BRUSSELS—Yes, “Europe will be the focus of the Cannes Summit.” Although anticipated, the blunt statement from European Commission President Barroso and European Council President Van Rompuy seemed both redundant and inspiring. Redundant, because a €1 trillion commitment needs implementation and global coordination that only the G20 can offer. Inspiring, because this crisis serves as the needed impetus to drive collective aspirations by the G20 for attaining sustainable growth.

Reflecting on the goals of the French presidency of the G20 and its original ambition, however, one wonders about the fate of other crucial issues, such as the reform of international financial institutions (IFIs), food security, and international development.

The past two summits demonstrated near irreconcilable disagreements between main players on long-standing agenda items ranging from addressing financial regulatory reform, to tackling macroeconomic imbalances and the way forward for multilateral trade. Finding agreement on issues involving structural adjustments is by no means a short order. But measurable progress on items long identified as a priority by the G20 is inherently related to the group’s shelf-life and its ability to move from a temporary crisis-fighting mechanism to an enduring forum capable of shoring up market confidence and providing political leadership and vision to tackle global economic challenges.

Deliberation over the crisis du jour in Toronto and Seoul threatened to hijack both of those carefully laid out summit agendas. “Stimulus vs. austerity” debates prior to the Toronto summit sidelined anticipated agenda items related to the reform of IFI governance structures and a global bank tax, and competitive devaluation of currencies brought “currency wars” to the forefront of discussions in Korea. This is a trend that observers predict will continue in Cannes as leaders continue to grapple with implications of the euro rescue fund and the unexpected announcement of a Greek referendum on last week’s agreement.

Although Europeans used the argument of a possible hijacking of the G20 summit to raise the stakes of sealing a deal on the Eurozone’s rescue fund, given the rap sheet of previous summits, there is little doubt that this will be the case from the start. French diplomats even warned against the possible “cannibalization” of Cannes.

In anticipation, President Obama has announced that he will meet Chancellor Merkel and President Sarkozy, chair of the G20, bilaterally. Yet, at a time when Europe is calling on the rest of the world to contribute to the recovery of its economy for the preservation of global wealth, the French president is scheduled to meet with the Chinese president first, the U.S. president second. Cannes’ focus may be Europe, but Europe’s focus in Cannes will be the rest of the world.

After consecutive summits with subpar performances, the G20 is past due to repeat the early successes of delivering on its commitments. The creation of the Financial Stability Board (FSB), raising the IMF’s lending resources, and boosting the capital base of MDBs and the IMF by $1.1 trillion demonstrated concrete results. This first propelled the G20, ahead of its institutional competitors, to prominence as the much proclaimed post-modern vehicle for getting things done. But without tangible results, pledges for taking coordinated action on long-standing agenda items are in danger of falling on deaf ears, and will continue to harm the G20’s credibility.

Naturally, the forum should and will continue to serve as a platform to address pressing crises . However, Cannes provides an opportunity for the G20 to go one step further. By striking a delicate balance between devoting time to short-term imperatives, i.e the eurozone crisis, and exhibiting strategic foresight in making strides toward implementing previously identified commitments, such as bolstering the authority of the FSB, injecting political leverage into the reform efforts of IFIs, and promoting its development agenda, the G20 will continue to build its credibility.

While its current informality is the source of its flexibility, the G20 needs to find a way to address short-term shocks without sacrificing its capacity to deliver on its standing commitments. And despite the creation of the troika of hosts, instituting a mechanism to ensure the smooth transition of working groups and structures from one host-country to the next may facilitate the process of sticking to its check-list by prioritizing pledges.

Michael Froman is right when saying that the G20 has been promoted to become the leading forum to review challenges facing the global economy. But in any era of “messy multilateralism,” as characterized by Richard Haass, establishing its reputation as an effective and legitimate body that is capable of achieving results by transcending divides between established and emerging economic actors hinges on the group’s ability to start thinking and acting in the long term.

In an ironic way, it’s a conundrum Europe has been facing in building its economic and monetary union for the past 30 years…

Guillaume Xavier-Bender is a Program Associate with the Economic Policy Program of the German Marshall Fund in Brussels. Roman Balin is a Program Coordinator for the German Marshall Fund’s Immigration and Migration Program in Washington, DC.

BRUSSELS — Any banking system relies on its depositors retaining their faith in the soundness of their banks. Investors have traditionally regarded government bonds as a relatively low interest, but safe place to park their funds. And voters have trusted their governments to deal competently with complex financial questions.

What happens when these components of trust and confidence suddenly erode? A Euro crisis results.

The crisis began, of course, in a quite different way, as the combination of heavy losses on sub-prime mortgages and runaway trading in financial derivatives led to a banking crisis, and a credit crunch which impacted very quickly on the real economy, threatening a major recession. Western governments reacted (except in Iceland) by rescuing the threatened banks to avoid a system collapse and pumping money into their economies in a bid to avoid recession. These measures were successful. But the price paid was considerable.

