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Strong Laws and Institutions for a Strong Global
Economy
By Christine Lagarde
Managing Director, International Monetary Fund
Washington Foreign Law Society
June 4, 2013
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Good evening. I am delighted to be here tonight. I
want to thank the Washington Foreign Law Society
for this special honor, and Ambassador Stapleton for
the very warm introduction
As you know, I started my career as an attorney, and
was a practicing attorney for 25 years. So it gives me
particular pleasure to return to my professional roots,
so to speak, and be here with you this evening.
Since my time as an attorney, I have taken on some
more varied roles – previously in two different cabinet
positions in the French government first as Secretary
of Trade and then Secretary of the Treasury, and now
at the International Monetary Fund. Each of these
roles has served to reinforce my belief in the
fundamental importance of strong laws and
institutions for a robust and well-governed global
economy.
Tonight I would like to explore some of these issues
with you. First, I will touch on the fundamental
importance of strong legal and institutional
frameworks for economic growth and stability, with
emphasis on the current state of the global economy.
Second, I will highlight some aspects of the IMF’s
role in helping our member countries to design strong
legal and institutional frameworks. Third, I will
conclude by exploring whether there is more that
should be done in this area, to assure and safeguard
long-term economic prosperity.
I should start with a brief update on the global
recovery, which is uneven and in fact suffering from
an unfinished agenda of critical legal and institutional
reforms. We are seeing now a three-speed global
economy, where some economies are growing nicely,
like the emerging markets in Asia; some are
experiencing a rebound, like the U.S.; and others that
continue to see weak or even declines in growth, like
in parts of Europe. Our projection for global growth
remains at 3.3 percent, not much higher than last year,
though recent data on manufacturing and industrial
production suggest we could be entering a softer
patch. This state of affairs is not optimal: we need to
move to a “full speed” global recovery with strong
economic performance for all countries.
1. Strong legal and institutional frameworks for a
strong economy
Turning to my first area of focus: legal and
institutional reforms are a critical component of the
unfinished agenda for global recovery.
The current crisis has played out most aggressively in
advanced economies ─ ironically the economies that
previously were assumed to have the strongest legal
and institutional architecture. Instead, their regulatory
and institutional weaknesses were the source of the
crisis, and they are now the economies in third, or at
best, second gear. To recover from their current
relatively weak position, these economies need to
implement a range of legal and institutional reforms in
areas such as banking, fiscal policy and
corporate/household debt restructuring, as well as tax
policies.
But at the current economic juncture, even those
economies that are on the mend or that are doing
relatively well, are not immune. They too need to
continue to adopt robust legal and institutional
reforms, for example, in the fiscal area and financial
sector, to address remaining vulnerabilities and
strengthen their growth trajectories.
So, what then is the nature of these strong laws and
robust institutions that are necessary for a lasting,
“full speed” global recovery? They have two essential
components:
First, there need to be laws underpinned by an
unwavering respect for the rule of law. As James
Madison wrote in the Federalist papers: “you must
first enable the government to control the governed;
and in the next place oblige it to control itself”. This is
the essence of the rule of law – the law must apply
equally to all citizens, including those who make the
law.
Secondly, and just as importantly, there must be
strong institutions that are capable of implementing
and enforcing the law in accordance with its terms. It
is a common saying that a “chain is only as strong as
its weakest link”. Well, in the same way, laws are
only as strong as the weakest institutions that enforce
them.
Above all, this requires a competent and independent
judiciary to implement the law consistently,
predictably and transparently. “Il faut que, par la
disposition des choses, le pouvoir arrête le pouvoir”
(Montesquieu). It also requires strong fiscal
institutions, and a credible and well-equipped
financial sector regulatory framework. These are key
pillars of a robust and inclusive institutional
framework.
There is a large body of evidence that confirms the
importance of a strong legal and institutional
framework, with the core features I have described,
for sustainable economic growth. This is recognized
by political scientists and economists alike, and above
all by history: countries that have developed strong
legal and institutional frameworks have performed
better in terms of sustained growth and human
development. The recent book “Why Nations Fail” by
Daron Acemoğlu and James Robinson made a very
convincing case for this.
