United States and the IMF
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Europe in the Global Financial World--Adapting to the Challenges of the Third MillenniumAddress by Michel Camdessus
Managing Director of the International Monetary Fund
videotaped for presentation
at the European Banking and Financial Forum
Prague, Czech Republic, March 19, 1996
I welcome this opportunity to speak to you at the European Banking and Financial Forum--even if it must be from the distance of Washington. If my other obligations had permitted, I would have much preferred to join you and our hosts in Prague. Still, I hope that I will be able to contribute to your discussions. And after all, when talking about globalization, shouldn' t we take as a working hypothesis that distance matters less and less?
I have been asked to speak about the challenges of the third millennium and how Europe should prepare to meet them in a world of global financial markets. In fact, this is a key question facing all countries--and it touches on one of the most important aspects of the work of the IMF--helping countries to strengthen their economic policies so that they will be prepared for both the challenges and the opportunities of the global economy.
From my vantage point, I see many opportunities--for Europe and the world. Will Europe be able to seize these opportunities? Well, given that the future is always uncertain--not the least in matters of economics and finance--I ought to be cautious in my remarks. But, in fact, I am quite hopeful about what could be achieved in Europe--and the rest of the world--with good policies, more effective international coordination, and, of course, a lot of persistence and hard work. So let me put aside the circumspection and gravitas expected of the head of an international institution and suggest an outline of the future for Europe and the global economy.
What does the future hold for Europe and the world?
First, there is every reason to expect that the international capital markets will continue to grow larger, more complex and more closely integrated. Further advances in technology, the continued removal of capital controls, the scope for additional portfolio diversification, and the availability of increasing amounts of investment capital as industrial countries, in particular, reduce their fiscal deficits--all of these factors should contribute to the further development of the international capital markets.
Moreover, once EU members move to a single currency--and this, I believe, is both desirable and feasible within the Maastricht timetable for EMU--we can expect to see a broader and deeper European financial market. Many factors will work in this direction, not least of which will be the use of one very strong currency to anchor macroeconomic policy and to denominate European trade and investment; the development of a unified market for government securities issued by EMU members; a large and increasingly dynamic internal market; expanding trade with the rest of the world; and, thanks to further fiscal consolidation, larger amounts of European savings available for investment in Europe and abroad, lower interest rates, and lower risk premia.
I would add that these same developments should help Europe return to the solid growth and higher employment of earlier years. Brighter prospects in the European Union should, in turn, provide further incentives for other European countries--notably those in central and eastern Europe--to complete the structural adjustments required for them to join the EU, as well. Hence, I would not be surprised to see--demanding as the challenge may be--both a wider and a closer European Union.
Second, with more countries pursuing sound policies, and with markets continuing to channel capital into promising investments around the globe, we can expect to see a number of major new players in the international economy. This will be a very positive development, since, with more engines of growth, the world economy could become increasingly resilient. Indeed, there has already been a major shift in the relative economic size of the United States and Asia. Indeed, there has already been a major shift in the relative economic size of the United States and Asia. Between 1966 and 1988, the relative size of the U.S. economy (measured in terms of purchasing power parities) declined from 27 percent of total world output to 21 percent; while the share of Asia (including Japan) rose from 18 percent to 32 percent. Such shifts are likely to continue during the next century, making today's rankings of country economic strength seem as anachronistic as yesterday's debates of North versus South.
I would venture that among the next countries to burst upon the global economy will be a number of the transition economies--countries like the Czech Republic, whose early and determined start on stabilization and reform under the leadership of President Havel and Prime Minister Klaus has paid off in the early resumption of growth and strong capital inflows. In many cases, we will no longer think of these countries as transition economies, for the transition, as such, will be over. Russia, too, has enormous potential, assuming that it perseveres with its strong adjustment program.
Of course, as positive as these developments will be for global prosperity, the world economy will not be risk-free. As Mexico illustrated just last year, markets are sensitive to changes in economic fundamentals. Any significant relaxation of policy discipline--and other events that might trigger a shift in market sentiment--will continue to have potentially costly effects. True, the world is now more aware of these risks, and precautions are being taken by the IMF and its members to minimize them. Nevertheless, I think that we can safely warn you that Mexico will not be the last crisis.
In fact, with larger and more closely integrated capital markets, future crises may be still more destabilizing--both for the country immediately concerned and for the world economy at large. This has implications both for Europe and for us in the Fund. As regards Europe, I would not be surprised if its more prominent role in global financial markets made it feel such crises more keenly in the future than it has in the past! For the Fund, it means we must continue to strengthen our surveillance over country policies and performance, so that emerging problems can be addressed before they become full-blown crises. It also means that we must ensure that we have adequate resources to continue fulfilling our mandate: to give confidence to members by making the general resources of the Fund temporarily available to them under adequate safeguards, thus providing them with the opportunity to correct maladjustments in their balance of payments without resorting to measures destructive of national or international prosperity. Here, I was quoting from our Articles of Agreement.
