A Remarkable Prospect: Opportunities and Challenges for the Modern Global Economy

Lecture by Anne O. Krueger
First Deputy Managing Director, IMF
McKenna Lecture at Claremont McKenna College
Claremont, California
May 2, 2006

Use the free Adobe Acrobat Reader to view the accompanying presentation slides.

Thank you for that kind introduction. I'm very pleased to be here this evening and to have the opportunity to discuss about the world economy in 2006.

In recent times the world economy has rarely been in better shape than it is today. The recovery from the modest downturn of 2001-2002 has been strong with global growth above trend levels. Those of you familiar with the IMF's latest forecasts, published just a couple of weeks ago, will know that the Fund has yet again revised upwards its expectations for global growth. This year we expect the world economy to expand by almost 5 percent, and we expect it to perform nearly as well next year—which will be the fifth successive year that the world economy has grown by more than 4 percent.

And we are talking about worldwide growth—every region of the world has been expanding in recent years. The pace has been set by China, India and the rest of emerging Asia, of course: and there is rapid growth in Latin America, the Middle East and Africa. Among the industrial countries, growth in the United States remains rapid; Japan appears to be making a strong recovery; and there are signs of an upturn in those parts of parts of Western Europe, including France and Germany, where growth has been sluggish.

There are, to be sure, significant downside risks to our central forecasts. Adverse geopolitical developments, such as a major terrorist attack; further increases in oil prices; worsening global imbalances; a disappointing outcome to the Doha Round of multilateral trade negotiations; an outbreak of avian flu: any of these could undermine the prospects for continuing rapid global growth. In some cases, we judge the risks to be very small, but the potential impact may be large.

Putting the economic policies in place that would make economies sufficiently flexible to accelerate their growth rates further and to strengthen their ability respond to shocks is one of the challenges confronting the global economy at the beginning of the twenty first century. Others include the need to adapt the multilateral framework established in 1945 in a way that reflects the changing structure of the world economy; and the need to ensure that the benefits of globalization continue to accrue while being spread even more widely than has been the case hitherto.

These are all challenges; but they are also opportunities to build on the enormous gains in economic welfare experienced over the past six decades; and so consolidate what was achieved in the second half of the last century as we look ahead to further economic progress in the present one. Making the most of these opportunities requires, first and foremost, the pursuit of macroeconomic stability linked with pro-growth policies by national policymakers. But the IMF has a crucial role to play. As the world economy has evolved over the past six decades, the Fund adapted as well, in order to remain relevant, effective and true to its founding principles. The Fund's history is intricately intertwined with that of the world economy as a whole.

So this evening I propose first to examine what was achieved in the postwar period and the lessons we have learned in recent years. I will then assess the key features of the modern global economy and its changing structure; before, finally, setting out some thoughts on how to respond to the challenges we face.

The long march of progress

It is, as I noted, sixty years since the multilateral economic framework that has served us so well came into being. The architects of that framework, meeting at Bretton Woods, New Hampshire, in 1944, could not possibly have imagined how successful and durable would be their creation. The aim was to prevent a return to the "beggar-thy-neighbor" policies of the 1930s, when high tariff and other trade barriers and competitive devaluations failed to protect national economies and succeeded only in undermining international stability and growth.

The International Monetary Fund was charged with promoting the expansion of trade and employment and was given specific responsibility for the maintenance of international financial stability, without which global trade could not flourish. The Fund's sister institution, the World Bank, had the task of spearheading economic reconstruction and development, initially in those countries whose economies had been devastated by the war.

But the founders of the postwar system clearly recognized the importance of multilateral trade liberalization in generating global economic growth: indeed, the Fund's role was intended to underpin this process. So established alongside the Bretton Woods institutions was, first, the General Agreement on Tariffs and Trade, or GATT, and later, its successor, the World Trade Organization, or WTO. Successive rounds of multilateral trade negotiations resulted in a dramatic fall in tariff levels. In 1947, average tariffs on manufactured imports were over 40 percent. By the late 1990s they had been lowered to less than 5 percent in the industrial economies.

