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FW: What I learned at the world economic crisis. by JOSEPH STIGLITZ, Chief economist and vice president of the World Bank
PLEASE NOTE: this is not an event, but it pertains to the IMF protests in
Washington next week. I would be grateful if someone would forward it to a
discussion list serve, for which I don't have the address handy. Thanks
-----Original Message-----
From: Sujatha Byravan [mailto:Sujatha@lead.org]
Sent: April 11, 2000 9:33 AM
To: allcohorts
Subject: What I learned at the world economic crisis. by JOSEPH
STIGLITZ, Chief economist and vice president of the World Bank
Next week's meeting of the International Monetary Fund will bring to
Washington, D.C., many of the same demonstrators who trashed the World Trade
Organization in Seattle last fall. They'll say the IMF is arrogant. They'll
say the IMF doesn't really listen to the developing countries it is
supposed to help. They'll say the IMF is secretive and insulated from
democratic accountability. They'll
say the IMF's economic "remedies" often make things worse--turning slowdowns
into recessions and recessions into depressions.
And they'll have a point. I was chief economist at the World Bank from 1996
until last November, during the gravest global economic crisis in a
half-century. I saw how the IMF, in tandem with the U.S. Treasury
Department, responded. And I was appalled.
The global economic crisis began in Thailand, on July 2, 1997. The countries
of East Asia were coming off a miraculous three decades: incomes had soared,
health had improved, poverty had fallen dramatically. Not only was literacy
now universal, but, on international science and math tests, many of these
countries outperformed the United States. Some had not suffered a single
year of recession in 30 years.
But the seeds of calamity had already been planted. In the early '90s, East
Asian countries had liberalized their financial and capital markets--not
because they needed to attract more funds (savings rates were already 30
percent or more) but because of international pressure, including some from
the U.S. Treasury Department. These changes provoked a flood of short-term
capital--that is, the kind of capital that looks for the highest return in
the next day, week, or month, as opposed to long-term investment in things
like factories. In Thailand, this short-term capital helped fuel an
unsustainable real estate boom. And, as people around the world (including
Americans) have painfully learned, every real estate bubble eventually
bursts, often with disastrous consequences. Just as suddenly as capital
flowed in, it flowed out. And, when everybody tries to pull their money out
at the same time, it causes an economic problem. A big economic problem.
The last set of financial crises had occurred in Latin America in the 1980s,
when bloated public deficits and loose monetary policies led to runaway
inflation. There, the IMF had correctly imposed fiscal austerity (balanced
budgets) and tighter monetary policies, demanding that governments pursue
those policies as a precondition for receiving aid. So, in 1997 the IMF
imposed the same demands on Thailand. Austerity, the fund's leaders said,
would restore confidence in the Thai economy. As the crisis spread to other
East Asian nations--and even as evidence of the policy's failure
mounted--the IMF barely
blinked, delivering the same medicine to each ailing nation that showed up
on its doorstep.
I thought this was a mistake. For one thing, unlike the Latin American
nations, the East Asian countries were already running budget surpluses. In
Thailand, the government was running such large surpluses that it was
actually starving
the economy of much-needed investments in education and infrastructure, both
essential to economic growth. And the East Asian nations already had tight
monetary policies, as well: inflation was low and falling. (In South Korea,
for
example, inflation stood at a very respectable four percent.) The problem
was
not imprudent government, as in Latin America; the problem was an imprudent
private sector--all those bankers and borrowers, for instance, who'd gambled
on
the real estate bubble.
Under such circumstances, I feared, austerity measures would not revive the
economies of East Asia--it would plunge them into recession or even
depression. High interest rates might devastate highly indebted East Asian
firms, causing more bankruptcies and defaults. Reduced government
expenditures would only shrink the economy further.
