Sovereign Rights & Sovereign Duties

For The Cambridge Union Society Address by The Right Honourable Paul Martin | January 17th, 2010

In the late 1990’s the G7 finance ministers of which I was one, laid out the solutions the countries caught in the pincers of the Asian financial crisis should follow, if they were to get out of the squeeze they were in.

Our advice was sound and well-meaning but was ignored, for the simple reason that none of the countries involved: Indonesia, Korea, Brazil which had been sideswiped by the crisis, were present for our discussions and they made it clear that the days when the G7 could dictate at will were over.

Representing a smaller G7 country I understood where they were coming from, and spoke to my US and UK counterparts Larry Summers and Gordon Brown, suggesting that in order to deal with the evolving global economy a new Finance grouping should be created, one that included not only the countries caught in the Asian crisis, but the major regional powers such as China, India and South Africa among others.

They agreed immediately, and I then approached the G7 and the other finance ministers of the countries that eventually made up the G-20. They as well were enthusiastic and thus the G-20 finance ministers was born and I became its first Chairman.

In 2003, when I became Prime Minister, it was evident that a similar gridlock was paralyzing the international system and that once again it was a lack of representativeness, this time at the leaders’ level that was preventing the G8 from acting as the world’s steering committee, the role it had once played with some success.

In short, issues such as global financial imbalances, agricultural protectionism, pandemic threats, endemic poverty, and climate change were all issues that required the emerging economies to be at the table.

For this reason, I once again approached my counterparts – this time seeking to recreate the G-20 at the leaders’ level and most were very supportive.

A couple however were less than enthusiastic and one, the President of the United States, was considerably less so.

I kept at it however until the Canadian election occurred in 2006 when, to put it delicately – I stepped down from government.

That being said, despite this rather inhibiting hiccup, I continued to push the idea with those governments who were favorably inclined all the while working with a series of universities and think tanks in Canada, the US, the UK, France, Germany and China.

All of us were convinced that the absence of China, India and others at the G8 table meant that the leaders’ G-20 was only a question of time. Indeed many felt that it would occur arising out of one of the world’s periodic financial crises and as we know now that is exactly what happened.

Ultimately, George Bush – and I congratulate him for his initiative – faced with a global financial crisis many of whose roots were found at home, convened the first G-20 summit in Washington in late 2008.

Gordon Brown quickly followed up in London, and Barack Obama a couple of months later convened the third such meeting in less than a year in Pittsburgh. It was at the latter summit that the G-20 was designated “as the premier forum for international economic cooperation.”

At this point I would like to be able to say: “The story is ended and they all lived happily ever after.”

Unfortunately however, whether the saga has a happy ending remains to be seen, and that is what I would like to talk to you about tonight.

The question is, what is the measure by which the G-20 should be judged. And the answer, for those of us who pushed for its creation, is the degree to which it improves the way globalization works in the here and now, and in the way it prepares for the road ahead.

This is not an academic yardstick. Our goal was to relieve the gridlock that was paralyzing the international system, and that on issue after issue will be the litmus test the G-20 will have to meet. For if it is not met, then the G-20’s tenure as the world’s steering committee will be short lived and I fear its replacement will be even less representative of the world’s reality and even less effective than was the G8.

Thus, what I’d like to do tonight is to highlight three issues as examples in order to gauge how the G-20 is doing in the wake of the Pittsburgh declaration and as the next two co-hosts Canada and Korea prepare for the G-20 summits to be held in their respective countries this summer and next fall.

Those issues are: Global poverty, Climate change and the Global banking crisis.

To the first issue - global poverty.

Today, almost 20% of humanity lives on less than a pound sterling a day. For many, famine is a regular reoccurrence.

In 2008 for instance, the price of the world’s food staples tripled in price. Developing countries budgets were decimated as they struggled to import food, and civil unrest spread throughout Africa and Asia.

Now the world’s great agrifood companies say that new technologies will solve the problem. I hope so! However at the present time, the growth rate in agricultural production is falling, not rising and the UN predicts that within a generation the demand for food will increase massively as the globe’s population soars by a third and growing affluent populations intensify the pressure on the agricultural resources.

Nowhere is the threat of famine more serious than in Africa where the shortages are due to drought and to major structural imbalances in the food chain.

