17.05.2003
Restoring G-8 Leadership of the World Economy
№2 2003 April/June

The Shadow G-8 unites a group of leading independent experts
from the G-8 countries, who prepare annual reports for G-8 summits.
This report was made under the chairmanship of Fred Bergsten,
Director of the Institute for International Economics (U.S.A.) and
member of the Editorial Board of Russia in Global Affairs, and
Barbara McDougall, President and CEO of the Canadian Institute of
International Affairs. Russia was represented by Sergei Karaganov,
Chairman of the Council on Foreign and Defense Policy and Chairman
of the Editorial Board of Russia in Global Affairs, and by
ex-Minister of Finance Boris Fedorov (for full list of the experts
see p. 164).


The Decline Of The G-8

The Evian summit in June 2003 will begin the fifth cycle of
annual conferences of heads of state and government since the
initial meeting of the group in Rambouillet, also chaired by
France, in 1975. It is thus an appropriate time, in considering a
course of action for this year’s conclave, to step back and assess
the evolution of the summit process over this span of almost three
decades.

In assessing the current state of the annual summits,
particularly in the economic area, our “Shadow G-8” has concluded
that the effectiveness of the G-5/7/8 has declined sharply since
the group was originally created. There are a few areas in which
the summits have continued to make useful decisions, especially in
continuing the global momentum toward trade liberalization. But we
believe that the overall record is one of substantial decline,
which has become exceedingly costly during an era of accelerating
globalization when international policy cooperation has become more
rather than less essential.

There are two basic reasons for this deterioration of the G-8
process. First, the group no longer seriously addresses the policy
shortcomings of its own members or seeks to devise effective means
of cooperation within the group to help remedy those shortcomings.
The original G-5 was inspired by two primary ideas: to conduct
informal but tough and candid “peer review” of each others’
performance and policies, and to fashion cooperative strategies
that would produce results that might elude any of the individual
members acting solely on their own.

The G-8 now seems to have given up on both of these themes. The
members seem to have adopted a non-aggression pact under which they
consciously refrain from criticizing each other. The result has
been a severe erosion of the utility of the institution in
identifying and promoting necessary changes in the economic
policies of the individual members.

Europe must substantially reform both its labor markets and the
Stability and Growth Pact, which now requires the adoption of
perverse economic policies – for example, tax increases and
expenditure cuts in the face of risks of recession. Japan must
escape deflation, and eliminate large parts of its banking system
to restore financial stability and thus a prospect for growth. The
United States must substantially reduce its external deficit, which
both drains resources from the rest of the world and poses a
constant threat of financial crisis, and avoid the buildup of large
new budget deficits. Yet recent summits have virtually ignored
these issues.

In addition to ignoring some of the deepest policy problems
within the group, the G-8 has apparently given up the idea of
attempting to fashion coordinated or even cooperative responses to
them. But there are clearly periods in which joint policy
approaches are demonstrably superior to purely national efforts.
Moreover, it is sometimes more feasible for individual countries to
adopt painful but essential reforms if other countries are doing so
at the same time.

The second fundamental reason for the decline of the G-8 is an
inevitable corollary of the first. Having decided to stop
addressing the problems and potential for economic performance and
policy within the group, the summiteers have taken increasingly to
instructing non-member countries on proper courses of action in the
rest of the world. To be sure, problems outside the G-8 itself,
such as financial crises in Latin America and East Asia or
epidemics and famines in Africa, have demanded international
attention. Leadership from the G-8 may often be an essential
component of resolving such “out of area” problems, including by
bringing external pressures to bear (as is currently being
attempted, for example, with respect to the NEPAD process in
Africa).

But the juxtaposition of these two basic changes in the
operation of the G-8 – the adoption of a non-aggression pact toward
each other alongside an energetic advocacy of reform by non-members
– has produced much of the contemporary problem faced by the
summits. On the one hand, the failure to improve their own
performance and policies makes it much more difficult for the G-8
to promote reform elsewhere. Such leadership must come at least
partly by example, especially in the international sphere, and the
absence of decisive action by the G-8 itself reduces the prospect
for decisive action elsewhere. Moreover, poor G-8 economic
performance weakens the entire global economy and produces a far
less hospitable environment in which the rest of the world can
pursue the changes that are necessary for their own progress.

On the other hand, the apparent unwillingness of the G-8 members
to criticize themselves, combined with their revealed proclivity to
criticize others, has produced a crisis of legitimacy for the
institution. The widespread charge that the G-8 is both
undemocratic and hegemonial stems fundamentally from its asking
others to do what it is unwilling or unable to do itself.

The result of all this is that the G-8 has come to appear both
ineffective and illegitimate, the basic cause of its weakness over
the past decade or so. There are two logical ways to remedy this
situation. One would be for the G-8 to return to its initial
approach of candidly addressing its own members’ problems and
seeking cooperative strategies for dealing with them. The other is
to broaden the membership of the group, to restore its legitimacy
by incorporating at least a substantial number of the previously
unrepresented countries to which much of the G-8’s attention has
been addressed in recent years.

These two strategies can be mutually reinforcing and we will
suggest a mix of them. The first emphasizes the need for policy
reform within the G-8 countries themselves, including the role that
cooperative or even coordinated strategies can play in achieving
these reforms. The second suggests an ongoing dialogue between the
G-8 itself and a group of additional countries, that are also very
important to the world economy, to which the G-8’s recommendations
are quite properly addressed but which cannot be expected to
respond effectively if they remain outside the process.