The linkage between international financial stability and progressive multilateral liberalization of trade was pivotal. Without financial stability, there was little prospect of achieving an open world trading system. But multilateral trade liberalization—all countries in the system liberalizing together—was, in turn, essential for an expansion of trade on the scale needed to drive global economic growth. In the event, linking financial stability and open trade succeeded beyond the dreams of the system's founders. It made possible an unprecedented expansion of world trade and facilitated growth rates in both industrial and developing countries that were undreamed of in earlier centuries. Rapid growth brought rapidly rising living standards and reductions in poverty.

The numbers tell the story clearly. According to the WTO, the volume of world trade was 22 times higher in 2000 than it had been in 1950.

SLIDE 1 The slide shows that world trade has expanded much more rapidly than global GDP. Merchandise exports have grown by an average of 6 percent a year for the past fifty years. World trade has grown from 10 percent of world GDP in 1960 to almost triple that level in 2005. If trade in services were added to trade in goods, the rise is even more dramatic. Indeed, trade in services was so small that it was not even separately estimated in the early postwar years; it is now more than one quarter of trade in goods.

Developing Country Disinflation

This rapid expansion of global trade has been a key driving force for growth in almost every part of the world. In the early post war period, the industrial countries experienced growth more rapid than anything experienced in earlier times, helped by the fact that these countries were rapidly lowering their trade barriers and tariff levels. Between 1950 and 1973—a period sometimes referred to as the "golden age"—real GDP per capita grew by an average of 2.4 percent a year in the United States; by more than 4 percent annually in Western Europe; and by more than 8 percent a year in Japan.

Even by the early 1960s, though, some developing countries had started to grow rapidly. After the Second World War many developing countries had pursued economic policies that relied heavily on state intervention and import substitution: instead of opening up to trade they favored closed economies and sought to satisfy their needs by domestic production. Some of these countries managed periods of growth and during some of those periods growth was relatively rapid. But it was not sustained over a long period. This was in sharp contrast to the much more durable improvements in growth performance experienced by those countries, especially in Asia, that began to pursue more outward-oriented policies and embarked on ambitious policy reforms aimed at increasing growth potential. For these economies, opening up at the same time as pursuing other economic reforms made possible growth rates that made those of the industrial world look tame.

Growth accelerated rapidly in the group of countries that eventually became known as the Asian tigers—Korea, Hong Kong, Taiwan province of China, Singapore and, later, Malaysia, Thailand and Indonesia. In the four decades from 1960, for example, Korean real per capita income grew roughly tenfold. With exports growing in excess of 40 percent a year over an extended period, employment and real wages grew rapidly as well. More recently we have seen high rates of growth over more than two decades in China and a significant acceleration of Indian growth once reforms were begun there in 1991.

The rapid postwar growth transformed the lives of millions as living standards rose and progress was made in reducing poverty in the industrial and many developing countries. The World Bank estimates that some 200 million people escaped poverty in the 1990s, mainly as a result of the rapid growth of China and India. And across the world we have seen dramatic improvements in the quality of life for most people.

SLIDE TWO: Infant mortality rates fell sharply in most developing countries. In the examples here, we see that in Egypt the infant mortality rate fell from 186 deaths per 1000 live births in 1960 to 33 deaths per 1000 births in 2003. Even in Bangladesh, one of the world's poorest countries, infant mortality rates have fallen, from 149 deaths per 1000 births in 1960, to 46 in 2003.

Infant Mortality

SLIDE THREE: It's a similar story with literacy rates. In 1970, 53% of Chinese adults were literate; by 2000, that figure had risen to 91%. Over the same period, India's adult literacy rate rose from 33% to 61%.

Literacy Rates

SLIDE FOUR: Perhaps the most telling statistic is life expectancy. In general, life expectancy in developing countries has risen at an astonishing pace. In the early 1950s, life expectancy in Korea, for example, was 48 years: by early years of this century that had risen to 77 years. Over the same period, life expectancy in India has risen from 39 years to 63 years.

Life Expectancy at Birth

Since 1960 life expectancy in the developing countries has risen at roughly double the rate in the richest. The gap between life expectancy in industrial and developing countries has narrowed from around 30 years in 1950, to around 10 years today—a visible result of rising living standards. Unfortunately, progress of late has not been universal: life expectancy has declined in Russia and some parts of Eastern Europe and in those countries in Sub-Saharan Africa that have been blighted by HIV/Aids infection. And many low income countries have yet to experience the full benefits of globalization. I will return to this point later.

