CHICAGO – As governments do more to try to coax the world economy out of recession, the danger of protectionism is becoming more real. It is emerging in ways that were unforeseen by those who founded our existing global institutions.

Unfortunately, the discussion between countries on trade nowadays is very much a dialogue of the deaf, with countries spouting platitudes at one another, but no enforceable and verifiable commitments agreed upon. There is an urgent need to reform global institutions – and more dramatically than envisaged by the G-20 thus far.

Protectionism is not just about raising tariffs on imports; it is any government action that distorts the global production and allocation of goods, services, and capital to favor domestic producers, thereby reducing overall efficiency.

So, for example, government pressure on multinational banks to lend domestically, or to withdraw liquidity from foreign branches, is protectionism, as are capital injections into multinational companies with the explicit requirement that domestic jobs be preserved.

Such actions are problematic not only because they insulate inefficient forms of production, but also because foreign countries respond by adopting similar measures towards their national champions, so that everyone is worse off.

The number of inefficient workers protected by these measures is offset by the number of efficient workers laid off by foreign multinationals responding to political pressures in their home country.

Perhaps of greatest concern, moreover, is that the public, especially in poor countries that cannot undertake offsetting measures, will come to distrust global integration, with multinationals viewed as Trojan horses.

In addition to explicit protectionist measures, governments now plan actions that will affect others across the globe. For example, the large volume of public debt that industrial countries will issue will undoubtedly raise interest rates and affect developing country governments’ borrowing costs.

There is little dialogue about how industrial country issuances can be staggered to minimize the impact on global markets, and what alternatives can be developed for countries that are shut out.

If developing countries are left to their own devices, they will conclude that they should self-insure by rebuilding foreign-exchange reserves to even higher levels, a strategy that has clearly hurt global growth.

We need a moderate-sized representative group of leaders of the world’s largest economies to meet regularly to discuss such issues, informed by an impartial secretariat that will place its analyses before the group.

Initially, the group should only exert peer pressure on its members to comply with international responsibilities. But, as confidence in the group’s decision-making – and in the impartiality of the secretariat – improves, members might give it some teeth, such as the ability to impose collective economic sanctions on recalcitrant members.

The United Nations is too large to serve this purpose, and the most obvious candidate for the group, the G-20, is not representative.

There is, however, a representative alternative – the International Monetary and Financial Committee (IMFC), a group of finance ministers and central bank governors that meets twice a year to advise the International Monetary Fund.

While the IMFC could be shrunk (for example, if euro-zone countries agree to a common seat), the real challenge is to make it a venue in which countries talk to one another rather than at one another. To meet this goal, some changes would be in order.

First, the frequency of meetings should be increased, especially in times of crisis, and the level of a few of these meetings enhanced.

So, for example, two meetings a year at the head-of-government level and quarterly meetings at the finance-minister level (with more at the deputy-minister level) would provide ample time for dialogue, and thus for trust-building, and would allow the commitments made by the heads of government to be monitored.

Second, the IMF’s permanent Executive Board, established in an era when travel was costly and communications difficult, and consisting of mid-level government functionaries, should be abolished. Important decisions should be vetted by the IMFC and others delegated to IMF management.

Current executive directors typically do not have the authority to make commitments on their countries’ behalf, so their effort is often diverted to minutiae. And, in an attempt to preserve its turf, the Board constantly attempts to keep the IMFC from discussing anything of substance.

Third, the obvious secretariat is the IMF. Unfortunately, the Fund is not regarded as being impartial, especially by countries that have been seared by its past conditionality.

The IMF has, however, become far more neutral than it is given credit for – though it could take more steps to distance itself from its past.

These include abolishing any region or country’s right to appoint IMF management; allowing the Fund to borrow from markets, so that it does not have to keep seeking key countries’ permission to expand; eliminating any country’s official veto power over major decisions; and having its agenda set by the IMFC rather than outside bodies.

Industrial countries should be happy that developing countries would take greater responsibility for global economic outcomes, rather than simply sulking about their lack of voice and representation.

Developing countries, in turn, would gain greater voice, but would also be forced to contribute ideas (and resources) to deal with global problems. And maybe, just maybe, we would preserve faith in globalization.

Raghuram Rajan is a professor at the University of Chicago School of Business and a former chief economist of the IMF.

Copyright: Project Syndicate, 2009.
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