It is my great pleasure to be back at the Monetary Authority of Singapore. When I was last here, in November 2009, the global economy was tentatively emerging from the Great Recession. Today, growth is recovering across the world. The IMF’s latest forecast, released just last week, is for global growth of 4½ percent this year. This is higher than the average over the last decade, and an upgrade from our October WEO forecast.
But while the recovery is underway, it is not the recovery we wanted. It is a recovery beset by tensions and strains—which could even sow the seeds of the next crisis. I see two dangerous imbalances:
First, the recovery is unbalanced across countries. While growth remains below potential in the advanced economies, emerging and developing economies are growing much faster—and some may soon be overheating.
Second, the recovery is unbalanced within countries. Global unemployment remains at record highs, with widening income inequality adding to social strains.
In my view, we will only get the recovery right if we take a holistic approach to managing the economy—one that focuses not only on standard macroeconomic and financial policies, but also on job creation and social protection. Because without jobs and income security, there can be no rebound in domestic demand—and ultimately, no sustainable recovery.
The two-speed recovery
Let me begin with how the recovery is proceeding at the global level.
In the advanced economies, we are expecting subdued growth of 2½ percent in 2011, with high unemployment and household debt weighing on demand. In the emerging and developing economies, we are forecasting much faster growth of 6½ percent—with Asia (excluding Japan) expected to grow by 8½ percent.
Looking more closely, we see a worrying development: the pre-crisis pattern of global imbalances is re-emerging. Growth in economies with large external deficits, like the U.S., is still being driven by domestic demand. And growth in economies with large external surpluses, like China and Germany, is still being powered by exports. As the IMF warned in the years leading up to the crisis—and as the G-20 has emphasized—these global imbalances put the sustainability of the recovery at risk.
The “global growth gap” is also straining the recovery in other ways. Energy prices are rising swiftly, reflecting rapid growth in the emerging economies. Food prices are rising too—though here supply shocks are the main reason—with potentially devastating consequences for low-income countries. Together, these prices increase are beginning to feed into headline inflation. Large and volatile capital flows to emerging economies is another challenging development. They are complicating macroeconomic management and in some cases raising concerns about financial stability.
How best to re-balance the recovery? The priorities are by now well-known.
In the advanced economies, the key is to promote growth and job creation. While structural reforms are essential to make these economies more competitive, these reforms are only likely to pay off over time. So what can be done to improve the short term? The most urgent task is to repair and reform financial sector, to reduce risk and pave the way for healthy credit growth.
Restoring fiscal sustainability is another top priority for the advanced economies. The average public debt to GDP ratio is set to exceed 100 percent of GDP this year—and will rise even higher in the absence of medium term adjustment. This could have worrying implications for global growth and even for financial market stability. Where the recovery is strengthening, countries should move quickly to formulate and implement credible medium-term fiscal consolidation plans. In some other countries, consolidation has to go even faster.
At the same time, monetary policy in the advanced economies should remain supportive. As long as inflation expectations are well anchored and unemployment stays high, this is the right policy from a domestic perspective. The accommodative stance in the U.S. has contributed to a welcome decline in long-term rates, while so far having only a limited effect on capital flows to emerging markets.
Turning to the emerging economies more specifically, it is impressive just how well they have weathered the crisis—especially here in Asia. This reflects the wide-ranging financial and structural reforms that many of these countries adopted in the years before the crisis. Indeed, one of the main objectives of the conference that the IMF and the Government of Korea hosted last summer was to see what lessons other countries could learn from Asia’s resilience to the crisis.
But there are also some clouds on the horizon. There are risks of overheating, and even a hard landing. This means that macroeconomic policies should be tightened in countries where output gaps have nearly closed, or have in fact already closed. In Asia, recent rate actions were the right decision—though more may be needed.
Let’s turn to one of the most recent features: the surge in capital inflows. First, macroeconomic adjustment would help offset the impact of sizeable capital inflows. Where these inflows raise financial stability concerns, macroprudential policies can also help. These might include measures to slow the rise of property prices, or tighten standards for exposure to foreign currency borrowing. In some cases, going back to capital controls may be of temporary use. But they should not be a substitute for necessary macroeconomic and macroprudential policies. Another important element is to deepen financial and capital markets. This makes it easier, and less risky, to absorb capital flows. Over the coming decades, many emerging economies—including several in Asia—face tremendous investment needs, in particular in infrastructure. Foreign investment can play a critical role in plugging the financing gap.
Now the most important question is to deal with the recurrent problem of some countries' large external surpluses. Acknowledging that it will take time to adjust and taking a longer view, it is clear for me that emerging economies with large surpluses need to diversify the drivers of growth. This is well understood in Asia, and especially in China, where policymakers are taking steps to bolster domestic demand. Exchange rate adjustment will obviously have to play an important role—which is why it should not be resisted. Holding back such adjustment in one country also makes it harder, and more costly, for other countries to let their exchange rate adjust. For this adjustment to take place, time is of the essence, but asking for time only makes sense if there is a significant and regular move in the right direction.
