Problems and Issues in the Global Economy: A Call for Action, Speech by Rodrigo de Rato, Managing Director, International Monetary Fund
November 22, 2005
Speech by Rodrigo de Rato
Managing Director, International Monetary Fund
At the Institute San Telmo, Seville, Spain
November 22, 2005
1. Thank you for inviting me to speak to you today, and for that very warm welcome.
2. Some of the most important functions of the IMF are to identify economic problems, to propose solutions to them, and to persuade others of the need to take action. Economics is an increasingly sophisticated business, and it is generally not too hard to identify key problems. It is harder to find the right solutions, but again this is an area where technical sophistication and a healthy application of common sense can deliver good answers most of the time. The hardest part of the Fund's job, and the part that I work most at, is persuading key actors in the world economy to do the right thing.
3. I'd like to talk today about a few of the major problems in the world economy, and some of the solutions that we see to those problems. In a few minutes, I'll talk about the outlook for the global economy, and say a few words specifically about Europe. I'll also talk about the risks to the global outlook, and what can be done to reduce those risks. I'll talk about the problems facing low-income countries, and the opportunities that exist to do something about those problems. And I'll talk a little about the need for reforms in the IMF itself, and the help that we need from others to make those reforms.
4. But I want to begin by talking about trade. Next month world leaders will met in Hong Kong for the meetings of the World Trade Organization. The purpose of these meetings is to discuss the Doha Round. On the agenda are reduction in tariffs on agricultural and industrial goods, reduction in agricultural subsidies, liberalization of trade in services and improvements in protection of intellectual property rights. The agenda is a long one, because there is much to be done, and there are many problems with the current rules and practices in world trade.
5. In this context, all players involved have to make an effort between now and Hong Kong to narrow the differences in their positions. And, among them, the EU, the US and Japan, as major trading blocks, have a particular responsibility. Allow me to give you a few examples to illustrate some of the distortions of trade policy.
6. The European Union and its members spend about 40 billion euros annually on assistance to developing countries. But they spend about 60 billion euros each year on agricultural subsidies. And these subsidies, and distortions in agricultural markets more generally, do great harm to most developing countries, and undo some of the beneficial effects of aid. About three quarters of the world's poor live in rural areas, and most of them are dependent on agriculture. And most would do better if they were able to sell their goods more freely on the world market. Does it make sense for the EU to be handing out money with one hand, and effectively taking it away again with the other?
7. Tariffs are sometimes justified as saving jobs, or as an instrument of social policy. Let us look then at the tariffs on baby clothes in the United States. In the US, imports of silk blend baby trousers face a tariff of 2.8 percent. Trousers made of cotton face a tariff of
15 percent. And synthetic fiber baby trousers, overwhelmingly bought by low-income households, face a tariff of 29 percent. In relation to their income, single-mother households living on social security pay the largest implicit tax to protect the domestic textiles sector. Moreover, according to a recent IMF research paper, the US actually collects a higher average tariff rate on imports from developing countries, especially least developed countries, than on imports from other developed countries. This might sound surprising given the various preference schemes that the U.S. is offering to poor countries. However, the existing preference schemes often exclude products that poor countries really want to sell. In addition, the costs of complying with rules of origin and other requirements of the preference schemes are often high enough that many developing country exporters may choose not to bother applying for the preferential treatment.
8. The industrial countries do not have the sole responsibility for ensuring the Doha Round's success. Emerging market countries such as Brazil, China and India are increasingly prominent participants in the world trading system, and they also maintain significant restrictions on imports. Such restrictions hurt exporters from other countries and their own consumers. They also hamper the development of a technologically sophisticated production structure.
9. The logic of trade reform is simple and clear. A successful conclusion of the Doha Round would benefit all economies, advanced, emerging and developing, and it would be of particular benefit to developing countries. Let me tell you why.
10. Significant trade liberalization would contribute to growth all over the world. Analysis conducted by the World Bank shows that even without taking into account effects on productivity, a successful conclusion of the Doha Round would increase world GDP by several hundred billion dollars. But the productivity effects could be much greater. Another study by World Bank economists found that countries in which trade increased as a share of their GDP during 1980 to 1999 had annual GDP growth that was a full percentage point higher than those without growth in trade. And increases in economic growth in developing countries produce a more than proportionate reduction in poverty.
11. Trade liberalization would also create particular opportunities for developing countries, because the areas where remaining restrictions on world trade are greatest—agriculture, textiles and services requiring labor mobility—are those of particular interest to developing countries. I should add that there is legitimate concern in some countries, especially developing countries, about the short-term economic costs of trade liberalization. But these are problems that can be overcome, and the IMF can help, both with policy advice, and with finance, including finance to offset the short-term balance of payments costs of trade liberalization. The IMF introduced a financing mechanism last year that is specifically aimed at providing assurances to countries that are concerned about possible negative impacts on them of trade liberalization by other countries. The IMF has already provided support to Bangladesh and the Dominican Republic under this mechanism.
