Köhler on growth and stability
In April 2002, it is clear that September 11 did not pull down the global economy for long. This is mainly due to the leadership of the United States, with its bold decisions to lower interest rates and reduce taxes. A recovery is under way now in the United States, and this is already beginning to have a positive impact on the economies in other regions. It is only fair now for me to pay off my bet with U.S. Secretary of the Treasury Paul O’Neill and treat him to dinner. His faith in a relatively early turnaround of the U.S. economy has prevailed over my more cautious assessment. And, of course, I am happy about that.
The question mark is mainly how strong and durable the recovery in the United States will be. This relates in particular to uncertainties about company earnings with their implications for business investment, the volatility of the oil price, and political uncertainties in the world, in particular related to the situation in the Middle East.
Such a situation does not call for frantic action. What is needed is vigilance and a firm policy hand to make the recovery robust and more dynamic. This means the main focus of policy must shift from short-term considerations to tackling decisively underlying problems. And, here, a main responsibility lies with the advanced economies.
The United States must pay special attention to preventing the reemergence of the twin deficits (fiscal and external) of the 1980s. This requires firm control over public spending and the definition of a long-term strategy to increase national savings.
The other major economies also can and must contribute to the reduction of the global imbalance related to the U.S. current account deficit. Europe has been a stabilizing factor during the recent slowdown. What I still miss is a stronger ambition to move to a higher potential growth path with stronger domestic demand dynamics. The road map for this is already defined in the reform agenda to create a truly single common market. And there is enough evidence that structural reforms must also be accelerated at the national level, in particular in labor markets and social security systems. Japan’s ongoing recession is still a drag on global growth, particularly on activity in the Asian region. There is now hope that the recession is bottoming out. But the return to a growth performance that corresponds to Japan’s size and potential demands decisive action for the disposal of nonperforming loans, industrial deregulation, and restructuring of its banking and corporate sectors.
For emerging markets and low-income countries, the worldwide slowdown in 2001 confirmed one important lesson: good policies pay off. Countries with sound fiscal and monetary policies and persistence with structural reforms have weathered the storm better than others and have demonstrated that it is possible to decouple from contagion. They should stay the course. Together, the global economy and the international financial system demonstrated a remarkable resilience in 2001.
With all due modesty, it is fair to say that the IMF has played a role in this. Our work to strengthen the global financial system has begun to bear fruit. And the fact that the membership of the IMF came together last November at a critical moment for the global economy was crucial. The Ottawa meeting of the IMFC [International Monetary and Financial Committee] emphasized a collaborative approach that worked.
- On the whole, the advanced economies used their room for maneuver to rebuild momentum for the global economy.
- The IMF helped shield poor countries through augmented financial support under the Poverty Reduction and Growth Facility (PRGF).
- We assisted emerging market countries, for example, through timely decisions on programs for Turkey and Brazil.
- We also defined an ambitious action program to support the international effort to combat money laundering and the financing of terrorism.
better trade opportunities for all and the expansion of trade must now become the centerpiece for a strategy to promote sustained global growth and truly shared prosperity.
But the crisis in Argentina and persistent vulnerabilities in a number of countries leave no room for complacency. Argentina, in particular, has shown that protracted external borrowing to finance public consumption, without generating sufficient external revenues, breeds disaster.
There is a more general point: the expansion of global capital markets needs to be better anchored in stronger trade integration and, thus, growth in debtor countries. The fact is, however, that since the late 1980s the degree of integration of developing countries as a group into global capital markets (measured by foreign assets and liabilities as a ratio to GDP) doubled, while trade openness (measured as the ratio of exports and imports to GDP) has increased relatively little with the important exception of Asia.
As highlighted by comparative analysis in the IMF’s upcoming World Economic Outlook, overall, Latin America’s external vulnerability is higher than that of other emerging market countries. Why? Latin American emerging markets as a group are relatively more integrated into global capital markets. But, at the same time, they have not managed to raise the share of their exports in GDP in line with their increased external borrowing.
If we understand crisis prevention as tackling the causes of crises, we need to view this imbalance as a fundamental problem. I am deeply convinced that we need not less, but more integration of economies to foster growth in the global economy, not least to fight world poverty. But if we do not manage a better balance between the opening of capital accounts and the expansion of trade, we may see a cyclical recurrence of financial crises.
This means that better trade opportunities for all and the expansion of trade must now become the centerpiece for a strategy to promote sustained global growth and truly shared prosperity. And in this context, I think the advanced countries again have a main responsibility—in particular, by opening up their markets and phasing out the multibillion-dollar business of trade-distorting subsidies. It is essential to have leadership to face and withstand the special interests of some groups for the benefit of the broad majority of the people in both rich and poor countries. But the leaders in the developing countries should be equally ambitious in getting rid of barriers to trade among themselves.
Where does the IMF stand today?
The IMF is working on a broad reform agenda, learning from experience and adapting to changes in the global economy. And I expect the IMF to learn even faster in the future thanks to the work of the Independent Evaluation Office. And there has been progress.
