Transcript of the Press Conference on the Release of the Analytical Chapters of the April 2016 World Economic Outlook Made
Gian Maria Milesi-Ferretti, Deputy Director, Research Department
Oya Celasun, Division Chief, Research Department
Romain Alexandre Duval, Adviser, Research Department
Luis Cat?o, Sr. Economist, Research Department
Davide Furceri, Economist, Research Department
Olga Stankova, Sr. Press Officer, Communications Department
MS. STANKOVA: Good morning everybody, and good afternoon to those who are watching us on line from various places in the world. Welcome to the press conference on the release of the analytical chapters of the World Economic Outlook: Chapter 2 is entitled “Understanding the Slowdown of Capital Flows to Emerging Markets”, and Chapter 3 is “Time for a Supply Side Boost, Macroeconomic Effects of Labor and Product Market Reforms in Advanced Economies.”
At the table, we have the lead authors of the analytical chapters. To my right is Romain Duval, who is the lead author of Chapter 3. To his right is another lead author of Chapter 3, Davide Furceri, and to his right is the lead author of Chapter 2, Luis Cat?o. We also have with us Oya Celasun who is Chief of the World Economic Studies Division, and Gian Maria Milesi-Ferretti, Deputy Director in the Research Department, who oversees the production of the World Economic Outlook.
Chapter 1 of the World Economic Outlook will be released on April 12 and you are most welcome to join the press conference on the release.
I will now we give the floor to the lead authors of the chapters for their introductory remarks and then we will take your questions.
So please, Romain.
MR. DUVAL: Chapter 3 is about the macroeconomic effects of labor and product market reforms in advanced economies. There are two main reasons why we did this chapter and why we think it's highly topical.
The first one is that, as you know, the continued weak growth in advanced economies and shrinking macroeconomic policy space have led policy makers to increasingly emphasize structural reforms. And high on this agenda are reforms aimed at strengthening the functioning of products and labor markets, which are exactly the focus of this chapter. And the second reason why this is a highly topical issue is that we actually know fairly little about the short to medium-term effects of these reforms.
There is one view according to which reforms could boost confidence and strengthen expectations and thereby raise aggregate demand. But on the other hand reforms may take time to pay off and in the short-term they might trigger wage and price deflation, and thereby weaken aggregate demand. These two views have been held in the debate and we take in this debate in the chapter.
To do this we actually collected new data covering four decades of major reforms in advanced economies and we use new techniques to analyze them. And here are our four main findings. The first main finding is that product and labor market reforms actually do pay off. They raise output and employment in the medium-term. So they warrant further efforts, particularly in many euro area countries and, for example, Japan. That said, in the short-term their contribution is likely to be more modest because they take time to pay off, especially when carried out under weak macroeconomic conditions.
And that brings me to the second findings, which is that macroeconomic conditions do matter for the short-term effects of some reforms. For product market reforms this is not the big issue because they do appear to pay off regardless of the macroeconomic environment under which they are carried out. If you remember the big waves of liberalization that we saw, you know, in air transport or telecoms in the '90s, they led pretty much everywhere to large increases in output, productivity, and improvements in quality of service. But for labor market reforms, macroeconomic conditions do make a difference. Some labor market reforms actually have bigger payoffs when they're carried out under weak macroeconomic conditions. This includes cuts in labor taxes, increases in public spending on active labor market policies. And the reason is that these kinds of reforms usually entail some form of fiscal stimulus, which is more valuable in bad times. But some other reforms, notably reforms of employment protection legislation and unemployment benefit systems, while expansionary in good times can become contractionary in bad times.
And that brings me to the third finding, which is a very important finding, namely that there's a role for complementing structural reforms with macroeconomic policy support. That includes fiscal stimulus wherever space is available and strong medium-term fiscal frameworks are in place. Such stimulus can amplify the short-term gains of some reforms and it can alleviate the short-term cost of some others, the others begin again reforms to employment protection legislation and unemployment benefit systems that I've just mentioned.
