Speech

What is the IMF doing to help countries maximize the benefits of globalization?

June 29, 2007

It is a pleasure for me to participate in this discussion today, which tackles a topic of importance for both policymakers and the public at large: how to make globalization work for all. I would like to address this issue from an angle you will find of particular interest, that of the policies and reforms the International Monetary Fund is pursuing—with its global membership of more than 180 countries but also within itself—to ensure that member countries maximize the benefits and minimize the risks of globalization.

How has globalization changed in nature?

Globalization refers to the increasing integration of the world's trade and financial markets. This integration is associated with the liberalization of trade flows and cross-border investment and helps countries converge over time in terms of wealth as well as welfare. The arguments for the benefits of liberalization are well known; these stem from the improved allocation of resources facilitated by trade and investment flows. Globalization is not a recent phenomenon but, today, the reach and depth of trade in goods and services as well as of capital flows are far more developed than they ever were. This process would not have taken place without the impressive technological progress, including in information technologies, and advances in the management of labor resources, which have spurred productivity gains around the world. As a result, an increasing number of countries are contributing today to world growth, and this makes for a much more deeply integrated and vibrant world. In the last 5 years, the world has experienced a strong and stable average real per capita growth in the range of 4-5 percent annually, accompanied by low inflation.

But the scope and nature of globalization has changed in two significant respects:

• First, the volume of international trade has risen sharply since the 1990s. The ratio of world exports to world GDP has increased from 19 percent in 1990 to 31 percent in 2006.

• Second, cross-border capital flows have soared. They have jumped from 4 percent of world GDP in 1990 to about 14 percent in 2006. Foreign direct investment flows, within the total, rose from US$160 billion in 1991 to US$590 billion in 2006.

These indicators alone show the quantum leap in the interdependence of countries' economic and financial sectors around the globe.

What are the risks?

The positive effects of globalization and the positive world economic indicators, however, should not make us complacent about the risks or concerns associated with globalization at this juncture. There are four main sources of risk:

• Greatly increasing capital flows have contributed to global growth but have also permitted current account imbalances on an unsustainable scale. The United States' current account deficit, which built up to 6½ percent of GDP in 2006, has a counterpart mostly in emerging economies and oil-exporting countries. The risk of a disorderly adjustment of these global imbalances is a medium-term challenge and has been a concern for quite some time.

• Integrated financial markets have allowed greater risk sharing, but also imply a faster transmission of shocks than in the past. Risk premia, which have fallen to unprecedented lows across the world, may be subject to sudden re-pricing in case market participants update simultaneously their risk perceptions to news, raising volatility. Sharp asset price corrections could spread rapidly across countries.

• As globalization develops, a share of the population in advanced and less developed countries has made only slow progress in well-being or has lost ground. While, in the aggregate, the integration of labor from emerging markets like China and India into the global economy has been a win-win situation and the size of the "pie" has grown tremendously, in advanced economies the income share of labor has declined relative to that of capital—and in less advanced countries as well, although data on this are limited—and inequality between rich and low-income countries, within each group, and within a number of countries, has increased.

• In this process of globalization, new economic powers have emerged in Asia, Europe, Latin America, and the Middle East. They take an increasing part in global trade and financial flows and they now own about a third of the world's stock of international reserves. The policies these countries pursue, as well as the way in which they manage their reserves, can have a profound impact on the world economy and financial system. Ensuring that their voice is appropriately represented in international fora is a major stake for a multilateral collaborative approach to global economic and financial issues.

The sustained global economic dynamism is thus pregnant with a risk of backlash. A major concern is that globalization does not pull everyone equally. Some, mostly in the industrialized world, have raised their voice against the threat globalization poses to their employment and living standards, as demand for labor and capital shifts to countries where inputs are cheapest. Others, particularly the low-skilled poor living in less developed countries, worry they are not receiving their share of the fruits of faster growth driven by a process of globalization they are however contributing to. Governments, responding to these calls, may be tempted to turn their back on globalization, retreating into protectionism by erecting barriers to imports and controls on capital. This would make things worse. What can be done to protect against the risks associated with globalization and avoid a return to protectionism?

How is the fund helping countries meet the challenges of globalization?

To address these concerns, the IMF has put in place a Medium-Term Strategy aimed at working with its member countries to minimize the risks of globalization and maximize the benefits. Based on this, it has undertaken a number of reforms in the way it operates to adapt its role to the new global world environment and enhance its tools. Let me highlight three key areas of reform.

First, the Fund has introduced a number of changes to modernize and strengthen its surveillance activities, namely the way it monitors and assesses countries' policies and provides policy advice.

• To help foster a dialogue on global issues requiring multi-country policy actions and coordination, a new surveillance tool—named "Multilateral Consultations"—has been set up. The first Multilateral Consultation focused on the issue of global external imbalances. Discussions with systemically important countries and groups of countries were successfully concluded, showing the value of this new tool. A set of comprehensive actions were agreed upon, including particularly tighter fiscal policy in the United States; greater exchange rate flexibility in Asia; structural reforms to improve potential growth and fiscal sustainability in Europe and Japan; and the gradual increase in expenditures on social systems and infrastructure in oil-exporting economies. Important steps have already been taken in these areas.

