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Keeping the Train on the Rails: How Countries in the Americas and Around the World Can Meet the Challenges of Globalization, by Rodrigo de Rato, Managing Director of the IMF
June 18, 2007
As Prepared for Delivery
1. Thank you very much. I am most grateful for Jean St. Gelais' kind words, and would also like to thank Gerald Tremblay, the Mayor of Montreal, for hosting this conference and making us all feel very welcome, and Gil Rémillard, who has done so much to make this conference one of the most important events in the calendar of international meetings and a highlight in the debate on the Americas.
2. I will begin with a short announcement, concerning a decision that the Executive Board of the International Monetary Fund took on Friday to provide the members of the IMF with a new legal framework for bilateral surveillance: the way in which we monitor and assess our member countries' economies.
3. The change we are making is the first major revision in the surveillance framework in some 30 years, and it is the first ever comprehensive policy statement on surveillance. The new decision reflects current best practice in our work of monitoring members' exchange rate policies and domestic economic policies. It reaffirms that surveillance should be focused on our core mandate, namely promoting countries' external stability. And it gives clear guidance to our members on how they should run their exchange rate policies, on what is acceptable to the international community, and what is not. To three existing principles relating to exchange rate manipulation pursued for certain purposes, and to when and how it is desirable to intervene in the foreign exchange rate markets, the decision adds a fourth principle: " A member should avoid exchange rate policies that result in external instability".
4. Until now, our surveillance policies have been based on a framework agreed in 1977. Our members felt the time was right for bringing this key activity up to date. This updating was needed because the 1977 Decision does not address the developments that have most challenged the stability of the system in the past thirty years. Reflecting the period when it was drawn up, it focused on potential exchange rate manipulation undertaken for balance of payment reasons and on short term exchange rate volatility. By contrast, the most prevalent exchange rate related problems since then have been the maintenance, for domestic reasons, of overvalued or undervalued exchange rate pegs and, more recently, capital account vulnerabilities.
5. The decision taken has very broad support, including from industrial countries, from emerging economies and from developing countries. The breadth of this support is telling, because it demonstrates very broad ownership of the way that Fund surveillance will be strengthened and of members' responsibilities in the process. This decision is good news for IMF reform program and good news for the cause of multilateralism. The new decision will sustain evenhanded treatment of Fund members, which is at the core of a cooperative institution. This progress will also help us move forward with the other elements of our reform program, to help all of our members meet the challenges of 21st century globalization.
6. I will now speak in French for a few minutes, and then continue in English.
7. Let me now say something about the general state of the global economy. I can sum up the International Monetary Fund's views in a few words: the global economy is remarkably strong. Over the last five years, the world has experienced a run of high and stable growth with low inflation better than in any comparable period since the 1960's. The global economy has enjoyed this period of growth and stability despite many of the concerns for the future that are flagged in the program for this meeting: international tensions, economic imbalances, the threat and sometimes the practice of terrorism, and high and volatile energy prices.
8. The strength of the world economy rests on many factors. It has been built on technology developments and improved business and management practices which have added to productivity in many countries. It also reflects a broadening base for global output. This has meant that as some large participants in the global economy lag, others are able to pick up the pace and drive global growth.
9. Global economic success has also been founded on good macroeconomic policies in many countries. Let me single out one development in particular, which is the emergence of more flexible and forward-looking monetary frameworks. Around the world, governments have recognized the virtues of central bank independence and central banks have followed the example of countries like New Zealand and Canada in adopting inflation targeting. Their reward has been increased credibility and—as the inflation risk premium has been stripped away—lower real interest rates, which have supported higher growth.
10. As to what we should expect from the global economy, I can also answer in a few words: we should expect more of the same—high growth and low inflation—so long as we continue to follow good policies. Of course, this will not always be easy. Today I want to focus on a few challenges that policy makers will face in the coming years, and make some suggestions on how they should tackle them.
11. Let me begin with a challenge on which we have recently made some important progress, which is how to reduce economic imbalances between the major economies while sustaining global growth. The most visible aspect of the problem is the large deficit in the current account of the balance of payments of the United States—some 6½ percent of GDP in 2006—and large surpluses in the external accounts of certain other countries. These include oil exporting countries, Japan, and some of the major Asian emerging market countries, especially China. Underlying the problem are different rates of savings and different patterns of growth.
12. The risk of a disorderly adjustment of global payments imbalances has been a concern for a long time, and in some quarters familiarity may have bred complacency. It should not. The imbalances between the United States and the rest of the world are not sustainable over the long term. The greatest risk is that a disorderly adjustment could be triggered by developments in financial markets. If investors become suddenly unwilling to hold U.S. financial assets at prevailing exchange rates and interest rates, this could lead to an abrupt change, and could cause global financial market disruptions as well as an economic downturn. This risk is not imminent, but if it materialized the consequences would be serious.
