Chairman Sarbanes, ranking member Gramm, members of the Banking Committee, I thank you for this opportunity to appear before you this morning to discuss our international economic policy.
The April 2002 Report reviews global economic developments in the second half of 2001. This interval and the most recent months encompass a turbulent period in which the events of September 11 and their aftermath shook the U.S. and world economies, and a period when the underlying strength in the U.S. economy showed itself forcefully, leading the world back to recovery. I have said before that creating economic growth and jobs in the U.S. economy is our overriding concern and that getting our economic policies right at home is one of the best contributions we can make to global economic growth.
Increasing economic growth and reducing economic instability are in vital interests of the United States. For this reason, I would like to touch on several of the Administration’s broad policy initiatives for facilitating growth and stability.
Reducing Barriers to International Trade
The global economic slowdown, from which we are recovering, brings into sharp focus the importance of international trade. Total U.S. trade in goods and services amounts to about one quarter of GDP. It now touches almost all parts of our economy and is a vital ingredient in its health, creating millions of jobs that pay above-average wages.
President Bush achieved a key objective in his trade agenda with the WTO Ministerial decision in Doha to launch multilateral trade negotiations. Negotiations are already underway for a Free Trade Area of the Americas (FTAA) and for Free Trade Agreements (FTAs) with Chile and Singapore. In January 2002, the United States announced that it will explore an FTA with the countries of Central America. An FTAA, when combined with existing free trade agreements, and s well as bilateral FTAs with Chile and Singapore, will fully open market access overseas for nearly 50 percent of U.S. exports.
Treasury has a special interest in promoting further liberalization of trade in financial services. The growth potential in many countries is being held back by a lack of deep and liquid capital markets. The swift removal of barriers in key markets will help strengthen financial systems internationally. It will also mean more American jobs in a sector with above-average wages.
In sum, both to help bolster growth and create new export and job opportunities for America, it is vital for the Senate to pass, and the Congress to expeditiously enact, Trade Promotion Authority.
Reform of the International Monetary Fund
The primary role of the International Monetary Fund is to foster conditions in the international economic and financial system that support growth. First and foremost, the IMF must seek to prevent crises that undermine and reverse growth. The IMF is making progress in enhancing crisis prevention, including through increased transparency. For example, nearly all countries borrowing from the IMF now release the details of their reform programs, but more steps are needed to release information and encourage policy-makers to take quick action to avert potential crises. Indeed, no matter how good the IMF's analysis and policy advice are, their impact will be limited if they do not serve to inform the public and markets. We look forward to further progress on transparency in coming months.
To help prevent financial crises and better resolve them when they occur, we are working with others in the official sector to implement a market-oriented approach to the sovereign debt restructuring process. This contractual approach would incorporate new contingency clauses, which would describe as precisely as possible what would happen in the event of a sovereign debt restructuring process, into debt contracts. We have proposed three clauses: super-majority decision-making by creditors; a process by which a sovereign would initiate a restructuring or rescheduling - including a cooling-off, or standstill, period; and a description of how creditors would engage with borrowers. While we believe it is important to move forward with this contractual approach as expeditiously as possible, we also support continued work on the IMFund’s statutory approach to sovereign debt restructuring. We believe the two approaches are complementary.
Reform of the Multilateral Development Banks:
Rising productivity is the driving force behind increases in economic growth and rising per capita income. The multilateral development banks (MDBs) can deliver better results by being rigorously selective in their lending, focusing their activities on a discrete set of high-impact, productivity-enhancing activities that diversify the sources of growth, foster competitive and open markets, promote accountable governance, raise human productivity, and expand access of the poor to physical infrastructure, new productive technologies and social services.
Education and private sector development in particular need to feature more prominently as a critical element in lifting people out of poverty.
Private capital flows now dwarf official development assistance; the challenge is to deploy development assistance in areas where we know it will unleash the entrepreneurial and creative capacities of people living in the poorest countries and encourage individual investment. Investment climate reforms and capacity-building at the government and enterprise level should be at the front and center of development policies. The scale of global poverty and unrealized human potential underscores the importance of the MDBs (and all other donors) focusing much greater attention on improving the effectiveness of their assistance. Delivering results means insisting on rigorous quantifiable measures of each aid project and accountability from each aid institution’s impact in improving living standards. An incentive structure must exist where performance will be rewarded and non-performance will not.. The U.S. has proposed such a structure for the IDA-13 replenishment in which the U.S. base-case annual contribution to IDA can be increased if specified input and output triggers are met in priority growth and poverty-reduction areas such as private sector development, primary education and health.
President Bush proposed that up to 50 percent of the World Bank and other MDB funds for the poorest countries be provided as grants rather than as loans. Investments in crucial social sectors (e.g., health, education, water supply and sanitation) do not directly or sufficiently generate the revenue needed to service new debt. Grants are the best way to help poor countries make such productive investments without saddling them with ever-larger debt burdens.
