Prospects and Challenges in our Globalized World Economy -- Remarks by Michel Camdessus
April 4, 199595/6
Managing Director of the International Monetary Fund
at the Wharton School of the University of Pennsylvania
Philadelphia, April 4, 1995
I was very pleased to be able to accept the invitation from your European Club to visit the Wharton School, and I appreciate this opportunity to speak to you about developments in and prospects for the world economy, some of the major challenges confronting economic policy makers today, and the role of the IMF.
The world economy today presents a picture of sharp contrasts. Success and progress on some fronts seem to provide grounds for confidence that within our reach there is great potential for sustained economic growth, increasing prosperity, and the alleviation of poverty. But on other fronts, there seems to be limited progress in tackling long-standing problems, and much of the progress that is made seems increasingly vulnerable to shifts in international financial markets and capital flows. To set out a course for the future, it is essential that we understand the origins of both the successes and the vulnerabilities.
Let us first look at the positive side. It can be argued that world economic prospects now are brighter than for many years. Following the global slowdown of 1990-93, the growth of world output last year, at 3.7 percent, was in line with its long-term trend, and in fact somewhat higher than we estimated last October. And IMF staff are projecting global growth at slightly faster rates this year and in 1996.
What is the basis of this improved performance and relatively bright prospect? I suggest that four elements are particularly important:
- success in reducing inflation in the industrial countries;
- policy improvements that amount to a "silent revolution"
in the developing countries;
- the recovery that has just begun in the economies in transition that
have made progress with economic stabilization and reform; and
- a strengthening that is going on in international trade and investment.
Let me say a word or two about each of these factors.
First, in the industrial countries, growth performance, and prospects for sustained growth, have improved as a result of success in the reduction of inflation. Consumer price inflation in the industrial countries last year was about 2 1/2 percent. This was the lowest in three decades--the lowest in the lifetimes of many of you! And our projections show inflation running only slightly higher this year and next as the expansion proceeds. This is indeed a promising basis for sustainable growth. In much of the past 20 years, the growth performance of industrial countries has suffered from high and rising inflation and the essential actions of monetary authorities to bring it under control. They have now managed to put the dragon of inflation back in its cave, and as I shall indicate later, their essential task now is to keep it there.
Second, the growth performance and prospects of the developing world have improved as a result of determined efforts at stabilization and economic reform in many developing countries over the past decade. The improvement in performance has been very clear in the past few years: during 1991-93, the developing countries saw average growth of 5 1/2 percent, well above their average growth rate of about 4 percent in the 1980s. And this acceleration is all the more remarkable because it occurred in spite of the economic slowdown in the industrial world and the weakness of commodity prices. This was quite unlike experience in earlier cycles. In fact, in 1993, growth in the developing countries rose above 6 percent and was the main engine of global expansion! Growth was maintained above 6 percent in 1994, and on the assumption that policy improvements are maintained, our projections point to rates of growth only slightly lower than this in the period ahead.
The source of this improvement in developing country performance and prospects can be narrowed down to about 40 countries--I am glad to say the list is growing--that have undertaken strong and persistent structural adjustment programs, with the financial support of the IMF, or with the help of our technical assistance, or continuing with strategies designed in cooperation with the Fund. In these countries, improved fiscal and monetary discipline has helped to increase financial stability and foster a favorable business climate. And market-oriented structural reforms--including price liberalization, privatization, and increased openness to foreign trade and investment--have reduced distortions and stimulated incentives and competition. The benefits of such policies have been most striking in the "dynamic economies" of Asia. But fundamental changes in policies have also occurred, or are underway, in many countries in Latin America, Africa, and the Middle East.go
The third component of the recent improvement in global economic prospects is the beginning of economic growth in the countries in transition in Europe and the former Soviet Union. The transition from central planning to market-oriented systems in these countries began more than five years ago. A milestone was Poland's adoption at the end of 1989 of a program of liberalization, stabilization, and structural reform supported by the IMF, which came after lively discussions--let me put it that way--with Finance Minister Balcerowiez and Mr. Lech Walesa, still head of Solidarity. Last December, the Polish Government invited me to Warsaw to celebrate... It was somewhat difficult to recognize President Walsesa, now in the Presidential Palace, but much more difficult to recognize what had been a somewhat gloomy Warsaw in the lively city of today. Since 1989, the Fund has provided support for programs in almost all the transition economies. All of these countries initially and unavoidably suffered deep declines in output. But in those countries where there has been substantial progress in reducing inflation through fiscal and monetary discipline, coupled with bold and broad-based reforms, output has turned around and growth has begun. In 1992, Poland was the first and only transition economy to see economic growth. In 1993, the number of growing transition economies increased to 4; and in 1994 to 11. Our projections for the countries in transition as a group point to a turnaround in output in the course of this year if policies remain on track, and positive year-on-year growth for the first time in 1996. Here is another group of countries where there is great economic potential to be tapped!