And, finally, we think that privatization and sequencing of reforms can also enhance their short-term payoff. Reforms that involve fiscal stimulus would be most valuable at the current juncture given persistently weak macro conditions in a number of advanced economies. So again that would involve cutting labor taxes, increasing spending on active labor market policies. And product market reforms should also be prioritized because, as I've mentioned earlier, they pay off regardless of the macroeconomic conditions under which they're carried out and therefore should be prioritized as well.
MS. STANKOVA: Thank you. Luis please.
MR. CAT?O: Thanks. Good morning. I'm one of the lead authors for this chapter. Rudolfs Bems, who is a now a in Japan is the other leading author.
This chapter of the Spring WEO, chapter two, looks at the causes of slowdown in capital flows to emerging markets. It's always a good idea to actually keep track of what happens to capital flows in emerging markets given the role that capital flows have played historically in growth and also in generating macroeconomic challenges for emerging markets. So the topic is very topical right now.
The chapter's analysis is based on quite a wide coverage of emerging markets -- more than 40 countries are covered -- and seeks to answer basically three sets of questions. So the first question is what are the main facts behind the slowdown in recent times: when did it actually start, how broad based it is across regions, and to which extent the decline in net inflows to emerging markets have been accounted for by outflows, that's to say money moving out of emerging markets, and inflows, that's to say foreigners buying assets in emerging markets. So, we do this decomposition in the chapter.
The second set of questions have to do with what drives those flows. We look at the broad range of macroeconomic variables and ask ourselves to which extent one or two or three variable account for most of the flows, which are the important variables to look at.
And the third set of questions pertains to a very important fact that the chapter documents, which is that at this time the capital flow cycle has had a bit of a different impact on emerging markets in the sense that the incidence of debt and financial crisis has been so far a lot lower than in previous cycles. So we ask ourselves why, and then we do a quite in-depth analysis of the factors behind these contrasts.
So as for answers, we find first that the slowdown in net capital inflows actually started in earnest from the peak following the global financial crisis in 2010, so has been by now quite prolonged. All regions have been affected. About three-quarters of all emerging markets covering this broad sample I have mentioned have been affected. So it's not really a matter of one, two, or a handful of emerging markets; it's quite broad based.
And thirdly, both the weaker inflows and stronger outflows have played a role. Now, one important fact that the chapter documents, and it's a novelty relative to what we have seen in the literature, is the fact that outflows this time, that's to say residents parking money abroad, has been an important factor behind these dynamics. So we document that.
As to the second question about the main drivers, so the main driver, by far the most important one, are the growth prospects in emerging markets which are slowing down relative to advanced countries. So we look at the broad range of factors you can read in the chapter, and then this one emerges as the most powerful.
Now, as to the third set of questions, which is what accounts for the difference this time in terms of the lower incidence of debt crisis, we actually come up with three main factors. One of them is that emerging markets this time, relative to old cycles like the sort of the downturn of the 1990s and the big downturn in the 1980s, are more integrated on the asset side to the world economy. Especially, they have higher foreign exchange reserves and this plays an important role in buffeting the cycle, the global cycle. Another important factor is that there is less of the so-called original sin. That's to say less debt denominated in foreign currency. So this is quite important for actually lessening the vulnerability of emerging market fluctuations in the values of their exchange rates.
And relatedly many emerging markets have now adopted more flexible exchange rate regimes. So this combination of less original sin and more flexible exchange rate regimes has been very instrumental in allowing orderly currency depreciations that are very much in contrast with the kind of abrupt depreciations that we've seen in the 1980s and the 1990s and can actually contribute to big debt crises and financial distresses.
So the key takeaways of these analyses are that countries are not simple bystanders in the global financial cycle, that's to say policy choices matter. Also, within that, the chapter provides extensive economic analysis of three factors which are important. One is that if you have prudent fiscal policies, that's to say lower debt, better managed debt, including with less original sin, you are less vulnerable to the global financial cycle. If you have higher reserves and manage sensibly your foreign exchange reserves, you are more resilient to the global cycle. And no less importantly, exchange rate flexibility emerges as a very important policy factor, a policy framework or a policy choice that actually limits the vulnerability of emerging markets in the global cycle.
