Globalization and its Challenges for Germany, Europe, and the IMF
January 10, 1997
Managing Director of the International Monetary Fund
at a conference sponsored by the Christian Social Union
Münich, Germany, January 10, 1997
It is quite a privilege for me to address this forum of the Christian Social Union. I must say that I received with enthusiasm the invitation of Dr. Theo Waigel to speak here about globalization. Coming from a man who plays such a crucial role at world level in helping the international community face the challenges of our times, this invitation was a distinct honor.
At a time when so much attention in Germany--and in Europe--is focused on the requirements of Economic and Monetary Union, it is essential not to lose sight of the broader issues concerning Germany and Europe's role in the global economy. In helping to bring these issues to the fore, the CSU is making an important contribution to the public debate. At the same time, the challenges of globalization and those of EMU have much in common; thus, your discussions on "globalization" can help bring some further insight into European issues, and vice versa.
Globalization is on the minds of policymakers around the world. The reasons for this are clear. As we approach the beginning of the twenty-first century, the world economy is undergoing a number of fundamental changes. Capital has achieved an unparalleled degree of mobility, and the international financial markets are growing exponentially. World trade continues to expand briskly, and investment and production decisions are now made by companies on a global basis. Many new economic powerhouses have emerged, and the relative economic power of countries is shifting. Indeed, virtually every country in the world is trying to come to terms with these changes and what they will mean for their economies, their citizens, their cultures and ways of life. The stakes are enormous: an unprecedented set, indeed, of opportunities and challenges.
Notwithstanding popular perceptions, globalization is a positive development for the world economy, including industrial countries such as Germany. To begin with, globalization is the continuation of the trend of growing openness and integration among economies that has brought the world a half century of unparalleled prosperity. That openness is now being extended to capital markets. The resulting flow of private capital to developing markets has not only helped finance increased production in recipient countries; it has also helped sustain demand for industrial country exports. For example, during 1990 to 1995, German exports to developing countries increased by close to 10 percent per year on average in U.S. dollar terms, while German exports to industrial countries increased by only 3 percent annually over the same period. As a result, by 1995, exports to developing countries represented 25 percent of total German exports, compared to just 19 percent at the beginning of the decade.1 Consumers also benefit from globalization through the wider choice of low-cost goods that increased trade specialization and trade liberalization have helped make available.
Meanwhile, globalization offers investors in the international capital markets a wider range of investment opportunities, higher returns on savings and greater portfolio diversification. For the global economy as a whole, globalization promotes a more efficient allocation of resources worldwide and, thus, higher world growth. Indeed, it is important to remember that during 1990-93, the dynamism of some 30 developing countries, strongly benefiting from these capital inflows, helped cushion the impact of successive economic downturns in industrial countries, particularly in Europe, and thus spare the world from a global recession.
But with these increased opportunities also come additional risks. Let me mention the most pressing ones. The first is financial instability. The global economy has suffered several costly financial crises over the last decade. Plunging asset prices, major bouts of exchange market volatility, a crisis in emerging markets sparked by events in Mexico, and the collapse of several major financial institutions, in industrial and emerging market countries alike, all underscore the major weaknesses of our system. Thus far, the international community has been able to cope with these episodes, but not without difficulty. Strengthening the financial system so that it can better face such risks is then a must.
The second risk is that of marginalization. While some countries are harnessing the forces of globalization to accelerate economic progress, others clearly are not. Indeed, countries that are unable to participate in the expansion of world trade or attract significant amounts of private investment run the risk of being left behind by the global economy. And the countries at greatest risk of being marginalized are precisely those most in need of the trade, investment and growth that globalization could bring. This raises the prospect of a widening gulf between countries that are able to take advantage of globalization and those that are left by the wayside. The world community cannot merely sit by and watch this happen, because it knows that it is now a unified whole. It knows that a financial crisis, regardless of its origin, can become worldwide in a flash. And it knows that it must not disregard the risk that marginalization entails for the world's geopolitical equilibrium.
