with a fiscal deficit of 10 per cent in 2011.

Portugal's debt to GDP ratio is 106 per cent, with a fiscal balance of 6 per cent in 2011.

Sovereign debt concerns have now spread to the core economies of Europe, particularly Italy (€1.9 trillion debt, 121 per cent GDP) and Spain (€733 billion debt, 67 per cent GDP).

Each of these Euro members has introduced significant measures to improve their short-term budget positions, in some cases enforced by the joint program of the European Central Bank, the European Commission and the IMF, in others enforced by the pressure from markets and the impact on the bond interest rate.

These austerity measures have themselves removed billions of euros worth of government demand from their economies — further undermining economic growth.

The banks too are impacted by sovereign debt concerns.

If any of the at risk countries default, the banks could lose significantly — lifting their risk profiles and forcing them to take measures to remain solvent. So the banks are holding onto profits, rather than taking on more risk by lending.

This banking conservatism, too, is reducing short-term growth.

United States

The US also faces challenges, although not of the same magnitude as those facing Europe.

In the US, sovereign debt problems primarily reflect political gridlock rather than a financial ability to pay.

Fiscal consolidation is a priority, but must strike a balance between not further harming an already weak economy on the one hand, with convincing markets that policymakers have a credible plan to return debt to sustainable levels on the other.

The deal struck in August between the Administration and the Congress raised the debt ceiling immediately by USD400 billion, enough to fund the federal government until September, which was subsequently extended until November.

USD917 billion in spending cuts will be made over the next decade.

Another USD1.2 trillion in savings is to be voted on by Congress before 23 December, which, if successful, will also see the debt ceiling lift by a further USD1.5 trillion.

But despite the ongoing US political challenges, US Treasuries retain their safe haven status.

Their demand is being lifted by global economic weakness, which is boosting the appeal of lower-risk assets.

But in the real US economy, the truth is that spending cuts will also decrease overall demand in a period of at best sluggish economic growth and very high unemployment.

And let none of us forget, that the US, as still the world's largest economy, has a real economic impact across the world, particularly in Asia, as US households tighten their belts.

The economic prognosis therefore for the US economy remains problematic for the future.

China

The situation in our own region is far different from that facing either side of the North Atlantic.

That is not to say that our region is immune from developments in the US and Europe.

Growth in China remains strong, although there are some signs of moderation in response to government policies to ensure the Chinese economy remains on a sustainable path.

Given its role as an engine of global growth since 2008, this is critical.

Inflation has recently eased somewhat, but remains high, as input costs rise rapidly in the Middle Kingdom.

Central bank officials are working to dampen domestic demand in response to these inflationary pressures, and while recent indicators suggest some easing in the pace of growth, the Chinese economy continues to expand at a robust pace.

The Chinese authorities are confident that they will achieve a 'soft' landing.

China's economic growth forecasts remain relatively robust but global policy makers cannot simply assume that Chinese growth can be lifted even further so as to fill the vacuum left by European and American growth, as it did in 2008/09.

The challenge facing Chinese policy makers is to sustain historical growth levels at around 7-8 per cent in order to continue to generate sufficient jobs for its growing population, while at the same time keeping inflation under control and not allowing a new set of potentially destabilising asset bubbles to be generated.

The Evolution of the G20

These then are the current set of challenges confronting the global economy and global policy makers, three years on from the start of the crisis.

But since the crisis began in 2008, there has been another positive evolution under way.

Faced with the threat of imminent financial and economic collapse, as we were in September 2008, the world refashioned its institutional framework for dealing with economic crises.

Our common threat meant we needed a coordinated policy response that markets would believe in, based on a real capacity to remove doubts about fundamental vulnerabilities in the financial system.

The pre-eminent body of the time was the G8 — but it failed the test of legitimacy in the first decade of our new century: it ignored the fact that the greatest engine of economic growth for the decade ahead would be the dynamic economies of the Asia-Pacific region.

The G20 had existed as a finance ministers meeting for a decade, but in 2008 global leaders seized upon it, suitably reformed, as the appropriate vehicle for our times.

Crucially the G20 was elevated to a leaders level meeting to drive a global response to a truly global crisis.

With India and China included it brought in the burgeoning economies so critical to the century.

But the G20 also included appropriate representation from around the planet.

The G20 represented 85 per cent of the world economy.

The G20 also embraced a widespread geographical spread, five states from Europe, six from Asia, five from the Americas and four from elsewhere.

Washington G20

The first G20 leaders meeting took place in Washington in November 2008 in response to the Lehmans collapse.

What we faced around the world was a failure of internal governance within financial institutions and in many jurisdictions, a failure of external oversight.

