April 20, 2024

Economix: The Problem With Christine Lagarde

Today's Economist

Simon Johnson, the former chief economist at the International Monetary Fund, is the co-author of “13 Bankers.”

Finance Minister Christine Lagarde of France is regarded as Europe's leading candidate to lead the International Monetary Fund.Pool photo by Lionel Bonaventure/ReutersFinance Minister Christine Lagarde of France is regarded as Europe’s leading candidate to lead the International Monetary Fund.

Christine Lagarde, France’s finance minister and the presumptive nominee of the European Union for the recently vacated position of managing director at the International Monetary Fund, formally declared her candidacy on Wednesday. The E.U. has just over 30 percent of the votes in this quasi-election; the United States has 16 percent and seems willing to keep a European at the fund if an American can remain head of the World Bank — an arrangement that has stood since the early years of the organizations.

It is likely that Ms. Lagarde will now travel around the world engaging in some old-fashioned horse trading, as her predecessors and no doubt leaders of other international organizations have done, seeking support and promising not to forget it.

But Ms. Lagarde has a serious problem that may still derail her candidacy, if there is any substantive, open or transparent discussion of her merits: There is major design flaw in the euro zone, and Ms. Lagarde is the last person that non-European governments should want to put in charge of helping sort that out. (In my time as chief economist at I.M.F., from March 2007 until August 2008, I did not deal directly with Ms. Lagarde.)

In a statement on Tuesday, the I.M.F. representatives of Brazil, China, India, Russia and South Africa called for a “truly transparent, merit-based and competitive process” and said that choosing a leader on “on the basis of nationality undermines the legitimacy of the fund.”

Ms. Lagarde is explicitly being put forward as someone who can represent the interests of the euro zone at a time when it needs help. And it is indeed the zone as a whole — including France — that needs help, not just the errant countries (Greece, Ireland, Portugal and whichever country might be next in line for market fears about its government debt and growth prospects).

The founding assumption for the euro zone in 1999, which became enshrined as a mantra in the early 2000s, is that its countries would converge in terms of productivity levels — to put it starkly, that Greece would become very much like Germany. In that view of Europe, it did not much matter if some countries within the euro zone ran current account surpluses while others ran large deficits.

The deficit countries could finance themselves with loans from the surplus countries, the reasoning went, because they would use the money for productive investments and economic growth would allow them to keep their debt levels relative to gross domestic product under control.

None of this happened.

The productivity gains were seen more in Germany and some other northern European countries. Unit labor costs, reflecting the net effect of productivity gains and real wage increases, rose sharply in Mediterranean Europe. French, German and other core banks facilitated this divergence with a surge in lending both to consumers and governments in the periphery — convincing themselves, shareholders and regulators that this was low risk.

Most of this is not Ms. Lagarde’s fault, of course, as she became France’s finance minister in 2007. Yet she has certainly played a leading role in denying that Europe had any serious issues as the global financial crisis began to brew in 2007 and early 2008.

The bigger issue is that more recently she and the French authorities in general have been at the forefront of efforts to deny there is any deep problem and to resist a systematic solution.

France worked long and hard to prevent increases in bank capital during the recently concluded Basel III negotiations. Bank capital is a buffer against losses; as long as this remains as low as the French government wants, there is no safe way for any euro zone country to restructure its debts. Low bank capital creates serious systemic financial risk for Europe and the world.

In a similar vein, Ms. Lagarde has led the “no restructuring” school of thought in recent months with regard to Greece — and presumably other euro zone countries, as well. Debt restructuring is no panacea, but to take the option completely off the table is not smart — unless you really think there is no deeper issue that must be addressed.

The euro zone in its first iteration has failed to operate as intended. Unless you think Greece can experience a miraculous productivity transformation, the euro zone leadership needs to make a choice. Do they integrate more, including generous fiscal transfers to poorer, less dynamic member countries where people do not like to pay taxes, or do they ease some countries out of the integrated financial system, creating two tiers of participation in the euro currency area — in which some euro zone countries cannot borrow from the European Central Bank?

Either way, the International Monetary Fund could potentially help with loans and with technical advice. But such money belongs to the international community — the 187 member countries.

And such help would take a lot of money. If Ms. Lagarde becomes head of the I.M.F., she is most likely to continue to throw loans at the euro zone problems. If there are preventive programs even for Spain, Italy or Belgium, the I.M.F. will need to tap its shareholders for at least another $1 trillion in credit lines.

Ms. Lagarde personifies the strategy of gambling for euro zone resurrection with other people’s money. Why would taxpayers in the United States and elsewhere want to support her?

Article source: http://feeds.nytimes.com/click.phdo?i=d3fd6494933bea5edbddcc587a68f526

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