All in all, the fact is that this time around the greater resilience of emerging markets to the capital flow cycle has much do to policy choices that are paying off. Of course there is more to do and one fact that emerges from this is that if there is policy upgrading, emerging markets do more of these things, improve further their policy frameworks, one would expect even more resilience to the global financial cycle moving forward.
MS. STANKOVA: Thank you, Luis. And now we will take your questions. Please introduce yourself and your affiliation when asking question.
QUESTIONER: Luis, if we can just start with you and then, Romain, if I could ask you a question as well.
The question of less original sin, has it fallen to a point where it is no longer a significant vulnerability for emerging economies, both at the sovereign and at the corporate level? I'm just trying to understand that. In the paper you talk about a reduction of 20 percent from the level in the 1990s when almost all the debt was essentially the subject of original sin.
Romain, the second questions, one of the things I'm trying to square here a little bit having read your chapter and having listened to Madam Lagarde and others from the Fund talk about the need for structural reforms here, and I see the qualified yes to your overarching question, is it time for a supply side moment here. I wonder if you can just tell me whether this should be seen by policy makers as somehow being a cause for being more cautious about structural reforms, or it might help explain some of the caution that we're seeing out there, or the lag in terms of implementing structural reforms in places like Japan.
MS. STANKOVA: Luis, please.
MR. CAT?O: Thanks for the questions. It is an important question. So if you look at the figure 2.14 of the chapter you'll see now that in fact the reduction of original sin is quite substantial and actually began sometime in the late '90s, but really intensified very much in the 2000s. And if you look at that figure, the government debt stock in domestic currency, that is the reverse of the original sin, that increased to about 80 percent in 2010. So it's quite a significant reduction on the public finance aspect of the original sin.
Now as you mentioned or you alluded to, the reduction in the corporate sector has been less intense; however, it’s still quite significant if you look at the panel just down below.
So I’m not saying here, and we arenot saying in the chapter, that it is over. We are just saying that it is actually much less intense than in the past. And this number especially for the public sector, and especially for the public sector of large countries, it is a very substantial reduction.
Mr. FURCERI: Thanks for your question. So indeed the chapter argues that now is a very important time to moving ahead with structural reforms first because there is an urgency, a need, in boosting growth, both for actual growth and potential growth. And second of all because the political environment is conducive to do so.
The qualification of the chapter are linked in part with the analysis, what Romain said, is that indeed a first best strategy will be to prioritizing reform. So as Romain said, product market reforms should be strongly implemented as their effect does not depend strongly on economic conditions. and also in countries where there is fiscal space it would be opportune to complement some labor market reform with macroeconomic policy support.
MS. STANKOVA: Any more questions? Yes, please?
QUESTIONER: You are recommending in your report the reduction of the labor tax wage to achieve labor market reform. Currently Greece insists on rising to meet the program targets. What is more important in your opinion, and what would be a budget-neutral way to achieve labor market reforms?
MR. FURCERI: Let me refer you for a specific question on Greece to next week when the Economic Outlook will be released. Our point is that evidence presented in the chapter is that capital labor tax has an important effect both in the short term and the medium term. Usually these effects tend to be largest in countries where conditions are weak. That said, the chapter also provides evidence that when you do this type of reform in a budget-neutral way -- so, for example, reduce unproductive spending or reforming the tax package. This reform can also pay off both in the short and the medium term.
So again, it’s a general lesson that this is applied to the vigorous finances of advanced economies, but, of course, the exact science of specific reform depends on counter specific political stances.
MS. STANKOVA: Yes, please?
QUESTIONER: Thank you. Recently we did see quite an increase in terms of the capital flow from China in buying foreign assets. People said this has been driven by some concern of the future depreciation of RMD. What’s your comments on this phenomenon? Thanks.
MR. CAT?O: Well, we look at this phenomenon quite broadly in a wide range of countries. And as we document in the chapter, there is a big difference in terms of how much we can explain in terms of inflows versus outflows. In general, econometrically and kind of statistically speaking, it’s much easier to explain why foreigners decide to buy or not to buy your assets than actually residents’ outflows. So I want to say this caveat because when we try to explain outflows, we have to be extremely careful.