Regulators in these jurisdictions, didn't recognise the systemic risk posed by financial institutions of such size.

But it wasn't just private financial institutions that were threatened.

There were cascading crises in credit markets, debt markets, derivatives, property and equity markets.

International financial markets "dried up", directly affecting interbank lending — lending on which otherwise robust Australian financial institutions depended.

The financial crisis became an economic crisis, which in many countries became an employment crisis, a social crisis and a political crisis.

The immediate task we faced in Washington was to rebuild confidence in the financial system, by making sure central banks provided enough liquidity, and, by that, ensuring systemically critical financial institutions could be recapitalised and remain solvent.

Leaders also agreed to the Washington Action Plan, to arrest deteriorating financial market conditions and to improve financial regulation over the medium term.

Leaders agreed not to resort to trade or investment protectionism and empowered the WTO, OECD and UNCTAD to provide a regular public report back to the G20 on any national breaches.

National governments and central banks also acted — with fiscal and monetary stimulus that kept their economies moving and bank guarantees that stopped a complete collapse of international bank lending.

In Australia, critical decisions were taken in October 2008 to avert a collapse in consumer confidence in the banks by guaranteeing bank deposits.

Sovereign guarantees where also extended to Australian inter-bank lending to keep the international arteries of finance flowing.

To prevent a collapse in consumer confidence, retail spending and employment, the Government issued controversial cash payments to households as a deliberate measure to sustain employment over the critical summer of 2008/09 when employment collapsed across the OECD.

London G20

Five months later, at the London G20 summit in April 2009, governments struck an unprecedented deal to coordinate fiscal and monetary stimulus measures to avert the threat of a new global depression.

USD5 trillion in stimulus measures were agreed.

As well as an extra USD1.1 trillion for the IMF and Multilateral Development Banks, the G20 agreed on support for trade finance to help sustain growth in the developing world and to prevent the drying up of global trade.

The G20 also established a new Financial Stability Board to coordinate and oversee the implementation of reforms in private financial institutions, as well as national and global regulatory arrangements to reduce the risk of another crisis.

Previously agreed commitments on protectionism also held.

The result according to later IMF analysis, and as reflected in market responses, was that the London Summit broke the fall.

Pittsburgh

Six months later, at Pittsburgh in September 2009, the G20 recognised the threat that rising national debt posed for many countries that had been running consistent deficits over the years — now exasperated by the cost to sovereign debt of bank bailouts and the cost of public funding for the necessary fiscal stimulus.

Pittsburgh therefore agreed on the Framework for Strong, Sustainable and Balanced Growth — setting out a way in which G20 countries could act together to support long-term global recovery, by supporting new drivers of growth and by charting a credible path back to surplus for deficit countries.

Pittsburgh also agreed on the need to further strengthen financial supervision, particularly to address the question of institutions that are too big to fail.

Leaders also reformed the global system to take into account the real shifts that had already taken place, and were continuing to take place, in global economic power structures.

Processes were established to increase the voting powers of emerging economies at the IMF and the World Bank.

This reflected in many respects belated global recognition of the critical future role of emerging and developing economies in long-term global growth.

China could not be ignored.

India could not be ignored.

Nor could Korea.

Nor could Latin America.

Nor could Africa.

Toronto and Seoul

In Toronto, consistent with the Global Framework on Sustainable Growth, as agreed to at Pittsburgh, advanced deficit economies committed to at least halve their fiscal deficits by 2013.

And in Seoul in November last year, the G20 agreed to develop guidelines to address large current account imbalances.

This built on the mutual assessment system of macroeconomic review of the world's largest economies, supported by the IMF, to report on the international state of national and global imbalances and the actions of surplus and deficit nations.

Seoul also agreed to the Seoul Development Consensus as the G20 recognised the challenges facing developing countries in meeting the Millennium Development Goals and the need to source funding through new models for innovative finance to underpin the development gap between rich and poor.

G20 performance so far

Many have criticised the G20's performance.

And in any fair-minded analysis — there will be much to criticise, and much to praise.

The core reality is that three years into its existence, it has thus far prevented a recession (induced by a financial crisis) from becoming a full blown depression.

Given that the dimensions of the financial market collapse of 2008/09 for a time exceeded those of the 1929/30, this was no small achievement.

Second, some reforms to regulatory arrangements for private financial institutions have been agreed and at least partly implemented — invariably against the organised political resistance of those institutions whose excesses caused the crisis in the first place.

Third, there has not been a wholesale outbreak of protectionism — again of the type seen in the 1930s that helped catapult a recession into a sustained depression. At the same time, however, repeated G20 proclamations about the conclusion of the Doha Round have failed to produce any tangible result.

