By International Monetary Fund, MD - Christine Lagarde
What a great privilege to be here among such distinguished guests to discuss such a significant topic.
Inclusive Capitalism Initiative in today life. Here I would also like to remember the great civic leaders.
We are all here to discuss “inclusive capitalism”—
But what does it mean?
As I struggled with the answer to that, I turned to etymology and to history.
Capitalism originates from the Latin “caput”, cattle heads, and refers to possessions.
Capital is used in the 12th century and designates the use of funds. The term “capitalism” is only used for the first time in 1854 by an Englishman, the novelist William Thackeray—and he simply meant private ownership of money.
The consecration of capitalism comes during the 19th century. With the industrial revolution came Karl Marx who focused on the appropriation of the means of production—and who predicted that capitalism, in its excesses, carried the seeds of its own destruction, the accumulation of capital in the hands of a few, mostly focused on the accumulation of profits, leading to major conflicts, and cyclical crises.
So is “inclusive capitalism” an oxymoron? Or is it the response to Marx’s dire prediction that will lead to capitalism’s survival and regeneration—to make it truly the engine for shared prosperity?
If so, what would the attributes of inclusive capitalism be? Trust, opportunity, rewards for all within a market economy—allowing everyone’s talents to flourish. Certainly, that is the vision.
Most recently, however, capitalism has been characterized by “excess”—in risk-taking, leverage, opacity, complexity, and compensation. It led to massive destruction of value. It has also been associated with high unemployment, rising social tensions, and growing political disillusion – all of this happening in the wake of the Great Recession.
One of the main casualties has been trust—in leaders, in institutions, in the free-market system itself. The most recent poll conducted by the Edelman Trust Barometer, for example, showed that less than a fifth of those surveyed believed that governments or business leaders would tell the truth on an important issue.
This is a wake-up call. Trust is the lifeblood of the modern business economy. Yet, in the world that is more networked than ever, trust is harder to earn and easier to lose. Or as the Belgians say, “confidence leaves on a horse and comes back on foot”.
So the big question is: how can we restore and sustain trust?
First and foremost, by making sure that growth is more inclusive and that the rules of the game lead to a level playing field—favoring the many, not just a few; prizing broad participation over narrow patronage.
By making capitalism more inclusive, we make capitalism more effective, and possibly more sustainable. But if inclusive capitalism is not an oxymoron, it is not intuitive either, and it is more of
a constant quest than a definitive destination.
I will talk about two dimensions of this quest—more inclusion in economic growth, and more integrity in the financial system.
Inclusion in economic growth.
Let me begin with economic inclusion. One of the leading economic stories of our time is rising income inequality, and the dark shadow it casts across the global economy.
The facts are familiar. Since 1980, the richest 1 percent increased their share of income in 24 out of 26 countries for which we have data.
In the US, the share of income taken home by the top one percent more than doubled since the 1980s, returning to where it was on the eve of the Great Depression. In the UK, France, and Germany, the share of private capital in national income is now back to levels last seen almost a century ago.
The 85 richest people in the world, who could fit into a single London double-decker, control as much wealth as the poorest half of the global population– that is 3.5 billion people.
With facts like these, it is no wonder that rising inequality has risen to the top of the agenda—not only among groups normally focused on social justice, but also increasingly among politicians, central bankers, and business leaders.
Many would argue, however, that we should ultimately care about equality of opportunity, not equality of outcome. The problem is that opportunities are not equal.
The money will always buy better-quality education and health care, for example. But due to current levels of inequality, too many people in too many countries have only the most basic access to these services, if at all. The evidence also shows that social mobility is more stunted in less equal societies.
Fundamentally, excessive inequality makes capitalism less inclusive. It hinders people from participating fully and developing their potential.
The disparity also brings division. The principles of solidarity and reciprocity that bind societies together are more likely to erode in excessively unequal societies. History also teaches us that democracy begins to fray at the edges once political battles separate the haves against the have-nots.
A greater concentration of wealth could—if unchecked—even undermine the principles of meritocracy and democracy. It could undermine the principle of equal rights proclaimed in the 1948 Universal Declaration of Human Rights.
Pope Francis recently put this in stark terms when he called increasing inequality “the root of social evil”.
It is therefore not surprising that IMF research—which looked at 173 countries over the last 50 years—found that an unequal countries tend to have lower and less durable economic growth.
So much for the diagnosis—what can be done about it? We have done some recent work on this as well. We focused on the fiscal policy dimension—which is part of the IMF’s core business. We found that in general, fiscal policies have a good record of reducing social disparities—for example, transfers and income taxes have been able to reduce inequality by about a third, on average, among the advanced economies.
But it is a complex issue and policy choices need to be made carefully. Fiscal discipline is often the first victim on the political battlefield, and we obviously want to choose measures that do the best and the least harm.
