Sustaining Global Growth, Address by Rodrigo de Rato, Managing Director of the International Monetary Fund at First Economic Forum of Comunidad de Madrid
March 30, 2007
As Prepared for Delivery
Thank you very much. It is a pleasure to be with you. I would like to say a few words this morning about the state of the world economy and the medium-term challenges that must be faced to allow the remarkable recent period of growth to be sustained.
The world economy is in the midst of its strongest period of sustained global growth since the early 1970s, while inflation remains at low levels. Notwithstanding recent jitters in the financial markets, this strong performance looks set to continue into 2007. Moreover, the expansion has been broadly shared. While the U.S. economy has recently slowed, spillovers on the rest of the world have been limited. Europe and Japan are showing solid momentum. The most dramatic growth has been observed in China and India, but it is noteworthy that almost all emerging markets and developing countries are growing robustly. The strong performance in low-income countries, especially in sub-Saharan Africa, is particularly welcome.
I will focus my remarks today on three questions. What have been the sources of this global prosperity? How can we ensure that the momentum is sustained over the medium term? And what are the implications for global imbalances, including in particular the large U.S. current account deficit? My main thesis is that the central arch of support for the recent exceptional performance has been strong productivity growth. Buoyant productivity has made possible healthy growth in profits in combination with rising real wages. It has allowed sharp increases in commodity prices to be absorbed without derailing inflation performance. Productivity has also contributed to the recent rise in asset values around the world, which has in turn sustained consumption and investment. And it has supported the capital flows needed to maintain the current pattern of global imbalances.
A. What are the Sources of the Global Productivity Boom?
It is well known that productivity growth in the United States over the past decade or so has been much higher than in previous decades, in substantial part in response to increasing use of new information and communication technologies. There have also been recent gains in other advanced economies, as Western Europe and Japan have emerged from periods of corporate restructuring. Less widely realized, over the same period productivity growth has also been strong and increasing in emerging market and developing countries. This is true on the basis of a crude but readily available broad measure of productivity, that is, output relative to working age population. Detailed studies with more precise measures of total factor productivity confirm this trend, particularly for countries that have undergone major structural transformations—notably China, India, and emerging Europe, which have made dramatic progress in opening their economies and advancing market reform.
In turn, strong productivity growth has been supported by the increasing integration of global markets for goods, services, finance, and labor—in a word, globalization. This process has been fed by a combination of rapid technological development, an increasingly open global trading system, increasingly sophisticated financial markets, and more resilient macroeconomic-policy frameworks. The rapid growth of international trade and the introduction of new technologies have allowed the production process to be unbundled. Both manufacturing and service activities are being offshored to lower-cost locations in an increasingly global market, thus providing productivity gains both in source and host countries. This process has been supported by important trade liberalization initiatives, including both the multilateral trade rounds, as well as the entry of former Eastern bloc countries in Europe into a free trade zone with the European Union in 1994, China's entry into the WTO in 2001, and India's progressive unilateral reduction in trade barriers since the early 1990s.
The shifting production structure has also been supported by the increasing international mobility of capital, especially rising rates of foreign direct investment and portfolio investment into emerging markets. This has not only provided a conduit for financing, but also enabled the diffusion of new technologies and management skills. Improved macroeconomic policy frameworks in these countries suggest that these flows are less likely to lead to the imbalances that caused boom-and-bust cycles in the past.
Within many developing countries, including in particular emerging Asia, growth has also been supported by large-scale movements of underemployed labor out of agriculture and into manufacturing and services. In addition, there have been important migration flows toward the advanced economies, including Spain. This migration has generated substantial remittances for poorer countries, while sustaining advanced-economy growth by relieving shortages and providing complementary skills.
B. Can the Productivity Boom Be Sustained?
What factors could threaten the continuation of these trends? There is some concern that global productivity growth may decelerate in the period ahead for a number of reasons. First, trade liberalization may provide less support for continued productivity gains. While I am hopeful that progress with the Doha round of multilateral liberalization will be forthcoming, I am seriously concerned that protectionist forces could rise over time, imposing new barriers to trade and investment flows, and reversing some of the gains from an increasingly integrated world economy. Sadly, despite its successes, "globalization" is often used as a negative word. Free trade is under pressure, reflecting a widespread perception that it only helps some countries, and some groups within those countries. Already there are concerns about recent resort to antidumping and "safeguards" actions around the world. Anti-trade measures could further intensify in the context of a cyclical downturn. Rising unemployment in particular will give added force to popular worries about the impact of globalization on the distribution of income, particularly in advanced economies.
