The Challenge Facing the Global Economy: New Momentum to Overcome a New Mediocre, by Christine Lagarde Managing Director, International Monetary Fund
October 2, 2014By Christine Lagarde
Managing Director, International Monetary Fund
Georgetown University, School of Foreign Service, October 2, 2014
As prepared for delivery
Dear President DeGioa, thank you for the gracious introduction!
Dean Reardon-Anderson, students and faculty: Thank you for welcoming me here today!
I am honored to be hosted by one of the world’s finest schools of foreign service. Your mission statement is “to contribute to global peace, prosperity and human well being by educating future generations of world leaders.”
The founders of your school had an ambitious and sustainable vision back in 1789; but they did not know that 70 years ago the IMF would be founded to pursue the same objectives — albeit by different means. I could not be at a better place than speaking here today.
As I look at the grey and blue colors of Georgetown that adorn this beautiful campus, I am reminded of the themes that I will touch upon today: some “grey” clouds hovering over the global economy; and the “blue” skies of growth and prosperity to which we both aspire.
This will be the topic for the Finance Ministers and Central Bank Governors of our 188 member countries as they arrive in Washington next week for the Annual Meetings of the IMF and World Bank. They will also be discussing, of course, the role of the IMF.
Let me say a few words about the IMF and its task.
Founded in the aftermath of World War II, the Fund has helped the world to fight many economic crises—from Europe, to Asia, to Latin America, to the former Soviet Union, and back to Europe. We have helped emerging markets and the world’s poorest nations to integrate into the global economy. Across our entire membership, we have helped to build economic and financial capacity.
In recent years, we have provided assistance during the global financial crisis—the worst facing the world since the Great Depression. In recent months, we have provided support to Ukraine, nations in the Middle East, and the Ebola-stricken countries of West Africa.
Our main job now is to help the global economy shift gears and overcome what has been so far a disappointing recovery: one that is brittle, uneven, and beset by risks.
This will be foremost on policymakers’ minds next week. Indeed, in many ways, the global economy is at an inflection point.
Yes, there is a recovery but as we all know—and can all feel it—the level of growth and jobs is simply not good enough. The world needs to aim higher and try harder, to do it together and be country-specific.
What does that mean? It means a mix of bolder policies to inject a “new momentum” that can overcome this “new mediocre” that clouds the future. That is what I want to discuss with you today.
As one of the most illustrious faculty members of this School and former Secretary of State Madeleine Albright once said: “The best speech will do it all—make us laugh, think, cry, and cheer—preferably in that order!” Today I would mainly like to make you think—and hopefully not make you cry too much!
I will focus on two topics:
(i) First, the state of the global economy—and the risk that the world could get stuck for some time with a “mediocre” level of growth; and
(ii) Second, how all policymakers can generate the policy “momentum” needed to power up global activity, and avoid the new mediocre.
I will conclude with what I see as priorities for a new “multilateralism”—how to galvanize global cooperation and the role of the IMF.
So three M’s”: mediocre growth, momentum on policies, and multilateralism for action.
1. State of the Global Economy—A New Mediocre?
First, a quick health check on the global economy. We will be releasing our updated forecasts next week, so today I will touch only upon the broad trends.
Overall, the global economy is weaker than we had envisaged even six months ago. Only a modest pickup is foreseen for 2015, as the outlook for potential growth has been pared down.
Prospects differ, of course, across countries and regions. In fact, this is one of the most striking characteristics of the current economic conjuncture: it is very country-specific.
Among advanced economies, the rebound is expected to be strongest in the United States and the United Kingdom; modest in Japan; and weakest in the Euro Area, within which there are disparities.
Emerging market and developing economies have been doing much of the heavy lifting during this crisis—accounting for more than 80 percent of world growth since 2008. Led by Asia, and China in particular, we expect that they will continue to help drive global activity. For them too, however, it is likely to be at a slower pace than before.
For the low-income developing countries, including Sub-Saharan Africa, economic prospects are rising—with growth projected broadly to accelerate beyond the 6 percent recorded last year. But as debt builds up in some countries, they need to be watching as well.
Finally, in the Middle East, the outlook is clouded by difficult economic transitions and by intense social and political strife.
The bottom line? Six years after the financial crisis began, we see continued weakness in the global economy. Countries are still dealing with the legacies of the crisis, including high debt burdens and unemployment. In addition, there are some serious clouds on the horizon:
Low growth for a long time is one.What do I mean? If people expect growth potential to be lower tomorrow, they will cut back on investment and consumption today. This dynamic could seriously impede the recovery, especially in advanced economies that are also grappling with high unemployment and low inflation. This is the case for the Euro Area.
