Nothing on unemployment, nothing on East Asia. What is G7 good for?

Hamish McRae on the issues where the main players can still make a difference

By almost universal opinion last weekend's Group of Seven meeting in London was a failure. Financial markets were disappointed that it did nothing to attack their main preoccupations, the East Asian crisis and the renewed recession in Japan. And delegates were evidently less than impressed by British triumphalism over our success in cutting unemployment, the meeting's other main preoccupation.

More about Japan and East Asia in a moment, for the unemployment issue deserves more attention. Since this country has cut unemployment faster than another large industrial country (faster even than the US), you might imagine that others would want an analysis of the methods used and the lessons learnt.

They probably would have done, but instead the assembled delegates got an eight-minute promotional video of the Government's ``New Deal'' for the jobless. My colleague Diane Coyle, who saw it, says that the film, complete with uplifting music, shows the Chancellor visiting young unemployed people at a JobCentre, all expressing their enthusiasm for the new programme.

Apparently this "young people acclaiming our happy smiling leader" line did go down slightly better than the Tories' more direct triumphalism on British job creation at the Lille summit on unemployment two years ago. Maybe our continental partners will take it from Labour but not from the Tories - or maybe after two years of total failure at job creation on the Continent, they are a little more humble themselves on this front.

But if anyone had expected the G7 to do anything on the Japan/East Asia difficulties or the continental European jobs disaster, they were looking at the wrong sort of institutions. The G7 - I suppose it should be G8, now that Russia joins as a sort of non-playing member - can be effective where there is a global macro-economic problem that can be solved by agreement between the main players. But it cannot do anything where the problems are regional micro-economic ones. These problems do not require international co-operation. They need structural action by individual governments.

That is not to say that G7 meetings are a waste of time. There have been at least three really important ones in the last 13 years. The first was the G5 (Italy and Canada had not joined the club at that stage) meeting at the Plaza Hotel in New York in 1985. That was when the dollar was soaring, US producers were finding themselves uncompetitive and Japanese exports to the US were rising at such a rate that the US was considering some form of trade barrier.

That agreement - a statement that the dollar had risen too high, plus some intervention on the exchanges - convinced the world that the peak had been reached. A fall began, which was checked by the next important G7 meeting, at the Louvre in Paris two years later. The Louvre Accord declared that the fall of the dollar had gone far enough and established unpublished target zones within which central banks would seek to hold currencies.

You can see the impact of Plaza and Louvre in the chart on the left, which shows the dollar against the yen. The fall of the dollar began in 1985 and then ended (for a while) in 1987. Eventually, after the Louvre unpublished bands system had broken up, the dollar fell to unsustainable levels. By 1995 the yen/dollar rate was down to 80. Then came the third key G7 meeting in Washington in April that year. It declared that the fall of the dollar had gone too far. It took a week or two for the markets to believe them, but as you can see, that was indeed the turning point, for the dollar has been rising against the yen pretty steadily since then.

Moral: when there has been a foreign exchange market error - driving currencies to unsustainable levels - G7 meetings can be very effective at bringing the markets back to their senses. But they cannot do much more. In particular, when they become an excuse for trying to persuade countries to do something they don't want to, they will disappoint; as they did last weekend.

This raises two questions. The first is: if G7 cannot help, what is the mechanism that will enable Japan to cope with recession and continental Europe to cope with unemployment? The second is: at what stage does G7 become useful again?

The answer to the first lies in close, dispassionate, apolitical study of the British model. Our experience is very interesting both to Japan and to the Continent, more interesting than that of the US because the scale of the reforms in the UK have been much greater and the starting point less favourable.

Thus the market reforms made by the UK in the 1980s are now being studied closely in Japan to see if there are lessons that can be applied. Japan's version of the City's Big Bang of 1986 is a good example. And if only continental Europe could carry out a non-politicised analysis of job-creation in the UK, it would have much to learn.

If the UK has turned out to be lucky in getting the reforms over early, Japan and continental Europe are fortunate in having a model. They ought to be able to use the model as a guide not only on how to make structural change, but also on how to avoid the collateral damage which structural change inflicted. They ought to be able to improve on our model, though there is only patchy evidence at the moment of their desire to learn from it. I suspect that the reform process, both in Japan and on the Continent, will be a 10-year-plus job, not a three- to five-year one.

Where does this leave a body such as the G7? There are gigantic imbalances in the world which will need to be tackled soon if they are not to damage the world economy. The graph on the right shows one of the most alarming: the way Japan has become the world's largest creditor nation and the US the world's largest debtor. This cannot go on. Graphs do not head in one direction for ever.

This is not a currency problem; it is structural one. So there is no quick fix, but the G7 is the one top-level body able to talk about it and, in particular, to try to persuade both sides that it is not in their mutual self-interest to allow such a build-up of claims on the other. When you hear that a G7 meeting is discussing a subject like that, rather than lack of demand in Japan and lack of jobs in Europe, expect useful action to follow.

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