Presentation of the Thirty-Second Annual Report1
- International Monetary Fund. Secretary's Department
- Published Date:
- October 1977
By the Chairman of the Executive Board and Managing Director of the International Monetary Fund. H. Johannes Witteveen
Mr. Chairman, I should like to join you in thanking the Governor for the United States for his cordial welcome and in greeting the assembled delegates and guests. I extend a special welcome to the Governors for Guinea-Bissau and Seychelles, which have become members since we met in Manila last year.
The Annual Report of the Executive Directors, which I have the privilege of presenting to you, provides a comprehensive review of developments in the world economy and in the international monetary system. I shall not try to go over this same ground in any detail. However, since the present situation is complex, and significant developments have occurred since the preparation of the Annual Report, I would like to single out a few key issues for discussion. I shall also touch on some important aspects of the work of the Fund.
First, let me comment on the pace of recovery from the severe international recession of 1974-75. It may be recalled that expansion of production in the industrial countries proceeded on a generally satisfactory course in the initial phase of the recovery, that the rate of expansion showed an unexpectedly sharp slowdown during the latter part of 1976, and that this “pause” was then followed by a fairly widespread pickup in the tempo of economic activity. Now, it is evident that during the past few months the pace of recovery has faltered again in a number of the industrial countries, especially in Europe. In the Federal Republic of Germany, real GNP in the second quarter failed to show any increase. Economic expansion has continued to conform closely to expectations in the United States, while easing markedly in Canada. In Japan, there was a fairly rapid expansion of real GNP during the first two quarters of 1977; but this centered on export gains and higher government expenditures, and the growth of private domestic demand and of the volume of imports was not satisfactory. Several of the industrial countries, including both the Federal Republic of Germany and Japan, have responded to these unexpected developments by adopting stimulative measures.
One distressing aspect of the current situation is the prevalence of high unemployment. For the industrial countries as a group, the overall rate of unemployment remains close to its recession peak of two years ago and is substantially above the levels that prevailed during the 1960s and early 1970s. This is rightly a matter of serious concern for national governments. Various types of specific measures now in widespread use may help to deal with the structural aspects of unemployment, but any major reduction in unemployment levels can only stem from markedly higher rates of economic expansion. The situation presents an acute dilemma, since the harsh experience of recent years has made governments understandably reluctant to switch from anti-inflation policies to a more aggressive stimulation of domestic demand.
On the inflation front, rates of price increase in most member countries have been brought down from their exceptional levels of 1974 and 1975 but are still much too high to be considered acceptable. National authorities will agree, I believe, that inflation remains a generally severe problem. In a longer-term perspective, as I observed at last year’s Annual Meeting, inflation redistributes wealth and income arbitrarily, undermines confidence, reduces investment incentives, and misallocates resources.
Among the industrial countries, the overall rate of price increase is still running at an annual rate of almost 7 per cent this year—only about half as high as in the second half of 1974 but well above historical standards. This overall rate conceals wide differences among individual countries. As measured by the comprehensive GNP deflators, the rate of inflation is relatively quite low in the Federal Republic of Germany and Japan, and it is also below the industrial-country average in the United States. Within the industrial world, inflation rates are by far the highest in Italy and the United Kingdom, although the stabilization programs adopted by those two countries in the course of 1976 have begun to produce some significant declines.
Among the nonindustrial, or primary producing countries, the economic picture is very mixed. In the more developed countries, the growth of total output lags well behind that of the industrial group, and this year’s increase in their consumer prices is expected to average some 15 per cent. The non-oil developing countries, which were less affected by the global recession than other groups of oil importing countries, achieved a growth rate of about 5 per cent in 1976 and are likely to show a still higher rate for the current year. The record of these developing countries with respect to inflation is quite uneven, but most of them have achieved some success in reducing their rates of increase in consumer prices. For the oil exporting countries, growth of output in recent years has averaged about 9 per cent annually, whereas consumer prices have been rising at a rate of over 15 per cent.
The domestic and external economic difficulties of the past few years, particularly the high level of unemployment, have given rise to pressures for protectionist measures in some of the major trading countries. These countries have generally managed to resist such pressures and have avoided imposing across-the-board trade restrictions to safeguard the balance of payments. Lately, however, there seems to have been a weakening in the commitment of some countries to a system of international trade free from restrictions and discrimination. One sign of this has been a gradual but definite spreading of selective restrictions on imports; other signs have been the negotiation of so-called voluntary restraints on exports and the interest being expressed in the organization of markets. Such restrictions add to the difficulties of adjustment for weaker countries, and particularly for those developing countries that have increased their manufacturing capacity and now depend heavily on an open and expanding system of world trade.
