Increased infrastructure investment and global trade liberalisation to push up global GDP growth by an extra 2% over five years is on the agenda of the G20 meeting in Brisbane. Issues such as the International Monetary Fund (IMF) quota and governance reforms as well as better coordinated risk management and regulation to avoid another financial crisis will also be discussed. The First Deputy Managing Director of the IMF, David Lipton, in an interaction with Arun S, shares why the global body is pinning hopes on higher public investment in infrastructure as a measure to boost growth even in the face of possible increases in interest rates in key regions. He talks about the IMF’s efforts to persuade the US Congress to ensure that the reforms of the institution are not delayed any further.
What is your assessment of the global recovery efforts?
We (the IMF) are realistic about the prospects of growth and the risks. We have talked about the risks, including the financial risks that come from unconventional monetary policies, the risks that come from shadow banking (including the non-banking finance companies) and the risks that come from a range of geopolitical events happening at the same time. During the recent (IMF/World Bank Group) annual meetings, there was an agreement on diagnosis. But there were differences on prescriptions—which is whether the risks in the financial markets warrant an adjustment of monetary policy or an application of macro-prudential structural policy.
What is important is if largely untested macro-prudential policies could now be effective and if monetary policy (raising interest rates) will serve the purpose of diminishing the risks. In practice, high interest rates will increase the weight of indebtedness and the debt service of countries with very high debt burden like some in Europe.
Our opinion is that the first line of defence for financial stability should be macro-prudential policies. Monetary policy should be used to achieve monetary policy objectives—meaning whatever that country’s central bank mandate is, which is to get inflation to the right level, and in the case of the US Federal Reserve and some others, to meet their objectives with respect to growth and employment.
IMF has recommended greater public investment in infrastructure to boost growth. What is the rationale behind this?
There are three channels that countries seeking growth must consider: (1) raising demand, (2) structural reforms to raise potential growth and eventually raise supply, and (3) rebalancing. Infrastructure, for sure, raises supply. When you put in more public capital in place, you raise more supply and output, and you provide infrastructure that raises the profitability of the companies that use this infrastructure.
When you build the infrastructure you also raise demand. So it works in two of the channels. In countries that have economic slack and unemployment, the demand effect of building infrastructure may lead to a substantial increase in output that sustains for a long time. Given that right now interest rates are low, it may be that the benefits of higher growth are stronger than the costs of higher debt.
The debt-to-GDP ratio is debt divided by GDP. The debt goes up because you borrow to build an infrastructure project. But the growth that results from it will be higher. So if the denominator goes up more than the numerator, the debt-to-GDP ratio goes down. In case of countries with a lot of slack, it seems quite clear that the debt-to-GDP ratio will go down and not up. It stimulates demand and supply.
Emerging market economies (EMEs) and developing countries have an obvious need for infrastructure. It is not a cyclical need but the countries are going to have a rapid growth and living standards converging to those of the richer countries, and for that they need to have modern infrastructure. The G20 has spent the whole year looking at how there can be more robust infrastructure programme in the developing countries and EMEs. There may be some circumstances where it is the other way around. But what we find is that for most countries at worst it doesn’t go up.
Why didn’t the IMF prescribe this a few years ago when a low interest rate regime kept the cost of infra projects low?
That was the period when the concern over high deficits and rising debt-to-GDP ratios was elevated and the focus of the G20 countries was on bringing fiscal deficits down and getting countries on a trajectory where their debt-to-GDP ratio would not explode. There were advanced economies that had very large deficits and rapidly raising debt-to-GDP ratios. That is still the case in some parts. But for most parts deficits have been brought down by a large margin. It is natural for the focus to shift to getting growth going and asking how much room is there to do this safely. There are many issues here: what projects to select, are they carried out efficiently, is financing cheap, is there enough slack in the economy that you get a strong demand effect? We don’t mean to suggest it is simple.
But it is promising enough that the international community should be looking at the subject as a possible area to take action to boost growth. In fact, we started and the G20 picked up an initiative this year to try to raise growth by two percentage points over five years. There are now 900-odd policy measures, including many on infrastructure that countries are committed to. Countries are actually doing it. We are just trying to put forward the analysis that provides the right rationale for doing it and urge that others would get it as well.
The US Congress is yet to adopt a measure required for the US to ratify the 2010 Quota and Governance Reforms. If the Congress does not adopt it by this year-end, do you have a plan B in mind?
These (the reforms) are very important to our institution and to our membership. We need to have a governance structure including the quotas and the voice that realistically reflect the economic power and influence of our members. This is only one round of reform, there is another one to be taken up in 2015. So it is important to the IMF that the 2010 Reforms agenda goes forward. We are encouraging the US administration and the Congress to act. The US administration, it seems to us, is dedicated to getting this done.
We have at the highest level in the IMF reached out to Congressmen and Congress-women who wanted to learn more about the IMF. We explained why we think an institution like the IMF serves its members including the US well. The IMF promotes macroeconomic and financial stability which creates a basis for exports and jobs, and this is good for member countries including the US. We don’t know what will happen this Fall. The US administration has a plan and their representatives in these annual meetings explained to the other governors and ministers that they were planning to put the legislation before the Congress during the lame-duck session—after the mid-term elections in November. We don’t know whether that would succeed or not. As an institution, our membership has taken the decision to wait and see what happens in the lame-duck session. So there is no ‘plan B’. There is simply the decision to wait until the end of the year and give the US time to reconsider the subject.