Economic lessons

The rising living standards that accompanied the rapid growth experienced in so many countries in the past few decades are tangible benefits of globalization. This is not a new process, of course—the integration of the world economy can be traced right back to the early traders of the Mediterranean; to Marco Polo who helped foster economic links between Europe and Asia; to the industrial revolution of the 18th and 19th centuries when we witnessed a sharp rise in world trade. But the multilateral economic framework established in 1945 provided the basis for the sustained and rapid integration of the world economy that has been broader and more inclusive than in previous periods.

As the process of globalization has continued, and has been accompanied by changes in the structure of the global economy, we have learned valuable lessons about macroeconomic policy and about the ways in which the benefits of globalization can be extended still further. By we in this context I mean academic economists, national policymakers, the policy community in general and, of course, the IMF itself. Indeed, many of the global economic changes that have taken place have, in turn, had a significant impact on the work of the Fund and the other multilateral institutions.

As the global economy evolved over the years, the Fund adapted. In the early 1970s, for example, the end of the Bretton Woods system of fixed exchange rates among the major industrial countries led to a fundamental shift in the role and work of the IMF.

But, more recently, the 1990s were a decade of remarkable change. The collapse of Communism; the dramatic rise in the size and importance of private capital flows; a series of financial crises in some rapidly-growing emerging market economies; and significantly improved understanding of what constitutes sound macroeconomic management: all these factors influenced the performance of the global economy and the work of the IMF. Let me address each of these issues in turn.

I mentioned a moment ago the rapid growth rates seen in Asia in particular during the 1960s, 1970s and 1980s. These had resulted from radical shifts in policy, towards openness and integration with the rest of the world. At the beginning of the 1990s, we witnessed the consequences of another dramatic shift in policies, this time in Eastern and Central Europe following the collapse of the Soviet Empire. For nearly four decades the centrally planned economies that formed part of the Communist world had minimal interaction with the rest of the world economy: for some that isolation stretched back long before the war. That changed virtually overnight and the newly-independent countries involved had to start the process of transition to become normally-functioning market economies.

This was an enormous challenge: it had never before been attempted, and there was a steep learning curve for all those involved. The Fund played a central role in this process, providing financial assistance where needed, but more importantly providing technical assistance and policy advice and expertise to national policymakers confronting enormous challenges in very difficult circumstances.

There were bumps along the way, of course, because of the momentous changes needed at every level—in terms of political structure and public institutions as well as in macroeconomic policy and the development of private enterprise. But progress overall was remarkable. Several of the former centrally-planned economies had made sufficient progress to enable them to join the European Union two years ago, and several others are hoping to join in the near future. In recent years, many of the Eastern and Central European economies have experienced significantly higher growth rates than their Western neighbors. Russia has succeeded in reversing the economic downturn of the early 1990s; inflation has been contained; and there have been sizeable revenue gains from higher oil prices.

It is a sign of how far we have come that the transition process is, in most cases, largely complete. By and large, the economic problems these economies face nowadays are "normal". They confront the same economic challenges that many other countries do. But the transition process taught us all a great deal about how to implement effective macroeconomic policies and I will say more about this in a moment.

Even as the former Communist countries were struggling with the transition process, other changes were taking place in the international economy that have proved to be even more far-reaching: foremost of which was the sharp rise in private international capital flows. The founders of the Bretton Woods system had largely assumed that private capital flows would never again resume the prominent role they had in the late nineteenth century. The framework that established the Fund and gave it the financial resources necessary to provide temporary support for members was therefore focused on current account transactions. The Fund had traditionally lent to members facing short term current account difficulties to provide finance while they undertook adjustment, while the World Bank made longer-term loans for specific projects and programs.

Private capital flows among the industrial countries had resumed in the 1960s. But by the 1990s they became the dominant source of finance for developing countries too. In the late 1970s, official capital flows to developing countries constituted around three quarters of total net capital flows to them. By 1990, that had fallen to about one third. And by 2003, private flows accounted for about 90 percent of total net flows to developing countries. And all this at a time when total capital flows were increasingly very rapidly. Such large flows of private capital around the world can have important consequences for policymakers and policy at the national level.

