Speech

Strengthening the Framework for the Global Economy, Address by Horst Köhler, Managing Director, IMF

November 15, 2002

It is a great pleasure for me today to honor Werner Otto, one of the most important German entrepreneurs of the post-war era.

Global economic situation

The global economy is currently in a state of heightened uncertainty. While our baseline assumption remains that we can expect a recovery in the coming months, it will be slower than was hoped for just a few weeks ago, and there is a risk of further setbacks. We should, however, not forget that the world economy has demonstrated remarkable resilience in the face of a series of massive shocks—such as the bursting of the stock market bubble in 2000, the terrorist attacks on September 11, 2001, and the corporate scandals in the United States this year. Furthermore, I consider that the U.S. economy remains fundamentally strong. It has experienced a lasting improvement in productivity and is more flexible than any other comparable economy. And perhaps the most important reason for my optimism is that new technologies and people's desire to improve their standard of living worldwide are sources of growth that are still far from being exhausted.

What the global economy needs now are entrepreneurs. Entrepreneurs who do not just follow the herd, but seek out new opportunities. And it is the responsibility of policy makers to provide such entrepreneurs with a favorable policy and regulatory framework for risk-taking and investment. At this juncture, economic, fiscal, and monetary policy must above all be designed to rebuild confidence, which requires first and foremost the determination and ambition to tackle structural problems, both at the international, and, more importantly, at the national level.

Allow me at this juncture to say a brief word on the debate about the Stability and Growth Pact in Europe. In my opinion, the European Commission was right to propose postponing the deadline for balancing national budgets to 2006. This is an appropriate response to the current economic situation. However, this should not to call into question the upper limit of 3 percent of GDP for budget deficits enshrined in the Amsterdam Treaty. Long-term monetary stability requires that the ECB's single monetary policy be supported by disciplined national fiscal policies. As things stand, this must primarily imply expenditure discipline, and in Germany that covers all levels of government coupled with a policy of reform promoting the permanent reduction in the size of government. In that context, the Stability and Growth Pact is above all part of the institutional and regulatory framework required to secure a culture of economic stability in Europe.

Challenges of Globalization

From an economic point of view, globalization represents a process of increasing international division of labor and growing integration of national economies through trade in goods and services, cross-border corporate investment, and capital flows. This process led average global per capita income to more than triple in the second half of the last century. Germany, with its export-led economy, has clearly benefited from it, with its per capita income rising almost five-fold between 1950 and 2000 from EUR 5000 to EUR 24,600. An even greater economic miracle took place in South Korea, where per capita income increased by a factor of about eleven in the past 50 years, from $900 to $9,900, in each case measured in today's prices.

However, globalization means more than just economic growth. It means the free exchange of thoughts and ideas and greater geographical mobility for people. And it is not simply forced upon us, but rather the result of forces of change that are deeply rooted in human nature: the drive for freedom and a better life, for new discoveries and broadening of horizons. For this reason also, there is no sense in seeking to turn back the clock. Globalization is neither good nor bad: it offers both opportunities and risks. This means that we must seize the opportunities and, at the same time, limit the risks. The world needs more not less globalization, but it must be a better globalization.

Today, I shall focus first and foremost on two challenges.

First, the advanced economies have been the main beneficiaries of globalization so far, although in the last 10 to 20 years a group of developing countries, including China, India, Chile, Mexico, South Korea, and Thailand, with a population close to 2.5 billion, have also benefited. However, clearly there have been losers as well. Almost 3 billion people continue to live on less than $2 a day. Such poverty is the greatest challenge to stability and peace in the twenty-first century.

A second important challenge is the reform of the institutional framework for international financial markets. On the one hand, we must recognize that the expansion of international capital markets contributed in no small measure to the improvements in living standards in recent decades. Private capital flows to emerging market and developing countries now exceed public overseas development aid many times over. Without this source of capital, emerging market countries, such as Brazil or China, would not be able to develop as rapidly as they do. Therefore it is right that in many industrialized and developing countries today people continue to work on ways to take advantage of the efficiency and creativity of capital markets, not least by aiming to create an additional private pillar for their old age pensions.

