Brazil Success and the Art of the Possible

Before I go any further, I should perhaps explain the reference to Bismarck for those of you impatient to know the thinking behind the slightly cryptic title of my talk – “Bismarck’s Warning: The Challenge of Economic Policy Reform in the Twenty-First Century”.

I am referring here to the German statesman’s assertion that, and I quote: politics is the art of the possible. I will elaborate further on how this relates to the issue of economic reform in due course.

In many respects, the global economic environment is unusually favorable at present. The prospects for global growth remain bright, after the best global growth performance in decades in 2004.

Thus far, the world economy has remained buoyant in spite of higher energy prices, geopolitical uncertainties and concern in some quarters about global imbalances.

There has been a remarkable absence, of late, of international financial crises.

This benign conjuncture might lead some to wonder why I choose now to talk about the challenge of economic reform. Why fix something that isn’t broken? And why address this topic in Ireland, of all places: a country where economic performance was described by the IMF’s own staff last year as “enviable”?

The answer is straightforward. Good times enable all to do better than in bad times: but the good times should be an opportunity for policymakers to press ahead with reforms that will permit their economies to grow more rapidly. If those opportunities aren’t seized, countries will not have the necessary resources to respond appropriately when the next downturn comes, nor grow as rapidly as they might during the upturn.

This evening I want to spell out the case for continuing economic reform across the globe; and to look at the challenges that policymakers face in seeking to introduce and implement reforms. I shall also say something about the role of the IMF in the context of economic reform.

The case for reform

Most economic reforms are intended to promote growth and improve citizens’ well-being. Economic growth permits rising living standards and poverty reduction. Arguing over how to cut the cake can never get us very far if we are serious about reducing poverty. Make the cake bigger is the only way of helping the poor over the longer term.

The postwar rise in living standards in the industrial countries was spectacular, and accompanied rates of GDP growth that then had no precedent. But the impressive rates of growth achieved in the US, Europe and Japan in the 1948-73 period started to look tame when countries like Korea took off. Over a period of four decades from the late 1950s, Korean growth performance was truly amazing, ensuring that Korea went from being one of the world’s poorest countries – and the third poorest in Asia – in 1960, to one of Asia’s richest economies today.

Other countries, especially in East and Southeast Asia did almost as well. More recently, the rapid growth rates experienced by China and India have seen large numbers of people – around 200 million during the 1990s – lifted out of poverty. Even countries whose economies did not grow as fast – Latin America, Turkey and others – did well.

Educational standards, infant mortality, life expectancy: on all these measures, people around the world, in both industrial and developing countries are better off than they were fifteen and fifty years ago. As developing countries have grown, the gap between life expectancy in the rich and the poor countries has narrowed, from about 30 years in the early 1950s, to around 10 years today.

Ireland has certainly experienced the benefits of economic growth – in a quite dramatic way. GDP growth was remarkable during the 1990s, averaging 10% a year between 1995 and 2000. As a result, per capita income rapidly caught up with the EU average, and unemployment fell from 16% in the early 1990s to 4% by the end of the decade. No wonder Ireland became known as the Celtic Tiger. And it is obvious to a first – time visitor like me that Dublin is a prosperous city in an increasingly prosperous country.

Continuing economic success requires continuing economic reform: this was true of America in the 19th and 20th centuries, and it is remains true of America in the 21st century. Those economies that have experienced rates of growth consistently above average are those where it is widely recognized that economies must continuously adapt, where policymakers and economic actors understand that the world economy is in a perpetual state of evolution.

This has become even more important as the pace of economic change accelerates – something with which all of you here are familiar. Indeed, I am reminded what Jonathan Swift, a member of this society in his time, once wrote, albeit in a different context:

“There is nothing in this world constant, but inconstancy.”

Rapid developments in transport, communications and technology have transformed our world. And they have permitted remarkable transformations of those economies that have been able to adapt to change and to exploit technological progress.