In Europe the budget deficits which resulted from these measures have resulted in several member states of the Euro reaching accumulated debts around or beyond the limits which markets believe they will be able to sustain. At that point these countries find that the interest rates they need to pay to finance their debts rise, so their budget expenditure on debt servicing rises, and they have to reduce other expenditure or raise taxes as a result. Either way, these deflationary measures (often labelled “austerity”) reduce economic growth, tax revenues decline, and a vicious circle sets in.

This has happened in Europe in Ireland, in Portugal, and in Greece. In the similar case of the United Kingdom the pound sterling was allowed to devalue to provide an offsetting stimulus to growth. This option was however not available to the countries concerned, as they are locked into the common currency of the Euro, together with countries such as Germany, France or the Netherlands, which are strong enough not to be suspected of defaulting on their loans. In fact they were bailed out by the other Eurozone countries, who took over responsibility for their debts through the EFSF, the European Financial Stability Facility.

The proximate cause of the newly acute phase of the crisis which was addressed at the European Summit, which took place this week on Sunday and Wednesday, was two new developments.

First, it became clear that Greece was still caught in a downward spiral. Even savage austerity measures were not succeeding in reducing levels of Greek debt, they had induced the onset of a severe recession, there were signs of the beginning of a run on the banks, and there were serious doubts about whether the Greek government would survive in the face of mounting protests.  A default seemed imminent. This would have created immediate problems for European banks holding Greek bonds, particularly in France, Spain and Italy.

Second, it became clear that the markets had detected that overall debt levels in Italy were too high, and that the weak government under Prime Minister Berlusconi seemed unable to take the necessary measures to reduce its budget deficit and revive economic growth through reforms. The interest rates on its debt rose rapidly. And the EFSF is nothing like large enough to be able to bail it out. For Greece, yes: for Italy, no.

It was in this situation that European leaders came up with a crisis package at 4 o’clock in the morning on Thursday. It contains three main elements:

• European banks have agreed to accept an arrangement through which they agree to swap their holdings of Greek government bonds for bonds worth only 50% of their face value. This “haircut” will considerably reduce the size of the accumulated Greek debts.
• European banks will increase their capital ratios by next June to 9% of total assets, in order to be equipped to deal with any future bad debts
• The EFSF , currently with size of €440 bn will be “leveraged” to be able to provide assistance up to €1 trillion

In addition the summit received a commitment from President Berlusconi to push through a series of economic reform measures in Italy.

Will this package be sufficient to stem the crisis? Will it restore confidence in the markets about the solidity of European banks and the credit-worthiness of European governments?

First signals from the markets are very positive. And the best judgement may well be that of President Obama in today’s Financial Times; “This week, our European allies made important progress on a strategy to restore confidence in European financial markets, laying a critical foundation on which to build.”

In other words, the foundation for renewed confidence is now there, but much work remains to be done. The details of all parts of the package need to be worked out and implemented, Italy needs to deliver on its promises (which may well require a change of government in the near future), the Greek economy needs to begin to recover and its citizens to recover their faith in the future. And elsewhere in Europe skeletons may still be lurking in closets.

But there are grounds for optimism:

• The leaders of the Eurozone have demonstrated that they will take the necessary measures to deal with a threat to any of its countries and not allow them to leave the euro.
• In Germany, which needs to stump up the lion’s share of any financial assistance packages, there is now a broad consensus that it is in the country’s national interest to ensure that the euro is stabilised. This is new.
• There is now greatly heightened awareness that governments must focus on budget discipline and on reforms for growth and not take their eyes off the ball.
• One little noticed element of the banking measures is that the banks will not pay boni until they have achieved their capital ratio targets. This may well go a long way to reconciling citizens with austerity measures.
• The European Task Force helping the Greek government to implement its reforms received the full support of the Summit.

The outlook for a company, which does business throughout Europe, is thus better now than it was last week. The political will to stabilise the euro, and thus to safeguard the Single Market seems indeed to be there. If market confidence is gradually restored,  the stage will be set for growth to gradually recover.

Washington – In yet another sign of the eurozone members’ inability to stem their regional financial crisis, last week Standard and Poor’s downgraded Spain’s credit rating to AA-. This move has raised new fears about the ability of beleaguered European nations to pay their sovereign debts. And it has revived calls for expanding the International Monetary Fund’s lending capacity to backstop eurozone members. IMF Managing Director Christine Lagarde has argued that the Fund’s readily available war chest of $390 billion would run short should the crisis worsen. Additional resources, perhaps as much as $350 billion, may be needed for precautionary lending to Spain and Italy alone.

