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Ottawa, April 26, 1995
1995-037

Notes for an address by the Hon. Paul Martin, Minister of Finance, before the IMF Interim Committee

Washington, DC
April 26, 1995

Delivered text is official version

The fiftieth anniversary of the Bretton Woods institutions has stimulated much reflection on their past record. More importantly, it has also generated careful examination of their continued ability to adapt to a rapidly changing global economy.

The Bretton Woods institutions have not stood still over the past 50 years. They have grown and evolved in response to a long list of challenges -- postwar reconstruction, decolonization, the collapse of the fixed exchange rate regime, the oil price shock, the debt crisis, the end of the Cold War.

They have been pillars of an economic multilateralism to which Canada has always been and remains fully and enthusiastically committed.

Canada will have the honour of hosting this year's economic summit in Halifax in six weeks' time. We look forward to using that occasion to further the examination of our structures for international cooperation to ensure that they are ready to meet the challenges that lie ahead into the 21st century.

I will focus first on how we can better equip the IMF to meet those challenges.

Since the IMF's founding, the global economy has become much more highly integrated and we each have a greater stake in developments outside our borders. Capital market liberalization, technological change, and financial innovation have changed the nature of international financial markets.

These developments have produced great benefits but they entail risks -- in particular, the turmoil that can result from sudden changes in the direction of financial flows.

I heard first-hand of the problems that erratic capital movements create, particularly for developing countries, at our recent APEC meeting. Clearly, for some of these countries, staged liberalization of capital account transactions may be appropriate.

More broadly, the recent turbulence in capital markets, most dramatically in the wake of Mexico's financial crisis, demonstrates yet again the need for a reconsideration of the adequacy of international financial structures and macroeconomic policies.

On the international plain, there are some concrete measures we can take to strengthen our capacity to adapt.

The IMF is the central institution responsible for international surveillance. For this reason, measures to strengthen our collective "early warning system" will first and foremost involve improvements in Fund procedures and policies. In particular, we need more critical analysis from the Fund, including a direct and frank appraisal of exchange rate issues.

Recent developments have revealed that problems in even a single country can have international repercussions. Therefore, steps to enhance IMF surveillance must apply equally to all countries coping with problems that could have systemic implications.

In this respect, I support fully the very recent changes in Fund practices and policies aimed at strengthening surveillance and better identifying potential problems before they arise.

I particularly welcome the steps that are being taken to encourage members to provide standardized and timely economic data.

Surveillance cannot be effective without the rapid dissemination of reliable information on recent economic developments.

Improved transparency will also help to reassure markets and help them work better, and effective markets are the best means of preventing crises. For this reason, I would favour publication by the Fund of a list of countries that satisfy minimum statistical standards.

I also believe that the IMF, as a core element of its confidential surveillance activities, should not hesitate to propose changes to a country's exchange rate system, or the level of its exchange rate, when a continuation of current policies would lead to an unsustainable current account deficit.

But however much we improve the Fund's policy advice and its capacity for giving an early warning, we have to recognize that no system is perfect and we will still have to be ready to deal with crises should they occur.

The increasing integration of global financial markets means that events can now move very quickly. For this reason, we need to improve existing procedures so that quick decisions can be taken.

This will involve strengthening both internal management and governance by Fund members. Fundamentally, we need a collective surveillance of each others' economies and policies. We cannot sit back and expect the Managing Director to carry the full burden alone. We will also need to review the adequacy of current Fund arrangements and its financial resources.

We will need to rigorously examine the role we would like the IMF to play in the years ahead in order to better assess its future resource needs.

A quota increase is one option. We also need to establish whether the Fund might be better positioned to respond to demands for additional resources through possible new borrowing arrangements. A revision of the GAB (General Arrangements to Borrow) and possible direct market borrowings could also be explored.

Our review could also include a study of the future role of the SDR in the international monetary system.

The Managing Director has proposed that continued Fund involvement in low-income developing countries, particularly those with protracted multilateral debt problems, could be supported by making the ESAF (Enhanced Structural Adjustment Facility) permanent and self-sustaining. In this context, I support the proposal submitted by Chancellor Clarke that a small amount of the IMF's gold reserves be sold.

We must continue our examination of these important issues in order to better prepare the Monetary Fund to meet the challenges of the future. In this context, I believe it is necessary to give fresh impetus to the Interim Committee and the Development Committee, perhaps by amalgamating them, in order to promote dialogue and ensure better leadership.