Arguably, the first signs of the power of the international financial markets came in 1992, when the European Monetary System was plunged into crisis. [The EMS, as it was known, was a system of fixed but adjustable exchange rates among most of the member states of the European Union: each currency could adjust by only a small movement in relation to any other and system members were obliged to defend these rates by foreign exchange intervention, or other measures such as interest rate adjustments, if necessary.] In September 1992, both the British pound and the Italian lire were forced out of the system when the scale of the flows out of those currencies became impossible for the authorities to reverse. In the case of both currencies, the financial flows were precipitated in large part by serious doubts about the economic fundamentals and the long-term sustainability of the prevailing exchange rates. There was further turbulence in the system in 1993 when the French franc came under pressure: again, the financial flows were so large that only significant changes to the system itself ended the crisis.

The problems of the EMS were but a foretaste of the problems that subsequently occurred in some emerging market economies during the decade. The IMF was not asked to provide financial support for the countries afflicted by the troubles of the EMS. But the Fund was involved almost from the start of the emerging market crises.

These capital account crises differed from the traditional current account or balance of payments crises, where the Fund had provided support to member countries facing balance of payments difficulties while they undertook policy adjustments. The key differences were twofold. First, the immediate origin of the difficulty was a major change in the willingness of foreigners and domestic residents to hold domestic assets—just as had happened in the case of the EMS. But the second difference was the speed and scale with which these crises erupted—again just as we had witnessed in the case of the EMS crises—and in the fact that there was little time in which to decide on policy changes.

The first capital account crisis erupted in Mexico in 1994. Crises followed in Asia in 1997-98; in Russia in 1998; and elsewhere. Our experience in this period underlined the extent to which sound economic policies both foster growth and help prevent crises from occurring in this new world of large private capital flows.

In Asia, for example, only a relatively small number of countries were directly affected, with Korea, Thailand and Indonesia the worst hit. For each of those countries years of spectacular growth ended abruptly with a dramatic financial crisis. But these crises had an impact well beyond the individual country involved, in part because it was shocking to see economies that had experienced such rapid growth over such long periods suddenly appear so vulnerable; and in part because there were, for a time, fears that the crises would spread further.

The sharp reversal of capital flows to Asia in the latter half of 1997 sparked the Asian crises.

SLIDE FIVE: As we can see, private capital flows to the Asian crisis countries were about 6 percent of their GDP in 1995, and nearly 7 percent of GDP in 1996. In 1997, net outflows were 0.3 percent of GDP, a figure which rose to nearly 5 percent of GDP the following year. That represents a reversal of capital flows equal to more than 10 percent of GDP in two years. The economic dislocation caused by reversals of this magnitude was huge, and would have been so for any country.

Private Capital Flows to Asian Crisis Countries as a percentage of  GDP: 1995 - 1998

The dramatic shift in capital flows had been prompted by a shift in investor sentiment reflecting concern about the underlying health of the economies affected. In particular, there had been a huge expansion of credit over a relatively short period of time. Rapid credit growth is almost always indiscriminate and, therefore, dangerous. The result had been a sharp rise in the number of bad loans. The rate of return on capital had fallen and, in consequence, non-performing loans started to rise. Once these problems became apparent, it was inevitable that international creditors would undertake a reassessment of the creditworthiness of debtors and loan exposure.

Several factors conspired to make the consequences of this shift in investor sentiment extremely painful. Fixed exchange rates prevented a more rapid adjustment to the shift in capital flows—and gave speculators the chance to make a one-sided bet. Government assurances that exchange rate pegs would be maintained had left currency mismatches unrecognized until governments were forced to devalue. Banks had built up liabilities in foreign currencies and assets in domestic currency. Devaluation then left financial institutions and businesses facing massive losses, or insolvency. The weaknesses of domestic banking systems, a result both of the poor quality of credit assessment and allocation and of the currency mis-matches, were revealed—as was the impact on economic performance.

The contraction in GDP that the crisis countries experienced made things even worse, of course, because the number, and size, of non-performing loans grew rapidly. The further weakening of the financial sector inevitably had adverse consequences for the economy as a whole. The crisis economies found themselves in a vicious downward spiral.

The speed with which capital account crises erupted meant that financial support from the Fund for countries affected was often urgently needed—in days rather than the weeks or months which Fund programs for current account crises had usually taken to put together. And the support needed tended to be on a much larger scale than the Fund had customarily provided because of the scale of the outflows experienced by crisis countries.

