The New Economic Century: Experience and Opportunity in the Reform Process, by Anne O. Krueger, First Deputy Managing Director, IMF

May 3, 2006

Address by Anne O. Krueger
First Deputy Managing Director, IMF
Address To The Fraser Institute
Vancouver, Canada
May 3, 2006

Good afternoon. Thank you for that kind introduction. I'm pleased to be here today, and to share some thoughts with you about the world economy at the beginning of the twenty first century and, in particular, to examine some of the ways in which we can use the experience of the past few decades to ensure continued growth and prosperity in the world economy and extend the benefits of that growth to all.

As Canadians you have first hand experience of the benefits of growth: this country has experienced average annual real GDP growth of 3.4 percent over the past decade—making it one of the most rapidly growing industrial economies. Per capita income has also outpaced the other big economies, growing by an average of 2.4 percent a year. Unemployment is at a 30 year low. And inflation has been contained. Canada has demonstrated that sound monetary policy and fiscal prudence—including a reduction in government debt—provide a solid foundation for rapid growth over a prolonged period.

Of course, the benefits of Canada's sound economic policy framework have been considerably enhanced by the strong performance of the world economy as a whole in recent years. 2006 is likely to be the fourth successive year in which real global GDP has grown by more than 4 percent. Indeed, the IMF's own forecasts—released just a couple of weeks ago—predict global growth to be almost 5 per cent this year. That's an upward revision to the projections we published last September.

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: but we are seeing rapid growth in Latin America, the Middle East and Africa. And among the industrial countries, growth both here in Canada and 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.

The currently buoyant outlook for the world economy is all the more remarkable given continuing geopolitical uncertainty and the sharp rise in oil prices we have seen, and it is true that these act as a reminder that there are downside risks to the central expectations of continuing rapid growth. Global imbalances pose another risk with a large U.S. current account deficit; large reserves building up in Asia and the oil-exporting countries; and low rates of growth in some parts of Western Europe. Unilateral action by one country or group of countries to tackle this issue could adversely affect growth prospects at the global level. Further rises in oil prices or a widespread avian flu outbreak might also result in slower global growth.

Thus far, though, the world economy has proved remarkably resilient in the face of shocks. Growth has remained buoyant, and the most recent global slowdown, in 2001-2002, was relatively mild and short-lived. This generally favorable global environment owes much to the lessons learned from the experience of the past decade and a half. Macroeconomic management has improved significantly in many industrial and developing countries and this, along with other reforms, has raised the potential growth rate in many parts of the world.

The current conjuncture provides us with the opportunity to press ahead with the reform process. This is vital if higher growth rates are to be sustained and, in the case of many developing countries, raised still further in order to permit large-scale reductions in poverty. Implementing further reforms will also reduce vulnerability to shocks. The larger the number of countries well-placed to cope with the next slowdown in growth, the more likely it is that the slowdown will be mild and recovery rapid.

So today I want to review the lessons we have learned about the best ways of delivering macroeconomic stability and fostering more rapid growth. I will then say something about the nature of the economic reforms that are needed.

A wealth of experience

The world economy has undergone some dramatic changes in the recent past. There is perhaps no clearer manifestation of this than our recent experience with inflation. Twenty five years ago, 111 of the IMF's member countries—close to two thirds of our membership at the time—had double digit inflation rates. Last year, only 35 countries had double-digit inflation: that's less than a fifth of our members. In 1980, 39 members had inflation rates above 20 percent. Last year only five did.

The global inflation rate has declined from an annual average of close to 15 per cent in 1980-84 to 3.8 per cent in 2005. The average inflation rate in the industrial economies fell from almost 9.5 per cent between 1975 and 1979, and nearly 9 per cent in the early 1980s, to 2.3 per cent in 2005 and is projected to decline further, according to our latest World Economic Outlook, or WEO.

In developing countries, the decline has been even steeper and more rapid. In the early 1990s, the average inflation rate in developing countries was around 80 per cent; that had declined to 5.4 per cent by 2005. The IMF forecasts currently project a further drop, to below 5 percent by 2007.

