Combating the Rise of Inequality

Benedict Clements, co-editor of an IMF book on Inequality, discusses “one of the defining issues of our time”

Inequality is at the forefront of the economic policy debate today in much of the world

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How is the IMF contributing to the debate about rising income inequality?  

On many fronts. First, we are doing new research on the causes of inequality and its macroeconomic implications. Second, we are doing studies on how economic policies and reforms can help countries achieve their equity goals. Our book on Inequality andFiscal Policy is an example of this kind of research.  Third, we are deepening our work on individual countries in the context of our annual consultations with them. 

What’s the importance of this work?

In many countries, achieving more “inclusive” growth—the kind that creates a high number of jobs and does not increase inequality—is a priority.  In this context, policymakers are eager to know the effects of economic policies on inequality and the effects of these policies on economic growth.  As an advisor to countries on macroeconomic and fiscal policies, the IMF has an important role.  In our book, we look at the evidence and provide guidance for policymakers and Fund staff on these issues.  The good news is that there are many reforms that both reduce inequality and boost growth.  Greater use of property taxes to raise revenues and the reform of energy subsidies are two such examples.     

How much has French economist Thomas Piketty’s book fueled this debate?

Piketty’s work has helped draw attention to the issue.  This is just one of many excellent studies that have documented the rise in inequality.  Of equal importance is the work that examines what countries can do to address it.

In your own case, what attracted you to economics and in particular to fiscal issues?

During my college years, I took a trip to Latin America with the Maryknoll Fathers, who work with the poor.  That trip helped show me that economics really matters when it comes to poverty and inequality. I’ve been interested ever since.

Benedict Clements is a division chief in the Fiscal Affairs Department of the IMF. He has worked in the IMF since 1991 and has published extensively on public finance and macroeconomic issues.

Testing the Soundness of Banks

The global financial crisis placed a spotlight on the stress testing of financial systems. Although weaknesses in stress tests were exposed by the devastating 2007-09 crisis, the recent experience of several countries has conversely provided a stark illustration of their potential benefit in examining the resilience of bank balance sheets when performed credibly and transparently. Nonetheless, the large menu of stress testing approaches, methods, and models raises questions about their appropriate application under different situations and, consequently, the comparability and reliability of the associated analyses.


The International Monetary Fund has had a long and detailed involvement in the stress testing of financial systems. Since the introduction of its Financial Sector Assessment Program more than a decade ago, IMF staff have conducted stress tests of banking sectors in over 120 countries, typically in close collaboration with country authorities.

Stress testing is also playing an increasingly important role in the IMF’s multilateral economic surveillance, through the analysis in its Global Financial Stability Report. Separately, member countries are increasingly requesting IMF technical assistance in stress testing as they develop their own expertise in this area. As a result, IMF economists have amassed a wealth of hands-on experience with stress testing techniques and their practical application.

Compendium of models

This book represents a compendium of stress testing methods, models, and tools developed or adapted by IMF staff over the years. Almost all the methods and models that are included in this volume have, at one time or another, been applied in its surveillance of, or technical assistance to, member countries. To guide users, each chapter offers a summary describing the application of a method or model, its strengths and weaknesses, and the data requirements. Where available, the stress testing tools or program codes are also provided for wider public use.

Although this volume will provide a valuable resource for policymakers, supervisors, academics, and private sector participants alike, caveats still apply. The crisis has underscored that stress tests, irrespective of their level of sophistication, are not fail-safe, stand-alone diagnostic tools.

Assessments of the soundness of any financial system cannot and should not be based solely on a “model” and must be complemented by other quantitative analyses, qualitative information, and, most important, expert judgment. Especially in light of evolving market practices, risks, and regulatory requirements, stress testing will necessarily continue to be art rather than science.

Ongoing work

Jose Vinals, head of the IMF's Monetary and Capital Markets Departments, says in a Foreword IMF staff are continually working to strengthen the analytical underpinnings of its stress testing, in ways that will help bolster its consistency and comparability and hence its credibility.