And one reason as to why you have to be careful also is because there are two things going on at the same time when it comes to outflows for emerging markets in general. One is the fact that emerging markets are growing. They are becoming richer even though they’re growing more slowly now. So a reason as to why you diversify away is because you want to diversify your portfolio. So it has to do with longer term considerations associated with portfolio composition. So you want to diversify your wealth. So as we become richer and grow, more we diversify. But there is also short-term considerations associated with concerns about macroeconomic vulnerabilities, so these two are together. So it’s very difficult to disentangle one from the other.
So I don’t want to get into specifics about China. I think it is probably best left for the press conference next week. But I’d like to make the general point so that based on this, you can draw your own conclusions.
QUESTIONNER: I’m quoting again to your analysis that political environment is currently conducive to reforms. Given the worries about weak growth, but especially the euro zone the societies as maybe you know are reform fatigued and they lack uniforms. So can you be more specific about which countries there is a first-time political ground for reforms?
MR. DUVAL: We have an analysis in the chapter that looks at what drove reforms, big reforms, in the past or I mentioned in my introductory remarks. And the most robust predictor of reforms is actually weak economic conditions. There are many examples and we are not even referring to the recent global financial crisis and euro crisis. Take examples from the past, Australia in the 1980s and 1990s, New Zealand and The Netherlands in the 1980s and 1990s, Ireland, Germany with the reforms. In all these cases, you either had protracted slow growth or high unemployment or divergence with advanced economies that drove the reforms.
So that’s why we think these current fairly weak economic conditions in a number of euro area countries should be conducive to reforms. And we’ve seen reform action the last few years, so that’s the rationale for this statement.
Now regarding reform fatigue, it’s clear in some countries there’s a risk that reform fatigue could settle in. But our view is really that you should not let reform fatigue settle in and you should press ahead with those reforms so as to deliver job gains and the gains in living standards that all citizens in Europe are looking for. And there’s evidence in the chapter that this is what you can achieve over the medium term if you implement them.
MS. STANKOVA: Right, thank you. And we’ll take a question from online and it’s on Chapter 3. “Your report refers to the importance of lowering the costs and simplifying the procedures for dismissing permanent workers. But in this way the Social Security system will lose resources from this increased flexibility. Why are you not calculating this risk?”
MR. FURCERI: Well, the evidence we find in the chapter is that streamlining and implementing employment protection legislation for temporary and permanent workers can have medium-term benefits in terms of productivity, but also in terms of employment and so on. Of course, there is some reservation that some of the labor market reforms such as this one may have a distributional consequence. One of the analyses that is mentioned in passing in the chapter, but we don’t provide all the estimates, is indeed most of the reforms that are discussed in the chapter won’t deliver any significant distribution of consequence either in terms of product market reform, but also for many labor market reforms including this one.
MS. STANKOVA: Okay. Thank you. Another question from online and this would be on Chapter 2 to Luis. “What could happen that would reverse the trend and lead to emerging market inflows? On the other hand, what kinds of things could trigger a crisis in an economy of outflows?”
MR. CAT?O: Thanks for the question. I thought I had dealt with some of the concerns that are associated with the possibility of crises and so on. So I don’t really have much to add to that. Concerning what’s going to happen to capital flows in emerging markets, I think this is best left again for next week’s conference. What we did in the chapter, as I mentioned before, is that we tried to highlight what factors are important and the factor that’s most important in explaining, explaining quite a bit of it, is the slowing down in growth prospects in emerging markets. So other factors play a role here and there, but they are not as strong systematically.
So very much what’s going to happen to capital flows based on the chapter’s analysis will depend on the growth prospects of emerging markets going forward.
MS. STANKOVA: Okay, thank you. And the next question we have online is probably also for next week’s press conference, but I will acknowledge and list it and maybe you would want to say a few words on the capital flows aspect. “What is the prospect for Brazil in 2016 in the context of the World Economic Outlook and political chapters?”
MR. CAT?O: Thanks for the question. Again it is best left for next week’s country-specific questions. Here we are trying to be as general and as analytical as possible. Thanks.
MS. STANKOVA: Do we have any more questions from the room? If not, then thank you very much for coming. The press conference will conclude at this point and have a good day. Thank you.