The IMF would like the EU to please get a move on

In Berlin last week, the IMF’s number two, Gita Gopinath, delivered a punchy speech on Europe’s position in a fragmenting global economy. I was at the same event, and caught up with Gopinath on the sidelines to ask about the prospects for the global economy and follow up on the recommendations she made for the EU. Read on for more about her speech and our conversation. Meanwhile, thanks to all who responded to my call for reactions to the financial engineering proposal for blocked Russian state assets I sketched out last week. Keep them coming!

Gopinath’s speech is worth reading in full, as is the new fund research it draws on. It is not new that the IMF worries about economic fragmentation and protectionism, but it is bringing more information to the table. For example, we know that global trade has recently been stable as a share of global gross domestic product (rather than increasing as it did in the heyday of globalisation). But Gopinath highlighted that trade within politically aligned blocs now grows faster than trade between them. So a stable rate of global trade integration in the aggregate camouflages a splintering into more deeply integrating blocs (as there have been reasons to expect).

The stakes for the EU are particularly large, Gopinath argued, because it is more open than the other big economic regions. But also because it has a unique mix of constituent economies that specialise in either innovation and manufacturing — which allows it to benefit more from that openness. And that also means the EU has a particular interest in safeguarding and boosting open economic relations not just in the rest of the world, but inside its own market. The fund research finds that deeper integration within the EU could boost its GDP by 7 per cent — comparable to the cost the fund has estimated of severe global fragmentation. If we are bound for a more regionalised globalisation, the EU looks reasonably well placed to cope with it.

Hence some much more ambitious recommendations from the IMF than what EU leaders themselves seem able to pursue (see Other Readables, below):

There is ample room to strengthen intra-EU integration. Better harmonizing taxes and subsidies across countries would increase investment in cross-border infrastructure and discourage “state aid” shopping. It is critical to complete the capital markets union and banking union to help mobilize sufficient funding for EU’s enormous climate and digital investment needs and keep the EU globally competitive and at the technology forefront . . . 

Given the externalities from carbon emissions, decarbonization targets should be set at the EU level, rather than at the level of individual members, to make sure efforts are concentrated where marginal abatement costs are lowest across the EU . . . 

To finance these interventions [in such areas as renewable energy, smart grids, and charging infrastructure] an EU-wide central fiscal capacity of a meaningful size can help ensure resources flow to where they have the highest benefits, and not where governments are more able and willing to provide state aid.

I spoke to Gopinath after her speech to follow up on these arguments — as well as to get her take on the global economy. The transcript below is edited for clarity and length.

Martin Sandbu: What are the challenges for the global economy over the coming year?

Gita Gopinath: As we described in October, we have slowing global growth but with diverging parts and countries. For instance, for the US, we had an upgrade. The third quarter, 5.2 per cent is a blockbuster growth rate number for the US. On the other hand we had a downgrade for Europe. So we are seeing this, these differences across the major economies, playing out in terms of the big questions about where everything is headed.

It depends, obviously, on what monetary policy needs to do. We’ve had a few good readings on inflation. But I think the strategy that both the US Fed and the European Central Banks have of not getting too euphoric about a few data points is a good, sensible strategy. We still have tight labour markets both in the US and in the euro area. And there is the question of what might happen with wage growth. Right now, that’s not an area of concern. But these are still tight labour markets.

MS: There has been a lot of discussion about “lags”, how long it takes for monetary policy to hit the real economy. Just today we’ve had downside surprises in European inflation. Are you not worried that monetary policy may be too tight for too long?

GG: You worry if you start seeing a significant increase in the unemployment rate. Are you seeing signs of significant slack building up in the labour market? Then, as a central banker, you would be more worried about this trade-off. [But] they’ve been getting the decline in inflation without much slack in the labour market, which is what makes this a truly exceptional period compared to past disinflations. Now, in the case of Europe, they do have the effects of the energy shock, which is of course generating weaker output. In the case of the US, you have 5.2 per cent growth. It’s hard as a central bank to look at 5.2 per cent growth and thinking: am I tightening too much?