It is worth noting that with hindsight the adjustment programs put in place with Fund support in the wake of these crises were far more successful than most observers believed possible at the time. Within eighteen months, for example, Korean GDP was back to pre-crisis levels—a remarkable achievement in the circumstances. And Indonesia, the last of the crisis countries to complete its Fund-supported program, was able to exit at the end of 2003.

These capital account crises brought a sharp reminder of the extent to which the world had changed: and we learned much. First, we came to appreciate even more the crucial importance of a sound macroeconomic framework that can deliver macroeconomic stability and the extent to which that is a prerequisite for sustainable growth. In a globalized world, economies must have monetary and fiscal policies that make possible falling or low inflation, that foster budgetary prudence and that limit public debt at sustainable levels. And, second, we also learned to look at the sustainability of public sector debt. Fiscal policy has to be capable of servicing the public debt without crowding out private investment. And that debt should not be so large that sharp changes in the global economy—rising global interest rates, for example—undermine the government's ability to service the debt. Too much foreign-currency denominated debt can also leave the government vulnerable to currency fluctuations. Governments need to ensure they have enough scope to pursue counter-cyclical fiscal policies.

Lesson three was the importance of flexibility. An economy needs to be flexible if it is to realise and raise its growth potential, and if it is to be able to adapt to changes in the global environment and respond to shocks. Most economists are now agreed that a flexible exchange rate regime is the best way of achieving this. Fixed exchange rates pose significant challenges because they mean fiscal and monetary policies must always be consistent with the exchange rate regime and subordinated to it.

A fourth lesson important lesson is the closeness of the link between the financial sector and economic stability and growth: and this has assumed increasing importance both in national policymaking and in the Fund's work. Let me elaborate.

Banks and the financial sector in general have a vital role to play in fostering economic growth: by providing credit to those investments that offer the highest risk-adjusted rate of return, banks contribute to a higher growth rate for the economy as a whole. But to be effective, banks, even small ones, must develop the ability to assess creditworthiness, risk and returns. They need to be able to assess the likely returns from competing borrowers and so direct resources to those offering the highest rates of return.

As economies grow, they become more complex and interdependent; and the demands placed on the financial sector grow commensurately. Banks grow bigger: they need to in order to meet the demand for investment capital. They must also grow more sophisticated, and become more diversified in terms of the risks they assume. Continued expansion means that firms need banks able to serve their needs across national boundaries and to provide specialized financing services.

But the financial sector has to meet the needs of the range of economic activity and other sources of financial intermediation—equity, bonds and insurance, for example—are important to provide the necessary breadth and depth. Healthy and sustained growth of firms and economies requires constant innovation as firms seek the best terms and intermediaries become increasingly refined in making risk and return assessments. Thus, for example, we have seen in recent decades the development of derivatives and, more recently, hedge funds.

Experience has repeatedly shown that high growth rates for the economy as a whole are sustainable only as the financial sector develops in parallel with the economy as a whole. A weak financial sector can undermine growth. Resources are misallocated, and average returns fall. The role that weak financial sectors played in the crises of the 1990s made us appreciate even more than before quite how central the financial sector is to sound macroeconomic management.

One key to improved financial sector performance, and key to the improved governance that makes possible improved macroeconomic performance in general, is the issue of transparency. We have learned that at the sectoral, the national and the global level the more openly individuals, firms and institutions go about their business, and the more open to public scrutiny they are, the more effectively they will perform. The risk of corruption is much reduced: there is less opportunity to conduct transactions in secret and more pressure to ensure everything is above board, and seen to be. There is also less risk that narrow interests will carry undue influence when firms, institutions or governments make decisions that affect large numbers of people. Doing things in the public gaze demonstrates that there is nothing to hide: doing things in secret arouses suspicions even when these aren't justified.

The IMF has taken a lead in this. The Fund has always sought to work in the best interests of all its member countries and of the international financial system as a whole. But a long tradition of secrecy exposed the Fund to accusations that it had something to conceal about its work. We didn't have anything to hide, and now we don't try to. We are now one of the most transparent institutions in the world and the better for it. Some have gone so far as to argue that recognition of the importance transparency in policymaking and execution will prove to be the most important and durable lesson of the past decade.