This extra arsenal would raise the Fund’s profile further in Europe, where, since early 2010, it has provided a third of the multibillion euro rescues for Greece, Portugal, and Ireland. Such a move would follow the tripling of the IMF’s lending power to $750 billion in 2009. It would also be more modest than then-Managing Director Dominique Strauss-Kahn’s proposal to supersize the Fund by increasing its firepower to $2 trillion.

But key IMF members are balking at increasing the institution’s resources. In mid-October, the G20 finance ministers rejected a proposal to make permanent a special $590 billion pool of Fund resources, which would have raised total lending power to a record $1.3 trillion.

The politics are thorny. The BRICS – Brazil, Russia, India, China, and South Africa – are the main proponents of a funding increase, in part for economic reasons. Despite forecasts by many bullish analysts, emerging markets have not created a new global “supercycle” of widespread growth and prosperity. Instead of becoming decoupled from the advanced economies, emerging economies find themselves held hostage to the transatlantic economic morass. Short of inflationary domestic stimulus, they see in the IMF the best lever to get Europe back on track, reviving global growth and their own economic fortunes.

However, the United States, the United Kingdom, Canada, Japan, and Australia are queasy about ponying up more money, calling instead on Europeans to fix their own problems. U.S. Treasury Secretary Timothy Geithner raised eyebrows recently by calling for the debt-laden Europeans to find their own resources to stimulate their economies.

The Obama administration was the main proponent of expanding the Fund two years ago. But the White House now finds itself up against the U.S. Congress, where resistance to bailouts has only grown since the 1990s large-scale rescues of Mexico and Asian emerging markets. Opposition is reaching a fever pitch as U.S. public debt peaks and many think it is Main Street America, not European welfare states, that should be bailed out.

Overcoming French concerns about U.S. influence via the Fund in Europe, Germany last year demanded the IMF co-manage the eurozone rescues and help design and enforce loan conditions that Europeans would hesitate to prescribe to each other. Berlin, however, worries that a larger Fund would risk moral hazard, encouraging fiscal profligacy in Europe and beyond.

Europe and the United States also agonize over the clout that a larger Fund could lend the BRICS, who would likely foot a large portion of the bill and would then demand more say in how it was used.

But the prolonged crisis casts a dark cloud on the world economy, and Eurozone has proven inept at managing it. Further external pressure would unlikely yield a positive, market-moving policy response. What should be done?

There is a middle ground between the options of no new resources for the IMF and a supersized IMF. One such option would be for the Fund to systematically leverage the financial reserves of emerging markets and sovereign wealth funds. Another would be to allow individual countries, such as China, to make ad hoc loans to the Fund or to contribute to a Fund-managed temporary special-purpose lending facility dedicated to halting the euro crisis.

Provided the response actually worked, all parties would benefit. Europeans would at last be freed to focus on long-term growth and fiscal targets. For the United States, a robust response would halt a crisis that now fuels fears in the transatlantic financial market and hobbles consumer demand in a leading trading partner, contributing to America’s jobless nonrecovery. It could also give the United States, the Fund’s largest shareholder, greater say in Europe, and be at least somewhat more palatable to Congress than a supersized IMF. Emerging markets would enjoy greater leverage in global affairs they covet.

For the IMF, the extra arsenal could pave the way to an exit from a crisis where its success currently depends on intractable regional politics.

Doing nothing is not an option. Policy uncertainty is poison to financial markets, and decisions must be made at the European Summit this weekend and the G20 Summit on 3-4 November in Paris.

The Fund’s engagement in regional crises makes perfect sense. The Eurozone crisis has painfully revealed the political limits to regional crisis management. Asians or Latin Americans would unlikely be much better at collective action. And the Fund’s technical expertise and its global experience are unrivalled. How to best raise money to handle contagious 21st century crises will take much more creative thinking.

Kati Suominen is Resident Fellow in the Economics Program of the German Marshall Fund of the United States in Washington.

Image by the European Commission.

WASHINGTON — Civil unrest is breaking out on both sides of the Atlantic. This year, Greek protestors took to the streets in resistance to government austerity measures. Riots broke out in London neighborhoods in response to cutbacks in government services and rising unemployment. Now Americans are camping out in city centers across the country, following the example of disgruntled citizens who decided the best way to be heard was to physically occupy Wall Street. Although some in the media dismiss this movement as simply an assembly of grumpy leftists angry at the inequities of capitalism, the fact that the Occupy Wall Street movement has spread so rapidly to far-flung towns reveals that it has touched a deep nerve in U.S. society.

Recent surveys show that over 70 percent of Americans think the country is headed in the wrong direction. This year, for the first time, a majority of Americans say they believe their kids’ generation will be worse off than they are. Given the United States’ precarious economic situation, the popularity of any movement based on anger over economic weakness comes as no surprise. Perhaps more interesting is that the Occupy Wall Street movement, at just under a month old, seems rooted more in a sense of civil unfairness than simply anger at unemployment. Though they have yet to settle on a single coherent message, the “occupiers” seem to share a common anger at what they see as a deep unfairness in U.S. economics and politics that has its root in the preferential access to political power enjoyed by the wealthiest Americans.