Although protectionist measures may be a natural response to high unemployment and low growth rates, such measures are unlikely to provide anything other than very short-term relief for these problems. The growth of international trade would undoubtedly be impeded by a proliferation of trade restrictions, with inevitable repercussions on the countries imposing them. It is, however, encouraging that on several occasions governments have publicly reaffirmed their opposition to protectionism and stressed their intention to pursue vigorously the wide-ranging trade negotiations in Geneva. I very much hope that these negotiations will be successful, and that they will provide a new impetus to the expansion of world trade.
Mr. Chairman, I have noted that members of the Fund are confronted by the problems of generally subnormal growth rates, high unemployment, and rising protectionism. These problems prevail in an economic environment dominated by the persistence of inflation, coupled in some countries with weakness of the external position.
In this situation, the industrial countries, and most other member countries as well, have been placing a primary emphasis in their demand policies on combating inflation and, where necessary, strengthening the external position over the next few years. This priority is based on the firm belief that such an approach will yield the best results for economic growth and employment in the longer run. At the same time, the approach being followed envisaged, at least for the industrial countries as a group, achievement of a rate of economic growth sufficient to permit a gradual reduction in unemployment.
This general strategy of policy was recommended in last year’s Annual Report, and national targets and expectations were broadly consistent with it. The difficulty that is now emerging very clearly is that these expectations have not been realized. The pace of economic recovery in the industrial countries as a group has become so slow that it is adversely affecting employment and foreign trade (including the exports of developing countries) while encouraging protectionism. This is a matter for serious concern.
One question that immediately arises concerns the reasons for the “pause” in cyclical recovery and in expansion during the second half of 1976 and the further slackening in the pace of activity that has occurred in recent months. In part, the explanation can be traced to the conduct of fiscal policy. Throughout the industrial world, some of the fiscal stimulus supplied in 1975 was withdrawn in accordance with the plan of exercising restraint over the rise in aggregate demand during the recovery phase of the cycle. However, in a number of industrial countries, the shift of fiscal policy in the direction of restraint has turned out to be greater than was intended. The latest surprising “shortfall’’ in fiscal expenditures has appeared in the Federal Republic of Germany, where indications are that the reduction in the public sector deficit this year will again be larger than planned.
The decision of industrial countries to shift the stance of fiscal policy in 1976 was based on one key assumption: that fixed investment would soon resume expansion and would become a major factor in sustaining the rise of general economic activity during the second half of 1976 and beyond. In the event, as is well known, the behavior of business fixed investment has been very disappointing—quite contrary to the pattern of previous economic recoveries. In retrospect, this is not surprising in the case of those countries which found it necessary to adopt very restrictive demand policies in order to deal with large payments imbalances and severe inflation. But the growth of investment also has been lagging in economically stronger countries, although in the United States it has gained momentum over the past few quarters.
Immediate explanations of the unusual behavior of investment can be sought, of course, in the depressed level of profits and the relatively low rates of capacity utilization. But such factors were also present in earlier recessions. It is clear that a number of somewhat different influences must underlie the depressed state of fixed investment. Of basic importance, I believe, is the cautiousness of the business community in the face of various kinds of uncertainty. In differing degrees among countries, there is uncertainty with respect to the future rate of inflation, the extent and character of government regulations, the movement of exchange rates, the risk of further trade restrictions, and the maintenance of political stability. In addition, cost-price relationships—notably with respect to the sharply higher cost of energy—have probably had an unusually depressive effect on the profitability of investment in recent years. For many industrial countries, certain structural changes in the world economy may also be hampering investment; for example, the success achieved by developing countries in the expansion of their manufacturing capacity means that some sectors of industry in industrial countries are becoming unprofitable and should contract.
In the present complex situation, there are no easy solutions to the problems posed by lagging investment and slow economic growth. The problems are interrelated, and the emphasis of any policy approach is bound to vary from country to country. But a few guidelines may be suggested.
First, let me emphasize that steadiness in pursuing a certain strategy of policy is highly desirable from the standpoint of reducing uncertainty and encouraging investment. Such a steadiness does not call for the “fine tuning” of policies, which is neither feasible nor conducive to the restoration of public confidence in government policies. But it does imply the need to adjust policies in time to avoid cumulative deviations from an equilibrium path over the medium term. As I mentioned earlier, the Fund supported the strategy of economic policy that has been followed by the industrial countries, and we recommended that, in the current inflationary environment, governments should not shade policy risks on the side of growth, as they had done in the past. This recommendation was followed by most governments, but national targets and expectations now seem to have been missed in a downward direction. The growth of domestic demand has been significantly less than that required by our strategy, particularly in countries with strong external positions. This lag in demand growth should now be decisively corrected. In addition, I believe that some special efforts could and should now be made to reduce inflation.
