Anchoring Stability to Sustain Higher and Better GrowthBy Christine Lagarde
Managing Director, International Monetary Fund
University of Zurich
Zurich, May 7, 2012
As prepared for delivery
I want to pay tribute to this magnificent university—an intellectual powerhouse with a strong global reach, having produced eleven Nobel laureates and home to Albert Einstein!
This evening, I want to address the central economic challenge facing the world today—how to get back to solid, sustained and balanced growth that lifts all boats and provides a better future for all.
Growth, of course, is not really an end in itself. It is a means to an end—enriching human lives, ennobling human dignity, engendering human potential and developing progress. And for that, we need growth that spreads its gains far and wide.
In a world that is more interconnected and bound together than at any time in human history, everyone has a stake in this. It is a collective responsibility toward a common destiny.
I know this is well appreciated here in Switzerland, which is deeply interconnected with the global economy. Trade accounts for 94 percent of this country’s GDP and, as you know, the Swiss franc plays a prominent role in the global financial system.
Clearly, today’s global economy needs higher and better growth. Getting there depends on choosing the right combination of policies.
With the wrong choices, we risk losing a decade of growth, a generation of young people, and an opportunity to put the global economy on a secure footing. We dare not fail.
In that context, let me talk about three issues today:
- The short-run path to growth.
- The medium-run path to growth.
- The fundamental importance of international cooperation.
By way of introduction, let us take a quick look at where we stand. The global economy is not delivering the growth the world needs. The IMF estimates global growth to be about 3½ percent this year, but much weaker in advanced economies—a mere 1½ percent, including a mild recession in the euro area.
Among the advanced economies, the output gap—the difference between what an economy is producing and what it can produce—remains close to 4 percent this year on average.
The emerging markets and developing countries are holding up much better, with expected growth of 5¾ percent.
Turning to the financial side, financial markets in the euro area have seen some relief, thanks in part to recent European policies, but conditions remain volatile.
Why is growth so urgent?
Look at the jobs situation. Right now, there are 200 million people worldwide who cannot find work, including 75 million young people trying to find their place in society. In countries of southern Europe, one in every five people and one in every two young people cannot find work. This is a potential disaster—in economic, social, and human terms.
In advanced economies, especially in Europe, the issue is well understood, but people have very different views on remedies. They gravitate toward one of two camps—growth versus austerity.
The growth camp says that we need more government stimulus to increase growth. The austerity camp says that markets are sitting in judgment over a mountain of public debt, and governments need to do what is necessary to reduce that debt as fast as possible.
These positions are slight caricatures, but—as you know—austerity versus growth is very much the debate of the hour.
I believe it is a false debate. I would argue it is not “either/ or”. We can design a strategy that is good for today and good for tomorrow. Good for stability and good for growth—where stability is conducive to growth and growth facilitates stability.
Let me turn to the first issue—short-run growth.
In the short run, demand matters most for growth and jobs. And here, one of the engines that drives demand is already running fast. I am talking about loose monetary policy and very low nominal interest rates. And while it is already at close to “full speed”, there might be some scope—and need—to go faster in some cases.
People tend to forget the full power of these central bank actions.
In normal times, this kind of monetary policy would lead to very high demand growth. But these are not normal times. The monetary engine cannot do the job alone. In fact, growth is being held back by three “brakes” in the system—fiscal adjustment, weak banks, and poor housing markets.
We need to manage these brakes so that the growth engine runs smoothly—much like a train in the mountains! Switzerland of all places understands the virtues of precision and precise calibration. Let me talk about each brake in turn.
The fiscal brake
First, fiscal adjustment. It is essential. Countries have a legacy of huge public debt—partly due to the crisis, partly due to the inability to store up the wealth when times were good. Among the advanced economies, the ratio of debt to GDP is expected to hit 109 percent next year—the largest ratio since World War II. It is not sustainable. It has to come down.
The most important element is to lay out a credible medium-term plan to lower debt. Without such a plan, countries will be forced to make an even bigger adjustment sooner.
At the same time, we know that fiscal austerity holds back growth, and the effects are worse in downturns. So the right pace is essential—and the right pace will be country specific. The right mix between cutting spending and raising revenue is also critical.
Some countries under severe market pressure have no choice but to move faster. On the whole, however, adjustment should be gradual and steady.
