Speech

The Tensions of Growth: Economic Perspectives and Key Factors for Human Development, Speech by Rodrigo de Rato, Managing Director of the IMF, at the Club of Rome, Madrid, Spain

September 24, 2007

As Prepared for Delivery

1. I would like to thank Ashok Khosla for that very warm introduction and Ashok and also Isidro Fainé for hosting this conference today, and for their very interesting opening remarks. I am honored to have been invited to this first annual meeting since the passing of Alexander King. There is little I can add to the moving commemoration that we have just witnessed. Alexander King was a great scientist and a great international civil servant. But perhaps his most notable achievement was to help found the Club of Rome after his retirement from heading the OECD. It is a timely reminder to me—not that I think I need one—that there are many interesting things and much important work that can be done after one leaves a major international institution.

2. Aurelio Peccei and Alexander King were visionaries, and one of the fruits of their vision was the first formulation of the book "Limits to Growth," since updated several times. I think that we have yet to find out whether there are binding limits to growth. For my part, I am optimistic about the prospects for long-term, sustainable growth. I believe that even where resources are finite, there is still scope for technological progress and for improvements in the way resources are used, which can lead to a continuing improvement in people's standards of living. But I certainly believe that there are tensions that accompany growth, and we are currently seeing these in several areas.

3. I would like to talk today about tensions arising in three areas. First, tensions in financial globalization—the very substantial increases in flows of capital across borders. These tensions are evident in the current turmoil in credit markets, and I will talk briefly about their implications for the global economy and the lessons we should draw from the recent turbulence. Second, tensions in the area of environmental policy and, specifically, the challenge of dangerous climate change, which is the most pressing environmental issue of the day. Finally, tensions coming from demographic change and, specifically, the effects and policy challenges for governments arising from aging populations.

4. I will begin with the turbulence that we are currently witnessing in financial markets. I will not speak in great detail about what is currently transpiring. An International Monetary Fund staff team headed by Jaime Caruana, who many of you will remember was previously Governor of the Bank of Spain, will be releasing a detailed report on global financial stability issues later today in Washington. I urge you to look at that for a comprehensive account of the Fund's views. But I can say that we regard the turbulence as a serious problem, and we do not think the crisis is close to being resolved. Events in the financial markets are still unfolding, and it will be some months before the extent of banks' and investors' losses become clear. But we welcome the efforts of the major central banks to relieve the liquidity shortages in credit markets, and believe that this will help to limit the wider economic impact of the recent turbulence.

5. The economic impact of recent developments will remain uncertain so long as the situation in financial markets remains fluid. On the basis of current information, we expect the consequences for the global economy to be modest. The turbulence is unlikely to have much effect on the growth figures for 2007—most of the production, investment, and consumption decisions that will affect global GDP had already been taken before the turbulence began. However, we now expect that global growth in 2008, while still high by historical standards, will be slightly lower than in 2006 or 2007. We also believe that risks to this projection of a modest decline in growth are mostly tilted to the downside. In particular, if the financial market turbulence turns out to be prolonged, the impact on the global economy could be substantial. The Fund will present its World Economic Outlook—a detailed assessment of global economic prospects—in about a month, just ahead of our Annual Meetings.

6. What lessons can be drawn from the tensions in financial markets? I do not see the recent turbulence as a reason to give up the benefits of financial innovation and globalization. The turbulence has demonstrated how risks and vulnerabilities can be transmitted across borders. But the same process of globalization also transmits opportunities across borders: opportunities for consumers to buy goods from many sources; opportunities for businesses and workers to sell goods in many markets; opportunities for savers to put their money where it can do most good; and opportunities for borrowers to raise capital and make productive investments.

7. However, I do think that recent developments hold some lessons for policy makers, and for the public. Regulators and financial market participants need to assess how transparency can be improved in various markets and make sure that there are sufficient incentives for market discipline to function. Ratings agencies need to improve their practices, especially when dealing with complex structured securities. Institutional investors need to recognize that ratings by others do not absolve them of their own responsibility to assess risk. Individual investors share this responsibility. But they also need some protection of their rights, and some help in understanding and exercising them. This suggests that there is a need to enhance transparency in order to protect consumers—both for lenders and borrowers—and to deepen financial education.

8. Policy makers also need to consider further the implications of spillovers between markets and between countries. I hope that one positive consequence of the events of recent months will be increased interest in international cooperation in monitoring global financial markets and coordinating their regulation. The Fund, together with other international institutions, has to play a role here, as we did in catalyzing the formulation of plans by major economies to address global imbalances. I expect that this issue will be a topic for discussion at our Annual Meetings next month.

