Horst Köhler
Horst Köhler

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Translation from German

The Challenges of Globalization and the Role of the IMF
Horst Köhler
Managing Director of the International Monetary Fund
At the Annual Meeting of the Society for Economics and Management
at Humboldt University Berlin
Berlin, May 15, 2003

1. It is a great pleasure for me to address you today and I would like to thank the Society for Economics and Management at Humboldt University Berlin and Dr. Manfred Gentz very much indeed for the invitation. Thanks also to Professor Plinke for such outstanding organization. Allow me to congratulate you on your initiative in bringing together theory and practice in a university context.

What is Globalization?

2. A Google search under the key word "globalization" yields more than 1.6 million hits — ample proof that both interest and definitions abound. From my perspective as an economist, globalization means a process of increasing international division of labor and the accompanying integration of national economies through trade in goods and services, cross-border corporate investments, and financial flows. This integration is boosted by technological progress, in particular in transport and communications. However, there is more to globalization than mere economics: globalization also means the free exchange of thoughts and ideas, and greater mobility of people. This is not something that is imposed upon us, but the result of forces for change that are deeply rooted in human nature: the drive for freedom and a better life, for new discoveries, and for a broader horizon.

A brief history

3. Globalization is not a recent phenomenon. Even in the pre-Google days humans were reaching out for new frontiers. Back in the 11th century the Venetian Republic was an early force in globalization. The age of the Portuguese, Spanish, and Dutch voyages of discovery gave further impetus to global integration through rapid advances in maritime technology. The discovery of electricity, the expansion of the railways, and the gold standard in the period from the mid-19th century to 1914 brought about an enormous increase in trade and financial integration. However, it is important to remember that this great wave of economic integration was interrupted in the first half of the 20th century by a phase of aggressive nationalism and protectionism in the aftermath of World War I, leading to the Great Depression of the 1930s and the catastrophe of another world war.

Opportunities and risks of globalization

4. An objective look at the last 50 years provides impressive evidence of the economic advantages of globalization. In the industrialized countries, real per capita income more than tripled in the second half of the 20th century. In some developing countries the increase was even more dramatic. In South Korea, for example, per capita income increased more than tenfold, measured in today's prices. Economic growth also brought about medical advances, for example: life expectancy rose by over a decade in industrialized countries and by over 20 years on average in developing countries. Some developing countries that have embarked on the road toward global integration, such as China, India, Malaysia, Brazil, Mexico, South Korea, and Thailand, now no longer export only raw materials, but also finished products, and services. In India, for example, IT exports alone account for nearly 40 percent of export earnings.

5. Nevertheless, globalization also contains risks. In my view, there are three major economic challenges:

  • First, the benefits of economic integration have primarily extended to the industrialized countries, along with, in the last 10 to 20 years, a group of developing countries, admittedly encompassing over 3 billion inhabitants. At the same time, however, according to a World Bank classification, a similar number of people live on less than $2 a day. Such poverty is the greatest challenge for stability and peace in the 21st century.
  • Second, the globalization of financial markets has been accompanied by devastating financial crises in emerging market economies. The causes of these crises are complex. However, a common feature has often been over-indebtedness and massive reversals in capital flows, leading to severe recession accompanied by a sharp rise in unemployment.
  • Third, globalization exerts pressure on the environment. Domestic environmental protection policies alone are no longer sufficient to address this pressure. In economists' language, an environment worth living in has become a global public good that warrants active engagement.

6. Globalization is neither good nor bad. It all depends on what we make of it — the extent to which we are able to exploit the opportunities and at the same time limit the risks. I believe that to alleviate world poverty, we need more, not less, globalization — but above all a better globalization. In other words, globalization requires political management. I welcome the critical debate on globalization, which should help us to find workable solutions for a better globalization.