MS: In an op-ed for us, you recently warned against the risk of public debt becoming excessively high. How do you reconcile that worry with the need to invest a lot more, especially in the climate transition, but also in digital transformation, defence, and many other things?

GG: We have countries starting out with record high levels of debt and with projected large spending needs, including the climate transition, defence spending, industrial policy and what you have already in the pipeline with pensions and health. So I think there should be a clear recognition that the amount of expenditure that’s being projected for many countries is quite high. And the point is that it’s important first for countries to decide how much they can do on the spending side in terms of what they can and cannot do. They cannot be the insurer of first resort for all shocks. They will have to take a much more targeted approach to social support in response to shocks.

The second thing is that they will have to make sure revenues are keeping up with expenditure needs. Now, not all of it, because there are obviously some investments that will generate their own revenues through higher growth. But still, there is a bit of a lagging effect between revenues and investments. There’s a lot more that needs to be done in terms of raising revenues. Get the [global] corporate minimum tax implemented. There’s a lot more in terms of loopholes, capital gains taxes, property taxes — fix those.

We are in a political environment where nobody wants to cut spending or raise taxes. And that is a particularly difficult cocktail. We are no more in this space where the central bank is buying government debt [so] interest rates are going to be higher [and] more sensitive to government deficits than they have been in the past. It doesn’t mean that you don’t undertake the necessary spending, but you have to make sure that your revenues are keeping up with it.

MS: We’re meeting in Berlin, and the German government, of course, now faces this dilemma in a very immediate way because of the constitutional court ruling. What’s your advice to them?

GG: What’s feasible right now is about reprioritising spending and finding new sources of revenue. We do believe that investing in green infrastructure, the green transition, is very important in terms of cutting back on expenditures. We think getting rid of subsidies to fossil fuels is a good saving. On the revenue side, having a higher carbon price will raise revenues. Doing more on property taxes will raise revenues. And of course, if they can push on the structural reforms of the single market, that will help with growth, which will then feed into higher revenues, too.

MS: This is a bigger question for the EU as a whole. And your speech tonight was about the EU’s situation in the current global economic reality. What’s your main message to Europe?

GG: My message to Europe is that Europe is different from the US and China in terms of the risks that it faces and also in terms of the ecosystem it has — in terms of being able to build resilience. Therefore it should really chart its own course in terms of dealing with risks to the supply chain or national security risks — it should do its own thing. It should absolutely continue to advocate for the rules-based global trading system and, importantly, it should protect and deepen the single market.

MS: On deepening the single market, you make some specific recommendations: better harmonisation of taxes and subsidies, carbon abatement set at the EU not the national level, a sizeable EU fiscal capacity. Those are quite big demands, right?

GG: Yeah. Having EU fiscal capacity is one thing. It seems to be difficult at this time. But on the other hand, deepening capital markets union, I feel there’s more momentum there. And the banking union, there’s more momentum there. So those are places also that would help. Deepening the single market through capital markets union would be terrific.

MS: But to be clear, you’re telling EU policymakers to do a lot more than they’re doing now. It’s a big leap.

GG: Yes, absolutely. So, for instance, in the whole discussion on the EU fiscal framework, we like the proposal of the commission. We do think that in addition, it would have been good to have an EU-level fiscal facility like a climate investment fund and also having a stronger EU level enforcement mechanism for fiscal rules. Those would be two things that we would add to it.

MS: And how do European policymakers respond when you make these recommendations?

GG: I think it’s a difficult one.

MS: Just to finish another difficult one, what do you think would happen if the US and Europe confiscate Russian central bank reserves?

GG: It’s a good question. The IMF has a policy of neutrality, which has implications of what we can say on these kinds of questions. What the implications could be for the international monetary system is, of course, something that we always look into whenever there are any actions of this kind. But this is not an area where we’re directly involved in.

MS: OK. Thank you so much.

Other readables

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Source: Economy - ft.com