In this context, a key imperative is to renew the political commitment to an ambitious outcome for the Doha round of multilateral trade liberalization. It will be especially important to achieve major advances in areas that benefit low-income countries, for instance by increasing access to advanced-country markets for agricultural products. The process of bilateral and regional trade liberalization may also continue, but it does not constitute a substitute for progress on the multilateral front. Bilateral and regional agreements—which already cover around one-third of global trade—are inherently less beneficial than liberalization on a "most favored nation" basis, and can be counter-productive if not well designed. Any such agreements must be subjected to greater discipline to minimize the costs to third countries from trade diversion, and to avoid creating a spaghetti bowl of diverse regulatory requirements. Such discipline will also maximize the chances that bilateral agreements will prove a stepping stone, rather than a stumbling block, toward global free trade.
More broadly, if globalization is to continue, I believe it is important to have a sober and realistic assessment of its consequences. It is not enough to appeal to the undoubted gains in the aggregate. One must also try to understand how these gains are distributed, and what strains may emerge for some groups. We in the IMF are very much aware of the need to examine these questions seriously. In fact, the latest World Economic Outlook, to be issued next month, discusses how the rapid growth of international trade, the increasingly global labor market, and the introduction of new technologies, have produced important gains to income levels in both advanced and developing countries, but have also had an impact on income distribution.
More can and must be done in the advanced economies to help those whose jobs may be particularly affected by recent trends in technology and trade. We need to ensure that adequate employment opportunities are created, and that the less well-off share in the general prosperity. Key areas for action include better education systems to ensure workers have the skills they need to compete, greater labor market flexibility to ensure that new jobs are being created, and strong social safety nets that cushion the impact of, but do not obstruct, economic change.
These issues are perhaps even more important in emerging markets and developing economies. Global integration of trade and financial markets has produced enormous benefits for these countries, and is the driving force behind the increase in income levels that should eventually allow their living and working standards to converge toward the levels found in advanced economies. But middle- and low-income countries must put as much or even greater emphasis than the advanced economies on ensuring that the fruits of growth are well-shared. Recent experience has shown that social programs targeted to helping the poor can be very effective, both in raising their living standards, and also in building up the human capital needed for longer-term growth and to progress towards the Millennium Development Goals.
Now, let me turn to a second source of concern: that global environmental and resource constraints are likely to impose increasing costs over time, which could undermine productivity performance. Efforts to date to address the long-term problem of global warming have been limited and partial. However, the potential long-term economic consequences of climate change are increasingly recognized, leading to rising interest across countries in taking actions to control hydrocarbon emissions, through both fossil-fuel taxes and carbon-trading schemes. I am very pleased that the European Union is leading the way in this area, providing an important example to others around the world.
Measures to address climate change inevitably add to the costs of doing business, but avert much graver long-term consequences. For instance, the recent Stern Review of Climate Change estimates that it would cost about one percent of GDP per year in order to stabilize carbon dioxide concentrations in the atmosphere. In contrast, the consequences of taking no action would be a long-term damage of 5 percent or more of global consumption, concentrated in lower-income countries in the tropics.
In this context, I should mention that while the IMF is not a center of expertise on the scientific aspects of climate change, we are building up our capacity to assess the macroeconomic significance of climate change and of policy efforts to mitigate it. This work will be important for our efforts to understand long-term macroeconomic challenges to the global economy, and will provide a basis for our policy advice to member countries, helping us contribute to the international efforts to deal with this challenge.
A third, crucial issue for maintaining productivity growth is the challenge posed by aging populations, especially in advanced countries. As the share of new entrants to the labor force declines, it will become harder to continually raise the knowledge base and expand the technological frontier. In addition, there are risks of mismatches between specific labor skills and needs. Perhaps most important, a rising ratio of dependents to working age population will raise pension and healthcare costs, imposing fiscal strains. A central challenge will be to ensure that fiscal policy frameworks remain sustainable in the face of aging populations.
During the present expansion, rapid revenue growth has helped to strengthen fiscal positions in a number of major economies. However, it remains uncertain how much of this improvement is cyclical—boosted by high profits, rapid growth of earnings at the upper end of the income spectrum, and rising asset prices—and how much will be permanent. On the whole, it seems likely that achieving fiscal sustainability in the face of unfavorable demographic trends will require substantial adjustments. Sustained progress toward fiscal consolidation seems particularly important in the United States, given concerns about the wide current account deficit, and in Japan, where deficit and debt levels remain particularly high. In the European Union too, greater advantage needs to be taken of the current momentum of the economy to bring down deficits in line with the medium-term objectives set under the Stability and Growth Pact.
How is such fiscal consolidation to be achieved? There will be significant pressure to raise tax rates, but this risks imposing considerable efficiency costs. Expenditure growth must also be contained; experience has shown this to provide a much more durable path to fiscal consolidation. In general, there is no doubt that more ambitious progress with structural fiscal reforms will be needed, particularly in areas like healthcare and pensions, to both contain increasing outlays and limit the erosion of revenue bases as populations age. For instance, pension system reforms could be designed to both encourage longer working lives, and safeguard long-term fiscal viability.