Some potentially beneficial options can include making income tax systems more progressive without being excessive; making greater use of property taxes; expanding access to education and health and relying more on active labor market programs and in-work social benefits.
But we must recognize that reducing inequality is not easy. Redistributive policies always produce winners and losers. Yet if we want capitalism to do its job—enabling as many people as possible to participate and benefit from the economy—then it needs to be more inclusive. That means addressing extreme income disparity.
Integrity in the financial system
Let me now turn to the second dimension of inclusive capitalism that I have chosen to address—integrity in the financial system.
In this age of diminished trust, it is the financial sector that takes the last place in opinion surveys. This might not be surprising in light of some of the behavior that triggered the global financial crisis.
But it is nevertheless disturbing. As many have pointed out, the very word credit derives from the Latin word for trust.
We are all familiar with the factors behind the crisis—a financial sector that nearly collapsed because of excess. A sector that, like Icarus, in its hubris flew too close to the sun, and then fell back to earth—taking the global economy down with it.
We can trace the problems to the evolution of the financial sector before the crisis. Financial actors were allowed to take excessive risks, leading to a situation whereby the profits on the upside went to the industry—and the losses on the downside were picked up by the public.
Some of the greatest problems, still outstanding today, lay with the so-called too-big-to-fail firms. In the decade prior to the crisis, the balance sheets of the world’s largest banks increased by two to four-fold. With rising size came rising risk—in the form of lower capital, less stable funding, greater complexity, and more trading.
This kind of capitalism was more extractive than inclusive. The size and complexity of the megabanks meant that, in some ways, they could hold policymakers to ransom. The implicit subsidy they derived from being too-big-too-fail came from their ability to borrow more cheaply than smaller banks—magnifying risk and undercutting competition.
Thankfully, the crisis has prompted a major course correction—with the understanding that the true role of the financial sector is to serve, not to rule, the economy. Its real job is to benefit people, especially by financing investment and thus helping with the creation of jobs and growth.
As Winston Churchill once remarked, “I would rather see finance less proud and industry more content”.
The good news is that the international community has made progress on the reform agenda. This is especially true for banking regulation under the auspices of the Basel Committee, where we are moving forward with stronger capital and liquidity requirements. This should make the system safer, sounder and more service oriented.
The bad news is that progress is still too slow, and the finish line is still too far off. Some of this arise from the sheer complexity of the task at hand. Yet, we must acknowledge that it also stems from fierce industry pushback, and from the fatigue that is bound to set in at this point in a long race.
A big gap is that the too-big-to-fail problem has not yet been solved. A recent study by IMF staff shows that these banks are still major sources of systemic risk. Their implicit subsidy is still going strongly—amounting to about $70 billion in the US, and up to $300 billion in the Euro Area.
So clearly, ending too-big-to-fail must be a priority. That means tougher regulation and tighter supervision.
Here, I believe that the new capital surcharges for systemic banks can work. We estimated that increasing the capital ratio on these banks by 2½ percent, beyond the Basel III standard, can reduce the systemic risk of a trillion dollar bank by a quarter. This is a big deal.
Yet the problem will not go away without steps to reduce the potential for contagion. First on the agenda should be an agreement on a cross-border resolution of megabanks—providing a framework to unwind them in an orderly way in case of failure. This is a gaping hole in the financial architecture right now, and it calls for countries to put the global good of financial stability ahead of their parochial concerns.
And we should not give up just because it is hard. Let me quote John Fitzgerald Kennedy here, who famously said that “we choose to go to the moon not because it is easy, but because it is hard”.
We also need more vigor across the rest of the reform agenda—better rules for nonbanks, better monitoring of shadow banks, and better safety and transparency over derivatives, an area that is still today excessively obscure and complex. To reduce the scope for contagion, I would like to see much more progress on cross-border issues, for example, in the mutual recognition of rules for derivatives markets.
Again, this is complex, and we need to be mindful of the risks of fragmenting the global financial system and hampering the flow of credit to finance investment. But complexity is not an excuse for complacency and delay.
Changing behavior and culture
As well as regulation, we need stronger supervision. Rules are only as good as their implementation. This calls for greater resources, and independence, for the supervisors who perform such a vital public duty, day in and day out.
Yet regulation and supervision by themselves are still not enough. Rules can certainly affect behavior—think of compensation practices, for example. But people who want to skirt the rules will always find creative ways of doing so.
So we also need to turn our attention to the culture of financial institutions, and to the individual behavior that lies beneath. Incentives must be aligned with expected behavior and be made transparent.
Here, the work of the FSB on Principles for Sound Compensation Practices, commissioned by the G20, is instrumental in realigning incentives with actual performance. We must push on with implementation.
