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Interview with Peter Heller: Putting “the future” on the global agenda

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
November 2003
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IMF Survey: Why did you write this book?

HELLER: I didn’t start with the intention of writing a book. I used a sabbatical year to learn more about some of the big global structural trends that are likely to affect the fiscal situations of IMF member countries in coming decades: climate change, globalization, demographic trends, increased interconnected-ness, national security threats, and rapid technological change. I also wanted to understand whether these trends are likely to be synchronous and whether they will principally affect industrial countries or have broader implications. And finally, I wanted to learn whether and how governments take account of long-term issues in thinking about budget policies. The project essentially evolved into a book.

IMFSurvey: You seem anxious to raise public awareness and rouse policymakers from complacency. What should we be most worried about?

Heller: Clearly, we should be worrying about the big demographic trends that will affect all countries. Climate change will inevitably have economic and, possibly, political consequences. Globalization will constrain the fiscal situation in many countries. Rapid technological change, which I believe will contribute, in net terms, to the rising costs of medical care, is likely to have significant fiscal implications. Regional tensions, particularly over religion and scarce resources (such as water), and terrorism are all troubling. And the possibility of persistent, even growing, income disparities between the poorest countries of the world and middle- and upper-income countries is also a concern.

Policymakers should start worrying now! Why? First, we’re already at the point where capital markets are starting to take account of some long-term factors. In the past year and a half, most major investment banks have appraised the economic implications of demographic change in industrial countries. Second, these issues are best handled while there is still sufficient time to make adjustments in the fiscal framework and in the behavior of households. Acting now will allow us to foster policies that reduce potential tensions, create incentives to increase appropriate investment, finance research and development to encourage adaptation to relatively certain developments and to narrow uncertainties, and take preventive measures to minimize potential fiscal costs. It will also allow households to begin to adapt their behavior to the financial benefits they can genuinely expect from the government in the future. Third, some of these issues, such as health care, are going to be very difficult to address. There will be troublesome ethical and political dimensions that will take some time to resolve.

Fourth, many fiscal uncertainties remain. Governments typically accept the need to respond to unanticipated shocks even when there is no legal obligation to do so. They need sufficient fiscal leeway, yet we have created enormous fiscal rigidities that will be much harder to tackle if we wait much longer. These issues will have to be dealt with. We’re not going to have tax ratios rising to 70 or 80 percent of GDP, so the question is, how do we deal with problems that we can readily foresee, despite obvious uncertainties? Will they be dealt with smoothly or abruptly, in a way that precipitously changes the positions of households and individuals?

Finally, these are not costs that bear only on remote generations. Those alive today will bear much of the burden: you and I could conceivably live another 40-50 years. While 2050 might seem a long way off, what will happen then is not irrelevant to our welfare and is certainly not irrelevant to that of our children and grandchildren.

IMF Survey: How likely is it, though, that politicians and policymakers will take up what are, effectively, medium- and longer-term concerns? Can the media, academia, policy analysts, and the public help raise awareness?

Heller: That’s a really hard question to answer because these groups tend to be myopic. But there are things multilateral institutions can do to elevate these issues on the agenda. We can foster research and analyses that take account of long-term scenarios, and, though it’s more difficult, we can examine the way in which aspects of the economy, like savings and investment, might be influenced by how major blocs of countries are aging earlier or later than others.

The IMF has already started, in its annual surveillance discussions with member countries, to do some analyses of fiscal sustainability that look at long-term fiscal dynamics. These have related mostly to demographic issues rather than a broader composite of possible developments. I also believe that other multilateral institutions—the World Bank, the World Health Organization, the United Nations, the UN Environmental Agency—have a responsibility to take a long-term view in their assessments of global trends and to push hard for greater public awareness of their implications.

We in the IMF could also do more. For example, in our public assessments of fiscal transparency practices, we could underscore more strongly that countries, as a matter of course, must explore and assess alternative long-term fiscal scenarios and carry out long-term risk assessments of their balance sheets. In our research, we could pursue some of the more sophisticated techniques of economics that try to gauge the effects over time of demographic trends and large external shocks, such as climate change.