Fourth, the G20 has begun to embrace the global economic significance of the developing world.

Development, is a key long term driver for international growth.

Africa's infrastructure investment shortfall deprives sub-Saharan Africa of two percentage points of growth every year.

As finance is so critical for development, the G20 has recognised that we need to leverage public finance to promote far greater private capital flows for development.

So the G20 has placed — and is continuing to place — significant emphasis on its international development agenda.

Nonetheless, much remains to be done on the global economic and structural reform agenda consistent with the far reaching implications of the Pittsburgh Framework.

In fact, it has been a failure fully to implement that Frameworks requirement for a credible path back to fiscal balance and debt stabilisation that has caused much of the financial market nervousness we see at present - as markets calculate the possibilities of sovereign default.

There has been much commentary on this over the past 12 months.

Greece, in this sense, has simply been the trigger.

The second wave of the crisis

While the circumstances of the current crisis are different from those we faced in 2008, most analysts agree that the current sovereign debt crisis has its roots in the 2008 crisis, which began in private financial institutions.

There are two fundamental imbalances that need to be addressed in the global economy to deliver strong and sustainable growth.

First, the private sector in the major advanced economies needs to re-establish itself as the engine of growth. Countries with already overstretched budgetary positions and loose monetary policy cannot rely indefinitely on short-term stimulus measures.,/

Governments must move to implement credible medium to long-term fiscal plans that restore finances to a sustainable level, where they can, while not compromising economic recovery.

Private financial institutions, particularly in Europe, need to be encouraged to start lending again through appropriate balance sheet restructuring.

Second, economies with large external surpluses, particularly China, must rely increasingly on domestic demand to drive their economies.

Going into the 2008/09 crisis, many countries had already run up substantial sovereign debt.

When the GFC hit, many governments propped up financial institutions threatened with collapse as credit markets shut down.

As a result, they took on huge new sovereign debt in the process.

And as noted previously, some governments also took on debt through implementing fiscal stimulus, while others lost tax revenues as tax receipts fell and spending on welfare measures increased.

Australia came out of the crisis with one of the strongest fiscal and sovereign debt positions in the OECD.

Japan's net sovereign debt in 2010 was JPY562 trillion (or USD7.3 trillion / 117 per cent of GDP).

US net sovereign debt in 2010 was USD9.9 trillion (68 per cent of GDP).

By contrast, for Australia, the Treasury forecasts net debt will peak at 7.2 per cent of GDP in 2011-12, less than one tenth that of the major advanced economies.

With the exception of Saudi Arabia, Australia has the lowest general government net debt to GDP ratio in the G20.

And Australia's current fiscal balance is far healthier than other G20 countries.

Australia's net borrowing to GDP will be 3.9 per cent in 2011, according to the IMF. This compares to the US net borrowing of 9.6 per cent of GDP and 10.3 per cent for Japan.

But it is on Europe, that the eyes of the global financial markets are currently fixed.

The eurozone initially created a European Financial Stability Facility (EFSF) to deal with the sovereign debt of Portugal, Ireland and Greece.

In its 21 July package, EU leaders announced the expansion of the EFSF to have a lending a capacity of €440 billion.

The 17 eurozone members are currently voting on this expansion and strengthening the EFSF and providing it with more flexible rules to respond to emerging challenges.

But it is widely recognised that the EFSF is not large enough to deal with contagion to core eurozone countries or to deal with possible private financial institutional exposure.

For example, Spain's funding requirements this year is assessed to be around €200 billion and Italy's around €400 billion.

The previous European plan of 'muddling through' is no longer viable.

The Australian Treasurer said recently he's wary of "Europe falling off a cliff".

Policy makers have been repeatedly caught behind market developments.

That's why Europe is now considering how to expand the resources available to the EFSF. A number of options for 'leveraging' existing funds into a multi-trillion euro package are under consideration to be announced later this year.

This broadly is where the problem currently lies — pending further announcements in Brussels, Paris and Berlin as we move to the next G20 Summit in Cannes.

And as noted, developments in Berlin overnight may well prove to be encouraging.

Nonetheless, whether we like it or not, the as yet unresolved European financial crisis is the most immediate challenge facing the G20's role as the premier institution of global economic decision making.

The G20 Cannes agenda

While this is primarily a European crisis, which primarily requires European leadership, there is also much the broader international community can do.

The meeting of the G20 Finance Ministers last weekend in Washington, crystallised the magnitude of the challenges we face and the importance of working together to meet this new challenge.

When the G20 next gathers in Cannes, markets will expect global economic leadership.

The G20 succeeded in fending off the crisis in 2008, although the fallout still remains.

