Globalization, Flexibility and Interdependence: Equipping Economies for the 21st Century Plenary Session Keynote Address by Anne O. Krueger, First Deputy Managing Director, IMF
June 13, 2006Plenary Session Keynote Address by Anne O. Krueger
First Deputy Managing Director, IMF
At the 10TH St. Petersburg International Economic Forum
St. Petersburg, Russia, June 13, 2006
Good morning and thank you for that kind introduction. It is a great pleasure for me to be back here in St Petersburg and at this economic forum. I believe this is an especially appropriate place to consider issues of globalization, interdependence and international competitiveness. This is, after all, a city founded by one of the first Russian leaders to recognize the importance of economic interaction with the outside world.
We are also gathered here at an opportune time. The outlook for the world economy remains strong: the IMF currently expects that growth in real global GDP this year will be close to 5 percent. This will be the fourth successive year that global growth has exceeded 4 percent.
The current global expansion is notable for its length and also its breadth: every region of the world has experienced growth. As a group, the CIS countries have continued to grow rapidly. Last year, most CIS countries grew more rapidly than the world economy as a whole, and the IMF currently expects that to remain true this year also.
Of course, uncertainty remains the faithful companion of all economic forecasting and the upbeat outlook reflects our central expectations: there are several downside risks that could yet result in a more disappointing outcome for the world economy. Persistent and rising global imbalances; lack of progress in the Doha trade negotiations; high and rising oil prices; continuing geopolitical uncertainty; the threat of an avian flu outbreak: any one or a combination of these could result in growth slower than we currently expect.
The best response to these risks to growth is to take the necessary steps to make our economies more flexible. That will strengthen them and raise potential growth rates—and so accelerate poverty reduction. Flexibility is vital for sustained rapid growth. Individuals and firms need to be able to respond, for example, to technological developments that alter the way business is conducted. Firms that cannot redeploy workers from one type of job to another because of labor regulation will soon become uncompetitive. Those economies that lack sufficient flexibility to enable policymakers, firms and workers to adapt to the constantly shifting global environment will, inevitably, fall behind those that are equipped to respond flexibly to new challenges. Insufficient flexibility results in slower growth and, in turn, makes poverty reduction more difficult.
Flexibility brings other benefits, too. It enables economies to be more resilient and so less vulnerable to the effects of the next global downturn. There will be a global slowdown at some point—everything we know suggests the business cycle is alive and well. But though we know a downturn will come, we cannot know when: which is why pre-emptive action now makes sense. The current period of global expansion is a rare opportunity for implementing economic reforms that strengthen national economies
At the national level, reforms that bring greater flexibility make sense because they raise potential growth rates and enable economies to weather a global slowdown more easily. But globalization means that the cumulative benefit from such reforms is greater than ever before, in part because national economies are more closely linked. The larger the number of economies that are sufficiently flexible to adapt to changing global circumstances, the more rapid global growth will be. National reforms that strengthen growth prospects also increase the likelihood that a global slowdown will be modest, relatively brief, and with a subsequently more rapid pace of recovery.
This morning I want to say something about the policies needed to make economies more flexible and enable them to take full advantage of the benefits of globalization. I will also talk about the IMF's role in the reform process.
The importance of flexibility
Anyone living in this part of the world hardly needs reminding that we live in an era of dramatic and rapid change. For the CIS countries in particular, those changes have been remarkable in scope. The path from central planning to market economy was truly challenging, and much remains to be done. But many reforms have been undertaken, and those reforms are starting to bear fruit in many countries.
There is a consensus that reflects what we have learned from experience about economic success. The economies that have achieved the most rapid growth over a prolonged period are, without exception, those that have undertaken ambitious and wide-ranging reforms—and have remained committed to reforms over a long period.
In the nineteenth century, countries like Britain, Germany and the United States embraced technological change and their economies adapted to make the most of the more rapid growth that developments in machinery, transport and communications made possible. In the years immediately following the Second World War, it was again the industrial countries that experienced rapid growth. Indeed, the growth rates of the advanced countries in the 1950s and 1960s made the achievements of the Victorian era seem modest.