By our estimates, most countries are moving at a prudent pace this year—about 1 percent of GDP on average.
As next year looms on the horizon, countries need to keep a steady hand on the wheel. If growth is worse than expected, they should stick to announced fiscal measures, rather than announced fiscal targets. In other words, they should not fight any fall in tax revenues or rise in spending caused solely because the economy weakens.
So again, there is no avoiding this brake of fiscal adjustment. But if set against a medium term plan and calibrated correctly, we can make sure it does not do too much harm to growth.
The banking brake
The second brake on growth comes from the banking system. Banks are certainly looking healthier today than a few years ago, but they still have too much leverage on their books. They need to shed excess weight to become fit and healthy. But as with any weight-loss program, there are good and bad ways to do this. Ideally, it should be done by raising more capital rather than cutting back lending.
We expect large banks based in the European Union to shed as much as $2.6 trillion by the end of next year, or 7 percent of total assets. Fortunately, only a quarter of this is coming from reduced lending. The effect on euro-area credit supply should be manageable—1.7 percent of credit outstanding over two years.
When bank health returns, we should see lower borrowing costs for all—and monetary policy should be able to do its job even more effectively.
The housing brake
The third brake on growth comes from the housing market. Another legacy of the crisis is too much housing and too much household debt that holds back the recovery. This is primarily a problem in the United States, and also in some peripheral European countries such as Ireland and Spain.
The good news is that it, too, is being resolved. The excess stock of housing is working itself out, as there is little new investment.
That said, we still need bolder programs to reduce the debt burden, defaults, and foreclosures. Countries like Iceland have done a lot, but countries like the United States still need to do more.
So let me try to tie this all together. The banking and housing “brakes” are easing, and will continue to ease over the next few years. The fiscal brake will not, but it can be applied in a way so as to do as little harm to growth as possible. And as I said earlier, monetary policy can stay supportive for as long as needed, and will become more effective over time, as the banking channel becomes more fluid.
So if countries choose the right policies, and calibrate them correctly, the economy can grow faster. As T.S. Eliot once said, “We wait, and the time is short, but the waiting is long”. We must not waste time by getting distracted from the issue at hand, or by losing focus on the end game.
This brings me to the medium-term dimension of the growth challenge.
Encouraging demand is the first step, to get the economic engine to run faster and stop it stalling out. But we need to make sure that the spark to demand will fuel sustained growth. If demand matters most for today, then supply matters most for tomorrow. That requires that product and labor markets work for everybody.
Product market reforms are the avenue to higher productivity and growth in the future. This is particularly the case in the nontraded sector, where the cosseted few reap the benefits of being shielded from competition while everybody else loses out. Sectors like distribution, construction, or regulated professions come to mind. This is a particular problem in southern Europe.
Let me give you an anecdotal example from Greece. Because the local trucking industry was so protected in Greece, it actually cost less to import a tomato from the Netherlands than to buy one from a Greek farmer. There is something deeply wrong with this picture—unlike the cold and damp north, Greece has a fantastic climate for growing delicious tomatoes! This sector is now being liberalized, so things should change for the better.
On labor markets, our primary concern must be youth unemployment. Here, I believe that well-designed labor policies can help young people take that crucial first step up the ladder. I am thinking of policies like jobs-search assistance, wages subsidies, on-the-job training and apprenticeship programs.
Young people are especially disadvantaged by dual labor markets, which give strong protection to insiders and weak or no protection to outsiders. In such situations, young people tend to bounce back and forth between unemployment and dead-end jobs. Again, this is an especially serious problem in southern Europe. And let me add that the same problem often confronts older people looking for work and similar solutions need to be identified for them.
Make no mistake: improving labor markets often means taking tough decisions. But it really is a matter of balance. We need to address the shortfalls and pitfalls of the market, while respecting the legitimate rights of workers and keeping a keen eye on income distribution. This can only be achieved through a constructive dialogue with all stakeholders, including workers and business representatives.
The issue of product and labor market reform is most pressing for countries that have lost competitiveness relative to their economic partners, such as those in southern Europe. This loss of competitiveness depresses growth today and blocks the path to sustained growth tomorrow.
In these Eurozone countries, with no exchange rate valve to release the pressure, the only options are boosting productivity or reducing wages.