So I began lobbying to change the policy. I talked to Stanley Fischer, a
distinguished former Massachusetts Institute of Technology economics
professor and former chief economist of the World Bank, who had become the
IMF's first deputy managing director. I met with fellow economists at the
World Bank who might have contacts or influence within the IMF, encouraging
them to do everything they could to move the IMF bureaucracy.
Convincing people at the World Bank of my analysis proved easy; changing
minds at the IMF was virtually impossible. When I talked to senior officials
at
the IMF--explaining, for instance, how high interest rates might increase
bankruptcies, thus making it even harder to restore confidence in East Asian
economies--they would at first resist. Then, after failing to come up with
an effective counterargument, they would retreat to another response: if
only I understood the pressure coming from the IMF board of executive
directors--the body, appointed by finance ministers from the advanced
industrial countries, that approves all the IMF's loans. Their meaning was
clear. The board's inclination was to be even more severe; these people were
actually a
moderating influence. My friends who were executive directors said they were
the ones
getting pressured. It was maddening, not just because the IMF's inertia was
so hard to stop but because, with everything going on behind closed doors,
it was impossible to know who was the real obstacle to change. Was the staff
pushing the executive directors, or were the executive directors pushing the
staff? I still do not know for certain.
Of course, everybody at the IMF assured me they would be flexible: if their
policies really turned out to be overly contractionary, forcing the East
Asian economies into deeper recession than necessary, then they would
reverse them. This sent shudders down my spine. One of the first lessons
economists teach
their graduate students is the importance of lags: it takes twelve to 18
months before a change in monetary policy (raising or lowering interest
rates) shows its full effects. When I worked in the White House as chairman
of the Council of Economic Advisers, we focused all our energy on
forecasting where the economy would be in the future, so we could know what
policies to recommend today. To play catch-up was the height of folly. And
that was precisely what the IMF officials were proposing to do.
I shouldn't have been surprised. The IMF likes to go about its business
without outsiders asking too many questions. In theory, the fund supports
democratic institutions in the nations it assists. In practice, it
undermines the democratic process by imposing policies. Officially, of
course, the IMF doesn't "impose" anything. It "negotiates" the conditions
for receiving aid. But all the power in the negotiations is on one side--the
IMF's--and the fund rarely allows sufficient time for broad
consensus-building or even widespread consultations with either parliaments
or civil society. Sometimes the IMF dispenses with
the pretense of openness altogether and negotiates secret covenants.
When the IMF decides to assist a country, it dispatches a "mission" of
economists. These economists frequently lack extensive experience in the
country; they are more likely to have firsthand knowledge of its five-star
hotels than of the villages that dot its countryside. They work hard, poring
over numbers deep into the night. But their task is impossible. In a period
of
days or, at most, weeks, they are charged with developing a coherent
program sensitive to the needs of the country. Needless to say, a little
number-crunching rarely provides adequate insights into the development
strategy for an entire nation. Even worse, the number-crunching isn't always
that
good. The mathematical models the IMF uses are frequently flawed or
out-of-date.
Critics accuse the institution of taking a cookie-cutter approach to
economics,
and they're right. Country teams have been known to compose draft reports
before
visiting. I heard stories of one unfortunate incident when team members
copied large parts of the text for one country's report and transferred them
wholesale to another. They might have gotten away with it, except the
"search and
replace" function on the word processor didn't work properly, leaving the
original
country's name in a few places. Oops.
It's not fair to say that IMF economists don't care about the citizens of
developing nations. But the older men who staff the fund--and they are
overwhelmingly older men--act as if they are shouldering Rudyard Kipling's
white man's burden. IMF experts believe they are brighter, more educated,
and
less politically motivated than the economists in the countries they visit.
In
fact,the economic leaders from those countries are pretty good--in many
cases
brighter or better-educated than the IMF staff, which frequently consists
of third-rank students from first-rate universities. (Trust me: I've taught
at
Oxford University, MIT, Stanford University, Yale University, and Princeton
University, and the IMF almost never succeeded in recruiting any of the
best students.) Last summer, I gave a seminar in China on competition policy
in
telecommunications. At least three Chinese economists in the audience asked
questions as sophisticated as the best minds in the West would have asked.