It is arguable that at least some of the improvement in global economic prospects and the apparently reduced vulnerability to shocks such as higher energy prices reflect significant improvements in macroeconomic management around the world. After all, economic performance has improved in almost every part of the world, including the dynamic economies of Asia and the low income countries in Africa and elsewhere.

But one of the most significant changes in recent years – perhaps the most important – lies closer to home. I am talking about the large and widespread reduction in inflation. Of course, the threat of rising inflation has not been eradicated. Monetary and macroeconomic policy must remain coherent and consistent to maintain price stability and so provide the right framework for the rapid sustainable economic growth that policymakers seek.

The return to something close to price stability has been a major achievement of economic policymakers because they implemented reforms – central bank independence, inflation targeting and other policy changes – that made possible the control of inflation. It is an achievement not to be underestimated and it is one for which policymakers can legitimately claim credit. It has directly resulted from steps taken in governments around the world to bring inflation under control.

One indicator of the extent of the turnaround in inflation performance is Latin America. For much of the 1980s and 1990s, average inflation in Latin America far exceeded 100%; at the end of the 1980s, it was almost 500%. Today, in Latin America, inflation rates in excess of 10% are very much the exception, and most countries in the region have rates of inflation well below that.

Reforms that deliver low inflation permit make it possible for countries to grow more rapidly than they otherwise could in good times and bad. The enormous progress made in bringing inflation under control around the globe was one reason why the global economy weathered the downturn of 2001-2002 more easily than has been the case in the past. The slowdown was more moderate, the recovery was more rapid and more buoyant than we have observed after some earlier worldwide downturns. There was a marked absence of international crises sparked off by the global recession. And the upturn has not so far been significantly interrupted by shocks such as rising oil prices or geopolitical tensions. For now, downside risks have not led to substantial downward revisions in growth expectations.

Reduced vulnerability, increased resilience, improving macroeconomic performance and, above all, more rapid growth are all welcome. The challenge now is to ensure that these improvements are preserved and how we can build on the progress achieved thus far.

Different countries at different stages of economic growth need to focus on the issues that matter most to them at the time. We can identify four categories of economic reforms: those needed at the international level, to maintain a global framework that fosters economic growth; those reforms that industrial countries need to undertake; those appropriate for emerging market economies; and those which need to be implemented in low income countries.

In the international sphere, we need to see policy reforms that will reduce global imbalances and policies that will make possible further trade liberalization. Industrial countries need to reform their pension systems to make them viable over the long term. Emerging market economies need to press ahead with fiscal and financial sector reforms that will deliver debt sustainability. And low income countries need to focus on issues like the rule of law, institutional and other reforms that will permit more rapid and sustainable growth.

I mentioned the striking economic achievements of the postwar era. Policy reforms at the national level were clearly central in determining the speed and sustainability of growth in individual countries. But the international environment also played a critical role, specifically the multilateral framework established at the Bretton Woods conference in New Hampshire in 1944 – when the International Monetary Fund and the World Bank were created. The founders of the postwar system recognized that international financial stability and the promotion of trade liberalization were essential pre-conditions for rapid sustainable growth – though I think even they would have been surprised by the growth performance achieved by many countries in the context of the rapid expansion of global trade, in the context of trade liberalization, that took place after the war ended.

The founders of the Bretton Woods were keenly aware of the damage that the economic policies of the inter-war years had inflicted on the global economy. Rising protectionism and the beggar-thy-neighbor policies pursued in the industrial countries had made the Depression worse and stifled growth in the industrial world. These policies had marked a reverse of the liberal policies of the nineteenth century that had enabled America and Europe to grow and prosper. One of the aims of Bretton Woods was to lock in progress and make a return to the damaging policies of the 1930s unthinkable.

But one lesson of the interwar years was, and is, that we can never take economic progress for granted. As we have seen time and again, protectionist pressures can undermine progress towards more open trade; and that, in turn, can undermine the prospects for global growth. Policymakers need to remain vigilant against such pressures.