The last major factor I want to mention that is giving a positive impetus to global growth is the strengthening that has been occurring in the growth of international trade and investment. In the first quarter-century of the post-war period, the industrial economies grew faster than in any comparable period before or since; and there is no doubt that one of the main factors contributing to that exceptional rate of progress was the expansion of trade made possible by the lowering of trade barriers under the GATT and the removal of exchange restrictions on current account transactions under the aegis of the IMF.
An essential part of the strategy of the successfully adjusting developing countries, as I indicated a moment ago, has been the opening of their economies to the world through trade liberalization and the removal of exchange restrictions. The same applies to the countries in transition that are eagerly integrating their economies into the global market after suffering the costs of decades of operating in a largely separate, restricted system. One indication of the increasing openness of developing and transition economies is the fact that in the past two years the number of countries accepting the obligations of current account convertibility of their currencies under the IMF's Articles of Agreement has risen from less than 80 to more than 100. Another has been the growing trend toward capital account liberalization in developing and transition economies, following the elimination of capital account restrictions in most industrial countries during the 1970s and 1980s.
Also, of course, in the area of trade, there has been the major achievement of the ratification of the Uruguay Round agreement and the establishment at the beginning of this year of the World Trade Organization. This has led to a welcome easing of trade tensions among industrial countries. Such regional initiatives as NAFTA and the development and expansion of the European Union will also make important contributions to the growth of global trade as long as they remain outward-looking to the rest of the world. Finally, of course, there are the major technological advances that have been reducing the costs and increasing the speed of transport and communication and that have made possible the globalization of financial markets.
All these developments have been contributing to the growth of international trade and investment. In 1994, world trade volume grew by as much as 9 percent, its highest growth rate in almost 20 years; and IMF staff are projecting almost equal growth this year and next. Another significant development has been the steady and substantial growth of foreign direct investment flows to the developing countries, from less than $20 billion a year, net, in the late 1980s to $60 billion in 1994.
These four developments provide, I believe, quite impressive grounds for expecting a continuation of solid economic growth in the world economy in the period ahead. But the main significance of these developments is not that they provide reasons to be optimistic--let alone complacent--about the future, but that they provide a basis on which to build, and lessons that must not be forgotten, as policymakers address the problems and challenges they face. If these are the opportunities we see in today's world economy, they must be preserved and extended as the problems we face are tackled. Let me turn, then, to some of the main challenges that have to be addressed.
For the industrial countries, there are three major challenges ahead. One is to safeguard the progress on inflation as growth proceeds: low inflation must be preserved. It is mainly the responsibility of central banks to prevent undue inflationary pressures from emerging, and this means that in an economic upswing such as we are now seeing they need to tighten monetary conditions well before unemployment and capacity utilization reach the levels where inflation picks up. If they fail to do this--if they act too late--the result is likely to be a "boom-bust" episode of the kind we have seen too often in the past. In the United States and other countries that are at relatively advanced stages of the current expansion, central banks have undertaken such pre-emptive monetary tightening over the past year or so. And in recent weeks, confidence seems to have grown that the Federal Reserve, at least, is successfully engineering a "soft landing" and preventing a "boom" that would inevitably be followed by a "bust." One indication of this increased confidence is the decline of roughly a full percentage point in long-term interest rates that has occurred in the past six months. Continuing vigilance to prospective inflationary pressures will be essential in all countries as the upswing proceeds.
In spite of the recent easing of long-term interest rates, they remain higher globally, in real terms, than throughout the post-war period up to the early 1980s. Such high real interest rates are a disincentive to investment and employment creation in the private sector, and an obstacle to better productivity growth; and they bring me to the second major challenge facing the industrial countries--the need for almost all of them to strengthen their saving performance, especially through further efforts to reduce their budget deficits.
The high level of world real interest rates that has persisted since the early 1980s can be traced in large part to a decline in world saving in this period; and this, in turn, is accounted for mainly by a widening of fiscal deficits in the industrial countries--increasing government dis-saving, in other words--and an associated growth of government debt. The need to reduce budget deficits, in order to increase the saving available to finance investment, and to reverse the rise in government debt-to-GDP ratios, is well-understood in almost all industrial countries, but in most cases--including, I fear, the United States--existing deficit reduction plans are too modest. For the United States, for instance, following the progress made in the past two years, our projections suggest that on current policies the federal deficit and debt-to-GDP ratio will begin rising again in 1996.