The third risk appears outside the economic sphere but deserves all our attention: can our national, our regional cultures--such as the very vibrant one here in Bavaria--preserve their unique value and traditional originality, when the forces of globalization seem to point toward increasing cultural homogeneity?
Mr. Chairman, these opportunities and risks are with us, here in Germany, in Europe, and worldwide. The particular responsibility of our generation is, of course, not just to take advantage of these opportunities, but also to mobilize our imaginations and energies to change risks into new opportunities. Let us see, then, what this implies for you in Germany, for us in Europe, for us in the world.
What kind of a future can Germany expect in this era of globalization? Being a long-time admirer of your unique record of economic achievement, I have every reason to look to your future with confidence. Remember: 50 years ago, you were confronted with three major economic challenges: to recreate a currency, to re-establish an economic and social order, and to build Europe. Your response was outstanding in all three fields.
This is an impressive record on which to build. So why all the apprehension these days--in Germany and, even more, elsewhere in Europe--about the future, about what globalization may bring? Perhaps, it is precisely because globalization seems to challenge each of these three achievements. To be sure, efforts to create a strong euro are coming to fruition at a time when the power of global financial markets presents new challenges for the authorities responsible for macroeconomic policy and, in particular, central banks. And now that the developed countries have become accustomed to extensive social protection, globalization demands increasing flexibility. Meanwhile, at a time when European policymakers are absorbed with preparations for Economic and Monetary Union, the global economy continues to evolve in a less predictable way. Competition in global markets is intensifying. Financial investments have become increasingly diversified across countries to minimize risk and raise rates of return. At the same time, the liberalization of trade and capital markets has made it far easier to shift production to locations where costs are relatively low.
Does this mean that all your achievements are now of a questionable value, that countries like Germany cannot compete with countries where wages are extremely low? Certainly not. The fact is that many other factors besides wage levels go into determining a country's relative appeal to investors and producers, including: its macroeconomic stability and the predictability of its exchange rate; the openness of its trade regime and capital account; the productivity of its labor force; and the transparency of its regulatory framework.
Clearly, Germany scores very well on many counts. In particular, it has a long-established tradition of low inflation, fiscal prudence, and a strong currency, all of which are conducive to investment, growth, and employment. It also has a long tradition of industrial excellence--and nowhere more so than here in Bavaria. I would add that, to Germany's great credit, it has also managed to absorb the costs of reunification without igniting inflation and come a long way in correcting the fiscal deficit that reunification helped create.
But as important as macroeconomic stability is, it is not enough. In particular, it cannot compensate for structural rigidities, especially in the labor market, which make it difficult for the German economy to adjust to the sectoral shifts in production and employment associated with globalization. Here, I would emphasize that the weaknesses in the German economy and in those of its European partners are not the result of globalization. Globalization simply exposes and intensifies existing structural weaknesses that need to be addressed in any case in order to achieve faster growth and create more jobs, particularly in countries facing the costs of an aging population.
The fact is, although German labor productivity is relatively high, relative wages are even higher; in fact, hourly labor costs in German manufacturing are about 50 percent above the average found in other G-7 countries. Indeed, this has contributed to the large erosion of competitiveness in the manufacturing sector--as measured by the rise in the trade-weighted relative unit labor costs since 1989--and has also put pressures on domestic profits and employment in this important sector.
Moreover, centralized bargaining on wages and working conditions--along with generous social transfers paid for by high payroll taxes--have discouraged flexibility in wage setting and work practices, raised the overhead costs associated with employment, and compressed wage differentials between high- and low-skilled labor. For example, real wages of low-skilled workers have risen faster in Germany than in other industrial countries. And, with social security contributions equivalent to more than 40 percent of gross wages, and marginal income tax rates steeply progressive, the tax wedge--that is, the difference between an employee's gross remuneration and his or her after-tax, take-home pay--is one of the highest of all OECD countries.
Likewise, the long duration of unemployment compensation--and the high proportion of a worker's former wages that it replaces--discourage job seeking. Moreover, the extension of this system to the new Länder has contributed to an overly rapid convergence of wages between east and west, particularly high unemployment in the east, and massive social transfers.