Twenty-four of the world’s twenty-eight poorest countries are there and so are the majority of the world’s fragile states.

Yet with the exception of a bow in its direction at the London Summit,the G-20 has virtually ignored Africa and the issue of food security.

Now the G-20 may plead the pressures of the financial crisis as its excuse, but the fact is the crisis was of its members’ making and yet it is the developing world beginning with Africa that has suffered the most grievously, as the significant economic gains of the last decade were wiped out through no fault of its own.

So, if the question is how has the world’s new steering committee done so far? The answer is – not all that well. Of course Africa’s leaders have much to answer for, but clearly the G-20 must respond much more urgently than it has if it is to live up to the hopes so many have vested in it.

The next issue is climate change.

On most questions, what is important are the signals the G-20 sends to the world’s negotiating tables. In the case of climate change, this meant Copenhagen where suffice it to say the wrong signals were clearly sent.

Of course, the prime responsibility historically for CO2 emissions lies with North America and Europe. But this does not mean that all of the G-20 members, including, China, India, and Brazil do not have an increasing responsibility as their emissions increase, to Bangladesh, the Philippines, Central America and Africa for instance, regions of the world that are virtually innocent of the causes of climate change and yet whose poor will bear the “greatest cost” in terms of creeping deserts, flooding and famine.

After Copenhagen, the world cannot afford another failure!

The next climate change summit will be held in Mexico next November-December. Before then, there will be the two G-20 summits. Rather than a last minute ad hoc meeting between the US, Brazil, China, India and South Africa as was held in Copenhagen let the G-20 prepare now to send the proper signals well ahead of time so that the Mexican meeting has a chance to succeed.

As an aside, important as climate change is, that’s not the only issue at stake here.

If after five meetings of the G-20, not to mention countless expanded meetings of the G-8, the differences between the developed and emerging economies show as few signs of being bridged in Mexico as they were in Copenhagen, then clearly we will have a problem on our hands that extends far beyond climate change to the very heart of the effort to revive true multilateralism after its lengthy siesta.

Multilateralism must mean more than a camouflaged concern only for one’s national interests. It must recognize the needs of others including those who are not at the G-20 table.

The point is quite straightforward.

The G-20 came into being because the world has changed. Its members are members because they have power and position, but they also have responsibilities. It’s time the developed and emerging economies assume them!

The last example I would cite arises not surprisingly from the current financial mess.

The fact is, despite all of our talk about globalization over the last 25 years, today’s crisis shows just how unprepared the world’s governments were and still are when faced with a global economy whose problems lie beyond the scope of purely national solutions.

This was not simply another economic downturn. It was one that mutated into a perfect storm because at its core was a banking crisis of unprecedented global reach.

In the never-ending cycle of financial downturns bubbles and implosions, bank crises are undoubtedly the worst, because bank credit is to the economy what wind is to sail. It is that on which all else depends.

When confidence in the banks fails, it drags everything else down with it.

The great strength of the free market is its ability to innovate, its great weakness is the tendency every so often to take that innovation a bridge too far.

Nowhere is that weakness more damaging than when it appears in the banking system, a system which depends almost entirely on the trust we repose in it. That is why the moral hazard posed by institutions who feel they can violate that trust will eventually eat away at the foundations of the free market and that is why I agree with Mervyn King, the Governor of the Bank of England who said: “if a Bank is too big to fail, it is too big”.

The fact is, the global economy must never again be put at risk by the failure of any country to understand how far the global tentacles of its institutions reach.

The consequences of the Lehman Bros. blowup will be felt for years. Ask yourself: what would have happened to global markets had the US let AIG go as well?

The answer however is not to prevent financial institutions from bankruptcy, it’s to develop a protocol on how failing mega institutions can be unwound without bringing down the whole global system.

That protocol cannot be voluntary, or catch as catch can. It must be part of a predetermined work out process established well in advance.

The broad proposal that major financial institutions should establish “Living Wills” to that end is interesting.

Fundamentally, what has to be done is to reduce the complexity and entanglements that prevent major elements of an existing institution from being separately regulated and hived off if necessary. Clearly the devil is in the details but this must not be used as an excuse for delay.