This dramatic fall owes a great deal to significantly improved macroeconomic management. Monetary policy has become much more effective, helped by the spread of central bank independence and, in many cases, by inflation targeting. And as inflation has declined, and more countries have adopted fiscally prudent policies, growth has become more rapid and more durable.

So the benefits of lower inflation have been amply demonstrated. But other developments in the global economy in the past fifteen years or so have taught us about the importance of macroeconomic stability in general and about what is needed to deliver long term economic stability.

A changing world

The history of the world economy is one of change, of course, and the history of economic policy-making is one of learning from experience. As we learn more about how economies work, we acquire a better understanding of how policies should be shaped to foster growth and prosperity.

The multilateral framework put in pace at the end of the Second World War was—and remains—highly successful. And it owed much to the lessons learned in the 1930s: the beggar-thy-neighbor policies that raised trade barriers and favored competitive devaluations had brought the global economy to the brink of collapse. The architects of the postwar system wanted to avoid a repeat of that. They understood the close link between rapid economic growth and the rapid expansion of world trade. They also understood that the maintenance of international financial stability was essential for the expansion of global trade: that, of course, is why the IMF was created at the Bretton Woods conference in 1944.

And the postwar architects also recognized that trade liberalization—the progressive reduction of tariff and non-tariff barriers to trade, implemented in a multilateral context—was an equally vital ingredient in this equation. As a result of the rapid postwar expansion of world trade that in turn acted as a key driver of global growth, millions of citizens around the world are far better off.

At the time this new multilateral framework was being established, the world was broadly divided into three groups of countries: the small group of industrial nations; the much more numerous developing countries and the centrally planned economies of the Soviet bloc, largely detached from the global economy. One of the most striking contrasts between the world economy then and now is the extent of differentiation among countries: we now have low income countries, emerging market economies, oil producers and industrial economies.

In the past fifty years, the industrial countries have all grown rapidly, of course. But there have been, and are, significant differences among them in terms of GDP growth and rates of productivity growth; and although inflation performance has converged in recent years, there have been sharp differences among the advanced economies in earlier periods.

But the diverging performance of developing countries has been much more pronounced since the 1950s. Some emerging market economies—those pursuing outward-oriented trade policies and focusing on macroeconomic stability—have grown much more rapidly. Korea, for example, is in the OECD. It is the world's 11th largest exporter. In terms of performance and per capita income levels it has more in common with the advanced economies than most developing countries. But in 1960 it was and the third poorest countries in Asia, and one of the world's poorest economies. The same is true, to a lesser extent, of several other Asian and some Latin American countries.

The result is that some of the larger developing countries are increasingly important players in the international economy—and if high growth rates persist, they will become more so in the years to come. China and India still have relatively low levels of per capita income. But they are the world's most populous countries, and among the most rapidly-growing; and their importance in the global economy has greatly increased. India's share of world exports has nearly doubled in the past fifteen years: China's share has tripled. Between 2000 and 2005, India's share of global services exports shot up, from just over one percent to more than two and a half percent. China's share grew by half, to almost three percent.

But at the other extreme are the low income countries: still extremely poor and, whose relative (and in some cases, absolute) position has even worsened. The poor economic performance of many Sub-Saharan African countries is well known. After the Second World War, Sub-Saharan African countries were generally reckoned to have real per capita incomes well above those of most Asian countries other than Japan. In 1956, Ghana's per capita income was estimated to be more than a third higher than that of South Korea. Yet so slowly has Ghana's per capita income grown since then that by 2003, Korea's per capita income was more than eight times that of Ghana. The plight of these low income countries is one of the most important challenges we face. Before I say more about this and other challenges, let me outline some of the most important lessons I believe we have learned about macroeconomic management.

Many of the policy reforms undertaken by industrial and developing countries in recent years reflect the lessons of experience during the 1990s. We learned a great deal, for example, from our experience with what we used to call the transition economies—the formerly Communist states of the Soviet bloc. Since turning centrally-planned economies into normally functioning market economies had never been attempted before, this was truly a case of learning on the job. But in spite of some temporary setbacks, most of these countries are now largely integrated into the global economy and share the same economic problems that many other countries face.