In the current environment of high inflation combined with economic slack, it would seem especially necessary for governments to do whatever they can in the difficult field of incomes policy. In this context, the marked declines in primary commodity prices that occurred in the middle months of 1977 provide a good opportunity to bring about a deceleration of wage and price increases. This could be strengthened by providing fiscal stimulus, in the countries where needed, in the form of tax reductions. In the design and operation of incomes policies, an effort could be made to take these two elements into account in such a way as to have a maximum effect on wage and price movements.
Even if a general strategy of policy is pursued steadily, and special efforts are made to reduce inflation, some additional steps will still need to be taken. These might include, for example, policies designed to improve supply conditions and alleviate cost pressures. Also, in view of the structural difficulties being encountered in a number of sectors, many industrial countries need to develop an active policy for structural reorientation and rationalization of manufacturing industries; this should be done with a clear objective of providing more room for imports from developing countries and helping to bring about a favorable climate for the international division of labor in a free trade system. Finally, even though the essential prerequisites of higher investment are a further reduction in inflation and a return to a more stable economic environment, investment can and should be strengthened by policies to improve the rate of return on capital. In developing countries, the incentives to invest, especially in manufacturing capacity, would be enhanced if their products had freer access to the markets of industrial countries. Also, the very fact that developing countries find it difficult to generate sufficient domestic saving for investment programs underlines the importance of raising the flow of capital and aid from the industrial countries to the developing world; this, in turn, would lead to additional demand for the exports of the industrial countries themselves.
I have discussed the question of an appropriate general strategy of policy largely by reference to the industrial countries as a group. However, as my remarks may have already indicated, the strategy cannot be applied uniformly to all countries, but rather must take into account the strength or weakness of the external position. This consideration brings us to a vitally important subject—the working of the international adjustment process.
The importance of the adjustment process in present circumstances is evident in two respects. The first is that a number of countries are now facing large payments imbalances. In the absence of satisfactory programs of domestic and external adjustment, their situations would simply deteriorate. These countries badly need to adopt policies ensuring a reduction of their current account deficits to levels that can be financed by sustainable capital flows and with a manageable structure of external debt. The second important aspect of the adjustment process concerns countries in relatively strong external positions; for these countries, the appropriate course of policy is to take expansionary measures strong enough to ensure meeting their own domestic objectives, thus helping to restore a satisfactory growth of world trade and assisting the adjustment efforts of deficit countries.
By last year’s Annual Meeting, it was evident that the time had come—as I said in Manila—to lay more stress on the adjustment of external positions and less on the mere financing of deficits. Since then, a number of deficit countries have taken important actions to adjust, and other such countries urgently need to follow suit. However, the functioning of the adjustment process has been impaired by the failure of domestic demand in some of the relatively strong countries to show adequate rates of expansion.
I would emphasize that all countries in a relatively strong position have an international responsibility to maintain an adequate growth of domestic demand. As the process of international adjustment evolves, we may expect an increasing number of countries—both developed and developing—to bring their inflation and balance of payments problems under control, and thus to be strong enough to contribute to growth of the world economy. Meanwhile, in the circumstances that have prevailed in recent years, particular attention has inevitably focused on the United States, the Federal Republic of Germany, and Japan—which because of their economic size can have a substantial impact on the pace of trade and activity throughout the world.
The German and Japanese economies exhibit several common features: relatively low rates of inflation, exceptional strength of the external position, sluggish growth of domestic demand, and a tendency for the exchange rate to appreciate. Since early 1976, the external value of the deutsche mark and of the yen has appreciated by some 15 per cent in relation to a composite of other major currencies—a development that, in and of itself, tends to depress domestic activity.
The stimulative measures recently adopted by the Federal Republic of Germany and Japan are essential for the purpose of meeting domestic objectives, and they are certainly very welcome from an international standpoint. In view of the difficulties and imponderables involved in directing economic policy in a modern industrial economy, I know that the German and Japanese authorities will be carefully assessing developments over the coming year. And I trust that they will be prepared to take further measures of stimulus in the event that the performance of their domestic economies does not improve substantially.
When attention is turned to the United States, it should first be noted that the U.S. economy experienced rapid growth of real GNP during the first two quarters of this year. The rate of growth achieved—averaging close to 7 per cent in those quarters—was neither meant nor expected to be sustained, and the economy is now in the process of shifting to a more moderate pace of expansion. Let me emphasize the importance for the rest of the world that expansion of the U.S. economy be maintained at a satisfactory rate. In this connection, developments on the external side do not indicate a need for U.S. fiscal and monetary restraint beyond that required on domestic grounds for the purpose of reducing inflation. I base this view, among other things, on the fact that the deficit of the United States on current account is accompanied by large inflows of capital.