Key areas of focus, according to Vinals, include extending the analysis to better cover nonbank financial institutions and infrastructures; to take account of spillovers between institutions and across borders; to consider the interaction between liquidity and solvency risks; and to address data gaps. In addition, IMF economists are developing the policy-related aspects of stress testing, namely, “best practice” principles, concepts, and frameworks, to complement and strengthen the application of the models. "These efforts represent a challenging and exciting part of the IMF’s broader support of global efforts to improve financial surveillance and promote sound macroprudential frameworks," Vinals writes.

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Getting Beyond the "Curse" of Natural Resources

Countries that have an abundance of natural resources—and this includes many countries in sub-Saharan Africa—often show a record of relatively poor economic performance compared with non-resource-rich countries. 

The consensus in both academic and policy circles is that the presence of abundant natural resources poses a number of potential challenges to these countries. 

Six of them can be readily identified:

(i) a loss of competitiveness in potentially dynamic, non-natural resource sectors, (ii) a consequent narrowing of the production base,
(iii) excessive reliance on commodities for both government revenues and export earnings,
 (iv) high vulnerability to fluctuations in commodity prices,
 (v) macroeconomic and financial volatility, and
 (vi) rent-seeking behavior that can undermine governance and exacerbate the difficulty of building robust, growth-enabling institutions. 

The ideas in this book, "Beyond the Curse: Policies to Harness the Power of Natural Resources,"  were first presented at a seminar that was aimed primarily at policymakers in sub-Saharan Africa and brought together ministers, central bank governors, other senior policymakers, and well-known academics.The seminar focused on how to manage these challenges so as to reap the benefits of resource wealth while avoiding the pitfalls.

Diagnosis

Starting from a diagnosis of the wide range of challenges to macroeconomic management and financial policies that resource-rich countries face, the seminar sought to propose solutions that are context-specific, drawn from the most successful experiences, and capable of being implemented in Africa. Discussed at the 2010 seminar, therefore, were fiscal, monetary and exchange rate policies; savings policies; institutional arrangements to safeguard economies against volatility; economic diversification; and institution building.

The consensus among both speakers and participants at the seminar was that government revenues derived from natural resource extraction should be used conservatively in order to avoid excessive real appreciation and to safeguard inter- generational equity.

Preserving intergenerational equity requires saving and investing a large part of the proceeds to benefit future generations. At the same time, when investing these proceeds, it is not easy to make the choice between investing in external financial assets and investing in domestic physical and human capital (including infrastructure).

A deliberate and measured pace of domestic spending, carefully focused on absorptive capacity, can limit real appreciation and attenuate the negative consequences to the economy’s tradable sector. Moreover, history is replete with examples of large government spending programs that have been inefficient and wasteful.

Knowledgeable senior officials at the seminar from Norway, Chile, Botswana, and Mexico outlined the history of how their governments addressed the problems posed by the existence of natural resources. Their measures included conducting countercyclical fiscal policies and setting up institutions that limit rent-seeking behavior.

While seminar participants were cautious about spending policies, they recognized that populations in low-income countries have high expectations regarding higher public spending. Large resource windfalls often trigger political pressures to enlarge government spending, in particular in countries with vulnerable populations. Managing those expectations is an important task in all resource-rich countries, and particularly in those with recently discovered resources.

Better with the private sector

All countries with significant natural resources, especially those whose resources are recently discovered, must choose between putting the extraction activity in the hands of multinational companies or keeping it in the hands of state-owned companies.

The weight of country experiences worldwide tilts the balance in favor of leaving the extraction as much as possible to the private sector, provided that
  (i) the companies are selected on a competitive basis, and
  (ii) the government has the capacity to ensure that contract negotiations lead to a balanced deal where the short- and medium-term objectives of both parties are reconciled.

Indeed, such an “optimal contract” would ensure that the inherent time-inconsistency problem is addressed. In other words, governments in resource-rich countries should credibly commit not to expropriate for themselves foreign investments after they have been sunk in exploration and extraction. In this discussion, many countries around the table recognized their lack of capacity to negotiate such contracts and expressed a need for independent international advice and assistance in this crucial area.

