TWN Info Service on Finance and Development (Oct12/06)
19 October 2012
Third World Network

Clash of views on austerity between IMF Chief and German Finance Minister at recent IMF-World Bank meetings

Bhumika Muchhala (Tokyo) - The Annual Meetings of the International Monetary Fund (IMF) and World Bank last week was held in Tokyo after initial plans to hold the meeting in Cairo had to be cancelled due to the political revolution in Egypt.

Although the Board of Governors (composed of member country Finance Ministers and Central Bank Governors) convened through high-level meetings and press conferences on major global economic and financial policy issues, the conclusion of the meetings were relatively unfruitful in terms of moving forward on key issues of governance reform in the IMF and World Bank, and in terms of deciding on any concrete policy actions, particularly in Europe and the US, towards a genuine economic recovery.

Developing countries Finance Ministers and Central Bank officials voiced their primary concern on the failure of developed countries to address economic recession, indebtedness and unemployment in their countries. Developing countries identified policy uncertainty, particularly in the Euro area, as the key factor impeding the restoration of confidence in the global economy. They stated their worry that problems in both Europe and the US are worsening and significantly affecting developing countries, particularly through the trade channel.

Developed countries Finance Ministers and Central Bank officials voiced concerns on the spillover effects of policies adopted by some developed countries, particularly their provision of huge volumes of credit. The US “fiscal cliff” is a looming threat as is the continuing European debt crisis and related banking problems.

A highlight of the meeting was the debate over austerity policy between IMF chief Christine Lagarde and German Finance Minister Wolfgang Schäuble at a BBC World Debate on Friday 12 October that also featured Raghuram Rajan, Chief Economic Advisor in the Indian Ministry of Finance and Peter Orszag, Vice Chairman of Global Banking in Citigroup.

The overwhelming consensus at the debate was that the global economy is hurting from an excessive emphasis on austerity in the wake of the financial crisis, leading to prolonged recession and persistent employment. Lagarde from the IMF, Rajan from the Indian Finance Ministry and Orszag from Citigroup all stressed the need to temper fiscal adjustment measures with strategic spending measures, such as automatic stabilisers, that will boost employment and economic growth.

However, German Finance Minister Schäuble stuck to the German policy stance for continued austerity measures, contending that in order to build confidence it’s necessary to cut deficits in the context of high sovereign debt in advanced economies.

Lagarde called for a “brake on austerity,” saying that as a result of the IMF’s reassessment of the damaging impact of fiscal consolidation on output (in the IMF’s bi-annual World Economic Report, released in late September), “eurozone countries should not blindly stick to tough budget deficit targets if growth weakens.” She also said that “automatic stabilizers” should kick in, such as higher welfare spending, unemployment insurance and pension benefits.

The IMF’s latest World Economic Outlook (WEO) report cuts the global growth forecast for 2012 to 3.3% (from 3.8% in 2011 and 5.1% in 2010), and shows increasing concern on the impact of government cutbacks on growth. However, an important caveat is that the forecast of 3.3% presumes that the US and Europe will make progress on resolving their problems in economic policymaking to address their recessionary economies, high debt and deficit levels and persistent unemployment.

While the WEO does not admonish against austerity, it argues that other policies are also needed, as “austerity alone cannot treat the economic malaise in the major advanced economies.” Macroeconomic policies must also address the “fundamental problems,” such as weak households in the US and weak sovereigns in the euro area. A “temperate approach to fiscal restraint” is thus called for in the WEO report.

At the BBC televised panel event, Lagarde said that governments around the world had systematically underestimated the damage done to growth by austerity. Lagarde clarified that the IMF has, since the onset of the crisis in late 2007, held a consistent position that adjustment, or fiscal consolidation, is necessary, but that it is a matter of pace and degree, and that adjustment is country-specific.

“There is no silver bullet,” she said, “Every country has a different situation in the market and needs a nuanced and tailored policy mix, including structural reforms to improve productivity and in some cases accommodative monetary policy.” She emphasised that adjustment is needed, but that “the burden of debt currently laying on the shoulders of developed countries is not sustainable. The adjustment process will take time. It’s a marathon, not a sprint.”

On Greece, Lagarde said that the government should be given two additional years to meet the drastic budget reduction targets that had been imposed by its “troika” creditors (the EU, the European Central Bank and the IMF itself). She noted that Greece had “adjusted 14% of its deficit, which is huge.” Given the lack of growth and the market pressure, a bit more time is necessary.