This was, in part, because of further technological progress. But it was also because of economic reforms that enabled these countries to benefit both from those technological advances; and from the increasingly open multilateral trading system established after the war, through successive rounds of GATT trade negotiations and the unilateral reductions of trade barriers in reforming countries.
From the 1960s onwards, a number of developing countries, especially in Asia, started to take off. Governments implemented reforms that made economies more flexible, enabling them to benefit from technological progress and from opening their economies to trade in the increasingly liberalized multilateral trading system. Incentive structures were put in place to encourage individuals and firms to be flexible as these economies became more integrated with the world economy. Exports, investment and enterprise were encouraged.
As a result, these economies experienced spectacular growth rates over very long periods. Take Korea, for example: in the 1950s, the third poorest country in Asia and one of the world's poorest economies. In the wake of a radical reform program introduced from the early 1960s, and implemented with remarkable determination, real GDP grew roughly tenfold over the four decades from 1960.
As the world economy has become more flexible, so the pace of change has accelerated. There have been quite dramatic changes in the structure of the world economy over a relatively short period. The impact of rapid growth in China and India, for example, has been profound. 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.
The perhaps uncomfortable truth to which policymakers must respond is that the rapid growth of, and rapid change in, the global economy has greatly increased interdependence and has thus made flexibility at the national level an ever more important ingredient of success. Yes, the need to adapt and implement policies that enable economies to be more flexible is perhaps a particular challenge for developing countries. But the challenge is one that advanced economies face, too. The rapid growth of the U.S economy in recent years owes much to the way firms and individuals are able—and encouraged—to respond to change.
Whether we look at Britain in the 19th century, at postwar Japan or Korea in the 1960s and 1970s, or at the U.S in the early 21st century, the lessons remain the same. Those countries that were flexible, continuously reforming and quick to identify and ease bottlenecks, were those that experienced sustained and rapid growth.
Achieving the right policy mix is vital if reforms are to succeed. But the principal ingredient of long-term economic success is the need to maintain flexibility. It is that which enables economies to adapt to the changing global environment and enables firms and individuals within an economy to respond to fresh economic challenges.
One important prerequisite of the currently benign economic environment has been the significant improvement in macroeconomic management in many countries around the world—in part a consequence of greater flexibility. The experience of the past ten or fifteen years has taught us a great deal about how economies work and what scope policymakers have for achieving and maintaining macroeconomic stability, accelerating growth and reducing poverty; and it has reinforced the importance of ensuring that economies and economic actors remain flexible.
Better macroeconomic management has already produced results in the form of higher and more stable growth rates. Much progress has been made in many parts of the world as governments have implemented policies aimed at achieving macroeconomic stability, including the reduction of inflation, sound fiscal policies that curb government budget deficits and reduce debt burdens. And progress towards stability at the national level has, in turn, led to greater international stability and more rapid global growth.
One of the most visible results of this improved macroeconomic management is the worldwide reduction in inflation rates. When I was last in St Petersburg, in 2003, average inflation in the CIS countries was around 12 percent. That itself represented remarkable progress—three years earlier, inflation had averaged more than 24 percent. But this year, the IMF is expecting average inflation in the CIS countries to come in at just over 10 percent and to fall to single digits next year.
The decline in inflation rates is a global phenomenon. 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. 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. We currently project a further fall, to below 5 percent by 2007.
Lower inflation enables decision-makers better to interpret changes in prices, and hence to respond more promptly to relative price signals. Lower inflation has been an important contributory factor to the more rapid growth we've seen around the world; and it helps explain why the downturn in 2001-2002 was both modest and short-lived.
The experience of the past decade has also shown that flexible exchange rates are an important component of macroeconomic stability. The capital account crises of the 1990s in Mexico, in Asia, here in Russia and elsewhere reminded us how important it is for economies to have the flexibility to respond to shocks. With fixed exchange rates, shocks must be absorbed by other variables—such as wage rates and domestic prices—that often impose larger costs and require longer adjustment periods. The exchange rate itself can be a significant shock-absorber.