Taxing natural resources

Taxes on rents are relatively efficient and less distorting. Therefore, higher levels of taxation in the natural resource sector make sense and facilitate lower taxes in other sectors. However, this usually leads to a structure of government revenues that is dependent on commodity prices and earnings and so can be highly volatile. There is therefore a need to establish medium-term spending plans, to decouple current spending from volatile government revenues, and to enact a strategy for countercyclical fiscal policy (especially because capital flows that also respond to current account strength, and thus commodity prices, can exacerbate cyclicality).

Fiscal institutions have proven to be instrumental in achieving such decoupling between spending programs and revenues. For countries that cannot establish institutional arrangements capable of credibly committing to countercyclical fiscal policies, the use of financial instruments—such as the Asian puts used to hedge government oil revenues in Mexico—are an effective second-best policy option.

Effect on exchange rate

Chile’s floating exchange rate coupled with an inflation-targeting regime has proved remarkably successful in recent years at sheltering the economy from external shocks. Many African countries are fearful of embarking on a fully flexible exchange rate regime, however. This is not the so-called “fear of floating” in the conventional sense—when a degree of fixity leads to foreign exchange liabilities that constitute a balance-sheet disincentive to floating—but simply a reluctance to embark on major institutional change based on a belief that the supportive institutional structure will take time to prepare.

It is clear that a more gradualist path to exchange-rate flexibility with inflation targeting will be pursued in many countries, with all the transitional difficulties that this will entail. In fact, the experience of Ghana, which adopted inflation targeting with limited exchange-rate flexibility in 2002-03, clearly illustrates this point.

The seminar stimulated much discussion about how to sterilize current account inflows (at times of high commodity prices) and the capital inflows that are correlated with these windfalls. Because their equilibrium domestic interest rates are almost always higher than those in advanced countries, in resource-rich countries the costs of sterilization can be significant and can create tensions between the fiscal authorities and the central bank. As the case of Botswana makes clear, however, insofar as periods of high commodity prices are also periods of large government surpluses held at the central bank, a properly managed countercyclical fiscal policy will provide a degree of automatic sterilization.

Diversifying away from dependence

Experiences with industrial policy around the world suggest that it is not a straightforward matter to design an appropriate incentive structure to help lay the groundwork for economic diversification in resource-rich countries. Seminar participants recognized that some government intervention is unavoidable but also stressed that such policies should be tailored to the context of each economy. It was also recognized that too-active industrial policies would open the door to corruption and thus risk undermining the broader institutional framework.

From the discussions certain things emerged that are clearly undesirable, such as commodity rents that are distributed through very high government salaries, which would have a detrimental effect on private sector development. On the other hand, low, predictable, and non-distorting tax rates on entrepreneurial activity could help foster diversification. Similarly, the use of commodity proceeds to establish a supportive physical and social infrastructure could raise returns and encourage private investment in other sectors.

INSTITUTIONAL ASPECTS

The existence of natural resources tends to distort the allocation of talent. Especially in countries with weak institutions, talent tends to shift out of private entrepreneurial activity and into more lucrative rent-seeking areas, with harmful implications for sustainable growth. Participants in the seminar spent a good deal of time focusing on how institutions should be designed to guard against such developments. For example, strong and reliable property rights can foster financial sector development, allowing the financial system to play a more active and significant role in mediating resources to help build small- and medium-size enterprises in the non-resource-rich sectors of the economy.

More generally, checks and balances and greater transparency in managing natural resource revenues can help counteract the misallocation of talent into unproductive activities. However, it was acknowledged that the problem was less difficult in countries with mature industrial economies than in those that were least developed when mineral resources were discovered. This, if anything, merely underscored the importance of a careful approach to institution building.

Foreign Policy review by Matthew Hulbert and Bas Percival 

VoxEU blog  "Beyond the curse: Policies to harness the power of natural resources"

iMFdirect blog on the escaping the "resource curse"

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OIL WEALTH IN CENTRAL AFRICA 

Policies for Inclusive Growth 

Bernardin Akitoby and Sharmini Coorey 

Paperback · ISBN 978-1-61635-376-6 · Stock# OWCAEA 

Drawing on new research on managing oil wealth and central Africa’s oil exporters’ experiences, this 

book addresses the challenge of strengthening the management of oil wealth and promoting policies for 

inclusive growth. 