Lagarde also emphasised that advanced economy “authorities need to give the world a feeling of certainty and confidence, and this will require the US to address its deficit and burden of debt and for Europe to address its banking problems and fiscal union.”

On the unemployment crisis, Lagarde stressed that “if people stay away from the job market, they lose their skills and they lose their hope. They may not be able to go back to the job market and that will create major rifts.” She said it is important to maintain fiscal policies with an emphasis on investing into programmes and sectors where skills and training are needed.

The response from the German Finance Minister, Wolfgang Schäuble, was a strong reproach, stating that Germany sticks to its requirement that Greece fulfill the targets on time as a condition for further loans. “Our position on Greece is that we first have to know what the final outcome of the Troika report is. The situation of Greece is very unique, there is nothing comparable in Europe, and last year we decided on a very ambitious programme for Greece, even more ambitious than that of the IMF. But Greece had new elections twice, and lost a lot of time.”

He also said Lagarde contradicts the IMF’s historical stance for austerity, noting that the IMF has “time and again” warned that high debt levels threaten economic growth, and that markets have also determined sovereign debt as a major risk. He said, “When there is a certain medium-term goal, it doesn't build confidence when one starts by going in a different direction.”

Schäuble reminded the audience that the international community had agreed in the aftermath of the Lehman crisis in 2008 that advanced economies will have to halve their deficits in three years. “And the Eurozone as a whole has indeed halved their deficit from 6.4% in 2009 to 3.2% in 2012,” he said, adding that “If policymakers decide on economic policies on the basis of protests, sustainable policy will never be reached. A sustainable fiscal policy is a precondition for sustainable growth, and people want medium-term sustainable growth because that is eventually the best way to create jobs.”

Public spending and other fiscal policies can often be “soothing but toxic remedies,” he said, stressing that one of the key solutions to the jobs crisis worldwide is to increase competitiveness in the context of the downward push on wages across all countries.

Raghuram Rajan, Chief Economic Advisor in the Indian Ministry of Finance, re-routed the focus of the debate back to some core issues. “Cyclical problems are overlaid on structural problems in Europe, and it must be remembered that even before the crisis peripheral Europe had very high levels of unemployment and the whole of Europe had very high levels of debt. We need to stop confusing cyclical problems for structural problems while still addressing how to deal with both at the same time,” said Rajan, adding that “policy decisions need to stop being reduced to austerity versus growth cliches.”

He pointed out that the real issue right now in terms of solutions is a question of who bears the costs? “Are we going to change property rights on pensioners, on shareholders or on savers? These are immensely important decisions that determine the attitudes of countries for a long time. The different attitudes of central banks in US and in the European Central Bank are derived from their national experiences during the Depression”

On the jobs crisis, Rajan said that debt-fuelled growth created a situation where the jobs created didn’t match the skills of the population. In the US, the manufacturing decline occurred in places where people were skilled in construction. In those particular areas, new jobs will not be in the construction sector and people don’t yet have the skills training for those new job sectors.

On austerity, Rajan clarified that when countries are in deep trouble and there is a lack of credibility in the market, austerity can’t be postponed without new financing. And there is a point beyond which if further spending is cut, the results are “extremely destructive in the short-run.” He said that the key question is “can the government take the political heat when they cut spending?”

On Greece, Rajan said that the international community “must recognize that the political capacity to deliver has come a long way, but there’s only so much that can be asked of a country. There needs to be more realistic expectations about what Greece is capable of. The task of the multilateral institutions is to assess that realistic capability – that this is the feasible debt limit that Greece can obtain.”

Rajan concluded by saying, “I fear very much that pushing Greece beyond a certain point can create a public reaction that we really don’t want in Europe.”

Peter Orszag, Vice Chairman of Global Banking in Citigroup, argued that there is a real question of whether fiscal consolidation should be implemented now. “For most countries it’s better to combine some immediate deficit reduction with spending for growth recovery,” he said, adding that “the right approach is the coupling of additional stimulus with medium-term fiscal consolidation.”

Orszag further emphasised that an additional round of fiscal stimuli right now would help to create jobs in the short-run.

Orszag also said that the IMF and Lagarde have accurately characterised the sluggish nature of the world economy, which cannot sustain the employment boost that is needed for recovery.

“There are two key risks, one, a real danger of people losing their attachment in the workforce, which makes it hard for them to become permanently employable. The second risk is that of a very rapid increase in sovereign debt. The duality of these problems necessitates a duality of response,” said Orszag. +