Arthur J. Rolnick - Senior Vice President and Director of Research, 1985-2010
Published December 1, 2002 | December 2002 issue
A quick check of the International Monetary Fund's Web site reveals how busy, and complex, Anne Krueger's life has become since she was named the IMF's first deputy managing director last year. One day she's in London discussing the euro and its possibilities for the European economy, the next she's in Moscow conferring about reform measures to ensure continued economic growth, the next she's in Sao Paolo lecturing on the role of sovereign debt restructuring in the prevention of financial crises, and finally she's back home in Washington, D.C., talking about the historical role of globalization.
Communicating ideas, it would seem, is as important to the IMF as establishing funding programs.
Krueger assumed the IMF's number two position on Sept. 1, 2001, just days before the international landscape was fractured by Al Qaeda's terrorist attacks on the United States. This baptism by fire was soon followed by financial flare-ups throughout the world, most notably, perhaps, in Argentina and Brazil. Through it all, Krueger says in the following interview, "[The world economy] has withstood a number of shocks with much less difficulty than I think most people would have anticipated."
From currency boards to moral hazard, Krueger found time to assess many issues that consumed her first year at the IMF, and she shared those thoughts with Arthur J. Rolnick, the Minneapolis Fed's Research director. The issues facing the IMF are often complex and devoid of easy answers, as the following discussion reveals, but Krueger provides a clear description of the choices at hand.
ROLNICK: Let's begin with your views on the world economy. A few years ago when The Region asked Stan Fischer [former first deputy managing director of the IMF] about the status of the world economy, he thought it was doing reasonably well. Since then, the world has had to face some difficult problems. What's your assessment of the world economy today? Is it as healthy as it was a few years ago? Is it moving in the right direction?
KRUEGER: I think so. Indeed, I think it's healthier. Given September 11th and the terrible prognostications that followed, look where things are today; the world economy is in much better shape than most thought it would be. It has withstood a number of shocks with much less difficulty than I think most people would have anticipated. There was a recession in the United States; that should surprise nobody. But it was incredibly mild by standards of past recessions. So we seem be on an upswing and things look pretty good.
ROLNICK: Why do things look so good? In particular, why has the U.S. economy fared so well?
KRUEGER: I think part of the answer has to do with lessons learned from the past. These include our working on crisis prevention, crisis management and various financial stability efforts at both the national and international level, more understanding of some of the issues and more cooperation among countries.
ROLNICK: When discussing the world economy, we often hear the term "globalization." Can you define this term for us, explaining how the economics of the world today is different than it was, say, a hundred years ago?
KRUEGER: Well, I think most people use globalization simply to mean there are more frequent and lower-cost interactions between people who are further removed in distance and, in particular, across country borders. But I don't think it means only that. I think in general just that everybody is much more aware and much more influenced by what's going on elsewhere in the world. Now I'm not sure it's all that different than it was a hundred years ago. In fact, if you stop and think about what it must have been like when the first telegraph wire went through, that must have been much bigger in some sense than the kind of things we see now. But obviously, if you have a process that's continuing and grows and grows and grows, why then people seem to think that what happened most recently is all there ever was. But I think it happened long before that.
ROLNICK: International trade was a key part of this country's economic development at its inception. The colonial economies were dependent on trade with Great Britain and the Caribbean. Indeed, international trade continued to play an important role in our economy throughout the 19th and 20th centuries. So what's really different today?
KRUEGER: All kinds of things. Living standards are higher. Higher living standards mean a much higher fraction of income is spent on things other than basic food and shelter. And the thing about that is those are the goods that are more tradable. And shipping: Until a hundred years or so ago it was difficult to ship anything more than wheat or corn or other bulk commodities, a few spices to be sure for the rich, that was it. Now you have a much broader range of goods that can be traded because there's a much broader range of goods that are used in production and consumption, and many of these traded goods are consumed by people at the low end of the income scale. So part of what is different today is simply that our production structure has changed enormously as a result of economic growth.
ROLNICK: That sounds good for the developed countries. Where do the developing countries stand?
KRUEGER: They gain enormously, too. When they do get their policies in order and decide that they'd like to join the international economy, they can specialize at first in labor-intensive commodity production, which gives their labor force experience, et cetera, et cetera. And it enables them to start moving up the value-added chain after awhile, without trying to start producing semiconductors right away when they don't have four people in the country who can figure out the chemistry of the whole thing.
ROLNICK: Your response is related to an ongoing debate in our profession on the question of why some countries have grown so much faster than other countries. The debate centers on two different explanations. Ed Prescott [University of Minnesota] and others have argued the importance of a country's legal and policy environment, for example, the credibility of its property rights and the openness of its markets to international trade. Bob Lucas [University of Chicago] has argued that while the environment is important, human capital is the critical ingredient. Without the human capital, a country cannot take advantage of technological innovations. Do you want to weigh in on this debate?
