How private capital can help solve global economic issues – an interview with the IMF

Jeffrey Franks, Director of the IMF Europe Office and Senior Resident Representative to the European Union, International Monetary Fund looks at how financial markets can help deal with geopolitical risks, economic uncertainty and even the Brexit effect

Insurance Investor Editorposted on Wednesday, September 11, 2019

This article is taken from the research report Insurance Asset Management, Europe 2019. To download the full report click here.

This is part three in a series – to read part two, which looks at the risks facing financial institutions – click here.

You can also read part one, which looks at how the glocal economy is faring and some of the short term threats facing it here.

I believe that private capital has the potential to help in five major challenge areas.

The first – reducing and sharing macro-economic risks – can be a way of helping to prepare and cushion against future crises.

The way money is invested can stimulate productivity.

It may also help to deal with ageing costs, particularly those who are managing life insurance and pensions.

The ways in which investors invest can help spread global growth versus concentrate global growth as well as investing in areas that are climate sustainable and environmentally sustainable too.

"In the US, most of a shock is absorbed by capital markets"

How an economy can absorb a shock – by government deficit budgets, private capital markets or unemployment, etc. – is important.

In the US, most of a shock is absorbed by capital markets and private markets will continue to play a role of mediating.

If you have a crisis in Texas, the capital markets absorb that across the US and the world. It isn’t just Texan banks that have to take that blow.

The Euro area however is the opposite, as most of the shock does not get smoothed like in the US and so the effect can be much bigger.

This is partly due to the way the fiscal rules work in Europe, but also because the role played by credit and capital markets is much smaller in the US.

So, there is a rising role for capital markets in Europe that could in the future help macro economically with cushioning future crises.

At the IMF, we are writing a paper with proposals for a capital markets union in the Euro area to try and provide a push to this initiative which isn’t moving that well in Brussels.

"There is a rising role for capital markets in Europe that could help with cushioning future crises"

We have also done research with European Union data that shows that in the pre-crisis era, investments in the Euro area were going to sectors of the economy that weren’t generating much productivity.

This may sound strange, but there were huge booms in real estate and consumer credit in places like Spain and Portugal and those are low factor productivity growth sectors of the economy as opposed to foreign direct investment, industrial, high technology, etc.

Not all doom and gloom

The good news is that as investment starts to recover, we are seeing much more of a share of investment going to moderate and high productivity activities.

My message to the private sector here would be to think about investing in high factor productivity growth areas, which will not only most likely be better for you but also for the economy as well.

On the ageing issue, the liabilities that the government carries from pensions are in the magnitude of 50 per cent to 100 per cent of GDP on top of the official debt levels. This is not sustainable as populations continue to age.

Private investment by individuals can help ease this problem over time and, in many countries, this is already happening.

"Think about investing in high factor productivity growth areas, which will not only most likely be better for you but also for the economy as well"

We would argue that investment can be a tool to improve income distributions between countries and within countries if they are targeted appropriately.

The amount of investment from advanced countries to developing countries has been declining since the global financial crisis and from advanced to advanced countries has been roughly stagnant.

If this investment were to increase again, there would be an opportunity for increased growth within emerging economies and it would start the process of catching up to the more advanced economies as well.

An illustration by the Global Commission on the Economy and Climate has shown that if we continue to invest in meeting the terms of the Paris Climate Agreement for the next 15 years, the total investment would be $89 trillion.

However, some of this can be found from not investing in fossil fuels and instead investing in more energy efficiency and low-carbon tech for power generation, which would deliver more decentralised, renewable sources of energy.

A low-carbon scenario would cost us $93 trillion and though this is a lot of money, it isn’t that big over 15 years.

We are talking about an increase of 5 per cent of investment and redirecting what we have to get us from an unsustainable carbon future to a sustainable one. This will come mainly from the private sector, not the public.

In conclusion, the world is in a much better place than it was 10 years ago economically, but we face major political and economic challenges. Further governmental action is needed, but the private sector can play a very useful and important role.

This article is taken from the research report Insurance Asset Management, Europe 2019. To download the full report click here.

This is part three in a series – to read part two, which looks at the risks facing financial institutions – click here.

You can also read part one, which looks at how the glocal economy is faring and some of the short term threats facing it here.