As time passed, my frustration mounted. (One might have thought that since
the World Bank was contributing literally billions of dollars to the rescue
packages, its voice would be heard. But it was ignored almost as
resolutely as the people in the affected countries.) The IMF claimed that
all it was
asking of the East Asian countries was that they balance their budgets at a
time of
recession. All? Hadn't the Clinton administration just fought a major
battle with Congress to stave off a balanced-budget amendment in this
country? And
wasn't the administration's key argument that, in the face of recession, a
little deficit spending might be necessary? This is what I and most other
economists had been teaching our graduate students for 60 years. Quite
frankly, a student who turned in the IMF's answer to the test question "What
should
be the fiscal stance of Thailand, facing an economic downturn?" would have
gotten an F.
As the crisis spread to Indonesia, I became even more concerned. New
research at
the World Bank showed that recession in such an ethnically divided country
could
spark all kinds of social and political turmoil. So in late 1997, at a
meeting of finance ministers and central-bank governors in Kuala Lumpur, I
issued a
carefully prepared statement vetted by the World Bank: I suggested that the
excessively contractionary monetary and fiscal program could lead to
political and social turmoil in Indonesia. Again, the IMF stood its ground.
The
fund's managing director, Michel Camdessus, said there what he'd said in
public:
that East Asia simply had to grit it out, as Mexico had. He went on to note
that, for all of the short-term pain, Mexico emerged from the experience
stronger.
But this was an absurd analogy. Mexico hadn't recovered because the IMF
forced it to strengthen its weak financial system, which remained weak years
after the crisis. It recovered because of a surge of exports to the United
States,
which took off thanks to the U.S. economic boom, and because of nafta. By
contrast, Indonesia's main trading partner was Japan--which was then, and
still
remains, mired in the doldrums. Furthermore, Indonesia was far more
politically and
socially explosive than Mexico, with a much deeper history of ethnic strife.
And renewed strife would produce massive capital flight (made easy by
relaxed currency-flow restrictions encouraged by the IMF). But none of these
arguments mattered. The IMF pressed ahead, demanding reductions in
government
spending. And so subsidies for basic necessities like food and fuel were
eliminated at the very time when contractionary policies made those
subsidies more desperately needed than ever.
By January 1998, things had gotten so bad that the World Bank's vice
president
for East Asia, Jean Michel Severino, invoked the dreaded r-word
("recession")
and d-word ("depression") in describing the economic calamity in Asia.
Lawrence
Summers, then deputy treasury secretary, railed against Severino for making
things seem worse than they were, but what other way was there to describe
what
was happening? Output in some of the affected countries fell 16 percent or
more.
Half the businesses in Indonesia were in virtual bankruptcy or close to
it, and,
as a result, the country could not even take advantage of the export
opportunities the lower exchange rates provided. Unemployment soared,
increasing
as much as tenfold, and real wages plummeted--in countries with basically
no
safety nets. Not only was the IMF not restoring economic confidence in East
Asia, it was undermining the region's social fabric. And then, in the
spring and
summer of 1998, the crisis spread beyond East Asia to the most explosive
country
of all--Russia.
The calamity in Russia shared key characteristics with the calamity in East
Asia--not least among them the role that IMF and U.S. Treasury policies
played
in abetting it. But, in Russia, the abetting began much earlier. Following
the
fall of the Berlin Wall, two schools of thought had emerged concerning
Russia's
transition to a market economy. One of these, to which I belonged,
consisted of
a melange of experts on the region, Nobel Prize winners like Kenneth Arrow
and
others. This group emphasized the importance of the institutional
infrastructure
of a market economy--from legal structures that enforce contracts to
regulatory
structures that make a financial system work. Arrow and I had both been
part of
a National Academy of Sciences group that had, a decade earlier, discussed
with
the Chinese their transition strategy. We emphasized the importance of
fostering
competition--rather than just privatizing state-owned industries--and
favored a
more gradual transition to a market economy (although we agreed that
occasional
strong measures might be needed to combat hyperinflation).