Perhaps the more significant development during the 1990s was the sharp rise in private international capital flows to emerging market countries. When the postwar economic framework was established, the working assumption was that private capital flows would never recover the dominant role they had at the end of the nineteenth century. In fact, private flows among the industrial countries had resumed on a relatively large scale in the 1960s. And by the 1990s, private capital flows to developing countries had eclipsed official flows.

It soon became evident that these large private flows would have significant implications for macroeconomic policy—and for the IMF. A series of emerging market financial crises, starting with Mexico in late 1994, were fundamentally different from the problems to which the IMF and its member countries had been accustomed. These were capital account crises, quite unlike the traditional balance of payments crises for which the Fund had provided temporary support to countries having to undertake policy adjustments.

Capital account crises had two principal features that made them different. First, was the source of the crisis: a major change in the willingness of foreigners and domestic residents to hold domestic assets. Second was the speed with which these crises erupted and with which a policy response had to be prepared. After Mexico we saw crises in some Asian countries in 1997-98; in Russia in 1998; and elsewhere.

At first it was assumed in some quarters that these crises reflected capricious shifts in investor sentiment; that national economies were now subject to the whims of speculators. The outflows of capital were certainly enormous: the Asian crisis countries, for example, experienced a reversal of capital flows equivalent to more than 10 percent of GDP in just two years. Such shifts would cause enormous dislocation for any economy. The falls in GDP were large, sudden and had enormously adverse consequences for many citizens.

But it became clear that painful though these crises were, they had their origins in underlying weaknesses in the economies affected—weaknesses to which investors had reacted. In some cases, governments had accumulated debts that were unsustainable. In others, rapid private sector credit growth had led to a sharp deterioration in the quality of lending with a rise in the number of bad loans with adverse implications for potential economic growth.

Other factors often made the impact of the shifts in investor sentiment worse. Fixed exchange rates made it difficult for governments to react rapidly to the shift in capital flows. Currency mis-matches were common, as banks built up liabilities in one currency and had assets in domestic currency: when devaluation was forced on governments in the wake of crisis financial institutions and businesses were left facing massive losses or insolvency. The role played by weak financial sectors—especially poor credit allocation and the currency mis-matches—had particularly important consequences for macroeconomic management.

The Fund was heavily involved in the resolution of these crises. Financial support was often needed more urgently, and on a larger scale, than had been the case in earlier episodes where Fund support was needed. Yet in spite of the difficulties, it is clear that with hindsight the adjustment programs put in place with Fund support were far more successful than most observers believed possible at the time.

The benefits of experience

So what did our experience in the 1990s teach us about delivering growth and prosperity? Several important lessons stand out.

First and foremost is the crucial importance of a flexible exchange rate regime. Fixed exchange rate regimes pose significant challenges because they mean fiscal and monetary policies must always be consistent with the exchange rate regime and subordinated to it. The countries affected by capital account crises were all hampered in their initial response to trouble by fixed or heavily managed exchange rate regimes.

Second, is the importance of a sound macroeconomic framework that can bring macroeconomic stability and sustainable growth. In a globalized world, economies must have monetary and fiscal policies that make possible falling or low inflation and foster budgetary prudence.

Third is the need for sustainable levels of public sector debt. Fiscal policy has to be capable of servicing the public debt. 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. Debt reduction is also important in enabling governments to pursue counter-cyclical fiscal policy during downturns.

Fourth is the importance of flexibility. An economy needs to be flexible to maximize its growth potential. It needs to be capable of smooth adjustment to changing circumstances, to enable it to continue to grow rapidly in the face of technological change, to respond to changing competitive pressures, to respond to demographic changes and, of course, to respond to shocks. So an economy needs to have flexible labor markets and flexible product markets, for example.