Millennium Challenge Account
Effective assistance means delivering against a set of priority objectives that is measurable. It requires a solid partnership between donors and client countries on priority reforms that drive growth and poverty reduction, while underscoring the need to measure the impact and accountability of those reforms.
On March 14, President Bush outlined a major new vision for development based on the shared interests of developed nations alike in peace, security, and prosperity.
The President's compact for global development proposes a truly historic, shared commitment to stop the cycle of poverty in the developing world and is defined by a new partnership between developed and developing countries to achieve measurable development results.
The compact creates a separateupplemental development assistance account called the Millennium Challenge Account. It will be funded by substantial increases over and above the approximately $10 billion in existing U.S. development assistance (better known as Official Development Assistance or ODA).
To take advantage of Millennium Challenge Account funds, developing countries must be committed to sound policies that promote growth and development, including the need to fight poverty. We will channel these funds only to developing countries that demonstrate a strong commitment to:
Experience has shown that policies that are effective in promoting these goals underpin successful growth, productivity increases, and poverty reduction. Further, these goals are mutually reinforcing.
Over the coming months we will be asking for ideas from our development partners – donors, developing countries, academics, NGOs – on developing a set of clear, concrete and objective criteria for measuring progress in these areas.
Combating Financing of Terrorism
Depriving terrorists of financial resources is critical to the war on terrorism. The President has directed me to take all measures necessary to pursue this goal.
On September 23, 2001, President Bush issued an Executive order listing 27 terrorist organizations and individuals and directing the blocking of their property. This Executive Order has now been extended to a total of 202 individuals and entities. To date, all but a handful of countries have committed to join this effort. There are now 161 countries and jurisdictions that have blocking orders on terrorist assets in force and over $104 million in terrorist assets has been frozen globally since September 11 -- some $34 million here in the United States, and another $70 million by other countries or jurisdictions. A portion of that amount linked to the Taliban has recently been unblocked for use by the new Afghan Interim Authority.
On April 19, I announced with my counterparts from the Group of Seven an unprecedented joint listing of terrorist targets. In March, the U.S. and Saudi Arabia designated jointly the Bosnia and Somalia offices of the Saudi-based charity Al-Haramain. These joint designations mark a new level of coordination in the fight against international terrorism.
Cooperation on International Tax Matters
International cooperation and coordination on tax matters are critically important for reducing investment distortions and for promoting the proper functioning of financial markets and systems. Tax rules should not serve as an artificial barrier to cross-border investment.
The United States has bilateral income tax treaties with approximately 60 countries. The purpose of those treaties is to coordinate our respective income tax systems so as to avoid double taxation and to reduce or eliminate tax "toll charges" on cross-border investment. We are working to update and modernize existing tax treaties and to expand our treaty network.
As I have said many times, we have an absolute obligation to enforce the tax laws of the United States, because failing to do so undermines the confidence of honest taxpayers in the fairness of our tax system. This can be done more efficiently, given the increasingly global nature of economic activities, with the cooperation of other countries. Currently, we have effective tax information exchange arrangements with many of the world's financial centers. We are working to extend and deepen this network.
International Economic Conditions
I would like to turn now to global economic conditions.
As you know, the U.S. economy began slowing in the summer of 2000 and this weakness extended through the first half of 2001. Then, the terrorist attacks of September 11 set off disruptions that quickly swept through our economy. The events battered consumption as consumers stayed at home, and with our passenger transport system significantly impacted, many associated industries such as tourism and hotels were badly hit. Activity fell at a 1.3% annual rate in the third quarter.
Prior to September 11, I had been optimistic about the prospects for U.S. recovery. My optimism now appears to have been well justified. The fourth quarter showed a healthy rebound at a 1.7% annual rate. Economic indicators for 2002 already paint a hopeful picture of an economy bouncing back. I believe that the data will show in the final analysis that last year’s downturn in real GDP will be the shortest, shallowest on record.
Why was the optimistic view well founded? Even before September 11, the economy appeared to be moving forward at a slow, but positive rate. The inventory overhang was being reduced.
The Administration and Congress had responded with timely relief action. The tax rebates and rate cuts from the Economic Growth and Tax Relief Reconciliation Act of 2001 had put money in people’s pockets and increased incentives in the economy to work, save and invest. The Federal Reserve had aggressively lowered interest rates and energy prices were then coming down.
Most importantly, the fundamental strengths of our economic system remain well intact – the American people are hard working; our markets are the most flexible and dynamic in the world; and our macroeconomic policies are sound. Our economy is the most advanced in the world because our economic structures are predicated on the recognition that the private sector drives growth, and that the role of government is to provide a framework that promotes competition and encourages individual decision making. This has produced, among other things, financial markets that are the deepest and most liquid in the world.
The confluence of these factors is reflected in the remarkable productivity growth of our economy. Unlike in past recessions, productivity continued to rise last year and posted an extraordinary 5.2% gain at an annual rate in the fourth quarter. Meanwhile, trend productivity growth remains around 2-1/2%, sharply higher than the 1-1/2 percent trend rate from 1973 through 1995, keeping inflation pressures well at bay.
