Speech

International Financial Policy in the Context of Globalization--Remarks by Michel Camdessus

October 11, 1999

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I am delighted and honored by your invitation today, which offers the opportunity to reflect briefly on the current state of the global economy now that it seems set on a path of recovery, and on the agenda for international financial reform. I am especially pleased to do so at the invitation of Gerhard Stoltenberg whose tenure as Minister of Finance not only coincided with very intense moments of my personal career but, more importantly, could be seen as an anchor for Germany, and Europe at large, in the increasingly turbulent times as the Iron Curtain was finally crumbling.

It seems especially fitting to reflect on global issues here in Germany, a showcase in many respects of the social market economy, but also a country at the cross roads of Europe, which is witnessing at first hand the profound transformation of countries that labored for decades under a failed central planning system. And in Frankfurt, the financial heart of Germany, you are participants in the other great trend of the latter part of this century, the acceleration of globalization, most evident in the rapid integration of international financial markets with all the benefits and risks that it has brought during the last decade.

"International financial policy in the context of globalization"! In asking me to offer a few comments on such a broad topic, you could have had, Mr. Chairman, two different intentions. One, which—knowing you well—I discard immediately, might be to give me a nice occasion to exchange with good old friends a few light remarks on the subject of many meetings, discussions, pleasant anecdotes and, at times, vigorous confrontations over the years. But you would not have invited such a prestigious audience for small talk. I must then turn to a more austere topic, one which will be, for some time more, a matter of well-deserved reflection: the extraordinary, deep, and certainly unfinished transformation that globalization has introduced to international financial policy.

It is commonly admitted that it is in the area of financial relations that globalization—in fact a much broader phenomenon—has had the most pronounced impact on our lives. Financial markets have become integrated to a large extent with undeniable benefits for the best managed economies. Yet on two occasions the more vulnerable economies were exposed to severe crises with dramatic consequences in financial and human terms.

These two occasions could be seen as the two first economic crises of the new millennium. I refer to the Mexican crisis of 1994-95 and the so-called "Asian crisis," from which the world is just emerging. But every crisis has its silver lining, not least by bringing attention to bear on underlying vulnerabilities that the international community had not identified earlier.

Let me then devote my remarks to three obvious questions:

1. the vulnerabilities revealed by these two crises;
2. the changes they made imperative in the architecture of the international monetary and financial system; and
3. the interaction between building this new architecture and a renewed emphasis on the fight against poverty.

* * * * *

But first, a few words on the situation of the global economy.

Several of the emerging market economies that were at the center of the crisis—notably Korea, Thailand, and Brazil—are regaining the momentum of development. They have arrived at what may be, for each of them, albeit in different ways, the most difficult part of their recovery. Formidable reforms have been initiated in these and other countries, and the momentum must be sustained even though, with their economies beginning to rebound, the temptation is to ease up a little. But let us imagine that they resist this temptation—as they intend; then the chances are high that they will enter the new century in a strong position and with better prospects for higher quality and more sustainable growth than they would have enjoyed on pre-crisis trends.

In the industrial world, Japan, mired in recession for so long, is now showing signs that a self-sustaining recovery is a near prospect. The US expansion, which has had such a vital role in sustaining the world economy throughout this crisis, can—and should—be expected to slow, with the slack being taken up by expansion in the other industrial countries. In Europe, although performance is quite mixed, we see a general firming of activity and a growing awareness, at least in some smaller countries, of the need to improve the prospects for longer-term growth by tackling the structural issues that have plagued the continent for so long. Here in Germany, monetary conditions have been supportive of activity and the economy looks set to rebound from the period of weakness triggered by the emerging market crisis. The short-term outlook is thus favorable, but a durable strengthening of economic prospects requires that Germany move ahead with fiscal consolidation and find cooperative solutions to its labor market problems.

In most countries, there seems to be no immediate threat to one of the great achievements of the 1990s, continued low inflation underpinned by sound macroeconomic policies. In these circumstances, it seems appropriate for the balance of policy decisions in most countries to be slanted in favor of growth, so as to sustain the global recovery as the United States slows. In brief, if one remembers the anxieties of last Autumn, the world can be seen as enjoying unexpectedly good circumstances. This is then a particularly propitious environment to devote some thoughts to framing international financial policy in the context of globalization.

* * * * *

Back then to the vulnerabilities revealed by these two first crises of a globalized financial world, prompting major debate around the world and many suggestions for a new architecture.