Let us take as an example the system of property
rights. The economist Hernando De Soto has long
argued that the lack of a system of formal property
rights is the main cause of under-development.
Among other things, it prevents individuals and
enterprises from using their assets to secure credit;
more generally, weak enforcement frameworks raise
borrowing costs significantly. This creates what De
Soto famously described as “dead capital” - a large
informal economy in which assets are undervalued,
unreported and untaxed.
Imagine transferring a title when institutions are not
strong, when boundaries and reported properties are
vague, at best, or not accounted for at all because
there has never been a cadastre.
The underground economy is estimated at 30-40
percent of GDP in developing countries, and about 15
percent in advanced economies like the U.S. Think of
the lost productive potential in an economy where
almost half of activity is unreported and almost half
the population is beyond the reach of public services.
2. The IMF: strengthening laws and institutions
This brings me to my second area of focus: the IMF’s
role in this area. Given the general points I have just
made, it will not surprise you to hear that
strengthening legal and institutional frameworks is
central to the IMF’s work, particularly as we aim for a
“full speed” recovery from the global financial crisis.
Because the IMF is often involved at crisis or nearcrisis junctures, we can serve as a catalyst for
countries to enact legal and institutional reforms that
they otherwise lacked the political will or urgency to
undertake. As I have mentioned, much of the IMF’s
efforts in this area are currently focused on advanced
economies, particularly in the euro area. But we also
continue to do a good amount of work with our
emerging market and low-income members, who too
have unfinished reforms in this area.
It is important to note though that this type of reform
takes time. The IMF therefore focuses on putting in
motion the process of reform. But member countries
must sustain these reforms over time to be effective.
Let me give you three important and topical examples
of how sound legal and institutional frameworks are
essential for the design and implementation of our
policy advice: first, in the area of fiscal frameworks;
second, in the area of debt restructuring; and third, in
the area of combating economic crimes. These areas
have taken centre stage in the IMF’s response to the
global financial crisis.
(1) Strengthening fiscal frameworks
Since the early days, the IMF has been involved in the
design of legal and institutional frameworks for fiscal
policy. Today, we are seeing the importance of strong
fiscal frameworks to underpin the credibility and
quality of planned fiscal consolidation, particularly in
response to the global financial crisis. As you know,
the appropriate pace of consolidation has been at the
top of the global economic agenda in recent months.
An important area is tax reform. We have found in
many of our member countries that weaknesses here
are as much about enforcement as they are about the
laws themselves. Tax enforcement requires an
efficient and independent judiciary, competent and
un-corrupt tax officials. Tax reforms have featured in
many of the recent IMF-supported programs,
including for Greece for instance.
The IMF also works extensively with countries rich in
natural resources, such as Liberia, Mozambique,
Malawi, Sierra Leone and Myanmar to help set up
sound, transparent institutions and fiscal regimes for
extraction that can ensure fairness to all parties and,
especially, long-term fiscal sustainability.
(2) Restructuring debts
Let me turn to my second example: A pervasive
theme of the current crisis has been the problem of
over-indebtedness – we saw this during the Asian
financial crisis and again today. It will not surprise
you that strong legal and institutional frameworks are
central to addressing this problem.
In the corporate and household sectors, the IMF has
helped countries revise insolvency laws, though we
found, once again, that implementation and
enforcement of the law was the key fault-line. In
Greece and Portugal, for example, the IMF is helping
put in place more effective procedural rules, fast-track
court approval procedures and out-of-court debt
restructuring frameworks. These and other measures
are needed to optimize the efficiency of court
proceedings, and in particular to reduce the large
backlogs of cases that are overburdening the system.
In the financial sector on the other hand, the main
issue is finding a way to efficiently resolve global
financial institutions that took on excessive debts in
the lead-up to the crisis. Large international financial
groups operate on an increasingly global and
integrated basis; however the legal and institutional
frameworks to resolve these groups in times of
distress are distinctly national in scope. As the
Governor of the Bank of England, Mervyn King,
famously said: “Banks have an international life, and
a national death”.
