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Global Imbalances and the Transatlantic Relationship, Remarks by Rodrigo de Rato, Managing Director of the International Monetary Fund
November 10, 2005
1. Thank you for inviting me to be with you today.
2. I'm delighted to be here at the European Institute. The mission and work of the Institute have always been important, but they have a special significance now. The United States and Europe have been interdependent since the first ships sailed the Atlantic. Now economic and financial globalization links their fates even more closely. At the same time, cultural differences and tensions seem both more prominent and more painful. The work of the Institute in promoting understanding is thus immensely important. I salute your work, and I am very pleased to be here with you today.
3. Let me begin with a quote from Jacques Delors, which I find both interesting and insightful. Ten years ago Delors said of the movement to promote European political and economic integration that "The hardest thing is to convince European citizens that even the most powerful nation is no longer able to act alone." The truth of this statement for European nations in the area of economic policy is quite clear now. But what of Europe and the United States? There appears to be a widespread belief among European policy-makers that global imbalances are only an American and not a European problem and that all that is necessary to deal with them is for the United States to reduce its fiscal deficit—and possibly for China to revalue its currency. I think that this view is way off the mark. A disorderly adjustment of global imbalances would harm all countries. And many countries need to share the work of reducing global imbalances and sustaining growth.
4. I think there is also still not full understanding in the United States of the risks of a disorderly adjustment to global imbalances. At a recent symposium in Paris, Kristin Forbes, until recently a member of the President's Council of Economic Advisors, made the point that if adjustments to global imbalances do not occur soon, there is a good chance that they will unwind much faster than people expect. I think this is absolutely right. What then are the key global imbalances, and what can policy makers do about them?
5. The symptoms of the current global imbalances are high current account deficits and rapidly increasing debt in the United States, and corresponding surpluses in Japan, many Asian emerging market economies, and increasingly oil-producing countries, including Russia as well as countries of the Middle East. These imbalances are unsustainable, and if they are corrected in a disorderly way, through an abrupt decline in the US dollar and rise in US interest rates, growth and prosperity all over the world will be threatened. Some progress has been made recently in addressing the underlying issues. Fiscal revenues in the U.S. have rebounded. There has been progress with structural reform in the euro area and Japan, and the prospects for further progress in Japan are bright. And we have begun to see greater exchange rate flexibility in Asia. But these are just the first steps, and much more action is needed.
6. I want to focus today mostly on Europe and the United States, but it is certainly true that other countries need to do their part. In emerging Asia, there is scope for greater exchange rate flexibility and increased domestic demand. The recent moves by China and Malaysia toward greater exchange rate flexibility are welcome, and I hope the authorities will use the flexibility afforded by their new arrangements, and that other countries in Asia that have been allowing more flexibility in their exchange rates will continue to do so. In addition, faster domestic demand growth in Asia through structural reforms—including to encourage higher investment in some countries and better investment in others—should be part of an orderly adjustment process. Oil producing countries, which now have some of the largest trade surpluses, can also help. Specifically, those oil producing countries whose macroeconomic positions are sufficiently strong can help reduce global imbalances by increasing productive spending, including in some cases social spending, in priority areas.
7. Let me turn now to the United States. The United States economy has for some time been one of the main engines driving global growth. But as the projected net external liabilities of the U.S. continue to increase, so the vulnerabilities of the U.S. economy continue to grow. Therefore, it is particularly important, and increasingly urgent, that the U.S. tackle its current account deficit by increasing domestic saving, to avoid the burden of adjustment falling on investment and growth. This requires bold action to reduce the fiscal deficit. The U.S. administration recognizes the need for this, but a major element in their plan is unprecedented cuts in spending. These would have been difficult to achieve even before the devastation wrought by Hurricane Katrina. Uncertainties about the costs of operations in Iraq and Afghanistan, the reconstruction of the gulf coast, and the outcome of Congressional debates on how to control entitlement spending, cast further doubt on whether the goals of the deficit reduction plan can be achieved.
8. This suggests that actions on the revenue side, preferably through reforms to broaden and simplify the tax base, will also be needed. I understand very well that measures to raise revenue are not very popular in Washington, but neither are higher interest rates, more expensive goods or financial market turbulence, which are among the possible outcomes in the U.S. of a disorderly adjustment of global imbalances. And it may be that the best prospect for making progress on tax issues would be consideration of innovative approaches which would also address structural issues in the U.S. tax system. So I hope that policy makers will give careful consideration to some of the measures suggested by the President's Advisory Panel on Federal Tax Reform, which issued its report last week. Although the report proposes packages of measures which are revenue neutral, it contains specific measures that could raise the tax yield and hence assist deficit reduction. Moreover, the report contains useful suggestions on how to streamline and simplify the current tax code, and suggests further shifting the tax burden from saving toward consumption, which could improve the efficiency of the tax system. It could also help to increase private savings in the United States, which could make an important contribution to the correction of global imbalances.
9. If the United States is prepared to undertake ambitious fiscal adjustment, and also to tackle the long-term financial health of entitlement programs, its position would be much stronger, and our hope is that tax reform will be debated in a manner that helps support these objectives. A balanced budget (excluding the surplus of the Social Security trust fund) over the medium term, coupled with reforms to place the Social Security and Medicare systems on a sound financial footing, would leave the U.S. fiscal system well placed to cope with the pressures of an aging population. And more immediately it would raise national saving and help reduce global imbalances.