Occupiers call themselves the 99 percent, and focus on the divide between the United States’ wealthiest 1 percent and the rest of society. The message resonates with working class Americans because so many share the view that, since the economy crashed, most Americans are suffering while the wealthiest are protected with bailouts and preferential tax treatment. The Wall Street symbolism works because the big bankers got saved while everyone else feels the pain. It is this deep sense of unfairness that attracts large numbers of new occupiers and gives the movement potential to become a serious political force. The dynamics feeding this populism will only strengthen as Congress struggles to tackle the mounting government debt. Middle class Americans feel detached from that debate, despite the fact that its outcome will affect their job prospects and the education of their children. They fear any debt resolution will only benefit powerful interest groups.

Many are asking if the Occupy Wall Street movement is the left’s equivalent of the Tea Party. Despite the quirky libertarian and anarchist views of some protesters, there is real commonality between the factors that led to the rise of the Tea Party as a national movement and “Occupy” activists. Both were built on a deep sense of unfairness resulting from the bank bailouts initiated in 2008. Both have attracted extreme partisan elements but also appeal to a broad group of politically independent Americans seeking an outlet for frustration over continued high joblessness. The difference is that while the Tea Party focuses on reducing the size of government, the “Occupy” movement is focused on a perception that the pain of recession is not evenly spread due to unequal access to government.

Whether the Occupy Wall Street movement will have an impact on the presidential and Congressional 2012 elections similar to the strong impact the Tea Party had on Congressional elections in 2010 depends on whether one political party can align its core message with the basic sentiments of the occupiers. The Democrats are moving quickly in that direction, asking party members to sign petitions declaring their solidarity with the Occupy Wall Street movement. President Obama’s theme of asking the richest Americans to “pay their fair share” to fund his jobs bill overlaps with the occupiers chief concern. On the other side of the political spectrum, Republican presidential candidates Mitt Romney and Herman Cain were quick to denounce the movement as “dangerous” and “anti-capitalist,” respectively. Romney’s subsequent shift to more sympathetic rhetoric indicates his realization of the movement’s potential to be either a very powerful ally or a problem for a presidential contender. Indeed, the best approach for Republicans will be to attempt to direct the occupiers’ anger about all things economic at the current President, in the hopes of solidifying blame against Obama, building momentum to ouster him.

Though the Occupy Wall Street movement has the potential to be a political force shaping the 2012 presidential election, it does not promise to move the United States closer to resolving its core challenges, either economic or political. The movement has tapped into a very deep and real sense of unfairness in U.S. society, but proposes no solution. If the Democratic Party can channel that sense of inequity into momentum for their candidates in 2012, it could have an electoral impact. But without a central political priority, like investment in preparing America’s kids for success in the new economy or promoting infrastructure development, the occupiers’ energetic involvement in the political process will not produce a mandate for how to deal with the United States’ economic weakness and debt. That spells more polarization and less compromise. That also seems to be the trap both Americans and Europeans find themselves in — popular anger over what’s wrong but no consensus on how to solve it.

Glenn Nye is a Senior Transatlantic Fellow at the German Marshall Fund.

Image by Jens Schott Knudsen

WASHINGTON—Despite economic worries and domestic political preoccupations, perceptions in the United States and Europe of each other appear to be in better shape now than they were during the presidency of George W. Bush. Americans and Europeans have generally favorable opinions of one another and majorities on both continents believe they share enough common values to be able to cooperate effectively on international problems.

But this year’s annual Transatlantic Trends survey also finds that while many of those polled in 12 member states of the European Union (Bulgaria, France, Germany, Italy, the Netherlands, Poland, Portugal, Romania, Slovakia, Spain, Sweden, and the United Kingdom) still believe the United States is most important for their national interests, Americans see Asia as important. When asked which was more important in terms of their country’s national interests in the most recent Transatlantic Trends survey, 52% of those polled in the European Union picked the United States over the countries of Asia such as China, Japan, and South Korea, while about 51% of Americans polled chose the countries of Asia over the European Union.

For several years, policymakers on both sides of the Atlantic have been speculating on how the transatlantic community will react to the rise of Asia. Would Asian competition move the United States and Europe — currently the two largest economic centers — closer together or pull them apart? At a time when U.S. unemployment remains high, the eurozone continues to suffer, and China’s growth is over 9%, this question is timelier than ever. Based on the results of this year’s Transatlantic Trends, it seems Americans have made up their minds to orient toward the Orient.