7. At the last IMF annual meeting I set out five guide posts for the IMF in its contribution toward a better globalization:

  • First: issues of international interdependence must be given greater priority in national policy agendas. Increasing mutual dependence requires that each country must give more consideration to the consequences of its actions on others. That in turn requires closer international cooperation and also institutions that are directly responsible for global problems;
  • Second, globalization urgently requires international solidarity. Solidarity is, however, not just an ethical and moral duty. In actively combating world poverty I see an investment in stability and peace for the whole of mankind.
  • Third, international cooperation and solidarity should not weaken or even replace national self-responsibility. At the end of the day, what matters is also, and above all, good governance, sound institutions, and respect for the rule of law;
  • Fourth, the market economy has proven to be the best mechanism in history for economic coordination. Nevertheless, market forces alone do not suffice. We need internationally recognized ground rules for participation in globalization.
  • Fifth, we should regard the diversity of experiences and cultures as part of the wealth of our planet. Strengthening the international financial architecture should not therefore be an attempt to force all countries into a uniform, one-size-fits-all economic or cultural model.

The international financial architecture and the role of the IMF

8. A key lesson from financial crises of the past few years is that crisis prevention must stand at the center of the IMF's mandate. The principal starting point for this task is the Fund's bilateral and multilateral surveillance work, that is the regular examination and assessment of economic developments and policies at the national and international level. We are currently honing this tool, by focusing more than ever on the sources of crisis vulnerability and on strengthening crisis resilience:

  • We are advising our members to incorporate more shock absorbers in their economic policies. The starting points for this are, for example, a fiscal policy that also leaves room for maneuver in difficult times; efficient and diversified financial sectors; and last but not least more effective social safety nets. Experience also shows that flexible exchange rates function particularly well as a buffer, by allowing gradual adaptation to changing economic circumstances.
  • Following the Asian crisis we have also been focusing increasingly on financial sector issues. In conjunction with the World Bank, we draw up profiles of member countries' strengths and weaknesses as part of our Financial Sector Assessment Program. So far, we have completed over 50 country analyses; for Germany, this work is currently under way.
  • Today's world economy looks dramatically different from that of 20 years ago, primarily due to the evolution of international capital markets. Private capital flows have overtaken public flows in terms of volume and variety. For this reason, one of my first decisions as Managing Director was to set up a special department at the IMF to provide better analysis and assessments of developments in international capital markets. This includes a regular dialogue with the private sector, and Dr. Gentz is a member of our International Capital Markets Consultative Group. Moreover, in the Global Financial Stability Report, we now analyze the risks in the international financial system semi-annually. In this we have identified, for example, the current weaknesses in corporate balance sheets as a threat to economic recovery. We also counseled in favor of greater transparency in financial derivatives at an early stage, so that market participants could evaluate the associated risks more easily.
  • Free movement of capital provides developing and emerging market economies with access to technology, investment, and also financial expertise. These are important prerequisites for economic growth and employment. Promoting further liberalization of capital flows therefore remains an appropriate and important objective. However, as the Asian crisis reminded us most recently, we know that opening up to the free movement of capital must be carefully sequenced, paying due attention to the establishment of sound institutions — including the necessary domestic regulatory and supervisory capabilities.

9. Crisis prevention is strengthened above all through more transparency in economic data and polices. In this respect there has been a veritable revolution since the financial crises of the late 1990s. This is especially true in the case of data transparency. Fifty-three member countries have now joined the IMF Special Data Dissemination Standard (SDDS), including most of the large emerging market economies, such as Brazil, India, and Mexico. The SDDS lays down consistent standards for the publication of important economic data. Private market participants confirm that the standard, for example, for the dissemination of information on foreign exchange reserves, is being increasingly used for country risk evaluation. Moreover, more transparency also helps to combat corruption.

10. Transparency is, however, rightly also required of the IMF itself. And this has been an important objective for the Fund. Nearly all country and policy documents are now publicly available, unless a member country explicitly withholds its consent, or unless a document contains market-sensitive information. Even our semi-annual work program is now published on the IMF website. In addition, we have established an independent evaluation office, which has the task to assess the work of the Fund. This office has already presented its second report on the role of the IMF in the financial crises in Indonesia, South Korea, and Brazil in the late 1990s. I am looking forward to discussing the report, as it will likely demonstrate among other things that the IMF has already drawn a number of important lessons from previous financial crises.

