Economic crossroads and AI: unveiling the future at the 2024 IMF-World Bank Summit

By Dr. Andreas Dombret and Dr. Oliver Wünsch (published in German by 3th of May 2024 at "Zeitschrift für das gesamte Kreditwesen" and online at https://www.kreditwesen.de/kreditwesen/themenschwerpunkte/aufsaetze/fruehjahrstagung-iwf-weltbank-kuenstliche-intellig-id95630.html

Once again, from April 15 to April 20, 2024, the global financial world met in Washington, D.C. for the traditional Spring Meeting of the International Monetary Fund and the World Bank.

While the official program of finance ministers and central bank governors follows a set ceremonial of committee meetings and conferences, the biannual meeting is unique. It includes the presence of high-ranking officials and private sector representatives from industrial and developing countries. This gathering offers an exceptionally differentiated and up-to-date picture of the mood in the financial markets and the global economy.

First, the good news: The economy is growing again.

In its outlook, the IMF forecasts global growth of 3.2%. The main drivers here are clearly the United States with 2.7%, as well as China and India with 4.6% and 6.8%, respectively. The figures only look good at first glance. Not only are growth prospects historically low (even though the global economy has come through the recent crisis years better than expected in some places), above all, the IMF expects only modest growth in the coming years.

Unfortunately, there is also no good news for Germany.

Not only was the country the only industrialized nation in recession in 2023, but it is also expected to be the weakest performer among developed countries in 2024, with an expected economic growth of 0.2%. Several factors are contributing to a lasting impact. These include a geopolitical crisis, sharply increased energy costs, and restrained investment willingness from both businesses and the public sector. Additionally, high labor costs, social expenditures, and the accompanying industrial transformation are also playing a significant role in this impact.

The disappointing economic growth is all the more worrying when looking at the debt ratios.

The sustainability of government debt is known to be measured by the ratio of outstanding debt to economic performance, as well as the level for debt service in relation to the total budget. Given the not very optimistic outlook - the IMF expects a decade of weak growth - it will hardly be possible to grow out of the debt. Especially since important countries, including in the Eurozone, show persistent fiscal deficits and accumulate further debt. There appears to be no improvement on the horizon for the sustainability of pension systems, coupled with the unfortunate and significant rise in military investment needs. And after the act of incurring debt had been extremely cheap in recent years due to low and sometimes negative interest rates, the turn in interest rates is now also affecting state budgets. The USA now spends about as much on interest payments as on the military, which is, after all, the strongest in the world. In the EU, the situation is very uneven. It is, however, clear that the comparatively strong countries support the creditworthiness of the entire Eurozone. A weakening Germany is also problematic against this backdrop.

In addition to the macroeconomic outlook, the IMF's semi-annual report on financial stability also attracts a great deal of attention.

With the demise of various regional banks in the US and Credit Suisse, several threatening events have taken place in the last twelve months, which - thanks in part to the courageous intervention of the central banks - have been overcome without further contagion. Contrary to expectations, the sudden, sharp, and globally synchronized rise in interest rates did not lead to major disruptions in the financial markets and the banking sector. The tensions in the markets have rather reduced in recent months. These problems were less pronounced this time, particularly in developing countries, which in the past were confronted with strong capital outflows when interest rates rose in the dollar zone: These countries have learned from the past and have also diversified their sources of financing in terms of currency and taken a more long-term view. With the exception of China, the stock markets are at all-time highs, even if the various industrial sectors are performing very differently. In particular, the expectation of interest rate cuts in view of the significant fall in inflation is priced in here. However, the rate of price increases in many countries is above the target corridor, including in the eurozone and the USA, where inflation has recently even risen slightly again. While interest rate cuts are certainly to be expected in the coming months, there is still uncertainty regarding the timing and scope, meaning that market corrections cannot be ruled out.

Besides the formal rituals related to growth and financial stability, and the tightly scheduled official agenda, it's the informal talks and topics of participants from around the world that are of special interest and reflect changing trends. In the past, crypto and “green finance” dominated in terms of the number of seminars and breakout sessions, but only played a marginal role this spring. The hype surrounding crypto has died down. Bitcoin has indeed staged a veritable rally in recent months. However, it is no longer seen as a threat to state currencies, but rather as a (highly speculative) asset class. The slowdown in inflation and the rise in interest rates have contributed to this, as a result of which even low-risk cash investments can generate positive returns, at least in nominal terms. Both central banks and the financial sector are working hard to exploit advances in technology, whether for more efficient settlement systems or for central bank digital currencies such as the digital euro. In the end, the crypto wave was certainly a useful catalyst here.

We also hear much less about the topic of “green finance”.

While the need for a more CO2-neutral economy is hardly in doubt, questions are being raised about its feasibility and financial viability, also in view of the weak growth cited. The belief in a green growth and jobs miracle is being pursued. We have a hard road ahead of us to achieve the reduction targets in a socially responsible manner and within the scope of technical possibilities. Developing countries have an important role to play. While at least some (such as South Africa) are at least planning for climate neutrality when adding new capacity, others (such as China) are placing greater emphasis on rapid growth. Social considerations, and therefore also questions of political stability, play a major role here. It is clear, however, that financial aid from developed countries alone is not enough and that private sources of financing must also be tapped.