That is why successful completion of the Doha round of trade negotiations, currently taking place under the auspices of the World Trade Organization, is so important. A Doha round agreement will lead to more rapid expansion of world trade and so boost global growth. And it will benefit developing countries, in particular. Estimates suggest that about two thirds of the benefits of a Doha agreement will go directly to developing countries. Much of that will result from developing countries liberalizing trade among themselves.

At the national level, too, the commitment to economic policy reform must be maintained and, in some cases, strengthened. Industrial economies need to adapt to the ever-changing world economy. They may be more robust than emerging market or low income countries, but they still face important challenges, not the least of which is the demographic changes that many of them are experiencing as their populations age. That is why ensuring that pension systems are viable into the future is important, and urgent.

Emerging market economies have, in most cases, experienced more rapid growth during the latest upturn; there have been some improvements in their debt position. But many of them remain vulnerable in the event of a sharp rise in global interest rates or other shocks which could undermine their growth prospects.

And there is an urgent need for further reform in low income countries if they are to achieve the more rapid growth they so badly need. For many, especially in sub-Saharan Africa, the improvement recorded over a relatively short time is welcome. But growth is not yet rapid enough to make attainment of the Millennium Development Goals likely. Reforms aimed at improving the rule of law, strengthening public institutions, combating corruption, make public expenditure more efficient and more effective – all these are part of the necessary groundwork to make more rapid growth possible.

Wise, and experienced, policymakers know that there will always be new challenges to face, new obstacles to overcome. Alas, we are not yet able – and are never likely to be able – to predict what many of those challenges will be, nor from whence they will come.

Of course, growth itself presents new challenges – which is why economic reform must be an ongoing process if rapid sustainable growth is to be maintained.

Take the so-called Asian Tiger economies. They did reform extensively in the 1960s, 1970s, 1980s, and in the early1990s. In that period, these economies had enviably high growth rates, sustained over many years. Their economies were transformed, living standards rose, poverty fell.

The Asian financial crisis of 1997-98 came as a tremendous shock to these successful countries. Even when the GDP of most economies had recovered to pre-crisis levels and growth had resumed – which happened rapidly in most cases, incidentally – the psychological scars remained.

With hindsight it was clear that policymakers in those countries had, in a sense, been victims of their economic success. As an economy grows rapidly, the financial sector becomes more important, and in many of these countries, credit rationing had undermined the efficient allocation of credit. This lowered the average rate of return on capital and, in turn, the rate of economic growth. Mis-directed lending resulted in many borrowers being unable to repay their loans, resulting in a sharp rise in the number of non-performing loans. These undermined the health of the financial system.

Once the international capital markets recognized that credit had been misallocated, with the consequent reduction in growth performance, it was inevitable that they would reassess the risks involved in lending to countries whose fundamentals were less sound than they had previously appeared.

As investor sentiment shifted, several factors conspired to make the situation worse. Fixed exchange rates compounded the problem. Poor regulation of the banking and financial sector in many countries had enabled banks to build up liabilities in one currency and assets in another. Government assurances that exchange rate pegs would be sustained left currency mismatches unrecognized. Devaluation then left financial institutions facing massive losses, or insolvency. Domestic banking systems were revealed to be weak.

The contraction in GDP that most crisis countries experienced as a result of the crisis made things even worse, of course, because the number, and size, of non-performing loans grew rapidly. That inevitably had adverse consequences for the economies a whole. In short, the crisis economies found themselves in a vicious downward spiral.

The rewards of reform

Economic success doesn’t grow on trees. Sound policies are easier to pursue when the global environment is benign. But a favorable global environment, or an improvement in the terms of trade arising from higher commodity prices, cannot be a substitute for sound policies. By sound policies I mean those that promote macroeconomic stability: prudent fiscal and monetary policy, the pursuit of low inflation, sustainable public debt levels, flexible labor markets, and a healthy and well-regulated financial sector.