In these remarks on the adjustment process, I have stressed the need for countries in relatively strong external positions to achieve faster growth of domestic demand. Another important requirement of the adjustment process relates to the provision of official financing to deficit countries—financing that is provided in sufficiently large amounts, over long enough periods, and with appropriate conditionality. I am pleased to say that, with the completion of work to establish the new supplementary financing facility, the Fund will be able to make an important contribution in this respect.
The supplementary facility comes at an appropriate time, and fits well into the present circumstances of the world economy. While the oil facility was designed to help mitigate deflationary forces in a recessionary atmosphere, the emphasis of the supplementary facility is on adjustment during a period of recovery and expansion that so far has been rather weak. It recognizes that a number of Fund members are experiencing external imbalances that are very large in relation to their economies; and it allows the Fund to encourage these members to adopt programs of adjustment by making available much larger amounts of financing than under the Fund’s normal credit tranche policies. At the same time, the periods to be covered by stand-by arrangements, and for repurchase, will be longer than usual, so that adjustment policies can be pursued more gradually—and the needed restrictive effects on demand spread over a longer period.
Commitments to lend to the Fund to support the facility have been made by industrial countries and oil exporting countries. Their cooperation in the establishment of the facility underlines the mutual interest of these countries both in the pursuit of sound adjustment policies by deficit countries and in the general stability of the international monetary system. I hope that the prospective lenders can conclude the necessary arrangements with the Fund so that the facility can become operational as soon as possible.
At present, commitments to lend to the Fund for the facility total about SDR 8.4 billion—close to $10 billion—and there are possibilities that these amounts will be increased. During the period the facility is in operation, the Fund will also be prepared to conclude borrowing agreements with other lenders in sufficiently strong external positions. The claims on the Fund that will be created under the loan agreements will be desirable international reserve assets, with an attractive rate of interest and a high degree of liquidity.
The facility will help to provide confidence in the international monetary system by ensuring that the Fund has sufficient resources immediately available to assist members facing difficult problems of external adjustment. In the last few years the Fund’s liquidity has been under some strain. This concern will be alleviated when the supplementary financing facility becomes operational, and the Fund’s liquidity will be strengthened further when the quota increases under the sixth review become effective following ratification of the second amendment. I urge those members that have not yet done so to take the necessary steps to ratify the second amendment so that it can become effective by around the turn of the year.
The need for the Fund to borrow resources over the past few years reflects the fact that the growth of Fund quotas has not kept pace with the growth in trade and payments and with disequilibria in members’ external transactions. This has been amply demonstrated not only by the squeeze on the Fund’s liquidity, but also by the need to establish facilities that enable members to use the Fund’s resources well beyond the traditional relationship to their Fund quotas. While the borrowing under the supplementary financing facility will help to deal with this situation over the next two years, it is essential that in the longer term the solution must be found in an adequate level of quotas rather than a reliance on special borrowing. I hope that the current discussions on the Seventh General Review of Quotas will result in a major step in this direction.
In addition to ensuring that the total of quotas provides an adequate source of conditional liquidity to its members, the Fund also must be concerned with the overall supply and composition of international reserves. The Annual Report highlights changes in the supply of reserves since the floating of the U.S. dollar and the further expansion of international credit markets. As a result of these developments, governments of creditworthy countries now face a highly elastic supply of reserves, both individually and in the aggregate. This situation results in a lack of control over the quantity of international liquidity. In my view, this aspect of the international monetary system raises serious questions with respect to both inflation and the international adjustment process.
In this area of international liquidity, the amended Articles of Agreement set out two important objectives: promoting better international surveillance of international liquidity, and making the special drawing right the principal reserve asset in the international monetary system. These objectives can be thought of as relating, on the one hand, to quantitative concerns and, on the other, to qualitative considerations, including the distribution and composition of international liquidity.
In judging the appropriateness of a further allocation of SDRs, the Fund will have to take into account both objectives. While there is some concern that a new allocation of SDRs might give added impetus to inflationary forces, such an allocation could improve the distribution and composition of liquidity. Careful study will be needed to reconcile these quantitative and qualitative objectives and to strike the right balance.
Mr. Chairman, I have focused my remarks on the problems and difficulties confronting us in order to promote discussion of how they might be solved. In doing so, I do not want to minimize the improvement in the general economic picture that we have seen over the past year or two. We have only to remember the gloomy outlook in 1974 to appreciate how much has been achieved. This should encourage us to tackle the remaining difficulties with determination and in a continuing spirit of international cooperation.
September 26, 1977.