Quotes of the Day
It has been six years since the east asian crisis began — a sudden collapse of the currencies followed by recession and depression. From East Asia, it spread around the world until some feared the global economy itself might be approaching collapse. The International Monetary Fund (IMF) came charging to the rescue, but its programs did little to fix the problem. In fact, critics such as myself argued that IMF policies — particularly its insistence on premature "liberalization," or forcing recipient nations to open up their financial markets to often volatile short-term capital flows — had helped bring on the contagion, and that its "medicine" had made the patients far sicker. Eventually, even the IMF agreed that it had imposed contractionary fiscal policies, and that premature capital market liberalization might expose countries to risks. Three years later protesters stormed the annual International Monetary Fund/World Bank meeting in Prague and, with a couple of exceptions, those meetings have continued to be marked by protest, as the one taking place in Dubai this month may be. These events sparked a worldwide debate about the need to reform the world's economic and financial architecture. Now it is time to take stock: Has there been reform? Have the protests made a difference?
At first glance, there have been enormous changes. Public pressure has worked. True, efforts at improving transparency have done more to improve the websites of international financial institutions than to improve public access to decision making. But the IMF has been subject to far more scrutiny, and calls for reform have even come from President George W. Bush as well as myriad officials around the world. These calls for increased accountability and oversight have brought at least seven changes for the better.
Conditionality The IMF had long been criticized for its excessive "conditionality" — dozens of requirements imposed on countries as a condition for their receiving assistance. In the East Asia crisis, countries in desperate need of funds had to acquiesce to conditions that had nothing to do with the crisis and which, in some cases, were of dubious economic merit. While in the U.S., the Federal Reserve focuses on inflation, growth and employment, the IMF insisted that Korea focus exclusively on inflation — even though Korea did not have an inflation problem (unemployment was a more pressing concern). Conditionality not only undermined democratic processes, but the huge number of conditions made it difficult for countries to focus on the most urgent needs. The IMF has now recognized that it pushed conditionality too far, and in some cases has cut back.
Ownership and participation One of the reasons for the failure of so many IMF programs was that the governments that had to implement them felt no sense of "ownership" over them. Programs were imposed on reluctant governments, who often accepted them over enormous public opposition. That meant that as soon as the country was less in need of IMF money, the reforms were abandoned. This is precisely what is happening today in Thailand; as soon as it paid back the last of the money it borrowed during the 1997 crisis, it announced a program to reverse key changes imposed upon it. (For example, a bankruptcy law widely viewed within Thailand as too friendly to creditors was effectively imposed in 1998; today Thailand is moving toward adoption of a law that balances creditor and debtor interests.) Ownership requires participation in the decision making; as World Bank president James Wolfensohn has put it, the "country should be in the driver's seat." While critics have said that effective control remains in the hands of the instructor (the IMF and World Bank), the fact is that — especially in many of the World Bank's country programs — there has been a real change in the relationship. Today, even the IMF recognizes the importance of ownership. The Fund's poverty-reduction strategy papers introduced in 2000, for example, which are supposed to guide government economic programs, require widespread participation by ngos and civil society. In principle, no longer is economic policy to be left to deal making between the IMF and the Ministry of Finance.
From bailouts to bankruptcy The bailouts of the Latin American debt crisis in the 1980s and the East Asian crises of the 1990s were severely criticized. They helped Western banks get repaid but left developing countries with bigger debt burdens. Indeed, the bailouts may even have contributed to the problem of debt crises, by inducing bad lending practices. The failure in the last six years of the mega-bailouts — in Thailand, Indonesia, Korea, Russia, Brazil, Argentina — made it apparent that an alternative is needed. Since the '80s, alternatives have been proposed — allowing nations to declare bankruptcy and standstills in the same way that individual debtors who cannot meet their obligations are permitted to have a fresh start, or at least reschedule payments. But these were long rejected by the IMF, which felt they were an abrogation of the sanctity of the debt contract. In November 2001, with the impending failure in Argentina, the IMF recognized the need for a systematic procedure for debt restructurings. Unfortunately, U.S. opposition and some major political mismanagement by the IMF put this reform on ice. But the fact that there were "official" discussions on the topic was a major step forward.
Debt Forgiveness It has long been widely accepted, even by the developed countries holding the IOUs, that some form of debt forgiveness was needed for highly indebted poor countries. Debt overhang was stifling their growth; and without growth, they would not in any case be able to repay what they owed. In 1996, the IMF and World Bank, together with the G-7, initiated a program of debt forgiveness, but in order to have their debts forgiven, countries had to meet a series of hurdles set by the IMF.
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Excessive austerity For more than 70 years, economists have recognized that, when an economy faces a downturn, there is a need for expansionary fiscal and monetary policies. The great economist John Maynard Keynes saw that a downturn in one country could have adverse effects on others. He was the intellectual godfather of the IMF — founded, he thought, to provide the funds and pressure for expansionary fiscal policies for countries facing imminent recessions.