I also mean policies that some of us can take for granted: the respect of law, property rights, effective, well-functioning public institutions, an economic environment that fosters competition and enterprise and enables actors to participate in the global economy. Citizens and economic actors in many parts of the world live in societies where property rights are ignored, public institutions are corrupt or poorly-functioning and where competition and the rule of law are alien concepts. So the ordering of policy reform priorities will depend on an individual country’s needs.

Sound policies bring considerable rewards. The spectacular rise in living standards in industrial countries over the past 60 years is evidence of that – of course. But the industrial countries prospered in the nineteenth century too because policymakers accepted the need to ensure that economies could adapt to the consequences of the industrial revolution.

As I noted at the outset, policy reform has to be an ongoing process even for the world’s rich countries. In recent years, industrial countries have had to focus on issues of corporate governance, financial regulation and pension reform: in some cases that focus has been the consequence of revealed shortcomings in existing policy frameworks: the BCCI case in Britain, Enron and World Com in America, are just a few of the more well-known examples. Looking ahead, the advanced economies need to become more flexible and more competitive if they are to withstand the pressures of demographic change that will see a rapidly rising ratio of retired people to workers over the next decade or two.

Even the better-performing countries have to press ahead with reforms – witness the current debate on social security reform in the US, for example. Or look at Britain – where recent growth performance has surpassed most of Europe since the introduction of successful counter – inflationary policy in the early 1990s and more recent economic reforms. In economic policy, though, resting on one’s laurels is not an option, if success is to be maintained. Britain faces fresh reform challenges in the public services and social insurance areas if the recent growth record is to be maintained

In Ireland, too, there will always be more to be done. Market – oriented reforms explain much of Ireland’s transformation. But the rapidly evolving global economy only increases the importance of further reforms. There are signs, for instance, that competitiveness may have deteriorated; there are still large infrastructure needs; and demand for high-quality public services is growing.

There is abundant evidence of the dangers of half-hearted reform, some of it only a few hundred miles from where we are. Ireland and Britain have experienced strong performance. But the picture is very different in continental Europe: sluggish economic growth, sticky levels of inflation (very low, of course, but higher than it should be for current levels of economic growth), and a persistent failure to adopt effective structural reforms.

Reform efforts to improve labor market flexibility and other issues are now under way, notably in Germany and France. But there is much ground to make up. A decade ago, Britain was both poorer and smaller in terms of total GDP than Germany, France, or Italy. So much has the relative performance differed, that Britain will soon be larger even than Germany.

Developing country reform

Many developing countries have also been reaping the benefits of successfully-implemented reforms. Countries like Chile where reforms were introduced from the 1970s onwards (and have continued) have consistently out-performed countries where the reform process has been uneven at best.

I mentioned Korea’s remarkable success. This resulted from an ambitious reform process on which the then Korean government embarked in the late 1950s. Successive governments pursued economic growth with skill and an unusual degree of single-mindedness. Opening up the economy to trade, strong encouragement for exporting companies, prudent fiscal policies: unwavering commitment to widespread economic reforms resulted in rapidly rising living standards over more than four decades. China, India, Turkey and Brazil are other examples of countries where economic reforms have paid dividends.

And we have seen significant improvements in many parts of sub-Saharan Africa. Inflation has fallen, and the GDP growth rate has risen in countries that have introduced macroeconomic reform – though, as I said earlier, much more needs to be done if more rapid sustained growth is to be achieved.

Economically desirable, politically feasible

As a prerequisite for more rapid growth, countries need a sustainable macroeconomic framework. That means bringing public debt down to levels that can be serviced and that will not undermine economic stability. It means putting the public finances in order: reducing budget deficits and finding room to services debts, yes. But well-managed public finances also involve effective – and fairly administered – tax collection; efficient public spending that targets infrastructure needs and the poor, without subsidizing the better-off.