The changing global environment

The policymakers of the 1940s, who shaped the multilateral economic framework from which we still benefit, would hardly recognize the world economy of 2006. So much has changed: the global economy is now far more inclusive, with many more countries participating in the international trading and financial system. The IMF had 35 members when it began operations in 1946; today we have 184. Many developing countries have seen spectacular rises in their standards of living, thanks to policies that had enabled growth more rapid than anyone could have imagined possible sixty years ago.

But the world economy has undergone dramatic changes even compared with 1990. I noted that most of the centrally-planned economies are now fully-fledged members of the global economy. I noted, too, the rise of private international capital flows -which, as I have outlined, had enormous implications for national and international economic policymaking.

The 1990s also saw the intensification of the process of economic integration among the members of the European Union. The problems with the European Monetary System were overcome and the process of monetary union carried on apace. In 1999, the Euro came into being, replacing twelve—later thirteen—national currencies and marking a step change both in the EU's policymaking process and in the degree of economic integration among its member countries. Several of the new members of the European Union who joined in 2003 are expected to join the Euro in the coming years, thus continuing and extending the process of integration.

But the process of global economic integration also continued in the 1990s and beyond. In part this reflected the rapid developments in communications and transport technology that have led to dramatic falls in costs and facilitated changes in the structure of international trade and investment. Technological advances and falling shipping costs have made it economic to chop up the value added chain: it makes sense for different parts of the manufacturing process for a single product to be located in different parts of the world, regardless of ownership or the location of the market. And the internet has made it easy for "white collar" activities such as technical support, call-centers and the back-office operations of financial institutions similarly to be located anywhere.

These developments have been accompanied by a significant improvement in macroeconomic management around the world—helped in part by what we learned in the 1990s. One striking result of the greater focus on macroeconomic stability has been the dramatic lowering of inflation rates.

SLIDE 6 As we can see from these slides, the inflation rates have fallen around the world. The global inflation rate has declined from an annual average of almost 30 per cent in 1990-94 to 3.8 per cent in the past 5 years.

Global Disinflation

SLIDE 7: In the industrial economies, the average inflation rate fell from almost 9.5 per cent between 1975 and 1979, and nearly 9 per cent in the early 1980s, to an average of 2.0 per cent between 2000 and 2005.

Industrial Country Disinflation

SLIDE 8: In developing countries, the decline has been steeper and more rapid. In the early 1990s, the average inflation rate in developing countries was around 80 per cent; that had declined to average of 6 per cent between 2000 and 2005. The IMF forecasts currently project a further fall, to below 5 percent by 2007.

Developing Country Disinflation

SLIDE 9: In 1980, 111 of the IMF's member countries had double-digit inflation rates: by 2005, only 35 countries had double-digit inflation. A quarter of a century ago, 39 countries had inflation rates above 20 percent: by last year only 5 did. And in 1980, 13 countries had inflation rates in excess of 40 percent. Last year, only one country did. That is a remarkable global transformation and has been an important contributory factor to the recent rapid growth experienced in most parts of the world.

Numbers of High Inflation Countries:
 1980 and 2005

Among the most rapidly-growing countries in recent years are the world's most populous nations: China and India. China has recorded high growth rates for more than two decades; and since reforms were introduced in India from 1991 onwards, that country has also seen a sharp acceleration in growth. As these two large countries grow rapidly, so has their share of trade and GDP, albeit starting from a low base.

Even as recently as 1985, China and India had per capita incomes (measured in constant 2000 dollars) below the average for what the World Bank defines as low income countries. Since then both have seen per capita incomes rise faster than other low income countries: by 2004 India's per capita income was about a quarter higher than the low income country average; and China's was almost three times as high.

Since 2001, export growth has averaged more than 22 percent a year in India, and about 25 percent a year in China. India's share of world exports has nearly doubled in the past fifteen years; and it has tripled in China. And between 2000 and 2005, India's share of global services exports shot up, from just over one per cent to more than two and a half percent. China's share grew by half, to almost three percent.

According to IMF calculations, on a purchasing power parity basis, China accounted for about a quarter of global growth in 2005, and India for about 8 percent. These trends seem set to continue. With both countries growing rapidly—and much more rapidly than the industrial countries, their share of the global economy will rise further in the coming years.

Challenges ahead

The changes we have witnessed in such a short time are striking. We have seen, and are seeing, greatly increased differentiation among countries: low income countries, emerging market economies, oil exporters, industrial economies. And there is no let-up to the pace of change. If anything it continues to accelerate, forcing us constantly to reassess what we think we know about the global economy. This can sometimes be a daunting challenge. But it is, as I said at the outset, an important opportunity for us to seek to maximize the gains from globalization.

