Professor at the University of Waterloo’s Balsillie School of International Affairs and a CIGI senior fellow
At the IMF-World Bank Annual Meetings in Tokyo this month, participants from the private and public financial sector gathered to assess the state of the world economy. With the Great Recession still fresh on everyone’s minds and the speed of economic recovery barely making the kind of positive impact that could be felt on Main Street, the mood was sombre and pensive. As the head of the International Monetary Fund, all eyes were on Christine Lagarde to guide the global recovery.
At the core of the Ms. Lagarde’s global recovery plan is the need to foster deeper global policy coordination within what is an increasingly multipolar and heterogeneous economic order. The IMF is needed to synchronize the recovery strategies of key global economic powers, while warning of and preventing any unintended consequences. These are not easy challenges for Lagarde to navigate, but in her words: “A world that is bound together must be a world that works together – a world that… ‘has not been broken up into fragments by narrow domestic walls’.”
Japan and the United States need to act swiftly to craft and implement credible, medium-term fiscal consolidation programs. Not a small task when the political systems in both countries are being held captive to divergent domestic interests and political squabbling has lead to decision-making paralysis. Christine Lagarde has criticized the significant negative spillover effects such inaction has on economic growth – particularly for low income countries.
Another issue of great concern to Lagarde is – of course - the eurozone. European leaders must move beyond a piecemeal approach to dealing with the euro crisis. This will require moving forcefully ahead with designing a genuine banking union, completing the long-overdue cleanup of the common currency zone’s financial system through direct bank recapitalizations, and finding a politically acceptable avenue for troubled countries to apply to the ECB’s OMT program. The political cost of this to sovereignty is high, but these are costs that Lagarde understands well, having once served as the finance minister of France. The alternative to further institutional consolidation is an unravelling of the eurozone that could trigger another “Lehman moment” in global financial markets. The challenge is for politicians to make the kinds of sacrifices needed to get the eurozone on the right track. The IMF must not let dogmatic policy inclinations trump sound – and from a social stability standpoint, realistic – structural economic reform and fiscal consolidation programs.
Ms. Lagarde’s statements indicate that she is committed to this path. She recently said: “Advice is sometimes difficult – both giving and receiving! Over the past year, we made a number of big judgment calls – some controversial. The call to recapitalize European banks; the call for a larger European financial firewall; the call for a more balanced approach to fiscal adjustment; and, the call for urgent attention to the fiscal cliff. These were tough calls, but it is our job to make them – to be an objective, independent arbiter of economic issues, especially during hard times.” The highly public disputes between Lagarde and senior German officials over the need to ease the path of fiscal adjustment in certain periphery eurozone countries (which IMF research now suggests has been subject to significantly larger multipliers than previously believed), highlight the difficult role that the IMF must play.
While growth rates in advanced economies have stagnated over the past few years, emerging markets economies, especially those in Asia, continue to grow. The prosperity of emerging market economies, however, will not continue if solely tied to growth in advanced economies. Rebalancing away from heavy reliance on external demand and government-led investment binges is necessary if emerging market economies are to sustain their positive growth patterns. There are potential political costs, however, to implementing reforms to boost private consumption. For countries like China, the fear is that such reforms will also raise political expectations, exacerbate socioeconomic divisions, and ultimately challenge the Communist Party’s authority. Domestic rebalancing also is certain to meet staunch backlash from entrenched interests in China’s powerful export-oriented industries.
Not to be forgotten is the challenge faced by low income countries, which remain highly exposed to negative terms-of-trade shocks – many of which are spillovers from the recent deterioration in global economic growth. The IMF has signed dozens of concessional lending agreements with these countries over the past four years. Lagarde has worked to convince the executive board to approve precautionary financing packages that would provide additional support should it become warranted. Under Lagarde’s watch, IMF staff have also prioritized the term “inclusive growth.” The IMF now admits that “...research tells us that less inequality is associated with greater macroeconomic stability and more sustainable growth. This has profound policy implications.” For those of us who have followed the IMF closely for the past decades, it is hard to overstate the extent of this paradigm shift – even if the IMF itself will not openly attest to this.
The IMF is also not without its fair share of criticism. A few years ago, policymakers called the organization irrelevant. It was strapped for financial resources and unable to find members who wanted funding, its advice despised. The international financial crisis has given the IMF’s a renewed sense of purpose. But it still must do more to earn its members’ trust. Indeed, global policy coordination requires it. Lagarde has worked feverishly to do just that. Some of this has come through a series of negotiated governance reforms aimed at increasing the voice and representation of dynamic emerging economies in the Fund’s key decision making bodies. Lagarde has also worked towards achieving the long-term goal of transforming the IMF into a genuine global lender of last resort, with considerable success.
The IMF has a difficult mandate at time when the world economy rests precariously between recession and recovery for the second time in four years. For the organization to successfully guide the global economy away from the abyss, it must be viewed as a trusted advisor and independent interlocutor; as an institution capable of providing strong surveillance and “speaking truth to power” when global growth and stability requires it. The changing power distribution of the global economy – from the “West to the Rest” – will place an even greater premium on economic policy coordination. A sustained global recovery will require the IMF to succeed in recapturing the spirit of shared fate and cooperation that allowed global leaders to prevent a repeat of the Great Depression. These tasks fall on the shoulders of the IMF Managing Director, Christine Lagarde.