Bismarck's Warning: The Challenge of Economic Policy Reform in the Twenty-First Century, Anne O. Krueger, IMF First Deputy Managing Director
IMF News, April 5, 2005
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Bibliographic details
- Published: April 5, 2005
Overview
- Lecture given to the University Philosophical Society, Trinity College, Dublin; delivered April 5, 2005.
- Central thesis: economic policy reform must be continuous; "politics is the art of the possible" (Bismarck) frames the tension between economically desirable and politically feasible reforms.
- Context: global environment "unusually favorable" after strong global growth in 2004, low incidence of international financial crises, but persistent risks (higher energy prices, geopolitical uncertainty, global imbalances).
The case for reform — objectives and payoffs
- Primary objectives:
- Promote growth and improve citizens' well-being.
- Permit rising living standards and poverty reduction.
- Historical examples of payoffs:
- Korea: transformation from one of the world's poorest in 1960 to a rich Asian economy over four decades starting in the late 1950s.
- China and India: rapid growth in the 1990s lifted "around 200 million" people out of poverty.
- Ireland: GDP growth averaging 10% a year between 1995 and 2000; unemployment fell from 16% in the early 1990s to 4% by the end of the decade.
- Key macroeconomic achievement cited:
- Large and widespread reduction in inflation worldwide.
- Latin America: average inflation in the 1980s and 1990s far exceeded 100%; at the end of the 1980s it was "almost 500%"; by the 2000s inflation rates in excess of 10% are "very much the exception."
Categories of reform and country priorities
- Four categories of reforms by level:
- International level: reduce global imbalances; further trade liberalization (Doha round emphasized; estimate: "about two thirds" of benefits to developing countries).
- Industrial countries: pension system reform to ensure long-term viability amid demographic change.
- Emerging market economies: fiscal and financial sector reforms to deliver debt sustainability.
- Low income countries: rule of law, institutional strengthening, combat corruption, improve public expenditure efficiency, and trade openness among developing countries.
Why reform is politically difficult (political economy)
- Core tension: reconciling what is economically desirable with what is politically feasible; uncertainty about reform outcomes increases reluctance.
- Sources of political resistance:
- Opposition from groups that perceive they will lose from reforms.
- Short-term political pressures (e.g., election cycles, poverty alleviation demands, unemployment concerns).
- Tendency to relax policies during good times, reducing resilience for the next downturn.
- Consequences of postponing or weakening reforms:
- Slower growth in both good times and bad.
- Reduced ability to withstand downturns and shocks.
- Erosion of policy credibility; markets respond to perceived future loosening (Brazil 2002 example).
Country examples illustrating reform dynamics and outcomes
- Ireland
- GDP growth averaged 10% a year between 1995 and 2000.
- Unemployment fell from 16% in the early 1990s to 4% by the end of the decade.
- Ongoing challenges: signs competitiveness may have deteriorated; large infrastructure needs; rising demand for high-quality public services.
- Brazil (crisis and recovery, early 2000s)
- IMF-supported program during 2002 pre-election period reassured markets.
- Government primary surplus: 4.6% in 2004.
- Growth accelerated to "over 5%" in 2004 and "is expected to be around 4%" in 2005.
- Inflation fell from 12.5% in 2002 to 7.6% at the end of 2004 and was targeted to be at 5.1% by the end of 2005.
- Government decided not to renew its loan agreement after seven years of IMF support, while committing to the policy framework.
- Turkey (reform and stabilization)
- Government primary surplus was "almost 7% of GNP" in the year prior to the lecture, slightly above target.
- Growth: 9.9% in the most recent year; average growth close to 8% over the past three years.
- Inflation: had been above 60% since the mid-1980s and was 70% three years earlier; "today it is below 10%."
- Remaining vulnerabilities: external debt at 60% of GNP; total public debt nearly 70%; large fraction indexed to foreign currencies or linked to very short term interest rates.