      Review in Foreign Policy

MANAGING THE OIL REVENUE BOOM 

THE ROLE OF FISCAL INSTITUTIONS

Rolando Ossowski, Mauricio Villafuerte, Paulo Medas, and Theo Thomas 

2008 · ISBN 978-158906-718-9 · Stock# S260EA · $30 

Increases in oil exports and revenues have revealed how governments manage fiscal 

policies in light of changing market conditions and the role of special fiscal institutions 

(SFIs). In this Occasional Paper, IMF experts examine the role of SFIs in fiscal 

management, review the experiences of selected countries, and draw general lessons. 

TAXATION OF PETROLEUM AND MINERALS 

PRINCIPLES, PROBLEMS, AND PRACTICE

Philip Daniel, Michael Keen, and Charles McPherson 

2011 · Paperback · ISBN 978-0-415-78138-1 · $38.95 

2010 · Hardback · ISBN 978-0-415-5692-7 · $150 

Copublished with Routledge. For more information, please visit www.routledge.com. 

“A timely and welcome guide to policymakers and advisors in the area of resource 

taxation, combining theoretical underpinnings and sound practical advice over a 

range of relevant topics, from tax design, through fiscal and financial modeling to 

tax administration.” 

Joseph Amoake-Tuffour 

Ministry of Finance and Economic Planning, Republic of Ghana 

COMMODITY PRICE VOLATILITY AND INCLUSIVE GROWTH 

Rabah Arezki, Catherine Pattillo, and Marc Quintyn 

Paperback · ISBN 978-61635-379-7 · Stock# CPVIEA 

This title discusses the challenges posed by commodity price volatility and discusses policies to promote 

growth that is inclusive of all the citizens in low-income countries. It also explores macroeconomic policy 

options and the building of fiscal institutions to prevent boom and bust cycles.

Seminar at the IMF on Commodity Price Volatility

Financial Crises and What to Do About Them

Financial Crises: Causes, Consequences, and Policy Responses, edited by Stijn Claessens, M. Ayhan Kose, Luc Laeven, Fabián Valencia, provides a comprehensive overview of research into financial crises and policy lessons learned. 

The book covers a wide range of crises, including banking, balance of payments, and sovereign debt crises. It begins with an overview of the various types of crises and introduces a comprehensive database of crises. 

Broad lessons on crisis prevention and management, as well as the short-term economic effects of crises, recessions, and recoveries are discussed. 

The medium-term effects of financial crises on economic growth, as well as policy measures to prevent booms, mitigate busts, and avoid crises are analyzed. Finally, policy measures for mitigating the adverse impact of crises and ways to restructure banks, households, and sovereigns are presented. 

The collection of research in this book provides an excellent overview of critical policy areas, with valuable lessons on how countries can better monitor their economies and financial systems. Read a blog by Stijn Claessens on the issue.

IMF eLibrary   IMF bookstore  Amazon Kindle version

RePEc -- Understanding Financial Crises

Riding the Digital Wave

Neat video from the IMF about their publications program:

Pulling Together in the Eastern Caribbean

The Eastern Caribbean Economic and Currency Union (OECS/ECCU) is one of four currency unions in the world. 

As in other parts of the world in the aftermath of the global economic and financial crisis, the region is at a crossroads, facing the major challenges of creating jobs, making growth more inclusive, reforming the banking system, and managing volatility, while grappling with high public debt and persistent low economic growth. Policymakers have the critical task of implementing strong reforms to strengthen the monetary union while also laying the foundation for accelerating growth. 

A new handbook provides a comprehensive analysis of the key issues in the OECS/ECCU, including its organization and economic and financial sector linkages, and provides policy recommendations to foster economic growth.

In an interview with IMF Survey magazine, economist Alfred Schipke, who is one of the authors, points out that, while the recent global financial crisis exposed significant weaknesses in the ECCU, it also provides a unique opportunity to move forward with needed reforms to strengthen the union.

