Christine Lagarde keeps the IMF moving with the times

The International Monetary Fund (IMF) is changing. Historically, as the bastion of economic orthodoxy, the IMF’s policy advice was strictly about deficit reduction, devaluation, slashing of subsidies and privatisation – the Washington consensus writ large in other words.

While these basic tenets still remain in place, a new kind of language has crept into the IMF’s dialogue – this concerns inequality, climate change and gender issues.

Watch 

In an extensive interview, The Banker’s editor Brian Caplen talks to the IMF’s managing director Christine Lagarde about the outlook for the global economy.

Is the 70-year-old institution, which was created following the Bretton Woods Conference in the summer of 1944, getting soft in its old age? Has it fallen victim to a new kind of orthodoxy – that of 21st century political correctness?

Adapting to stay relevant

The IMF’s managing director, Christine Lagarde, is adamant that there is no inconsistency between the new liberal values of financial inclusion and income distribution and the old-fashioned ones of open markets and free trade. In a speech in June she talked about the need for economic growth to lift small boats as well large ones. “In too may cases, poor and middle-class households have come to realise that hard work and determination alone may not be enough to keep them afloat. Too many of them are now convinced that the system is somehow rigged, that the odds are stacked against them,” she said.  

Such a speech is music to the ears of the IMF’s many left-leaning critics who have long argued that the institution’s medicine is unduly harsh and can injure as much as it cures. Its role in the Asian crisis of the late 1990s remains a topic of heated debate, especially in South Korea.

But is the IMF changing fast enough to keep faith with these and other critics in the emerging markets who complain that the institution’s governance and quota system – based on a country’s economic strength and which determines its voting rights – have not kept pace with the changing structure of the global economy? Back when the IMF was created, China’s share of global output stood somewhere in the region of 2%; now it stands at 15%, yet IMF quotas have not moved sufficiently to reflect this. As a consequence new development banks such as the China-led Asian Infrastructure Investment Bank (AIIB) and the BRICs-initiated New Development Bank have been set up.

Some commentators have argued that these new banks are designed to replace the IMF. Former advisor to George W Bush Philippa Malmgren has been quoted as saying: “China and other developing countries have been asking for changes in the way the IMF is run – and they have not got those changes. So they have gone off and set up an alternative, the Asian Infrastructure Investment Bank. Make no mistake, this is designed as a replacement for the IMF – a whole new architecture designed to funnel investment into China’s own markets and its own companies.”

Of this, Ms Lagarde says: “I think the emerging market economies are determined to play their legitimate role in the global economy. If they do not see their role – their seats at the tables, their quota shares, their voices – commensurate to the role they play in the global economy, the temptation is great to actually set up shop somewhere else.

“I think this is partly the reason why we are seeing a BRICs bank, partly the reason why we are seeing this Asian Infrastructure Investment Bank, [and] partly the reason why we are seeing this network of swap lines between the central banks. I don’t think [these initiatives are intended] necessarily to compete with the IMF or the World Bank but it’s a way to have a shadow system that could eventually play a key role if this institution, the IMF, or others [if they] do not reform enough to be more inclusive and better mirror the structure of the economy.”

A collaborative approach

So would the IMF consider working together with the AIIB on a future bail-out of an Asian economy?

“Yes and no,” answers Ms Lagarde. “I see us very much co-operating and working in a very concerted fashion with this swap-line network between central banks because that would be our [natural] counterpart.  [There are] regional arrangements already in place, whether it’s the Chiang Mai Initiative or the European Stability Mechanism, and we work co-operatively [with these] and we try to operate with good understanding, which certainly would be our plan and intention with the BRIC institution. The AIIB is a slightly different beast, if you will, because it’s investing. We are not investing, we are lending. We are doing surveillance and helping countries in trouble. We are not in the investment business.”

On the failure to push through governance reform, Ms Lagarde says: “A governance and quota reform was decided back in 2010 [shifting six percentage points of a doubled quota, or effectively equity capital, and two directorships to developing countries] which should have been completed by 2012.

“Most members of the institution have actually completed the process ratifying back at home in their respective parliaments [of] those two reforms and they are both important. Essentially, the governance [reform] improves the representation of all economies at the table and increases the voice of those that were under-represented – particularly the emerging market economies – and the quota reform doubles the quota of the institution, making it more solid and reliable vis a vis the membership in case of trouble. Now a few members have not ratified it and one is key for completion of the process – that is the US, which has more than 15% of voting rights in the institution and therefore holds a veto over such reform. So the entire membership has pretty much agreed, ratified, implemented what needs to be implemented, but the whole process is held hostage by the US."

Another issue is whether China’s currency, the renminbi, will be included in the IMF’s special drawing rights (SDR) 'currency', in which quotas are denominated. Currently the SDR is made up of a basket of dollars, euros, sterling and yen.