A sound macroeconomic framework also requires institutions that can administer laws fairly, that can enforce property rights, that don’t put unreasonable burdens on businesses that export, that encourage competition and enterprise. It means reducing trade restrictions, lowering or removing tariff and non-tariff barriers, encouraging foreign investment. It means developing a sound financial system, with well-capitalized and well-run banks that can allocate credit where it can be most efficiently used, rather than propping up badly run but politically well-connected companies. There has to be a level playing field, with a clear and balanced incentive structure, and microeconomic reforms that foster enterprise.

Simple to describe yes, in part because we have learned a great deal in recent years about what works, and about what measures are needed to create the conditions for rapid growth and so reduce poverty.

But not simple to implement, which is where the late Herr Bismarck comes in:because governments don’t have the luxury of pursuing reform without regard to the views of their citizens. Politics is the art of the possible. So governments have to create the conditions that make it possible for them to implement reforms.

The politician’s task – of reconciling the tensions between what is economically desirable and what is politically feasible – is made more difficult because of the problem of uncertainty. Uncertainty ex ante surrounds the outcome of the reform process. That is why it is difficult for the economist to give categorical answers to questions about the scope for adjustment in policy, and especially those relating to structural reforms that have a longer term payoff.

The authorities cannot know how much opposition there will be to reforms, and they cannot know how long it will take economic actors to recognize that the new policies are not quickly going to be reversed – and that there is therefore no point in betting on their reversal. Nor do the authorities know how long it will take speculative measures to subside, how rapidly actors will respond to changed incentive structures that will result from reforms.

And there is opposition from those who – often mistakenly – believe they will lose out from reforms because they see the prospect of jobs being lost without realizing that more rapid growth will create new jobs elsewhere in the economy.

Sometimes the opportunity to press ahead with reform arises accidentally. Past policy failures, sometimes coupled with external shocks, can lead to an economic or financial crisis. Reform is then inevitable, forced upon a government and its citizens by circumstances. The greater the policy failure – or the longer reform has been postponed – the higher will be the short-term price of ending the crisis, of putting the economy back on an even keel.

But it is not just a matter of introducing reforms. The reforms have to be the right ones, those that will deliver rapid sustainable growth. We can all think of countries where reforms have led to reduced or negative growth and falling living standards. Bad reforms can be even more harmful than no reforms.

Nevertheless, a crisis can represent an important opportunity for policymakers who seize it. I want to look at two recent examples of countries where in response to crises governments have introduced and remained committed to macroeconomic reform programs that have brought significant improvements in economic performance: Brazil and Turkey.

In the summer of 2002, as some of you may recall, Brazil was widely perceived as being on the brink of a major crisis. Increasing nervousness about the outcome of the presidential election in Brazil and speculation about the economic policies that might follow the election had undermined international confidence in the economy. Concern about the sustainability of Brazil’s very large public debt grew. The markets became increasingly nervous about whether a new government would maintain sound economic policies.

Underlying policies were, at the time, judged to be sound: Brazil had been through a major financial crisis only three years earlier, when the government had abandoned its fixed exchange rate regime and introduced wide-ranging reforms. The issue in 2002 was one of whether the commitment to those policy reforms would persist after elections in the fall of that year.

The crisis was eventually headed off with the help of the IMF. A Fund-supported economic policy program was agreed during the pre-election period: under this, there was a commitment to maintain the fiscal and monetary framework that had been established and that envisaged the gradual reduction of the country’s large debt burden. All three major Presidential candidates publicly undertook to maintain the policy framework should they win the election. In the context of the Fund program, this unusual solution rapidly reassured the financial markets.

Those of you who follow developments in Latin America will already know the outcome. The election victor was President da Silva – or President Lula as he is widely known: and he stuck firmly to his pre-election commitment. The result has been a remarkable transformation in Brazil’s economic fortunes. The floating exchange rate regime that had been introduced in 1999 has helped smooth the adjustment process. And prudent fiscal policies have paved the way for more rapid growth and falling inflation. The government’s primary surplus – that is, the budget surplus before the costs of debt interest payments are taken into account – was 4.6% in 2004. Growth accelerated to over 5% last year, and is expected to be around 4% this year. The inflation rate has fallen from 12.5% in 2002 to 7.6% at the end of last year and is targeted to be at 5.1% by the end of this year.

