Institutions in an Age of Globalization

Humpty Dumpty said to Alice, "When I use a word, it means just what I choose it to mean — neither more nor less." So let me explain first what I mean by "globalization." In his excellent book Why Globalization Works, Martin Wolf remarks, "Globalization is a hideous word of obscure meaning, coined in the 1960s, that came into ever-greater vogue in the 1990s."

I think of globalization as a process of increasing international economic integration accompanied by political agreement on the rules of the game that govern that process. The rise of China and India as trading powers is an example of increasing integration. And the accession of China into the World Trade Organization is an example of the application of the rules of the game.

Globalization is the driving force of many of the most significant changes in our economies. But it is far from a new phenomenon. It is as old as the human race itself. The European settlement of Australia represented the globalizing forces of migration and capital flows over several centuries. To me, one of the most poignant symbols of globalization is the Australian War Memorial at Hyde Park Corner in London.

In the first half of the twentieth century — described by Isaiah Berlin as "the worst century there has ever been" — thousands of Australians went to fight on the other side of the globe and to give their lives to a cause that transcended national interests.

One of the consequences of globalization is that the impact of change in one part of the world on the lives of people in other parts is growing. In areas as diverse as trade, energy, combating terrorism, climate change and the economic consequences of massive global imbalances with capital flowing from poor to rich countries, there are now growing spillovers from decisions in one country to the lives of people in others.

In contrast to the horrors of two World Wars and the Great Depression, the strains and stresses of today's world do not seem insurmountable. How can we best deal with these challenges?

When the movement of people in Manchuria from subsistence rural agriculture to industrial employment influences which industries flourish in Manchester and Melbourne — and when changes in attitudes toward asset management in Beijing affect currency values and hence living standards from Birmingham to Brisbane — it is in the interest of all nation states, recognizing their growing interdependence, to make commitments to each other about what they will and won't do.

Such commitments are embodied in international institutions. They are the rules of the game. Impressive offices and grand meetings are not the test of whether our international institutions are successful. The test is whether member countries are ready to make genuine commitments to each other.

Without that, the institutions lack any real purpose. So the subject of my talk today is why we need rules of the game to govern globalization, and the institutions that are necessary to oversee those rules.

At the end of the Second World War, a new global order was put in place by the United States, Britain and their allies. One of those primarily responsible, U.S. Secretary of State Dean Acheson, described his time as being "present at the creation" of a new global order.

A range of new international institutions was created — the United Nations, the two Bretton Woods institutions (the IMF and World Bank), the OEEC that implemented the Marshall Plan (and later became the OECD), NATO and GATT (which has subsequently been succeeded by the World Trade Organization).

Those institutions are now, for the most part, past their 60th birthdays. And there has been much heart-searching over the past few years as to their role and governance. Unless the spirit of the original founders is rekindled, there is a real danger that the present institutions will wither on the vine, leaving us with a more unstable and fragile international environment.

As Martin Wolf pointedly wrote, "To defend a liberal world economy is not to defend the International Monetary Fund, the World Bank, the World Trade Organization or any specific institution. These must be judged — and reformed or discarded — on their merits."

My argument is simple. Existing institutions were designed for a world radically different from that of today. The cost of closing them down and building new institutions is high. So we must work with our existing institutions and make them more relevant to today's problems. Unless we do so, it will be harder to defend an open and liberal international economic order that has brought benefits to hundreds of millions of people around the globe.

The generic challenge facing all the post-war institutions is to find a role relevant to present circumstances and to decide on the operational capabilities and instruments which that role requires. Holding meetings and issuing communiqués is not enough.

It is worth noting the scale of the challenge. The specific commitments made at the end of the Second World War are no longer relevant. The shared experience of the Great Depression, protectionism and two World Wars has faded. And the majority of current nation states were not "present at the creation."

Those changes have meant that, over time, the post-war settlement has become less relevant. But the need for international institutions has increased. Our own standards of living are now, more than ever, affected by decisions elsewhere.

And many people already feel they are worse off from globalization. The number of workers in the world trading system has more than doubled in a short period, with inevitable consequences for real wages of the unskilled in the industrialized world. Governments are having to work harder to explain what the principle of comparative advantage means to people in their daily lives.

In fact, most people are winners from globalization. China is now the second-largest buyer of Australian exports. And the Australian terms of trade have risen by 40% since 2000, providing a substantial boost to the growth rate of real incomes.

Nothing could be more damaging to the prospects of developing and developed countries alike than the abandonment of further trade liberalization. But protectionist sentiments are abroad again, even with high employment rates around the world.

In Europe, protectionist sentiments are concealed as cries for "national champions," in Latin America as populism, in the United States as complaints about unfair competition. But the damage that protectionism can wreak is clear. The experience of the Great Depression should be enough to ring alarm bells.

