Nations Ready Big Changes to Global Economic Policy

By BOB DAVIS and STEPHEN FIDLER

The Group of 20 nations is scrambling to finalize a plan before this week's Pittsburgh summit that would commit the U.S., Europe and China to make big changes in national economic policies to produce lasting growth as the world recovers from the worst recession in decades.

The G-20 summit, the third such gathering in a year, is shaping up as a test of whether industrialized and developing nations can function as a board of directors for the global economy.

The focus is on a U.S. proposal, called the "Framework for Sustainable and Balanced Growth," whose details haven't been previously disclosed. If implemented, the framework would involve measures such as the U.S. saving more and cutting its budget deficit, China relying less on exports, and Europe making structural changes to boost business investment.

Leaders from the G-20 are working on ways to enforce commitments countries make, which would involve reviews -- though no specific sanctions. Similar efforts have been attempted and have failed in the past. This time, though, the U.S. and other nations believe they can produce a different result, having grappled with the deepest recession since the Great Depression.

"As private and public saving rises," in the U.S. and other countries, "the world will face lower growth unless other G-20 countries undertake policies that support a shift towards greater domestic, demand-led growth," senior White House aide Michael Froman wrote to his G-20 colleagues in a letter dated Sept. 3. In the missive, which has not been made public, he called the framework "a pledge on the part of G-20 leaders" to press new policies.

The proposal has set off political wrangling among the G-20, with European countries arguing that the U.S. may be unrealistic about how rapidly the global economy can grow and with China only reluctantly agreeing to participate. The U.S. helped bring along the Chinese by endorsing Beijing's view that developing countries deserve a bigger stake in international institutions such as the International Monetary Fund.

The G-20 countries have yet to decide how detailed to make their pledges to change. And the U.S. and Europe have different ideas on how to enforce them. "Implementation is always the issue," says Timothy Adams, a former senior Bush Treasury official. "If we wait even one more year, it may be too late." The sense of urgency will have faded, he says.

Past efforts to remedy these issues have collapsed, especially after a sense of crisis had passed. In the 1980s and early 1990s, the Reagan, Bush and Clinton administrations regularly pushed for rebalancing -- although Japan was the target then -- and never made much headway. Once Japan plunged into a decade-long slump, the U.S. eased off.

In the days leading up to the Pittsburgh summit, representatives of the G-20 nations have agreed how to dodge one big issue: devising an "exit strategy" to withdraw the monetary and fiscal stimulus deployed to fight the global recession. The solution is to promote such a strategy as necessary, while stopping short of articulating specifics. Any prescription to phase out various economic programs could spook markets into anticipating a quick pullback, G-20 officials say.

A compromise is emerging on another, two-pronged issue: How best to keep financial excess and corporate compensation in check. The summit is likely to produce support for new limits on compensation, a theme being pushed by the Europeans. The G-20 is also expected to approve new requirements sought by the U.S. that banks hold more capital to discourage risk-taking and absorb big losses.

G-20 officials say they are counting on sense of camaraderie to keep them working together rather than pursuing conflicting national goals. "In this age of deeper globalization, international coordination is critical," says Il SaKong, a prominent South Korean economist who oversees that country's G-20 effort. "The leaders learned this lesson; they felt it."

China, meanwhile, has pressed for more voting power for developing countries at the IMF. In response, the U.S. is pushing the G-20 to agree to change IMF voting, so that it's split nearly 50-50 among industrialized and developing countries, rather than the current 57% to 43% lineup. Although much of the lost power would come at the expense of Europe, the European Union leaders said at a recent meeting that they are willing to support some degree of change.

The move to give developing countries a bigger voice has built a degree of trust within the G-20 and helped give impetus to make the framework for growth a central focus. If approved, the framework would require countries to make specific proposals promising significant change.

Those countries running current account deficits, most notably the U.S., would have to define ways to boost savings. Nations running surpluses -- China, Germany and Japan, among others -- would detail how they propose to reduce any reliance on exports. The U.S. would likely need to commit to a sharp deficit reduction by government.

Europe would need to commit to improving competitiveness. That could mean passing investment-friendly tax measures and reopening the debate about making it easier to fire workers -- viewed as one way to encourage employers to hire more freely.

China would face perhaps the biggest challenge: remaking its economy so it relies far less on exports to the U.S., thereby running up huge foreign-exchange reserves. In the past, China has shied away from such "rebalancing" efforts because of the magnitude of the changes and because it believes it's being singled out for the world economic woes, which it feels were caused by regulatory lapses and other failings in the U.S. and Europe. "They don't want fingers pointed at them," says Nicholas Lardy, a China expert at the Peterson Institute for International Economics, a Washington D.C., think tank. "It comes up over and over again."

But U.S. and European officials say that this time China is on board because it recognizes that its export-driven model won't deliver sufficient growth in the future, and because the new framework would potentially spread the political pain to trading partners too.

In 2006, the IMF tried its hand at rebalancing by convening talks among the U.S., euro-zone nations, Japan, China and Saudi Arabia. Specific proposals were made, but nothing was implemented, as Treasury Secretary Henry Paulson figured he'd have better luck bargaining bilaterally with China. He didn't, especially when each country's economy was expanding.

"The really hard part is getting an agreement of what the rules should be and what the penalty is" for breaking them, said Anne Krueger, a former IMF deputy managing director. G-20 officials argue that if they don't succeed this time, the world will remain stuck in economic patterns that could reduce potential growth and perhaps produce another crisis down the line.

Any new framework hinges on proper enforcement. To that end, European sherpas, including the British, are pushing for a "trigger" mechanism. If country's current account surplus or deficit goes over a certain limit, for instance, that would require negotiations to get the country back in line.

The U.S. is pressing for what it calls a "peer review" process, by which G-20 countries, with the help of the IMF, would assess whether each other's policies are working.

None of the countries, though, are calling for specific redress, such as trade sanctions or foreign-exchange penalties for countries that don't live up to their promises. Threats of penalties have frightened off Asian nations in the past and would likely sour any deal.

Instead, the G-20 officials point to how they have dealt with protectionism as a model. Each country regularly pledges it won't take any protectionist action. The World Trade Organization calls out countries that violate their pledge. Generally, G-20 officials believe the pledges have had a restraining effect on governments.
—Jonathan Weisman contributed to this article.

Write to Bob Davis at bob.davis@wsj.com and Stephen Fidler at stephen.fidler@wsj.com