Michael Deppler, head of the IMF’s European Department for the past 11 years, speaks in the following interview about the effects of the subprime crisis on Europe and the IMF’s first multilateral consultation, a high-level initiative aimed at reducing global economic imbalances.
Deppler, who is retiring after nearly four decades of service, also gives his take on the future of the IMF.
IMF Survey: What impact will the subprime crisis have on Europe’s economy?
Deppler: First, you have to be clear about the nature of the problem. In the United States, the housing market was both the spark and the fuel of the crisis. The situation in Europe is different—household saving, loan-to-value ratios, and household balance sheets are generally far stronger there than they are in the United States. This means that the adverse feedback loop between the financial sector and housing in the United States does not have the same force in Europe.
But there is no escaping the fact that we have a global shock to the financial system, and it is bound to affect Europe as well. The slowdown in the United States will pervade the world economy, and the IMF is steadily bringing down its forecasts for Europe. Some people have expressed great pessimism about Europe’s prospects. I would not go that far. In my view, Europe will experience a couple of years of slow growth. Unemployment, which until now had been declining steadily, will probably start to rise again. That said, I remain reasonably sanguine that Europe’s economy will be more resilient than that of the United States.
IMF Survey: How real is the risk of a financial crisis in Europe’s emerging markets?
Deppler: In my view, Europe’s emerging countries are also resilient. But some of them are susceptible to financial shocks, which could make the situation dramatically worse. While financial markets clearly are backing away from assets they view as too uncertain, there is still an appetite for relatively high-yielding assets for which risks are perceived as less influenced by the crisis in advanced country financial markets. Therefore, lending to emerging Europe remains reasonably buoyant and growth is being sustained, at least for now.
In sum, we do not know yet how big the shock is going to be in emerging Europe. But these countries will not be able to avoid the more general slowdown, and a number of them need to work harder at ensuring the continued confidence of investors.
IMF Survey: As Director of the European Department, you have led missions to the euro area for a number of years. Do you think Europe has finally overcome the ills that has prevented its economy from realizing its full potential?
Deppler: I wish I could say yes, but I have to say no. Europe has made major strides forward over the years, and its prospects are the better for it. But it still has structural problems it really needs to address. During the 1970s and 1980s, these problems were essentially ignored. But since then, reforms have been implemented—to my mind, with considerable success. If you look at employment, clearly we are in a different frame of reference than we were 10 to 15 years ago. And if you think in terms of Europe’s standing in the world economy, the continent has also come a very long way—the 27-member European Union is, at current exchange rates, the world’s largest economy. European goods are renowned for their quality and design, and Europe’s institutions are admired for what they have been able to achieve—not least, a single European currency.
That being said, Europeans still have a lot of problems to deal with, and some are quite tough. These problems can often be traced back to privileges that have been bestowed upon various social groups—privileges that have now become deeply embedded in society, dragging down economic performance and productivity.
European performance relative to that of the United States has flagged, most noticeably in terms of lagging productivity in the service sector. However, while it is clear that sectors sheltered from competition are doing poorly, it is less clear how Europe’s politicians can put together the majorities needed to reform them. The people who profit from the lack of competition are obviously not keen to see these protectionist measures dismantled. Collectively, however, these privileges add up to a huge burden on overall performance.
IMF Survey: Does Europe’s positive experience with integration hold lessons for the rest of the world?
Deppler: It is hard to imagine what Europe would look like today if it were not for integration. It has been a source of tremendous growth and opportunity, essentially because it brings competition to markets that would otherwise remain protected. Although there are some downsides, such as the agricultural policy, being a member of the European Union amounts to reform by stealth. That is why, of course, there has been a certain backlash against integration in some countries. But I firmly believe that Europe stands tall. The continent’s experience—including with the euro and the single market—has excited a lot of interest around the world.
IMF Survey: You are about to leave the IMF after 37 years. As you look back at your career, what stands out as the most important events, for the Fund and for you personally?
Deppler: It has been a very exciting 37 years. I received my letter of acceptance to the Fund on April 15, 1971—the day Nixon announced the break with gold. All my colleagues in university were saying: “Why are you going to the Fund? The Fund no longer has a job.” And yet, looking back, I have been involved in many exciting things over the years.