The need for stronger fiscal action has been accentuated by recent instability in foreign exchange markets, since most of the countries that have seen their currencies weaken--for example, the United States, Canada, and Italy--suffer not so much, as is often the case with weak currencies, from relatively high inflation, but from chronic fiscal problems, associated in some cases--including the United States--with balance of payments weakness. International investors seem to have become less inclined to go on financing persistent borrowers, especially when they are borrowing to consume rather than invest, preferring to place their funds in countries with stronger fiscal positions. More determined efforts to restore fiscal balance in the countries with weak budgets would help to achieve greater stability in exchange markets and financial markets more generally. Moreover, the current economic expansion provides a clear opportunity to undertake the more ambitious fiscal consolidation that is required.
The third major challenge facing industrial countries in Europe and Canada is to reduce unemployment from the intolerable levels to which it has climbed over the past two decades. In much of Europe, especially, with unemployment rates around 10 percent or higher, this is the main blight on the economic landscape and the highest item on the policy agenda. Of course, a strong expansion will perform part of the task of reducing unemployment, but it will not be sufficient: even at the peak of the last expansion, unemployment in many of these countries stood well above 7 1/2 percent, which was the highest level reached in the United States in the last recession. Especially in Europe, it has long been evident that unemployment is a structural problem, and that it can be tackled only by changes in labor market policies. Here again, more determined action is needed, in the environment of the current expansion, to improve the flexibility of labor markets--including restructuring unemployment benefits, liberalizing employment and wage-setting practices, and improving training.
For the developing countries, the challenges are to sustain, consolidate, and extend the improvements I referred to earlier. The successfully adjusting countries must sustain and consolidate their progress on the basis of the strategies that have brought such success over the past decade--strategies consisting of strong fiscal and monetary discipline, market-oriented structural reform, openness to the world economy, social policies as an integral part of programs, and good governance.
But what about Mexico? What are the implications of the crisis in this country that was thought to be one of the models of successful development strategy? Developments in Mexico since December, and their repercussions, have highlighted many facts of economic life in the 1990s.
- One is that even countries that have made impressive progress in many
areas--and Mexico has certainly done so--cannot afford to relax their discipline
with macroeconomic fundamentals or become over-dependent on foreign borrowing.
The problems experienced in Mexico can be traced in large part to the widening
of its external current account deficit (to 8 percent in 1994)--which was
related to a low and declining private saving rate and the appreciation
of its real exchange rate--and also to an insufficiently tight domestic
monetary policy. Mexico is now in the process of correcting these shortcomings
through a strong adjustment program supported by the Fund.
- A second fact of life highlighted by the Mexico crisis is that when
a country's economic policy fundamentals are awry, financial markets can
change their perceptions and their minds, and force adjustment, swiftly,
suddenly, and with an ample degree of over-reaction. I recently referred
to the Mexican crisis as the first crisis of the 21st century, meaning
that it is the first major crisis to have arisen in an emerging market
economy in our new age of globalized financial markets. It is surely not
the last, but in order to reduce the likelihood of future crises all countries
will need to be even more careful than in the past to ensure that their
policies are sound and that unsustainable economic imbalances are not allowed
to emerge and persist. Let me make clear here that it is not a lesson of
the Mexican crisis that countries should retreat from globalization, or
that countries should regress toward less open markets. This is well understood
by the Mexican government, which quite appropriately is addressing its
problems without imposing any trade or exchange controls. As I indicated
earlier, increasing openness to trade and financial flows has formed an
essential and reliable basis of economic progress; and to fall back on
restrictions because of financial market reactions to policy inadequacies
would be akin to shooting the messenger. It is policy inadequacies that
have to be addressed.
- A third fact of life highlighted by the Mexican crisis is that the
need for international economic cooperation, and the responsibilities of
the IMF, are now greater than ever before. I shall return to this in a
Apart from Mexico, of course other successfully adjusting developing countries are continuing to face a variety of challenges. China is a prominent example of a country where exceptionally strong growth in recent years has brought overheating and the authorities have been working to reduce demand pressures. In a number of other countries, improvements in policy regimes and in economic performance are still relatively recent. In Brazil, for example, the stabilization plan introduced last year has already reduced inflation substantially; to ensure that this progress is not jeopardized, the authorities will need to strengthen public finances, which will also help to contain the balance of payments deficit. In India, where the dismantling of controls on private industrial activity has been extensive in recent years, relatively high trade barriers and slow public sector reform continue to impede competition and productivity. India will also need to step up fiscal consolidation efforts to alleviate inflationary pressures and strengthen national saving.
But what about the other developing countries--those, particularly the poorest, and especially in Africa, that have seen little progress and suffered such tragic stagnation and decline in living standards over the past decade and longer? Their challenge is to muster the determination, with the support of the international community--including the conditional financial assistance that the Fund can provide, but also aid and enhanced debt relief by bilateral creditors--to implement programs of the kind that have brought such success to others. That is the way--the proven way--they can achieve the sustained improvement in living standards and human conditions they so badly need.