The Asian crises showed the dangers of mismatches of currency exposures of assets and liabilities. And fixed exchange rates require monetary policy to be subordinated to the exchange rate regime.
As a result of what we learned during the capital account crises of the 1990s, most countries now have flexible exchange rates regimes.
Another important lesson brought home more forcefully than ever by the experience of the past decade or more is the importance of a healthy financial sector. This is a key component of macroeconomic stability. A weak financial sector can undermine efforts to achieve stability and growth through prudent fiscal and monetary policies. Resources are misallocated, and average returns fall. We all knew that a healthy financial sector was an important ingredient of macroeconomic stability. But 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's role is.
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 rates of return, banks contribute to a higher growth rate for the economy as a whole. To be effective, banks, even small ones, must develop the ability to assess creditworthiness, risks 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. And, like other sectors of the economy, the banking system needs competition to be efficient, subject to appropriate regulation, of course.
As economies grow, they become more complex and interdependent; and the demands placed on the financial sector grow even more rapidly. Continued expansion means that firms need banks able to serve their needs across national boundaries and to provide specialized financing services. And appropriate regulatory and supervisory regimes assume increasing importance.
But the financial sector has to meet the needs of the full range of economic activities 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 in the financial sector as firms seek the best terms on which to borrow and financial intermediaries become increasingly refined in making risk assessments.
In a sense, the increased focus on financial sector soundness is one—albeit very important—way in which the rapid integration of the global economy has highlighted the importance of structural economic reforms. In many parts of the world we have made considerable progress in maintaining macroeconomic stability. But stability alone can only do so much to raise growth rates and reduce poverty. Other policy reforms are also necessary to raise an economy's growth potential.
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 IMF has taken a lead in this: we are now one of the most transparent institutions in the world. Some have gone so far as to argue that the importance of transparency will prove to be one of the most significant and durable lessons of the past decade.
More generally, we have come to appreciate that institutional health is an important ingredient of economic progress. Enterprise is stifled and foreign investment discouraged if a country does not have an effective judiciary that makes contract enforcement possible. Businesses simply relocate to other places that offer them greater legal protection. Similarly, countries that do not offer legally and easily enforceable property rights will find it hard to attract much new investment. Such shortcomings have always undermined business activity and, in consequence, economic growth: but as the world economy becomes more integrated, business has become more mobile and a climate hostile to business even more damaging. Even some of the advanced economies have business red tape that makes establishing a new business difficult or costly, or that makes the process of enforcing contracts time-consuming and cumbersome. Such red tape lowers prospective returns.
Labor market regulation also hampers business enterprise and growth. There is a great deal of evidence showing that where it is difficult to fire workers, employers are much more reluctant to hire them in the first place. Firms need the flexibility that enables them to reduce workforce numbers in difficult times and recruit new staff when the business is growing.
Equally important is a tax structure that has few or no distortions. Firms and individuals can operate more efficiently when they can do so on a level playing field. Tax exemptions distort price signals and prevent the market from ensuring the most efficient allocation of resources.
The Fund, in co-operation with our sister institution, the World Bank, now works actively to promote institutional and structural reform among our members as a vital ingredient in promoting sustained and rapid economic growth.
The World Bank now publishes an annual report on the progress made in reforms to encourage business and enterprise. The latest, "Doing Business 2006", makes for interesting—and sometimes surprising—reading. We learn that in 2004, the latest year for which data are available, the countries in the region classified by the World Bank as Eastern Europe and Central Asia were the most intensive reformers.
But there is still a big reform agenda for many countries in this part of the world if the business environment is to come close to what we might call "best practice". For instance it only takes two days to start up a business in Australia and 5 days in the United States. It takes 33 days in Russia: that could prove something of a disincentive to those looking to start up business. Not as much as in Azerbaijan, though, where it takes 115 days to start a business, or in Belarus, where it takes 79 days.
Globalization makes such comparative data all the more telling. Technological advances and lower transport and communications costs mean that in many cases, firms can choose where to set up business. In such cases they are likely to go where the procedures are most streamlined, where running a business is easier, and where they have most protection under the law. When it is expensive to establish a new firm in one country, a country that offers an easier and less costly process gains an important advantage.