We fully agree that the G-8 should address global security and
political issues, and have indeed offered numerous suggestions in
those areas in our three previous reports. We would note, however,
that the substantial erosion of G-8 effectiveness on economic
issues began well before the recent explosion of concerns over
terrorism, proliferation of weapons of mass destruction, increased
conflict in the Middle East and other crises. Indeed, it was
thought that the end of the Cold War over a decade ago would enable
our governments to devote more attention and more resources to
their domestic, including economic, problems. Yet economic
performance in much of the G-8, notably Japan and Europe, worsened
substantially over the succeeding decade and the failure of the G-8
to respond effectively has become increasingly apparent and
increasingly costly.

In addition, we believe that the renewed imperative of security
cooperation among the leading industrial powers heightens the need
for effective G-8 economic cooperation. The pressure to devote
increased resources to military budgets increases the need for
improved economic performance. The imperative to strengthen poorer
parts of the world economy, including to reduce their
susceptibility to terrorists and other destabilizing blandishments,
does so as well. The political urgency of displaying G-8 solidarity
in the face of threats from outside the group, as surfaced at least
temporarily after 9/11 to help achieve the agreement at Doha to
launch a new round of multilateral trade negotiations at the WTO,
further supports the case for a sharp renewal in G-8 economic
activism.

There is finally the traditional concept of comparative
advantage. The G-8 can sometimes provide useful support for
political cooperation among its members. It is not, however, the
proper body to deal with most of the world’s security and political
issues. Those functions properly and usually fall to the United
Nations, to NATO or to other bodies that have been created and
developed specifically to address such topics.

The heightened urgency of political and security issues at
present in fact suggests a new strategic role for the G-8. The
group should focus intensively on the economic aspects of the
contemporary security problems. This approach would call for
particular emphasis on energy markets and energy security, sharing
the costs of the military and especially post-conflict situations,
and the global economic growth profile that both heavily affects,
and is so heavily affected by, these other variables. For example,
any new “Marshall Plan for Iraq,” or for the Middle East more
broadly, should be worked out and implemented through intensive G-8
cooperation. The current situation indeed offers huge new
opportunities for G-8 cooperation, as well as demanding better
performance, and thus better economic policies, from all its
members.

The World Economy

The world economy is in tolerable shape. We expect a modest
recovery throughout 2003 and 2004, led by a pickup in the United
States and continued rapid expansion in China.

At the same time, numerous crises remain possible. Potential
military and subsequent actions in the Middle East, and their
aftermath, could go badly and weaken rather than stabilize the
world economy through a renewed sharp spike in oil prices and other
disruptions. Deflation is already evident in two of the world’s
largest economies, Japan and China, and could set in elsewhere
(perhaps particularly Germany and even the United States) in the
near future. Renewed bubbles, e.g., real estate in the United
Kingdom or United States, are real if unlikely risks. The Japanese
financial system could implode. The orderly decline of the dollar
over the past year could accelerate into a hard landing. Renewed
currency disruptions in Latin America or elsewhere could imperil
global capital markets.

Our main economic concern, however, is that so many countries
and indeed entire regions are performing far short of their
potentials. Japan’s “lost decade” has now extended well beyond ten
years. The European Union is performing poorly in terms of both
realizing its current growth potential and, even more so, expanding
that potential to provide the more buoyant prospects of which it is
clearly capable. The economy of Latin America is faltering and is
replete with financial crises; it will continue to falter until
Brazil, which accounts for half the continent, achieves a decisive
turn-around and until stabilization is achieved in several crisis
countries. Most of sub-Saharan Africa and much of the Middle East
remain mired in stagnation or worse.

Moreover, world growth is badly unbalanced. The United States
accounted for 70 percent of G-8 growth in the second half of the
1990s and has again become the dominant factor as Europe and Japan
continue to disappoint. One major result has been an explosion of
the external deficit of the United States, rising by about U.S.
$100 billion (or 1 percent of GDP) annually in all but one of the
past five years. It has now reached over $500 billion (about 5
percent of GDP) per year, far above all previous records. The net
international investment position of the United States has reached
a negative level of about $3 trillion and is rising by 20-30
percent annually. The gradual and orderly decline of 5-10 percent
in the average value of the dollar over the past year, as called
for in our last report, will help reduce these imbalances. But
faster and more consistent growth in the rest of the world,
particularly in the other G-8 countries, must be part of any
constructive and lasting remedy to this threat to international
financial stability, the open trading system and global prosperity
as well as to meet the domestic needs of those countries
themselves.

Yet the G-8 has said very little about these issues in recent
years, let alone done anything about them. The “finance G-7” of
ministers of finance and (usually) central bank governors, which
also conducted extremely effective coordination strategies in
earlier periods, has done no better recently, undercutting the
excuse that sometimes emanates from the summits that “these matters
can be left to our top economic officials.”

To pursue the strategies that we propose to deal with these
problems, the G-8 should keep three basic principles fully in mind.
First, each member needs to address both macroeconomic and
microeconomic shortcomings in its current policies. Japan must
reform its banking system and enact structural reforms in many of
its uncompetitive (mostly services) sectors, while countering
deflation with more effective monetary policies and further
short-term fiscal stimulus. Europe must reform its labor and
capital markets while revising the Stability and Growth Pact (and
perhaps the modus operandi of the European Central Bank). The
United States must increase its national savings, including by
avoiding renewed deterioration of its long-term budget position,
and reform its energy and environmental policies.

Second, the reform agenda must comprise both short-term and
long-term measures. Japan must eliminate deflation in the short run
while restoring fiscal prudence for the long run. Europe must avoid
tightening fiscal policy in the near future and achieve more
flexible labor markets over time. The United States needs an
orderly but early correction of its huge external imbalance while
ceasing to drain the world of both capital and energy over the more
distant future.

