The IMF’s Interest in Inclusive Growth: Promising or PR?

Prakash Loungani Chief, Development Macroeconomics

Research Department, IMF

CIGI

February 19, 2016

VIEWS EXPRESSED ARE THOSE OF THE PRESENTER AND SHOULD NOT BE ASCRIBED TO THE IMF. AN EARLIER VERSION OF THIS TALK WAS GIVEN AT THE IDRC. I AM GRATEFUL TO PARTICIPANTS AT THAT SEMINAR FOR COMMENTS.

Growing Interest in Inclusive Growth

Global interest in “inclusive growth” … … mirrored at the IMF

Definition of inclusive growth

Based on Elena Ianchovichina & Susanna Lundstrom (“What is Inclusive Growth?”, World Bank, 2009)

• Inclusive growth = ‘growth that is broadly shared’ – “it should be broad-based across sectors and inclusive of the large part of the country’s

labor force”

• “inclusiveness – a concept that encompasses equity, equality of opportunity, and protection in market and employment transitions – is an essential ingredient of any successful growth strategy” (Growth Commission)

• In long-run, “productive employment rather than direct income redistribution as a means of increasing incomes for excluded groups”

– “In the short run, governments could use income distribution schemes to attenuate

negative impacts on the poor of policies intended to jump start growth, but transfer schemes cannot be an answer in the long run”

– “for growth to be inclusive, productivity must be improved and new employment opportunities created”

What I add: Maintaining inclusive growth in the face of cyclical fluctuations & crises

Growth

Equity Jobs

THREE (inter-related) COMPONENTS OF IMF’s WORK ON INCLUSIVE GROWTH

Growth & Jobs: Key Messages

Part A. Short-run growth: • Don’t forget “aggregate demand” • Settings of monetary and fiscal policies key for short-run growth

Part C. Long-run growth:

– A more diagnostic approach

– Emphasis on structural transformation

– Realism about the effects of structural reforms

Part B. Short-run employment:

•“Two-handed approach” (don’t forget aggregate demand)

•Short-run link between growth and jobs

Part D. Long-run employment: – Framework for IMF advice on

design on labor market institutions & policies

– (Female) Labor force participation

Part E. Equity: Key Messages

New research findings

– Equity helps durability of growth (Berg & Ostry)

– Redistribution within reason doesn’t hurt growth (Ostry et al)

– Drivers of inequality:

• ‘Austerity’ and ‘(financial) openness’ have increased inequality in the past

• Decline in union density associated with increase in top share of incomes

BACKGROUND SLIDES

Part A: Short-Run Growth Fluctuations

IMF work on Fiscal Policy

• Support for global fiscal stimulus at the onset of the Great Recession

• Fiscal consolidation lowers output and raises unemployment in the short run

• Impacts of fiscal consolidation on output may have been underestimated by IMF and others in the early years of the start of the Great Recession

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How IMF advice on fiscal issues was viewed

during our 2013 Spring Meetings

How the IMF became the friend who wants us to work less and drink more

-- Washington Post April 16, 2013

“It is to the credit of the economists at the Fund that their recommendations to policymakers have adapted to this strange world we’re living in rather than sticking with their more normal, doctrinaire advocacy of monetary and fiscal restraint.”

IMF Renews Push Against Austerity

-- Wall Street Journal

April 17, 2013

“ … the International Monetary Fund called on countries that can afford it … to slow the pace of their austerity measures.”

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Part B: Short-Run Fluctuations in Labor Markets

An old view: getting macro policies right will help labor markets

• “There is sometimes the naïve belief that unemployment must be due to a defect in the labor market, as if the hole in a flat tire must always be at the bottom, because that is where the tire is flat” (Solow, 2000).

• "It takes a heap of Harberger triangles to fill an Okun's gap.” (Tobin, 1977)

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Facts and Diagnosis, 1985

• “[In Europe ] 11.2% of the labor force is unemployed today compared to only 2% in 1970. Long-term unemployment is a large and increasing portion … [There has been] an increase in both the level of youth unemployment and its share of total unemployment since 1979”

• “These are very gloomy statistics. Do they reflect an inevitable new

economic reality, or can employment growth be restored?”

• “… a sharp decrease in aggregate demand is indeed the proximate cause of the rise in unemployment in the EC since 1980. The use of monetary policy to fight inflation and the major shift in

fiscal policy towards "budgetary consolidation", however justified, seem to explain much of the poor growth performance of the 1980s “

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Recommendations, 1985

• “Neither supply nor demand measures will by themselves create and sustain employment growth. This simple point forms the basis of our approach …”

• “Supply measures, without accommodating demand policies, will have little impact on employment and output, at least in the short run … if firms do not see improved sales prospects, they will not increase capacity in response only to an improvement in factor prices … it is essential to make sure that demand is there to sustain supply … [But without supply measures] gains will be temporary at best and may in fact worsen structural problems. Thus, our call for a two-handed approach.”

• “We believe that structural changes on the supply side are more important than wage cuts at this stage, that they require a social compact which may not be feasible if workers are asked to take substantial wage cuts”

• “In summary …What is now needed is a social pact in which supply-friendly measures go hand in hand with a vigorous recovery”

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Fast forward to 2010: déjà vu all over again?