KRUEGER: I think it's all of the above. And I think that we've had a lot of efforts in both directions. A single factor explanation simply doesn't tell the story. You can't do it without a legal environment, at least to give basic protection to property rights. And you certainly can't develop very much if you don't have investment in humans, a higher quality human capital. You need to develop all these things, and I think that as one moves away from a subsistence economy, where people were consuming in the village, all these things become more important. And if you don't get them right, they become bottlenecks to further development or at least growth retardants.
ROLNICK: Your position sounds very pro globalization, but as you know there are the critics out there who think globalization is only going to benefit the rich countries at the expense of the poor countries. How would you respond to the critics?
KRUEGER: Well, the statistics are simply against them, and that is the easiest part of the answer. We saw very little change, if any, in standards of living in most developing countries from the beginning of time until the middle of the last century. And since then, we've seen rising life expectancies; we've seen vastly reduced infant mortality rates, rising nutritional standards and greatly reduced illiteracy rates. Then on top of that, you find people voting with their feet. They go where there are more opportunities, and they go where the chances to build a better life are. And so people like it. They live longer, they're healthier, better nourished, better educated. I find it very difficult to be all that convinced that there's something terribly wrong. Now this doesn't say that everybody in every country benefits every day, and whenever you have economic change some people aren't necessarily as well off as they were. But on the whole and over a period of 10 or 20 years, the increase in living standards is so great that the rising tide does in fact take almost everybody with it.
ROLNICK: Critics might still disagree. Even if they concede that ultimately opening up markets is a good idea, economies will face a difficult transition problem. Getting from A to B can be very costly, and maybe you don't even get there without a revolution because too many don't move up the income ladder.
KRUEGER: There's almost no evidence to support that view. I know very few countries where there's any evidence of significantly falling living standards for any significant part of the populationrelatively. I agree the bottom 10 percent of the income distribution may instead of getting 8 percent get 7 or 7 1/2 , but when it gets to 7 1/2 percent of the distribution it may still be double the real income.
ROLNICK: Let's take a specific exampleeconomic reforms of the Russian economy. Critics say the reforms went too fast. I'm not exactly sure what they mean by too fast, but they argue that when you move from a planned economy to a market economy you have to go slowly. It's never clear to me what is wrong with going fast. If we were talking about property rights, a credible legal system, I would think you want to go as fast as you can. However, when you're talking about privatizing state-run companies, there are likely to be periods of high unemployment. Maybe that is why critics want a slower pace of reform. How would you respond to these critics?
KRUEGER: The first part of the answer is that the countries that went faster, such as Poland, did better. So there is already a problem, I think, even with the facts. Secondly, I think there are lots of problems in terms of asking what could you have expected in transition from the old regime to the new one, and we don't know what the best you could have done was. And it's certainly not at all clear to me that going more slowly would have made the pain less; it could even have made the pain more. Now the transition economy situation and the subsistence agriculture situation in the economy, where there has never been very much development, are I think a little bit different. I had more in mind, let's say India in the 1940s where 75 percent or 80 percent of the people were still in agriculture at that time. When you've had kind of an economic development that's of what I'll call an unnatural kind, as happened under communism, and you put a town, there's one factory that hires 10,000 people, there's nothing else in the town, and then you've got all those people, it is obviously going to be more dislocation in changing that than there is in having the oldest son wander off to the city while the parents keep on with the farm. But even so, it's not clear to me. I mean when you are having reasonably free elections in most of Eastern Europe and Russia and so on, and there seems to be not everybody doing better, but very few people are really saying they want to go back to the old regime.
ROLNICK: Consider the history of the South Korean economy. This was a poor country back in the 1950s that adopted free-market reforms; today it is a very successful economy. How were they able to handle the transition?
KRUEGER: Well, they didn't have anything they had to handle. I mean the growth was so rapid that virtually everybody, and I mean almost everybody, benefited. The argument that there are so many losers does not appear to be all that well founded with very rapid growth. In the Korean case there's every evidence the income distribution in about 1980 was at least as equal or was no more unequal than in 1950, and they grew at an average of 10 percent per year for two decades.
ROLNICK: Let's go back to Russia. They didn't start growing very fast. In fact, by some measures of GDP they actually declined for a while. Was that a transition that was too fast or, maybe as you were suggesting earlier, too slow?