Third, the G-8 must look for new international arrangements that
can help the governments of its member countries overcome domestic
resistance to the needed policy reforms. The international rules of
the WTO help countries avoid the creation of new trade barriers
and, in cases such as China’s recent entry to the organization,
dramatically promote their liberalization. The goal now should be
to fashion statements, policy recommendations and joint action
programs that will enable the leaders of the G-8 countries to take
the steps that they know are needed, and frequently wish to
implement, by helping them overcome the entrenched domestic
opposition that has prevented timely adoption of these measures to
date.

With these principles in mind, we turn to a review of the
situation in each of the major G-8 regions. We believe that
important policy changes in each are feasible as well as necessary
and that the G-8 can play a helpful, sometimes even central, role
in galvanizing those actions.

Japan

Japan has experienced a “lost decade” of economic stagnation
since its financial bubble burst in the early 1990s, the worst
performance of any G-7 country in the postwar period. It is
experiencing the first prolonged deflation in an industrialized
nation since the 1930s. Its national debt and budget deficits are
far higher than those of any other G-7 member. Unemployment and
bankruptcies have soared to postwar highs for Japan. The country
will probably benefit from the global recovery that is now underway
but its longer run outlook remains shaky.

The most important element of the problem is the structural
weakness of Japan’s banking system. Non-performing loans have
reached such a level that respected analysts estimate that fully
one half of the banking system is insolvent and that the inevitable
recapitalization of the remaining institutions will cost 15-20
percent of GDP. On some accounts, the situation is in fact getting
worse and a major financial crisis – embracing capital flight from
Japan and runs on individual banks – could erupt at almost any
time.

Underlying these economic difficulties are fundamental political
problems in Japan. It has proven extremely difficult to overcome
institutional rigidities that block reform of the banking system
and other entrenched impediments to restoration of economic
progress. Major changes may be needed to create a political system
that is more responsive to Japan’s fundamental needs. Japan must
move quickly and decisively, at all these levels, to begin the
necessarily extended and painful process that will rectify its deep
current problems and provide a foundation for the renewed economic
progress which the country remains fully capable of achieving.

The preceding three paragraphs are repeated verbatim from our
report of a year ago. Japan has not erupted into crisis but neither
has any fundamental improvement occurred in its dire economic
situation. Japan continues to “muddle through,” with further
deterioration in both the banking system and the prospects for
ending deflation along with continued severe deterioration of the
country’s fiscal position.

The agenda for urgent reform in Japan, that should be candidly
addressed and pursued by the G-8, is thus quite extensive. The
required “creative destruction” will inevitably cause transitional
hardships in the country, although a restoration of confidence in
the future could also usher in a period of surprisingly high
“catch-up growth” that would absorb some of the output gap that has
ballooned over the decade of stagnation. The G-8 should press Japan
to adopt the following initiatives:

* immediate and substantial write-off of non-performing
loans in the banking system and restoration of the underlying
assets to the productive economy, to revive the country’s financial
health and confidence in its economic future (and thus renewed
growth in both private investment and consumer spending);

* a sharp further expansion in the supply of reserves to
the financial system, to reverse the current deflationary
expectations as soon as possible;

* aggressive and complete deregulation and privatization,
particularly in the services sector, to encourage creation of new
businesses and employment; and

* further short run fiscal stimulus to counter the
inevitable additional disruption of the economy from comprehensive
banking reform for a year or so, with particular emphasis on
creating new governmental safety nets, to cushion the inevitable
adjustments to the new situation, coupled with clear plans to start
reducing the budget deficit and national debt as soon as sustained
economic growth is restored.

Europe

Europe is the most perplexing of the three major economic zones.
It never fell into absolute recession during the 1990s, unlike
Japan or the United States, and we do not expect a recession now.
Some of the members of the European Union (particularly smaller
countries and those on the periphery) are doing well. The euro has
strengthened steadily in the exchange markets over the past year. A
number of initial reforms, including in difficult areas such as
taxes and pensions, have been adopted.

The overall economic performance of Europe, however, is deeply
disappointing. The annual growth of labor productivity for the
region as a whole dropped in half over the past decade, as in
Japan, while it was doubling in the United States. The weakness was
particularly acute in Euroland; countries that have not adopted the
euro, notably the United Kingdom, have done better than those that
have. The largest countries of the euro zone, especially its former
bellwether Germany, have dragged down the entire region. The
pending enlargement of EU membership will make its collective
decision-making process even more difficult in the years ahead.

At the same time, plans for many of the needed reforms have
already been developed. The EU summit at Lisbon in 2000 endorsed a
series of needed structural changes. The Lamfalussy Committee
spelled out how to achieve a truly unified financial market. The EU
Commission itself has provided numerous blueprints, most recently
“to restore the competitiveness of the Union.” The European Central
Bank is engaged in an intensive review of its own policies and
practices. Numerous academic studies have suggested reforms of the
Stability and Growth Pact. The issue for action is to select from
these myriad proposals, prioritize among them, and – most
critically as in the other countries – assess how the G-8, and
international encouragement and/or pressure, can help overcome the
internal resistance to essential changes.