The second group consisted largely of macroeconomists, whose faith in the
market
was unmatched by an appreciation of the subtleties of its
underpinnings--that
is, of the conditions required for it to work effectively. These economists
typically had little knowledge of the history or details of the Russian
economy
and didn't believe they needed any. The great strength, and the ultimate
weakness, of the economic doctrines upon which they relied is that the
doctrines
are--or are supposed to be--universal. Institutions, history, or even the
distribution of income simply do not matter. Good economists know the
universal
truths and can look beyond the array of facts and details that obscure
these
truths. And the universal truth is that shock therapy works for countries
in
transition to a market economy: the stronger the medicine (and the more
painful
the reaction), the quicker the recovery. Or so the argument goes.
Unfortunately for Russia, the latter school won the debate in the Treasury
Department and in the IMF. Or, to be more accurate, the Treasury
Department and
the IMF made sure there was no open debate and then proceeded blindly
along the
second route. Those who opposed this course were either not consulted or
not
consulted for long. On the Council of Economic Advisers, for example,
there was
a brilliant economist, Peter Orszag, who had served as a close adviser to
the Russian government and had worked with many of the young economists who
eventually assumed positions of influence there. He was just the sort of
person whose expertise Treasury and the IMF needed. Yet, perhaps because he
knew
too much, they almost never consulted him.
We all know what happened next. In the December 1993 elections, Russian
voters
dealt the reformers a huge setback, a setback from which they have yet
really to
recover. Strobe Talbott, then in charge of the noneconomic aspects of
Russia
policy, admitted that Russia had experienced "too much shock and too little
therapy." And all that shock hadn't moved Russia toward a real market
economy at
all. The rapid privatization urged upon Moscow by the IMF and the Treasury
Department had allowed a small group of oligarchs to gain control of state
assets. The IMF and Treasury had rejiggered Russia's economic incentives,
all
right--but the wrong way. By paying insufficient attention to the
institutional
infrastructure that would allow a market economy to flourish--and by
easing the
flow of capital in and out of Russia--the IMF and Treasury had laid the
groundwork for the oligarchs' plundering. While the government lacked the
money
to pay pensioners, the oligarchs were sending money obtained by stripping
assets
and selling the country's precious national resources into Cypriot and
Swiss
bank accounts.
The United States was implicated in these awful developments. In mid-1998,
Summers, soon to be named Robert Rubin's successor as secretary of the
treasury,
actually made a public display of appearing with Anatoly Chubais, the chief
architect of Russia's privatization. In so doing, the United States seemed
to be
aligning itself with the very forces impoverishing the Russian people. No
wonder
antiAmericanism spread like wildfire.
At first, Talbott's admission notwithstanding, the true believers at
Treasury
and the IMF continued to insist that the problem was not too much therapy
but
too little shock. But, through the mid-'90s, the Russian economy continued
to
implode. Output plummeted by half. While only two percent of the
population had
lived in poverty even at the end of the dismal Soviet period, "reform" saw
poverty rates soar to almost 50 percent, with more than half of Russia's
children living below the poverty line. Only recently have the IMF and
Treasury
conceded that therapy was undervalued--though they now insist they said so
all
along.
Today, Russia remains in desperate shape. High oil prices and the
long-resisted
ruble devaluation have helped it regain some footing. But standards of
living
remain far below where they were at the start of the transition. The
nation is
beset by enormous inequality, and most Russians, embittered by experience,
have
lost confidence in the free market. A significant fall in oil prices would
almost certainly reverse what modest progress has been made.