The G20 now has no less daunting a challenge ahead of it — particularly if Europe has failed to act effectively prior to November.

We all need to look beyond our immediate regions — and look immediately to our collective global responsibilities.

Gordon Brown put it another way recently, noting that "ten years ago the US engine could drive the world economy, and ten years from now the emerging-market countries stand to take over that role."

The problem is that the world economy now lies somewhere in between.

The US and Europe need to demonstrate that they have the solutions to their own political and economic questions.

In the US, this is as much a matter for the Administration as it is for the Congress.

And in the EU, we need leadership to demonstrate that the Euro project has not reached a dead-end, that a way forward can be found that allows for deeper, more effective fiscal and economic union.

China too has a global role to play.

Premier Wen made it clear in June that China wanted the stable development of the world economy.

China has offered to help with European sovereign debt positions.

But China also needs to act on the appreciation of its own currency — good for China (reducing China's reliance on the rest of the world for its economic growth), good also for the world.

Other emerging powers, too, need to play their part.

During last week's meeting of finance ministers in Washington, Brazil, Russia, India, China and South Africa agreed to do what they could to help global financial stability.

On the macro-economic front, we need Cannes to deliver a credible political commitment to address the key vulnerabilities in the world economy.

Major economies need credible but carefully-calibrated plans for fiscal consolidation, a return to surplus and a shift in demand from public to private.

This means a renewed focus on structural reforms and a commitment by Euro members to ensure the adequacy of the EFSF.

On financial regulation, the emphasis at Cannes should be on timely and effective implementation of already-agreed reforms: Basel II and III, and capital requirements for the 28 currently-identified systemically important financial institutions.

The G20 must focus on providing momentum to these reforms, which will reduce global financial instability, lessen the risks of moral hazard and ensure taxpayers are no longer asked to bail out irresponsible major institutions.

We also need to strengthen oversight of the shadow banking activities and oversight and transparency of over-the-counter derivatives.

The development agenda also remains essential to the G20's legitimacy — as well as recognising the potential for the developing world to itself become a critical driver of global growth in the 21st century.

Growth increasingly needs to come from the developing world — a reminder that all countries are partners in building a balanced global economy.

Food security will be a major focus at Cannes, including making humanitarian assistance more effective, strengthening early warning systems and boosting agricultural productivity, particularly in Africa.

Other important areas to make progress on include mobilising private funding for infrastructure, particularly in Africa, reducing the costs of remittances, and strengthening social protection in the developing world.

The G20

The G20 can continue to provide the leadership that the global economy needs.

With its membership and structure the G20 is the optimal (albeit imperfect) platform to address these challenges.

The G20's summits to date have shown that the G20 is capable of performing as an effective decision making group.

The reality is that the G20 will only continue to attract support so long as it remains capable of delivering on its core economic objectives.

The G20's credibility will rise or fall on its ability to provide the guidance and action that the global economy needs.

In 2011, Australia's G20 membership now lies at the absolute core of Australia's foreign policy.

It provides a platform for Australia to do so much more in the world as a middle power with global interests.

It provides us with a platform to engage directly (not indirectly through the proxy of others) on the critical challenges of the global economy, the environment and climate change — challenges which all directly affect our national interest.

Australia first sought membership of an expanded G7 more than a quarter of a century ago.

We failed.

Three years ago, we succeeded.

It was a hard-won prize.

Many others around the world actively fought against it.

We prevailed through more effective global diplomacy.

And now, under no circumstances, can we allow it to falter.

We have too much at stake.

So too does the world.

In recent years, we have moved from a G7 with no emerging country representation to a G20 which corrects the euro-centric nature of the G7.

Some now argue for a G193 — to gain the perfect legitimacy of the total membership of the UN.

But with perfect legitimacy comes equally perfect ineffectiveness in dealing with the complex, dynamic and potentially destructive beast called the global economy.

Of course the alternative to the G7, the G20 and the G193 is the G-0 — that is the effective collapse of any form of credible global economic leadership.

For these reasons, the G20 is the best blend of legitimacy and effectiveness the international community has had so far in dealing with the great challenges of the global economy.

Besides, now is not the time for a global seminar on the structure of the G20.

The times are pressing.

Action is needed.

We should learn from history.

The financial crisis that began with the Wall Street crash occurred in 1929.

It was not until 1933 that countries gathered at the London Conference — including Australia — to resolve a collective response to the rolling financial and economic crisis which followed.

That London Conference failed and the history of the 1930s — economic and political — is too familiar to us all.

It is imperative that the world succeeds at Cannes.

Australia, for its part, will be throwing everything at it.

END

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