(Archived Content)
TG-701
Economic Challenges for the Americas in the Post-Crisis World
Rio de Janeiro, Brazil
Thank you. It is a great pleasure to be in Brazil and to speak at this renowned institute at a time when the economic partnership between our two countries is strong. Not only do we have a close bilateral relationship, but we are also working closely together on regional issues such as helping Haiti cope with its massive earthquake and in multilateral fora to tackle the critical challenges facing the global economy.
Brazil's impressive economic progress in recent years means that its influence is increasingly felt around the globe. From your significant contributions to global economic growth, to your leading role in energy markets, and to your selection as host of both the 2014 World Cup and the 2016 Olympics, this nation's influence and strength is an example for others. Your country is a leader among South American economies and a global example of how well managed macroeconomic policies contribute to economic stability and balanced growth.
These policies are particularly important given the difficult economic environment we have all faced over the last two years.
The global economy is now emerging from its deepest recession since the 1930s. As the recent events in Europe remind us, this recovery is still fragile. A striking feature of the recession has been the comparative strength of many emerging markets, including Brazil and much of Latin America, in stark contrast to earlier episodes. This greater resilience is a tribute to the improved macroeconomic policy making in Brazil and other countries in the region.
While the gathering strength of the global economy is encouraging, we should recognize that this recovery is still multi-speed and policy-dependent. I will focus in my remarks on three sets of economic challenges facing the Americas.
First, the challenges we face in the United States. Our recovery is still in its early stages and needs continued support. At the same time, we must lay the foundations for a sustained strong expansion, notably by planning for fiscal consolidation and overhauling our approach to financial regulation to prevent the reemergence of financial excesses.
Second, I will make some comments on the challenges facing Brazil and Latin America. While the present recovery is strong, a renewed commitment to reform will be crucial to raising growth rates in the region on a sustained basis and continuing progress in reducing poverty and income inequality.
And third, I will talk about the challenge of rebalancing the global economy. The G-20 is playing an important part in meeting this challenge, and close cooperation between our two countries in the G-20 can make an important difference in ensuring strong, sustained, and balanced growth of the global economy.
Regarding the U.S. economy, we are starting to see economic growth, though at a relatively moderate pace compared to the severity of the downturn, and unemployment remains unacceptably high.
GDP increased 3.2 percent in 1Q10, the third consecutive quarter of recovery. Most components of domestic demand are showing signs of greater strength. Business investment is rising quite rapidly, while inventories are now being rebuilt. Consumer spending is returning, although savings rates are likely to remain considerably higher than pre-crisis as households still have a long way to go to deleverage their balance sheets. The residential real estate sector has shown emerging signs of stabilization after a deep correction, although the commercial real estate sector is still weakening. Fiscal policy remains supportive: around 60% of the 2009 stimulus package is still to come.
The Administration agrees with private forecasters that the economy will grow by around 3 percent during 2010, and pick up further speed in 2011. The unemployment rate has moved lower, but is still close to 10 percent, a level that the President has described as unacceptable. Private forecasters predict that unemployment will decline only gradually this year and next.
Financial conditions continue to normalize, although securitization markets are still under strain and real estate-related losses continue to accumulate. Major banks have regained profitability and raised private capital so that much of the public capital provided by the government has been repaid. With a large output gap, inflation is well contained.
The crisis took a heavy toll on U.S. fiscal balances, as government stimulus was crucial to support activity, avoiding an even deeper recession. Now the administration has set a clear path for medium-term deficit reduction, while refraining from an overly hasty removal of fiscal stimulus that could endanger the recovery:
The fiscal deficit is projected to peak at 10.6 percent of GDP in FY 2010. Under the President's budget, a combination of economic recovery and fiscal restraint should bring the deficit down to under 4 percent of GDP by FY 2014.
About 2 percentage points of this adjustment will be delivered by the unwinding of the stimulus measures, while the cyclical recovery and closing of the output gap would contribute around 3 percent of the adjustment. The remainder comes from policy measures, including the recently enacted healthcare reform legislation, placing a cap on discretionary spending, and allowing tax cuts on high individuals to expire as scheduled. Under current policies, the deficit is projected to remain just under 4 percent of GDP through 2020. However, net debt held by the public would still be rising, from 47 percent of GDP in FY09 to 69 percent of GDP in FY20.
This is a large improvement, but not sufficient in itself. The Administration is committed to putting the debt ratio on a sustainable path. Toward this objective, the president has established a bipartisan Fiscal Commission to identify policies to bring the deficit down to 3 percent of GDP by 2015, which should stabilize the debt to GDP ratio, and to achieve fiscal sustainability over the long run. Return to entitlement programs like social security and healthcare will need to be carefully considered to contain long-run increases in spending in these programs. As a further important contribution to restoring fiscal discipline, the Congress has reinstituted pay-as-you-go (PAYGO) budget rules. All in all, the path will be hard, but as you have shown here in Brazil, fiscal discipline is an essential lynch-pin of a healthy economy.
