Globalization and Its Discontents

GLOBALIZATIoN AND ITS DISCONTENTS Joseph E Stiglitz w W NORTON COMPANY NE YORK LONDON Copyrighl C 2002 by Joseph E Stiglitz All rigb rved Prinled in the Uniled StalCS of America Finl Edition For infurmation aboul permission 10 leproduce selections fiom this book wrile 10 Permissions ww Nonon Company Inc 500 Filih AV1nue NcwYork NY tOt to The ICXI and dispby of this book an composed in Bembo Composition by Sue Carlson Manufaccuring by Quebecor Fairfield Book design by Chris Welch Production managu Julia Druskin Library of Congress CataioginginPublication Da Stiglitz Joseph E Globalization and i disconccnts I Joseph E Stiglitz pem Includes bibliographical references and index ISBN 0393051242 I International economic integration 2 Foreign trade regulation 3 Intcrnationill finance 4 GlobalizationEconomic aspectsDeveloping countries S International Monetary FundDeveloping counaic 6 United StatcsCommcrcial policy I Title HF14185 575 2002 337dc21 W W Norton Compnylne 500 Fifih Avenue NcwYork NY 10110 wwwwwnortoncom 2002023148 Ww Norton Compny Ltd C de House 75n6Wells 5trcet London WIT 3QT 90 To my mother and father who taught me to care and reason and to Anya who put it all together and more CONTENTS Preface IX Acknowledgmems XVII 1 The Promise of Global Institutions 2 Broken Promises lJ 3 Freedom to Choose 53 4 The East Asia Crisis How IMF Policies Brought the World to the Verge of a Global Meltdown 89 5 Who Lost Russia IJJ 6 Unfair Trade Laws and Other Mischief 1M 7 Better Roads to the Market 180 8 The IMFs Other Agenda 195 9 The Way Ahead 214 Notes 253 Jllde 269 PREFACE I N I 993 I left academia to serve on the Council of Economic Advisers unde President Bill Clinton After years of research and teaching this was my first major foray into policy making and more to the point politics From there I moved to the World Bank in 1997 where I served as chief economist and senior vice president for almost three years leaving in January 2000 I couldnt have chosen a more fascinating time to go into policy making I was in the White House as Russia began its transition from communism and I worked at the Bank during the financial crisis that began in East Asia in 1997 and eventually enveloped the world I had always been interested in economic development and what I saw radically changed my views of both globalization and development I have written this book because while I was at the World Bank I saw firsthand the devastat ing effect that globalization can have on developing countries and especially the poor within those countries I believe that globaliza tionthe removal of barriers to free trade and the closer integration of national economiescan be a force for good and that it has the potential to enrich everyone in the world particularly the poor But I also believe that if this is to be the case the way globalization ha been managed including the international trade agreements that have played such a large role in removing those barriers and the poli IX x PREFACE lies that have been imposed on developing countries in the process of globalization need to be radically rethought As a professor I spent a lot of time researching and thinking about the eonomic and social issues I dealt with during my seven years in Washington I believe it is important to view problems in a dispas sionate way to put aside ideology and to look at the evidence before making a decision about what is the best course of action Unfortu nately though hardly surprisingly in my time at the White House as a member and then chairman of the Council of Economic Advisers a panel of three experts appointed by the president to provide eco nomil advice in the executive branch of the US government and at the World Bank I saw that decisions were often made because of ideology and politics As a result many wrongheaded actions were taken ones that did not solve the problem at hand but that fit with the interests or beliefs of the people in power The French intellectual Pierre Bourdieu has written about the need for politicians to behave more like scholars and to engage in scientific debate based on hard facts and evidence Regrettably the opposite happens too often when academics involved in making policy recommendations become politicized and start to bend the evidence to fit the ideas of those in charge If my academic career did not prepare me for all that I encoun tered in Washington DC at least it did prepare me professionally Before entering the White House I had divided my time spent on research and writing between abstract mathematical economics helping to develop a branch of economics that has since come to be called the economics of information and more applied subjects including the economics of the public sector development and monetary policy I spent more than twentyfive years writing about subjects such as bankruptcy corporate governance and the openness of and access to information what economists call transparency These were crucial issues when the global financial crisis began in 1997 I had also been involved for nearly twenty years in discussions concerning transitions from Communist to market economies My experience with how to handle such transitions began in 1980 when I first discussed these issues with leaders in China as it was beginning its move toward a market economy I had been a strong advocate of PREFACE XI the gradualist policies adopted by the Chinese policies that have proven their merit over the past two decades and I have been a strong critic of some of the extreme reform strategies such as shock therapy that have failed so miserably in Russia and some of the other countries of the former Soviet Union My involvement in issues of development dates back even fur therto the time I spent in Kenya on an academic posting 196971 shortly after its independence in 1963 Some of my most important theoretical work had been inspired by what I saw there I knew the challenges facing Kenya were difficult but I hoped that it might be possible to do something to improve the lives of the billions of peo ple there and in the rest of the world who live in extreme poverty Economics may seem like a dry esoteric subject but in fact good economic policies have the power to change the lives of these poor people I believe governments need