There is also a cloud hovering around asynchronous monetary policy normalization in advanced economies and its potential spillovers to other countries around the world—and back—both through their impact on interest rates and exchange rate variations.
As well as these “economic” clouds, there are financial ones. There is concern that financial sector excesses may be building up, especially in advanced economies. Asset valuations are at an all time high; spreads and volatility are at an all time low.
A further worry is the migration of new market and liquidity risks to the “shadows” of the financial world. This is part of the less-regulated, nonbank sector, which is growing rapidly in some countries. In the United States, for example, shadow banking is now considerably larger than the traditional banking system; in Europe, it is roughly half the size; and in China, at 25-35 percent, it is the fifth largest shadow banking sector in the world.
Of course, nonbank activities can complement the banking sector in financing the economy in important ways. Yet, the opaqueness of these activities warrants heightened vigilance. They also warrant increased efforts to complete the agenda of financial sector reform, including resolving the too-important-to-fail problem, setting an appropriate perimeter for the monitoring of shadow banks, and making the derivatives markets safer and more transparent.
As well as economic and financial “clouds”, there are geopolitical risks. They include:
- A possible further escalation of the situation in Ukraine, which could provoke disruptions in commodity prices, financial markets and trade;
- Political developments in the Middle East and in some parts of Asia;
- And an expansion of the Ebola outbreak in Africa, which could pose a significant risk to the region and indeed the world, if not urgently and appropriately addressed.
All of these risks, of course, also involve immense human suffering and we hope that they do not develop. But we would be remiss simply to ignore them.
2. New Momentum—Policy Priorities
The global economy is at an inflection point: it can muddle along with sub-par growth—a “new mediocre”; or it can aim for a better path where bold policies would accelerate growth, increase employment, and achieve a “new momentum”.
How can this second “m”—momentum—be generated?
For one thing, we need better balance in our policy toolkit – using both the demand and supply side of the economy. Think of the famous Georgetown Hoyas basketball team—you need all players to work together to win. You need teamwork. The same is true for the global economy. Each policy instrument must play its part in order to achieve proper balance.
Monetary policy has provided important support to demand during this crisis. In the U.S., for example, the Federal Reserve’s quantitative easing has done much to aid recovery.
But monetary policy cannot suffice. Moreover, the longer easy money policies continue, the greater the risk of fuelling financial excess. This needs to be monitored and managed.
Equally important, as I mentioned earlier, where the prospect of exit from monetary easing looms—as in the U.S.—the implications for other parts of the world need to be monitored and managed. A continued gradual approach with clear communication from the Fed is key.
So too is the adoption of appropriate macro-prudential policies by those countries that stand to be most affected by monetary normalization—especially emerging markets. What does “macro-prudential” mean? It means measures that can help prevent financial excesses and protect the stability of the financial system, such as minimum liquidity ratios.
So back to the Hoyas: monetary policy is playing its part. Now it needs more support from the rest of the team—other policies. There are three important and interrelated elements here—and all can help promote a higher level of growth and jobs: fiscal policies; structural reforms of labor and product markets; and public investment in infrastructure.
Let me touch on each of these.
(i) First, growth-friendly and job-friendly fiscal policies.
A great deal has been achieved in many countries in recent years to reduce excessive deficit and bring debt under control. These gains must not be squandered. And yet, there are still a few levers that fiscal policy can pull to boost growth and jobs:
- The pace of consolidation and composition of fiscal measures should support economic activity to the extent possible. Of course, specific timing and scope for flexibility must be attuned to country circumstances. That is why the IMF has given this issue priority in the programs that we support—from Africa to the Euro Area. A sensible pace.
- Well-targeted fiscal measures can contribute too, such as reforms that can address tax evasion, support more efficient public spending, and reduce the burden on labor – lower payroll taxes, for instance. A sensible mix.
- The reform of energy subsidies, which we estimate at about US$2 trillion, can also generate revenue. As it stands, these subsidies mostly benefit the relatively affluent, not the poor. They also harm the environment.
So growth-friendly, job-friendly, environment-friendly fiscal policies can help. But they cannot substitute for policies to remove deep-seated distortions in labor and product markets.
(ii) That brings me to the “structural reforms” that are so essential to raise productivity, competitiveness and employment.
What should be done? First of all, the scale of the challenge should not be underestimated. Today, more than 200 million people around the world are still unemployed, of which 75 million are youth. In addition, with the exception of the top 1 percent, most people have seen their incomes stagnate or shrink over the past few years.
To lift consumption and investment, we need more robust job and wage growth. In particular, we need to make labor markets stronger. How?