Similarly for the countries in transition, the challenge is to sustain and extend the progress with policies that has begun to bring economic growth to many. There are substantial reforms remaining to be accomplished in all these countries. And a number, including Russia and Ukraine--the largest countries of the former Soviet Union--have yet to achieve the macroeconomic stabilization that is needed for sustainable growth; but with IMF support they are now implementing strong programs aimed at securing that urgent objective.
Russia, for example, began this year with inflation at a monthly rate of 18 percent, but has recently embarked on a strong program for 1995 aimed at reducing inflation sharply, to 1 percent a month on average in the second half of the year. The program designed in collaboration with the Fund to attain this objective entails a halving of the federal fiscal deficit and a number of key structural reforms, including a liberalization of the export regime that will have an especially significant impact on the domestic oil market. The program presents formidable challenges for the Russian authorities. But when I was in Moscow last month I was reassured by President Yeltsin and Prime Minister Chernomyrdin as well as by other cabinet ministers and the head of the central bank that the necessary commitment is there. I was particularly impressed when President Yeltsin told me that after the opportunities missed twice in the past two years, the government cannot afford to fail this time. By way of illustrating his resolve, he told me there is a long queue of people seeking special treatment, and that he is giving them all the same answer: nyet. An indication of this commitment is that the Russian government is cooperating with us to protect the program under especially stringent IMF conditionality and unusually close monitoring. If, as I fervently hope, it is fully implemented, there are good reasons to expect that after more than four years of deep decline, growth will begin in Russia in the course of this year.
I have been attempting this afternoon to give you my view of some of the main features of the global economic situation and outlook. It is a story of chances and challenges, but also one of difficulties and dangers. Tomorrow and later this week, we shall be discussing these and other aspects of the world economic outlook in the Fund's Executive Board in Washington, and in three weeks' time it will be the turn of the finance ministers and central bank governors who will come to Washington for the meeting of our Interim Committee. In this presentation, you have already heard a lot about the IMF and its activities in its membership of 179 countries; but let me conclude by saying a few words about how I believe the IMF can continue to strengthen its contribution to a better global outlook.
There are two aspects I would emphasize. First, the Fund, through the policy advice it provides to its member countries in the course of its so-called surveillance activities, can help them achieve progress and avoid policy mistakes. Our twice-yearly discussions of the world economic outlook form part of IMF surveillance. But also vital are the annual consultations we hold with each of our individual member countries, big and small. It is through these annual consultations that each member meets its obligations to subject its policies to the scrutiny of the Fund, so that the rest of the membership has an opportunity to comment on those policies and especially their effects outside the country concerned. We are working to strengthen the Fund's surveillance in a number of directions--by sharpening our analysis of developments and policies; by improving the provision of data to the Fund by members on a regular and timely basis; by seeking closer dialogue with members between consultations, as needed; by strengthening the contribution of the Interim Committee; and so on. I referred at the beginning to the "Declaration on Cooperation to Strengthen the Global Expansion" that the Interim Committee issued in Madrid last October. That Madrid Declaration set out a framework of policies for wise use of the current economic recovery, and progress in implementing those policies will be reviewed in our Executive Board this week and by the Interim Committee at the end of the month.
IMF surveillance is an international cooperative effort aimed at improvements in policies, the prevention of policy mistakes, and the promotion of exchange market stability and sustainable growth. By making surveillance more effective, we should be able to help countries see how their own houses need to be put in order, before they are forced to adjust by the sometimes brutal discipline of markets.
If surveillance is to do with prevention, the second role of the Fund that I wish to emphasize is concerned with cure. The IMF's Articles of Agreement, written more than 50 years ago, state that one of the purposes of the Fund is "to give confidence to members" by providing them with temporary financial assistance to help them "correct maladjustments in their balance of payments without resorting to measures destructive of national or international prosperity." That is precisely what the IMF is doing today for Mexico, what it is about to do again for Russia, and what it is doing at the present time in more than 50 other member countries. Over the past 50 years, the Fund has adapted its lending facilities in many ways to meet the changing needs of its growing membership. And we are now considering carefully whether the Fund's financial resources are adequate for it to continue playing in the years ahead its essential role of providing financial support for stabilization, adjustment, and reform in the new environment of our globalized world economy. Here is another set of issues where we shall be seeking guidance from finance ministers when they meet in our Interim Committee later this month.
Our globalized world economy has opened up new opportunities and increased the scope for economic progress in the world. Globalization is something we must embrace. But it has also brought increased risks, and increased the importance of vigilance and discipline in economic policies, of strengthened adjustment and reform efforts, and of active international economic cooperation. The IMF is well aware of its increased responsibilities in this environment, and you can count on the Fund to make every effort to fulfill them.