Not surprisingly, German employers have tried to take every opportunity to remain profitable and competitive. This has meant investing in labor-saving, capital-intensive technology and outsourcing to countries where production is less expensive. As a result of all this, Germany's structural unemployment has risen, and the associated costs have added to Germany's fiscal burden. This, in turn, has necessitated higher tax rates, which have further discouraged investment and job creation.
One could see here the components of a vicious circle. I would prefer to see it as the basic elements of a tremendous challenge you are facing and, I hope, you will meet: that is, by streamlining all these features of your regime of compensation and social protection and adapting them to the new competitive condition of the global markets, while, at the same time, preserving the unique and exemplary social partnership you have been able to develop so far. A very tall order indeed! How to respond to it?
Of course, seen from the outside, the key elements of the response can appear straightforward!
First, making wage determination and work rules more flexible. Recent government initiatives to ease dismissal rules, promote part-time jobs, and extend the uses of fixed-term contracts are helpful. There have also been some signs of greater flexibility in the workplace from employers and unions. But more seems necessary, including greater realism in wage negotiations and more flexibility in the centralized collective bargaining process, so that wage levels better reflect productivity and differences in skill levels, and wage agreements take account of conditions in individual firms.
Second, reducing the level of employers' non-wage costs and of disincentives for the unemployed to seek jobs. One fundamental problem is that the tax burden, particularly marginal tax rates, is simply too high. At the same time, social security costs have continued to rise. Sweeping reforms are needed to broaden the tax base, flatten the steep marginal tax schedule, and lower the statutory corporate tax rate; these would be positive steps toward making the tax system more competitive and encouraging other countries to carry out similar reforms. Reforms are also needed to limit the need for further increases in social security contributions as the German population ages. In this connection, I have no doubt we can look forward to wise proposals from the Waigel Commission on tax reform and the Blüm Commission on pension reform.
Third, further deregulation is also needed: increased competition--across borders and between Länder--in areas such as electricity, natural gas, trucking and telecommunications to reduce firms' input costs. Deregulation is also needed in the financial arena so that financial market development in Germany is not held back by tax disincentives and cumbersome procedures and regulations. While some progress has been made in promoting Finanzplatz Deutschland, including the introduction of short-term government paper and the lowering of reserve requirements, more will be needed to bolster Germany's appeal as a world financial center.
Let me repeat, Mr. Chairman, it is easy, from the outside, to see what is desirable, what is probably indispensable. What is more difficult is to achieve it while maintaining the quality of your social consensus. This will require all the wisdom and leadership that the government, parliament and social partners have frequently demonstrated in the past.
Having achieved that and maintaining its emphasis on macroeconomic stability, Germany will be well placed to compete in global markets. For society as a whole, the rewards will be high in terms of new investment, new jobs, and stronger growth. There will, of course, be short-term costs for some sectors and some segments of the population. This implies a responsibility for government and the social partners to help ease the pain of adjustment. But this must be done through measures that promote adjustment and jobs--not, as is often the case in Europe today, through measures that primarily aim to protect those who already have jobs, with not enough regard for the millions of unemployed. In this connection, I would highlight the example of the Netherlands, which has increased labor market flexibility and thereby reduced unemployment, while maintaining its social preferences. The task is hard. Your success in finding the right responses to such questions will be a major contribution to the future of your country and of Europe.
But what does globalization mean for Europe? In fact, I see a number of parallels between the benefits that EU countries have already derived from European integration and those they will reap by embracing globalization. For example, just as Germany and its European partners have benefited from increased trade within Europe, so too will they gain from continuing to break down barriers to the exchange of goods and services at the global level. And in the same way that many non-EU countries have benefited from access to the deeper and broader world markets that the EU has achieved through European integration, EU members will benefit from the deeper and broader markets achieved through globalization.
What, then, must Europe do to reap the benefits of globalization? In many respects, the challenges facing Germany are a microcosm of those facing Europe. Certainly, macroeconomic and monetary stability are essential. Needless to say, the timely and full completion of the Maastricht process is, in my view, a "must" for Europe. Let me add that I welcome the stability and growth pact proposed by Dr. Waigel, which seems to strike a reasonable balance between the need to penalize lax policies and the need to provide enough flexibility to deal with unexpected developments.