“Every five years we have to revisit the basket of currencies that determines the value of the SDR which is that strange currency that was invented decades ago to be a single unifying currency that would [balance] key currencies against each other. There are several criteria that need to be taken into account – one is that the currency should play a critical role in terms of exports and the country holding that currency should be an export leader, which is certainly the case with China. The other criteria is the freely tradable aspect of that currency that clearly will be under review and we will determine whether, technically, the conditions are satisfied. Then it will be for the board to make a decision as to whether the basket of currencies should be enlarged to include the renminbi and any other currency that satisfies [those conditions].”

The new mediocre

On the question of global growth and inequality Ms Lagarde has talked about what she calls “the new mediocre” – growth that is not sufficient to raise living standards for all. Classical economists have argued that the rising inequality that comes with high growth was a price worth paying to obtain lift off, and that eventually the benefits will trickle down to the wider community. But Ms Lagarde has broken faith with this idea, arguing that what we are seeing instead is trickle up, with only high earners benefiting from growth. This is turn slows down the overall growth rate.

She says: “We [are now] forecasting 3.3% [global growth] this year, and 3.8% next year. What has been striking is how we have had to revise downwards [our forecasts] over time in the past couple of years, which is an indication of how lower and slower and unbalanced the recovery has been. Many of us thought that after the very deep crisis – which was a combination of a financial and economic crisis – the economy would bounce back much earlier and the bounce would be bigger than what we are experiencing.

“Last year, growth was about 3.4%, this year 3.3% so it’s even slowing down a little, and that’s really a symptom of that ‘new mediocre’ that I referred to... which is fuelled by some fundamental issues ranging from demographics, to ageing, to the rapprochement between the various stages of development, to more conjectural issues and legacies of the crisis.”

Broader issues

Given this analysis it is perhaps less surprising that in its new mode the IMF is engaged with broader issues, such as inequality, climate change, financial inclusion and gender issues. In July, the IMF approved concessional finance arrangements for developing countries to help them achieve post-2015 Sustainable Development Goals. 

Ms Lagarde says: “We very much think that those three issues [climate change, inequality and gender] are part of the macroeconomic stability objective that we pursue. If you look at the Articles [of Agreement] of the IMF, we have to worry about growth, we have to worry about income and we have to worry about jobs.

“When you start really digging deep into what is causing slow access to the jobs market and when you are looking at why there is not sustainable, highly balanced growth, you inevitably hit those issues of inequality of opportunities, lack of participation of women in the job market, the issue of excessive inequality.

“Clearly climate change is also an issue that is going to weigh on growth going forward and that has a massive fiscal dimension. When we advocate the gradual phasing out of subsidies, for instance, we are strongly encouraging countries to remove a tool that is not helping climate change, and that is taking revenue away from where it could help with health, with education and with productivity."

Ms Lagarde says that there is “a once-in-a-generation occasion to make a difference in terms of development, in terms of the fight against poverty, in terms of climate change”.

“Within our area of competence we have tried to identify deliverables. I don’t want to be advocating things that we cannot actually do. We have increased access to loans and financial support for low-income countries by 50%, we have maintained a 0% interest rate for all the vulnerable, fragile states when they borrow from us under particular credit lines, and we have tried to focus on those [countries] that most need our help at those very concessional terms,” she adds.

The Greece question

But for all the progress that is being made in these areas, the issue that has dominated the headlines during Ms Lagarde’s four years at the helm of the IMF is Greece. Greece is the first developed country in the history of the IMF to default on a payment (which has since been repaid) and the struggle to get the country’s finances back on a sustainable path continues. The IMF has been criticised for getting involved in a bail-out that did not involve a sufficient debt haircut to allow the country to return to the private markets.

In the August issue of The Banker, former Bank of England senior manager Gabriel Sterne argued that European dominance of the IMF board may have led to its failure to take a more forceful stance towards Greece’s creditors – other eurozone governments – in terms of getting sufficient debt relief.

Ms Lagarde sees it differently. “What happened in 2010 [at the time of the first bail out] was right after the Lehman crisis, when the sovereign debt crisis was looming or was brewing in the background, and when there was no fire wall and no systemic defence at the eurozone level. There was no European Stability Mechanism, there was none of that. The systemic risk of that crisis was extremely high at the time,” she says.

“So in those days, doing a bail-out, doing a debt restructuring, were really existential questions that the eurozone had to address and resolve and couldn’t address and resolve on its own, which is why the IMF had to be involved at that moment. Later on, in 2012, there was a serious debt restructuring and the private sector took a big hit in the process. My recollection is that there was a 53% write-off on the private debt and that a lot of debt moving forward was then held by public institutions, which is now causing this issue.”

When asked what lessons can be learned from the Greek crisis, Ms Lagarde responds that having the right data early on is essential, which did not happen in the case of Greece, as is having a resolution system in place, which is now the case in the eurozone. It is also, she says, essential to have “a dose of realism as to what should be expected in terms of potential growth, in terms of energy for reform”.

“The bottom line for me – the lesson – is that to put a country back on its feet takes two legs. And Greece needs to make all the hard decisions and hopefully will do so. I am talking about structural reforms, I am talking about changing the culture of society. The other leg is the one that deals with the financing and with the debt burden, which also has to be realistic and in a monetary union requires a degree of solidarity among the members, which is also hopefully going to be on the cards,” she says.