We therefore believe that the G-8 at Evian should candidly
discuss the outlook for Europe and seek agreement by the European
members of the group to pursue the following reforms:

* fundamental reform of labor markets, at both EU and
national levels, to enhance the mobility of workers and thus
productivity of the overall economy;

* full adoption and implementation of the Lamfalussy
Report, to complete the creation of truly unified capital and money
markets;

* linked to these structural reforms, amendment or
reinterpretation of the Stability and Growth Pact to focus on
national debt positions rather than annual budgets, and on changes
in those debt positions over the life of the business cycle rather
than in individual years, to restore at least a modicum of
flexibility for the use of discretionary national fiscal policy to
counter cyclical downturns;

* modification of the guidelines of the European Central
Bank, to pursue an inflation target of 1-3 percent that is
symmetrical (with a well-defined floor to protect against deflation
as well as a ceiling to protect against inflation) and a ceiling
that is a bit more relaxed than at present;

* further moves to end barriers to competition (e.g.,
further liberalization of energy markets) and a significant review
of state support for vital public services; and

* long-term adjustment of pension systems, retaining
necessary benefits for retirees while restoring fiscal prudence in
the countries most seriously affected.

The United States

The United States has performed by far the best of the G-8 over
the past decade. In particular, productivity growth has increased
sharply while it was falling in Europe and Japan.

But the United States has also experienced major problems in
recent years. Recovery of the financial markets from the bursting
of the stock market bubble may take some time. The corporate
governance scandals have weakened consumer and investor confidence.
Comparative international results continue to show that America’s
primary and secondary education systems require substantial further
improvement. Renewed increases in health care expenditures are
draining substantial resources from other parts of the economy. The
high costs of the legal system have a similar impact.

The main economic policy problem now facing the United States,
however, is the renewed deterioration of its budget position. Even
allowing for purely cyclical effects, the sharp increases in the
deficit over the past two years – and especially the outlook for
further increases over the next five to ten years – are alarming.
Some increases in government spending for homeland security, and
perhaps for national defense, may be unavoidable. Modest tax cuts
with immediate impact, to help assure renewed growth, can be
justified.

The G-8 at Evian should, however, urge the United States to
avoid any new tax cuts that are not aimed at immediate stimulus and
to freeze the sizable tax cuts that are now scheduled to phase in
over the rest of the decade in ways that will substantially erode
the revenue base of the U.S. Government. The expansionary effect of
those cuts on the economy, given their structure, is of uncertain
merit in any event. They were adopted prior to 9/11 and the
movement toward war in Iraq, and simply need to be rescinded in
light of all that has occurred since that time.

This fiscal outlook is particularly worrisome because the
national savings rate of the United States remains far too low to
finance the levels of investment needed to sustain recent
productivity growth and economic expansion. The country has
therefore depended on huge inflows of foreign capital, which
average about $4 billion every working day (to cover the large
outflow of U.S. foreign investment as well as the current account
deficit). The stability of the U.S. economy, the global financial
system and indeed the entire world economy is dependent on a
continuation of these flows – or on smooth adjustment of the
underlying imbalances.

Macroeconomic Cooperation and Adjustment

We are thus encouraged by the “soft landing” of the exchange
rate of the dollar that has begun to occur over the past year, as
called for in our report in 2002. However, the smoothness of the
adjustment so far appears to be much more a matter of luck than
design. Moreover, we suspect that the decline of the dollar to
date, which amounts to less than 10 percent on a trade-weighted
average basis, has achieved no more than one half of the needed
correction. Hence we continue to recommend that the G-7 Leaders
instruct their ministers of finance to develop a plan of action to
both limit any serious damage that might result in the short run
and to promote a constructive correction over the next year or so.
(We also recommend that that finance ministers be brought back into
the G-8 summits, where they played an important role in earlier and
more successful periods.)

We would also repeat our admonition that no country, least of
all a member of the G-8 itself, should intervene in the currency
markets to drive exchange rates away from levels required for
systemic stability, e.g., by promoting renewed appreciation of the
dollar. Japan has done so with its repeated efforts to “talk down”
the yen and even buy dollars directly, despite its being by far the
world’s largest creditor country and its continuing to run large
and growing current account surpluses.

The sharp increase in U.S. trade deficits in recent years has of
course provided an important stimulus to growth in other countries
in both the G-8 and around the world. Hence any substantial
reduction in the U.S. deficits, without a corresponding pickup in
domestic demand elsewhere, could substantially weaken the world
economy. A central element in any constructive long-term correction
of the present international imbalances is thus a sharp increase in
economic growth in the other parts of the G-8 itself, notably
Europe and Japan. The reforms proposed above in the policies of
those countries, which are needed primarily to improve the lives of
their own people, would therefore also serve an international
purpose of the highest priority.

Trade Policy

Substantial progress has been made on international trade policy
over the past couple of years. Led by the strong support of the G-8
at its Genoa summit in 2001, as recommended in our report to that
meeting, the membership of the World Trade Organization agreed at
Doha in November 2001 to launch an ambitious new set of
negotiations to further reduce global barriers to trade and to
strengthen the international rules that govern it; they properly
agreed to focus the round on the needs of the poorer countries, and
indeed to call the initiative the Doha Development Agenda. In the
summer of 2002, President Bush succeeded in obtaining Trade
Promotion Authority from the Congress so the United States can now
participate meaningfully in the new endeavor. Following another of
our recommendations, the United States and the European Union seem
to have implemented a de facto standstill agreement on any renewed
cycle of retaliation and counter-retaliation that could seriously
threaten the global trading system.

Historians of the G-5/7/8 process have concluded that its most
consistently successful arena for policy initiatives has been
international trade. The group was in fact initially created, in
large part, to resist the protectionist pressures that were
inevitably unleashed by the first oil shock in the early 1970s.
Former top trade officials of member countries have testified that
the successive rounds of global liberalization in the GATT/WTO
would never have occurred without the political impetus provided by
the G-5/7/8 summits. The successful recent effort to launch Doha
reinforces this stellar record.