If there is any single lesson to emerge from the major crises of the past decade, it is that the origins of external payments crises often extend far beyond the macroeconomic imbalances that give rise to disequilibrium in the current account of the balance of payments—the domain to which our founding fathers, more than 50 years ago, had limited the jurisdiction and surveillance of the IMF. In the Latin American debt crisis of the 1980s, the dominant creditors were international banks, and the main domestic cause of imbalance was excessively expansionary fiscal policy, a public sector out of control. By contrast, in the emerging markets crises of the 1990s, especially in Asia, the macroeconomic fundamentals did not appear to be pointing to imminent meltdown. But problems of a different nature were severely undermining the very fabric of these economies.

What these crises have done is to lay bare many shortcomings of an international financial system designed at a time of public sector predominance. Now with the explosive growth and increasing integration of the capital markets during the past decade, it is the private sector that occupies a prominent, perhaps dominant, position on both sides of the ledger, as creditor and debtor. The range of players in the international markets has become far more diverse: direct investors, portfolio investors, banks, bondholders, and others. And the domestic private sector—both banking and corporate—is typically a much more significant player. Now as the private sector is so important, new forms of tensions have emerged. On the debtor side, be it in Thailand, Indonesia, Korea or elsewhere, national economic policies and institutions have revealed weaknesses in one or more of a number of areas: financial systems; public and corporate governance and transparency; and certain aspects of macroeconomic policies. But it must also be recognized that the crises have not been entirely of these countries' own making. Significant too were poor investment decisions by external creditors, based on inadequate risk assessment. On the official side also deficiencies were found in monitoring and supervising capital markets and institutions engaged in international capital transactions. These shortcomings allowed risk exposure to accumulate to the extent that it threatened global financial stability.

In a nutshell, the crises of the last decade have suggested and, in fact, have made imperative three fundamental lessons:

• First, the golden rule of transparency;
• Second, good governance as a universal "must" both for the private and public sectors;
• Third, the importance of the triangular relationship between monetary soundness, high quality growth, and poverty reduction, if we are to respond, using the words of Minister Gurria from Mexico, to the "ultimate systemic threat," poverty.

Lessons one and two will not surprise those of you who have analyzed the Asian experience in particular. But lesson three is no less important as it derives both from the Asian experience—with the inadequacy of traditional models of social protection when confronted by globalization crises—and from the too slow progress of the efforts for poverty reduction among so many poor countries in the world. No wonder then, that the international community has been busy these last years in addressing both the issues of the new architecture of the international monetary and financial system and of poverty as a global systemic threat.

Toward a new monetary and financial architecture

Let's consider first the international community's work on how to reform the architecture of the international monetary and financial system. The avoidance of crises in future, or at least the reduction in their frequency or intensity, hinges on the success of these efforts. The goal, summarized in a very few words, is to build a sounder international financial system that is conducive to free, but orderly, international capital movements, based on sound national systems and prudent, transparent macroeconomic policymaking. It would be a system that promotes transparency through internationally recognized standards and codes of good practice; here we will see "the golden rule" in action. It would be also a system:

• that fosters financial sector soundness, based on strong regulatory and supervisory practices;
• that seeks to develop a mature relationship between the private and public sectors such that each plays its full and responsible role, including in forestalling and resolving financial crisis;
• that aims to develop open, integrated capital markets, with progress toward liberalizing capital movements being undertaken by individual countries in an orderly and well sequenced fashion;
• that ensures that the international financial institutions and other agencies must be adapted and strengthened to enable them to play their full part in an evolving world.

Where are we now in all these domains? The international community was given a progress report two weeks ago in the form of the communiqué of the Interim Committee—its last before being reconstituted as the International Monetary and Financial (IMF) Committee. It pointed to major progress in several key areas: broad agreement on the importance of transparency, on the definition of global standards to underpin efficient, fair and stable markets, and on financial sector stability. In these areas, the emphasis is shifting from the defining of standards to their dissemination, implementation, and monitoring. This next stage will prove to be time-consuming and resource-intensive, requiring sustained efforts by many standard-setting agencies. But here the task waiting for all of us is crucial if we are to respond seriously to the challenges of globalization.

For the Fund the issues are quite clear: the codes for which we have direct or shared responsibility—data dissemination, transparency in fiscal policies, transparency in monetary and financial policies, banking supervision—are operational. With help from our members, they can be implemented. But in other areas much remains to be done, and the responsible agencies tell us that they do not have the capacity to monitor implementation on their own. To what extent Fund surveillance should be used for this purpose is a question that remains to be resolved.

Progress has been slower in some other areas where full consensus has yet to emerge. First, involving the private sector in crisis prevention and resolution raises a number of difficult issues. There is an understandable desire to derive rules that would offer a uniform approach to involving the private sector when crisis strikes. But experience is showing how widely circumstances can differ and how tricky and possibly illusory it would be to try to find a "one-size-fits-all" approach. Nevertheless, while this debate has been underway, a number of actual country cases are providing us with a body of "case law". These experiences will help as the international community proceeds to distill a set of principles that will help crises to be resolved at less cost than in the past.