With respect to macroeconomic policy, there is an international consensus on the measures needed to enhance our long-term prosperity and expand job creation.

We can take some satisfaction that our policy course in recent years is providing a payoff. Prospects for sustainable growth in both industrial and developing countries are better than ever. But we must persist with appropriate policies. Deficit reduction must remain a top priority.

By using the recovery to reduce borrowing and stabilize our public sector debt, we address two linked goals: creating the conditions that will help extend the current recovery, while also strengthening our ability to cope with future recessions. Lower deficits will free up private sector savings to finance productive investment.

We must also recognize another fundamental fact: the best way of prolonging the recovery is to prevent inflation from re-emerging. Vigilant monetary and fiscal policies will also help reduce financial market volatility.

Structural reform is the third area in which we must not waste the opportunities provided by this recovery if we want to maximize our potential to create prosperity.

In a world of accelerating change, it has become increasingly clear that growth by itself, however robust, no longer guarantees low unemployment. We want to improve the efficiency of labour markets and help our people embrace new technology. This is the only route to better standards of living.

These three elements -- fiscal consolidation, inflation control, and structural reform -- summarize quite nicely the policy approach we have adopted in Canada.

Previous Canadian governments for years tried to address fiscal deficits with long-term strategies that delivered little success. We have taken a different approach to setting Canada's public finances on a sustainable footing. This has meant setting firm, rolling two-year deficit targets and then doing whatever was necessary to meet our commitment. Given Canada's past experience, it is easy to understand why some observers were concerned that unexpectedly high interest rates over the last year would mean that we would miss our fiscal targets. But our budget actions have proved that we will accept no failure in delivering on our promise.

The federal deficit for 1994-95 should come in at $1.8 billion below our target - even after substantial new charges tied to our program to restructure government operations. And in our February 1995 budget, we took the tough action needed to counter-act the pressure of interest rates on our debt charges, and ensure that the deficit will be cut to no more than 3 per cent of GDP by 1996-97 and - just as importantly - will continue to fall thereafter. In fact, in 1996-97, our government's financial requirements (new money we will have to borrow on financial markets) will be down to $13.7 billion, or 1.7 per cent of GDP, compared to well over 2 1/2 per cent in the United States.

How we are cutting the deficit also reflects our policy approach and commitment to economy building. We chose expenditure reductions over revenue increases by a ratio of $7:$1. We are reducing government program spending - all operations except debt charges - to a level (relative to the economy) lower than at any time since 1951. And our budget planning is based on extremely prudent economic assumptions, and includes sizable contingency reserves. So even if rates are higher than we forecast and our growth lower, we will still meet our deficit targets. In contrast, if Canadian growth conforms to the more optimistic private-sector outlook, our deficit will fall even faster.

But our deficit targets are just the beginning. We will continue to set firm, short-term deficits goals until the deficit is erased.

Canada is also taking steps to ensure that inflation stays well under control, because we know that following every inflationary "boom" comes a recessionary "bust".

Canada is currently experiencing the best inflation performance in 30 years: inflation is well within the 1-3 per cent inflation target established jointly by the Bank of Canada and the Government. We intend to keep it there. One of my first acts on becoming Minister of Finance was to reaffirm and extend these targets together with Governor Thiessen.

Structural reform is the third area where we in Canada are determined to use the recovery to make progress. As I mentioned above, fiscal responsibility demands that the role of government be reviewed. We have done that, starting by setting out clear principles on what government can do, and what it can not. We applied these principles through a government-wide program review, and implemented the result in the 1995 budget.

But our approach is not one of blindly reducing the size of government simply to save money. It also demands making government smarter and better able to maximize the long-term prosperity of Canadians.

This is why we have dramatically reduced subsidies to business. We share the growing international consensus that the best way of ensuring a vibrant and entrepreneurial business climate is not some set of government subsidies, but an environment of stability and predictability that lets the private sector do what it does best - create wealth.

We are also acting on labour market reforms. One of the major findings of the OECD Jobs Study, completed last June, was that government social assistance policies, though well- meaning, can sometimes contribute to unemployment and dependency.

We in Canada are addressing this challenge. We will be overhauling the unemployment insurance system as part of our broader social security reform - putting the emphasis on active help to get Canadians back to work, rather than just the sort of passive support for the unemployed that can ultimately increase dependence and hopelessness.