The IMF has already seen a revolution in transparency and openness. It is now better focused on macroeconomic stability and sustainable growth. To this end, our work is concentrating increasingly on the soundness of financial sectors in member countries and on the assessment of developments in international capital markets. We have also reviewed our conditionality to focus better on priorities and give room to ownership of reforms by the countries themselves. Finally, we have intensified our cooperation with other international institutions, in particular the World Bank.
Learning from experience also leads us to be more humble. We must draw firmer conclusions from the fact that sound institutions and good governance are crucial for sustained growth and financial stability. That is, we have to be more realistic about what the IMF can influence by providing money. And we must bear in mind that, to resolve homegrown problems, no money in the world can substitute for self-responsibility and political unity in a society.
I am deeply concerned about the developments in Argentina—particularly the social hardship for a large part of the population. The IMF wants to help Argentina. We are not asking for the impossible. But it is of fundamental importance that the federal government, the congress, and provincial governments face reality, pull together, and agree on an economic reform program that gives new trust to the Argentine people and to domestic and foreign investors. There is also agreement with the government that every effort must be made to help cushion the impact of the crisis on the poor. Here, the World Bank and the Inter-American Development Bank have the lead in developing specific programs.
Crisis prevention and resolution
A well-functioning market economy draws its strength and dynamism from competition. This means a continuous search for better results, better products, and higher productivity. We have to accept that some degree of overshooting and correction will always be part of that process if we want to preserve a system based on freedom of choice and self-responsibility. And there are limits to the ability to predict and thereby prevent crises. Our objective can only be fewer and less severe crises.
The major vehicle to promote this objective is the IMF’s surveillance function. The Executive Board of the IMF recently began a major review of surveillance. There is agreement that further strengthening the effectiveness of surveillance has two main aspects: better policy advice and greater impact. From the Board discussion I draw the following conclusions.
First, the IMF needs to concentrate even more on vulnerabilities and risks, on seeking improvements in the quality and timeliness of data provided by countries, and on promoting standards and codes as “rules of the game” for the global economy.
Second, member countries need to strengthen shock absorbers that make them more resilient to adverse external developments. This points to the importance of more flexible exchange rate regimes, prudent fiscal policies, and stronger, deeper, and more diversified financial systems, but also to the importance of more effective social safety nets.
Third, and perhaps most important, we need to become better at persuading countries to take early action to address emerging problems and imbalances. This applies to both advanced and developing economies, because vulnerabilities and risks to the global economy and to financial stability do not originate in emerging markets alone but from the major economic and financial centers as well. More transparency and greater candor in our advice is one major avenue toward this objective. A more proactive engagement of the IMF to reward good policies through contingent or precautionary financing is another.
Over the past couple of decades, international capital markets have become the most important source of capital flows to emerging markets. By the same token, private sector financing has become increasingly crucial for innovation and economic growth more generally. Adapting to these changes also means building a public-private partnership between private financial institutions and public institutions such as the IMF. As part of this approach, the IMF has launched an informal but regular dialogue with the private sector, and I am quite pleased about the way the Capital Markets Consultative Group has evolved. As a result, we have been able to engage constructively on issues, such as investor relations programs in member countries and promoting standards and codes, including on corporate governance and accounting principles.
In this context, I encourage the private sector to come forward with more ideas on how to strengthen the self-correcting mechanisms of markets. Here, I would include more effective self-regulation and restraint to counter excessive risk taking and “creative” accounting.
For crisis resolution, it is an indispensable principle that debtors and private creditors must bear the responsibility for the risks they take. But private financial institutions also—and rightly so—have asked for greater clarity and predictability about the decisions the IMF will make in a crisis to enable investors to price risks adequately.
Our current work program is directed in large measure at this goal. It is focused on three critical and interrelated areas: better-informed judgments about debt sustainability; clarifying the policy on access to IMF resources, which means establishing clearer presumptions about limits to IMF financing; and working on a new legal framework for restructuring unsustainable sovereign debt.
On this last point, there is broad agreement on the need for better incentives and tools to allow for a more timely, orderly, and less costly restructuring of unsustainable debt. The IMF Board is discussing two principal approaches:
- a statutory framework, based on an amendment of the Articles of the IMF, which would facilitate an agreement between a sovereign debtor and its creditors. In this new approach, creditors could decide by a qualified majority on the terms of a restructuring deal and make these terms legally binding on all creditors.
- a contractual approach, which seeks to achieve similar results through the widespread inclusion of collective action clauses in bonds and other debt contracts.
It is clear that there is a gap in the current approach to crisis resolution that has to be closed. While more ambitious use of collective action clauses is desirable, I do not believe this alone would be sufficient. The proposal for a new Sovereign Debt Restructuring Mechanism (SDRM), developed by Anne Krueger and IMF staff, is, in my view, farsighted and will close this gap. Work remains to be done in these areas, but I hope that we will have found a broad consensus on the SDRM by the time of our Annual Meetings this fall.