10. What now of Europe? While Europe has not so far been at the center of the problem of widening external imbalances, it should be part of the solution, for its own sake, as well as for the health of the global economy. The fact that the euro area's current account balance has been small and stable while imbalances have grown elsewhere is no assurance that it can escape the fallout from a disorderly adjustment—especially given the major international role of the euro. Moreover, whether adjustment of the U.S. current account deficit is orderly, occurring through a gradual increase in its public or private savings, or disorderly, occurring through an abrupt exchange rate depreciation and a rise in interest rates that would force a drop in investment and growth, one outcome is likely to be lower growth of exports from other countries to the United States. This will hurt growth in Europe, which is the last thing Europe needs.
11. Europe's key economic challenge, as you know, is to raise its growth and employment performance, with an aging population. Social cohesion is already under pressure. Symptoms include growing hostility toward further European integration and globalization. Absent reform, social cohesion is likely to diminish further. A falling working age population and rising aging-related spending will cause major problems. At present there are somewhat 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.
12. Part of the solution must be to achieve higher employment. A number of countries in Europe have already shown ways to tackle structural problems in employment, without undermining social solidarity. Indeed, employment growth in the EU has been about the same as that in the United States over the past decade. This achievement is mostly due to more job-friendly wage setting, the liberalization of part-time and temporary employment, and the phasing-out of early retirement schemes.
13. This shows that reform is possible in Europe, and that it can both improve economic prospects and support social solidarity. But more needs to be done if Europe is to enjoy sustained strong growth.
14. A major priority is to reform welfare and improve labor utilization. Different countries need to do different things, and European countries can learn from each other. Here are a few examples of actions to consider—each relevant for some countries more than others:
• Reforming pensions in a sensible way: raising statutory retirement ages by linking them to life expectancy and introducing actuarial fairness would promote intergenerational equity and help the sustainability of pension plans.
• Supporting the jobless, but strengthening incentives: being generous with unemployment benefits but limiting their duration. Long-term unemployment benefits can also be linked to active search and the performance of socially useful work.
• Making it easier for people to work, but limiting distortions: for example, governments could help people maintain adequate living standards through income tax credits (rather than subsidizing employers to create jobs at high minimum wages).
• Continuing to overhaul employment protection legislation. For example, more flexible labor contracts would promote job creation and prevent the existence of dual labor markets. This would be a more equitable approach to job protection than that embedded in the current employment protection legislation in many countries.
• More active social spending. Better education and job retraining would improve employment and income prospects and lessen the need for income support through welfare mechanisms.
15. Another promising avenue toward higher growth and efficiency is through further integration of Europe's financial markets. More financial integration should enhance competition, improve efficiency, lower the cost of capital, and improve monetary transmission. Some progress has been made, and much has been done at the EU level to advance the integration of national financial markets. But effective implementation is still needed, and work has barely begun on differences in taxation and legal systems that have impeded financial integration. Also, financial innovation is still very much proceeding at the national rather than European level. Making progress will require overcoming vested interests at the national level, and establishing a level playing field for financial institutions to compete and innovate, to the benefit of consumers and investors.
16. Last but not least, it will be crucial to advance product and services market deregulation. While some progress has been made in deregulation of product markets, wide divergences exist across EU countries. And the largest sector of the economy—services—remains insular. A good start would be the adoption of the EU Services Directive without delay and dilution.
17. This is a difficult agenda for both European countries and the United States, but there is high pay-off from structural and fiscal reform. From an international perspective, restoring confidence and revitalizing growth in Europe through structural reforms that address supply-side constraints and raise domestic demand will help raise global growth and offset the contractionary effect of fiscal adjustment in the United States. And structural reform that will help the global economy is also in the best interests of the people of Europe. Similarly, fiscal reform in the United States is not primarily a service to the world but a service to the American people. Both are simply the right things to do.
18. Before closing, I want to touch on a subject that is of vital importance for relations between Europe and the United States, and also for the world. This is the discussions in Hong Kong next month on the Doha round. A substantive and favorable outcome to the Doha round would lift millions of people in developing countries from poverty and boost growth in rich and poor countries alike. And the governments of the European Union countries and the United States have a particular responsibility and a particular opportunity to make it happen. I am concerned about comments made by some government spokesmen in recent days. There's a saying in soccer that sometimes players like to "get their retaliation in first", to foul before they are fouled. All parties should resist the temptation to get their retaliation in first, or to indulge in recriminations and grandstanding. They should be flexible, constructive, and considerate of their partners in these negotiations. The stakes are very high, and the world expects and needs the best of its representatives.
19. I began with a quote from one European statesman. Let me end with a quote from another, Konrad Anenauer, who said that "History is the sum total of the things that could have been avoided." When we look back at 2005, I hope that we will not say: "we could have avoided a recession; we could have avoided strained relations between America and Europe; we could have avoided the perpetuation of poverty in developing countries." We have the power to avoid all of these things. A substantive and favorable agreement in Hong Kong next month would make a major contribution to doing so.
Thank you very much.
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