A second risk is that of greater protectionism. As developing countries increase exports--especially in agriculture and basic industry, where many of these countries have, or are likely to develop, a comparative advantage--trade competition will surely intensify. In many industrial countries, the prospect of increased competition, reduced employment in some sectors, and declines in their shares of global output will prompt some to think of globalization in terms of winners and losers. But this will be a very short-sighted--and ultimately self-defeating--point of view. The inevitable changes in relative economic size will not necessarily be detrimental to the countries whose economic weights decline; on the contrary, as long as the global economy continues to expand, even countries with a decreasing share of the total can still enjoy rising levels of domestic income. Of course, the way to achieve this is to ensure that trade continues to be an essential engine of growth. By encouraging countries to specialize production according to comparative advantage, trade will promote a virtuous cycle of increased investment and productivity, leading to a further expansion of world output and trade. It is clear, however, that increasing trade competition will call for permanent structural changes in industrial countries, including more flexible labor markets, better worker training and retraining, and more effective social safety nets.
Finally, you may wonder what kind of international currency arrangements I envision for the next century. To begin with, the continued expansion of world trade, direct foreign investment, and other international capital flows should make the costs of exchange rate misalignments and the benefits of exchange rate stability all the more apparent. Let us hope that the success of EMU will provide the world with some useful lessons on the merits of working hard and paying the necessary price for international monetary stability, as the European countries did. At the same time, however, the emergence of many new players in the international system will probably make policy coordination all the more necessary and demanding, requiring more effective cooperation among the major countries and groups of countries. This latter trend will reinforce the need for the IMF to play a central role in "promot[ing] international monetary cooperation and provid[ing] the machinery for consultation and collaboration on international monetary problems." And, however strong the world s main currencies turn out to be, perhaps the world will see the need for an even stronger central monetary asset--such as the SDR--to help anchor the international monetary system.
So these are broad outlines of my vision for the future: a more dynamic global economy based on free trade and a high degree of capital mobility; a more dynamic European economy and a more prominent role for Europe in the global financial markets and in the international monetary system following EMU; and greater international monetary cooperation, leading to a more stable international financial system.
No doubt some of you will find this vision too optimistic. I hope that you will be proven wrong! In any event, I assure you-and this we will agree upon-that I have no illusions about the amount of effort that will be required to turn these aspirations into reality. Let me say a few words, then, about what the major requirements are.
First, all countries will need to pursue high quality policies. As I indicated earlier, I see great benefits in a single European currency-for Europe and the world-but EMU is neither a panacea for Europe s problems nor a substitute for fundamental reform. Irrespective of EMU, European countries need to reduce their fiscal deficits-both to ensure a reasonable degree of price stability without overburdening monetary policy, and to allow for adequate levels of investment and growth. Moreover, deficit reduction must be long lasting-both for the health of European economies, and for the sustainability of EMU. Accordingly, European governments need to address, among other issues, the problems of health care and pension costs-an additional structural burden on public finances that will become increasingly onerous with the aging of Europe s population.
At the same time, Europe needs to rethink its present labor market policies. It has become increasingly apparent that the current impediments to job search and job creation not only complicate deficit reduction, they also aggravate the problems of unemployment and low growth, and even undermine the social welfare that these policies were supposed to help protect. Clearly, reform is needed. Moreover, in order for EMU to work well over the longer term, EU members will need to increase both domestic labor market flexibility and international labor mobility within Europe, since exchange rate flexibility will no longer be available to correct competitiveness problems. Tackling these problems now would help boost market confidence, lower interest premia, and thereby facilitate adjustment and convergence.
I have also mentioned my hope for wider European integration. So far, the EU has negotiated Europe Agreements with ten transition economies. All of these countries have made progress in liberalizing, opening, stabilizing, and reforming their economies. But challenges remain, including the need to reduce inflation, reform budgets and social security systems, strengthen the financial sector, and accelerate progress on privatization and enterprise reform. With or without EU membership, these reforms will need to be made. But the prospect of EU membership can help support the transition-by providing a road map, a cooperative framework, and a boost to confidence.
I think enlargement can also help bring positive changes on the other side of the partnership-by acting as a catalyst for the reform of European institutions, including the Common Agricultural Policy. The world must also hope that as the EU evolves and lowers trade barriers vis-a-vis associated countries, it-and its non-EU trading partners-will also lower barriers on a multilateral basis, and thereby contribute to freer world trade.
The development of the financial markets also calls for action to strengthen the soundness of domestic banking systems, by reinforcing internal controls and prudential supervision. At the same time, however, more could be done to strengthen the role of the market in ensuring the soundness of financial systems-for example, by encouraging the market to provide high-quality and standardized information on financial sector operations and by governments adopting appropriate exit policies vis-a- vis financial institutions. As the markets become more global and interconnected, initiatives such as these would be a useful complement to official oversight.
Finally, a few words on the requirements for greater international financial stability-not just in Europe, but among all the major currencies. If countries want to achieve greater stability-and I do believe that it is in all of their interests to do so-they must work for it. Thus, in addition to pursuing firm domestic policies, countries must also coordinate their policies more effectively. What will this entail? It will entail countries making a greater effort to understand the interests and policies of others. It will involve countries listening more carefully to the judgments of others about their own economic policies. And finally it will require countries to take a more enlightened view of their own national interests-they will have to recognize that taking the interests of other countries into account is in their own self-interest.
I hope these remarks will provoke you to think-not of what is, but of
what should be. I think you will agree that the opportunities are great-both
for Europe and the world.
IMF EXTERNAL RELATIONS DEPARTMENT