9. The need for cooperation is also clear in one of the other areas that I would like to discuss today: the response to dangerous climate change. A couple of years ago, at the Davos meetings, President Clinton said that he saw climate change as perhaps the one thing that could threaten human civilization. In the two years since then, published scientific opinion and public perception have begun to catch up with President Clinton's insight. Each successive scientific study casts more light on the potential damage from climate change, and many suggest that we are closer to the tipping points that would turn change that is damaging into change that is catastrophic. Yet I also see some encouraging signs that climate change is a challenge that the world can meet.

10. To economists, climate change is a clear global externality. The social consequences of emitting the greenhouse gases that drive global warming are not borne fully by those doing the emitting, but shared across the world. The problem is compounded by the fact that those doing the emitting are often among the most powerful individuals, companies, and countries in the world, and those most affected are among the least powerful. Indeed, the greatest effects will fall on future generations, who have no voice, unless parents and those who will become parents speak for them. So it seems difficult either to generate economic incentives for action or to generate an effective political consensus around the need for change.

11. Yet such a consensus is emerging. Around the world, there are examples of individuals and companies voluntarily reducing their own emissions, and lobbying their governments for political responses to the problem. Around the world, instead of free riders, we are seeing people who are willing to pay freely. For many, action to prevent dangerous climate change has become a priority.

12. How then can policy makers channel this effort to overcome the externalities of man-made climate change? I believe that they should look for answers in the same place that the problem originates: in economics. Policy makers around the world need a reasoned assessment of the economic costs and benefits of climate change and of the policies that can be adopted to combat it. These include policies to mitigate climate change—to prevent what can be prevented—and also policies to adapt to climate change—to respond to what cannot be prevented. The International Monetary Fund has a role to play here, too. The World Economic Outlook that we will present in October will discuss estimates that others have made of the economic costs of climate change. It will also consider some of the economic issues involved in the choice of methods to mitigate climate change—especially the main options of imposing taxes on greenhouse gas emissions or of setting caps on them, combined with a system of internationally traded emissions permits. It will also discuss some of the economic issues involved in adaptation to climate change by countries. This is just the beginning of the Fund's work—we will have more to say in the following World Economic Outlook, which will be published in the Spring—and what the Fund is doing is only part of the work that needs to be done. Other international institutions are working on other aspects of the problem. And cooperation between international organizations and between governments will be needed to solve the problem. But with reason and with political will, I believe it can be solved.

13. Let me turn now to demographic changes. When the Club of Rome began considering population and demographic changes 35 years ago, its focus was on the risks of overpopulation. There are still parts of the world where increasing population puts pressure on the environment, resources, and on societies. But there is also increasing concern about the economic effects of aging populations, both in advanced economies and in major emerging economies.

14. In many countries, life expectancy is increasing and birth rates are falling. These are generally welcome developments. People are living longer and healthier lives, and they are exercising their freedom to have or not to have children. But there are also some unwelcome economic effects. Older populations are likely to produce less, because the active labor force is a smaller part of the population. For example, in the euro area, there are at present about four people in the age range 15-65 for every one over 65. By 2050, that ratio is projected to be closer to two to one. Demands on health care systems will also tend to be greater, because more people will be older, and the average cost of health care tends to rise as people age. And strains on pension systems will clearly increase as the population grows older.

15. To anticipate and manage the economic effects of demographic changes, governments will need to make a number of changes. Governments can make structural reforms to improve productivity, so that a relatively smaller active labor force will be able to produce more. Reforms such as reductions in tariff and legal barriers, opening up of markets to competition, and measures to create a more business-friendly environment can all help to produce such an increase in productivity. So can financial sector reform, including financial sector integration. Governments in countries with aging populations can also help reduce labor market shortages by encouraging immigration and putting in place policies to integrate immigrants into their societies. Reform of health care systems can help to offset the increased costs arising from demographic changes. Reforms could include both measures to improve efficiency and reduce market failures in health care, and increased emphasis on preventive medicine and improving health behavior by individuals. An important element of pension reform is likely to be increases in retirement ages—something that is already happening in many countries. But governments should accompany such measures with labor market reform, to improve job opportunities, particularly for older workers.

16. The tensions that I have talked about today show that economic change and economic growth can surprise us. When the Club of Rome was founded, financial globalization, climate change, and aging populations did not seem to be the most pressing challenges. But a spirit of inquiry and innovation and a recognition of the complexity and interlinkages in the global economy are as necessary today as they were when Aurelio Peccei and Alexander King began their great enterprise. I believe that this spirit can be brought to bear on the tensions and challenges that we face today.

17. Thank you very much.