The fact is that as a result of mergers and takeovers such as Lloyd’s and HBOS, Wells Fargo and Wachovia, the problem of size has gotten worse not better.

Thus, the third test I would cite as we judge the success of the G-20, is one the leaders themselves put up front and center last year, and that is the need for the international monitoring of cross-border financial institutions and the need for comprehensive financial regulation.

Let me be clear. A single global regulator is simply not workable. Such a body could never have the domestic insight and intuition required to provide adequate national regulation.

That being said however, if globalization is to work, we must recognize as well that national regulation cannot deal with the gaps in the global financial system.

Thus we must ensure that the effectiveness of national regulation itself is monitored by an international coordinating body both for scope and competence. Furthermore we must ensure that the enforcement of this coordination is mandatory, not voluntary. Therein lies the rub, for it is in the quicksand of the debate around these issues that the G-20 is currently bogged down.

After what the global economy has just been put through, this is more than passing strange. For given the difficulty major US and European bankers now appear to have remembering how remorseful they were but a couple of months ago, it should be pretty clear that a voluntary process of global coordination will lead nowhere.

Quite simply, over time, regulatory arbitrage (i.e.: shopping for the weakest jurisdiction) will make it impossible in a permissive system for the G-20 to deal with escalating breaches in the dike.

The fact is that history does repeat itself.

The push for the deregulation of financial institutions occurred for many reasons not the least of which was the competition between

London and New York for market dominance, and while the animal spirits that gave birth to that competition may be in abeyance, they will not be for long!

Furthermore, as today’s crisis memories fade, London and New York will not be alone in seeking to gut regulatory constraints to attract the world’s financiers. Already Paris and Frankfurt are gearing up for the next round.

And of course, this is but the tip of the iceberg.

Wait until Hong Kong and Shanghai combine to challenge the incumbents. Then the battle will really be on!

At the present time the G-20 is going after corruption which it should and some smaller jurisdictions where it has to, but so far it has not decided what should be the core standards in G-20 countries themselves. Nor has the G-20 addressed how it would enforce such new standards if they were put in place.

As anyone who has witnessed the rise of the living dead that now pose as banks in the USA, Germany and the UK would testify and who grasps how much their imprudence has contributed to the pain and suffering of so many innocent people around the world, it is difficult to watch the resistance to universally higher equity standards and universally lower leverage ratios for financial institutions.

If we are seeking to protect the global economy against undue risk to the global banking system, if we want to inhibit contagion across borders of the kind we have just lived through, then not only must we have more prudent ratios, we cannot have widely different rules for different countries.

For instance, the fact that so many banks even today are pock marked with toxic assets they refuse to properly value and which are a blockage to a desperately needed economic recovery because they are impeding the flow of credit is in itself reason enough to stop the game playing across borders.

As well, assuming acceptable global standards are eventually put in place, they are going to have to be enforced by the G-20 against G-20 members, and that is going to require enforcement by a supervisory body with an experienced staff of professionals whose only responsibility is the integrity of the global system. In short, no more one-day monthly trips to Geneva or Basle to check the temperature.

Furthermore this supervisory body must have an enforcement capability. The announcement last weekend by the Financial Stability Board that regulators around the world will submit to public peer reviews and that consideration is being given whether to publicly identify countries that refuse to cooperate is welcome, but only as a first step. Eventually, much stronger counter-measures will in all likelihood be necessary.

Why?

Because in a world of seamless capital markets there are no borders, and if those are the rules of the game the bankers play by, then those must be the rules the referees referee by as well.

For instance let’s assume increased equity ratios and reduced leverage becomes the order of the day. The immediate effect will be to reduce the return on equity of the major financial institutions and in all probability the compensation paid their senior executives.

In these circumstances how long does anyone think it will be before the bankers find ways around the rules – ways which will certainly increase systemic risk? Does anyone think, when this happens that the voluntary subscription to global standards that are not continuously reviewed and enforced will be sufficient? Only if they believe in the tooth fairy!

The next question of course, is by when must all this be settled. Well, as mentioned earlier there is one G8 meeting and two G-20 meetings scheduled in 2010.