Trade has played a crucial role in spreading the benefits of global integration and growth; and the open international trading and financial system remains key to future global economic growth. Trade has served as an engine of growth for the past half century. The integration of financial markets has furthered the process. And the benefits, as I noted, are there for all to see.

Trade liberalization has been critical to the expansion of trade and since 1947, the world's trading nations have engaged in a series of multilateral trade negotiations, each so-called "round" leading to further reductions in trade barriers. 23 countries took part in the first negotiations, 149 are involved today. The current Doha Round of trade negotiations, launched in Doha in November 2001, is intended to mark a further and important stage in this process, tackling sensitive subjects like agriculture and services, and focusing particularly on the needs of developing countries in the trading system: indeed, it is called the Doha Development Round.

The potential gains from a successful Doha round are enormous. The prospect of a significant lowering of barriers to agricultural and services trade, and further liberalization of trade in manufactures, could provide a boost to world trade and, in turn, global growth. And it is the developing countries who would gain most from a successful Doha outcome. In part their gains would come from increased access to industrial country markets and the reduction of agricultural subsidies in the industrial countries. But by far the biggest gains for developing countries would result from a lowering of trade barriers among themselves. The World Bank estimates that around two thirds of all the gains from a Doha agreement would go to developing countries—and those gains could run into hundreds of billions of dollars over a ten year period.

A Doha agreement would greatly strengthen the global trading system. But a failure would weaken it and give encouragements to protectionists who mistakenly believe that economies gain from erecting trade barriers against other countries. Without a Doha agreement global growth would be slower; and the world economy could be less resilient in the face of shocks.

Trade negotiations by their nature are nail-biting affairs. And the Doha negotiations have been unusually tense, with several deadlines already missed. Yet all those involved know how high the stakes are, and no one will want to be blamed for failure. Experience tells is that there is still time for agreement to be reached and there are signs that those most closely involved are still working hard to reach a deal.

Further trade liberalization will bring clear benefits for all countries. But at the national level, too, there is much that can be done to strengthen economies, raise their potential growth rates and reduce their vulnerability to shocks. I started by noting the remarkable growth performance of the world economy—and noted too that more rapid growth was a worldwide phenomenon. Periods of rapid growth provide the perfect opportunity for pressing ahead with economic reforms. It is always easier to implement reforms in an upswing: they can be well-planned and it is easier to marshal the necessary support for them. Having to introduce reforms in a crisis means that they are hastily put together and are painful to implement.

Many developing countries have made considerable progress in achieving macroeconomic stability and higher growth rates: and this has enabled them to make progress in reducing poverty. But some low income countries have stood still or, worse, fallen further behind the rest of the world. The Millennium Development Goals agreed by the United Nations in 2000 highlighted the extent of this problem. Experience over the past half century has taught us that ultimately it is domestic policy reform that will determine whether those countries that have yet to integrate with the global economy in any meaningful way can begin to share in the benefits of global growth. Without policies that enable these countries to integrate more successfully into the global economy, their citizens will remain poor—and, indeed, will in some cases become worse, rather than better off. Improved governance, reduced levels of corruption, policies aimed at achieving macroeconomic stability are essential for the sustained growth that will make poverty reduction possible. Without such policy reforms, the scope for help from the international community will be restricted.

Yet the international community—bilateral and multilateral donors alike—has a vital role to play in helping these countries. Aid transfers continue to be vital of course. Debt relief has also played a part, and 20 developing countries have now benefited under the IMF's own Multilateral Debt Relief Initiative, which came into effect at the beginning of this year.

But capacity-building, policy advice and technical assistance are important too. Much of the IMF's work with these countries involves assisting the reform process, for example, by enabling them to implement public expenditure management and by improving tax administration. And countries need assistance from the international community if they are to be able to absorb increased aid flows in ways which do not further undermine economic progress.

The currently buoyant outlook offers national policymakers in emerging market countries a chance to press ahead with reforms that reflect the lessons I described earlier. In many economies, measures are already being taken to reduce debt vulnerabilities by bringing down the debt to GDP ratio, reducing foreign currency exposure and lengthening debt maturities: but debt levels in many countries remain uncomfortably high and there is scope to do more. Strengthening fiscal policy by lowering fiscal deficits and aiming for balance over the business cycle can make it possible for governments to operate counter-cyclical fiscal policy when the economy slows. Economies with high budget deficits when times are good have no room for maneuver when the going gets tough.