• Exchange rates have been at the heart of Fund surveillance, and with the greater levels of trade and financial flows, this has become all the more important. The Fund has, therefore, given greater prominence to its work on exchange rate issues. The Executive Board just replaced the 1977 Decision on Surveillance Over Exchange Rate Policies with the 2007 Decision on Bilateral Surveillance over Members' Policies. The new Decision provides more complete guidance to members for the conduct of their exchange rate policies, so as to cover all major causes of external instability rooted in these policies. The 1977 Decision enjoined members to avoid exchange rate manipulation for specific purposes, in particular to gain an unfair competitive advantage over other countries. The new Decision adds a principle recommending that members avoid exchange rate policies that result in external instability, regardless of their purpose, thereby capturing exchange rate policies that have proven to be a major source of instability over the past decades. The new Decision is also much more comprehensive than the old one, covering not only exchange rate policies but also domestic policies. Paradoxically, this will help prevent surveillance from spreading itself too thin, since it will help identify which domestic policies are really critical for external stability. Overall, the Decision crystallizes a common vision of the best practice of surveillance, as it has evolved over the last 30 years, for greater clarity and, hence, more accountability.

• Further, to guard against the risks of financial crises in emerging market economies, a new Fund financing facility is being considered to help assure financing to countries pursuing appropriate policies in the event they face a crisis. Together with the 2007 Surveillance Decision, the facility could contribute to enhancing crisis prevention in emerging countries.

• To tackle the challenges raised by integrated financial markets, the IMF is giving increased emphasis to financial sector issues in its bilateral, regional, and multilateral surveillance work. To this end, financial sector analysis is being strengthened, in particular by devoting particular attention to the linkages between the financial sector and real economy. Also, the analysis of financial sector vulnerabilities is being made an integral part of the Fund's macroeconomic analysis and policy advice in the surveillance of individual economies. To support the effort, a Monetary and Capital Markets (MCM) Department was established by merging and consolidating two departments that were previously undertaking monetary and financial assessments.

A second set of reforms aims at helping low-income countries (LICs) reap the full benefits of globalization. More than 40 percent of the IMF's membership is potentially affected (78 countries out of 185). Many of these countries are in Africa, and although the region as a whole has been growing at impressive rates of around and often above 5 percent a year in the past few years, there is a divergence across countries. The Fund is following several lines of action:

• It has renewed its commitment to help LICs meet the Millennium Development Goals through policy advice, technical cooperation, financial assistance and debt relief. In the face of a potential large scaling-up of aid, the Fund helps LICs ensure that their debt burden remains sustainable and new financing effectively promotes pro-poor growth. In this, the Fund will continue to work closely with the World Bank, donors, civil society, and governments. The IMF can also continue to play a catalytic role in the scaling-up of aid in the absence of direct financial assistance by endorsing a country's macroeconomic policies through, for example, the Policy Support Instrument.

• The Fund provides support in other areas that are critical to growth, particularly trade. The successful conclusion of the Doha Round is key to promoting growth and poverty reduction, and the IMF has consistently called on industrialized countries to eliminate distorting subsidies, especially in agriculture, and on developing countries to open their industrial sector. The Fund stands ready to provide financial assistance to member countries to help them address the potential balance of payment impact of trade reform measures through its regular financing facilities. In addition, the Fund has also created the Trade Integration Mechanism (TIM) to augment its support to countries suffering temporary balance of payments setbacks due to trade liberalization by other countries.

Of course, multilateral trade liberalization is an issue in advanced economies as well, because of the perceived impact of globalization on inequality. This also has been the focus of new Fund work with the goal of helping governments design adequate policies to alleviate the cost of globalization. An in-depth study by the Fund on the effects of globalization on employment was published in the April 2007 World Economic Outlook (WEO). It supports the following conclusions:

• Globalization, by providing cheaper imports, has been beneficial to advanced countries. It is technology, not globalization, that has been the larger contributor to the decline in the share of labor.

• In this light, and to avoid a protectionist backlash, policies should aim at improving the flexibility of labor markets and reduce the tax wedge on labor to ease job creation and relocation; develop workers' skills through investment in education and training; and develop adequate social protection systems to help workers in the job transition process.

• The same set of policy challenges, of course, applies to emerging markets and developing countries, which likely suffer from the distributional consequences of globalization and rapid growth (income data are scarce for an adequate measurement).

Third, the Fund has made some very important changes to its own governance structure to strengthen the voice and representation of emerging countries. The first stage of a reform of quotas at the Fund has already been implemented, which raised ad hoc the voting power of China, Korea, Mexico, and Turkey to reflect better their weight in the global economy. The Fund is seeking a consensus on a new quota formula to continue the process. By increasing ownership of Fund advice, this promotes the commitment of all member countries to a multilateral approach to addressing economic and financial issues.

There is much potential in globalization to foster the integration of emerging and developing economies into the world economy and to enable these countries to benefit from the process. Advanced economies are already benefiting through steady growth with low inflation. Governments have a role to play in explaining to their populations the sources of changes, as well as the benefits and challenges. They will need to smooth the costs of transition through flexible labor markets, education, and social safety nets. In this process, the Fund has been a strong supporter of the Doha Round, encouraging a rapid and ambitious conclusion. The talks have been dealing with difficult issues, yet the successful conclusion of the Round will be critical to improve export opportunities and set up stronger multilateral rules. It is the objective of the IMF to implement reforms to adapt its role and strengthen its tools to help countries to reap the full benefits of globalization while managing its risks.

¹ The views expressed here are those of the author and should not be attributed to the International Monetary Fund, its Executive Board, or its management.