A fifth 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. Our experience in the 1990s reinforced what we already knew but did not always fully appreciate: that a weak financial sector can undermine growth. Resources are misallocated, and average rates of return fall. A well-regulated financial sector, with proper supervisory arrangements, is essential: without this, financial sector weakness can undermine stability and, in turn, growth.

Closely related 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 so. 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 opportunity for further progress

Much progress has been made on many issues in many countries and many of these lessons are already bearing fruit. But while progress on many fronts has been impressive, many challenges remain. At the global level the most important is securing a satisfactory outcome to the Doha round of trade negotiations. 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.

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 us 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.

At the national level, the favorable short-term outlook is a window of opportunity that policymakers cannot afford to ignore. It is always easier to introduce reforms during periods of expansion: they can be planned carefully, for maximum effectiveness. And building a consensus for reform, while always challenging, is easier during good times.

There are challenges for all countries. Among the industrial economies, there is scope for further fiscal adjustment, to aim for balance over the business cycle. Economies with high budget deficits in good times have little room for maneuver in more difficult times. Global growth performance may have been strong, but there is no evidence that we have abolished occasional downturns.

Most industrial countries are also facing the prospect of significant 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. Action is needed sooner rather than later in order to avoid a fiscal crunch.

In emerging market countries, governments need to press ahead with further fiscal reforms and with debt reductions. Measures have already been taken in many emerging market economies to bring down debt to GDP ratios, to reduce foreign currency exposure and to lengthen debt maturities. But debt levels remain uncomfortably high in many emerging market countries, making them more vulnerable than is desirable to changes in the global interest rates or liquidity environment, or to currency fluctuations. Without further fiscal consolidation and debt reduction, governments will not be able to use counter-cyclical fiscal policies when appropriate.

But fiscal reform is also important because many of these countries will also confront demographic change: it may be further off for most of these countries but the challenges are greater: public pension schemes, while more limited in coverage, are already expensive and unsustainably generous to those who are covered.

The currently favorable outlook also provides an important opportunity for governments, particularly in developing countries, to press on with the structural reforms that will further enhance the flexibility of their economies and increase their growth potential. Many economies have labor market rigidities that hamper growth prospects; many have burdensome business regulations and weak enforcement of contracts and property rights that discourage enterprise and so undermine growth and, in turn, poverty reduction. Let me say a little more about this.

A useful—and revealing—publication by the World Bank, called Doing Business 2006, illustrates the scope for improvement in many cases. Take labor market regulation. The economic evidence shows that labor market rigidities stifle employment growth and lead to stickiness in the unemployment rate. Paradoxically, the easier it is to lay off workers, the more likely employers are to hire them. Because they will be able to respond more easily to a downturn, for example, they will be less resistant to hiring staff during an upturn and so better able to take advantage of good times. It's a situation where everyone gains.

The World Bank has constructed several indicators measuring labor market flexibility. In New Zealand, for instance, there is no cost to the employer in laying someone off; nor is there in the United States. But in Ecuador it costs 131 weeks of salary to fire someone and in Sierra Leone it costs 188 weeks of salary.

It's a similar picture with business red tape. I hardly need tell this audience that business in today's globalized world is highly mobile. Firms seeking to set up business or expand will gravitate to where the costs are lower, and regulation lighter. A strong enterprise culture is a vital ingredient of a dynamic and growing economy. Here in Canada, only 2 procedures are needed to start a new business, and it can be done in 3 days. There is zero minimum capital required. Contrast that with Venezuela where 13 procedures are involved and it takes 116 days; or Brazil where the process takes 152 days or Saudi Arabia where the minimum capital required is 1,237 percent of per capita income!

In the Netherlands it takes 48 days to enforce a contract; it takes 50 days in Japan. Yet it takes more than 1000 days to enforce a contract in Vietnam—and 1390 days in Italy. In some countries—Indonesia and Malawi, for example—the cost of enforcing a contract is greater on average than the original debt.

In many parts of the world, therefore, there is plenty of scope for reforms that would help create a more business-friendly climate, encouraging investment and so making possible more rapid growth.