The second challenge that must be met is to ensure that the U.S. financial system is placed on a much firmer footing, capable of funding innovation and growth while avoiding hugely costly crises. The financial crisis was caused in large part by financial excesses and a failure of regulators to keep up with financial innovation by the private sector. The Administration's reaction at the height of the crisis was to intervene to prevent a collapse of the financial system. Now that financial conditions have broadly normalized, the Administration is working closely with the Congress to ensure passage of a robust regulatory reform bill that will protect the country from a recurrence of this kind of crisis.
The aim of reform is to increase the resilience of the financial system and end too big to fail. The reform has 3 parts. First, constraining risk-taking by major financial firms, including by raising the quantity and quality of capital. Second, strengthening the basic shock absorbers and infrastructure in the financial system as a whole so that we face reduced risk of contagion in a crisis. And third, providing the government with better tools to manage the failure of major financial firms while safeguarding the overall financial system.
These policies are currently being debated by our Congress, and we hope to have this legislation passed with bipartisan support over the summer.
Now let me turn to the economic challenges facing Latin America. Latin America has been a source of resilience during the recent global crisis, in contrast to the past when downturns in global activity or sudden stops in external financing often caused damaging collapses. We are now seeing a robust V-shaped recovery in most of the region, with a steadily improving outlook for 2010 and beyond. Regional growth may reach 4% this year. Brazil is rebounding particularly strongly, with growth forecasts by the private sector ranging up to 7%.
The improved resilience in the region compared to past global crises is explained in large part by stronger and more credible monetary and fiscal policies:
Thanks to robust inflation-targeting regimes, this time central banks were able to cut rates countercyclically during the crisis: with inflation expectations well anchored, the initial currency depreciations did not pass through to inflation. Lower exchange rates provided a useful buffer for activity, while reserves were used judiciously to avoid disruptive movements and ensure liquid markets. Moreover, many years of fiscal consolidation created space for a counter-cyclical fiscal response, very different from the usual pro-cyclical need to tighten weak fiscal positions as external financing flows were curtailed.
The next economic challenge for the region will be managing safe exits from monetary and fiscal stimulus. As the economy gains speed, it will be important to reinforce fiscal sustainability and withdraw monetary policy stimulus at an appropriate pace. In view of the strong recovery, this exit is taking place here in Brazil and elsewhere in advance of exits by advanced economies like the United States. This could exacerbate the challenge of dealing with resurgent capital inflows, particularly since interest rates in advanced economies may remain low for some time.
We recognize that sudden surges in capital inflows may complicate macroeconomic management and create financial risks. While there is no silver bullet, there is a wide range of policy tools available to manage the impact of strong capital inflows. Allowing the currency to appreciate rather than intervening to hold the rate fixed helps to absorb some of the pressure on monetary conditions. Steps to shift the macro policy mix towards tighter fiscal policy can help by allowing lower domestic interest rates, thus reducing the incentives for capital inflows. At the same time, introducing macroprudential regulation--such as tightening regulatory limits on bank credit as the cycle moves towards a peak--can help to contain vulnerabilities in the financial sector. It bears emphasizing that capital controls are no substitute for sound macroeconomic policies. Even temporary controls have costs, are difficult to administer, and may be evaded. Moreover, they could do longer term damage to financial development and investor confidence. We would caution against their widespread use.
Let me now turn to the challenge of sustaining high rates of growth. Increased resilience in the face of external stress is a huge achievement for Latin America, given this continent's history of repeated debt crises. But there remains the major challenge of raising the region's overall growth on a sustained basis. Growth performance has generally improved in Latin America relative to past decades: the region's output grew by an average of 3.1% in the 2000s, up from 2.9% in the 1990s and 2.1% in the lost decade of the 1980s. Even so, as a region, Latin America was firmly at the bottom of the growth league for emerging and developing countries, lagging far behind Asia, but also emerging Europe, the Middle East, and Africa. Renewed commitment to structural reforms will be needed to return to the 5-6% annual growth rates that Latin America achieved every decade from the 1940s to the 1970s, when it was one of the strongest performing regions. Let me highlight three key challenges:
First, inadequate infrastructure is a crucial bottleneck by raising the costs doing business, especially exporting. Transport and logistics costs are 16-26 percent of GDP in Latin America, compared to 9 percent in OECD countries; for small firms, which are the main source of employment and growth for the region, costs average 48 percent of the value of their sales. Substantial investments will be needed to bring down these costs. For example, here in Brazil, $70 billion needs to be spent annually to meet growing infrastructure needs. The public sector will only be able to fill a fraction of this overall need. It is therefore welcome that some Brazilian states are successfully using public money to catalyze private investment in infrastructure, for example through public-private partnerships.
Second, education in Latin America, including tertiary education, lags well behind the average for OECD countries and developing Asia. Secondary school enrollment rates remain low, and PISA test scores show a large performance gap equivalent to 3 years of schooling (though there have been recent improvements). Improving educational performance and training is critical to improving productivity, competitiveness, and narrowing the region's persistently high income inequality.