Last week, the government announced that it had decided not to renew its loan agreement, ending seven years of reliance on IMF support. But the government also insisted that it would stick with the policy framework that has delivered the very significant improvement in Brazil’s economic prospects.

Turkey, too, has benefited from recent and effective economic reforms. That country had experienced many years of stop-start reforms and a series of crises that arose because successive governments failed to stick with reform programs, or omitted certain key ingredients that would have made reforms more comprehensive and effective. Things came to a head at the end of the 1990s. An economic crisis that started in 1999 resulted in a banking crisis in 2000-2001 and then led to wholesale reforms. Here, too, the IMF played a role, supporting reforms with a Fund program. And in Turkey, just as in Brazil, a floating exchange rate has been an important factor in making rapid change possible. Successive governments have remained wholly committed to the reform program. And the result has been as striking as in the Brazilian case.

Strengthened fiscal policy has been critical in Turkey, providing the framework needed for rapid growth and falling inflation. The government’s primary surplus was almost 7% of GNP last year, a little above the government’s own target. Tightening fiscal policy has been accompanied by accelerating growth: 9.9% last year. Average growth over the past three years has been close to 8%.

The inflation record is, if anything, even more striking. Turkish inflation had been above 60% since the mid-1980s, and was 70% just three years ago. Today it is below 10% – the first time since the 1960s it has been in single digits.

The government has also embarked on important structural reforms, many aimed at strengthening the banking sector and the domestic financial system more generally.

Clearly much has been achieved. Just as in Brazil, the challenge now is to make these improvements durable. It is crucial for Turkey’s long-term prospects that the government perseveres with the current policy framework for several more years, so that the economy is on a sound footing. External debt, for example, is still relatively high, at 60% of GNP. And total public debt is nearly 70%. It is on a downward trend now, but a large part of the public debt is either indexed to foreign currencies or linked to very short term interest rates. That makes the repayment burden vulnerable to shifts in foreign exchange rates or global interest rate movements.

Why do I put so much emphasis on the need to press on with current policies? After all, the benefits obtained are tangible and visible. Growth has made possible rising living standards and poverty reduction. No one would want to see the prospects for poverty reduction diminished.

That much everyone can agree on. But as memories of crisis fade, the tensions between what is economically desirable and what is politically feasible become more apparent. Does it matter if a government’s fiscal policy is loosened slightly, perhaps to enable more infrastructure spending, or target more support for the poor? Would it be such a risk if inflation was allowed to edge up just a little? Would there be a crisis if the pace of public debt reduction was eased just a touch?

These are real questions that governments the world over face every day. If you are the Prime Minister of India, you will find yourself under intense pressure to alleviate poverty. If you are the French finance minister you will be faced with calls to do more – and those calls means spend more – to reduce unemployment. Every member of the US Congress could tell you why the fiscal deficit needs to be reduced – and why some favored spending program or other should be exempt from fiscal stringency. Governments with elections in the offing are particularly vulnerable to pressure from such lobbying.

It is not altogether surprising that when politicians are given nuanced answers by economists, they can find them less than helpful at times of great pressure.

And the difficulty, of course, is that the answer to any of those questions I posed a moment ago is probably no: no a slight up tick in inflation, a slowdown of debt repayment, a modest increase in government spending would not by themselves lead to crisis – provided the world economic outlook remains benign. And so, politically, they are more difficult to resist. But they leave economies exposed, with no safety margin come the next downturn – which will come, we just don’t know when – or in the face of shocks.

Sound policies are meant to provide increased resilience to the ups and downs of global economic activity; they are meant to reduce a country’s vulnerability to the unexpected and help it ride out downturns and shocks with less damaging loss of output. Relaxing policies undermines that objective and undermines the credibility of policymakers.