12. Let me conclude my remarks on trade with an example of countries seeking to surmount some of the obstacles to greater openness. I have this afternoon come from Algiers where I had the opportunity to discuss the challenges of trade liberalization over the past two days with your neighbors, Algeria, Morocco and Tunisia. Although the Maghreb has the potential to become a regional market of more than 75 million consumers, it engages in little intra-regional trade and less than 2 percent of each country's international trade is with its immediate neighbors. I was gratified to see the governments of these countries committing to improve this state of affairs by agreeing this morning in Algiers to a work program and timetable aimed at adopting tangible measures to facilitate trade between the three countries. Mauritania and Libya have also been invited to join this initiative.
13. Let me turn now to the issue of global imbalances, where action is no less necessary. The global economy has been strong over the past couple of years. World output growth in 2004 was the highest in three decades, at over 5 percent. The IMF expects expect growth to continue at a good pace in the remainder of 2005 and 2006, despite a number of recent shocks, including higher oil prices and the hurricane damage in the United States. Even with a possible dip in U.S. growth caused by the hurricanes, we expect global real GDP growth to be close to its trend rate in 2005 and 2006, at over 4 percent. The outlook, although it has improved recently, is not so good in the euro area—we are projecting growth at 1.3 percent this year and less than 2 percent next year. Spain is something of an exception to this, with growth expected to be over 3 percent in 2005 and 2006.
14. Global inflation has picked up slightly, but remains moderate, despite the hike in oil prices. In the major industrial countries, inflation expectations are generally well-anchored, and wage increases have been moderate. International financial market conditions have been benign for quite some time, and the resilience of the financial system has strengthened a great deal in recent years. However, asset prices bear close watching—especially housing prices, as you know here in Spain. Here and in a number of other countries, housing seems richly valued, and corrections could have significant repercussions on consumer demand and financial sector balance sheets.
15. Despite the broadly satisfactory prospects for the global economy, there are risks to growth. One of these stems from higher oil prices. There are things that can be done about this. While excess capacity is very limited, oil producers can begin to increase investment in new facilities. Oil-consuming countries have work to do as well. They need to start increasing refining capacity and to take measures to curb oil demand, such as improving conservation and energy efficiency. Also, those countries that have reacted to higher oil prices by increasing subsidies instead of passing on price increases should reconsider their policy. The regressive distributional effects and economic distortions arising from high and indiscriminate subsidies at a time of high oil prices are profound. So I welcome the measures that have been taken in some countries to contain the cost of subsidies while protecting the poorest people from the effects of rises in prices of oil products.
16. Another major risk comes from global imbalances. Today's global payments imbalances, and more broadly, the current geographical patterns of growth, saving, and investment in the world economy, should be a major concern to policy makers. Indeed, communiqués of finance ministers' meetings show that they are a major concern. Put simply, they are unsustainable. Higher net savings—private and public—are needed in the United States, and lower net savings are needed in a number of other key countries. If the U.S. current account deficit remained at present levels it would mean ever-growing U.S. external indebtedness, and it is difficult to see this being accepted by private investors or central banks of countries that would need to hold the U.S. assets. I do not share the view of some policy makers that correction of global imbalances can be entirely left to the market. I think the risks are too great. 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.
17. If global growth is to be sustained, many countries will need to share the work of reducing global imbalances.
18. It is particularly important, and increasingly urgent, that the United States tackle its current account deficit by increasing domestic saving, and this means mainly reducing its 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 Hurricane Katrina. Uncertainties about the costs of operations in Iraq and Afghanistan and the reconstruction of the gulf coast, and questions over the willingness of Congress to curb entitlement spending, cast further doubt on the realism of the current deficit reduction plan. So I believe that actions on the revenue side, preferably through reforms to broaden and simplify the tax base, are also needed. I hope that policy makers will give careful consideration to the measures suggested by the President's Advisory Panel on Federal Tax Reform, which issued its report last week. In particular, the panel's report contains welcome suggestions on shifting the tax burden from saving toward consumption, which could improve the efficiency of the system, and on how to streamline and simplify the tax code.
19. In emerging Asia, there is scope for greater exchange rate flexibility in a number of countries, and for increased domestic demand. Moves by China and Malaysia a couple of months ago 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 more productive investment in others—should be part of an orderly adjustment process.
20. Oil-producing countries can also do their part. Specifically, those oil-producing countries whose macroeconomic positions are sufficiently strong can help by increasing productive spending, including in some cases social spending, in priority areas.
21. European countries also need to take actions that will both benefit their own economies and help to reduce global imbalances. European governments can promote better growth performance in their own economies and sustainable global growth by reducing the rigidities prevailing in labor, product and service markets. This would also improve their economies' resiliency to shocks. In a number of European countries there is also a need to address fiscal problems. Many countries remain unprepared for population aging, with productivity growth too low, and public deficits and debt too high. What is needed is a convincing plan to improve public finances, raise participation in the labor force—which will probably require reform of benefits—and improve productivity through increased competition.
22. There is much to be done. But there is also a large pay-off from action, and all of the actions that are necessary—including fiscal consolidation and reform in the United States, more flexible exchange rates in Asia, and structural reform in Europe—are in the interests of the countries that need to take them as well as in the broader international interest.