Asia is especially important in the minds of young Americans. Around three-in-four Americans between the ages of 18 and 24 feel that Asia is the more important region for U.S. national interests. With each older age cohort, the importance of Asia decreases, so that only about one-in-three Americans over 64 think of Asia as the more important region for U.S. national interests. Younger Americans are also more likely to see China as an economic opportunity rather than as an economic threat. Fifty-two percent of those aged 18-24 consider China an economic opportunity for new markets and investments, while 72% of those between the ages of 55 and 64 see China as threatening their jobs and economic security. Similarly, more than half of Americans older than 54 perceive China as a military threat, but only one-third of those between the ages of 25 and 34 and 40% of those younger than 25 do.

The rise of Asia divides Europeans too — but by nationality rather than by age. While over half of those polled in Italy, Romania, Germany, Britain, and Poland name the United States as more important than Asia, half of those surveyed in France and more than half of the respondents in Spain and Sweden see Asia as more important for their national interests. Europeans are also more likely than Americans in general to see China as an economic opportunity. The majority of Germans, Dutch, Romanians, Swedes, and British see China as an opportunity. On the other hand, majorities in France and Portugal still see China as an economic threat, though their numbers have decreased over the past year

What does all of this mean? Although Barack Obama rehabilitated the image of the United States in Europe, Europe has so far failed to reinvigorate its image in the United States, particularly among younger Americans who do not necessarily have strong links to European ancestry or positive memories of Cold War-era alliances. For transatlantic relations to thrive in the future, Europe needs to do a lot more to capture the imagination of a new generation of Americans.

Zsolt Nyiri is Director of Transatlantic Trends at the German Marshall Fund of the United States in Washington.

By Mark Allegrini and Kate Ritterspach

This summer, the issue of food security in sub-Saharan Africa has been thrown into cruelly sharp focus. The United Nations reports that over 3 million Somalis (almost half the country’s population) are in need of food aid, and the U.S. Agency for International Development claims that over 12 million people in the eastern Horn of Africa are in need of immediate food, water or medical assistance. Last month the U.N. declared an official famine in two regions of Somalia, and recent U.S. statistics indicate that nearly 30,000 children under the age of five have already died.

Hunger in Africa is a daily reality for many across the continent, though it rarely makes headlines. The current situation in the Horn of Africa is, to be sure, a particularly dramatic case, with several of its own peculiarities. The current famine was triggered by a severe drought that affected the whole of eastern Africa. Somalia, where the official famine has been declared, is essentially a failed state, and long-standing armed conflict and militant control over some areas of the country exacerbate the effects of the drought and make delivery of essential food aid much more difficult.

However, some of the food crisis’ other contributing factors are more structural, and are not unique to one region or one dry season. Drought, while potentially devastating to farmers around the world, does not automatically produce food shortages or famine. But a basic and crippling problem in many parts of Africa is the lack of reliable, fully functioning food systems. This includes the lack of technology required to protect crops and maximize yields, and, just as crucially, the lack of infrastructure necessary to harvest, store, process, transport, and ship food locally, regionally, and internationally.

Since 2009, major donors have devoted significant attention and funds to agriculture and food security. Encouragingly, there is widespread recognition that real food security requires a holistic, value chain approach. Ultimately, for donors this means a shift away from business as usual, where large sums of money are allocated and spent largely by the donors themselves on isolated projects. The imperative of transatlantic budget austerity has added to the urgency of doing things differently. Donors must leverage the skills and financial resources of other donors, host countries, regional institutions, civil society and businesses. They can no longer go it alone.

Actually implementing this new approach, however, has proven to be a difficult task.  While high-level donor dialogues have produced commitments to coordination and a more holistic approach, there remain large gaps on the ground.  In many cases, donors’ focus on decreasing the number of countries and sectors receiving funds and attention for the sake of efficiency and specialization (“selectivity,” in the development vernacular) has not been accompanied by the necessary increase in coordination.  In order to achieve development goals in a time of smaller budgets and greater need, a focus on partnerships is a good place to start.

While one could characterize most donor programs as partnerships between the donor and host country, it has become essential to look beyond this traditional dyad toward ways to leverage other funding sources.  Generally speaking, the private sector is best suited to create economic growth. Functioning food systems are, of course, ultimately built and operated by business. Therefore, a key part of a donors’ role in ensuring food security should be helping to create a friendly and stable investment climate.  In the context of food security, donors need to bring in both the private sector and civil society to determine where investment can have the most catalytic effect. Once this is determined (for example, in Tanzania a study found that investments in food processing have a higher multiplier effect than those in any other sector), donors and businesses must come to an agreement about the right balance of resources and roles to make investments scalable and sustainable.