Second, what is the optimal rate of proceeding with liberalizing capital movements and what should be the role of direct exchange controls? Here I believe we are closer to a workable consensus. Already most agree with two basic ideas: that liberal capital movements are beneficial to worldwide growth; and that liberalization should follow an orderly path, tailored to each country's situation. In the coming months, the IMF will be considering proposals for a gradual, country-specific approach that explicitly recognizes the great variety of country situations. Once consensus is reached, which I hope will not be long delayed, it will be possible to resume the momentum that was established at the 1997 IMF Annual Meetings in Hong Kong, but which—understandably of course—gave way to second thoughts in the wake of the emerging markets crisis.

Third, we come to the core of the Fund's mandate, the question of exchange rate regimes. We have become well aware of the potential of deficiencies in exchange systems or exchange rate management to trigger or to amplify crises. The debate on the choice of regimes is still very wide-ranging, some arguing for more widespread use of fixed rates, while others favor the opposite end of the spectrum, unrestrained floats. It is clear that, for the time being, the diversity of exchange rate regimes will continue, although it is increasingly accepted that today's greater mobility of capital makes the maintenance of fixed rates more demanding on domestic economic policies. In the end, whichever arrangement a country adopts, sound economic fundamentals are essential. Here the exemplary process leading to the launching of the euro, and the experience during its first year of life, provide a crystal-clear illustration of the role of prudent macroeconomic policies. Hans Tietmeyer, so instrumental in the advent of the European Monetary Union, in his recent book "Social Market Economy and Monetary Stability", stresses this point admirably, and also hints at the arduous task that lies in front of these regional groupings that would wish to emulate the euro's experience.

Mr. Chairman, as you see, the efforts of the past two years to contain the virulent contagion that spread through global capital markets and the steps to reform the international financial system to minimize the risks for the future, have produced some welcome changes, but they still leave us with a great deal to do. And the same can be said of our efforts to make the initiatives for a new architecture and the fight against poverty mutually reinforcing.

Fighting poverty and stability of the international monetary system

Poverty in the world is for many, including myself, the more important and deeper crisis. The systemic risks entailed by widespread poverty around the world need no elaboration but certainly call for urgent and decisive action. The renewed emphasis given to this issue in IMF-supported programs and surveillance is, contrary to many recent comments, an initiative which remains very close to our core mandate and basic experience¹. From its experience as a monetary institution—with the emphasis on macroeconomic problems and related structural reforms—the IMF has learned much about the connection between sound monetary and economic policies, high quality growth, and poverty reduction. It is now solidly demonstrated that price stability and low fiscal deficits promote economic growth. Economic growth in turn is a sine qua non and the most significant single factor that contributes to poverty reduction. Yes, macroeconomic adjustment benefits the poor. And structural policies also: dismantling product and factor market rigidities helps reduce poverty by increasing not only the supply of essential goods, but also the poor's access to them. In addition, there is increasing evidence that lower inflation also enhances income equality.

All of this is now abundantly documented.² We now have clearer evidence of the interconnections among the elements of the triangular relationship. Sound monetary and macroeconomic policies can promote poverty reduction. But now it is also much better understood and acknowledged that the effect also runs in the other direction. For the discipline of a strong monetary policy to be maintained long enough to eradicate inflation and to contribute to sustainable growth, it must be implemented in a context in which integral parts of government policies include: the fight against poverty, the adoption of appropriate social safety nets, and a recognized effort to reduce severe inequalities in income distribution over time. By giving legitimacy and fostering broad-based support for sustained reform, these social policies can contribute decisively to create the political environment in which sound monetary policy can and must develop its beneficial efforts.

In a word it is clear that no poverty reduction can be achieved in a sustained way without sound monetary policy. But now we can see also that no sound monetary policy can be sustained if "patent injustice," to take the words of Amartya Sen, is left unaddressed.

This is why the fight against poverty has gained center-stage in our programs, is being developed hand-in-hand with our efforts on the international monetary and financial architecture and has justified recent major changes in our strategies by:

• suggesting much closer cooperation in this respect between the two Bretton Woods institutions, and
• taking advantage of the readiness of key creditor countries to authorize a major debt reduction in favor of heavily indebted poor countries (HIPCs) to create the right incentives for these resources to be allocated to poverty reduction and human development.

Let me tell you where we are in this respect.

