Constant Purpose, Changing World: The IMF in the Twenty-First Century, Anne O. Krueger, First Deputy Managing Director, IMF
October 30, 2003Constant Purpose, Changing World
The IMF in the Twenty-First Century
Anne O. Krueger, First Deputy Managing Director, IMF
Bradley Public Policy Lecture
School of Business Administration
University of Wisconsin, Milwaukee
Thursday October 30, 2003
It's a great pleasure to be here today, and to participate in the Bradley Foundation public policy lecture series. I'm grateful to Dr Kanti Prasad for inviting me in the first place, and I'm very glad that we were able to find a time when I could come to Milwaukee.
I'm also pleased to be able to pay tribute to the work of the Bradley Foundation. It has a distinguished record in supporting academic research on policy issues and I know it also plays an active role in many other aspects of community life, especially here in Wisconsin.
I suspect Dr Prasad thought he would never get me here! But as it turns out, the timing of my visit is fortuitous. The International Monetary Fund is now in its sixtieth year‚we celebrate our birthday next June. My theme today, though, is looking forward: I want to assess the challenges facing the IMF and to outline how we plan to respond to them.
In some ways, the task ahead of us is more demanding than ever before.
We now have far more member countries. When the Fund was established after the now-famous Bretton Woods conference, there were 32 founding members: the membership expanded to 68 in 1960 and 121 in 1971. Today 184 countries belong to the IMF. What's more, many of those countries need‚and use‚our help: not just financial help, but policy advice and technical assistance of various kinds.
Of course, the process of globalization long predates the IMF. But the integration of the world economy has accelerated rapidly in the postwar era. This brings its own challenges. The potential benefits are enormous. But many countries, especially those that are poor or most vulnerable to economic shocks, need help to exploit those benefits. They often look to the IMF to provide that help.
We cannot‚and we do not‚underestimate the scale of the task we face. But I believe that in many ways the IMF is better prepared today than ever before, and today I want to show how and why.
The historical context
Let me start by reviewing what the IMF is for. It is fashionable these days for organizations to talk about their core purposes. Whenever I think about our aims, I am filled with admiration for those who drew up the Fund's articles of agreement. These are worth reading because they underline the extent to which the Fund's objectives have remained consistent over the years. At the beginning of the twenty first century, the IMF is still promoting financial and economic stability, growth, and the expansion of trade. Back in the 1940s, the negotiators were looking back to the searing experience of the 1930s. They wanted to ensure that there could be no repeat of the beggar-thy-neighbor economic policies of that dismal decade, when countries were busily erecting barriers to trade and engaging in competitive devaluations that benefited nobody and cost everyone dear. The participants at Bretton Woods were determined to avoid global financial meltdowns of the kind that had cast a long shadow over the 1930s.
The context today may be different. But our fundamental task has not changed. I think our overarching objective‚the maintenance of global financial stability‚is at least as important today as it was in the 1940s. It is one of the clearest examples of an international public good, because global prosperity depends on it, in a very real sense. When I listen to the critics complaining about what we do, I am tempted to speculate about a world where the IMF did not exist. I am not saying the Fund has never made mistakes. But the international financial system has been much less volatile, during a period of enormous economic change, that many of our founders could have imagined, or dared hope.
The critics often fail to acknowledge that the world is a very different place than it was sixty years ago. One of the principal differences is that it is far more prosperous. Everybody‚rich and poor‚has benefited from the rapid expansion of trade and economic prosperity in the past sixty years. The postwar decades were a golden age‚yes, for the industrial countries above all, but for almost all the developing countries too.
Let's look at some of the facts. In the decades immediately after the war, the growth rates of the major industrial countries made the achievements of the nineteenth century seem modest. America saw per capita income growth averaging 2.4% a year between 1950 and 1973: Germany grew on average by 5% a year, and Japan by more than 8%. Impressive though this performance seemed at the time, it was only a foretaste of what was to come for the newly-industrializing countries. Most of the Asian tiger economies grew at annual rates of 7%, 8% or more between 1985 and 1994, for example. China averaged GDP growth of more than 10% a year during the same period.
Some economies have been transformed in the post war period. We're all familiar with the rapid growth of China as a force in the global economy. But look, too, at Korea: its per capita income rose almost sevenfold between 1962 and 1992. Even India, slow at first to engage with the world economy, has recently enjoyed very good economic performance: in the 1990s, following the first wave of economic reforms, it averaged GDP growth of about 6% a year, making it one of the fastest-growing of all developing economies.
Greatly improved performance at the macroeconomic level has translated into better living standards‚for all. Infant mortality rates have declined sharply. In East Asia and the Pacific, for example, they dropped by nearly 60%, to 39 per 1,000 births, between the 1960s and the 1990s. Literacy rates have risen worldwide‚to around 80% for men and 70% for women. Perhaps most striking of all is the improvement in life expectancy in the developing world. It now averages 65 years, up from 40 years half a century ago. And the gap between life expectancy in the developed and developing world has narrowed, from 30 years in 1950 to around 10 years today.