Schipke recently co-edited The Eastern Caribbean Economic and Currency Union: Macroeconomics and Financial Systems, which was launched at IMF Headquarters in Washington, DC. IMF Deputy Managing Director Min Zhu, in his opening remarks, reflected on the challenges facing small island economies, particularly with loss of market share in the tourism industry, the mainstay of the economy in most of the island states. 

He said that the IMF and its partners can do a better job in helping the region to further push macroeconomic, as well as structural, reforms, and noted that the new book would help in providing a framework for developing solutions to the ECCU’s financial sector problems and stimulating economic growth.

The Damaging Effects of Global Inequality

World Bank economist Branko Milanović has a great introduction to global inequality in his The Haves and the Have-Nots: A Brief and Idiosyncratic History of Global Inequality. He uses history, literature, and stories straight out of today’s newspapers, to discuss one of the major divisions in our social lives: between the haves and the have-nots. 

Milanovic reveals just how rich Elizabeth Bennet’s suitor Mr. Darcy really was; how much Anna Karenina gained by falling in love; how wealthy ancient Romans compare to today’s super-rich; where in Kenyan income distribution was Obama’s grandfather; how we should think about Marxism in a modern world; and how location where one is born determines his wealth. 

He goes beyond mere entertainment to explain why inequality matters, how it damages our economics prospects, and how it can threaten the foundations of the social order that we take for granted.

The book, by the lead economist with the World Bank’s research division and one of the world’s leading experts on inequality, was discussed in a three part series in Think Progress:

Part 1:  Inequality: The Global View
Part 2: Five Things You Might Not Know About Inequality
Part 3: Why Rich People Hate Talking About Inequality

See also Finance & Development magazine on inequality.
         Branko Milanovic's article: More or Less
                                 podcast interview on inequality  
          IMF research: Andy Berg and Jonathan Ostry

Inequality may be hazardous to your growth
How inequality affects savings behavior

Branko Milanović talking about inequality research:

Reexamining Economics

The global economic crisis and the subsequent weak recovery has shaken up macroeconomics.

A conference on the theme “Macro and Growth Policies in the Wake of the Crisis” took place at the IMF’s Headquarters in Washington, DC on March 7-8, 2011. The conference was hosted by four of the world’s most noted economists, including two Nobel laureates: Michael Spence (Stanford University), Joseph Stiglitz (Columbia University), Olivier Blanchard (Economic Counselor and Director of Research at the IMF), and David Romer (University of California, Berkeley). The event brought together leading policymakers and academics from both advanced and emerging countries, as well as representatives from civil society, the private sector, and the media.

The aim of the conference was to distill the policy lessons of the global financial crisis. Participants focused on six key areas: monetary policy, fiscal policy, financial intermediation and regulation, capital account management, growth strategies, and the international monetary system. They also sought to make concrete policy recommendations for how to revive sustainable growth while safeguarding macroeconomic and financial stability.

Review in F&D magazine
LSE review

Conference website In the Wake of the Crisis: Leading Economists Reassess Economic Policy by Michael Spence
My rating: 5 of 5 stars

The global economic crisis has challenged Economics to the core. This is the first pass at reexamining Economics in the light of lessons learned and still being learnt.

The IMF held a conference of leading economists in 2011. Conference co-host and Nobel Prize winner Joseph Stiglitz noted that “the models that were used before the crisis neither predicted the crisis nor gave us a framework for responding to the crisis when it happened.”

IMF Chief Economist Olivier Blanchard said: "The global economic crisis taught us to question our most cherished beliefs about the way we conduct macroeconomic policy." http://blog-imfdirect.imf.org/2011/03...

This book is a collection of thoughts following the crisis and an examination of the future direction of the international monetary system.

View all my reviews

How Fiscal Policy Can Help Battle Climate Change

Efforts to control atmospheric accumulations of greenhouse gases that threaten to heat up the planet are in their infancy. Although the International Monetary Fund is not an environmental organization, environmental issues matter for the organization's mission when they have major implications for macroeconomic performance and fiscal policy. Climate change clearly passes both these tests. 