While partnerships with the private sector and coordination amongst donors are not new concepts, they have become increasingly important given today’s political and economic realities. To be successful, donors need to find better ways to coordinate and leverage existing sources of funding at all levels.  Country-led plans such as the Comprehensive Africa Agriculture Development Program (CAADP) and the Feed the Future Initiative represent a good first step toward this approach.  Coordinating directly with a country on its own priorities, as in CAADP, and having a clear set of goals and mechanisms, as outlined in the Feed the Future Initiative, create a transparent platform for high-level donor dialogues.  The United States and European Union have gone so far as to identify priority countries that will be the focus of increased efforts at coordination.  However, while much of this work has begun at the highest levels, these are two programs where change will require a renewed focus on ground-level action and partnerships.

There are many instances where ground-level focus has yielded real development results.  Much of the work left to be done lies in identifying, scaling, and duplicating the successes that have already been achieved while getting past those projects that have failed to achieve real results.  It is all too apparent that some partnerships exist more on paper than in reality, and in a time of increased constraints, donors should not shy away from distinguishing success from failure and concentrating resources. Successful partnerships with host countries, civil society, and business need to be recognized and repeated; those that have not been successful need to be honestly acknowledged and left behind.

The German Marshall Fund is supporting a Transatlantic Experts Group to examine successful and failed food security partnerships in east Africa, with the goal of transmitting best practices and policy recommendations to transatlantic and African policymakers and other stakeholders in early 2012. The group will look beyond high-level commitments to partnerships in practice on the ground, and will work to provide an honest view of what works and what doesn’t.

Even aggressive action to increase coordination and focus on successful partnership models will not relieve the current crisis in the Horn of Africa. The current situation calls for intensive and immediate humanitarian relief. However, in order to minimize the likelihood of future famines and food emergencies, much remains to be done in creating the robust, functioning food value chains that so many in the developed world take for granted.

Mark Allegrini is a Program Officer and Kate Ritterspach a Research Assistant for GMF’s Economic Policy Program.

WASHINGTON — The world faces a near-perfect financial storm of unprecedented proportions. Europe and the United States face debt and deficit problems that are coming to a head at the same time, threatening to plunge both economies into recession.

There is a single unifying theme to this transatlantic crisis: a profound failure of economic governance on both sides of the Atlantic.

For Europe and the United States to get their fiscal houses in order, they must simultaneously fix the ways they tax and spend. Both America’s economic governance, with its roots in 18th century concepts of Congressional preeminence and federalism, and Europe’s unwieldy division of monetary and fiscal responsibility, barely a decade old, are not up to the challenges of a global economy driven by international capital markets that can mercilessly punish fiscal shortcomings.

The recent economic downturn exposed the fraudulence of the Greek government’s accounting, the lack of Portugal’s competitiveness, and the hollowness of Ireland’s real estate boom. Meanwhile, Washington’s spending to forestall a Depression pushed U.S. public debt to unsustainable levels.

Yet three years after this downward spiral began neither Europe nor the United States is on top of their problems. Greece faces almost inevitable default on its sovereign debt, with the danger it could pull down with it Portugal, French and German banks, and the euro. And America risks defaulting on its debt, raising the cost of credit for all Americans for years to come.

In the face of this crisis, European and American officials have repeatedly kicked the can down the road, putting off until tomorrow decisions that should have been made today. And they are likely to do so again this month.

When first faced with the Greek, Irish, and Portuguese debt problems, European leaders dragged their feet and then bought time with inadequate bailout packages. Debt restructuring and bank recapitalization to shore up the European financial system were postponed because they were too difficult. Now, facing new concerns about the solvency of Spain and Italy, Europe appears likely to take half measures that staunch the bleeding, but do not cure the patients.

Similarly, for several years Washington has faced a growing mismatch between spending and revenues. But as recently as last December’s budget agreement, the White House merely stitched together a compromise that delayed the day of reckoning. Now, facing the need to raise the national debt ceiling, Congress is scrambling to come up with a compromise that will simply get politicians past the next election, not create a framework for resolving the U.S. fiscal situation.

There is a dangerous mismatch between the need for both Washington and Brussels to make tough fiscal decisions and the needs of their economies.

The U.S. Constitution gives Congress the power to tax and to spend. But Congress frequently dodges that responsibility by failing to pass a budget. Rather, to demonstrate its symbolic commitment to fiscal forbearance, it has created a periodic vote to raise the national debt ceiling, which has needlessly created the current crisis. Moreover, the United States has heedlessly tied its hands in its search for new revenues. A national value-added tax, which would generate much-needed revenue, is off limits because in America’s federal system sales taxes are the jealous preserve of the states.

Europe created a single currency and a common monetary policy without a common fiscal policy to back it up. Without the power to tax or to raise money through the issuance of euro bonds, Brussels lacks the funds necessary to stabilize the European economy in a time of crisis or to fix the financial system by recapitalizing weak banks. It must resort to passing the hat among national governments, which has led to stopgap measures that fail to fix the underlying problems.