13. The problem and the risk have been recognized by most of the countries involved. There is also a broad consensus on the solutions: greater exchange rate flexibility and measures to stimulate consumption in major Asian emerging economies; more investment in large oil producers with strong macroeconomic positions; more structural reform in Europe and Japan; and, of course, steps to raise national saving, including fiscal consolidation, in the United States. But so far, limited progress has been made in translating this analysis into action.
14. There are now signs that things are changing. Over the past year, the Fund has organized a Multilateral Consultation focused on reducing global imbalances while sustaining strong global growth. During our recent Spring Meetings, the five major economies participating in this process—China, the euro area, Japan, Saudi Arabia, and the United States—jointly set out their policies in a document circulated to ministers representing the Fund's 185 members. The policy plans set out by the participants were concrete and mutually consistent, and they reflect ownership by the countries concerned. If implemented, they will reduce imbalances while sustaining growth. We are now in the process of wrapping up the Multilateral Consultation with a report to the Fund's Executive Board which will assess the process and discuss how to follow it up in our discussions with individual countries. But the overall outcome is already clear: this new tool has made a significant contribution—through a cooperative approach—to a serious problem, and it may be useful in tackling other issues where a multilateral solution needs to be found to common problems.
15. Of course, the plans that the participating countries have set out need to be implemented. So far the indications are good. In the two months since the participants set out their plans at the Fund's Spring Meetings there have been a number of positive developments:
• China has widened the currency band for daily exchange rate fluctuations against the dollar;
• Japan has made progress with its reform agenda, including in the area of job placement and training and foreign direct investment;
• In Saudi Arabia, growth in public expenditures in key areas is on schedule and is stronger than in some earlier estimates;
• And in the United States, congressional budget resolutions have adopted the administration's balanced budget objective over the medium term.
16. This is a good start, but it will be important to keep up the momentum of change. The Fund will monitor implementation of countries' plans in our regular consultations on members' economies. But most of the work now needs to be done by the other participants. The Multilateral Consultation organized by the Fund points the way forward. It is up to the countries concerned to take it.
17. Let me now turn to trade reform. The interest of many countries in a solution to the problem of global economic imbalances was increased by their concerns about another and more immediate challenge: growing protectionist pressures. I believe that meeting this challenge and taking further steps toward trade reform are essential if we are to maintain the momentum of global economic growth.
18. Multilateral trade liberalization has been an enormous stimulus to global growth. It has contributed to a tripling of world trade in the last fifteen years. It has added billions of dollars to the annual GDP of trading countries over the same period. An ambitious Doha Round agreement by the end of this year would expand these gains, help reduce poverty around the world, head off protectionist pressures, and promote multilateralism.
19. Leadership from all of the major players will be needed to achieve it. Developed countries—led by the European Union and the United States—must make major liberalization commitments on agricultural trade barriers and domestic agricultural subsidies. They and others should also provide duty-free and quota-free access to all goods from least-developed countries. For their part, major emerging and developing countries must make major liberalization commitments in non-agricultural market access and trade in services if the developed countries are to have any reason to agree to liberalize in agriculture.
20. It is also important that multilateral talks are not sidelined by the false promise of bilateral and regional trade agreements. One can argue about the merits of bilateral trade agreements—whether they on balance add to or subtract from global welfare. The broad consensus at the moment is that if they are properly designed, they can be helpful. There are good examples in the Americas. But we should not be fooled into thinking that they are an adequate substitute for multilateral trade reform. I am also concerned about the motivations behind some bilateral agreements. Some countries seem to favor them as a means of tightening their control over the trade liberalization process—for example, insisting on more favorable treatment of some domestic industries in bilateral agreements than has been agreed multilaterally. Other countries are dragged into the process by fear that they will be left out of a network of bilateral agreements made by their neighbors. This seems to demonstrate just the kind of collective action problems that devastated the global economy in the 1930s and led to the creation of the GATT and subsequently the World Trade Organization. The conclusion I would draw is that the best thing that countries can do is to use the good international institutions that we have on trade, including by taking the necessary political steps to conclude the Doha Round.
21. We should also recognize that many people around the world are suspicious of trade agreements—another reason why bilateral agreements, over which their governments seem to have more control, are more popular. This is part of a broader skepticism about the benefits of globalization, and a concern about the implications of globalization for inequality. If globalization continues to go forward, as it will—and as it should because it carries many benefits—these concerns need to be taken seriously.
22. There are many good political and philosophical reasons to care about inequality, not least the close association between high levels of inequality and high levels of absolute poverty. Nancy Birdsall, of the Center for Global Development, has also made a persuasive case that there are economic reasons to be concerned about high levels of inequality. In a lecture delivered last year under the title, "The World Is Not Flat: Inequality and Injustice in our Global Economy," Ms. Birdsall argues that inequality inhibits growth when markets are underdeveloped, and can also harm a country's economic prospects by leading to economic and social policies that inhibit growth and poverty reduction.