Third, fiscal management systems can be improved across Latin America. The keys are to broaden tax bases, lower tax rates, and improve targeting of public expenditures. Progress along these dimensions would help to (i) solidify the recent gains in fiscal stability; (ii) reduce distorted incentives for economic actors and bring informal activity into the measured economy; and (iii) create fiscal space for pro-growth investment and to address lingering social issues such as inequality and poverty. For Brazil, effective expenditure control was an important contributor to the fiscal discipline achieved over the past ten years. Even more impressively, social programs including bolsa familia and fome zero have yielded important gains at relatively low cost. Still, there remain important challenges ahead to reduce tax distortions and to achieve a greater focus of spending on social and economic priorities.
Finally, let me briefly discuss the role of the G-20 in responding to the global crisis and what lies ahead, including the role of the Americas. Since the crisis, with strong U.S. support, the G-20 has emerged as the primary forum for economic cooperation, replacing the less representative G7/G8. The increased role now played by the G-20 recognizes the rising importance of dynamic emerging countries in the global economy such as Brazil, and has been underpinned by institutionalizing the involvement of G-20 Leaders, which has stepped-up the degree of political commitment.
The G-20 has already had notable achievements. Working closely together, the G-20 countries all put in place strong fiscal support to counter the collapse in demand and confidence following the crisis – fiscal stimulus amounted to 2 percent of G-20 GDP in both 2009 and 2010. Leaders also agreed on a substantial increase in resources available to the international financial institutions and multilateral development banks, which helped to reassure markets that emerging economies would be able to weather the storm. In fact, the London Summit in April 2009 marked the beginning of the recovery in global financial markets, soon followed by the resumption of economic growth.
The need for a powerful group like the G20 has not diminished as the global economy pulls away from crisis. But we do face a challenge to maintain the momentum of the G-20 process now that impetus to action from the global crisis is waning. This will require building on key commitments made at the Pittsburgh Summit last September. Let me mention two of them.
First, the G-20 Leaders have pledged to lay the foundation for strong, sustained and balanced global growth through an unprecedented exercise in global macroeconomic policy coordination. It has to be recognized that the pattern of growth of the global economy in the next 5-10 years will be very different from that of the past 10 years. Countries that for years have relied on export-led growth and run large current account surpluses can no longer expect their traditional customers to run offsetting deficits. Most obviously, the United States will no longer act as the global consumer of last resort, as both households and the public sector move forward with the repair of their balance sheets. So a rotation of global demand will be needed, with stronger growth in domestic demand from countries that previously have run large current account surpluses and been heavily dependent on exports as a source of their growth.
How is this rotation of demand to be achieved? Under the auspices of the G-20 Framework, member countries have submitted information on their fiscal, monetary, trade and structural policies to the IMF, which is now developing a number of scenarios of the evolution of the world economy based on this information. This analysis will provide the basis for an assessment of what specific policy initiatives may be needed from G-20 countries to contribute to strong, sustained and balanced growth at the global level. At the upcoming G-20 summits in Toronto in June and Seoul in November, the G-20 leaders will face the challenge of agreeing on a set of policies that sustain the recovery and re-balance the global economy.
A second key commitment of the G-20 is to further extend and consolidate the role of emerging and developing nations as part of the steering committee for the global economy. A central task will be to expand and modernize the Bretton Woods institutions. Among the Pittsburgh Summit's commitments were to raise the IMF quota shares of dynamic emerging markets and developing countries by at least 5 percent; the G-20 Leaders similarly agreed to increase the voting power of developing and transition countries at the World Bank by at least 3 percent. Alongside the capital increases and changes in voting shares, the G-20 Leaders called for reforms in the mandate, mission and governance structures of the IMF, World Bank and the regional development banks that will increase their relevance and improve their legitimacy.
Brazil's responsible leadership has played an important role in the success of the G-20. With a growing consumer base driving domestic demand growth, Brazil offers an example of a well balanced growth strategy that combines both rising integration with global trade and finance with a robust domestic economy. This strategy provides a path to securing the important productivity and efficiency gains from economic openness while also raising standards of living and alleviating poverty.
I would also like to recognize that Brazil, in partnership with the United States, has been a powerful and effective advocate for strengthening and reforming the Bretton Woods institutions. Brazilian leadership has helped to influence the world's most important and established bodies for economic decision-making, and this influence will ensure that Brazil is a rule maker as well as rule taker.
To close, we in the U.S. Treasury look forward to continue building on our strong relationship with our Brazilian counterparts. We share a productive collaboration on global economic issues, consistent with the Obama Administration's vision for a new era of global partnership. The Brazilian government's interest in playing a rising role in steering the global economy is commensurate with Brazil's growing economic importance at the global level. Both Brazil and the United States must continue to show economic leadership by example, and I am confident that this will be the case.
Thank you, and with that, I look forward to your questions.
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