I am convinced that the United States has regained its economic footing. In fact, the figures released just last week showed real GDP rising at an exceptionally strong 5.8% percent annual rate. This performance is a testimony to the inherent resilience of our economy that over the past six months has continually surprised on the upside.
So far, I have focussed on the United States. The world economy, while beginning to recover from the recent slowdown, is still in the early stage of recovery. Last year, global growth was highly anemic, at roughly 2-1/2%. Prospects for 2002 are somewhat better but strong growth may not be fully visible until the second half of the year.
Before becoming the Secretary of the Treasury, I had the pleasure of gaining a special appreciation for the strength of the Japanese economy and its people. Over the last decade, however, Japan’s economic performance has been well below its potential. The resulting cost has been high not only for Japan, but also for the world economy. Restoring strong Japanese growth is one of the keys to unlocking strong global growth.
President Bush has expressed support for Prime Minister Koizumi’s commitment to reform. The United States also shares his view that it is important for Japan to increase price competition through deregulation and structural reform and to vigorously tackle its banking sector problems. We in the United States learned from the S&L crisis the importance of comprehensively addressing banking sector problems and returning distressed assets to private hands by selling loan claims and underlying collateral rapidly in the market.
We also learned that these reforms can take place only in a supportive macroeconomic environment. For the last seven years, except for 1997 in response to a one-time tax increase, Japan’s economy has been mired in deflation. Last March, the Bank of Japan committed to expand the money supply until the CPI was either stable or increased slightly on a year on year basis. Since then, a welcome and sharp expansion in monetary aggregates has indeed taken place. So far, however, deflation remains entrenched.
The Euro-zone recorded its best growth in a decade in 2000. Going into 2001, there was substantial optimism that the foundations for sustained growth were well in place. But despite these expectations, Euro-zone growth slowed markedly and was negative in the fourth quarter. While Europe too was affected by the events of September 11, Europe’s slowdown in 2001 underscored the fact that the interactions and transmission mechanisms among our economies run deep and extend well beyond the realm of trade.
The Euro-zone is poised to begin growing anew. However, the consensus outlook is that the recovery will lag and be slower than the U.S. upturn. That said, it is in many respects difficult to speak about the Euro-area as a single entity. Indeed, there are many successful pockets of reform, such as Ireland, Spain, and the Netherlands. But European policy-makers recognize the need more generally to implement tax reforms within the context of efforts aimed at achieving medium-term fiscal stability and to undertake structural reforms targeted especially at increasing employment and raising potential growth.
On April 19-20, I hosted a meeting of the G-7 Finance Ministers and Central Bank Governors. We recognized that a recovery is already underway in our economies, influenced by macroeconomic policies put in place last year. Nonetheless, while confident about our collective prospects, we also agreed that downside risks remain, especially those arising from oil markets. In this spirit, we agreed that each of our countries has a responsibility to implement sound macroeconomic policies and structural reforms to sustain recovery and support strengthened productivity growth in our own economies and in the global economy.
The U.S. current account deficit was around 1 1/2½% of GDP in the mid-1990s. It rose to 4 1/2% in 2000 before falling, during last year’s global slowdown, to just over 4% in 2001. We have all heard the view that this is a threat to America’s economic fortunes and global financial stability. I believe this view ignores forces that are working in the market. The current account represents the gap between domestic savings and investment and has grown in the face of a productivity-fed U.S. investment boom for the past decade. It is financed by international capital inflows whichinflows that have risen over this period due to strong foreign interest in investing in the United States.
In the last two years, these capital inflows were sustained despite a slowing of U.S. economic activity, a fall in U.S. interest rates, and a decline in equity prices. This is a clear demonstration that foreigners regard investment in the United States as continuing to offer extremely attractive rates of return. These inflows are attracted by the long term soundness and relative strength of our economy’s fundamentals: – our underlying productivity growth, our low inflation and sound macroeconomic policies, our flexible labor markets, and our financial markets which are the deepest and most liquid of any in the world. As I often say, these investments in our economy’s future are not a gift. They are made because of the prospect of a sound return.
Emerging market and developing economies also felt the effects of the slowdown in the major economies in 2001, and their prospects were also set back by the uncertainties stemming from the events of September 11. However, I am hopeful that their prospects will brighten over the course of this year. The truth is that many emerging markets have not performed well in recent years and investment flows going to these markets have declined sharply. On the positive side, though, many emerging market economies are now better able to withstand external shocks, having reduced short-term external liabilities and built up reserves. Many countries, such as Brazil, Indonesia and South Korea, have moved to more flexible exchange rates regimes, which allow their exchange rates to absorb the brunt of external shocks. I think there is a much greater appreciation throughout these countries on the need to run sound policies. And there has been very little contagion from recent events in Argentina.
I would also like to submit for the record the Report to Congress on International Economic and Exchange Rate Policies as mandated by Section 3004 of the Omnibus Trade and Competitiveness Act of 1988.
In conclusion, I thank you again for this opportunity to testify before you. I would be delighted to take any questions you might have.
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