A growing economy also offers the best environment for structural reforms that will make the economy more flexible and so raise its potential growth rate and reduce its vulnerability to shocks. More flexible labor markets, more competition in product markets, creating a business-friendly climate with less red tape and more legal protection: all these are areas that, over time, can significantly enhance an economy's growth performance.

All industrial economies and a growing number of developing countries face another challenge to domestic economic policy: demographic change. As populations age—very rapidly in some countries—public pension systems are coming under increasing strain. As the elderly dependency ratio rises, and fewer workers support an increasing number of older retired citizens, measures will be needed to ensure that fiscal policy remains on a sustainable path. In industrial countries action is needed sooner rather than later in order to avoid a fiscal crunch. In emerging market countries, there may be more time in some cases, but the challenges are greater: public pension schemes, while more limited in coverage, are already expensive and unsustainably generous to those who are covered.

This is also a period of change for the IMF itself. The Fund has always adapted to reflect the changes taking place in the world economy: And further changes are now in train. The first of these results from the need to give Asia appropriate weight in the international financial system and in the IMF. Asia has a powerful and legitimate claim to greater weight in the Fund than allowed for under the current rules. Asia has a voice, of course: it wields considerable influence in Fund discussions. But it is clearly under-represented and it was agreed at our Spring Meetings in Washington a few days ago that specific proposals would be put forward for rectifying this at our Annual Meetings, in Singapore, in September.

At the same time, there is a pressing need to strengthen the mechanisms for resolving global imbalances. This is more than just a case of tackling the U.S. current account deficit, or structural reform in Europe and Japan, or addressing low domestic consumption in Asia. The current imbalances in the global economy are complex in their origins and require action on several fronts at once if they are to be resolved without undermining global economic stability and growth. There is a clear opportunity for strengthened multilateral surveillance by the IMF to play a central role in this process and this too was agreed at our recent Spring Meetings.

Conclusion

Let me briefly conclude.

The world economy has undergone momentous changes since 1945, but the process of change has accelerated as we can see from the developments of the past fifteen years. The global economy is more closely integrated than could have been foreseen sixty years ago. It is more prosperous, and that prosperity is distributed more widely across countries and citizens. For many parts of the world, rapid growth over a long period has brought dramatic rises in living standards. Poverty has been reduced.

Growth has brought changes in the global economic structure as emerging economies, especially in Asia, account for a rising share of world trade and world GDP.

The multilateral framework is adapting to reflect these changes—just as it has evolved in the light of earlier developments. As we learn more about what enables economies to achieve higher growth rates and reduce poverty, it is important to implement those lessons, and so enable all countries to achieve accelerated growth. The IMF has an important role to play here, especially through our surveillance and policy advice; and through our technical assistance work. And the IMF, along with the other international financial institutions, has a strong record of adapting to reflect changing circumstances and lessons learned. The strengthening of our multilateral surveillance work is important and in line with our evolutionary tradition.

But it is important to remember that many of the basic principles of the multilateral framework established all those years ago hold true. International financial stability remains crucial if the opportunities for economic growth are to be fully realized. And multilateral trade liberalization remains equally crucial as an engine of world economic growth. The nature and composition of trade may have changed over the years but not, fundamentally, its role in the promotion of global growth. That is why a successful outcome to the Doha round is so important. And that is why the continuing evolution of the international financial system is also vital.

I noted at the outset that the world economic outlook remains bright. The global economy appears to be more resilient in the face of shocks than it was even a short time ago. The policy reforms of the 1990s, above all the reduction of inflation around the world and the improvement in macroeconomic management, have played an important role in this.

But history teaches us that complacency is a dangerous thing. The world may be more resilient than in the past but there is no evidence that it has become wholly immune to shocks, any more than we have cause to believe that the business cycle has disappeared. The present conjuncture, then, is an opportunity to consolidate the gains we have made and build on them: to continue with trade liberalization at the global level and with economic policy reforms at the national level. It is by seizing the moment that we will ensure that the twenty first century is one of further progress for the world economy and its citizens.

Thank you.



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