But reforms take time to unlock productivity, and time is what these countries do not have. So, in some instance, wages will have to adjust. Sometimes this is just common sense. While minimum wages serve valid social goals, they can sometimes get out of line, which hurts the young and the unskilled in particular. For instance, the minimum wage in Greece is 50 percent higher than in Portugal, 17 percent higher than in Spain, and 5-7 times higher than in Romania and Bulgaria.
Over the medium term, reforms will pay off. Some preliminary analysis by the IMF for the euro-area countries suggests that over five years, large-scale product market, labor and pension reforms could boost GDP by 4½ percent. Part of this reflects the magnified gains from a synchronized effort, showing the importance of everybody moving together.
These gains are too important to turn down. That takes me to my third point—the centrality of cooperation.
The centrality of cooperation
The final point I want to make is that strong and sustained growth in each country benefits all countries. So we must all support the common effort.
Let me talk about cooperation in three main areas—rebalancing the global economy, financial sector reform, and the global financial safety net.
On rebalancing—better growth means more balanced growth. With many of the advanced countries saving more and going through a fragile healing process, other countries must step into the breach. I am thinking especially of the emerging markets with external surpluses like China, which are starting to shift more from exports toward domestic demand. This is good for them, good for the world, and they need to continue walking this path.
The only way for global deficits to shrink is for global surpluses to shrink too. In other words, the advanced economies must export more to grow more, and other countries need to have enough demand to buy these goods and services. It is two sides of the same coin.
As we talk about rebalancing, let us not forget the plight of the low-income countries. These countries are especially vulnerable, home to millions of poor people, just one short step away from financial ruin and economic disaster. By implementing sound policies, these countries did relatively well during the crisis, but are now running short of options to cope with any further dislocation. We need to help them help themselves, urgently.
The second issue where we must do more together is financial sector reform. We cannot continue with the faulty financial system that toppled the global economy. We need a financial sector that puts societal interests ahead of its own financial gain. As with product markets, we face some powerful vested interests here.
I am pleased to note that progress is being made under the Basel III process, which seeks to improve banks solidity. The ongoing work on shadow banking will also help address risks that lie outside the banking sector. The time has come to implement what has been agreed, and make more progress on what has not.
But this will only work with cooperation. Any new regime of heightened regulation and fairer taxation must be implemented consistently across countries to avoid the risk of arbitrage.
And here, I want to pay tribute to Switzerland, which is living proof that strong financial regulation is compatible with, and conducive to, a thriving financial sector. For example, it is imposing capital requirements on large and globalized banks that are well above the Basel III standards, and yet its financial sector, profoundly modified, is faring well.
The third area for increased cooperation is the global financial safety net—to help protect all countries against sharp economic downturns or the risk of financial contagion. Here, the recent efforts by European countries to build such a “firewall” are to be commended.
This is also why the recent decision by the IMF’s membership to boost its resources by more than $430 billion is a major step in the right direction—a true symbol of global solidarity in the face of common threats to our common future. And I am proud to say that Switzerland played a key role in that response.
Let me make one more point. So far, I have talked about solidarity between countries. But solidarity within countries is also important. Difficult decisions in tough times are best taken in an atmosphere of social partnership—where everybody has a seat at the table, where the poor and vulnerable are protected, and where the government acts as an honest broker. This makes it easier to share fairly the gains of growth in good times and the pains of adjustment in bad times—ensuring greater political buy-in and social cohesion.
To sum up this evening: strong, more sustained, balanced and inclusive growth is within our grasp. It is for us to choose the right combination of policies and walk resolutely the path together.
This is not the time for short-termism or insularity.
Switzerland is a country that shows how stability goes hand-in-hand with growth, how fiscal decentralization goes hand-in-hand with monetary union, and how financial sector success goes hand-in-hand with strong oversight. It is a country that shows how cooperation with its neighbors can benefit all. Important lessons.
If I were to leave you with one thought today, it would be this: growth and stability are not mutually exclusive—it is not “either/ or”—and we can design a path that reconciles them both.
It is the job of the IMF to stand with its members and to help its members. We bring 188 countries together to seek stability and growth, the sure foundations of a better future.
Let me end with some wisdom from Albert Einstein, who once invited people to “learn from yesterday, live for today, hope for tomorrow”. Let us work together today to make our collective hopes for tomorrow a reality.