The multilateral framework
Of course I would not presume to argue that the IMF deserves all the credit for such progress. But the multilateral economic framework established after the Second World War has played an important role in facilitating trade and economic growth. We must not lose sight of that when we look ahead to what we in the Fund, alongside our member governments, need to do to deliver prosperity and growth in the future. The link between global prosperity and the growth of international trade was recognized by those drafting the IMF's articles. They also realized that a sound international financial system is crucial in fostering trade growth: thanks to their foresight, that is what the world has enjoyed in the past 60 years.
The period between 1946 and 1973 was not without its ups and downs. But the system of fixed exchange rates established at Bretton Woods served the world economy well for many years. The switch to floating exchange rates among the industrial countries from 1973 onwards was far more successful than many anticipated, and has also contributed to sustained economic growth. The oil price shocks of the mid and late 1970s were disruptive, of course: but much less than they might have been, because of the flexibility that floating exchange rates provided.
The oil shocks are sometimes seen as a turning point in postwar economic history. In fact, the rise in oil prices was related to the worldwide surge in inflation in the late 1960s and early 1970s. The jump in oil prices certainly brought important changes in the nature of the Fund's work, because it was in this period, and after, that developing countries became the IMF's biggest customers.
The oil producing countries suddenly found themselves awash with cash surpluses in need of a home. As oil revenues were recycled, Western commercial banks lent aggressively to oil-importing developing countries, usually on a floating rate basis. With hindsight, the result was predictable‚many countries were unable to service their debts as interest rates rose in the early 1980s as part of the drive to curb inflation in the industrial countries. The IMF played a leading role in helping resolve what became known as the third world debt crisis of the early 1980s.
Of course, financial crises have always been part of the Fund's work. The challenge for the IMF is to do as much as possible to prevent them but, once crises occur, to resolve them as smoothly as possible. Of course, even if the Fund were always right in detecting trouble ahead, governments would not necessarily follow the advice on offer. There are many reasons why a government might want to delay acting on external advice or might choose to ignore it altogether. And unless a government seeks financial assistance from the Fund, the staff ultimately has little leverage in persuading reluctant governments to introduce reform.
Failure to heed warnings by the Fund will inevitably lead to crisis in some cases. Crises in individual countries have been frequent: but they have rarely brought widespread disruption to the global financial system. I come back to my point: that the multilateral framework put in place in the 1940s has served the international economy well.
The 1990s were years of profound change‚in the international political system as well as in global finance. The changes brought with them some of the biggest challenges the IMF has yet faced. It was, in many ways, a difficult decade. But it was, in some senses, an enriching experience for the Fund, and I think we‚and many of our members‚emerged the stronger for it.
The most dramatic change, of course, was the collapse of the Soviet empire. The political upheaval was momentous and altered the character of international relations. It brought us a large number of new members‚all urgently needing our help. They needed financial assistance, of course. But they also needed advice on how to develop normally functioning market economies. We, along with other agencies and governments, tried to provide that advice.
In the early days, the learning curve was steep for everybody concerned: the sort of economic transformation needed had never been attempted before. But it is perhaps a measure of how far all those involved succeeded that many of the countries that for decades had been completely outside the international financial system are about to join the European Union. And after twelve years, tomorrow marks the last day of the IMF department known as European II. We concluded that those countries once under the yoke of Communism have made sufficient progress that they no longer need a special department of their own.
But the former Comecon countries weren't the IMF's only pre-occupation during the nineties‚the world was changing so fast in many ways that it was difficult to keep up. One crucially important factor was the rapid growth in private international capital flows that followed the deregulation of capital markets in many countries. Some of the biggest financial crises the Fund has ever dealt with seemed to come thick and fast. The Mexican debt default in 1994; the Asian crisis of 1997-98, Russia in 1998, Turkey in 2000 and, most recently, Argentina in 2001: these all involved enormous upheaval for the countries concerned, for the IMF and, to a great extent than usual, for the international financial system.
These crises were different in nature as well as scale. The most significant factor was that they were capital account crises, rather than the current account crises that the IMF had been used to handling. They erupted much more quickly, and the provision of assistance was often much more urgently needed. Many of us belatedly realized that financial market liberalization brought with it the need always to be conscious of the markets' judgment. At the time, that judgment can sometimes seem harsh; it can certainly be unforgiving. But we and our member countries are learning, as I shall explain in a moment, to live with and benefit from the discipline that the market can impart.
