IMF Managing Director's Interview with Maeil Business: S. Korea needs to pursue ‘different kind of growth’ to promote fairness, efficiency -IMF Chief

January 2, 2013

Published in Maeil Business, January 2, 2013

International Monetary Fund (IMF) Managing Director Christine Lagarde, one of the most influential figures in global finance, spent most of the year 2012 jetting around the globe to rescue countries in the throes of a severe financial crisis.

Lagarde who is in charge of the global economic rescue squad will have another busy year in 2013 with a laundry list of challenging tasks ahead of her.

In a New Year’s interview with Maeil Business Newspaper, Lagarde was asked about strategies of mitigating inequality without hurting economic growth in South Korea. The IMF head suggested that Korea should adopt a growth-promotion model that pursues an inclusive growth and not simply the fallout from unfettered globalization. In other words, Korea should be centered on promoting efficiency but also keeping equity in mind when setting fiscal policy. It means fairness in sharing the burden of adjustment, and protecting the weak and vulnerable.

The following is a transcript of the interview.

Maeil Business Newspaper (hereinafter referred to as MBN): It has been more than four years since Lehman Brothers collapsed and the global financial crisis began. What is your general assessment of the world economy now compared with then?

Lagarde: We have come a long way since 2008, but obviously more needs to be done. Uncertainty about the path of policies in Europe, as well as in the U.S. with the fiscal cliff debate and consequently the pace of recovery has been one of the major factors holding back economic activity worldwide. This has affected investment and business decisions for sure. We have seen the global growth momentum slow—likely to about 3.3 percent for 2012—lower than we thought earlier in the year.
But it’s not all bad news. Recent policy actions by major central banks and governments have helped ease financial stress. In Europe, for example, the ECB’s announcement to help Euro Area countries in trouble by supplying easy access to liquidity (Outright Monetary Transactions) and implementing a proper crisis mechanism—the European Stability Mechanism, is good news. And the pace of global activity appears to be picking up relative to the second quarter. Also, the U.S. housing market seems to be picking up gradually. This is a welcome sign, since that same market was at the heart of the financial crisis in 2008. So, there are some encouraging developments as well. The key will be for policymakers across the globe to continue implementing the decisive actions to bring us back to stronger growth.

MBN: Most of the global central banks such as the Federal Reserve, the ECB as well as the Bank of Japan are entering new rounds of quantitative easing. The question is whether central bank liquidity has left financial markets disconnected from reality. Increasingly, investors fear higher inflation. What is your take on this?

Lagarde: We should remember that monetary policy has been absolutely critical, in general, to avoid a deepening financial crisis and to support economic recovery. However, there is a concern that the vast acquisition of assets by central banks will ultimately mean a rise in the money supply and thus inflation. As we have discussed in our previous World Economic Outlook reports, however, expanded central bank balance sheets need not necessarily translate into higher inflation. Central banks have more than enough tools to absorb the liquidity they create, for example by selling the assets they have bought or selling their own paper, just to name a couple.

MBN: Related to the previous question, quantitative easing in the U.S. has given rise to difficulties in some emerging countries. They are expecting a repeat of a cash flood, and are intervening again in the spot market to avoid currency appreciation. Do you worry about the so-called ‘currency war’?

Lagarde: On balance, unconventional monetary policies by major central banks have been generally helpful. Our position has consistently been that while quantitative easing could be contributing to capital flows to emerging markets, it is only one factor, along with growth differentials and other macro fundamentals. The effects so far have been broadly balanced, with the support for growth in advanced economies offsetting costs to emerging economies. That said, the balance may be shifting as further quantitative easing becomes less effective at stimulating growth, while increasing the risks to financial stability in emerging economies. This risk bears watching closely.

MBN: Following the elections, Korea will have a new leadership running the country until 2018. A new leader may want to map out a longer-term plan for Korea’s economy. What do you think is the biggest threat to the global economy in the next five years?
Lagarde: Perhaps the greatest roadblock will be the huge legacy of public debt, which now averages about 110 percent of GDP for the advanced economies—the highest level since World War II. This leaves governments highly exposed to subtle shifts in confidence. It also ties their hands, especially as they seek to build the infrastructure of the 21th century while respecting social promises. The needs of aging populations will add to these pressures.

There are two clear lessons from history—reducing public debt is incredibly difficult without growth and increasing growth is incredibly difficult with huge public debt. So we have a twofold priority—securing growth while reducing debt. The key now is to move from deliberation to action on the policies we know are needed—and to move together and on all fronts.

MBN: How to mitigate inequality without hurting economic growth is at the center of political debate in Korea. Could you explain what policies are needed to achieve this?

Lagarde: Growth is essential for the economy, but we must pursue a different kind of growth—a growth that is inclusive and not simply the fallout from unfettered globalization. This has profound policy implications. It means focusing on efficiency but also keeping equity in mind when setting fiscal policy. It means fairness in sharing the burden of adjustment, and protecting the weak and vulnerable. It means better financial inclusion, so that everyone has access to credit and financial markets. It means better transparency and governance.

To achieve these, we also need greater global cooperation. A world that is bound closely together must be a world that works closely together if it is to prosper together. There is simply no other choice. We are multiple players, but it is a single game, a game that must be cooperative, not simply competitive.
MBN: With advanced economies continuing to stumble due to factors like the European debt crisis, the world has come to rely on emerging economies as a source for growth. What is your opinion on the potential for continued growth in emerging economies considering the recent slowdown?

