The International Monetary Fund and Global Stability, Remarks by Rodrigo de Rato, Managing Director of the International Monetary Fund
June 10, 2005
Remarks by Rodrigo de Rato
Managing Director of the International Monetary Fund
At the IESE Business School, University of Navarra, Madrid
Madrid, June 10, 2005
As Prepared for Delivery
1. Good morning. It is a great pleasure to be here. As you know, I assumed the position of Managing Director of the IMF about a year ago. It has been a very interesting period, and I wish to use this opportunity today to discuss what I see to be some of the key challenges that currently confront the global economy. This will be done against the backdrop of the IMF's role in the international economy, and how we contribute to global economic stability.
The International Monetary Fund
2. Let me start with a brief overview of what is happening at the IMF, and what we are doing in furtherance of our objectives. It may be helpful to recall that the IMF's mandate is directed squarely at the promotion and maintenance of macroeconomic and financial stability, both in individual countries and at the international level. We do this through a variety of ways. First, the IMF serves as a forum for international economic cooperation, recognizing that a country's domestic policies can have impact beyond its physical borders. Second, it helps countries design macroeconomic policies that achieve and maintain high levels of employment and real income, with a belief in the benefits of open trade being a key element of these policies. Third, it helps in the orderly correction of a country's balance of payments problems by providing temporary financing.
3. These unique facets of the IMF distinguish us from other international financial institutions like the World Bank and regional development banks, whose focus lie in development and poverty reduction. Operationally, the ways in which we discharge our mandate are also unique in several ways. For convenience, our work may be divided into three main categories of activities:
• First, surveillance—In surveillance, each country engages in a consultation with IMF staff of its economic and financial policies, usually on an annual basis. Surveillance helps us to identify economic risks and vulnerabilities early, and is a key instrument for promoting economic stability. All member countries of the IMF, regardless of economic strength or stage of development, are subject to the surveillance process. With increasing regional economic integration, surveillance is also conducted at the regional and international levels, such as for the euro area, and in our World Economic Outlook and Global Financial Stability reports.
• Second, lending—Our primary financing role continues to be in the provision of temporary funds to help countries correct balance of payments problems. Although we do not provide development loans, IMF financing is available on concessional terms for our poorest members, and with longer-term maturities. We continue to see an important role for IMF financing. It provides breathing room for countries to correct underlying economic problems without resorting to measures that may harm global stability—for example, trade restrictions and currency manipulation.
• Third, technical assistance—The ability to receive technical assistance is an important benefit of IMF membership, especially for developing and low-income countries. Many of these countries lack adequate capacity and knowledge in the formulation and implementation of strong economic policies. IMF technical advice and assistance, primarily in the areas of macroeconomic and financial policymaking, fills a critical need in this regard. Subject areas where assistance may be provided range from banking supervision, to tax and customs administration, to statistical systems.
4. These three operational instruments—surveillance, lending, and technical assistance—are the key ways through which we promote economic stability in the world. Needless to say, the world economy has witnessed dramatic changes in the 6 decades since the IMF's birth. For instance, IMF membership has grown four-fold, from around 40 to 184. The world's financial landscape has also been dramatically altered by the rise of private international capital flows. Throughout the changes of the last six decades, the IMF has continually evolved to meet the needs of its members and the international economic system. This spirit of evolution and renewal—an important and healthy aspect of the institution—has helped to ensure that we continue to serve the interests and needs of our members.
5. With increasing globalization, the volume and pace of economic change is now more intense than ever before. We are very mindful of that, and of the fact that the IMF needs to keep pace with the changes so as to serve our members effectively. The IMF must continue to evolve with the varying needs of our members and the international community. For that reason, late last year, I initiated an internal review of the IMF's medium-term strategic direction. The review is still at the preliminary stages, but it will touch on all the key themes of the IMF's role in the international economic system. Issues that will be explored include:
• The IMF's continuing role in the promotion and maintenance of stability and growth in the global economy, including through multilateral cooperation;
• How the IMF can best help countries design and implement strong macroeconomic policies;
• The role of IMF financing in the international economy and in individual countries;
• IMF governance, particularly the voice and participation of emerging market and developing countries in our decision-making; and
• How the IMF can best meet the special needs of low-income countries. The IMF is a key partner in the global war on poverty, and is fully committed to helping developing countries reach the Millennium Development Goals.
6. Notwithstanding this ongoing process of review and reflection, there appears a consensus that the central tenets of the IMF's mandate—international cooperation and financial stability—will continue to be of crucial importance to the world economy in the coming years. I would even say that international economic cooperation has acquired added significance today. In a global economy that is increasingly driven by cross-border finance and trade, there will undoubtedly be issues which can only be addressed through international cooperation. The IMF, with its near universal membership of 184 countries, remains the natural forum to address these. Let me just highlight one which is currently playing center stage in the international economic arena, and that is the issue of imbalances in the global economy.
Addressing Global Imbalances
7. When we speak of "global imbalances", we are referring to today's situation where the balance of transactions in international trade, services, and transfers is very uneven across countries. This has resulted in large differences in the external current accounts of countries. At present, there is a large current account deficit in the United States, with counterpart surpluses concentrated in a few other countries, mainly in emerging Asia and oil-exporting countries.