I noted that capital account crises can occur very rapidly and require an immediate response. Such crises occur because the holders of a country's debt lose confidence in its ability to service that debt. In principle, a crisis can occur even if the country's current macroeconomic policies are sound‚if the creditors believe such policies will not be sustained. When there are real‚and justified‚doubts about a country's economic policy, these can erupt into a full-blown crisis with astonishing speed. The only effective response is to restore creditors' confidence that a country will be able to meet its debt obligations in full. That, I hardly need add, is easier said than done.
So the past decade or so has been a very steep learning curve‚yes, for the IMF, but also for economists outside, and for governments. We have been trying to work out how best to detect when a crisis is imminent, how to respond to the warning signs‚and, of course, how to handle crises when they do occur. Our conclusions have led us to shift the focus of much of our work: though I should point out that, for the IMF, the learning process is continuous as we adapt to new information and developments.
One thing we now know is that fixed exchange rates tend to compound the problem. It is simply not possible to have a fixed exchange rate, capital mobility and an independent monetary policy‚such a combination is a recipe for trouble. Today, far fewer emerging market countries attempt to maintain fixed exchange rates.
Recent IMF research has shown that there is a strong case for embracing exchange rate flexibility as countries grow richer and become more integrated into the global capital market. This is because flexibility allows easier adjustment to shocks, which, in turn, helps maintain higher growth rates.
We also recognize how important debt sustainability is in judging whether a country has sound economic policies that will deliver lasting economic growth. But we have also learned that many more fundamental reforms are needed if emerging market countries are to enjoy greater economic stability. Our experience in the former Communist economies reinforced our view that countries need properly functioning judicial systems, enforceable property rights, accountable and transparent public institutions, efficient tax systems, modern and effective public expenditure management. In other words, exactly the sort of things that you and I can take for granted here in the United States but which citizens and businesses in so many countries around the world cannot. Their absence impedes everyday economic activity.
Investors get nervous if they cannot be sure they will get legal protection in the event of, for example, arguments about property ownership. If tax evasion is the norm, ordinary citizens have no incentive to pay their taxes, and the government's public finances remain precarious. Inadequately supervised banks can undermine confidence in the domestic financial system. Secretive public institutions do not inspire the confidence of citizens or foreign investors. Bribery and corruption do not usually go hand in hand with prosperous well-functioning economies.
All these issues are now an essential part of the Fund's work. We regularly examine the economies and economic policies of all our members‚what we call Article IV surveillance. As part of that process, we now pay far more attention to debt sustainability. We have introduced what we call the Financial Sector Assessment program, aimed at looking more closely at banks and other financial institutions, and at how they are regulated and supervised. We also help countries adopt internationally established Standards and Codes. We provide technical assistance to countries who need help to implement some of the reforms I've mentioned. And, of course, we continue to provide advice on macroeconomic policy.
We've also learned that transparency is important‚for us and for our member countries. Many of you here today might not be aware of quite what a revolution has taken place at the Fund in recent years. We used to be criticized‚often with justification‚for our secretive ways.
We still are criticised: but nowadays the charge is false. We pride ourselves on being one of the world's most transparent organizations. We publish nearly everything we write‚including most of the papers that go before our Executive Board. [Indeed, my remarks today will probably be on our website before the weekend!] We have also been encouraging our member countries to let us publish the reports we produce after our Article IV consultations‚with considerable success, I might add. So much so, in fact, that we have just modified our transparency policy again. Now the presumption is in favor of publishing such material, unless a member country objects.
One reason‚but not the only one‚for our own transparency policy is to lead by example. We are encouraging member governments to see the benefits for them of transparent policymaking. Citizens have more confidence in their government when they know what it is up to. So do the financial markets. Markets can generally cope with bad news: what they loathe is uncertainty. Lack of transparency creates uncertainty and doubt‚sometimes unnecessarily.
And now we have another carrot with which to tempt governments. A recent research paper prepared by IMF staff suggests that greater transparency can bring financial rewards. It can reduce borrowing costs, as measured by what we call sovereign spreads‚the interest premia that countries pay above US treasury bonds. The research found that markets respond not just to publication of reports, but to the content of those reports. So transparency can reinforce the drive towards good policies.
I think it's worth noting that some of the most vociferous opponents of transparency‚both inside and outside the IMF‚are now some of its strongest supporters. Nothing succeeds like success!
Crisis prevention and resolution
All the steps I've described come under the broad heading of crisis prevention‚a critical part of the Fund's work. When appropriate we can back this up with financial assistance. The loan agreement between the IMF and Brazil last year‚the largest in the Fund's history, by the way‚was a good example of such a pre-emptive move. We were satisfied that the policies being pursued with the then government were sound. But as the presidential election approached, the financial markets became increasingly concerned lest the new government abandoned or relaxed those sound policies. The agreement with the IMF explicitly committed the new government to maintain those policies‚and the markets recovered their nerve. This year, as the new government has stuck to its commitment, the markets have remained calm and Brazil has seen the interest rates it pays on its bonds fall sharply.