toand canadopt policies that help countries grow but that also ensure that growth is shared more equitably To take but one issue I believe in privatization selling off say government monopolies to private companies but only if it helps companies become more efficient and lowers prices for con sumers This is more likely to happen if markets are competitive which is one of the reasons I support strong competition policies Both at the World Bank and the White House there was a close link between the policies I advocated and my earlier largely theoret ical work in economics much of it related to market imperfections why markets do not work perfectly in the way tlut simplistic models which assume perfect competition and perfect information claim they do I brought to policy making my work on the economics of information in particular on asymmetries of informationthe differ cnces in information between say the worker and his employer the lender and the borrower the insurance company and the insured These asymmetries are pervasive in all economies This work pro vided the foundations for more realistic theories of labor and finan cial markets explaining for instance why there is unemployment and why those most in need of credit often cannot get itthere is to use the economists jargon creditrationing The standard models that economists had used for gcnerations argued either that markets worked perfectlysomc even denied the existence of genuine XII PREfACE untmploymtntor that the only reason that unemployment existed was that W1ges wtrt too high suggesting the obvious remedy lower wagts Intormation economics with its better analyses oflabor capi tal and product markets enabled the construction of macroeconomic lllodds that provided deeper insights into unemployment models th1t txplained the fluctuations the recessions and depressions that h1d marked capitalism since its beginnings These theories have strong policy implicationssome of which are obvious to almost anyone in touch with the real worldsuch as that if you raise inter tst rates to exorbitant levels firms that are highly indebted can be torced into bankruptcy and this will be bad for the economy While I thought they were obvious these policy prescriptions ran counter to those that were frequenrly insisted upon by the International Mone tary Fund IMF The IMFs policies in part based on the outworn presumption that markets by themselves lead to efficient outcomes failed to allow for desirable government interventions in the market measures which can guide economic growth and make everyone better off What was at issue then in many of the disputes that I describe in the following pages is a matter of ideas and conceptions of the role of the government that derive from those ideas Although such ideas have had an important role in shaping policy prescriptionsin development in managing crises and in transi tionthey are also central to my thinking about reforming the international institutions that are supposed to drive economic development manage crises and facilitate economic transition My research on information made me particularly attentive to the conse quences of the lack of information I was glad to see the emphasis during the global financial crisis in 199798 of the importance of transparency but saddened by the hypocrisy that the institutions the IMF and the US Treasury which emphasized it in East Asia were among the least transparent that I had encountered in public life This is why in the discussion of reform I emphasize the necessity for increased transparency improving the information that citizens have about what these institutions do allowing those who are affected by the policies to have a greater say in their formulation The analysis of PJlHACE XIII the role of information in political institutions evolved quite naturally from my earlier work on the role of information in economics One of the exciting aspects of coming to Washington was the opportunity not only to get a better understanding of how govern ment works but also to put forward some of the perspectives to which my research had led For instance as chairman of Clintons Council of Economic Advisers I tried to forge an economic policy and philosophy that viewed the relationship between government and markets as complementary both working in partnership and rec ognized that while markets were at the center of the economy there was an important if limited role for government to play I had stud ied the failures of both markets and government and was not so naive as to think that government could remedy every market failure Nei ther was I so foolish as to believe that markets by themselves solved every societal problem Inequality unemployment pollution these were all issues in which government had to take an important role I had worked on the initiative for reinventing governmentmaking government more efficient and more responsive I had seen where government was neither I had seen how difficult reform is but I had also seen that improvements modest as they might be were possible When I moved to the World Bank I had hoped to bring this bal anced perspective and the lessons I had learned to the far more diffi cult problems facing the developing world Inside the Clinton administration I enjoyed the political debate winning some battles losing others As a member of the presidents cabinet I was well positioned not only to observe the debates and see how they were resolved but especially in areas that touched upon economics to participate in them I knew that ideas mattered but so did politics and one of my jobs was to persuade others not just that what I advocated was good economics but also that it was good pol itics But as I moved to the international arena I discovered that neither dominated the formulation of policy especially at the Inter national Monetary Fund Decisions were made on the basis of what seemed a curious blend of ideology and bad economics dogma that sometimes seemed to be thinly veiling special interests When crises hit the IMF prescribed outmoded inappropriate ifstandard XIV PREfACE solutions without considering the effects they would have on the people in the countriestol totollow these policies Rarely did I see torecasts about what the policies would do to poverty Rarely did I see thoughdul