So do countries which offer firms a better chance of collecting debts, for example. In Georgia it takes 375 days to collect a debt, according to the World Bank, and it costs, on average, almost half the total debt to collect it. In Armenia, the process is shorter—185 days—and cheaper—less than a fifth of the total debt. In New Zealand, though, it takes only 50 days on average, to collect a debt and costs less than 5 percent of the debt.
It's not just a matter of attracting new business. A more business-friendly climate will help companies become more efficient and more competitive, and can so help them grow. Take tax payments, for example. In Hong Kong, companies have to make one tax payment that represents about 14 percent of gross profits and they need to spend on average 80 hours preparing their tax returns. In Armenia, companies need to spend an average of 1120 hours a year working on their tax returns and have to make 50 separate tax payments. In Belarus it takes even longer—1188 hours—and the tax burden represents 122 percent of gross profits. That offers more of an incentive to close down than to expand.
Individual regulations by themselves may not tip the balance. But the cumulative impact can be important in determining how business-friendly a country is; that, taken together with the overall macroeconomic environment, can be critical in determining both future growth rates and an economy's ability to respond flexibly to any slowdown.
The role of the Fund
The Fund's principal objective remains the maintenance of international financial stability. But the way we carry out our role has, inevitably, changed over time. The Fund, like national economies, has adapted as the global economy has evolved.
The need to maintain international financial stability gives the Fund an important role in crisis prevention and resolution. But the Fund also has an important advisory role. Macroeconomic reform is, in a very broad sense, the Fund's business. When appropriate we also offer technical assistance on a wide range of macroeconomic issues in order to help governments adopt and implement reforms and we have done so in many areas when working with countries in this region as we do in all our member states.
The Fund uses the annual Article IV consultations to draw attention to policy weaknesses and recommend appropriate reforms. But both in our surveillance discussions and in discussion with countries embarking on reform programs with financial support from the Fund, we always seek to remind policymakers that it is they who have to adopt reforms and try to ensure their success. It is they who have to secure the support of civil society and the various economic actors involved and whose response will contribute to the success or otherwise of the reforms.
But many of the most pressing challenges facing the international economy today can be most effectively addressed multilaterally. The IMF is ideally placed to address these issues: we are a global institution, with a macroeconomic policy mandate. For some time, we have been moving to strengthen our surveillance work at the multilateral and regional levels. At our Spring Meetings in April it was agreed that we should take this work even further and establish a new process of multilateral consultations to address issues of global concern. It was also agreed that the first issue we should address in this new process would be the problem of global imbalances.
Coordinated action to reduce global imbalances will increase the gains to be had by all the countries involved and reducing the likelihood of a disorderly adjustment. A multilateral solution to the problem is therefore vital and the Fund is now moving ahead rapidly to fulfill this new mandate. Last week, we announced the first set of multilateral consultations involving China, the Euro Area, Japan, Saudi Arabia and the United States, all of whom have agreed to participate in the search for a multilateral solution to the problem of imbalances.
Let me conclude.
If we have learned anything since the IMF was established more than sixty years ago, it is that the art of economic policymaking is one of learning from experience and adapting to change. The policy community as a whole has learned much about how economies function and how, in this age of globalization, they interact. In the past decade or so, policymakers around the world have done much to implement reforms based on what we know; and many of those reforms are bearing fruit.
We know that economies need to be flexible if they are both to raise their growth potential—and to reduce poverty—and to weather the ups and downs of the global economy. We know the sorts of reforms needed to achieve that flexibility. And we know that flexibility is a vital ingredient of macroeconomic stability, which in turn is essential for growth.
There can be no better environment than the present global expansion in which to press ahead with the reform process. Taking the opportunity now to make economies more flexible will raise potential growth rates at the national and global level. It will also enable countries to respond more flexibly, and with less pain, when we encounter the next slowdown, as we undoubtedly will at some point. The better prepared all countries are to weather a downturn, the less severe, and less prolonged, that downturn is likely to be.