When things go wrong the IMF often gets the blame, or part of it. To some extent I believe that is inevitable. Apart from anything else, the IMF often has an uncomfortable message to impart. In the short-term, a crisis will require a government to adopt strong measures‚and to do so quickly. Recommending such measures is, very often, doing little more than stating the obvious. That will not stop governments facing political and economic turmoil at home from looking for a scapegoat, preferably one located outside the country.
In the medium and longer term, working to achieve stability, sustainability and prosperity also involves tough, uncomfortable decisions for political leaders. Lasting progress, as I've said, means undertaking fundamental reforms‚in economic policy, but also in judicial and institutional arrangements. It is tempting for governments to put off change which takes time to work through and which, in the short-term, will bring them little but political unpopularity.
It is tempting to say that there really is no alternative for governments confronting economic difficulties. But that is wrong, of course. There is an alternative path‚but the consequences will be far worse. Failing to act to restore short-term stability and longer-term economic growth will simply ensure that a country continues to slide towards the abyss. Inaction puts off the turning-point in a crisis. It also ensures that far more painful measures will eventually be needed to halt the decline.
The IMF does all it can to convince governments that if they adopt‚and stick to‚sound economic policies, their economies will be much better placed to weather the economic shocks that are inevitable from time to time. The Article IV consultations I mentioned earlier offer one important opportunity.
But the Fund can get its message across more effectively when a country is seeking financial assistance. Reaching agreement on a program of assistance is a two-way process, and because the IMF is a member‚based organization, a process which involves a country negotiating with its peers. When a country is not immediately seeking financial help, though, the IMF's scope for influence can be limited. Sometimes staff will have little or no leverage until a crisis erupts‚even when trouble is clearly on the horizon.
The changes I've described reflect, as I said, our experience in the 1990s. Some reflect greater understanding of how economies and markets function in the modern world, and how crises occur. Some reflect what we might call institutional failings. If anything, in the 1990s, the IMF was, on occasion, perhaps too understanding, too ready to accept partial reform, and too ready to ignore failure. We are now more conscious than ever that lack of reform, or reforms unenthusiastically or half-heartedly implemented, will hamper economic progress. Markets lose confidence and it can be difficult to restore. Indeed, it can be progressively more difficult to regain the confidence of the markets‚and for that matter of ordinary citizens‚if expectations are raised and then disappointed on successive occasions.
In spite of some of the recent headline-catching crises‚most notably in Argentina, but also in Turkey‚I believe the changes in the Fund's approach and working methods have borne fruit. In spite of the synchronized global downturn, and the after-effects of September 2001, there have been remarkably few crises. The Asian economies have bounced back impressively‚emerging Asia is now the world's fastest growing region. Indonesia, to take just one example, is now thinking of coping without a new IMF program once the current one expires. And Turkey's economy is now growing rapidly, woith a falling inflation rate and a lower debt-to-GDP ratio.
Of course, crisis resolution will always be an important feature of the Fund's work. It is certainly the aspect that catches most public attention. By definition it is difficult to throw much light on how we will handle crises in the future: each one is different, and those most difficult to resolve are often in cases where a government is particularly reluctant to accept the diagnosis‚let alone and take the necessary medicine.
But here too the Fund has made progress. The wide-ranging public debate we initiated on the Sovereign Debt Restructuring Mechanism did much to focus people's minds on how best to respond to crises where a country's debt burden is so high that it can truly no longer maintain or restore full debt servicing. One tangible result of this debate has been the adoption of Collective Action Clauses by several countries who have issued bonds under New York law this year. They have done so without having to pay any penalty in the market.
I said at the outset that the Fund's objectives have not changed in the nearly six decades of our existence. We still aim to help countries achieve economic stability and prosperity‚and for that, international financial stability is essential. By working in a multilateral framework, in which trade liberalization plays a central part, we can all help to promote global stability and prosperity. We live in an increasingly inter-dependent world. All countries‚not least the United States‚have an interest in seeing living standards raised worldwide.
The global growth record of the past sixty years demonstrates conclusively that this is not a zero-sum game. Everybody can benefit from a stable international financial environment, free trade and growth-oriented but sustainable economic policies. We've achieved much in recent years, but significant challenges remain if all the IMF's members are to gain maximum benefit from globalization.
I said the timing of my visit was fortuitous. A global economic recovery is, finally, under way. The next couple of years should therefore provide an opportunity which governments need to seize. The real challenge of modern political leadership is to embrace reform‚and to do so when it makes most sense, not when a government has its back against the wall in the middle of a full-blown crisis.
The challenge for the IMF is different. We cannot force reform on reluctant governments. But we can use argument and persuasion to bring them round. We can help them implement reforms in an effective way. I cannot guarantee we will always be successful. But I can assure you that the challenge is one we will do our utmost to meet.
Thank you very much.