Nevertheless, financial markets have also experienced episodes of "irrational exuberance" as Alan Greenspan noted as early as 1996. Indeed, the bursting of the financial bubble of the 1990s presents us with great problems today. In this regard, we have to recognize that greed, limitless speculation, and dubious accounting practices, as recently revealed in the United States, are not just occasional exceptions. Hence, we must work toward finding better ways to counter hubris and excess in capital markets in the future. The dialogue with the private sector under the auspices of the IMF and the Financial Stability Forum should help work toward this. Ultimately, it should be in the interest of both the public and the private sector to define the right balance between self-responsibility and government regulation.

Meanwhile, I welcome the broad public discussion of the opportunities and risks resulting from globalization. There remain many questions to which there are still no conclusive answers. But, in my view, it would not be productive to blame all the negative aspects of globalization on market-oriented reforms. Of course, mistakes were made, including by the IMF. However, careful analysis reveals that it was often the absence of reform, rather than an excess of reform, and especially the inconsistency of reforms that were the root cause of countries' problems. For example, when privatization was pursued without an effective competition policy in place; when fiscal discipline was applied only to the central government and not to the provinces; or when the accelerated opening up to capital flows was not accompanied by the rapid establishment of an efficient financial supervision.

There is no doubt in my mind that the international community severely underestimated the importance of sound institutions and a secure legal framework for the functioning of a market economy in developing and emerging market countries. And the extreme income inequality that persists in many countries of Latin America and elsewhere suggests that both social and economic objectives would benefit from close review in these countries. Perhaps they would have fared better if some of Ludwig Erhard's thoughts had been taken into account. Ludwig Erhard, who was Germany's Finance Minister and later Chancellor in the 1950s and 1960s, said that the key task of a social market economy was to pursue free markets while respecting the social equilibrium and the principle of moral responsibility of each individual toward the whole of society.¹ I encourage both academic and political circles in Germany to become more actively involved in the debate about a better globalization by contributing ideas about a modern social market economy. For we should never forget that freedom, democracy, and the market economy are more widespread than ever at the beginning of the twenty-first century, and I consider that to be a huge step forward for mankind.

Toward a better globalization

I would propose six guide posts that may be helpful in seeking a design for a better globalization.

• First, the issues of international interdependence must be given greater priority within national policy agendas. Increasing mutual dependence means that each country must give more consideration to the consequences of its actions for others. That in turn requires closer international cooperation and also institutions that are directly concerned with global problems.



• Second, however, international cooperation should not replace national self-responsibility. Recognizing this principle was a breakthrough at the UN conference on Financing for Development in Monterrey, Mexico, last March. It is impossible to combat financial crises and poverty without better governance, a secure legal foundation, and less corruption.



• Third, globalization urgently requires solidarity, too. Solidarity is, however, not only an ethical and moral duty. In actively combating world poverty, it is an investment in stability and peace for the whole of mankind. The target set by the United Nations of 0.7 percent of GDP in development aid, should therefore be firmly established in industrial countries' national budgets. That is measurable and honest solidarity.



• Fourth, the ecological threat to the planet knows no national boundaries. For this reason, national efforts and international cooperation must also be integrated in this area. Kyoto is by no means the last word, but it is an important step in the right direction. I think it is high time to give stronger institutional support to international cooperation for protecting the environment, for example, by extending the mandate of the UN Environmental Program, or even transforming it into an international environmental agency.



• Fifth, we need recognized rules of the game, or a level playing field, for participation in globalization. The IMF and other international institutions are working on this by formulating and reporting on the observance of international standards and codes, promoting greater transparency, efficient financial market supervision, and good corporate governance.