More open immigration policies and other steps to reduce the dependency ratio may also help address fiscal concerns. Spain provides an example of how an open attitude to immigration can be very positive for growth and help strengthen the national finances. However, such approaches can only partially compensate for aging trends, and in any case need to be set within appropriate labor-market frameworks that promote the absorption of newcomers.
An additional concern is that the boost from technological advances in the information technology and communication sector may diminish, unless the business environment is flexible and supportive. Most countries have so far lagged the United States in reaping the benefits from advances in information technology, and in principle should be able to continue achieving gains. However, doing so will depend in part on sustained reforms to reduce regulatory impediments and increase competition, particularly in service sectors such as wholesale, distribution, and finance, where the U.S. productivity performance has been very strong. In particular, it will be critical for policymakers to open up services to foreign entry and competition. In a similar vein, given the still-high share of employment in agriculture in China, India, and several other Asian economies, sustained growth will depend on efforts in these countries to improve agricultural productivity, and on a continued shift of labor toward industry and services. Such developments will only occur within a policy environment that encourages greater competition and flexibility. In Latin America, an acceleration of labor reforms, accompanied by liberalization of product markets and financial markets, will discourage the rapid growth of the informal sector that has lowered productivity, weakened worker protection, and reduced opportunities for improving skills.
C. Implications for the Unwinding of Global Imbalances
Any slowdown in productivity growth will have important implications for investment and consumption trends and the unwinding of global imbalances. Maintaining GDP growth rates in the face of slower growth of total factor productivity will require higher rates of capital accumulation than observed over the present expansion. At the same time, consumption growth could be dampened by lower expectations of future income growth, although aggregate consumption is likely to be boosted as a rising share of population in advanced countries retire and as populations in fast-growing countries in East Asia—especially in China—adjust to new levels of affluence and precautionary savings dwindle. The balance of these complex forces affecting saving and investment is hard to predict with any precision, but it seems likely that the recent period of "savings glut" or "investment dearth" (depending on perspective) will come to an end. This has an important implication: in the medium term, there will be growing pressure on financial resources, and we may see a period of rising real interest rates.
In this context, countries such as the United States with large current account deficits may face greater difficulties in attracting the continuing large-scale foreign financing needed. Such difficulties will arise particularly if returns on investments in the United States lag returns elsewhere. We must also anticipate that other countries' financial systems will start closing the gap with the United States by offering a similar array of financial vehicles for savings. In such circumstances, it seems likely that the current large U.S. current account deficit will need to come down. This process should be market-led, driven by a return of U.S. saving rates to more normal levels, supported by some realignment of exchange rates. Prospects for a smooth unwinding of imbalances will benefit from trade reforms and other structural initiatives to remove obstacles to the smooth reallocation of resources in response to exchange rate movements.
More generally, joint action by both advanced and developing economies will be important to ensure an environment conducive for the smooth unwinding of global imbalances. While the necessary policy steps are in each country's own long-term self-interest, concurrent actions across a range of fronts will generate synergies. Adjustments that may bring some short-term costs or have distributional consequences should be easier to advance in an environment of continued global prosperity and one in which countries are seen to be acting cooperatively toward common goals.
The international community has endorsed a multi-pronged approach, which includes four important elements. First, efforts to raise saving in the United States, including a commitment to more ambitious fiscal consolidation in the medium term. Second, advancing growth-enhancing reforms in the Euro area and Japan, especially in the services and financial sectors. Here, I am pleased by the Euro area's progress, as seen in the introduction of the revised Services Directive and Financial Sector Action Plan, although implementation must be pushed forward, and there is still considerable scope for additional measures. Third, initiatives to encourage consumption and more flexible exchange rate movements in emerging Asia, including China, so as to reduce its reliance on exports and high investment. And, fourth, efforts by oil exporters, especially in the Middle East, to boost spending in areas with high rates of return—a process that is already underway and needs to continue.
I believe that the IMF is playing an important role in promoting this approach, bringing key players together for multilateral discussions that are increasing the mutual understanding of the issued involved, and are helping to build resolve towards implementing the agreed strategy.
D. Concluding Remarks
In conclusion, the past five years have been a period of great global prosperity, underpinned by strong productivity growth. It is hard to predict what lies ahead, given the potential impact of climate change, population aging, and large global imbalances. I remain optimistic, but we cannot take it for granted that the current success will continue. Reforms are needed, both to maintain the pace of productivity growth, and to ensure that the resulting benefits are widely shared. I am aware of the growing popular concerns about the impact of globalization. I believe governments, both in the advanced economies and in emerging markets, can and should do much more to ensure that the gains from globalization—very clear at the aggregate level—are well distributed. We must recognize that some groups may be adversely affected and need to be given greater support in adjusting to increasingly global markets, without obstructing the process of change. Doing so will prevent the emergence of protectionist sentiment, and make it easier to continue advancing the ambitious policy agenda needed to sustain strong global growth. Gaining support for such reforms is never easy, but the present period of sustained growth should provide an ideal opportunity. Thank you.