It also sends a signal of weak commitment. Remember that in the case of Brazil the markets grew nervous in 2002 not because anyone had done anything to alter current macroeconomic policies: no, crisis loomed because investors thought somebody might loosen policy at some point in the future. When the going gets tough, risk-averse investors get going.

These tensions extend to longer term structural reforms; indeed, it is arguable that they have more impact in this area of policy. The temptation for governments to postpone or weaken labor market reforms that will inevitably encounter opposition and take longer to bear fruit is understandably great. Yet labor market reforms are even more difficult to undertake in a downturn, when unemployment is high and rising – yet another reason why acting now, in the current global environment, makes sense.

It is the same with trade issues: giving in to protectionist pressure, or ducking the chance to undertake further trade liberalization, may prove irresistible to a government facing difficulties on other fronts. Often, postponing reductions in tariff and non-tariff barriers to head off political opposition might seem like the best course of action.

And governments frequently find it difficult to tackle financial sector reform. That can mean, among other things, forcing banks to deal with non-performing loans, which can in turn mean companies going out of businesses, voters losing their jobs – all in the name of reforms which don’t seem to have much in the way of a short – term political return. These reforms, too, are far more difficult to implement during a downturn.

Delayed or abandoned structural reforms do matter. They will certainly mean that other economic policies will be less effective: more reforms bring greater returns to all the reforms.

And failing to tackle structural problems will, ultimately, undermine attempts to create a stable macroeconomic framework because growth will slow. I mentioned the importance of financial sector reforms in the context of the Asian financial crisis. I could equally well have pointed to the sluggish economic performance Japan has experienced since the early 1990s, one factor in which has been the slow progress at tackling financial sector reform.

Low income countries in Africa and elsewhere could greatly enhance the payoffs from the fiscal and monetary reforms they have introduced by taking steps to enforce commercial codes, strengthen property rights and generally stimulate private enterprise. They would also benefit enormously from further opening up their economies to the rest of the world – and to each other. Developing countries impose higher tariffs on goods from other developing countries than those that the industrial countries impose on poor nations. And poor countries desperately need more rapid growth if they are to reduce poverty. By delaying structural reforms they are lowering the payoffs from the reforms they have introduced. But trade issues are often captured by special interests who represent a minority of citizens; and this is true as much if not more so in poor countries as it is in rich ones.


There is no way round the dilemma, alas. There is no easy way of resolving the competing needs of economic objectives and political constraints.

But there are some things we have learned at how best to keep these tensions to a minimum.

Perhaps the most important, certainly in the current context, is that reforms can be most easily introduced at times of rapid growth. That is why it is important for policymakers to seize the chance offered by the currently buoyant global environment. Fiscal consolidation is more easily and certainly more wisely tackled in a more favorable environment partly because it helps deliver future growth and partly because it gives governments scope for counter-cyclical policy come the next downturn. There is limited scope for expansionary fiscal policy in a downturn if policy was already expansionary in the upturn.

Ambition is also important. Roger Douglas was finance minister in New Zealand in the 1980s and a key figure in the sweeping reform program introduced by the Labor Government. He argued that reforms needed to be introduced on a broad front. That clearly brought results in New Zealand and in Korea; Chile’s experience also supports that thesis too.

Roger Douglas has also argued forcefully that speed is of the essence in introducing reforms – indeed, he argued that it is impossible to go too fast. In part he took this view because structural reforms in many cases take several years to implement and have their full impact.

Despite the reluctance of many politicians, experience shows that there are considerable advantages to pressing on with trade and exchange rate reforms as an early priority. The more rapidly an economy is opened up to the rest of the world, the better. This is partly because opening brings considerable economic benefits; but also because the more open the economy the more difficult it will be to reverse the reforms.

Identifying potential winners and enlisting their support can help reduce resistance. So too can identifying potential losers and seeking to minimize their opposition. But at times, political leaders need to be ready to confront their opponents. How this is done can be critical. In Britain, Margaret Thatcher successfully took on the miners in 1984 as part of her efforts to reform the coal industry and the labor markets: but the Heath government failed when it confronted the same group in 1973-74. Confronting opponents is partly a matter of picking fights that are winnable – and luck plays an important part here – and it is partly a matter of having the courage to see the battle through to the end.