- Through well-designed, active labor market policies and training programs that bolster the demand for workers – especially young people. There are some useful examples in countries like Australia, Germany, and Sweden; and
- Through policies that increase labor participation, especially of women. In Japan, for example, a major effort is ongoing to expand the supply of day-care centers to encourage women to join the labor force—and as a way to offset aging pressures. Similar policies are explored in Korea.
Opening up of product and service markets can also reinforce the gains from labor market reforms—one example being the many professions, from lawyers to taxi drivers, which are closed to competition in many countries.
Even then, these policies would only go so far unless we improve the flow of credit to the economy. We need insolvency regimes that can help banks and the private sector effectively deal with their debt burdens—to free up their balance sheets so credit can flow back and grease the wheels of the economy.
Again, no one size fits all here. Policies must be designed according to country circumstances. But whatever the country-specific measures might be, all nations need to place a much higher premium on structural reform—and on investment.
(iii) Public investment in infrastructure is especially important. Why?
The crisis has inflicted a heavy toll on both growth and investment, which remain well below their long-term trends. As of last year, we have estimated that for the G-20 countries, GDP is 8 percent lower than it could otherwise have been. The shortfall in investment is even higher—nearly 20 percent below trend.
In advanced economies, capital stocks – airports, electricity, internet grids—were depleted as public investment was steadily scaled back by a quarter—from about 4 percent of GDP in the 1980s to 3 percent today. Is it any surprise that aging infrastructure is now such a major concern?
Right here in Washington DC, the American Society of Civil Engineers estimates that 99 percent of the major roads are in poor condition. Globally, some estimates place spending on infrastructure at US$6 trillion over the next 15 years. This is an obvious imperative in many countries, where bottlenecks and obstacles to transportation and energy supply abound and hamper development.
Again, the scope for investment differs across countries—depending on infrastructure gaps and fiscal space. And for all countries, ensuring efficient infrastructure spending is crucial. There is no question, however, that it can be a powerful impetus for growth and jobs.
One more point: recent estimates – by the Global Commission on the Economy and Climate – indicate that integrating lower emission standards into infrastructure investment would cost only a tiny fraction (about 4.5 percent) of total projected spending. So efficient investment–especially at a time of historically low interest rates–can be good for growth, good for jobs, and good for the environment.
Concluding remarks on the new multilateralism and role of the Fund
We have talked about “mediocre” growth and the policy “momentum” needed to overcome it. I would like to conclude with my third “M” – multilateralism.
We have seen some concrete examples of global economic cooperation in action during this crisis.
Perhaps most prominent has been the G20 nations coming together—including to provide additional resources to the IMF—to bolster confidence and safeguard the global financial system. Just a few weeks ago, the G20 announced further progress in developing strategies to lift medium-term growth by a collective 2 percent of GDP by 2018 – holding the promise of more growth and jobs.
The IMF, of course, has been a forum for cooperation throughout its 70-year history. This has continued during this crisis.
We have revamped our lending toolkit, including by making our instruments more flexible in providing liquidity on a precautionary basis and easier to access in emergencies. And we introduced zero-interest loans for our low-income members. We have also significantly increased our financial assistance across the globe – close to US$700 billion in commitments over the last 6 years.
We have done some new analysis and thinking on a range of critical issues: on capital flow management and capital controls; and on the growing interconnectedness of the global economy and the spillover effects of one country’s policies on others. We have pushed the envelope on the negative effects of excessive inequality on growth; the fiscal implications of climate change; and—something very close to my own heart—the role of women in the work force and their powerful potential to boost growth and incomes.
It might surprise you to learn that the largest service that the IMF now provides is capacity building and technical assistance. Almost 90 percent of our 188 members have benefited– from Mauritius to Myanmar to Mexico. We have also initiated a massive open online course – a “MOOC”— with almost 2000 graduates from all over the world, in the last year.
To be effective in the 21st century, of course, we need to be adequately resourced and adequately reflect the dynamic nature of our global membership. To that end, the vast majority of our members have approved an IMF governance measure: the 2010 Quota reform. We now await approval by our largest shareholder–the United States–which we hope will happen soon.
Seventy years on, we continue to adapt to fulfill our raison d’être—to safeguard stability by helping countries through economic fallouts, and forging cooperative solutions to global problems. For you and for generations to come.
As I like to say sometimes: “This is not your father’s IMF”. Actually, it is yours!
Together, as we look forward to the future, perhaps those wonderful Georgetown colors can help guide us: there are some “grey” clouds, but—aiming higher, trying harder, doing it together—we can gain new momentum and bring the “blue” skies.