Unemployment and income inequality
Let me now turn to the second imbalance, which occurs within countries: high unemployment and rising income and wealth inequalities.
The sharp rise in global unemployment is a major social problem. If you lose your job, you are likely to suffer from poorer health and shorter life expectancy, and your children are likely to perform worse in school. And where people are without hope of finding a job, society as a whole suffers—which in turn can threaten political stability.
But unemployment is also a major economic problem. The need for action to overcome the jobs crisis was the central message of President Obama’s State of the Union address last week. It was also a strong undercurrent of the political turmoil in Tunisia, and of rising social strains in other countries.
Over the next decade, as 400 million young people join the labor force, the world faces a daunting employment challenge. Indeed, we face the prospect of a “lost generation” of young people, destined to suffer their whole lives from worse employment and social conditions. Creating jobs must be a top priority not only in the advanced economies, but also in many poorer countries.
Income inequality is also something that touches countries at all stages of development. In the U.S., for example, income inequality before the crisis was back to levels not seen since 1929—right before the Great Depression. But income inequality matters for emerging and developing economies too.
Here in Asia, there have been remarkable social advances over the last decades, with over half a billion people lifted out of poverty. At the same time, income inequality has been on the rise. The leaders of China and India have put tackling income and wealth disparities high on their policy agendas. And even in a wealthy nation like Singapore, Prime Minister Lee has noted that the widening income gap is an issue of national concern.
There are abundant social and ethical reasons why we should care about income inequality. But there are also important macroeconomic reasons.
Inequality can dampen economic opportunity, since the poor have less access to credit. It can divert people toward unproductive activities. It can also make countries more prone to shocks—where fewer people have savings for a rainy day, more will suffer when the storm hits. Inequality can even make it harder to recover from shocks: more equal societies tend to grow for longer.
How best to respond to these challenges?
In countries facing high joblessness, well-designed unemployment schemes, social assistance and public work programs effectively prevent long-term unemployment and help shorten recovery from recession. Adequate social protection, drawing on a basic social protection floor as proposed by the ILO, can protect the most vulnerable from the brunt of the crisis. As fiscal consolidation gets underway in the advanced economies, we must also ensure that fiscal policy remains as job-friendly as possible.
Over the long haul, the most effective way to promote income growth at the lower end of the distribution is to invest in education, innovation, and ramping up the skills of workers. The 21st century economy is ultimately a knowledge economy, where returns to education are tremendously important. We must give people everywhere the tools they need to prosper in the highly competitive global economy of today.
Supporting a better recovery—the role of international institutions
As governments take on these challenges, international cooperation will be essential to find solutions with a lasting impact.
To achieve more balanced global growth, the world’s largest economies—under the auspices of the G-20—have created an historic framework for policy coordination. Through the so-called Mutual Assessment Process, the G-20 countries are being held accountable—to each other—for adopting the policies needed to achieve strong, stable and balanced global growth.
At the request of the G-20, the IMF is lending critical technical support to this important initiative. More broadly, surveillance of our members’ economic and financial policies—and the impact of the interlinkages and spillovers between economies—lie at the heart of the IMF’s mandate. Building a more stable international monetary system is also part of the solution and features prominently in the IMF’s work program. We must gain a better understanding of what drives capital flows and commodity prices, and strengthen the global financial safety net. It will certainly be helpful that these issues are also a key focus for the G-20 this year.
Turning to jobs and social conditions, international cooperation on these issues has increased markedly in the wake of the crisis, and has become a core element of the G-20’s work program. At the IMF, we are moving the agenda forward at the global level through events like the joint IMF-ILO conference in Oslo. And at the national level, we are keeping the focus on fighting unemployment and protecting the poor through our close dialogue with national trade unions and civil society.
For international policy coordination efforts to be successful, we need a system of global governance that reflects the balance of global economic power. Specifically, we need a system in which Asia is given a role in keeping with its large—and growing—economic weight. Of course, with a greater role also comes greater responsibility—and the world is looking to Asia to take on a new leadership role in helping to resolve the world’s problems.
Historic governance reforms at the IMF are changing the way countries work together. Once the most recent reform package is implemented, we will at last have an IMF that reflects the economic realities of the world today. We look forward to continuing our vital partnership with Asia—and with all our members—in this new, 21st century IMF.
Let me conclude.
There are no easy solutions to the challenges I have discussed today and there are no domestic solutions to these challenges. But if we ignore these challenges—or take them only lightly—we face risks far greater than the recovery running out of steam. As tensions between countries increase, we could see rising protectionism—of trade and of finance. And as tensions within countries increase, we could see rising social and political instability within nations—even war.
I am worried about the momentum of global cooperation. But I am confident that by working together—across countries, and across segments of society—we can overcome the challenges and build a stronger, fairer, and ultimately more successful global economy. Together, we can build a better recovery. And Asia, as one of the leading economic regions of the world, will play an essential role in achieving this goal.