Introduction
The recent global financial crisis (GFC), mainly caused by the U.S. subprime crisis, is the deepest recession since World War II (IMF 2009, p. xvi). The global growth is now recovering (IMF 2010a, p. xi), but the next crisis is always on its way. Rapid globalization increases the risk of a new financial crisis globally because of the high economic interconnection among countries. One fundamental problem is the imbalance between reach of markets and their supporting institutions at the global level (Rodrik 2009). The global growth recovery and financial stability can be achieved only through an international coordination. That is the essence of the 2008 Washington Action Plan, hereafter called "collective action", which was agreed on by the G-20 leaders during the 2009 London Summit.
Key Issue
The key issue to enact the international coordination is how to ensure all G-20 member countries implement the collective action. While all members have common interest to recover the global growth and to have global financial stability, hereafter called "collective good", the rational individual members tend to maximise their own benefit which can act contrary to the group's interest (Olson 1965, p. 9). This is commonly known as "free rider" problem. The potential for free riding can be found, for example, in the agreement to strengthen the financial regulation (G-20 2008). Although strengthened regulations could create financial stability, this also could hamper capital inflow especially from the high risk investors. A country with a need of high capital inflow could disobey the action plan. If this is the case, an excess supply of capital might occur in the free rider country which could lead to asset bubble and could end up with another GFC (Stiglitz 2002, p. 101).
Solution Options
Option-1: Internalize the externality
The G-20 should internalize the externality of the collective action by forming sub-groups in regions. That is the collective action that carried out by, and affected only, the members in the region (the subset) (Coleman 1972, cited in Liao 1994, p. 52). For example, if East Asia is a subgroup, economic resources and financial exchanges must be localized in East Asia only. Therefore, when East Asian members commit to the collective action they are the one who will benefit the impact. Similarly, when they are, or any one of the member is, not committed to the action plan, it is only them who will suffer. There will be no contagion effect because the economic exchange is localized.
Besides internalizing the externality, this approach also reduce the size of the group. In a small group, any member will receive larger fraction of the total group benefit which lead to the increase of reward for any group-oriented action (Olson 1965, p. 48). Smaller group tends to increase individual member's influence on shaping the collective goods which lead to a stronger incentive to contribute to the collective action (Olson 1982, p. 24).
The combination of smaller size and localizing the impact will raise the incentive for all members in the region to implement the collective action accordingly. Not only because each of them worry about the impact, but also because they will be more active to look after each other.
While this option can overcome the free rider problem, this will disrupt the global growth (as part of collective good) because of the exchange restriction. Global growth requires external openness in trade and economic exchanges (IMF 1997, p. 84; Stiglitz 1998, p. 36).
Option-2: Selective incentive
The G-20 must apply a selective incentive. That is an additional gain, beside the collective good, that applies only to the member that contribute to the provision of the collective good (Olson 1982, p. 23). Selective incentive could stimulate a rational member to support the collective action (Olson 1965, pp. 133-134).
The source of selective incentive could come from the IMF's loan and technical assistance (the IMF facilities). The G-20 leaders pledged to increase the IMF's lending capability to serve their members (Alfaro & Kim 2009, p. 5). IMF and the G-20 leaders must agree that any G-20 member who fully supports the action plan has a special access to the loan and technical assistance.
There is a concern that IMF facilities may not so attractive because of the experiences during the late 1990s Asian crisis (Alfaro & Kim 2009, p. 5). However, the fact shows that number of IMF member countries keeps increasing. As of now, member of IMF is 187 countries (IMF 2010b).
In order to make the IMF facilities become more attractive for the G-20 members, IMF must loosen the loan conditions while in the same time improve its credibility on its advisory function.
Furthermore, the selective incentive must be extended to non G-20 countries once the collective action among the members runs well. The extension is important to prevent a threat of global financial stability from non G-20 countries. Once the coverage is extended, the IMF lending capacity must be enlarged. This is because the incentive diminishes as the group size increases (Olson 1982, p. 31).
Proposal
By applying the following criteria: (a) individual-group interest alignment, and (b) in line with the collective good achievement, option-2 is the most plausible one.
The alignment of the individual and group interest is central to eliminate the free riders. The more alignment, the less free riding practices will happen. Option-1 creates the alignment by increasing pressure to each member through localizing the impact of the collective action. Option-2 improves the alignment by providing the committed member a special access to the IMF facilities. It can be argued that option-2 will improve the alignment better because the IMF facilities are valuable enough for G-20 members to direct the rational individual interest to be aligned with the group interest. Option-1 creates strong alignment as well. However, the alignment is based on the region. Since the region is so independent, it is quite possible the region will change the collective action to meet their interest. This means the alignment to the G-20 as a (mother) group is uncertain.
There is no doubt that option-1 will secure the financial stability. However, it could impede the global growth because of the restriction of financial and resources exchange. Whereas option-2 does not limit the globalization and in the same time support the global financial stability through reducing the free riders. In short, option-2 is more in line with the collective good achievement.
Reference
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—— 2009, World economic outlook April 2009: crisis and recovery, International Monetary Fund, Washington, D.C.
—— 2010a, World economic outlook April 2010: rebalancing growth, International Monetary Fund, Washington, D.C.
—— 2010b, Tuvalu joined the IMF on June 24, becoming the institution’s 187th member, viewed 7 September 2010,
Liao, T 1994, “A theoretical framework of collective action for the evaluation of family planning programs.” Population Research and Policy Review, no. 13, pp. 49-67.
Olson, M 1965, The logic of collective action: public goods and the theory of groups, Harvard University Press, Cambridge, Mass.
—— 1982, The rise and decline of nations: economic growth, stagflation, and social rigidities, Yale University Press, New Haven.
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Stiglitz, JE 1998, Towards a new paradigm for development: strategies, policies,
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—— 2002, Globalization and Its Discontents, Penguin Books, London.
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