Why is this so important? Because the behavior of the financial sector has not changed fundamentally in a number of dimensions since the crisis. While some changes in behavior are taking place, these are not deep or broad enough. The industry still prizes short-term profit over long-term prudence, today’s bonus over tomorrow’s relationship.
Some prominent firms have even been mired in scandals that violate the most basic ethical norms—LIBOR and foreign exchange rigging, money laundering, illegal foreclosure.
To restore trust, we need a shift toward greater integrity and accountability. We need a stronger and systematic ethical dimension.
In grappling with this, it helps to go back to the ancient philosophers. They would have raised the most basic question—what is the social purpose of the financial sector? Or, as Aristotle would have asked: “what is its telos?”
He answered his own question: “Wealth is evidently not the good we are seeking; for it is merely
useful and for the sake of something else”. Or as Oscar Wilde put it, “the true perfection of man lies, not in what man has, but in what man is”.
From this perspective, we can identify the true purpose of finance. Its goal is to put resources to productive use, to transform maturity, thereby contributing to the good of economic stability and full employment—and ultimately, to the wellbeing of people. In other words—to enrich society.
In Aristotle’s framework, once we know the purpose, we can identify the virtues needed to fulfill it. It becomes a matter of every person doing the right thing.
When we think about finance, surely one of these core virtues is prudence—which is about stewardship, sustainability, and safeguarding the future. Prudence has long been a byword of banking, and yet has been sorely missing in action in recent times.
We know that regaining virtues like prudence will not happen overnight. Aristotle teaches us that virtue is molded from habit, from developing and nurturing good behavior over time. As with anything worth doing, practice makes perfect.
Getting back on the right path requires education and leadership that is sustained over many years. It requires alert watchdogs, including from civil society.
Most importantly of all, it requires investors and financial leaders taking values as seriously as valuation, culture as seriously as capital.
As Mark Carney pointed out in an admirable speech in Canada last year, the financial sector needs to be grounded in strong connections to clients and to communities—to the people served by the financial industry.
Ultimately, we need to ingrain a greater social consciousness—one that will seep into the financial world and forever change the way it does business.
The good news is that we are seeing some positive signs. The Inclusive Capitalism Initiative is one such example—pursuing practical ways to make capitalism an engine of economic opportunity for all.
We can draw some parallels here with our expanding environmental consciousness. Not so long ago, we had much higher levels of pollution, and littering was commonplace. Today, we are more educated about these issues, and more in the habit of respecting the planet.
By comparison, the equivalent kind of awareness in the financial sector—the idea that private misbehavior can have a broader social cost—is only in its early stages. It is akin to the initial period of environmental consciousness, which focused on the banning of lead from petroleum products.
Just as we have a long way to go to reduce our carbon footprint, we have an even longer way to go to reduce our “financial footprint”.
Yet we must take those steps.
I realize that these are deeper questions than economists and policymakers are normally comfortable talking about. Yet I also believe the link is clear—ethical behavior is a major dimension of financial stability.
Conclusion for Inclusive Growth
Let me conclude. The topic of inclusive capitalism is obviously a vast one. I could have talked about many different aspects: women’s exclusion, disregard for the environment, corporate social responsibility.
Yet I wanted to focus my remarks today on the behavior that continues to deplete the treasury of trust and could again destabilize the global economy.
This is why the work of your Initiative is so important. It needs to infuse the consciousness of all economic leaders, across all sectors and countries.
At the end of the day, when the global economy is more inclusive, the gains are less elusive. The market is more effective, and a better future—for everyone—is more likely.
Thank you very much.
History tells us that societies succeed when the fruits of growth are broadly shared. Indeed, no society has ever succeeded without a large, prospering middle class* that embraced the idea of progress.
Today, the ability of free-market democracies to deliver widely shared increases in prosperity is in question as never before. The primary challenge democracies face is neither military nor philosophical. Rather, for the first time since the Great Depression, many industrial democracies are failing to raise living standards and provide opportunities for social mobility to a large share of their people. Some of those countries that have produced economic growth have done so in a manner that has left most of their citizens no better off. This is an economic problem that threatens to become a problem for the political systems of these nations—and for the idea of democracy itself.
The citizens of industrial democracies continue to value their freedom and their opportunity to participate in the task of self-government. But they also count on their political systems to create circumstances in which they can use their talents and their labor to provide a decent standard of life for themselves and their families. When democratic governments and market systems cannot deliver such prosperity to their citizens, the result is political alienation, a loss of social trust, and increasing conflict across the lines of race, class, and ethnicity. Inclusive prosperity nurtures tolerance, harmony, social generosity, optimism, and international cooperation. And these are essential for democracy itself.
The economic troubles of the democracies also erode support for the democratic idea around the globe. In our time, advocates and apologists for anti-democratic regimes argue that the democracies are no longer capable of managing their problems or creating a sense of social dynamism. Democracies are cast as sclerotic, inefficient, and ungovernable. We believe that this critique is wrong today, as it has been historical. But countering this persistent attack on democracy requires that free economic and political systems restore their vitality and reclaim their ability to deliver on the promise of prosperity for all.