The G-8 needs to address trade again at Evian. The most
immediate requirement is to infuse renewed vigor in the Doha
process, which already shows signs of faltering as deadlines for
advancing key components of the negotiations are missed. In
particular, there are worrisome indications that G-8 countries are
failing to meet legitimate concerns of developing nations to the
extent that the latter could withhold cooperation from the
initiative and thus condemn it to irrelevance or even failure.

Even more seriously, there are signs of significant erosion of
open markets within the G-8 itself. Major disputes, on issues
ranging from agricultural trade through steel to export subsidies,
threaten renewed conflict between the United States and a number of
its trading partners, especially the European Union. Subsidies on
agriculture remain high within all G-8 countries and have even
increased recently in some, including the United States. Renewal of
the momentum toward liberalization remains the best defense against
these protectionist relapses.

The most urgent target of a new G-8 effort should be the
upcoming ministerial meeting of the WTO at Canc?n in September
2003. This “midterm ministerial” could play a critical role in
restoring momentum to the entire Doha process. It must impart
substantial impetus to that process if the round is to have a
chance to be concluded successfully by the agreed target at the end
of 2004, or even at a later date if political realities force a
delay. In particular, several decisions must be made at Canc?n to
respond to the legitimate needs of the dozens of developing
countries whose active participation in the round is extremely
important for both economic and political reasons.

We therefore recommend that the G-8 agree at Evian to make the
following offers at Canc?n, conditional of course on acceptance by
the developing countries of appropriate obligations on their own
part to contribute meaningfully to a successful final package for
the Doha round:

* a major contribution, of both money and human
resources, to building the capacity of the developing nations both
to participate in the round itself and to implement its agreed
outcomes, to avoid replication of the widespread view in those
countries that they were unable to bargain effectively in the
Uruguay Round and are even today unable to fulfill some of the
obligations they accepted in it;

* agreement that the poorer countries can import as well
as produce generic drugs to help counter the ravages of a wider
range of diseases than already agreed, notwithstanding the
strictures of the TRIPS accord in the Uruguay Round; and

* acceptance of considerably longer timetables for
implementation of components of the Doha liberalization package by
the poorer countries, as a much more constructive resolution of the
dispute over “special and differential treatment” for those nations
than exempting them from the liberalization obligations
themselves.

There are two other trade policy issues that the G-8 Leaders
should address for Canc?n. One is agriculture, which has
traditionally been the most difficult component of major
multilateral negotiations. As noted above, it has recently been
moving in the wrong direction once again. It is the most crucial
area of trade relations for some developing countries, many of
which could become major exporters in the absence of the large and
rising subsidies of their much richer competitors. This may be a
policy area where international agreement, and even external
pressure, can be particularly helpful in pushing national policies
in constructive directions – both within the G-8 itself and in some
other key countries.

There are two steps that the Leaders should start addressing
that would be of central importance in resolving the crucial
problems of global agricultural conflict: reducing their overall
levels of support for agriculture, and further redirecting their
remaining subsidies away from price supports toward income
supports. It will inevitably take time to translate such
preliminary conversations into substantive policy changes, and this
is indeed the main reason why the conclusion of the Doha round may
be delayed beyond its target date. It is imperative that the effort
begin at Evian, however, to offer a prospect for credible inclusion
of the agricultural issue in the final Doha package – which will be
a make-or-break item for numerous developing countries and other
participants in the negotiation.

The other trade issue for the Leaders to address at Evian is
regionalism. Over two hundred bilateral and regional trade deals
have been agreed and many more, including among large trading
countries such as the United States and Australia or Japan and
Mexico, are now being negotiated. Indeed, well over half of world
trade is now covered by these pacts and that number will rise
sharply if megaregional negotiations, as for a Free Trade Area of
the Americas and deals between the European Union and Mercosur and
between China and ASEAN, are successful.

Throughout the past fifty years, regional and global trade
liberalization have proceeded in tandem. Indeed, the two paths to
the reduction of barriers have often reinforced and even catalyzed
each other. However, the current explosion of new FTAs and the
problems described above in effectively pursuing the multilateral
Doha negotiations provide a strong reminder that the former could
impede, or even derail, the latter.

Hence there is, again, a need for G-8 Leaders to face the issues
candidly and reaffirm their commitment to give priority to the
multilateral system, seeing any regional and bilateral agreements
they pursue in that broader context and making sure that they
structure those agreements in ways that are compatible with their
global obligations. In addition, the Leaders should agree that any
free trade agreements that they conclude will be comprehensive in
scope, including agriculture, to assure their conformity with the
WTO. They should also instruct their trade ministers to devise the
most effective methods available, including possible amendments to
the charter, to substantially strengthen the WTO rules that govern
regional and bilateral agreements in order to insure that they do
not deviate importantly from the goals and precepts of the
multilateral system. These techniques should then be pursued as
either an integral component of the Doha round itself or
independently.

The most dramatic step that the G-8 Leaders could take at Evian,
to underline their commitments both to the success of the Doha
round and to the superiority of the multilateral trading system in
the global trade hierarchy, would be an agreement to eliminate all
of their tariffs on industrial products by a date certain (perhaps
2015 or 2020) if the rest of the WTO membership was willing to do
so (perhaps with a longer phase-in period for the poorer
countries). In addition to the traditional economic merits of
liberalization, such a commitment would signal the elimination of
all preferential tariff arrangements over the same timetable by the
simple expedient of eliminating all tariffs on a global basis.
Proposals to this end have already been tabled in the Doha
negotiations and we urge the Leaders to endorse them at Evian.