I don’t believe it is too much to ask that both issues, the definition of bank equity or tier one capital, coupled with the ensuing leverage ratios on the one hand and how all this is to be regulated on the other, be settled before the end of the year. Beyond that memories of the crisis will begin to fade, and so will the urgency to act as well – until the next time that is!

In short, the time for the G-20 to draw the line in the sand is now fast upon us and while the right words were said in Pittsburgh, it’s clear from the ongoing delays and incessant debates that not all of the G-20 members are prepared to carry through.

Once again what the recalcitrant should remember however, is that they are there to speak not only for themselves but also for the 173 countries who are NOT at the G-20 table. In short the parochialism of rigid borders makes no sense, not if you want to make globalization work.

The G-20 is a global steering committee, not a small club of the selfinterested, and the question to ask, is not how do you keep New York, London or German bankers happy, it’s how do you keep the global economy healthy. So where does all this leave us?

We have touched on the litmus test for the G-20 with reference to three examples: global poverty, climate change and the financial crisis.

In each case, the jury remains out but the grounds for optimism are there. In each case however as well, there are two constants that have to be dealt with if the G-20 is to fulfill the hopes so many have for it.

The first is the trade off between generations. This of course is most evident when addressing climate change. It should be every bit as evident when dealing with global poverty, but apparently there continue to be those who believe the rich world can isolate itself from the misery of others.

Well let them not kid themselves. In 2030, Africa will have a population equal to China or India. In 2050 it will have a population of 2 billion, 500 million more than either one at that time. This will be the largest agglomeration of people and the highest proportion of young people anywhere in the world.

Hopefully that massive percentage of young by mid century will provide the world with an engine of growth when the global economy needs it, comparable to the shot of adrenalin China is providing today.

Indeed if the transportation and energy infrastructure that would lead to the African Common Market is built, if Africa’s governments build the schools and health care systems that are needed and if the G-20 lives up to the commitments that are so essential to all this happening, then that bright future can be within Africa’s grasp.

However if in 2050, Africa’s young are unemployed and rootless, millions, desperate, with no hope but plenty of anger, migrating in a wave of discontent which no wall will be able to resist, then those young people will turn, as so many in their circumstances would, what could be the success story of the 21st century, into an unstoppable source of global instability with all the misery and terror that entails.

The choice is ours, the consequences of that choice however will be borne by our grandchildren.

The second constant which is crucial to the success of the G-20 is whether the leaders of the member countries show a capacity to rise above the political comfort of narrow nationalism - this because coming to grips with what it takes to make globalization work requires a global consensus that cannot be squared with the traditional exercise of sovereignty.

In establishing the G-20 as the world’s new steering committee, there was no intention to create some kind of international superstructure overseeing the 193 countries that make up the United Nations.

The purpose of the G-20 can be no more than a deliberative body whose recommendations will not always be followed but which will certainly carry considerable weight because of the nations that make it up.

What in the end will determine the G-20’s success or failure will depend on the ability of its greatest powers to recognize that the protection of national sovereignty in today’s world no longer depends on territorial isolation but territorial cooperation.

To illustrate this point, let me return to the issue of the financial crisis and the resistance to enforceable universal standards of financial regulation.

At the core of this resistance is a counterproductive definition of sovereignty – of “Who is Boss” – a definition which is increasingly outdated.

The Treaty of Westphalia established the definition of national sovereignty in 1648. That was a long time ago and it was all about sovereign rights. However, my point quite simply is that the definition of sovereignty today must now include sovereign duties.

For instance: when the US and European financial players created toxic assets and sold them around the world to everyone’s detriment, was that not an infringement on the rest of the world’s sovereignty?

Is today’s global recession itself not partially the result of the infringement on the sovereignty of every country that has been affected by the failure of the European and American banking systems to exercise minimum standards of prudence?

In short, I believe recasting sovereignty by stressing its duties as well as its rights, thus bringing it into the reality of today’s interdependent world is the key to making globalization work.

Now this is all too theoretical some may say, but the fact is arguments over sovereignty have already provided the unconscious underpinning of virtually every debate at the G-20 table.

Well, the time has come to move on. What is required now is a new approach to an old concept.