Even beyond the stability pact, I would suggest that the ECOFIN Council of Ministers undertake a major effort to agree on a set of rules for fiscal transparency and rectitude to make sure that the same exemplary methods apply to the public sector in all countries of the EU. This would be a timely measure, not only to strengthen mutual trust in the Union, but also to ensure that EU practices conform with the Declaration unanimously adopted by the Interim Committee of the IMF last September, which aims at strengthening fiscal discipline and at enhancing "the transparency of fiscal policy by persevering with efforts to reduce off-budget transactions and quasi-fiscal deficits."
But, as in Germany, a strong euro and macroeconomic stability are not enough. Structural reforms are needed. Social security regimes must be restructured to face demographic changes and concentrate more social benefits on those who are truly needy. The EU also needs more flexible markets, especially a more flexible labor market, so that it can adjust to changes in the global economy, raise its potential rate of output growth, and take advantage of emerging opportunities in global markets. At present, however, labor market rigidities impede such adjustment and drive up unemployment. Moreover, the problem could intensify with the completion of monetary union, since countries will no longer have recourse to exchange rate changes to adjust to excessive wage increases and other disturbances. Indeed, in the absence of a flexible labor market, such developments could produce pockets of high unemployment, with unwelcome fiscal and social effects that, in turn, could create protectionist pressures and undermine the credibility of monetary policy.
If, on the other hand, the EU remains open and adaptable, it will be able to provide a strong competitive system. It will have all the potential to create a financial system that is as deep and efficient as that of the United States. This, in turn, would imply greater opportunities for growth, a larger international role for the new European currency, and greater influence in world affairs. The extent to which--and the speed with which--the euro achieves its potential as a key currency in the international monetary system will depend in large part on the support that fiscal and structural policies provide. The stability and growth pact is now in place; now structural reforms will have to be central to the agenda of all those in charge of preparing Europe's future. Central, but not exclusive. As the prosperity of Europe will be more and more dependent on the stability and strength of the global world economy, Europe will have to participate more and more in the global community effort, in the framework of the world financial institutions, to counter the risks of global instability and marginalization of the poorest.
The International Community's Response to Global Risks
Let me now call your attention to the world community's response to global risks. In fact, in one way or another, the entire world is actively facing the challenges of globalization.
To begin with, globalization has encouraged more and more countries to embrace macroeconomic stabilization and structural reform, and they are looking to the IMF for policy advice and financial support. Our membership has expanded to 181 countries, and we are supporting through our financing adjustment and reform programs in about 60 of them. This gives you an idea of the formidable effort of structural adjustment being undertaken worldwide. Many of our newer members are the transition economies of Eastern Europe and the former Soviet Union, which the Fund has been helping to reintegrate into the global economy. The results there are still quite uneven, and a lot remains to be done in many of them, but it is good to see that the more successful of these countries are now among the most dynamic economies on the continent. This has brought Europe greater competition, but also new markets, greater stability and, of course, greater prospects for peace.
Supporting these efforts and developing strong surveillance over them are the traditional tasks of the IMF. But the globalization of the international financial markets has prompted the IMF to strengthen its surveillance over member countries' policies, so that emerging problems can be detected and addressed before the global financial markets force more disorderly adjustment. In particular, we have sought to develop a more continuous and probing dialogue with member country authorities. We are also paying greater attention to the soundness of banking systems, to the sustainability of financial flows, to countries potentially at risk of adverse market reactions, and to countries where financial market tensions could have major spillover effects.
In addition, recognizing that markets function better when they have adequate information, we are developing standards to guide members in the dissemination of economic and financial data to the public.
In this globalized and at times unpredictable world, the IMF cannot limit itself to encouraging its member countries to undertake policy reforms; it must also be equipped with adequate financial resources to help them in these efforts. In this connection, work is underway on the Eleventh General Review of Quotas, and this will remain our top priority. Quotas are the main resource base for IMF lending, and we are aiming for a substantial increase. I hope that, as always in the past, Germany will be active in supporting it.