What has become abundantly clear is that we need a
way to encourage cooperation and coordination
between national authorities in the resolution of these
institutions. The IMF has therefore worked closely
with the Financial Stability Board to develop a set of
international standards for effective resolution
regimes, which includes measures for cross-border
cooperation.
In Europe, the IMF has also strongly supported efforts
to create a European banking union – a key pillar of
which is a single resolution authority, backed by a
common resolution fund.
Without the necessary legal and institutional
framework in place, countries may be pushed to “bailout” those institutions perceived to be systemic for
their financial systems – but this can be hugely
detrimental for sovereign balance sheets.
This brings me to the issue of the sovereign itself. We
must recognize that, at a certain point, a country’s
public debt level may become unsustainable. And
while this should be the last resort, a strong legal
framework is needed to support any debt restructuring
process. The ongoing litigation related to Argentina’s
debt restructuring highlights the legal vulnerabilities
that remain to be addressed in this area.
The IMF Executive Board met recently to discuss the
IMF's legal and policy framework regarding sovereign
debt restructuring. We will be looking at these issues
more closely in the coming months. Amongst other
areas, we will focus in particular on ways in which the
contractual, market-based approach to facilitate
sovereign debt restructuring can be improved.
(3) Combating economic crime
So after tax law, bankruptcy and resolution, coupled
with debt restructuring, another area in which sound
legal and institutional frameworks are crucial to the
IMF’s role is in combating financial fraud, tax
evasion, corruption, and the money laundering that
accompanies it.
These activities can severely undermine national and
global financial stability and eat into a government’s
revenue stream, with severe fiscal consequences. To
give you a few examples, there is no doubt that tax
evasion has been widespread in Greece. In Cyprus,
weaknesses in the anti-money-laundering framework
may have contributed to the attractiveness and
unsustainable growth of its financial sector. Financial
fraud was at the centre of crises in a number of other
countries in which the IMF has been involved.
Our efforts in this area thus work to address the
vulnerabilities in legal and institutional frameworks
that allow these activities to flourish. In particular, this
involves strengthening frameworks for tax
administration, financial supervision and public
financial management.
In addition, it requires mobilizing the anti-money
laundering and counter financing of terrorism
framework to clamp down on economic crimes, for
example, by increasing the monitoring of suspicious
fund flows, and ensuring that related assets can be
frozen to support tax debt collection.
Ultimately, left unchecked, these activities allow
criminals to amass wealth, power and influence. This
undermines the rule of law and erodes the social
fabric, hindering prospects for growth and human
development.
3. Conclusion: Governance, inequality and long term
prosperity
Let me conclude by stepping back a bit. The examples
I have identified often arise in the context of a crisis and this should not be surprising given the fact that
crisis resolution is a critical area of our work. But it is
not the only area of our work. We also have a mandate
to prevent crises and to promote sustainable growth
for the future.
In that context, we have realized that perhaps we need
to spend more time identifying and reflecting on those
factors that, over the longer term, may have an impact
on economic prosperity. I have discussed the
importance of strong laws and institutions,
underpinned by the rule of law, for long term
economic prosperity. Those countries whose legal and
institutional frameworks are particularly weak are
likely to pay for those weaknesses over time.
But there are also other long-term trends that can have
a major impact on economic prosperity. For example,
there is significant evidence that, over time,
growing inequality can adversely affect both growth
and stability. Equally, we need to take into account
trends such as climate change and resource scarcity,
and reconcile our aspiration for growth with the
constraints of a finite planet – sustainable growth is
also green growth.
Accordingly, it makes sense to ask whether the need
for reforms in these areas should not also form a
greater part of our conversation with member
countries - even if, in the short term, a crisis does not
appear to be on the horizon. Clearly, there will be
other international organizations that are also wellplaced to play a leading role in this area. But I think
the IMF can do more to identify this as an issue - and
this is an area that we will be exploring further.
Thomas Aquinas defined law as “an ordinance for
reason for the common good, made and promulgated
by him who has care of the community.” The IMF is a
public economic institution with a higher purpose of
promoting the common good and the best interests of
the global community. We need to foster strong laws
and institutions, and think about the longer term
consequences of the decisions we make today, if we
are to achieve the sustainable economic growth that is
central to the IMF’s mandate.
Thank you.