23. So far I have talked mostly about policies in advanced economies. Let me now turn to the low-income countries. The IMF is a partner in the global effort to reduce poverty, and is committed to helping countries meet the Millennium Development Goals. To maximize its contribution, the IMF has during the past year reassessed its role in low-income countries, with the aims of better adapting its instruments to meet their needs and better defining the IMF's role in its work with low-income countries. Let me tell you a bit about what we have learned, and what actions are needed by the international community—low-income countries, donor countries, and multilateral institutions like the IMF—to help countries make faster progress toward the Millennium Development Goals.
24. First and foremost, we need policies in low-income countries that promote economic growth. Growth is the main engine that drives development. To achieve economic growth countries need at a minimum three things: economic and financial stability, structural policies that help the private sector to flourish, and a supportive external environment. Developing countries themselves are largely responsible for putting in place policies that promote stability and support the private sector. In other areas, responsibility is shared by all of the members of the international community.
25. Among the elements of a supportive external environment are some of the things I've already talked about—global financial stability and more open trade. With regard to trade, I have already stressed the importance of a successful conclusion to the Doha round for developing countries. But even if trade barriers were to disappear, many low-income countries would still be limited in their ability to compete. Low-income countries can also help themselves by eliminating trade-distorting subsidies and reducing trade and administrative barriers, which can be big obstacles to trade.
26. More aid to developing countries is also very important. The recent pledges of the G8 countries are very welcome, and so is the multilateral debt relief initiative, which offers relief on debt to international financial institutions owed by some of the poorest and most heavily indebted countries in the world. The IMF is now well-advanced in implementing this initiative, and we expect to be able to complete this work in the next few weeks. But aid is not the only source of financing that can support the achievement of the MDGs. In many countries, private investment—from both domestic and foreign investors—helps boost growth. This is why the IMF emphasizes the importance of creating an environment conducive to private investment.
27. Developing countries also need to make more effective use of aid. Aid is most effective when it is aligned with recipients' priorities and is predictable, and when donors harmonize their aid to ease the administrative burden on recipients. Developing countries will also have to meet the macroeconomic challenges of managing higher aid inflows in order to maximize the benefits of aid. For example, large aid flows sometimes complicate fiscal management, and the quality of spending can suffer. So there is a need to improve public expenditure management to ensure that additional aid does not lead to wasteful and inefficient spending. Higher aid flows can also cause real exchange rate appreciation, and thus weaken external competitiveness. The Fund can help, advising on macroeconomic problems and suggesting solutions to them. For example, real exchange rate appreciation can be countered by enacting structural reforms and using aid resources for imports that improve productive capacity or by measures to increase domestic saving. And the Fund will continue to provide financial support for developing countries to help them meet their balance of payments needs while they are reforming.
28. Before concluding, let me talk briefly about another important issue, reform of the IMF. During the past year, I have asked for a review of the work the IMF does in many areas, to make sure that we are able to help all our members meet the challenges of globalization. This review is now well advanced, and we have drawn some important conclusions from it. In particular, we need to sharpen the focus of our surveillance, and to integrate work on the financial sector better with our broader macroeconomic advice. We need to be more focused in our work on low-income countries, but also to do more in some areas, including some of those that I have just talked about. Many of these reforms will require changes in the culture, and in some cases the organization of the IMF, and the support of our members, through the Executive Board, will be important. I am pleased that this support has been very strong.
29. But another area that we need to reform is the IMF's own governance, and on this we need initiatives and action from member country governments. Specifically, there is a need for change in country voting shares and representation at the IMF. The Fund's credibility with its members rests as importantly as anything on the Fund's perceived legitimacy as an international organization representative of its members. Our legitimacy suffers if we do not adequately represent countries of growing economic importance. This means, in particular, a need for increases in voting power for some emerging-market economies, especially in Asia. We must also ensure that our members in Africa, where so many people are profoundly affected by the Fund's decisions, are adequately represented.
30. IMF quotas are not immutable. But in recent years, there have been only gradual changes in IMF quotas, and a rebalancing is needed to bring the quota structure more into line with today's world. Changes in quotas are a matter on which the IMF's members are going to have to come to a political consensus. In considering this issue, they will need to consider the interests of the institution as well as their national interests. Indeed, I think the two are consistent. Decisions on quotas are not a zero-sum game. If there is broad acceptance of the IMF's legitimacy, the institution and all of its members will benefit.
31. There is a common thread that runs through all of the issues that I have talked about today. In all of them it is not hard to identify the problems, and not too hard to identify good solutions to them. But it is proving very hard for countries to do what they need to do. There is too much of a tendency to either deny that there is a problem, or to blame others for it, and insist that action by others must come first. It is very important that governments resist this tendency. We need action on IMF governance. We need action from both advanced and developing countries to help poor countries meet the Millennium Development Goals. We need concerted action on global imbalances. And most urgently we need governments to work to produce a good agreement on trade liberalization. They world will be a better place if they do act, a more dangerous place if they do not.
32. Thank you very much.