Other areas where we are undertaking significant structural change include reforming the fiscal relationship between Canada's federal government and our provinces; and reviewing our programs of support for the elderly, to ensure we can provide a fair and sustainable system of protection.

I also represent Ireland and ten Caribbean countries at this Committee. The same policy approach has paid important dividends in these countries as well.

Despite the difficult questions posed for Ireland's monetary and exchange rate policies by the instability in currency markets, inflation should be controlled at about 2 1/2 per cent in 1995. GNP growth remains very buoyant at over 5 per cent and strong employment growth is making inroads into an unemployment rate, which nonetheless remains too high at 14 per cent.

The challenge for policy in Ireland is to consolidate the structural reforms that constitute the long-term basis for the reduction in unemployment and to secure a sustainable path for public expenditure growth consistent with continuing reductions in the public debt-to-GDP ratio, which is expected to fall by some 5 percentage points this year.

In the period since the last meeting of the Interim Committee, the Caribbean countries that I represent have persevered with the challenge of creating conditions for more rapid and sustainable growth. The countries of the area have continued to pursue responsible monetary policies, particularly in the context of the collective monetary regime of the East Caribbean countries, and thus have experienced stable exchange rates. Some of the countries that I represent have made considerable progress in strengthening public finances, although others still have some way to go in reducing or eliminating fiscal imbalances. Further progress has been made in structural reform, although governments recognize that these reforms must in general be extended and deepened in order to enhance the efficiency of their economies and the prosperity of their citizens.

Many of these countries face special challenges owing to their special vulnerability as small economies with narrow resource bases. For instance, the fiscal and external positions of the Windward Islands came under strain in 1994 from unfavourable developments in the production and marketing of bananas, their main export crop. There are concerns elsewhere in the region over possible restraints on textile exports.

The Caribbean countries, with technical support from the Fund and other agencies are continuing to improve the institutional framework for fiscal and monetary management, particularly in the context of the fragile revenue base of the East Caribbean countries, and in view of capital surges experienced elsewhere in the recent past. They welcome the arrangements being pursued with the IMF to improve statistical systems and strengthen tax collection and expenditure control procedures, and to rationalize the structure of public services in the region in co-operation with the World Bank.

Let me turn from developments within my own constituency to the broader international arena.

Recent experience both among economies in transition and developing countries demonstrates the global relevance of the policies that we espoused in Madrid.

In the economies in transition, it is becoming increasingly clear that taking resolute action early on to reduce budget deficits and inflation is essential to generate the domestic savings and investment necessary for economic renewal and sustained growth.

This is borne out by hard evidence. Those countries that put into place bold and ambitious stabilization policies have already begun to reap the benefits of stability in the form of rising standards of living. But those that tried to delay adjustment are still experiencing falling GDP.

It is also quite clear that economic reforms must not only be broadly-based if they are to be sustained, but must also address social aspects of the transition. We cannot ignore the human issues these nations must confront in the process of dramatic, rapid -- and often painful -- change. Addressing the basic needs of the population in countries in transition is perhaps the most difficult aspect of the reform process.

Turning to the developing countries, many of these countries have experienced strong growth over the last few years following their adoption of policies consistent with macroeconomic stability and improved resource allocation.

Although developments in Mexico -- and the spillovers to other developing countries -- have slightly dampened broader prospects over the short-term, the longer-term outlook remains encouraging.

From my perspective, the Mexican financial crisis and its aftermath underscore the speed with which macroeconomic imbalances can arise, and the difficulty of foreseeing potential difficulties.

In this respect, the best way for any developing nation to avoid problems is to always maintain appropriate policies, including sound public finances, a low and stable rate of inflation, and a competitive exchange rate. It is also important to remove structural impediments to efficient resource allocation, strengthen domestic savings, deepen financial markets and increase transparency, and thus improve the sustainability of foreign investment flows.

In closing, I believe that world economic conditions demonstrate the wisdom of the policy prescriptions that we in Canada and we in this Committee have been urging. But much remains to be done -- domestically and internationally -- if we are to sustain recovery and minimize the impact of the next downturn. And it is clear that one of our most compelling priorities must be to continue to work together - emphasizing cooperation, innovation and imagination - to ensure a positive evolution of our international institutions to meet the needs of the global economy.