East Asia is better off, though it still struggles, too. Close to 40
percent of
Thailand's loans are still not performing; Indonesia remains deeply mired
in
recession. Unemployment rates remain far higher than they were before the
crisis, even in East Asia's best-performing country, Korea. IMF boosters
suggest
that the recession's end is a testament to the effectiveness of the
agency's
policies. Nonsense. Every recession eventually ends. All the IMF did was
make
East Asia's recessions deeper, longer, and harder. Indeed, Thailand, which
followed the IMF's prescriptions the most closely, has performed worse than
Malaysia and South Korea, which followed more independent courses.
I was often asked how smart--even brilliant--people could have created
such bad
policies. One reason is that these smart people were not using smart
economics.
Time and again, I was dismayed at how out-of-date--and how out-of-tune with
reality--the models Washington economists employed were. For example,
microeconomic phenomena such as bankruptcy and the fear of default were at
the
center of the East Asian crisis. But the macroeconomic models used to
analyze
these crises were not typically rooted in microfoundations, so they took no
account of bankruptcy.
But bad economics was only a symptom of the real problem: secrecy. Smart
people
are more likely to do stupid things when they close themselves off from
outside
criticism and advice. If there's one thing I've learned in government,
it's that
openness is most essential in those realms where expertise seems to matter
most.
If the IMF and Treasury had invited greater scrutiny, their folly might
have
become much clearer, much earlier. Critics from the right, such as Martin
Feldstein, chairman of Reagan's Council of Economic Advisers, and George
Shultz,
Reagan's secretary of state, joined Jeff Sachs, Paul Krugman, and me in
condemning the policies. But, with the IMF insisting its policies were
beyond
reproach--and with no institutional structure to make it pay attention--our
criticisms were of little use. More frightening, even internal critics,
particularly those with direct democratic accountability, were kept in the
dark.
The Treasury Department is so arrogant about its economic analyses and
prescriptions that it often keeps tight--much too tight--control over what
even
the president sees.
Open discussion would have raised profound questions that still receive
very
little attention in the American press: To what extent did the IMF and the
Treasury Department push policies that actually contributed to the
increased
global economic volatility? (Treasury pushed liberalization in Korea in
1993
over the opposition of the Council of Economic Advisers. Treasury won the
internal White House battle, but Korea, and the world, paid a high price.)
Were
some of the IMF's harsh criticisms of East Asia intended to detract
attention
from the agency's own culpability? Most importantly, did America--and the
IMF--push policies because we, or they, believed the policies would help
East
Asia or because we believed they would benefit financial interests in the
United
States and the advanced industrial world? And, if we believed our policies
were
helping East Asia, where was the evidence? As a participant in these
debates, I
got to see the evidence. There was none.
Since the end of the cold war, tremendous power has flowed to the people
entrusted to bring the gospel of the market to the far corners of the
globe.
These economists, bureaucrats, and officials act in the name of the United
States and the other advanced industrial countries, and yet they speak a
language that few average citizens understand and that few policymakers
bother
to translate. Economic policy is today perhaps the most important part of
America's interaction with the rest of the world. And yet the culture of
international economic policy in the world's most powerful democracy is not
democratic.
This is what the demonstrators shouting outside the IMF next week will try
to
say. Of course, the streets are not the best place to discuss these highly
complex issues. Some of the protesters are no more interested in open
debate
than the officials at the IMF are. And not everything the protesters say
will be
right. But, if the people we entrust to manage the global economy--in the
IMF and in the Treasury Department--don't begin a dialogue and take their
criticisms to heart, things will continue to go very, very wrong. I've seen
it happen.
JOSEPH STIGLITZ is professor of economics at Stanford University (on
leave) and a senior fellow at the Brookings Institution. From 1997 to 2000,
he was
chief economist and vice president of the World Bank. He served on the
president's Council of Economic Advisers from 1993 to 1997.
...............................................
Sujatha Byravan
Director, Fellows Program
LEAD International
700 Broadway, 3rd Floor
Tel: 212-460-9001 (227)
Fax: 212- 460-8633
http:// www.lead.org
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