Both Europeans and Americans need to confront their economic governance problems head on.
A deal now under consideration in the U.S. Senate would give the president unprecedented ability to raise the debt ceiling, subject to Congressional disapproval, and would create a fast-track procedure for raising revenue and cutting spending. Both initiatives attempt to break the logjam on fiscal decision-making. But more is needed to bring revenues in line with spending, possibly including spending limits so successfully employed in Sweden and a European-style value-added tax.

Europe is inching toward some form of euro bonds and a collective oversight of the 27 member-country budgets. But the former must be more robust and the latter needs teeth if it is to be effective. The euro will never rival the dollar as long as Europe cannot issue securities comparable to U.S. Treasury bonds. And with Germany having added a balanced budget amendment to its constitution, much like 49 of the 50 U.S. states, Brussels desperately needs the counter-cyclical spending power Washington now enjoys.

Debt-ceiling fights and dangers of default make headlines. But they reflect underlying failures of economic governance that plague governments on both sides of the Atlantic. Until Washington and Brussels reform how they raise revenue and spend money, they are likely to continue to delay tough decision-making on fiscal policy, forestalling an immediate crisis while raising the likelihood of a cataclysmic perfect storm down the road.

Bruce Stokes is a Senior Transatlantic Fellow with the Economic Policy Program of the German Marshall Fund in Washington.

Photo by Orin Zebest.

WASHINGTON — With public finances in disarray following the financial crisis, recent political debate in Europe and the United States has focused on national debts. The ongoing crisis in the eurozone and daunting government deficits in the United States have added a sense of urgency. As the United States reaches its statutory debt ceiling and Europe seeks to prevent further debt crises, balanced-budget amendments, spending caps, and other debt-limiting proposals are under active consideration on both sides of the Atlantic.

Like Odysseus, who ordered his men to tie him to the mast so he could not be lured by the Sirens, some policymakers are proposing to tie themselves (and their successors) to stricter fiscal rules. The effectiveness of such proposals is being vigorously contested, with some seeing them as the only way to reign in growing deficits and others fearing the loss of legislative independence and needed fiscal policy tools in the future. The problem seems clear: if fiscal rules are introduced, they need to be strict enough to have an impact, but at the same time flexible enough not to limit future policymakers in times of economic downturn.

Proposals advocating strict and legally binding fiscal rules are not new. In the 1990s, in Europe, countries that entered the European Monetary Union agreed to the Stability and Growth Pact, which included a commitment to an annual budget deficit no higher than 3% of gross domestic product (GDP) and a national debt lower than 60% of GDP. Germany and France as well as a number of other countries have at different times broken these rules. In 2009, German political leaders went a step further in their attempts to “tie themselves to the mast” when the grand coalition introduced a “debt brake” into the German basic law. This constitutional amendment limits the federal structural deficit to 0.35% of GDP from 2016 on and does not allow the federal states to run any deficit at all after 2020. France and Spain have signaled an interest in adopting similar rules, but economists still disagree whether such stringent laws can be successfully exported.

Balanced-budget rules are not limited to Europe. In the United States, a vast majority of states have some variation of balanced-budget requirements. At the federal level, such measures have been introduced and discussed several times and have now, together with proposals on binding spending caps, resurfaced during the debate about the debt ceiling. The statutory debt limit itself differs from balanced-budget rules as it focuses on the overall debt and not annual deficits. But some members of Congress have signaled that they will only agree to raise the debt limit if a balanced-budget amendment is passed simultaneously. Others are demanding spending cuts as a prerequisite for their vote to increase the debt limit. The debt limit has thus become less of a fiscal rule and more of a political tool in a debate between liberals and conservatives over the role of government.

According to U.S. Treasury Secretary Timothy Geithner, the United States has nearly reached the current debt ceiling of $14.29 trillion but can extend it by implementing “extraordinary measures” until around August 2. There is little to no doubt among experts that raising the debt ceiling is economically necessary and will have to happen. Mark Zandi, chief economist at Moody’s Analytics, describes a failure to raise the debt ceiling as knocking out the cornerstone of the global financial system, namely “that the United States will make good on its debt payments.” Given that the debt limit has had to be raised ten times since 2001, political debates around the votes are not new and have previously been used by the opposition party to embarrass the administration. Then-senator Barack Obama himself voted against raising the ceiling in 2006, calling reaching the limit a “sign of leadership failure.” Still, today’s apparent determination on the part of some policymakers not to allow an increase under any circumstances makes the current situation more precarious. Despite the urgency of the situation, the debate about the debt ceiling has been merged with the broader political discussion about current and future U.S. budgetary policy. The debt ceiling is thus neither preventing the buildup of debt, nor helping to foster constructive policies.