KRUEGER: What I'm suggesting is that we haven't in human history had very many economies that have been built up on the command and control principle that then had to be dismantled. And we don't really know for sure what the ideal way of doing it is, but everything that I know of in theory says that as long as people are uncertain as to what property rights are, they're not going to move. As long as people think politically they can fight to protect whatever was theirs, they're going to fight politically and they'll slow down the process. That tells me that fast would probably be better than slowremember there were about six or seven years of great uncertainty as to how things were going to evolve in Russia, and it wouldn't at all surprise me if it wasn't that uncertainty that was responsible for much of what took so long.
ROLNICK: It sounds like you do put a lot of weight on the importance of a credible legal system.
KRUEGER: And credible economic policy and all the rest. In the case of Russia, you don't have to argue the human capital issue because clearly it's a highly educated workforce.
ROLNICK: Let me turn to what has become a controversial issue about the role of the IMF. In this new international environment, "new" meaning more international investors and a greater potential for contagion, some have argued that the IMF should become an international bankruptcy court rather than an international central bank [see the Minneapolis Fed's 1998 Annual Report]. I know you've touched on this issue in some of your recent writings. What do you think of this proposal?
KRUEGER: Well, there are a number of parts to that question.
ROLNICK: Agreed. So let's start with the problem with bailouts, the problem known as moral hazard. Anytime the IMF explicitly or implicitly insures international investors you encourage more risk taking than otherwise. How do you manage this problem?
KRUEGER: But that assumes that investors would not otherwise have been whole. And if you look at countries such as South Korea in '97 or Mexico in '94, they repaid all their IMF and their other debt. There was no loss to investors. So I find it hard to accept the bailout argument. If they had not paid the IMF back, then there might have been something to it. If the IMF lending were highly subsidized, you might find something, but if you don't find either of those, if we simply are a preferred creditor because, indeed, we're lending when marketsfor whatever reasonhave closed to a particular country, then I don't understand where the bailout charge comes in.
ROLNICK: The argument would be that if a troubled economy had to go to the market, it would have had to pay a much higher rate than the IMF rate. Consequently, even if the loan was paid back, it was subsidized.
KRUEGER: But South Korea and Mexico didn't receive low-interest rate loans. The rates the Fund charges are very close to market rates, if not market rates. Indeed, if it's the long-term market rate, I don't have a problem with the notion that almost a test of whether the markets are wrong is whether their interest rates are way above the long-term ratewhich is presumably a risk premium, which if everybody paid back, wasn't bad.
ROLNICK: Are you saying that there are times when the IMF can see that the market is overstating the risk, and the IMF or central banks should intervene?
KRUEGER: Well, central banks have been known to be lenders of last resort.
ROLNICK: Central banks, however, create moral hazard problems when they lend directly to troubled banks that are considered too-big-to-fail, as occurred in 1984 with the bailout of the Continental Bank of Illinois. An alternative way for central banks to manage a systemwide financial crisis that does not cause moral hazard problems is through open market operations.
KRUEGER: Well, Continental Illinois is within the country, so I think that's a bad example to go from.
ROLNICK: My point here is that just as central banks have gotten involved in trying to second-guess the market in the name of preventing a systemwide financial crisis, so has the IMF. And there may be a better alternative than providing emergency loans.
KRUEGER: I think there's a difference in a sense of lending. I guess the analogy would be a company that has a short-run liquidity problem where the creditors, when they reorganize, get all their money back. And I think the issue arises when there are reasons why debt clearly is unsustainable. And that does on occasion happen, and it happens in cases where at the moment we don't have a clear-cut way of solving that particular problem, which is where the discussion of the bankruptcy procedures that you mentioned comes in. And that would be an instance where, for whatever reasons, everybody figures that the country will not, no matter what they do, be able to repay.
ROLNICK: And that would be a reason not to do a bailout?
KRUEGER: That would be a reason to have an alternative mechanism. I mean there are countries whose debt is so high that under any even mildly possible scenario their debt is going to grow without limit because they simply cannot get sufficiently large primary surpluses and growth rates to start lowering the ratio of debt to GDP.
They're going to have to borrow enough to pay the interest, but their debt is going to go up faster than their GDP. And in those circumstances, of course, you've got to do something else. That's where we think we can still further improve the international financial system by finding a better, more orderly, more predictable mechanism for handling those situations. We must, therefore, distinguish between the ones where we're lending into a circumstance where there is a systemwide liquidity problem and ones where there's a more fundamental problem.
ROLNICK: Exchange rate regimes. We haven't touched on them. Do you have a preference for one or the other, fixed vs. floating, currency boards, et cetera?
KRUEGER: Well, I think more and more people are coming to the conclusion that the fixed exchange rate, where you just change the exchange rate when it's no longer permitting a viable balance of payments, is no longer the way to go. And most people are more and more reaching the conclusion that the floating rate regime is the one that has the greater viability in those circumstances, which isn't to say you cannot do a currency board. But if you're going to do a currency board, the fiscal and monetary discipline that imposes is pretty enormous. And if you've got to do that discipline anyway, why bother with the currency board.