If that is to be avoided and we are to maintain widespread support for an open international trading system, it is in all our interests to establish clear rules for what we will and won't do in areas where our decisions affect stability elsewhere. And if those commitments are to be upheld, we will need international institutions.

Changes to the number of nation states and the way they interact mean that reform of our multilateral institutions is needed. But piecemeal reforms are unlikely to work. In my view, there are five principles that should be followed.

First, create international institutions only when there is a need to do so. International institutions should focus on those areas of global governance where we need to tackle problems collectively — whether on trade, the environment or large spillover effects of changes in macroeconomic policy.

Second, ensure that the commitments countries enter into are clear. The job of institutions is to support those commitments. In many cases, like an umpire, their job will be to uphold them. That will only be possible if the players — countries — are very clear about the agreed rules of the game. Without that, any further design is pointless.

Third, provide institutions with the necessary tools to umpire the commitments of nation states. But, just as umpires are accountable for their performance to the whole community of cricket-playing nations through the International Cricket Council, the staff and management of the international institution should be accountable to the whole community of nation states for their performance in upholding the rules.

Fourth, recognize that we do not start with a blank sheet of paper. We must accept the constraints of history. Existing institutions have an institutional memory, talented staff and much of the infrastructure that will be needed in the future. But that is not to say reform will be easy. There are far too many vested interests for that to be the case.

Fifth, avoid unnecessary duplication. Because the cost of abolishing institutions is high, the number of international groupings and institutions has proliferated in recent years. Many of them tread on each others’ toes. As a result, the IMF, World Bank and OECD have all been bruised. Duplication of roles is wasteful of time, money and focus. Each institution should have one very clear remit — and focus on it. Of course, countries which play a role in one institution but not in another will have an incentive to build up the role of the former at the expense of the latter. So it is up to the member countries to limit the battle for turf.

There are few examples where all these principles appear to have been followed. The World Trade Organization has been an effective umpire of countries' commitments about trade restrictions and comes close. But the example of the WTO highlights the importance, above all else, of clear commitments from nation states themselves.

The failure of countries to conclude a multilateral trade round since the WTO was formed more than a decade ago is worrying. The Doha round has continued past its expected completion date — and only a brave commentator would forecast eventual success.

The fault does not lie with the WTO. Instead, it reflects the fact that national governments have not been willing to make the necessary commitments.

Likewise, the surveillance activities of the IMF have been criticized because they pay insufficient attention to spillover effects and instead examine in unnecessary detail microeconomic issues. For example, the sharp rise in oil prices over the past two years has posed a risk to economic stability in many countries.

But there is no reference in the IMF's Article IV report on China to the role that Chinese demand may have played in pushing up world oil prices. And the report on the United States this year singled out the electricity sector and competition among auto manufacturers and airlines as areas warranting special examination by IMF staff.

It would be better if those microeconomic issues were examined within the OECD, and, in turn, issues of macroeconomic spillovers and global "imbalances" were left to the IMF. But even when IMF surveillance has been well-focused, as in the analysis of Thailand's exchange rate policies in 1996, it has not always carried sufficient weight to influence countries' policies.

Unnecessary duplication is a waste of both time and money. I have already spoken about the respective comparative advantages of the IMF and OECD. There has also been some discussion about the roles of the IMF and the G7 in respect of exchange rate issues.

Over the past three years — especially since the Boca Raton G7 summit of February 2004 — the inability of the G7 to deal with the major spillover effects in the world economy has become more and more evident.

Adding new members, even if they were willing to join, is not the answer. More productive would be to use the IMF as a flexible forum to bring the relevant group of countries together to handle issues as and when they arise.

The meetings of the IMF in Washington and Singapore this year marked the beginning of an attempt to define more clearly the role of the Fund in the world economy. Whether that will prove successful is too early to tell. But the challenge is clear.

Globalization increases our dependence on each other. It is no longer sufficient to rely on the commitments made sixty years ago. The world has changed too much since then.

It is up to the member countries to make a multilateral trading system work. As Joseph Conrad wrote a century ago in his great novel Nostromo, "Action is consolatory. It is the enemy of thought and the friend of flattering illusions."

The frenetic activity of international meetings and the flattering illusions of a stream of communiqués do not add up to a coherent set of commitments.

Failure to reform the international institutions will condemn them to irrelevance and obscurity. We are at that point. If this generation fails, then the work of those who were "present at the creation" will have been undone. It is our duty to re-create the institutional framework that we inherited.

This Globalist Document is adapted from Mr. Mervyn King’s lecture to the Melbourne Centre for Financial Studies on December 21, 2006. For the full text of Mr. King’s lecture, click here.