Economic Externailities and the G-20 Summit

The G-20 summit was last week in Pittsburgh.  While the summit did spend some time on politics, such as what to do about Iran's nuclear program, the heart of the meeting was about Economics.  Especially the kind of economic issues we call externalities.

Externalities are situations of market failure, which means in this context that outcomes delivered by profit-driven supply and demand are not the best outcomes from the point of view of overall global economic efficiency.  Externalities can be positive, which implies that markets produce too little of some activity that we benefit from (education for example), or negative, which implies that markets produce too much (pollution for example).  Most of the time, when heads of states and their ministers get together to discuss "common solutions," they are talking about negative externalities.

As we know too well, the last year witnessed many situations where actions taken in the pursuit of private benefits by firms - mainly financial - in a handful of countries wreaked havoc across borders.  In other words, the costs of these actions have been painfully borne by many countries, some of which had little input into or control over the decisions of the firms that took these actions.

In the hope of reducing the risk of such negative spillovers in the future, the G-20 discussed externalities related to banker pay, raising mandatory bank reserves, and the worrisome problem of financial institutions that are "too big to fail."  

On the question of bank reserve requirements, it turned out that the U.S. was in favor of higher reserves while the European Union was against.  At first blush, it seems like these positions are the reverse of what we would expect.  If you dig a little deeper though, it makes sense, and stems from the different approaches to regulation in the U.S. and the E.U..  The U.S. position is based on a more hands-off view of regulation, and is the argument that raising reserve requirements forces banks to maintain larger cushions to forestall bank runs and financial fragility, but that beyond this firms should be free to run their business as they see fit.  The E.U. objection is based on the argument that banks are already more strenuously regulated in Europe than the U.S., and therefore raising reserve requirements is redundant, only serving to hobble their ability to compete.  


The importance of the G-20 (as opposed to the G-8) as a forum for dialogue and discussion among the worlds most powerful economies (producing 90% of the world's output and 80% of trade) is itself a reflection of the growing clout of "emerging economies" such as the so-called BRICS (Brazil, Russian, India, China, South Africa).  A change in the balance of global economic power.

You can access an article from the New York Times about the G-20 summit here.