On the eve of the millennium, the international community has taken a significant step to alleviate the debt burden of the poorest and most heavily indebted countries by a substantial enhancement of the initiative for the HIPCs. It offers two innovations: first it provides more extensive debt relief, to more countries and on a quicker path than was envisaged under the original initiative. Second, it involves an explicit link between debt relief and poverty reduction, a response to widespread concern that excessive debt servicing obligations undermine the provision of basic social services, especially to the poorest. Our goal is to help countries—as they undertake reform, as they stabilize their economies, and as they receive international assistance, including very highly concessional debt relief—to channel the benefits to where they are most desperately needed, reducing poverty, so giving the Köln initiative a lasting impact on human progress in these countries.

One must keep in mind that for the poorest countries, there are two distinct elements in the war on poverty. The first and most important is the domestic one: strong, sustainable, high-quality growth. It is therefore the national authorities' responsibility to create an environment that is conducive to such growth—a stable macroeconomy, an open, efficient market economy, sound financial sector, transparency and all the other aspects of good governance. But equally recognizing that growth is most likely to flourish in the presence of strong social policies, or where—put in the cold language of economists—essential investments in human capital are taking place.

The other element is an international one. Let me highlight two steps that the international community can offer in parallel with the Köln initiative:

• Industrial countries can open their economies to the exports of the poorest countries, not only primary products but all exports, so that incentives are provided for new, more diversified export production. This step need not await the outcome of the new round of trade liberalization due to be launched in Seattle next month.
• Donors could commit themselves to substantial improvement in the quality and quantity of official development assistance, to support the many pledges that the international community has adopted over the past decade to promote human development. In particular, I bring to your attention the pledge to reduce absolute poverty by one-half by 2015.

In a word, a fully articulated social policy is vital for achieving sustained high-quality growth. It is a key component in a country's development objectives but can only be effective if it enjoys broad-based support within the country, and is accompanied by strong international, financial and technical support. What role does the IMF have in all this? The interrelationship between growth and social development has been too loosely defined so far in our activities, even though for many years IMF-supported programs have explicitly incorporated social considerations. It was time to go one major step forward. So, we are left, here also, with a major agenda for implementation.

Already we have taken steps in this direction by transforming our concessional ESAF into the Poverty Reduction and Growth Facility, in parallel with new steps for debt reduction, an explicit link with poverty reduction, and a new level of cooperation with the World Bank. This link with the World Bank will be essential, for, of the Bretton Woods institutions, it is the Bank, not the Fund that has the expertise to help countries develop their social services. Will the IMF determine how many clinics a government should build, or what student/teacher ratio is appropriate in a country's schools? Absolutely not. Will we question the level of unproductive spending to ensure that adequate room exists within national budgets to allow the governments to promote minimum standards of health care and education compatible with the level of development of the country? Yes, certainly. The Poverty Reduction Strategies that will be a central feature of our new facility, will allow coordinated input from international agencies—the World Bank, the United Nations, other donors—and civil society in the interested countries to assist governments in implementing the broad social objectives, while allowing the IMF to stay in the domains of its comparative advantage.

Should this emphasis on poverty, and social policy enter more generally into the Fund's other, non-concessional lending operations or more generally into our policy dialogue with member countries in the context of surveillance? The debate is still open on this issue. But let me just make two simple observations. Every country confronts poverty to at least some extent. In the poorest countries we may find that poverty can have macroeconomic consequences as it undermines social cohesion and saps the capacity of the population to participate in productive activity. At the other extreme, notably in industrial countries, social protection systems can, without periodic policy changes, lead to a sclerosis of the economy, reducing incentives and limiting potential output. It is in such areas, where macroeconomic policies intersect with social goals, that the Fund has a legitimate basis, and I should say, a responsibility to engage in a dialogue with the authorities in the pursuit of its primary purposes.

* * * * *

Before concluding, with so much emphasis on action and implementation, how can the industrial countries such as Germany contribute to a solid foundation for the financial architecture? First, they can be exemplary in applying the new or revised standards, building on their already strong record in this regard. Second, regulators, supervisors and market participants all will have a part to play, and they will benefit greatly from the work of the Financial Stability Forum, a brainchild of Hans Tietmeyer. Third, for many years to come there will be a heavy demand for technical cooperation as emerging market and developing countries strive to strengthen financial systems and introduce new standards. In this domain, Germany has a very great deal to offer.

Mr. Chairman, I believe we have reached a hopeful point in the recovery. The worst of the crisis is well behind us. An agenda for the evolutionary reform of the international monetary and financial system is clearly established. Implementation of many key aspects of reform is underway, although there is much to be done. This progress has now allowed us to concentrate attention on the plight of poorest members of the international community, to better help them help themselves to escape from poverty, so bringing their own contribution to global prosperity. The emphasis in the coming months and years must be on the rapid implementation of our demanding agenda in a spirit of international cooperation. I am certain, Mr. Chairman, ladies and gentlemen, that the world can count on your strong sense of international responsibility and solidarity.