There are thus three specific initiatives that the summiteers
should take at Evian in the area of trade policy: a package of
measures to respond to the legitimate needs of developing countries
within the context of the Doha round, commencement of reforms to
reduce the adverse impact of current agricultural policies on world
trade (and especially on developing countries), and initiation of
steps to assure the continued compatibility of regional/bilateral
agreements with the multilateral trading system, including the
ultimate elimination of all tariffs.

Energy Security

Following a sharp increase in crude oil prices in 1999, the
ability of OPEC countries (with help from key non-OPEC exporters)
to defend historically high prices (around $25/barrel) through the
years 2000 to 2002, the 9/11/2001 events and their aftermath in
international and especially Middle East politics, and especially
the current prospects for conflict in Iraq, energy security is back
on the agenda. It is now widely recognized that there is no
sensible alternative, for any major importer, to trading oil with
foreign partners. Even for the United States, which still has much
larger reserves than other large importers, there is little scope
for cost-effective reduction in the rise of oil imports (let alone
a reduction in absolute levels of imports). Moreover, even if
possible, the reduction of so-called “oil dependence” would not
make sense in a globally integrated oil market.

In this context, there are two dimensions to international
energy security, apart from military protection of unstable
exporting regions: 1) defense against short-term “shocks” and 2)
access of exploration and development capital to world energy
resources. Each of these should be addressed by the G-8.

First, the G-8 should strengthen emergency oil stockpiles.
Stockpiles are the only available tool to deal with severe
short-term supply shortages, whatever their origins. There are two
problems that could be remedied to improve international energy
security.

One is that the emerging market economies generally lack
emergency stockpiles. These economies account for a growing share
of global petroleum demand and would suffer substantially in case
of a severe oil “shock.” As oil security is clearly a public good,
OECD countries should support financially the building of such
stocks. The proposal of the Bush administration that emerging
countries could lease spare capacity in the U.S. Strategic
Petroleum Reserve also deserves attention.

The second problem is that existing strategic stocks lack a
clear doctrine for utilization. There are many reasons for that,
some of them quite good. For example, governments want to keep
their hands off price management, which would be both very costly
and bound to fail. (The EU proposal of building a
Commission-controlled strategic stock dedicated to counter-cyclical
intervention makes little sense, has been sharply criticized by the
vast majority of industry and academic experts consulted, and
should be abandoned.) A practical solution, long advocated by
economists but never implemented, consists in treating strategic
stocks as a publicly provided source of supplementary supply that
the private sector can bid for through options contracts.

Second, the G-8 should consider ways to strengthen the legal
regime for international energy investment. A great deal has been
done in this area over the last 15 years. More is needed, however,
as most of the energy-rich regions are plagued with defective
governance and especially defective security for investments, which
especially hinders the flow of foreign investments. The United
States favors bilateral approaches as well as a regional scheme
that would be part of the Free Trade Area of the Americas (FTAA).
The Energy Charter Treaty (ECT), the only multilateral
energy-specific international legal instrument, already has 50
parties and perhaps more in the near future. The United States, by
far the largest “exporter of energy capital,” has not signed it.
The G-8 should endorse the Energy Charter Treaty process and
encourage its enlargement to both new capital-importing and
capital-exporting countries.

Climate Change And Global Environment

Especially in the wake of the U.S. decision not to ratify the
Kyoto protocol in 2001, climate change has become a major subject
of disagreement within the G-8. In March 2002, the U.S. government
unveiled an alternative strategy. Under that plan, the United
States commits to reduce the greenhouse gases (GHG) emissions
intensity of its economy by 18 percent over 10 years. This
objective would be attained through essentially voluntary
measures.

Most observers agree that this is a “wait and see” position
rather than an aggressive plan to reduce GHG emissions. “Business
as usual” projections show a 14 percent decrease of emissions
intensity by 2012, which suggests that the Bush administration’s
target requires merely a continuation of the historical decline in
the energy intensity of the American economy plus a modest effort.
In any case, absolute emissions will continue to grow; under the
assumptions used by the administration, U.S. emissions would rise
by 14 percent between 2002 and 2012. (The target agreed upon by the
United States under the Kyoto protocol was minus 7 percent between
1990 and 2010.)

The U.S. rejection of Kyoto reflects inter alia a deeply
rooted allergy toward the idea of quantitative mandatory
commitments enforced at the international level – a view not
limited to the current administration. It would be hopeless and
counterproductive to suggest that the United States should return
to the protocol. But the G-8 Leaders should encourage the United
States – the largest single emitter of GHG, one of the highest per
capita emitters, and one of the richest economies in the world – to
adopt a more radical approach to combating climate change. Russia
should also be encouraged to sign the Kyoto protocol.

The Bush administration strategy includes a substantial
financial effort in R&D, including in low-carbon technologies
like renewable energy and carbon sequestration technologies.
Technological breakthroughs in the energy and transportation
sectors will clearly be needed to tackle effectively this global
problem. Hence the “Kyoto countries,” especially Europe and Japan,
should endorse more aggressively the R&D effort led by the
United States and contribute more to it themselves. But both the
development and the commercialization of new technologies require a
strong and lasting price signal: each ton of carbon emitted should
be priced to guide the choices of economic agents.

The U.S. stance is not the only problem. Developing countries,
especially the bigger ones, will account for most of the growth in
emissions in the coming decades. They have made clear, however,
that they will not accept constraints on their economic growth
potential to deal with an issue that the rich countries’ economic
growth has created over the past century. Beyond Kyoto, new
approaches are therefore needed to engage the developing world in
the global effort to reduce GHG emissions. Possible avenues include
rethinking emissions targets, supporting low-carbon technology
transfers, greening development assistance, and creating incentives
to adopt the least carbon-intensive growth path.

