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On Global Dealmaking

12 Oct 2010

Shane Fitzgerald

Alan Beattie had an interesting article in today’s Financial Times about the continuing failure to establish convincing mechanisms for global economic cooperation and policy coordination.
 
From Copenhagen to Basel to Washington DC and onwards to Seoul and Cancun, we are all getting used to watching those at the commanding heights of the global economy spectacularly fail to get their collective acts together in the name of urgent common goods.
 
This is hardly surprising, says Beattie but:
 
There is a widespread misdiagnosis of what is going wrong – specifically a belief that the friction arises from mere difficulties in co-ordination rather than a fundamentally different analysis of the world.
 
N. Gregory Mankiw picks up this thread in a New York Times analysis of what increasingly looks like a budding currency war. In thinking about this issue, he says, policymakers must recognize what has been called the fundamental trilemma of international finance:
 
What is the trilemma in international finance? It stems from the fact that, in most nations, economic policy makers would like to achieve these three goals:
 
Make the country’s economy open to international flows of capital. Capital mobility lets a nation’s citizens diversify their holdings by investing abroad. It also encourages foreign investors to bring their resources and expertise into the country.
 
Use monetary policy as a tool to help stabilize the economy. The central bank can then increase the money supply and reduce interest rates when the economy is depressed, and reduce money growth and raise interest rates when it is overheated.
 
Maintain stability in the currency exchange rate. A volatile exchange rate, at times driven by speculation, can be a source of broader economic volatility. Moreover, a stable rate makes it easier for households and businesses to engage in the world economy and plan for the future.
 
But here’s the rub: You can’t get all three. If you pick two of these goals, the inexorable logic of economics forces you to forgo the third.
 
The US chooses the first two. China opts for the second pair. By forming the Eurozone, most of Europe’s countries have picked a third way of forsaking national monetary policy in the name of eliminating currency fluctuations within the zone and ensuring free movement of capital.
 
Each strategy has its merits, or as Mankiw puts it, ‘[i]n this area of economic policy, as well as many others, there is room for reasonable nations to disagree.’
 
Valid the three approaches may be, but it seems clear that we should not expect too much of policy cooperation initiatives that attempt to transcend what are fundamental disagreements.
 
European integration succeeded because of a constant focus on common goals, interests and benefits. It is plain that the more diverse these were, the weaker the policy outcome (e.g. the EU’s still elusive common foreign policy).  Prospects for comprehensive global deals on fixing finance, stabilizing the climate and minimizing poverty are retreating not because of institutional failures within the global multilateral framework, though these no doubt exist, but because of the radically different perspectives and priorities that key players are bringing to the negotiating table. The diversity of these players is set only to increase.

As an independent forum, the Institute does not express any opinions of its own. The views expressed in the article are the sole responsibility of the author.


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gurumurti balakrishnan says: 13 Jan 2011 10:23

Trilemma is indeed a dilemma for man on street.True you can pick up two but all three. Article is an interesting read. but countries subject poor to innumerable advantages of disadvantages of facing life realities. One thing is sure today world is over heated. You need renewable economic energy from new economic energies already traded. one thing is sure a lot lopsidedness in economies all over due to mis-mesh or mis-match of economic theoretical thinking as human behavior economics is most unpredictable. can we really hit bulls eye of current international problems in straight terms. will the author address the topic with answers to my questions. true there is no single magic panacea! Yet we attempt at least in thinking legions!

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