IMF Survey: If quick or one-shot fixes are unlikely, are there smaller, more feasible steps that could help build momentum for broader reforms?

Heller: Addressing long-term issues requires a multi-pronged strategy. The first thing is to build a long-term focus into the way in which budgets and fiscal frameworks are constructed. That means carrying out analyses of long-term trends and doing scenario analyses; it would also be desirable to apply more sophisticated techniques to assess the probability of more adverse outcomes. These long-term projections and assessments should become annexes of the overall budget documentation.

It means getting away from thinking only about stable, linear scenarios and focusing also on the possibility of adverse shocks and their fiscal consequences. What would be the consequences of several adverse scenarios occurring in a roughly similar time frame? How would we address such situations, and what would be the impact on the fiscal framework?

The challenging question you raised earlier was “how do you make governments think about these things?” Another policy approach involves, essentially, institutionalizing an independent perspective on the long-term fiscal situation. I have already argued that budget laws should require governments to prepare long-term scenarios. I believe that it is vital to have some kind of independent national mechanism (perhaps analogous to the U.S. Congressional Budget Office) to evaluate the long-term assessments that a government makes. Such a body should raise questions and force debate on whether governments have adequately addressed significant future risks and challenges.

I also believe that fiscal rules, such as the euro area’s Stability and Growth Pact (despite its shortcomings), have a very beneficial role to play because they can implant some fiscal discipline in a government, reducing public debt ratios substantially over the long term. Finally, there is no substitute for detailed assessments of how expenditures will evolve over time, taking account of long-term structural factors. When a particular program is likely to become a source of fiscal pressure over the long term, policy reforms to affect the likely time path of expenditure are warranted. We have already begun to see such pension reform initiatives in a number of Western European countries.

IMF Survey: With regard to demographic and other changes, isn’t it fair to say that developing and industrial countries will be confronting different problems with different causes and solutions?

Heller: We all know about the aging populations in industrial countries, but less attention has been paid to demographic trends for emerging market economies and developing countries. Most emerging market economies are likely to confront the same demographic trends as industrial countries, only lagged by about 15 to 20 years. We will see the graying of the populations of China, Thailand, Singapore, Taiwan Province of China, and Korea within a couple of decades. Even developing countries are going to see a fairly significant increase in the share of their elderly. You won’t see 30 percent of the population over 65, but you might see the share of this age group grow from 3 percent to 10 percent—still a low number, but with significant economic effects. Another major demographic change is that while populations are going to be stabilizing, if not shrinking, in much of the industrial world and China, populations will continue to grow in Africa, the Middle East, and parts of south Asia. This will be reflected in a significant youth bulge. Creating jobs will be an enormous challenge, and the risks of failure are high.

IMF Survey: Is there scope for greater cooperation and potentially complementary solutions? Or will two different sets of priorities simply exacerbate tensions between the two groups of countries?

HELLER: Industrial countries risk dampening the pace of global economic growth if they fail to tackle the fiscal issues associated with aging populations. This would adversely affect developing countries. One obvious point of cooperation would be for industrial and developing countries to narrow their prospective outstanding primary fiscal gaps. Also, industrial countries have shrinking and aging labor forces, while many developing countries have very young populations. It would seem there is obvious room for cooperation through migration (both real and virtual!) from developing to industrial countries. This is inevitable. Borders are porous, especially in Europe and the United States, so the question is how to facilitate migration in a way that addresses the needs of both developing and industrial countries. The more that these countries can work together on how migration takes place, the better off we’ll all be. We are already starting to see calls for a more coherent policy framework for managing migration.

Another potential area of cooperation would involve strengthening the capital markets of emerging market economies and developing countries. The IMF has focused on this issue in the past several years. If we can promote and facilitate flows of capital to these economies where there is the potential for higher rates of return on investment, we’ll all be better off. It’s a win-win solution. But it requires far greater strengthening of governance in the capital markets of these countries to mitigate and reduce the risks investors now face.

Industrial countries risk dampening the pace of global economic growth if they fail to tackle the fiscal issues associated with aging populations.