- Asian financial crisis lessons
- Rapid growth increased the financial sector's role; credit rationing and misdirected lending produced rising non-performing loans.
- Fixed exchange rate pegs and currency mismatches magnified problems when investor sentiment shifted.
Key statistics and exact fiscal/macro figures preserved from the lecture
- Ireland: GDP growth averaged 10% a year between 1995 and 2000; unemployment fell from 16% to 4%.
- Korea: transformed from third poorest in Asia in 1960 to one of Asia's richest economies (no numeric GDP figures provided).
- China/India: "around 200 million" people lifted out of poverty during the 1990s.
- Latin America inflation: "in excess of 100%" in much of the 1980s and 1990s; "almost 500%" at the end of the 1980s; inflation rates in excess of 10% are now "very much the exception."
- Brazil:
- Government primary surplus: 4.6% in 2004.
- Growth "accelerated to over 5%" in 2004; "is expected to be around 4%" in the current year.
- Inflation: 12.5% in 2002 → 7.6% at end-2004 → target 5.1% by end of current year.
- Turkey:
- Government primary surplus "almost 7% of GNP" last year.
- Growth: 9.9% last year; average growth close to 8% over past three years.
- Inflation: above 60% since mid-1980s; 70% three years prior; "today it is below 10%."
- External debt: 60% of GNP; total public debt: nearly 70%.
Policy recommendations and implementation strategies
- Timing and sequencing:
- Seize opportunities during buoyant growth periods to implement reforms.
- Fiscal consolidation is easier in favorable environments and creates room for counter-cyclical policy later.
- Breadth and speed:
- Pursue reforms on a broad front (citing Roger Douglas and examples of New Zealand, Korea, Chile).
- Speed matters; structural reforms may take years to deliver full impact.
- Early priorities:
- Trade and exchange rate reforms early: more openness increases economic benefits and makes reversals politically harder.
- Political tactics:
- Identify potential winners to build coalitions.
- Identify and mitigate impacts on potential losers to reduce opposition.
- Be prepared to confront opponents strategically—pick winnable fights and commit to seeing reforms through.
- Communication and transparency:
- Clear communication of aims, costs, and benefits to citizens is critical to build support.
- Specific policy areas highlighted:
- Monetary policy: central bank independence, inflation targeting to secure price stability.
- Fiscal policy: prudent fiscal stance, reduce deficits, ensure sustainable public debt levels, efficient and equitable public spending.
- Pension reform: early modest adjustments to contributions, benefits, and retirement ages to avoid larger future costs.
- Financial sector: deal with non-performing loans, strengthen banking regulation, ensure well-capitalized banks.
- Rule of law and institutions: enforce property rights, commercial codes, reduce corruption, foster competition and enterprise.
- Trade liberalization: complete Doha round; reduce tariff and non-tariff barriers; promote south-south trade liberalization.
The IMF's role in reform
- Core mission: maintenance of international financial stability; crisis prevention and resolution.
- Tools and functions:
- Article IV surveillance: annual assessments and reform recommendations for member countries.
- Financial assistance: Fund-supported programs with payments in installments against agreed benchmarks; Fund endorsement signals credibility to markets.
- Technical assistance: advice on tax administration, budget accounting, financial sector regulation, commercial codes, and other implementation support.
- Nature of engagement: advisory respect for sovereignty, combined with conditional financial support when requested by governments.
Conclusion — tradeoffs and long-term stakes
- Reform is necessary for sustained, rapid economic growth; without it, countries and the world will grow more slowly.
- Policymakers face choices to postpone or abandon reforms—short-run gains may appear, but long-run costs include slower growth, reduced resilience, and diminished poverty reduction.
- Rewards of reform: higher sustainable growth, higher living standards, poverty reduction; success can be politically reinforcing and make further reform more feasible.
- Closing observation: persistent, steadfast pursuit of reforms can alter political possibilities and remove excuses for postponement, consistent with Bismarck's maxim that "politics is the art of the possible."
International Monetary Fund