11. Nevertheless, much work remains to be done. This is particularly the case for the work on the internationally-accepted rules for the global economy. In the context of our surveillance responsibility, we are promoting acceptance and observance of standards and codes agreed by the international community. Such standards and codes extend from economic statistics, as in the IMF Special Data Dissemination Standard, via transparency rules for fiscal and monetary policy, minimum capital requirements for banks, supervisory standards for the investment and insurance industries, to a methodology for combating money laundering and the financing of terrorism. The broad implementation of these initiatives will take time, and the various standards and codes must be regularly reviewed. However, there is no doubt in my mind that these initiatives, together with the systematic review of our member countries' financial sectors, have already gone a long way to strengthening the international financial system.

12. Even the best efforts of prevention will not completely eliminate the possibility of future crises. Overshooting and correction will always be part of an open and dynamic market economy. Nevertheless, the objective must be to have fewer and less severe crises, and also to avoid contagion. In any case, even in the event of a crisis, self-responsibility is indispensable, if only to minimize moral hazard. The IMF is no lender of last resort in the sense of an unlimited availability of liquidity to help countries in financial difficulty. For this reason, we have clarified the conditions and limits of access to IMF resources. We have also concluded a long discussion of how best to help a country that faces a threat of insolvency. The Fund's proposal to create a mechanism similar to private sector bankruptcy for such rare cases failed to achieve the high degree of voting support required to bring about a change in the IMF Articles of Agreement. There is consensus, however, on proceeding with the introduction of what are known as Collective Action Clauses (CAC) in government bonds, so that individual creditors cannot block an essential debt restructuring. The inclusion of such clauses by Mexico, Brazil, and recently South Africa in their most recently issued bonds is a welcome development. The IMF also supports the creation of a voluntary code of conduct establishing ground rules for debtors and creditors in debt rescheduling procedures. And finally, we are continuing to work on further open questions, such as the aggregation of debt claims across different bonds. I have no doubt that these measures have created a framework that will considerably improve crisis management in the future.

***

13. It is both appropriate and important that the IMF focus not only on rich countries but on poor countries as well. We are a global institution with 184 member countries, and in (too) many of these countries, poverty remains the greatest challenge. Globalization requires a policy framework for one world. With the outcome of the United Nations Conference on Financing for Development in Monterrey in March 2002 there is now a remarkable degree of international consensus on the right approach to alleviating poverty. That approach rests on two pillars:

  • First, greater efforts on the part of the poor countries themselves; that means they must ensure observance of the rule of law, good governance, the fight against corruption, and a better investment climate in their own country.
  • And second, swifter, more comprehensive, and more effective support from the advanced economies. Above all, the latter must realize that aid becomes more effective, the more cooperation with developing countries is treated as a partnership.

This approach, and the spirit of Monterrey can already be seen in the efforts of a new generation of African leaders in putting forward the New Partnership for Africa's Development (NEPAD).

14. The World Bank and the IMF — under the leadership of the World Bank — are supporting this concept with technical assistance and financial support as part of the Poverty Reduction Strategy Papers (PRSP). These are long-term development strategies adopted by the countries themselves. What is new about this concept is especially the broad consultation process involving civil society, aimed at strengthening ownership and thereby improving the chances of success. Moreover it is important that these country strategies be discussed with other bilateral and multilateral donors, and with NGOs, so as to improve aid coordination. Within this approach, the IMF contributes its expertise in the area of macroeconomic policy and financial stability. In doing so, we do not pursue stability as an end in itself, but because experience has shown that inflation and weak government finances hamper sustainable economic growth and, as a result, hurt the poor most of all. So far, twenty-eight developing countries have prepared full PRSPs and twenty-one others are coordinating their development process with the help of interim PRSPs. The first signs of success can be clearly seen in countries such as Mozambique, Tanzania, and Uganda. These countries have weathered the shocks to the global economy of the past three years with relatively stable growth. Moreover, in these countries there has also been a structural increase in expenditure on education and health. Overall, the IMF has strengthened its involvement in Africa, particularly through the establishment of two regional technical assistance centers in Tanzania and Mali. These centers offer countries education and training, with the objective to improve the efficiency of the management of public finances and to support the establishment of financial sectors that promote development.