The dominant topic in Washington this time was artificial intelligence (AI).

The exponential progress of the last few years or even months raises the question of the extent to which AI will influence economic and social structures. The consensus is that the impact will be significant. However, it remains to be seen whether these developments will be positive for society, as previous innovation boosts have been. Daron Acemoglu from MIT outlined perspectives on possible future paths at the G30 lecture. If AI were mainly used for automation, this would primarily affect jobs that do not involve physical labor, but this would apply to all income levels. AI could also be used to perform highly skilled work that requires little creativity and is standardized. As those affected are the pillars of society today, who bring democracy to life and also make significant tax contributions, the expected upheavals would be fatal. An alternative scenario would be an “augmenting” AI that supports workers, i.e. makes work easier and more efficient and provides skills that the respective workers do not have. This could take society as a whole to a new level of productivity, both quantitatively and qualitatively. Acemoglu sees the need for regulation here in order to guide AI developments onto the “right” track. However, simply minimizing risk, as the EU is striving to do, is not enough. It is also very important to counteract monopolization tendencies, which are unfortunately already visible.

Another topic of discussion was the “Basel Endgame” in the US, which is taking place at the same time as the Spring Meeting but independently of it. Like many other countries and the EU, the US has committed to implementing the Basel Accord on banking regulation. Some time ago, the Fed, which is responsible for implementation, submitted a “proposed rulemaking” that would have tightened up some of the Basel rules in national implementation. The US banking lobby fought back with an unprecedented campaign, including commercials during the Superbowl, the most expensive advertising time on US television - and was successful. Jay Powell, also careful not to use too much political capital, has now toned down the proposed rules to such an extent that it is questionable whether the rulemaking process will have to be restarted in view of the extensive changes. In view of the upcoming elections, the timetable will determine the outcome. With a Republican majority, it will hardly be possible to push through full Basel III implementation.

In the worst case scenario, the USA will only partially implement the rules that it itself helped to draw up and which it pushed for to be implemented internationally. This does not bode well for the credibility of the Basel process and an international “level playing field” in banking regulation and will lead to even more fragmentation. Yet the last crisis once again showed how important international coordination is.

The Bretton Woods institutions, the IMF and the World Bank, also suffer from geopolitical fragmentation.

The institutions have always been exposed to the political preferences of their members and owners, and understandably so. Formal influence is determined on the basis of voting weight, the so-called “quota”, which is calculated using a complex formula with a strong weighting on economic performance. Larger developing countries in particular, such as China, have been able to increase their share in recent years through “quota reforms”, e.g. by taking into account the size of the population.

However, the USA still has a blocking minority today and does not want to give it up. In many fundamental issues, the further development of the institutions is thus blocked, even though it was recently possible to increase the capacity of the IMF, with all countries participating proportionally. This calls into question the previously undisputed role of the IMF as a financial fire department. For although limited crises in individual countries could be addressed via bilateral arrangements - and in some cases with far fewer reform requirements than the IMF would have made - in the event of extensive, supra-regional upheavals, a platform would once again be needed on which many countries could come together and seek joint solutions without playing each other off against each other and at the expense of the crisis countries. If the IMF loses this role in view of the geopolitical blockades, this would not only pose a risk to the existence of the institution itself, but also to the global economy.

Under the leadership of Kristalina Georgieva, the successor to Christine Lagarde as Managing Director of the IMF, the IMF has embarked on a search for meaning and is now explicitly pursuing development mandates such as the green transformation or poverty reduction - topics that were previously reserved for the World Bank, Georgieva's former place of work. Critics argue that the IMF's financial resources are now released far too freely and that the recipient countries are only given a few conditions regarding reforms, debt sustainability and competitiveness, partly in order to make the IMF's rescue packages more attractive to new competitors. Georgieva, as head of the IMF the most important advocate of this approach, has now been confirmed for a further five-year term of office. However, this did not happen quietly. The USA in particular openly expressed its displeasure at Georgiewa's understanding of the mandate. In the end, however, the desire for personnel stability prevailed and probably also the Europeans' fear of losing “their” implicit prerogative to the position of IMF Director to an up-and-coming developing country in the event of a possible castling. It remains to be seen whether the “scope creep” will carry the institution through difficult times or cause lasting damage in the end.

After the volatility of the Covid crisis, inflation and rising interest rates, there is now a tense calm in Washington. Geopolitical developments in Europe, the Middle East and Asia are causing considerable uncertainty, which has only partially materialized on the markets so far. The IMF rightly warns of fiscal discipline and is concerned about weak growth. The days of cheap money are over. The world must once again turn its attention to the most important, but also the most difficult question: How to generate sustainable productivity growth for all. The answer will be of crucial importance for the stability of our society.