Climate change is only one of many global environmental problems
that will require stronger international regimes. We suggested the
creation of a Global Environmental Organization in our 2001 report.
We continue to believe that this would be an appropriate means of
strengthening the governance of the world’s environment and suggest
that G-8 discussion of such a new structure would be useful.

North-South Issues

Underdevelopment remains a major challenge to be faced by the
G-8. Persistent political instability, together with situations of
extreme poverty in several parts of the developing world, pose a
serious threat to global stability as they may lead to the
emergence of vast zones of lawlessness and undermine the stability
of the international system. The ongoing debate about the new aid
architecture, and the ways to make development assistance more
effective, should thus continue to rank high on the G-8 agenda.

Debt remains a major burden for many developing countries. The
HIPC initiative, jointly launched by the IMF and the World Bank in
1996, was intended to be a comprehensive solution to unsustainable
debt with an emphasis on multilateral debt. The initial HIPC
initiative was modified in 1999, under public pressure, to make it
more effective and to place debt relief within an overall framework
of poverty reduction.

Despite the shortcomings of the HIPC initiative, the most
realistic approach is probably to support improvements in the
enhanced framework rather than call for a replacement of the
current plan. We would repeat four suggestions made in our report a
year ago:

* limit the annual debt service of any qualified HIPC to
2 percent of its GDP;

* expand coverage to all poor countries, including
several larger ones (especially Indonesia, Nigeria and
Pakistan);

* create a contingency fund that would safeguard HIPC
debt servicing capabilities from natural disasters and changes in
eligible countries’ export prices; and

* fund relief of debts to the IMF and some of these other
costs, especially the contingency fund, by using up to $10 billion
of IMF gold.

In addition, the G-8 should agree that HIPC debt relief will not
be deducted from traditional development assistance (from both
bilateral and multilateral donors).

Nepad

The pursuit of development goals is of course not the exclusive
responsibility of rich countries. It implies crucial efforts at
good governance from developing countries, as recognized in the
NEPAD initiative. As already underscored in our report of last
year, this initiative, launched by African countries themselves for
the first time in history, should receive strong but not
unconditional support from the G-8.

The NEPAD is already facing enormous difficulties, making the
scheme extremely fragile. Recent developments in Africa necessarily
raise doubts about its chances of success. The situations in
Zimbabwe and in C?te d’Ivoire, and the lack of constructive
reactions on the part of neighboring countries, suggest that the
prospects for the implementation of good governance and sound
economic policies are rather bleak and that the effectiveness of
peer pressure is badly wanted. African solidarity with President
Mugabe is clearly incompatible with the NEPAD commitment to
critical self-evaluation and should be forcefully denounced.

The Management Of Globalization

There are widespread perceptions, however, that the process of
global integration is both outside control by responsible
authorities and unfair to the poor. This message, which has been
widely repeated especially since the late 1990s, has received even
more credibility after the bursting of the bubble of the New
Economy and the doubts raised about corporate governance in various
countries. The perceptions are largely based on flawed arguments
but governments also have a responsibility for failing to
effectively counter their spread. In order to counter the distrust
of globalization in the general population, governments from the
G-8 should deliver a much clearer message about their assessment of
globalization and design more adequate policies to both address the
challenges of increased global competition and to achieve a wider
spread of the benefits of globalization.

In addition, many analyses have underlined the techno-economic
dynamics of globalization and governments have often reinforced the
perception that globalization is a compelling trend that is out of
their control. International markets and globalization have indeed
often become easy scapegoats for governments looking to excuse
their own failures or shortcomings. The G-8 has sometimes
contributed to the problem by suggesting that it, and its member
governments, are impotent in the face of global capital flows.

Poverty Reduction

Since the 1980s, a number of developing countries, in particular
China and India, but also more recently smaller poor countries such
as Vietnam, have been experiencing sustained growth and rising
living standards. At the global level, these remarkable experiences
have resulted in a substantial reduction in absolute poverty and
lower inequalities between the populations of developing countries
and populations of richer countries. Results based on the
observation of life expectancy and malnutrition also show that the
situation of hundreds of millions of poor people has become less
difficult over the last decades.

These positive results are unevenly spread among poor countries,
however, and absolute poverty is now more concentrated in Africa.
The situation there is worsening, and life expectancy is falling in
the countries stricken by AIDS. These facts, along with the
increasing demand for equality in the context of globalization,
should nevertheless not make us forget the positive dynamics of the
process.

Domestic policies in rich countries can also contribute by
reducing protectionism, which hampers exports from poor countries,
especially in agriculture and textiles. Trade issues, which are
being discussed as part of the Doha development round, are also
addressed above but it is important to underscore the role of
domestic policies in facilitating liberalization.

The G-8 And Global Leadership

In recent years, the legitimacy of the global governance regime
has been questioned in many quarters. Much has been said, for
example, about the “non-democratic” character of the international
economic institutions with a focus on the WTO, the World Bank and
the IMF. As a consequence, these institutions have made efforts to
become more open to NGOs and to take care of the specific problems
that representatives from the poor countries face to participate
fully in their meetings and negotiations. The G-8 should recognize
the growing role of civil society in the building up of global
governance and encourage the search for innovative mechanisms aimed
at introducing the voice of representative groups into policy
deliberations, particularly in the multilateral institutions.

A related issue is the role of global summits in the provision
of leadership and the definition of the group of Leaders who
participate in these summits. Collective action is necessary both
to avoid damaging beggar-thy-neighbor policies and to provide for
global collective goods such as peace and stability, rules-based
frameworks for international trade and finance, and environmental
preservation.

