A Rising Tide Lifts All Boats: How Europe, by Promoting Growth, Can Help Itself and Help the World, Speech by Rodrigo de Rato, Managing Director, IMF
IMF News, May 22, 2006
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- Published: May 22, 2006
Overview
- Speech by Rodrigo de Rato, Managing Director, International Monetary Fund, at the Austrian National Bank Seminar, Vienna, Austria, May 22, 2006.
- Central thesis: raising potential and actual growth in Europe is the key policy objective—growth will ease fiscal pressures, help manage demographic change, reduce social tensions, and contribute to rebalancing global demand.
Global risks and imbalances
- Key present risks:
- High and volatile oil prices affecting global growth and inflation.
- Risk of an avian flu pandemic; need for business continuity plans, especially for the financial sector.
- Global current account imbalances:
- United States current account deficit: almost 6½ percent of GDP in 2005, and expected to be as high again this year.
- Large surpluses in Russia, Saudi Arabia, Japan, and emerging market countries of Asia, especially China.
- Disorderly adjustment scenario:
- Abrupt fall in U.S. consumption growth (e.g., triggered by housing market).
- Sudden investor unwillingness to hold U.S. financial assets → abrupt depreciation of the U.S. dollar and increases in U.S. interest rates.
- Potential global financial market disruption, downturn, and resurgence of protectionism with serious consequences for Europe.
Europe's economic challenges
- Growth and employment:
- Euro area growth: about 1¼ percent in 2005; IMF projects it will remain at about 2 percent in 2006.
- Europe's key challenge: raise growth and employment while preserving social cohesion.
- Demographics and fiscal pressures:
- Current demographic ratio: less than four people in the age range 15-65 for every one over 65.
- By 2050, that ratio could be closer to two to one.
- European Policy Committee's Working Group on Aging Populations estimates additional public expenditure of about 4 percent of GDP due to aging; IMF estimates somewhat higher when including long-term health care costs and different growth assumptions.
- Labor market outcomes:
- Almost one in ten of the labor force in Europe cannot find a job.
- Among the young the ratio is twice as high.
- Social and political risks:
- Growing hostility toward further European integration and globalization.
- Risk that complacency about current external balances leaves Europe vulnerable to spillovers from global adjustment.
Structural reform agenda: product markets, financial sector, labor markets
- General prescription:
- Pursue structural reforms—product market reform, financial sector reform, labor market reform—and fiscal consolidation to raise growth.
- Product market reform:
- Defined as reduction in tariff and legal barriers, opening up markets to competition, creating a more business-friendly environment, and reducing distortions from state involvement.
- Direct effects: increase productivity, reduce companies' costs (e.g., reduced administrative burden, lower barriers to trade).
- Indirect effects: increased competition incentivizes efficient resource use, innovation, and disciplinary threats of bankruptcy or takeover.
- Complementarity: product market reform is complementary to labor market reform—preceding or accompanying product reform raises employment payoffs from labor reform.
- Country examples: Denmark, the Netherlands, and the United Kingdom undertook major product market liberalization alongside labor market changes; UK privatization reduced the share of GDP produced by public companies from 12 percent to 2 percent (1979–1997).
- Financial sector reform:
- Productivity gap: productivity has grown by about 1 percent a year more in the U.S. than in Europe since 1996; almost half of this difference is accounted for by differences in productivity in financial services; much of the remainder is accounted for by retail trade.
- Causes of lower European financial productivity: limited financial integration, fragmented payments and clearing systems, concerns over national ownership, differences in regulatory and supervisory frameworks, limited cross-border retail banking activity.
- Benefits of greater integration: enhance competition, improve efficiency, lower cost of capital, improve monetary transmission.
- Implementation barriers: differences in taxation and legal systems—especially commercial and consumer protection law—impede integration.
- Supervisory framework: need for improved cross-border supervision, better crisis management arrangements, and a centralized repository for up-to-date information on systemically important financial institutions.