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The ‘Two-Handed Approach’ during the Great Recession: Unemployment and Output

Output and Employment Since the Great Recession

Employment growth since the Great Recession can be explained well by changes in output

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-15 -10 -5 0 5Part explained by GDP growth

y = 1.03 x + 1.03 (Adj. R2 = 0.8)

Spain’s unemployment & employment growth can be explained by fall in output

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Much of increased youth unemployment can also be explained by fall in output

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Jobs-Growth Linkages across Countries: Summary

(group average)

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All Economies (81)

Advanced Economies (24)

Emerging Markets (20)

Other Developing Economies

(26)

Frontier Market Economies (11)

Change Specification Level Specification ( HP 100 ) Level Specification ( HP 12 )

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Making Output-Employment Linkages Part of IMF Staff’s Toolkits

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Part C. Long-Run Growth

IMF’s VIEWS ON GROWTH: CORPORATE DOCUMENTS

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DIAGNOSTIC CHECK: GROWTH

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“The IMF a Convert to Growth Diagnostics”

• “It’s surprising how the language of growth diagnostics and binding constraints springs up in all kinds of unexpected places. The latest example is the IMF’s new report on jobs and growth. The IMF’s analysts say all the usual things about the primacy of macroeconomic stability and fiscal sustainability – no surprise there. But then we get a plea for contextual analysis and recipes that sounds, to this set of ears, at least quite pleasing.

“There is scope,” the IMF says, for: More systematic diagnostic analysis

of the growth and employment challenges and the identification of the most binding constraints to inclusive growth and jobs so as to provide more tailored and relevant policy advice.

• “In bureaucratese, “there is scope” means: “gee, we sort of forgot

about this until now, didn’t we?”

• “Better late than never.”

• Dani Rodrik, April 5, 2013.

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Part D. Long-Run Employment

“IMF view” on Design of Labor Markets Institutions: Blanchard, Jaumotte, Loungani (2014)

http://www.izajolp.com/content/3/1/2/abstract

“Labor Market Flexibility”: Moving Beyond Mantras

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Unemployment insurance (UI)

– welfare improving but possible efficiency cost

– what matters: design of the system

quality of active labor market policies

Employment protection (EP)

– some of it is desirable but too much can be harmful

(lower reallocation, longer unemployment duration)

– dual protection systems have ambiguous effects on

efficiency and welfare

– reduce judicial uncertainty

Micro Flexibility: Two Key Institutions La

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Micro Flexibility

Some countries don’t do it well: low flows, long U duration

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Unemployment Duration

and Employment Protection (months; 1995 – 2007 average)

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• Need for reallocation is greater …

– Rodrik and McMillan (reallocation to higher-productivity sectors

key to growth in developing economies)

• … but also constraints:

– High level of informality

– Fiscal constraints may preclude generous UI

Micro flexibility: How applicable to developing economies?

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Two dimensions

– A low average U rate

– Limited fluctuations in U rate in response to shocks

Key institutions

– Minimum wage

– Tax wedge

– Collective bargaining structure

Macro Flexibility La

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Minimum wage

– Small effect on E or U within a range

– Limited redistributive role

– Redistribution through negative income tax

(combined with ‘low’ minimum wage)

Tax wedge

– Tends to increase labor cost and U (especially in

combination with high minimum wage or UI and if no

deferred benefits)

Level of Unemployment La

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Can Flexicurity Be Exported?

The Importance of Trust

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• Minimum wage

– Difficult issues of appropriate level

– Greater need for it as redistributional tool but perhaps also

greater efficiency costs

• Collective bargaining

– Very low levels in many countries

– Informality

Macro flexibility: How applicable to developing economies?

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Part E. IMF Research on Inequality

IMF Research on Inequality

• Consequences: Inequality lowers the duration of growth spells (Berg & Ostry)

• “Causes”:

– ‘Austerity’ and ‘(financial) openness have raised inequality in the past (Ball, Furceri, Leigh and Loungani; Furceri & Loungani)

– Decline in union density has raised share of top incomes;

increases in minimum wages have lowered the top share (Jaumotte & Osorio-Buitron)

• “Cures” – Redistribution, if not extreme, does not harm growth (Ostry,

Berg & Tsangarides) – Greater care in design of policies (e.g. fiscal consolidation

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Distributional effects of ‘austerity’

Ball, Leigh and Loungani, “Painful Medicine,” Finance & Development, September 2011

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Impact of ‘austerity’ on the Gini

Ball, Furceri, Leigh and Loungani, “The Distributional Effects of Fiscal Consolidation” IMF Working Paper, June 2013

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Impact of ‘openness’ on the Gini

Furceri and Loungani, “Capital Account Liberalization and Inequality” IMF Working Paper

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Impact of ‘openness’ on the Gini depends on financial depth

Furceri and Loungani, “Capital Account Liberalization and Inequality” IMF Working Paper

IMF

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Baseline

Low Financial Deepening

High Financial Deepening

Impact of ‘openness’ on the Gini depends on whether opening is followed by a crisis

Furceri and Loungani, “Capital Account Liberalization and Inequality” IMF Working Paper

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Baseline

No crises

Crises

THANKS!