It has always been the mission of progressives to ensure rising prosperity and opportunity. A strong, inclusive economy is the platform for a socially mobile, optimistic, and successful society. While the economic mission of progressives is unchanging, the means of its achievement change from generation to generation as the economy evolves. Today, we are living in the age of globalization and technological revolution. Both have delivered many benefits to society but have reshaped the political economy of western industrialized countries in ways that challenge the middle class and those striving to get into it.
Our report is about embracing the new economic opportunities of the 21st century by finding ways to ensure they serve the vast majority of society. In previous eras, political institutions have responded to economic transformations to ensure prosperity is shared: the New Deal in the United States and the European social welfare state; the “third-way” politics of putting people first of Clinton and Blair by investing in people and reforming institutions. Just as it took the New Deal and the European social welfare state to make the Industrial Revolution work for the many and not a few during the 20th century, we need new social and political institutions to make 21st-century capitalism work for the many and not a few.
We offer this report on the urgency of achieving inclusive prosperity because we believe democracy must serve this common good, the cause of social justice and the aspirations of parents for their children. For democracies to thrive, rising prosperity must be within reach of all of our citizens.
Key Democrats have reached agreement on a set of policies known as “inclusive capitalism”: a forceful market-oriented economic agenda intended to counter inequality, restrain the accrual of vast wealth at the top and provide the working and middle classes with improved economic opportunities.
The concept of inclusive capitalism has expanded over the past 13 years to apply to those at the bottom and middle of the ladder in developed nations, including the United States. The fundamental “inclusive capitalism” argument is that business enterprises lose profit-making opportunities when consumers have little money to spend. Inadequate purchasing power among the many threatens corporations and poses a direct danger to the top 1 percent, and, indeed, to capitalism itself.
The economic environment has shifted, income inequality has grown, and the
recovery from the economic crisis is not yet complete. But these challenges are
There is considerable evidence that certain national policies can produce vastly
different outcomes. While all advanced economies have been buffeted by
increased global competition and rapid technological change, the consequences
for their citizens have not been uniform. Canada, Australia, and Sweden, for
example, have access to the same automation and are at least as exposed to trade
and low-wage competition as other countries, but they have maintained a closer
link between productivity and wage growth in the face of these pressures.
The failure of advanced economies to successfully address the low growth and
high unemployment that have flowed from the financial crisis may translate into
reduced long-term growth. One major finding of academic economic research
during the Great Recession is that long spells of unemployment can permanently
lower both workers’ earnings and potential GDP.
Alongside rising sustainable levels of aggregate demand, economies in advanced
countries must increase the productive capacity of their workforces, make
much-needed investments in public goods and infrastructure, and put in place
the conditions for innovation that are the best way of increasing trend growth.
Raising human capital is critical to improving economic growth. Improving the
quality of compulsory education and providing both vocational and academic
routes to high skills is vital. Improving education levels for all helps reduce
inequality by ensuring that everyone is able to benefit from a growing economy.
Increasing the quality and quantity of skills for disadvantaged children is an
essential way of creating inclusive prosperity.
Investments in infrastructure, such as transport, energy, telecom, and housing, are
also essential to improving economic growth. Because they tend to be large scale
and long term, they require high levels of coordination in order to maximize the
wider benefits to society as a whole. This means that in many cases, governments
will play a vital role in planning, delivering, and financing these projects.
Capitalism has guided the world economy to unprecedented prosperity. Yet it has also proved dysfunctional in important ways.
It often encourages short-sightedness, contributes to wide disparities between the rich and poor, and tolerates the reckless treatment of environmental capital.
Yet there is a limit to what any one company can achieve. Transformational change will come only from businesses and others acting together. Again, we are hopeful, because momentum is building. Coalitions are being formed to tackle issues ranging from illegal deforestation to food security. Bodies like the World Business Council for Sustainable Development and the global Consumer Goods Forum are uniting key industry players and putting pressure on governments to join forces in the search for sustainable capitalism.
As the cost of inaction rises, governments and businesses must continue to respond. None of us can thrive in the world where 1 billion people go to bed hungry each night and 2.3 billion lack access to basic sanitation. Nor can business thrive where public optimism about the future and trust in institutions is so low.
We have a long way to go, but we believe the necessary transformation is beginning. A growing body of evidence suggests that new business models can deliver responsible growth. The Conference on Inclusive Capitalism represents another step forward. Though our work has only just started, we are convinced that within a generation we can redefine capitalism and build a sustainable and equitable global economy.
We have no time to lose. As Mahatma Gandhi once put it: “The future depends on what you do today.”