ROLNICK: What about pegging currencies? The Europeans have adopted an extreme form of a pegged currency, a single currency.
KRUEGER: But that's a hard peg. That's really closer to a currency board than it is to a fixed exchange rate. Those countries have agreed to the monetary and fiscal disciplines that go with it. And the difficulty comes when someone else fixes their currency but doesn't figure that they've got to accept the discipline.
ROLNICK: You're optimistic about the euro, then, as a system?
KRUEGER: I think the euro, like so many other things in Europe, has been adopted, in part, because there's a political imperative to move closer together. I see no reason why that won't continue.
ROLNICK: Let me turn to some questions about the U.S. economy and the Federal Reserve. The U.S. economy has been very resilient over the last two decades. The Federal Reserve likes to take some of the credit because we've succeeded in engineering a low-inflation environment. Our commitment to this policy appears credible, and it looks like the rest of the world is also moving in that direction. In fact, some central banks have explicit inflation targets. What do you think of inflation targeting?
KRUEGER: I think for Europe, the United States, Japan and the other industrialized countries, how they want to handle their monetary discipline really is a matter for internal policy debate. I think that some of the developing countries, where there has been a history of inflation and where, indeed, bringing inflation down is a major policy priority, then there's got to be some inflation targeting, providing you enter it sensibly and credibly and are committed to seeing it through.
ROLNICK: And you would agree that low inflation is probably what central banks should be aiming for as a long-term policy in terms of promoting economic growth?
KRUEGER: Yes. How low is low is, of course, the interesting question.
ROLNICK: Why do you think the U.S. economy has done so well over the last 20 years? Why has it been so resilient?
KRUEGER: I think a number of factors, including the fact that we moved to a more flexible exchange rate regime has obviously helped. If the United States had stayed on a fixed exchange rate after 1973, the course of economic growth would have been far less satisfactory. I think the American economy as a whole has gotten more flexible as progress was made with deregulation. There is also evidence from labor economists that labor markets in the United States increased their flexibility over time. And all of that helps. Meanwhile, as we move more toward a service economy you don't get quite the indivisibilities of layoffs in the same way that you did in manufacturing, so the inventory cycle is at least somewhat moderated.
ROLNICK: Could you pinpoint one or two factors that distinguish the United States from Japan in the '90s from the list that you just gave me?
KRUEGER: Those wouldn't be the factors. Labor market perhaps, but the factors I would probably pinpoint would be first that the Japanese banking system, as far we know, was not extending domestic credit as would have had to have happened for a healthier economy, and that was quite critical in the Japanese case.
ROLNICK: I would like to address an issue that has concerned Chairman Greenspan: overvalued stock market, speculative bubbles, irrational exuberance. Does the chairman have it right or was this just the normal workings of the stock market trying to figure out how to profit from new technology?
KRUEGER: There's certainly some of that. I mean, having lived in Silicon Valley in those years, there were quite clearly firms that failed and firms that succeeded. There were a lot of bankruptcies that weren't very much noted along the way, which may have led people to be overly optimistic on the success end of it.
ROLNICK: Do you think the Fed has a role here? Should it be focusing its policy decisions on the stock market itself?
KRUEGER: I think until we understand more, it would be dangerous to place too much emphasis on it.
ROLNICK: Economic literacy. You made several insightful comments at our Washington conference in May that we co-sponsored with the National Council on Economic Education [see the September Region] that seemed to imply that economic literacy is very important for our citizens generally. Yet one might make the argument you don't have to know a whole lot about economics to behave like an informed consumer or investor. Why is it so important that we make sure high school students know something about economics?
KRUEGER: Well, I mean there is knowledge that permits intelligent consumption and all that, but even there, there's a bit of economics, as you and I both know, that needs to be known. On the other hand there are a whole variety of citizenship issues, which I think if you're going to run a democracy are pretty important. And it is, I think, perhaps something close to human nature if they see a Volkswagen tootling down an American street to think, there go American jobs. It takes a little bit of economic education to know that the opposite may be true. And I think, in fact, we're seeing something of a buildup in terms of the influence of special interests in Washington and the popular reaction to that. And I think some degree of economic literacy can help in that discussion.
ROLNICK: Do you have a book that you'd recommend to our readers?
KRUEGER: How the West Grew Rich: The Economic Transformation of the Industrial World by Nathan Rosenberg and L.E. Birdzell Jr.
ROLNICK: I've enjoyed our conversation. Thank you, Ms. Krueger.
More About Anne O. Krueger
Awards and Affiliations
Also see Reporting Economics Well, Dr. Krueger's remarks at the 2003 Supply, Demand & Deadlines economics workshop for journalists.