Economic Inclusion and Financial Integrity—an Address to the Conference on Inclusive Capitalism, Speech by Christine Lagarde, Managing Director, International Monetary Fund

IMF News, May 27, 2014

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Canonical URL: Economic Inclusion and Financial Integrity—an Address to the Conference on Inclusive Capitalism, Speech by Christine Lagarde, Managing Director, International Monetary Fund

Definition and purpose
- Inclusive capitalism: trust, opportunity, rewards for all within a market economy—allowing everyone’s talents to flourish.
- Inclusive capitalism is posed as a continuous quest rather than a definitive destination.
Context and diagnosis
- Recent capitalism characterized by “excess”—in risk-taking, leverage, opacity, complexity, and compensation—leading to massive destruction of value, high unemployment, rising social tensions, and political disillusion in the wake of the Great Recession.
- Trust is eroded: the Edelman Trust Barometer showed that less than a fifth of those surveyed believed that governments or business leaders would tell the truth on an important issue.
- Restoring trust requires making growth more inclusive and ensuring the rules of the game create a level playing field favoring the many, not just the few.

Key empirical findings (as stated)
- Since 1980, the richest 1 percent increased their share of income in 24 out of 26 countries for which we have data.
- In the US, the share of income taken home by the top one percent more than doubled since the 1980s, returning to where it was on the eve of the Great Depression.
- In the UK, France, and Germany, the share of private capital in national income is now back to levels last seen almost a century ago.
- The 85 richest people in the world control as much wealth as the poorest half of the global population—that is 3.5 billion people.
- IMF research looked at 173 countries over the last 50 years and found that more unequal countries tend to have lower and less durable economic growth.
- Fiscal policies—transfers and income taxes—have been able to reduce inequality by about a third, on average, among the advanced economies.
Policy recommendations to enhance inclusion
- Make income tax systems more progressive without being excessive.
- Make greater use of property taxes.
- Expand access to education and health.
- Rely more on active labor market programs and in-work social benefits.
Implementation caveats
- Redistributive policies produce winners and losers; policy choices must balance doing the most good and the least harm.
- Fiscal discipline is often politically vulnerable and must be preserved while pursuing inclusion.

Systemic problems identified
- Financial sector contributed to crisis through excessive risk, leading to a socialization of losses and privatization of gains.
- Too-big-to-fail (TBTF) firms remain major sources of systemic risk: in the decade prior to the crisis, the balance sheets of the world’s largest banks increased by two to four-fold, with rising size accompanied by lower capital, less stable funding, greater complexity, and more trading.
- TBTF implicit subsidies persist: about $70 billion in the US, and up to $300 billion in the Euro Area.
- Some firms remain involved in major scandals violating basic ethical norms—LIBOR and foreign exchange rigging, money laundering, illegal foreclosure.
Core argument
- The financial sector’s true role is to serve the economy—financing investment, creating jobs and growth—rather than to dominate it. Trust and integrity are fundamental to this role.

Regulatory progress and gaps
- Progress under the Basel Committee on stronger capital and liquidity requirements aims to make the system safer and more service oriented.
- Progress is “too slow” and the finish line remains distant; complexity, industry pushback, and reform fatigue impede action.
- A gaping hole remains: agreement on cross-border resolution frameworks for megabanks is lacking.
Recommended regulatory and structural actions
- End too-big-to-fail through tougher regulation and tighter supervision.
- Implement capital surcharges for systemic banks: increasing the capital ratio on these banks by 2½ percent, beyond the Basel III standard, can reduce the systemic risk of a trillion dollar bank by a quarter.
- Agree on cross-border resolution of megabanks to enable orderly unwinding and reduce contagion risk.
- Strengthen rules for nonbanks and monitoring of shadow banking.
- Improve safety and transparency over derivatives; pursue mutual recognition of derivatives market rules to reduce cross-border frictions.
Supervisory and implementation priorities
- Strengthen supervision with greater resources and independence for supervisors.
- Recognize that rules require committed implementation; rules alone are insufficient.

Cultural and ethical focus
- Incentives must be aligned with expected behavior and made transparent; compensation practices are a key area.
- The FSB’s Principles for Sound Compensation Practices (commissioned by the G20) are instrumental and require implementation.
- Virtues such as prudence (stewardship, sustainability, safeguarding the future) must be re-embedded in finance.
- Ethical awareness should be cultivated over many years via education, leadership, alert watchdogs, and civil society engagement.
- Investors and financial leaders should take values as seriously as valuation, and culture as seriously as capital.
Analogies and examples
- Inclusive Capitalism Initiative cited as pursuing practical ways to make capitalism an engine of economic opportunity for all.
- Parallel drawn to environmental consciousness: early stages of recognizing that private misbehavior can have broader social costs; reducing the “financial footprint” will take sustained effort.

Summary points
- Inclusive capitalism requires both more inclusive economic growth and greater integrity in the financial system.
- Addressing extreme income disparity and completing the financial reform agenda are key to restoring trust and making capitalism more effective and sustainable.
- Ethical behavior and social purpose are central to financial stability and to enriching society.
Call to action
- Infuse the consciousness of economic leaders across sectors and countries with the principles of inclusive capitalism.
- Pursue practical reforms—fiscal, regulatory, supervisory, cultural—that enable broader participation and trust in markets.

Speech by Christine Lagarde, Managing Director, International Monetary Fund, London, May 27, 2014 (as prepared for delivery).