Speech

The Challenges to Sustaining the Global Recovery

October 23, 2017

Good afternoon. Thank you for the kind introduction.

I am always happy to visit Germany—a country that provides an important voice in the international community for responsible economic policies.

I would like to set the stage for your discussions today with an overview of the global economy—recent positive developments and some perspectives on longer-term trends that we need to address. I’ll point toward some practical solutions where I can—and will—highlight some looming issues that require more attention.

The bottom line is that the global recovery is strengthening. That provides an environment of opportunity to address key policy issues that can help support stronger and more sustainable growth—and foster the financial stability essential to the health of the global economy.

The IMF has just released its latest World Economic Outlook, which we update on a quarterly basis. It forecasts 3.6 percent global growth this year and 3.7 percent next year. That is well above the 3.2 percent we saw in 2016.

This is good, but not enough. Before talking about what’s missing, let’s review the progress.

Consumption and Investment

The sources of strength this time include both consumption and investment. The strengthening of investment is important, because many companies have been reticent about making physical investments since the Global Financial Crisis. Investment, which is very import intensive, is contributing to an acceleration of trade, which is a way of spreading the beneficial effects of recovery across the global economy. For the first time in several years, trade is growing faster than GDP. That is most welcome.

Another important development: the recovery has become more broad-based. The advanced economies are finally all growing, led by the euro area and Japan. This, too, we haven’t seen since the crisis. We also have stronger growth across many emerging market countries, especially China, emerging Europe, and Russia.

We see Germany growing at 2 percent this year, and moderating to 1.8 percent in 2018. The U.S. is also growing—at a little over two percent. But we’ve reduced that forecast a bit because of uncertainty about the fiscal stimulus under discussion in Washington. We also have downgraded the UK forecast.

The countries contributing to the recovery add up to about 75 percent of the world, measured by GDP. Not bad. But that also leads us to what is absent.

The 25 percent of the world that is not growing represents a broad swath, in fact a large number of the developing countries. This includes some emerging market countries and the commodity exporters, especially oil-rich countries. In fact, some 46 countries are experiencing falling GDP growth in per capita terms.

Many countries are still adjusting to the sharp fall of commodities prices in 2015. This is especially the case in sub-Saharan Africa, where several countries are trying to return to growth. But they are a long way from the rapid expansion in the years of the commodities boom. This is one of the important policy challenges I referred to a moment ago.

This gap between the countries that are partaking of the recovery and those that are not tells us that this recovery is simply not strong enough. That, broadly speaking, is because many countries have not yet taken the policy steps needed to return to growth.

It also important to point out that, in terms of the benefits of the recovery, there are also disparities within many of the countries that are growing. For example, across the advanced economies, real wage growth has remained low and many people have lost ground since 2008.

Some of that stems from the lingering impact of the global crisis. Some can be blamed on technological change and trade. Whatever the cause, we have witnessed an increase in inequality that has helped breed populist resentment against globalization, migration, and change in general.

Continuing Challenges

This brings me back to the environment of opportunity—and the challenges we face. Walter Baghehot, the 19^th century British journalist, said, and I paraphrase: often, the worst decisions are made in good times. That is because the best decisions often come when we are forced to act, i.e. in bad times.

It is perhaps inevitable that policymakers may be less inclined to act at the present moment. Relief over recovery may lead to complacency. But they must act, for this recovery to be sustained.

One of the overriding challenges we face is the normalization of monetary policy from the unconventional monetary policies undertaken by several major central banks after the global crisis. We are comfortable with the accommodative stance where it remains in effect. And the first steps toward normalization by the Federal Reserve have proceeded smoothly.

But we cannot ignore the risk this process poses for a financial system accustomed to historically low interest rates.

We have also just published our Global Financial Stability Report, which analyzes market trends and risks. Most importantly, the report points to a global financial system that has become more resilient. The major banks and insurers have increased their capital and liquidity buffers, and addressed many issues from the global crisis. Emerging markets have benefited from low-cost capital flows over the past year and can borrow to spur growth.

That said, the report highlights growing vulnerabilities, for example those stemming from low rates, which make countries and investors more susceptible to unexpected shocks. A sudden shift in market sentiment or a geopolitical event could carry considerable weight.

The pursuit of higher yield has left many investors exposed to potential credit, maturity and liquidity risks. Volatility is extremely low across asset classes and countries, fueling investor complacency. These are issues that many market participants have expressed concern about.

Rising Debt

In addition, debt is increasing across the globe. In the G20 countries, private sector leverage is higher than before the financial crisis. And we are witnessing a rapid increase in the indebtedness of low-income countries, where non-traditional sovereign lenders like China, Russia and Saudi Arabia have been very active. These lenders operate outside the Paris Club of sovereign lenders, which may complicate and delay the of resolution of problem loans.

It is the responsibility of central bankers and other policymakers to address financial and debt vulnerabilities before they become more acute and more expensive to act upon.

I just mentioned progress on bank legacy issues from the global crisis. Without a more sustained effort to deal with this unfinished business, risks will remain higher and growth harder to support. This certainly applies to the euro zone, where the work of cleaning up bank balance sheets and improving cost efficiency must continue, in parallel with the effort to complete the banking union.

