By the late 1990s, the global economy had become too interconnected for the institutions governing it. Capital could cross borders in seconds. Financial crises could move from one country to another with little regard for geography. Yet the principal forum for managing the international economy remained dominated by the advanced economies of the G7.
That arrangement looked increasingly inadequate.
The first warning had come from Mexico in 1994. A sudden reversal of capital flows pushed the country into a financial crisis and forced an international rescue. The lesson was uncomfortable: an emerging economy could become a source of instability far beyond its borders.
Three years later, the problem became much larger. In July 1997, Thailand abandoned its exchange-rate peg and devalued the baht. What initially looked like a national currency crisis quickly became a regional financial collapse. Indonesia, South Korea and Malaysia were hit by capital flight, currency depreciation and banking failures. Economies that had spent decades building reputations for rapid growth, fiscal discipline and macroeconomic stability suddenly found themselves fighting for financial survival.
The crisis challenged more than currencies and banks. It challenged the prevailing assumptions about emerging markets. These were not governments that had simply spent recklessly. Many had high savings, relatively strong fiscal positions and low inflation. Their vulnerability came from a financial system increasingly exposed to volatile international capital and weak domestic banking and corporate structures.
By 1998, the crisis was no longer confined to Asia.
Russia defaulted on its domestic debt in August and the resulting shock intensified global risk aversion. Private capital flows to emerging markets dried up. Brazil came under pressure. Japan was struggling with recession. By the beginning of 1999, the IMF was warning that turbulence originating in Asia had developed into a broader threat to the global economy and could produce a worldwide credit crunch.
For the G7, the message was clear: financial stability could no longer be managed exclusively by the major industrial economies. The response began to take shape in 1998. G7 finance ministers and central bank governors acknowledged that the Asian crisis had exposed weaknesses both in emerging-market economies and in the international financial system. They called for stronger international co-operation and reforms to strengthen the system.
Germany and Canada were particularly important in turning that recognition into an institution. The idea was not to replace the G7, IMF or World Bank. It was to create a wider forum in which the major emerging economies would have a permanent seat alongside the established powers.
The United States, Japan and the major European economies would remain at the table. However, the choice of new members reflected the changing balance of economic power. China and India were already too important to exclude. Brazil and Mexico were major Latin American economies. Indonesia and South Korea had been at the centre of the Asian crisis. Saudi Arabia brought its importance to global energy markets. South Africa represented the African continent. Russia had become a major player in global finance and commodities.
The objective was practical rather than ideological: bring together economies whose policies and financial systems could materially affect global stability. In September 1999, G7 finance ministers and central bank governors agreed to establish the Group of Twenty. The new forum would operate at the level of finance ministers and central bank governors, with the IMF and other international institutions closely involved.
The first meeting followed in Berlin in December, hosted by Germany. The timing mattered. The immediate crisis was already receding. Korea and Thailand were recovering, capital was beginning to return to emerging markets and Brazil had regained some market access. But the recovery had not erased the lesson of the previous two years.
The G20 was therefore created not at the height of the crisis, but in its aftermath. There was little indication at the time that the G20 would become a leaders' forum or acquire a wider geopolitical role. It was principally a mechanism for preventing the kind of financial instability seen in Asia from exposing weaknesses in international economic co-operation again.
That distinction matters when considering the G20 today.
The organisation was not created because the world had decided that emerging economies should collectively govern the global economy. It was created because the financial crises of the 1990s had demonstrated that the existing arrangements were no longer sufficient. The G20 was therefore, from its beginning, a recognition of economic reality. Its first test would come less than a decade later, when a financial crisis originating in the developed world would force the group to move far beyond the mandate envisaged in Berlin.