- Labor market reform:
- Successful measures already implemented in some countries: liberalization of part-time and temporary employment, phase-out of early retirement schemes have improved labor utilization.
- IMF recommendations:
- Raise statutory retirement ages and adjust actuarial regimes to promote intergenerational equity and pension sustainability.
- Improve targeting of social benefits for the unemployed (e.g., generous but time-limited unemployment benefits; link long-term benefits to active search and socially useful work).
- Use income tax credits rather than high minimum wages to promote higher employment.
- Merge permanent and fixed-term employment contracts into a single contract with severance pay based on duration of employment—recent IMF research suggests this would lower the structural unemployment rate in France by two percentage points.
- Employment protection legislation: reduce restrictions on hiring and firing to lower structural unemployment, while finding ways to ameliorate social costs for those adversely affected.
Fiscal policy and sustainability
- Fiscal outlook:
- Most budgets are not in bad shape currently, but demographic changes will impose significant challenges.
- IMF view: costs of aging and long-term health care are significant and should not be offset by assuming higher employment and productivity growth without concrete measures.
- Policy recommendations:
- Place public finances on a sustainable footing; governments should be reducing rather than raising debt now.
- Target: broadly balanced fiscal positions by 2010.
- Consolidation pace: steady consolidation of about ½ percent of GDP per annum is necessary to achieve objectives.
- Governments should propose concrete measures to achieve agreed objectives and improve transparency.
- Specific transparency measures: debate stability plans in parliaments alongside budgets; strengthen auditing agencies.
International coordination and multilateral consultations
- Multilateral approach:
- IMF mandate to pursue multilateral consultations to address vulnerabilities affecting individual members and the global financial system within a joint-action framework.
- Multilateral consultations intended to facilitate collective analysis, consensus-building, and overcome hurdles to individual action by emphasizing benefits of joint action.
- Europe’s role in rebalancing:
- Neither Asian exchange rate changes nor U.S. fiscal adjustment alone can defuse global imbalances.
- Europe can contribute by structural reforms that raise domestic demand (especially in non-traded goods) and revitalize growth—this will ease global adjustment burdens and make action by others politically easier.
Key statistics and projections (preserved exactly as in the speech)
- United States current account deficit: almost 6½ percent of GDP in 2005, and expected to be as high again this year.
- Euro area growth: about 1¼ percent in 2005; IMF projects it will remain at about 2 percent in 2006.
- Productivity gap: productivity has grown by about 1 percent a year more in the U.S. than in Europe since 1996; almost half of this difference is accounted for by differences in productivity in financial services.
- Demographic pressure: less than four people in the age range 15-65 for every one over 65; by 2050, that ratio could be closer to two to one.
- Aging-related public expenditure: European Policy Committee's Working Group on Aging Populations estimates additional public expenditure of about 4 percent of GDP; IMF puts the costs somewhat higher.
- Fiscal consolidation recommendation: steady consolidation of about ½ percent of GDP per annum; target broadly balanced fiscal positions by 2010.
- Unemployment indicators: almost one in ten of the labor force in Europe cannot find a job; among the young the ratio is twice as high.
- Labor market reform impact example: merging permanent and fixed-term contracts would lower the structural unemployment rate in France by two percentage points.
Conclusions and policy priorities
- Growth is the central policy objective—"the tide that lifts all boats"—because it:
- Reduces the fiscal crunch from aging.
- Eases social discontent.
- Helps rebalance global demand.
- Priority policies:
- Product market reforms to increase competition and productivity.
- Financial sector integration and supervisory improvements to boost efficiency and monetary transmission.
- Labor market reforms to raise labor utilization, complemented by product market reform to maximize payoffs.
- Fiscal consolidation and greater transparency to ensure sustainability.
- Active participation in multilateral consultations and coordinated international action to address global imbalances.
Speech by Rodrigo de Rato, Managing Director, International Monetary Fund, At the Austrian National Bank Seminar, Vienna, Austria, May 22, 2006.