The G-8 has contributed to the building up of more collective
action since the 1970s but faces a crucial dilemma in the context
of globalization. Collective action between more than 150 countries
cannot be organized without a smaller group providing guidance and
leadership. Given its weight in world economic, financial and
military affairs, the G-8 is the obvious locus to do so and has
technical legitimacy. At the same time, the G-8 represents the
interests of the largest and richest countries, and will not appear
politically legitimate to other countries or to civil society
groups. This is compounded with the growing perception around the
world that G-8 governments are failing to reach cooperative
solutions to some of the world’s most pressing economic, social,
and environmental problems – especially by failing to deal with
major problems within their own borders, as stressed at the outset
of this report.

The answer to this issue of leadership, and the need to build
consensus among a relatively large group of countries, can be
twofold. First, the G-8 should focus on generating collective
action among its own members to deal with problems internal to the
group, as laid out in the previous section on the world economy.
Second, on broader global issues, the G-8 should aim at providing
impulses and building effective coalitions rather than at imposing
the preferences of its member countries. This should prove less
difficult if the G-8 has fruitful consultations with a number of
developing countries, including the poorest. In this perspective,
the G-8 could seek broader participation in its own meetings in
order to anchor its political leadership in a more legitimate
structure.

Since 2000, host countries of the G-8 meetings have in fact
tried different ad hoc mechanisms for consulting the leaders of
some developing countries. These exercises have had to deal with
the central issue of the selection criteria to choose the countries
which should be included, an issue addressed in the 2001 edition of
this group’s report to the Leaders of the G-8 member countries.
There we suggested the criterion of “systemic significance” for
inclusion in the process and noted that this principle is used to
organize the G-20 meetings of finance ministers and central bank
governors. Hence we proposed that the G-8 invite additional
countries that are members of the G-20 to join it at periodic
summits, and we repeat that proposal here with a specific call for
that process to begin at Evian.

Such a criterion, however, does not allow for the participation
of the poorest countries. The last two G-8 summits, at Genoa and
Kananaskis, have addressed this need by inviting the five African
leaders chosen by their counterparts to represent the NEPAD
process. We believe that this group, perhaps along with one or two
other of the poorest countries, should be added to the G-20 to
provide a fully representative group that would greatly enhance
both the effectiveness and legitimacy of the G-8 in carrying
forward the proposals made in this report.

An Action Program For Evian

The G-8 must substantially reform its own activities. Its
members must be willing to candidly address the problems of their
G-8 partners and thus have their own problems addressed as well.
This is the only means by which the group can deal effectively with
the most pressing issues now facing the world economy. Doing so
would also help restore legitimacy to the G-8 as an
institution.

The G-8 would then be far more able to help resolve “out of
area” problems in the rest of the world. This leadership function
is highly desirable, indeed essential, but cannot be carried out
unless the G-8’s members are putting their own houses in order and
devising collective action programs to do so by moving together.
They should thus seek to construct, and subsequently implement,
such a program for Evian. The elements of such a program are
clear:

* reform of domestic economic policies, at both the macro
and micro levels and over both the shorter and longer runs, as
described above for Japan, Europe and the United States to
strengthen the prospects for renewed and sustained global economic
growth;

* major new trade initiatives, especially in agriculture
and to eliminate all industrial tariffs by a date certain, but also
to limit the risks to the global trading system of the
proliferation of new bilateral and regional arrangements, to assure
a successful WTO Ministerial Conference at Canc?n and provide
needed impetus for the Doha round;

* new initiatives in the energy and environmental areas,
especially by the United States but hopefully also by a number of
other G-20 (including developing) countries, to strengthen
international energy security and reduce the risks of further
environmental degradation (especially global warming);

* additional improvements in debt relief, the provision
of foreign assistance, and especially trade policies toward the
poorer countries to enhance their development prospects; and

* a series of steps, both substantive and procedural, to
counter the critics of globalization (1) by expanding public
understanding around the world of the benefits of that phenomenon;
(2) through the adoption of domestic policies that will more
efficiently counter its adverse transitional effects on some groups
and indeed expand the opportunities for all sectors of our
societies to take advantage of globalization even if they may now
feel that they are being victimized by it; and (3) to “democratize
the G-8” itself by inviting the rest of the G-20, along with the
designated representatives of the NEPAD process, to meet with them
at Evian and periodically thereafter.

A wide-ranging program of this type would generate substantial
benefits for all G-8 member countries (and for the world as a
whole).

Members of the g-8 preparatory conference

C. Fred Bergsten, Co-chair, Institute for
International Economics; Leon Brittan, UBS Warburg; John Chipman,
International Institute for Strategic Studies; Richard N. Cooper,
Harvard University; Wendy Dobson, Institute for International
Business, University of Toronto; Bill Emmott, The Economist; Boris
Fedorov, Former Minister of Finance, Russia; David Folkerts-Landau,
Deutsche Bank; Yoichi Funabashi, Asahi Shimbun; Paolo Guerrieri,
Istituto Affari Internazionali; Toyoo Gyohten, Institute for
International Monetary Affairs, Tokyo; Karl Kaiser, German Council
on Foreign Relations; Sergei Karaganov, Council on Foreign and
Defense Policy, Russia; Henry A. Kissinger, Former Secretary of
State; Barbara McDougall, Co-chair, Canadian Institute of
International Affairs; Patrick Messerlin, Groupe d’Economie
Mondiale de Sciences Politiques; Thierry de Montbrial, Institut
Francais des Relations Internationales; Joseph Nye, Jr., Harvard
University; Richard Portes, Centre for Economic Policy Research;
Renato Ruggiero, Former Minister of Foreign Affairs, Italy; Paul
Volcker, Former Chairman of the Federal Reserve Board.