—Peter Heller

Addressing global disparities in income is a third area of cooperation. Industrial countries and their populations can lose only if massive income disparities persist in 15 to 20 years. Large parts of the world where people are desperately poor will be a source of global instability. It’s very shortsighted of us not to recognize that the greatest risks we confront are these sources of political instability, which foster terrorism and disruptions to economic activity. A scaling up of official development assistance is long overdue.

Beyond promoting development in the poorer countries through mutually beneficial investment, there’s an equal imperative for industrial countries to promote solutions to long-festering political crises. This means the Israeli-Palestinian conflict, the India-Pakistan dispute over Kashmir, and the North Korean situation. One can also foresee potential tensions associated with the scarcity of water in the Middle East, south Asia, and elsewhere, as well as competition for oil resources in the South China Sea and the Caspian region. The world community must address these issues. The events of September 11 and the SARS epidemic showed that problems arising in one region can quickly have global economic ramifications.

Finally, climate change is something that we’re all very aware of. The Intergovernmental Panel on Climate Change has provided reasonably conclusive evidence that it will happen—affecting precipitation patterns, the sea level, and the frequency and impact of extreme weather events. There is a small probability that such changes will occur abruptly rather than gradually over the century. Industrial countries could sponsor research and development to narrow existing areas of uncertainty on the dimensions of climate change and to develop new technologies that will facilitate adaptation and prevent excessive costs from being borne by affected countries.

IMF Survey: Should developing countries worry about fiscal burdens that will not arise until the distant future? And, if so, which issues are particularly important?

Heller: Developing countries should think now about the long-term challenges they will confront. How much? For the poorest countries, I accept that the highest priority should be to increase per capita incomes as fast as possible. But that still doesn’t let them off the hook of thinking about potential long-term challenges, which will obviously differ depending on the demographic and geologic environment. For some countries, for example, there may be a large payoff to adapting to foreseeable long-term climate trends. They should be investing in research and development in new varieties of crops that are resistant to reduced precipitation or creating incentives for populations to shift from agricultural regions that are going to be adversely affected by climate change.

Clearly, too, developing countries should explore preventive steps. Large coastal cities are likely to be vulnerable to extreme weather events and a rise in the sea level. This suggests the need for policies to discourage further coastal infrastructure development and to encourage infrastructure and population settlements in less exposed areas.

Thinking long term is also likely to require a stronger emphasis on human capital development because it can increase a country’s options for economic development. It also argues for taking account of the experience of industrial countries and learning from their mistakes, such as in the area of social insurance systems. This means being aware of how demographic change can alter the financial viability of a policy program and the dangers of excessive precommitments of budget resources.

IMF Survey: Are you optimistic or pessimistic about the future?

Heller: That’s a very difficult question to answer. There’s much to be optimistic about. We certainly have, today, a far greater capacity to look ahead and identify the big trends on the horizon. Our scientific capacity and data available are extraordinary. We also know that many of the challenges we face can be addressed if the political will is present. Put all those things together, and there are grounds for optimism.

But there are also obvious grounds for pessimism—take, for example, the events of the last couple of years. There’s political disorder in many regions, growing disparities of income, and the prospect of large parts of the world remaining in a kind of “fourth” world state—not privy to the medical care or technologies available even in middle-income countries. There are many uncertainties of climate change that are scary, and we have to worry about them. The myopia of politicians and the public with respect to long-run challenges is also worrying, as is the prospect of a shortsighted, graying electorate. All these issues can make one very pessimistic.

But, on balance, I would rather dwell not on optimism or pessimism but on the stance we take in approaching the future. In working for the international community, I have cast my lot with trying to promote an intelligent response to future challenges.

The myopia of politicians and the public with respect to long-run challenges is also worrying, as is the prospect of a shortsighted, graying electorate.

—Peter Heller

Copies of Who Will Pay? Coping with Aging Societies, Climate Change, and Other Long-Term Fiscal Challenges are available for $28.00 from IMF Publication Services (please see page 325 for ordering details).

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