The final reform challenge is for those countries left, or falling further, behind, and is in some ways the most daunting. The Millennium Development Goals agreed by the United Nations in 2000 have highlighted the extent to which some low income countries have fallen behind. 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 corruption, policies aimed at achieving macroeconomic stability are all 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—have 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 also important. 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 role of the IMF

In fact, the IMF has an important role to play across the whole range the reform challenges I've discussed. I noted earlier that the maintenance of international financial stability is our principal mandate: our main focus is on macroeconomic policy. Better policies delivering more flexibility and thus stability at the national level greatly reduce the risk of instability at the global level. More rapidly growing national economies make for more rapid global growth—which was, after all, the ultimate objective of the postwar economic framework.

But our experience in recent years has taught the policy community as a whole that macroeconomic stability depends on a wide range of factors that economists used to think of as microeconomic issues. A sound financial sector, effective and well-functioning institutions, more flexible labor markets, respect for contracts and property rights: these are all important ingredients in establishing macroeconomic stability and in laying the foundation for more rapid growth. Failure to pursue reforms in these areas will undermine growth and can eventually undermine macroeconomic stability as well.

So the Fund has an important role to play, through our surveillance work, in highlighting the need for and the benefits of reform. Our surveillance work at the national level, through annual Article IV consultations with our member countries, draws attention to potential policy weaknesses—and also notes policy successes. The Fund has a unique cross-country perspective, enabling us to understand better what works and what doesn't and to provide appropriate advice to our members.

But we are now moving greatly to strengthen our surveillance work at the global and regional level. Many of the most pressing challenges facing the international economy—the problem of global imbalances, for example—need to be addressed multilaterally. These issues often cut across existing groups of countries and policy fora. The IMF is ideally placed to address these issues: we are, after all, a global institution, with a macroeconomic policy mandate.

So it was agreed at our Spring Meetings, held in Washington just a few days ago, that we will develop our multilateral surveillance work to enable us to assume this central role in fostering the resolution of international economic problems. We plan to move rapidly ahead with this work.

The Fund also provides technical assistance to member countries wanting specific help with reforms. This now accounts for a significant element of our work and ranges from assistance in improving customs procedures or tax administration to the management of monetary policy as more and more countries recognize both the importance of macroeconomic stability and the role within that of an efficient public sector. Helping countries to improve tax collection procedures, for example, can significantly raise the revenue stream from any given tax rate; removing exemptions and lowering tax rates can also raise revenues by acting as a disincentive for people to participate in the informal sector of the economy. Streamlining customs procedures can help governments create a more business-friendly environment. We can also provide assistance with institution building.

Of course, we continue to have an important role in crisis prevention and resolution. The past fifteen years or so have given us plenty of experience with the latter. But the fact that we currently have a very small number of borrowers might suggest that we are now doing better at prevention. I would hesitate to be so glib: but our aim is certainly to push for further reforms and further strengthen economic performance in the hope that the world economy will be more resilient when the next slowdown comes.


I started by noting the remarkable buoyancy of the global economy at present. Notwithstanding the downside risks, 2006 looks like being another year of strong growth, in almost every part of the globe.

The aim now should be to prolong this period of expansion. The more rapidly economies grow, the more rapidly the living standards of their citizens will rise, and the more progress that can be made with poverty reduction. For many of the IMF's member countries, reducing poverty remains an important priority.

Much progress has been made in improving macroeconomic management in the wake of our experience in the 1990s. There has been a worldwide reduction in inflation. Growth has accelerated in many countries. Fiscal and monetary policy reforms have been undertaken. Considerable effort has gone into strengthening financial sectors.

But much remains to be done, especially in the area of reducing debt vulnerabilities and in structural reforms. And now is the ideal time to press ahead. The more flexible economies are, the greater their growth potential and their ability to respond to changing circumstances. The global economy will be stronger as a result.

The IMF is well-placed to help member countries, both by encouraging those policymakers tempted to take time out from the reform process and by providing appropriate policy and technical advice.

This is a time of remarkable success and opportunity for the world economy. We must all do what we can to make the most of it.

Thank you.


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