A new book, Fiscal Policy to Mitigate Climate Change: A Guide for Policymakers, provides practical guidelines for the design of fiscal policies (carbon taxes and emissions trading systems with allowance auctions) to reduce greenhouse gases.

Providing incentives

Not only are these instruments potentially the most effective at exploiting emission reduction opportunities in the near and longer term, but they can also generate for many countries a valuable new source of government revenue. The chapters, written by leading experts, explain the case for fiscal policies over other approaches; how these policies can be implemented; reasonable levels for emissions prices; policies for the forest sector; appropriate policy for developing countries; the most promising fiscal instruments for climate finance; and lessons to be drawn from prior policy experience.

This is essential reading for policymakers in finance and environment ministries in developed and developing countries alike, and others grappling with balancing environmental and development concerns.

Purchase your copy:

• IMF Bookstore: Fiscal Policy to Mitigate Climate Change: A Guide for Policymakers
• Amazon: Fiscal Policy to Mitigate Climate Change: A Guide for Policymakers 

Also available to IMF eLibrary subscribers: 

• Fiscal Policy to Mitigate Climate Change: A Guide for Policymakers

  + on Goodreads

Fiscal Policy to Mitigate Climate Change: A Guide for Policymakers by International Monetary Fund (IMF)
My rating: 5 of 5 stars

Clearly written book on how taxes and other instruments can help in the battle against climate change by reducing energy-related carbon dioxide emissions (which account for about 70% of projected greenhouse gas emissions). By some of the leading experts in the field.

View all my reviews

Sharing Publications with the Disabled

IMF Publications has agreed with Bookshare, a global online library for blind, vision impaired, learning disabled, and physically disabled readers, to make IMF books and other publications available through the program.

Bookshare makes publications accessible to those with a disability that makes it difficult for them to read a printed book. We have provided the online library with digital versions of all IMF publications and they in turn transform them into their ‘Daisy’ format which can be read using free software that reads the book aloud (text-to-speech) and/or displays the text of the book on a computer screen or Braille access device.

We are currently working with Bookshare to bring the Daisy files into the IMF eLibrary, so we can provide accessible books directly to our own subscribers.

Bookshare is a global online library for blind, vision impaired, learning disabled, and physically disabled readers to download into a variety of formats (Braille, synthetic speech, speech to text, large print). 

Over 60 publishers have signed with Bookshare and are donating digital files, including all the major trade publishing houses (Random House, Simon & Schuster, HarperCollins, Hachette, and Scholastic) as well as top university presses (Cambridge, Chicago, Princeton, Columbia, California, NYU, Michigan, Stanford) and K-12 and post-secondary publishers. https://www.bookshare.org/  

Getting a Grip on Public Spending

Two books from the IMF are putting the spotlight firmly on the big spending issues of our times in advanced economies and some emerging markets--health care and pensions.

Health care reform is likely to remain a key fiscal policy challenge in both advanced and emerging economies in coming years. In the advanced economies, the health sector has been one of the main drivers of government expenditure, accounting for about half of the rise in total spending over the past forty years. 

Aging populations

These spending pressures are expected to intensify over the next two decades, reflecting the aging of the population, income growth, and continued technological innovations in health care. 

Spending increases will come at a time when countries need to undertake fiscal consolidation to reduce public debt ratios in the wake of the global financial crisis.

In the emerging economies, health care reform is also a key issue, given substantial lags in health indicators and limited fiscal resources. For these economies, the challenge will be to expand public coverage without undermining fiscal sustainability. The Economics of Public Health Care Reform in Advanced and Emerging Economies provides new insights into these challenges and potential policy responses, with cross-country analysis and case studies.

Pension reform is also high on the policy agenda of many advanced and emerging market economies. In advanced economies the challenge is generally to contain future increases in public pension spending as the population ages. In emerging market economies, the challenges are often different. 

Where pension coverage is extensive, the issues are similar to those in advanced economies. Where pension coverage is low, the key challenge will be to expand coverage in a fiscally sustainable manner. The Challenge of Public Pension Reform in Advanced and Emerging Economies examines the outlook for public pension spending over the coming decades and the options for reform in 52 advanced and emerging market economies.