But this is not just a matter for the private sector. Governments also must still deal with crisis legacies. These issues include emerging market debt, fiscal consolidation in many countries, and, as I just said, the euro area banking architecture.

There are also broader structural issues that the crisis brought to the fore: demographic change and migration, infrastructure gaps, labor and product market regulation, and educational shortcomings.

The IMF has not been shy about expressing its views on these issues. So, instead of revisiting a well-worn path, I would like to focus on the predicament of emerging market and developing countries.

Emerging markets have been the high-flyers of the global economy for decades, seeking rapid growth to catch up with the advanced economies. That should be possible by investing, acquiring technology, better educating workers, and thus boosting productivity. The end result of that trend would be a convergence of living standards.

But right now, convergence does not look like a foregone conclusion. We project that over the next five years the emerging markets and developing countries will grow about 1.5 percentage points faster in per capita terms than the advanced economies.

In aggregate, this sounds good. Catching up by 1 ½ percentage points a year. But then you must consider that a small group of very large economies are catching up very fast. China, India and a few others grow rapidly enough to catch up by 4 to 5 points per year. In fact, the rest—about 43 countries—are growing more slowly than advanced economies, so they won’t be gaining ground on the advanced economies: They risk falling further behind.

That is why our message is to take advantage of this recovery, to repair the roof when the sun is shining. Continuing reforms — reforms that will be easier to pursue while the global economy is in recovery mode — can restart and accelerate convergence.

Technological Transformations

Now, I’d like to introduce another set of looming changes that will undoubtedly affect our economies in a future that in one sense is already upon us. They are technological innovations that have the potential to be both disruptive and transformative.

Let me briefly outline three issues that we at the IMF are beginning to grapple with in our analytical work.

First is what is being called the Future of Work; specifically, the ways in which automation and artificial intelligence are affecting the factory floor and the very process of industrialization. This process is well underway. I know, for example, that the Japanese company Softbank has put together a $100 billion Vision Fund to help seed innovations in this area.

But we really do not understand how this process will play out—and that includes in the realm of macroeconomics. Will it substitute for workers, putting large numbers of people out of work? Or will it enable and equip workers to be more effective, creating an array of new businesses and employment opportunities, as occurred with the advance of IT?

We particularly need to consider how this transformation will affect the developing world. Will it allow low-income countries to speed up the process of industrialization, or even leapfrog development stages other countries had to go through, all to the advantage of their young and rapidly growing work forces? Or will technological advances actually reduce the need for lower-skilled workers, closing off a route to development first forged by the emerging markets a generation ago?

The second issue is one you all are facing: cyber-threats. I recently was told by an executive with a major bank that his institution is attacked once every ten seconds by hackers. In the U.S., we just experienced the wholesale looting of credit information from Equifax. This one incident affects hundreds of millions of people—and the threat will only become more dangerous.

The international community is paying close attention to this issue. The G7 has done quite a bit of work already, and the Financial Stability Board is also leading an effort.

One thing to consider is whether the answer to the cyber-threat is the decentralized, private-sector response that we have relied on so far. Or, whether information technology is a global public good, and the time has come for governments to consider a coordinated response.

Of course, the field of cyber-security is far from the IMF’s core expertise. But we are prepared to help come to grip with the macroeconomic implications of the issue.

Digital Finance

All of which leads us directly to the third area of change: the broader universe of digital finance, which you will be discussing this afternoon. This is playing out right now before our eyes in the online payments platforms like PayPal and China’s Ali-Pay. In only a few years, many people in China’s cities have stopped using cash altogether. In East Africa, the online banking pioneered by M-Pesa has benefited millions of people who previously lived outside the financial system.

These success stories show how Fintech can be a force for inclusion and development.

But Fintech also presents a serious challenge to traditional banking models. And as online platforms develop lending and investment products, effectively acting like banks, every regulator and supervisor must be concerned with whether the current regulatory framework is adequately encompassing these businesses. Here, too, work is underway, with Fintech firms interacting with regulatory authorities on a range of possible solutions.

But we are still talking about a business that fits broadly within our frame of reference for financial services. A case can be made that next level of this digital transformation—the emergence of crypto-currencies, and new transaction and settlement technologies—is moving well beyond familiar boundaries.

The so-called distributed ledger technology is dispensing with the backroom and moving to instantaneous transactions outside the reach of governments—and that includes the scope of monetary policy. We now see central bankers starting to talk about issuing their own virtual currencies and considering ways of regulating the bitcoins and others.

Here, too, the implications are enormous. National regulators and international standard-setters need to move quickly to define a regulatory setting that can address the issues that will emerge almost before we know it. At the same time, we cannot “throw out the baby with the bathwater” by imposing a regime that stifles innovation.

The Fund has just begun to address these issues within its mandate. Like cyber-threats, there is a great deal of work to do to understand the potential macroeconomic impact. But, here, we first have to define the playing field.

Conclusion

In conclusion, I’ve covered a lot of ground in a very short time—global recovery, income convergence, technological change. Some are issues we can get our arms around. But we are just beginning to gain purchase on the others.

Each will influence the fortunes of the global economy—on our watch and further down the road. It is our responsibility to face up to the opportunities and challenges with the tools at our disposal, or to invent the new toolkits that can make a difference. Thank you very much.