Lagarde: You are right. Growth prospects do appear weaker than they did half a year ago, reflecting primarily weaker external demand, but also domestic factors in a few cases. However, recent activity indicators suggest that economic momentum is stabilizing, including in Asia. And going beyond the near term, I am optimistic that emerging markets will continue to be the engine of world growth, even though the global environment will remain challenging.

MBN: Which macroeconomic policy should Korea implement? Do you think Korea needs more stimulus?

Lagarde: We believe that the key near-term challenge for Korea is to guard against the risks to growth. Fortunately, Korea has ample room to deploy supportive macroeconomic policies to respond to the risks, in particular given its relatively small public debt and low inflation. In response to a weaker-than-expected growth outlook, the Korean authorities have introduced two modest fiscal stimulus packages and cut the policy rate by 50 basis points since July 2012.

We believe the government’s measured response to the weakening growth outlook so far has been largely appropriate. In the event of a sharp downside scenario, Korea has sufficient space to respond more forcefully, particularly on the fiscal side. Given the uncertainty over the global outlook and weak growth, the current accommodative monetary policy stance is appropriate.
MBN: Exports--the growth engines of Korea’s economy, are declining rapidly. What is the most desirable policy to transform an export-dependent economy into domestic-oriented economy? Are there any countries which have successfully achieved this transformation?

Lagarde: Korean manufacturing exports are globally competitive and will continue to be an important engine of growth for the economy. However, Korea needs to rebalance its economy by developing the non-tradable sector as an additional engine of growth. To facilitate the adjustment, Korea can favor a stronger exchange rate and eliminate policy incentives favoring the export sector in order to encourage investment in the non-tradable sector. It can also liberalize the services sector to attract foreign investment into the sector and increase social spending on workfare, education, and the healthcare program. Germany and Japan are often cited as examples of countries that successfully diversified their engines of growth.

MBN: Korea’s housing prices are declining to a point where the bubble could burst. Many are concerned that this bubble burst would worsen household debt and may break down the economy. Because of this, some suggest that the government should purchase houses and actively intervene. On the other hand, some people claim that the drop in prices is needed to a certain extent. What is your suggestion for Korea on this issue?

Lagarde: Korean housing prices have been declining, particularly in Seoul, but this is a healthy correction of the housing market, which will mitigate the risk of a hard landing. Hence we do not believe that there is a need for the government to intervene in the housing market. The correction in housing prices will set the stage for the eventual recovery of the housing market and also help prevent household debt from rising.

Christine Lagarde noted that the sovereign debt crisis in the euro zone will take time to be resolved but predicted that there will be a good chance of exiting the crisis in the foreseeable future. Christine highlighted that the implementation of fiscal policies should be country-specific.

MBN: Regarding European debt crisis, do you see light at the end of the tunnel? Greece has decided not to leave the eurozone, but larger economies like France do not look too good either. When do you think the euro crisis will be over?

Lagarde: Policymakers in euro area countries have taken significant measures on all fronts—fiscal, monetary, and structural—to respond to the challenges brought on by the sovereign debt crisis. Prompt and effective implementation of these measures is now essential to restart growth and reduce unemployment.

But recovery will take some time before the effects of the reform measures will show lasting results, so unfortunately, growth will remain weak for a while. The euro area economy as a whole contracted again in the last quarter and growth has now been flat or negative for a year. However, as I said, if Europe continues to implement the measures which have been announced and strengthens integration in a timely fashion, then it has a good chance of getting out of the crisis sooner rather than later.

MBN: Most of the global central banks such as the Federal Reserve, the ECB as well as the Bank of Japan are entering new rounds of quantitative easing. The question is whether central bank liquidity has left financial markets disconnected from reality. Increasingly, investors fear higher inflation. What is your take on this?

Lagarde: With growth and employment weak, getting the pace of fiscal consolidation right is of the essence. Countries where market pressure is high have little choice but to proceed rapidly with consolidation. But the adjustment elsewhere should be conducted at a pace that balances the need to bring down deficits and support the economy. In other words, both the pace and the nature of deficit reduction should be country specific. The mix of revenue and expenditure measures will determine whether the burden-sharing in the adjustment process is fair across society and will demonstrate the sustainability of deficit reduction efforts.

MBN: The European Council on June 28 and 29 sent a clear signal to the market: we want to exit the eurozone crisis with more Europe--by putting in place a roadmap to create a Union with four building blocks: financial, fiscal, economic, and political. Is this the right direction for the EU?

Lagarde: The crisis calls for a continued strong collective effort to demonstrate policymakers’ unequivocal commitment to sustain monetary union. A credible roadmap toward a banking union and fiscal integration makes the necessary crisis action more effective. This will inevitably be a bumpy process, but it needs to be done. Changing the architecture will not be sufficient without measures to support growth. Structural reforms are essential to raise growth across the region and to improve competitiveness. In some economies, for example, improving competitiveness requires policies that help reduce labor costs, such as raising labor productivity. In other economies, what is needed is product market reforms, especially in service sectors. So every country needs to do what is necessary to strengthen its own economy to make it function better and more effectively and in synch with its partners in the union.


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