Such an approach was broached by the UN when the reform commission recommended “the Responsibility to Protect” as a restraint upon a country’s ability to oppress its own people. Ultimately it was one of the few reforms that passed, but the difficulty that any reference to sovereignty entails is highlighted by the fact that attached to the R2P is a Security Council override.

Another suggestion can be seen in a recent article in Foreign Affairs by former US Homeland Security Secretary Michael Chertoff, which deals with the “Responsibility to Contain” the threat of terrorism. At the very beginning of the article, Chertoff defends the Westphalian definition.

However as his purpose is to focus on the need for the United States to deal with terrorist threats emanating from other countries, he is finally drawn to a different conclusion at the end of his article when he writes: “States can no longer refuse to act by hiding behind seventeenth-century concepts of sovereignty in a world of twentyfirst-century dangers. International law should not be powerless to prevent deadly non-state threats from spreading from one state to others.”

I have the greatest respect for Michael Chertoff. I just wish others would travel the road to Damascus as honestly as he has.

This is true in the case of the R2P. It is true in the case of the responsibility to contain. And it is true in the case of the responsibility of great powers not to decimate the global economy because of failures in their own regulatory processes which is what the G-20 and the Financial Stability Board are wrestling with now.

That global banking standards will eventually be negotiated I have no doubt. What they will be however and how they will be enforced, as we have seen, these are the 64 billion dollar questions!

Nor are the reasons to redefine sovereignty arising out of the financial crisis limited to the gripping domain of bank regulation!

Just as Michael Chertoff has set out the argument in the case of counter-terrorism, a similar argument can be inferred from a recent newspaper article where Dennis Blair the US Director of National Intelligence was cited as suggesting that the primary US security concern is now the destabilizing global political fallout from the economic crisis.

If this is so, can the G-20 allow an archaic definition of sovereignty to forestall global action? I for one do not believe so, and furthermore I believe the time to act is now, while memories of the financial crisis are fresh and the window of opportunity is open.

Clearly, if the G-20 seeks to do its job, it is here in the definition of sovereignty (whether its expressed that way or not) that the battle lines will be drawn, for with the designation of the G-20 as the world’s new steering committee, the debate is no longer what will replace the G8, it is can any steering committee succeed under the old rule of sovereign rights without sovereign duties.

Indeed the argument to be made goes well beyond the G-20. It is, in the light of 21st century realities, that the redefinition of sovereignty should no longer be viewed as a threat to the integrity of the nationstate but as a necessary protection of nationhood.

What European and North American legislators must come to grips with is the reality that in the years to come, when the Chinese and Indian economies become as large as the American, and a Chinese hedge fund fails, or a mortgage meltdown occurs in India — it will be voters in Munich, Manhattan, Montreal, Manchester and Cambridge who will bear the disproportionate share of the fallout if we hide behind the traditional interpretation of sovereignty to frustrate the effective resolution of global issues now — now when we have the opportunity to improve the rules of the game, an opportunity we may not have in a decade when the emerging economies are feeling their oats even more than today.

The fact is effective global coordination does not mean the slow road to global government as some seem to fear. Nor do global institutions with teeth infringe on national sovereignty!

Quite the opposite. In fact, effective global institutions are the reaffirmation of national sovereignty in that they allow national governments to deal with problems that affect the common good, problems that transcend their borders which otherwise they could never solve. Indeed they are the very manifestation of enlightened national self-interest in an age of ever increasing interdependence. That is the argument the G-20 must not only make, it must deliver on!

In summary then, let me conclude with the reminder that the future of globalization is the great issue of our time and the issues of global poverty, climate change and the financial crises are all manifestations of the need to make it work better.

In that vein, how the G-20 deals with them will provide an indication of how it will deal across the board with the interdependence of states in the future.

The question the G-20 has to answer is now that there will be not one or two but for the first time in our lives, five or six giant economies at the table, what is it we must do to ensure that this works to everyone’s benefit. The answer to that question does not require genius but what it does require is a level of international cooperation that improved in Pittsburgh but which clearly failed the test in Copenhagen.

If the G-20 is to succeed, what it must do is to ensure that its dialogue takes place not just on the basis of the sovereign rights of its members but on the basis of their sovereign duties as well. Indeed, this could be the most important role the G-20 has to play as the world’s steering committee.

Thank You!