23. At this event, it is fitting to give some examples particularly relevant to the Americas. Economic inequality grew in much of Latin America during the 1980s and 1990s. More recently there has been an improvement, with both poverty rates and inequality coming down. But there is no question that Latin America remains highly unequal compared with other regions of the world, and it is unequal in some of the areas most important for promoting growth under globalization.
24. The effects of inequality in the Americas can also be seen in its tendency to produce bad policies. For example, populist programs financed by increasing fiscal deficits have often dissolved into episodes of high inflation and interest rates, both of which hurt most the very people who populists are trying to help. Similarly, price controls often hurt rural food producers most. Fortunately, many governments in Latin America have figured this out. We are now seeing a new generation of leaders interested in making social changes and also aware of the importance of macroeconomic stability.
25. There are a number of actions that governments can take—and are taking—to reduce inequality and poverty. For example, reform—minded governments are devoting more resources to targeted social assistance programs such as Oportunidades in Mexico, Bolsa Familia in Brazil, and Chile Solidario in Chile. These have been highly beneficial to the poor, and there may be scope to strengthen them further.
26. There are also structural areas where reform would help to reduce inequality and also help countries to reap the benefits of globalization. Let me give two examples.
• Labor market constraints often block employment growth in the formal sector and protect those who are relatively better off. As a result, employment tends to grow mostly in the informal sector, where workers typically do not get the benefits available in formal employment. A reduction of labor market rigidities and of tax wedges would increase employment in the formal sector and also increase productivity.
• Improving the quality of education would both raise productivity and increase opportunities for the poor. Efficiency could be improved by spending relatively more on capital, textbooks, and classroom material. Incentives—for example, linking teachers' salaries to performance—could also help. And shifts in cost recovery and financial support within the education sector could also help to reduce inequality. For example, a large share of public resources are devoted to universities, where they largely benefit upper-income groups. The proceeds of increased cost recovery here could be used to strengthen the quality of secondary education, especially in rural areas.
27. I have made the case that reducing global imbalances matters, that trade reform matters, and that addressing issues of inequality matters. Before concluding, let me emphasize another important challenge, which is the need to improve the quality of institutions, both public institutions and financial market institutions.
28. The Fund has recently completed a study on what countries need to do to reap the benefits of financial globalization—the increasing volume of cross-border financial holdings. Financial globalization has the potential to reduce income volatility, by enabling citizens to diversify their financial holdings outside their own country, and also to raise growth, by allowing capital from all over the world to flow to places where it can be invested with the greatest return. But this potential is much more likely to be realized if the financial frameworks of countries receiving flows are strong. Financial globalization is least likely to produce instability for countries with more developed financial sectors, stronger institutions, sound macroeconomic policies, and more open trade systems. There is also some evidence that financial integration is more likely to lead to higher growth in countries with these attributes.
29. These results are interesting, and they should not come as a surprise. For a long time, we in the Fund have been urging countries to move in exactly the policy directions implied by these findings. But they do underline the need for emerging and developing countries to develop strong financial systems and continue sound macroeconomic policies. And they suggest this need is urgent in those countries which are currently experiencing substantial capital inflows, including some in Latin America receiving high levels of remittances.
30. The effects of institutions on economic life are evident all over the world. Montreal is one of the most cosmopolitan cities in the Americas, exemplifying the positive impacts of globalization. And it is situated in a country that has a strong financial sector, excellent public institutions, sound macroeconomic policies, and an open economy. It is not surprising that Canada has been a beneficiary of globalization, and that its economy is in great shape, with high growth, low inflation, and unemployment rates near all-time lows.
31. Let me now finish with a different observation. Good institutions and good financial systems do not come about by accident, but by hard work and dedication from the people that run them. The leadership and commitment to internationalism of Prime Minister Harper is expanding Canada's influence in global economic policymaking and further strengthening the ties between Canada and the Caribbean and Latin America. Finance Minister Flaherty has steered the economy wisely and prudently. And I cannot let this moment go by without giving some praise to one of the architects of Canada's fiscal and monetary institutional framework, and one of Canada's greatest public servants, David Dodge, Governor of the Bank of Canada.
32. Governor Dodge announced a couple of months ago that he intended to leave the Bank of Canada at the end of January 2008. His tenure as governor has been marked by remarkable economic stability and growth in the face of many problems and disruptions, from a global stock market fall to a global commodities boom. In his previous job as Deputy Finance Minister, Mr. Dodge also played an important part in setting Canada on the right fiscal path. And in all of his roles, Governor Dodge has been a staunch friend of the International Monetary Fund and an articulate spokesman for multilateral cooperation. I would like to end by thanking him for all of his help and support—and of course ask him to continue supporting us in his remaining months in office.
33. Thank you very much.
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