The Problem With Christine Lagarde
By Simon Johnson
Ms. Christine Lagarde, French finance minister, is the nominee of the European Union for the recently vacant position of managing director at the International Monetary Fund. The EU has just over 30 percent of the votes in this quasi-election; the US has another 16.8 percent and seems willing to keep a European at the fund if an American can remain head of the World Bank. It should be easy for Ms. Lagarde to now travel round the world engaging in some old-fashioned horse trading, along the lines of: Support me now, and I or the French government will get you something suitable in return, either at the IMF or elsewhere.
The contest to run the IMF seems over before it has even really begun. But Ms. Lagarde has a serious problem that may still derail her candidacy, if there is ever any substantive, open, or transparent discussion of her merits. There is major design flaw in the eurozone and Ms. Lagarde is the last person that non-European governments should want to put in charge of helping sort that out.
Ms. Lagarde is explicitly being put forward as someone who can represent the interests of the eurozone – at a time when the eurozone needs help. And it really is the eurozone as a whole – including France – that needs help, not just a couple of errant countries (Greece, Ireland, Portugal, and whoever might be next in line for market fears about its government debt and growth prospects).
The founding assumption for the eurozone in 1999, which became a myth during the early 2000s, is that eurozone countries would converge in terms of productivity levels – to put it starkly, Greece would become very much like Germany. In that view of Europe, it did not much matter if some countries within the eurozone 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 GDP under control.
None of this happened. The productivity gains were seen more in Germany and some other North European countries; unit labor costs, reflecting the net effect of productivity gains and real wage increases, rose sharply in Mediterranean Europe. And French, German and other “core” banks facilitated this divergence with a surge in lending to both 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 only became French finance minister in 2007 – although she certainly played a leading role in denying Europe had any serious issues as the global financial crisis began to brew in 2007 and early 2008. But the bigger issue 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 eurozone country to restructure its debts. Low bank capital creates serious systemic financial risk for Europe and the world.
Relatedly, Ms. Lagarde has led the “no restructuring” school of thought in recent months with regard to Greece – and presumably other eurozone countries also. Debt restructuring is no kind of panacea. But to take the option completely off the table is also not smart – unless you really think there is no deeper issue that must be addressed.
The eurozone in its first iteration has failed to operate as intended. Unless you think Greece can now experience a miraculous productivity transformation, the eurozone leadership needs to make a choice. Do they integrate more, including with 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 eurozone countries cannot borrow from the European Central Bank?
Either way, the International Monetary Fund can potentially help with loans and with technical advice. But such money belongs to the international community – there are 187 member countries after all.
And it would need to be a lot of money. If Ms. Lagarde becomes head of the IMF, she will most likely continue to throw loans at the eurozone problems – if there are even preventive programs for Spain, Italy, or Belgium, the IMF will need to tap its shareholders for at least another $1 trillion in credit lines.
Ms. Lagarde personifies the strategy of gambling for eurozone resurrection with other people’s money. Why would taxpayers in US and elsewhere want to support her on this basis?
An edited version of this post appeared this morning on the NYT.com’s Economix; it is used here with permission. If you would like to reproduce the entire post, please contact the New York Times.