Tackling even difficult reforms in a timely way can reduce their potential cost. Pension reforms will be much easier to implement now than later; because now, the longer term problem could be successfully tackled by relatively small adjustments in pension contributions, benefits and retirement ages. Such modest adjustments would be insufficient if governments put off change in this area until it is forced on them.

Effective reform also requires good communication, so that citizens know what the aims are and what the potential ramifications are. Transparency is also important because it is an important means of building support.

The IMF’s role

Reform is, in a very broad sense, the core business of the International Monetary Fund. The Fund’s principal objective, as it always has been, is the maintenance of international financial stability. That gives us an important role in crisis prevention and resolution. Article IV surveillance on our member countries provides an annual assessment of economic policies, along with recommendations for reform, as appropriate. This applies equally to the largest industrial economies, emerging market countries and the poorest countries.

The Fund’s role in the reform process under surveillance is an advisory one. This is partly in order to respect the sovereignty of member governments. But it also reflects the recognition that national policymakers are those who have to adopt reforms and try to ensure their success. It is they who have to determine what is possible.

The Fund also provides financial assistance to countries that need it when implementing reforms. The government puts together a reform program, with the advice and financial support of the Fund as appropriate. Payments are provided by the IMF in installments against agreed benchmarks. That the Fund endorses a reform program is often seen as an important signal by the financial markets.

The Fund can also assist countries who need technical assistance in implementing reforms. This can be more important than is often realized. On a wide range of policy issues, from tax administration to budget accounting, from financial sector regulation to the development of commercial codes, the Fund has amassed considerable expertise and experience that can benefit governments seeking advice on formulating and implement such measures. It is clear from the wide range of governments that seek technical assistance from the Fund that this expertise has become a valuable and valued resource.


Let me sum up briefly.

Economic policy reform is a necessary condition for sustained, rapid economic growth. Without continuing reforms, at the multilateral and national level, countries will experience slower growth than would otherwise be possible; and the world economy as a whole will also grow more slowly.

That said, policymakers have a choice. They can choose to duck difficult reform challenges; they can postpone or abandon reforms that encounter strong opposition. But there will always be a price to pay. In the short run that price may be marginally lower growth. In an economy performing well in a buoyant global environment that price might seem worth paying.

But delayed or abandoned reforms leave an economy unable to grow as rapidly as it otherwise would, and much less able to withstand the next downturn. Growth will be slower both in good times and the bad. The slowdown will be more severe and more costly than it need have been: costly in terms of a smaller or no rise in living standards, and in terms of less poverty reduction than would otherwise have been achievable. There is also likely to be a political cost, in terms of diminishing electoral support.

Conversely, the rewards of economic reforms are well worth having. They lead to higher sustainable growth rates than would otherwise be possible. They raise living standards, and reduce poverty. And as we have seen in Turkey, Brazil and, indeed, here in Ireland, the time lag before the payoff of reforms begins to show need not be long. Some reforms, such as those in the financial sector or in the labor market can take several years to work through. But better monetary policy and sound fiscal policies can have a more rapid impact on inflation and growth. Governments that have stuck with sound policies and persisted with reforms have often enjoyed political success as a result.

And success breeds success. The more benefits that economic reforms deliver, the easier it will be for policymakers to introduce further reforms that will, in turn, bring yet higher returns. Bismarck’s assertion is undoubtedly true: politics is the art of the possible. But the steadfast pursuit of economic reforms can alter what is possible: and in so doing, remove yet another excuse for policymakers to postpone reform, with the inevitable, and negative, consequences for their citizens.

Thank you.

Anne O. Krueger is the First Deputy Managing Director of the International Monetary Fund. The text above was her lecture at the University Philosophical Society of Trinity College, in Dublin, on April 5, 2005



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