Yet, over the years, the IMF began to push policies that were diametrically opposed to those that Keynes advocated, and which formed the rationale for its creation. Ironically, the IMF has helped provide some of the most convincing evidence that Keynes was right: its austerity policies have worsened economic downturns. In its review of its policies in East Asia, even the Fund recognized that it had pushed fiscal austerity too far. Yet it went on to make the same mistake again in Argentina (which last week reached a deal with the IMF to refinance some $21 billion in loans). On the positive side, in Brazil, it pursued more reasonable stances.
Improved transparency of financial markets In the aftermath of the East Asia crisis, there were demands for increased transparency on the part of developing countries. Although the crisis stemmed more from imprudent financial and capital market liberalization than from a lack of transparency, the call for greater transparency struck a chord — until it became apparent that greater transparency could apply also to the advanced industrial countries' offshore bank accounts and hedge funds. At that point, some in the U.S. Treasury became decidedly less enthusiastic. Nonetheless, the OECD developed an agreement restricting bank secrecy — an initiative vetoed by the Bush Administration shortly before Sept. 11. In the aftermath of the attacks, the role of these secret bank accounts in financing terrorism was at last recognized, and thus there has been progress in loosening bank secrecy.
Capital market liberalization Perhaps the biggest — and least celebrated — change has been in perspectives on capital market liberalization. Six years ago, the IMF proposed changing its charter to include a requirement that member countries liberalize their capital markets. I, and others, had criticized the proposal because there was no evidence that such a change would promote economic growth or stability. We argued that such a major change to the global financial architecture needed evidence showing it would help those in the developing world.
In fact, studies at the World Bank showed that capital market liberalization was systematically associated with instability, which increased poverty and economic insecurity and was bad for growth. The IMF had tried to argue that, without capital market liberalization, one could not entice foreign investors. Yet China had attracted more foreign direct investment than any other developing country, and it has still not fully liberalized its capital market.
By the end of the 1990s, it was hard to resist the mounting evidence. Every major emerging market that had liberalized its capital market had had a crisis; the two major countries that had not, China and India, had not only avoided the East Asian crisis, but managed to grow steadily throughout the period. Finally, to its credit, the IMF took note of what had long been obvious: capital market liberalization does not enhance growth, and it does increase instability. In March, its soon-to-be-departing chief economist and three co-authors released a survey of the evidence, confirming what the critics had been saying all along.
There were two reasons this was so important: first, destabilizing short-term capital flows — "hot money" transactions — were at the root of much of the instability that has afflicted so many developing countries, during the past quarter century. The IMF, rather than helping to stabilize the global economy, was actually contributing to global instability. The reversal of its position, if actually translated into well-thought-out policies, may contribute to a more stable global economy. Secondly, it was an admission that free, unfettered markets, by themselves, may not always be a good thing. There are limits to markets. Of course, to most people, this had long been obvious, but this was a new position for the IMF and could bode a change in the way it does business.
And so even critics looking at this record are compelled to conclude: There have been major changes in six short years. But in many areas, there has been greater change in rhetoric than in reality. While the improvements in the debt-forgiveness programs are to be lauded, countries like Moldova must still spend up to three-quarters of their scarce public revenues servicing foreign debt. In advocating a statutory framework for debt restructuring, the IMF was right, but until the U.S. backs this reform, it won't happen. Global governance remains highly undemocratic. And the IMF's own democratic insensitivities have been revealed in several ways. For instance, in its approach to sovereign debt restructuring, it wanted to retain a pivotal role; yet its role as a major creditor would compromise the impartiality of the proceedings. By the same token, while the U.S. has recognized the role of secret bank accounts in financing terrorism, secret bank accounts are also important in money laundering, tax evasion and other forms of corruption. There needs to be a much stronger and broader attack on bank secrecy.
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The global reserve system is both a major source of inequity and instability. It's no accident that much of the world's reserves are held in dollars. Prudence requires developing countries in East Asia and Latin America to hold substantial reserves in hard currencies, and most choose dollars and U.S. government bonds. The result: America lives well beyond its means — importing over $500 billion more than it exports every year — while developing countries that run much smaller deficits are chastised and severely punished by the markets. The system guarantees that developing countries are lending to the U.S. at low interest rates; but many are also borrowing from the U.S. to finance government spending and investment, paying substantially higher rates. The result is a net transfer from the poor countries of the world to the richest.
We should applaud the attempts at reform, but we should not be complacent. In an arena where change typically occurs at glacial speeds, the change is observable. The global community can be proud. Yet those who expected a major reform in the global financial architecture have been sorely disappointed. Any fundamental reforms would have to address issues of global governance, and there are strong vested interests in keeping the status quo — rearranging the chairs around the table, but not changing the table or those who have a seat at it. Thus many of the reforms have only just begun. Fundamental weaknesses in the global financial system — and in its governance — have yet to be addressed. The glass is still more than half empty.
- Nobel Prize-winning economist Joseph E. Stiglitz dissects the IMF