Historically, most fiscal constraints have been circumvented and, in the end, proven to be ineffectual. Constitutional amendments, like the German “debt brake,” might prove to be more resilient, but, until they are tested during an economic downturn, this remains to be seen.  Either way, the economic wisdom of such amendments is doubtful. Finding solutions to the long-term challenges of public finances will require major political decisions, for example on the future design of social programs, levels of national security and public investment spending, and overall tax rates. These decisions will profoundly impact the future shape of societies and economies. They are inherently democratic choices. And budget rules will not produce sustainable and viable results without public engagement and understanding of what is at stake. Instead of passing the buck to future politicians (who may find ways to circumvent the rules), today’s policymakers and the public need to engage in a serious political debate about these issues now. Tying oneself (and future policymakers) to the mast of binding fiscal rules dodges tough decisions or abdicates the responsibility of actual political decision-making.

Peter Sparding is a Program Associate in the Economic Policy Program of the German Marshall Fund.

WASHINGTON — When the G20 finance ministers and heads of the central banks gather this weekend in Paris, attention will center on some of the major pledges made at the G20 Summit in Seoul—most notably the commitments related to a more market-determined exchange rate system and to policies to address current account imbalances, whether excessive deficits or large external surpluses. Likely to be added to the agenda are two newer issues: the role of the dollar as a reserve currency and controls on international capital flows.  All of these issues flow in part from the priorities that French President Nicholas Sarkozy set out for himself as leader of the G20 this year.

Substantial movement on these four issues is probably unlikely, given the big differences that emerged in Seoul with respect to the specifics underpinning a number of these general principles. However, buried in some of the devilish details of their weekend agenda is a proposal to create a new governance model for the international monetary system, which could potentially reap immediate results and carry with it long-term benefits.   France’s economy minister, Christine Lagarde, is expected to take up some of the recommendations made by the Palais-Royal Initiative, a group of 18 former ministers and central bankers, headed by Michel Camdessus, former head of the IMF, Alexandre Lamfalussy, the founding president of the European Monetary Institute, and Tommaso Padoa-Schioppa, former Minister of Economy and Finance in Italy, and a panel that also includes former Chairman of the Federal Reserve Paul Volcker.

The report calls for a three-tiered governance structure for the international financial system, with the top tier consisting of the heads of state, meeting once a year, presumably to set and coordinate overall direction for the IMF.   The second-tier would be made up of the G20 finance ministers and central bankers—the very group meeting in Paris this weekend—sitting as a newly formed “Council” to make strategic decisions relating to the international monetary system and its institutions. The third-tier would consist of the current executive directors, who would oversee the work of the IMF and its managing director.

Placing the G20 heads of state in such an overarching role makes a good deal of sense, as does the formation of a “Council” made up of the G20 finance ministers to give more detailed strategic direction to the IMF.  However, the Palais-Royal Initiative’s recommendation should be taken one step further and applied not only to the IMF, but also to the World Bank, the World Trade Organization (WTO), and the newly created Financial Stability Board (FSB). The G20 heads of state, when sitting as a “Council of Governors,” could set the overall strategic direction of these international institutions.  This would ensure that their mandates are broad enough to cover the many issues that can fall between the cracks of the various institutions, such as exchange rates, energy policy, climate change, and food security, yet tailored enough to ensure that inefficient overlaps or mission creep are avoided. They would also ensure that the work of each of the various institutions moves coherently toward the same goals.  A Council of G20 finance ministers would foster more specific strategic direction-setting for each of the international financial institutions.

Providing the G20 with such a role would allow it to set broad-based strategic direction for all of the international economic institutions, while using the considerable expertise and qualified personnel working for each of these bodies to carry out their leaders’ instructions.  By giving the G20 heads of state the continuing role of coming together at least once a year to perform the fiduciary duty of direction-setting and oversight for these institutions, the G20 would be assured of a consistent and ongoing role in setting the course of global economic activity.   Use of the G20 for this purpose would also give the emerging market countries a permanent and significant voice in global economic governance, getting them more engaged in addressing problems at the multilateral level.  Playing this strategic leadership role would also allow the G20 to fill an oft-cited need for high-level political engagement in the work of the international institutions.   Finally, inclusion of the WTO within the ambit of responsibility of this “Council of Governors” would ensure that the WTO takes its rightful place among the international institutions, in recognition of the critical link between finance, development, and trade, and the imperative of using the expertise and rules of the WTO to ensure that private enterprise can be fully engaged in worldwide economic recovery and future prosperity.

Coming to an agreement on specific targets for deficits or surpluses or finding a solution to perceived currency manipulation or excessive use of capital controls may be too much to expect from the Paris weekend.   But moving forward with long-term revisions to governance structures of international financial institutions may well be just bland enough not to attract too much opposition and just important enough to warrant the time and energy required to reach an agreement that would both improve the overall governance and coherence of international economic policy and carve out an important on-going role for the G20 and its finance ministers.

Jennifer Hillman is a Senior Transatlantic Fellow at the German Marshall Fund and a current member of the World Trade Organization’s Appellate Body.