• Sixth, and finally, we should regard the diversity of experiences and cultures as part of the wealth of our planet. Strengthening the global institutional policy framework should not be an attempt to force all countries into a uniform economic model. The market economy has many variations, and some healthy competition between different approaches can contribute to better globalization.

The IMF in a process of change

At the IMF, we are guided by these principles, too. The lessons of the capital market crises of past years have already led to significant changes:

• There has been a near revolution in transparency of economic and financial data both within IMF member countries and in IMF policy itself.



• We are focusing more than ever on crisis prevention, not least by means of improved analysis of debt sustainability and the stability of international financial markets and national financial sectors.



• We are working on improving crisis management through a clearer definition of the conditions and limits for the use of IMF resources. And to deal better with the exceptional event of sovereign bankruptcy, we are discussing changes in the international legal framework to enable a more rapid, orderly, and less costly restructuring of sovereign debt. This debate is still in full swing.

I am firmly convinced that these and other reforms have already considerably strengthened the international financial architecture.

Allow me two points of clarification. Firstly, a well-functioning market economy derives its strength and dynamism from competition. Competition is a never-ending quest for better results, better products, and greater productivity. Hence, we must accept that overshooting and correction will always be a part of this process. This is necessary if we want to preserve a system founded on freedom, market economy and self-responsibility. In other words, in an open and dynamic market economy there are limits to our ability to predict and prevent crises. All we can strive for is to ensure that they are fewer in number, and that they are less severe. Secondly, even in a crisis, self-responsibility remains indispensable. The IMF is not an international lender of last resort with unlimited access to liquidity. Private creditors as well as sovereign borrowers must always remember that they bear the ultimate responsibility for the risks they take.

Returning to the state of the global economy, I am concerned that growth in world trade has slowed considerably. According to IMF estimates, it should reach about 2 percent in 2002, compared with an average annual growth rate of 7 percent during the 1990s. It is very much in Germany's interest that international trade remains an engine of growth and employment. For this reason, Germany should forcefully support further multilateral trade liberalization. Clear signals of political determination to bring the Doha Round, held under the auspices of the World Trade Organization, to a successful conclusion would immediately create confidence among investors worldwide. IMF economists estimate that successful multilateral trade liberalization could lead to growth in trade of 30 to 50 percent, with the greatest boost occurring in the trade of emerging market and developing countries (IMF World Economic Outlook October 2002). This is exactly the kind of structural change that we now need to boost the growth of the world economy and strengthen its resistance to crises decisively.

Trade is also the key to poverty reduction. It is the best help toward self-help, and the advanced economies should accelerate opening their markets to products from developing countries, both for raw materials and processed goods. Phasing out trade-distorting measures in the agricultural sectors in the advanced economies is particularly long overdue. In 2001, agricultural sector support in the OECD totaled over US$300 billion, which is six times the level of overseas development aid. If poverty reduction in developing countries is to be tackled seriously, this discrepancy must be addressed now. Far-reaching reforms in the agricultural policy of all industrial countries are therefore urgently needed, both for fundamental moral reasons, and because it makes economic sense. But regardless of the pace of progress in this area, developing countries, for their part, can and must also do more amongst themselves to dismantle barriers to trade.

A global world needs global ethics

Ladies and Gentlemen,

I am an optimist and I am convinced that with the right policy, and in particular the right institutional framework, better globalization is possible. As part of this, the recent financial scandals in the United States should remind us that the strength of a market economy and good corporate governance are not measured by quarterly profits alone. We need a corporate code of ethics that promotes sustainable value creation, and takes into account shareholders, workers, and the environment. I agree with Hans Küng that the world cannot survive without a global ethic. This ethic must respect human rights, but should also remind us that we have duties as well as rights. Hans Küng also showed that there is a great deal of commonality between the major world religions. This, too, offers us the hope and confidence that it is possible to make globalization work for the benefit of all.