In addition, the G-10 countries, including Germany, along with a number of emerging market economies and other countries in a strong balance of payments position, are in the process of establishing parallel financing arrangements complementary to those already in place, so that the IMF could have access to emergency resources of up to approximately US$50 billion in the event of a systemic crisis.
But we must also be prepared to fight marginalization worldwide and ready to help our poorest members' reform efforts on appropriate terms. This is why we are working to ensure that the IMF's concessional window for its poorest members, the Enhanced Structural Adjustment Facility (or ESAF), has sufficient resources to continue operating until it becomes self-sustaining early in the next century. ESAF will also be the vehicle through which the Fund contributes to the joint IMF/World Bank initiative to relieve the debt burdens of heavily indebted poor countries.
As important as ESAF and the debt initiative are, they will not solve all the poorest countries' problems of underdevelopment and vulnerability. These countries, especially those in Africa, will continue to need bilateral support on concessional terms. I know that Germany wants to maintain and hopefully increase its effort in this area, provided that countries seeking international assistance--from bilateral or multilateral sources--do their utmost to establish a domestic policy environment in which this assistance can be used productively. Not only does this require sound macroeconomic policies and comprehensive structural reform, but also an institutional framework that gives confidence and security to savers and investors. At the same time, however, international assistance cannot replace fuller access to world markets, especially for the kinds of products for which the poorest countries have, or are likely to develop, a comparative advantage: agricultural and mineral products and basic manufactures.
By maintaining and developing this solidarity effort, our member countries thereby introduce an essential dimension to their globalization strategy. In the same way that our national efforts to improve competitiveness must be complemented by efforts to increase the effectiveness of our support to the most vulnerable in our societies, globalization will only be a success at the world level if transformed into a new chance for the poorest countries. A lot is at stake here also. As politicians, you are frequently confronted, as I am--particularly when addressing university students or NGOs--with the fundamental question of what is the sense in perpetually trying to increase the competitiveness of our economies. Why? Should we not stop? The only satisfactory response is this one: we must make our economies more efficient, not only to survive in a harshly competitive environment, not only to maintain our living standards, but also to be able to show more solidarity to the most vulnerable people in our countries and to the poorest countries in the world.
Mr. Chairman, I have left so far unanswered the question--important indeed--of the risks for our own cultures arising from the universal trend towards cultural homogeneity. As a matter of fact, as an economist--and to speak the language of the economists--I have no comparative advantage to address this issue. Let me then, for the sake of comprehensiveness, give you my response as an ordinary man in the street, as a simple European. It is straightforward.
First, I am so fond of our common culture and such an admirer of the variety of ways in which throughout the centuries it has provided Europe and the world with new answers to the permanent questioning of humankind, that I just cannot imagine that it could be threatened by supermarket cultural products even when they are brought to our homes by the most sophisticated satellite devices. More importantly, I observe that the task of keeping this cultural heritage alive and vibrant is very high on the agenda of European leaders at national, regional and local levels--and rightly so. Let us encourage them in this endeavor, as this is an essential aspect of the quality of our lives, and it is important that the world be able to continue counting on Europe to provide it with its own responses to the changing concerns of humanity. Lastly, let us, as at the best moments in our cultural history, open ourselves to a dialogue of cultures. More than ever this is a key condition of a civilizational renaissance.
In conclusion, globalization will bring many challenges--to Germany, to the European Union, to the world and, yes, therefore, to the IMF. The inescapable fact is that the trend toward globalization affects all countries. Whether the impact of globalization will be for better or for worse, whether it becomes a threat or an opportunity, will depend on how they respond to its challenges. I will be happy if I have been able to share with you my confidence that with appropriate policies Germany and its European partners can not only preserve their earlier achievements, but build a stronger, brighter future in Europe and the global economy. To paraphrase what Chancellor Kohl once said about the European Union being the success story of the twentieth century, let us hope that Europe will be able to play a decisive role in making globalization the success story of the twenty-first century.
1 Source: Direction of Trade Statistics Yearbook, 1996 (Washington: International Monetary Fund).