15. Debt relief clearly must be part of a comprehensive approach to poverty alleviation. The enhanced HIPC initiative of the IMF and the World Bank has so far reduced the external debt of 20 countries by $40 billion, a reduction by two thirds in net present value terms. At the same time, in these countries, social expenditures are now on average three times higher than their debt service. However, I should caution that debt relief is no panacea. The word "credit" comes from the Latin credere, to trust. Developing countries must maintain or build up the confidence that contracts will be honored, if they wish to open up the possibility of access to private financial resources. Promoting such a credit culture is crucial not only for development, but also for the stability of the international financial system as a whole.

16. The true credibility test for industrial countries in combating poverty lies in their readiness to open their own markets to developing country exports, including by dismantling market-distorting subsidies, and in honoring their pledges to provide overseas development assistance. Trade is an engine of economic growth, without which no real progress can be made in alleviating poverty. Trade is the best form of help to self-help and reduces dependence on development aid. It is high time that the industrial countries open their markets more widely to products from developing countries. Far-reaching reforms in agricultural policy in all industrial nations are therefore urgently needed — both for fundamental moral reasons and because it makes economic sense:

  • Abolishing all trade barriers in goods markets would lead, according to best estimates, and before taking into account productivity gains and improved investment prospects, to an annual increase in global income of $250 billion to $620 billion — of which one third to one half would benefit developing countries;
  • Total financial support to the agricultural sectors in the OECD reached over $300 billion in 2001 — six times overseas development assistance from these countries. The average European cow receives a daily subsidy of $2.50 — statistically, that is more than almost 3 billion people in developing countries have to live on per day!
  • Trade barriers prevent manufacturing industries from emerging in developing countries. For example the EU applies a zero tariff on imports of cocoa beans, but cocoa paste, a semi-finished product, is subject to a 9.6 percent duty, and processed chocolate is taxed under a mixed set of tariffs that can add up to as high as 25 percent.

It was a moment of inspiration in development policy two years ago when trade negotiators, meeting under the auspices of the World Trade Organization in Doha, Qatar, agreed to make the new multilateral trade liberalization initiative a "Development Round." Today we must ask ourselves with concern whether this optimism is still justified. In any case, it is disappointing that the March deadline for agreeing to the modalities for the agricultural trade talks was missed. Three fourths of the world's poor live in rural areas and are dependent on agriculture. The agricultural sector is thus the key to a true "Development Round." Moreover, the successful conclusion of the Doha Round by the agreed deadline in 2005 is also a vital step in strengthening confidence in global cooperation, thereby supporting the emerging economic recovery.

17. It is also high time that industrial countries finally keep their promise to spend 0.7 percent of their gross national product on development aid. In Germany, development aid is now 0.26 percent of GNP. Anyone looking for causes and culprits for injustice in the world should at the very least reflect upon this number. It is a concrete expression of current social preferences in Germany.

***

A global world needs a global ethic

18. I am basically an optimist and I am convinced that with the right policy a better globalization is possible — and that also includes not least the elimination of glaring poverty in the world. Nonetheless, the recent financial scandals in the United States and in Europe should remind us that good market economics and good corporate governance are not measured by quarterly profit alone. We also need a corporate code of ethics that fosters sustainable value creation that takes into account shareholders, workers, and the environment. I agree with Hans Küng that the world cannot survive without a global ethic. This ethic must respect human rights, but should remind us that we have duties as well as rights. Hans Küng also demonstrated that there is a great deal of commonality between the great world religions. In this too I see a basis for optimism, not least for the vital healing process in the Middle East. We must and indeed can all help in bringing about Roman Herzog's ideal of a common civilization living together in peace. That is also the basis for my vision for the IMF.




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