8. This situation is of great concern because these imbalances cannot go on forever, and it is inevitable that a correction will occur. As it is, the current account deficit of the U.S.—which measured an unprecedented 5.7 percent of GDP in 2004, as compared to the average of 1 percent of GDP in the early 1990s—is being financed by record levels of debt in the hands of foreign investors. It is unlikely that investor appetite for U.S. assets will continue to grow at this pace indefinitely. Absent action by policymakers to facilitate an orderly resolution of these global imbalances, we run the risk of investors drastically reducing—or even reversing—the flow of capital into the U.S. In that event, currency and capital markets could turn volatile, and interest rates could rise sharply, posing serious threat to global economic stability.
9. It is tempting, given these facts, to argue that the U.S. alone holds the solution to this problem—that is, that the large U.S. current account deficit can be addressed by increasing savings in the U.S. But that would be only partially correct at best. Global imbalances are, by their very definition, a problem of the global economy. The resolution of these imbalances are the shared responsibility of nations, requiring a collaborative international effort to address its underlying causes. Policymakers should stop blaming one country or another for the imbalances problem. They should also refrain from counter-productive measures like trade restrictions, which do not solve the imbalances problem. Rather, the key economic actors of the world should exercise strong leadership and make determined efforts to unwind these imbalances through the following measures.
10. A major contributory factor to the widening global imbalances has been the unbalanced pattern of global growth of late. Specifically, growth has been, and remains, unduly dependent on the United States and China. Non-oil exports to the U.S. in 2004, for example, accounted for 18 percent of global trade. In the euro area and Japan—which together account for nearly one-quarter of global output—economic performance continues to be weak. Lifting growth in Europe and Japan will create alternative centers of global economic expansion, and will go a long way towards unwinding the existing imbalances.
11. The key to stronger growth in Europe remains structural reform. Important progress has been made in recent years, including in pension, healthcare, and labor market reforms. While recent misgivings may have been expressed by some Europeans about the benefits of these reforms, the results of these reforms speak for themselves. The radical change in Europe's employment performance since the mid-1990s deserve special mention, for wage moderation and labor market policies have helped add some 12 million European jobs in that period.
12. These gains provide a firm foundation from which to further strengthen the European economy. The precise future reform requirements would of course differ across countries, but they should in general focus on further boosting labor utilization, product and service market deregulation, and greater financial market integration. Labor market reform, in particular, will take on added significance with Europe's rapidly aging population. To sustain its social model for the benefit of future generations, Europe needs to create more jobs and maximize labor utilization. Measures such as limiting the workweek's length will achieve the opposite, making it harder for the working population to fund the pensions of a rising number of retirees. The result will be a reduction in pension and welfare payments. Our advocacy for greater labor utilization is therefore geared towards sustaining Europe's social model, and not at replacing it with a different one. In any event, it is instructive to note that, as recent as the late 1960s, overall labor utilization was actually higher in Europe than in the United States.
13. Moving on, Japan, like Europe, requires further structural reform to generate sustained growth over the medium term. Much has been accomplished by the Japanese authorities in recent years, but many issues still call for their attention. The financial sector needs to be strengthened by improving bank profitability and capital bases, so that these institutions are able to extend credit and support investment and growth. Corporate debt levels should be brought down and restructuring intensified. Other areas of priority include greater labor market flexibility, public enterprise reform, and increasing competition in sheltered sectors of the economy, such as the retail sector.
14. China and emerging Asia also have a part to play in solving the imbalances problem. Their role here would be to move towards greater exchange rate flexibility, coupled with continued financial sector reform. The Chinese economy, in particular, is a significant contributor to the global economy. A more flexible exchange rate for the Chinese renminbi, together with action by other key economies, would facilitate the adjustment of global imbalances. More importantly, China and Asian emerging economies should pursue greater exchange rate flexibility simply because it is in their own best interests to do so. As these economies continue to liberalize and open up, a less rigid exchange rate would give their authorities more control over monetary policy, and enable them to better manage external economic shocks.
15. Finally, let me turn to the United States. As I indicated earlier, the U.S. current account deficit is being financed by record levels of investment in the United States by foreigners. The continued financing of that deficit therefore depends on the future attitude of foreign investors towards U.S. assets. Maintaining investor confidence in the dollar—and in the strength of the U.S. economy—would help prevent a destabilizing dollar depreciation. A strong commitment to reducing the U.S. fiscal deficit would go a long way towards achieving that. In this connection, the U.S.'s budget proposals for fiscal year 2006 aim to halve the budget deficit in 4 years. If carried through, this effort at fiscal restraint will be a step towards sustainability. However, firm implementation of these proposals is critical and slippage must be avoided. What would be even more desirable is bolder deficit reduction, especially in view of the cyclical strength of the U.S. economy, and the importance of lowering government debt ahead of the retirement of the baby boom generation.
16. These are the steps that the key economic actors can and should take without delay. Through international cooperation, the imbalances problem can be resolved without major disruptions to world economic growth and financial stability. The measures I have discussed are in fact in the countries' own best interests to pursue. The United States needs to undertake fiscal consolidation for its own economic and financial health, just as a more flexible exchange rate would give China greater control over its economy and monetary policies. Similarly, labor and product market reform can benefit key European countries in tackling unemployment, as well as contribute to a more balanced pattern of global growth. And Japan's contribution to relieving imbalances by further financial and corporate sector reforms will raise potential growth, helping to address its own upcoming demography issues.
17. The continuing global economic expansion, and the favorable conditions that currently exist, provide a valuable window for these reforms to be implemented. Countries should take full advantage of this environment to put in place measures that will lock in sustained medium-term growth. The IMF, with its mandate to facilitate international monetary cooperation, provides the natural forum for countries to collaborate in these policy efforts.