First there was the creation of the IMF’s World Economic Outlook—a secret activity back in the early 1970s. Then came the oil facility, the debt problems in the 1980s, the transition economies in the 1990s, and our programs with Poland and Bulgaria, and later Turkey. So it has been a career full of continuing interest.
The lessons to take from these varied experiences are pretty basic, but they have been important to me—as well as to the institution—over the years. The first lesson that has struck me repeatedly is how critical politics is to economics.
I was on the 1976 Stand-By mission to the United Kingdom when confidence in sterling reached a low ebb and the country came to the Fund for support [the United Kingdom was the last industrial country to borrow money from the IMF]. As far as I could tell, this crisis reflected mainly a lack of political resolve. They could have taken a few measures, told us to go home, and done fine.
Twenty years later, I was leading the missions to the United Kingdom when Gordon Brown became Chancellor of the Exchequer. He came into office with an ambitious reform program, including a commitment to achieve the very tough expenditure targets of the previous government, which had lost all credibility. He promptly set out to do just that, gained massive credibility, and succeeded in crowding in even larger volumes of private spending, which helped spur the sustained growth that has followed.
Turkey was the same thing. The government that was in place from 1998 to 2002 wanted to do the right things, particularly once Kemal Dervis became treasury minister, but it did not have the necessary political cohesion to make its commitments credible. When the new government came in with a large majority, it committed to basically the same policies, also with financial support from the IMF. We now had a success in the making. So politics is central to economic outcomes—an obvious point, but one that economists focused on doing things right by the lights of our trade need to bear in mind.
The other big lesson I take away from my years at the Fund is the importance of institutions. I was in favor of shock therapy back in the early 1990s working on the transition economies, and I remain in favor of it. Political opportunities must be seized. But the transition experience has taught us the importance of institutions to well-functioning markets. The Fund’s new emphasis on governance and capacity building stems from that lesson.
Regional outlook for Europe
Financial market strains, spillovers from the U.S. slowdown, and the global reassessment of risks will adversely affect Europe in 2008, the IMF’s latest Regional Economic Outlook(REO) says. The euro’s appreciation and the increase in commodity prices are adding to these troubles.
In advanced Europe, output growth is expected to slow from 2.8 percent in 2007 to 1.5 percent in 2008. In emerging Europe, growth should decelerate from 6.9 percent in 2007 to 5.5 percent (see table). Uncertainties surrounding the outlook remain unusually high, emphasizes the REO, published on April 21.
Growth in Europe is expected to slow significantly in 2008-09, reflecting spillovers from weaker global growth, rising commodity prices, and the strains in financial markets.
(real GDP growth; annual percent change)
|Advanced European economies1||2.8||1.5||1.4|
|Emerging European economies1, 2||6.9||5.5||5.2|
|Advanced European economies|
|Emerging European economies|
But probably the most important lesson for today is the quickening of financial markets, all the more so in the face of political and governance issues. I remember thinking, back in Poland and even Bulgaria in the 1990s, how slow the markets were to react. Nowadays, of course, markets can—and often do—react almost instantaneously. Here, also, the Fund has moved in the right direction by giving much higher priority to the financial sector and its links to the real economy.
IMF Survey: You were one of the leaders behind the Fund’s first multilateral consultation, which aimed to reduce global economic imbalances. What lessons did you take away from that experience?
Deppler: The multilateral consultations were proposed by former IMF Managing Director Rodrigo de Rato. In his view, the world had become much more multipolar, and the IMF needed to have procedures in place that would enable us to engage key players on key problems, directly and at a high level. The need for such a mechanism—with the Fund acting as an independent broker—remains patently obvious, in my view. And to make progress, you need genuine, active debate, which means keeping participation limited and engaging high-level policymakers.
The first multilateral consultation did so. It was aimed at reducing global economic imbalances, and involved the United States, the euro area, China, Saudi Arabia, and Japan. My view of the outcome is very positive: it remains the touchstone of how we look at global imbalances. The context, of course, is evolving. The financial crisis has brought a new dimension, and there is a need to incorporate the lessons learned so far.
But I would say that in terms of both the concept itself and our achievements—a better understanding of what the key players thought about global economic imbalances, and how their policy intentions fit with those of other key players—the consultation was very much to the Fund’s credit. I am certain it will be viewed as a significant first step toward redressing the imbalances that have made the global economy vulnerable to a slowdown.
IMF External Relations Department