discussions and analyses of the consequences of alter native policies There was a single prescription Alternative opinions were not sought Open frank discussion was discouragedthere Was no room tor it Ideology guided policy prescription and countries were expected to follQw the IMF guidelineswithout debat These attitudes made me cringe It was not just that they often produced poor results they were antidemocratic In our personal lives we would never follow ideas blindly without seeking alternative advice Yet countries all over the world were instructed to do just that The problems facing developing countries are difficult and the IMF is oftencalled1Ipon in the worst of situations when the country is facing a cris Butjtsrni fuilcraSoneii or evenmoreften than theyVed IMF structurai djustment poiicietheplicies designed to help a country adjust to crises as well as to more persis tent imbalancesled to hunger and riots in many countries and even when results were not so dire even when they managed to eke out some growth for a while often the benefits went disproportion ately to the betterotT with those at the bottom sometimes facing even greater poverty What astounded me however was that those policies werent questioned by many of the people in power in the IMF by those who were making the critical decisions They were often questioned by people in the developing countries but many were so afraid they might lose IMF funding and with it funding from others that they articulated their doubts most cautiously if at all and then only in private But while no one was happy about the suffering that often accompanied the lMF programs inside the IMF it was simply assumed that whatever suffering occurred was a necessary part of the pain countries had to experience on the way to becoming a successful market economy and that their measures would in fact reduce the pain the countries would have to face in the long run Undoubtedly some pain was necessary but in my judgnlent the level of pain in developing countries created in the process of global ization and development as it has been guided by the IMF and the international economic organizations has been far greater than nec essary The backlash against globalization draws its force not only PlIIlfACE xv from the perceived damage done to developing countries by policies driven by ideology but also from the inequities in the global trading system Today fewapart from those with vested interests who ben efit from keeping out the goods produced by the poor countries defend the hypocrisy of pretending to help developing countries by forcing them to open up their markets to the goods of the advanced industrial countries while keeping their own markets protected poli cies that make the rich richer and the poor more impoverishedand increasingly angry The barbaric attacks of September t t 200 t have brought home with great force that we all share a single planet We are a global com munity and like all communities have to follow some rules so that we can live together These rules must beand must be seen to be fair and just must pay due attention to the poor as well as the power ful must reflect a basic sense of decency and social justice In todays world those rules have to be arrived at through democratic processes the rules under which the governing bodies and authori ties work must ensure that they will heed and respond to the desires and needs of all those affected by policies and decisions made in dis tant places THIS BOOK IS based on my experiences There arent nearly as many footnotes and citations as there would be in an academic paper Instead I tried to describe the events I witnessed and tell some of the stories that I heard There are no smoking guns here You wont find hard evidence of a terrible conspiracy by Wall Street and the IMF to take over the world I dont believe such a conspiracy em The truth is subtler Often its a tone of voice or a meeting behind dosed doors or a memo that determines the outcome of discussions Many of the people I criticize will say J have gotten it wrong they may even produce evidence that contradicts my views of what happened J can only offer my interpretation of what I saw When J joined the World Bank I had intended to spend most of my time on issues of development and the problems of the countries trying to make the transition to a market economy but the global financial crisis and the debates about reforming the international economic architecturethe system by which the international eco XVI PRIiFACE nomic and tlnancial system are governedin order to make global ization more humane effective and equitable occupied a large frac tion of my time I visited dozens of countries all over the world and spoke to thousands of government officials finance ministers central bank governors academics development workers people at non governmental organizations NGOs bankers business people stu dents political activists and farmers I visited Islamic guerrillas in Mindanao the Philippine island which has long been in a state of rebellion trekked through the Himalayas to see remote schools in Bhutan or a village irrigation project in Nepal saw the impact of rural credit schemes and programs for mobilizing women in Bangla desh and witnessed the impact of programs to reduce poverty in vil lages in some of the poorest mountainous parts of China I saw history being made and I learned a lot I have tried to distill the essence of what I saw and learned and present it in this book I hope my book will open a debate a debate that should occur not just behind the closed doors of government and the international organizations or even in the more open atmosphere of universities Those whose lives will be affected by the decisions about how glob alization is managed have a right to participate in that debate and they have a right to know how such decisions have been made in the past At the very least this book should provide more information about the events of the past decade More information will surely lead to better policies and those will lead to better results If that hap pens then I will feel I have made a contribution ACKNOWLEDGMENTS T HERE IS AN ENDLESS list of those to whom I am greatly indebted withom whom this book could not be written President Bill Clinton and World Bank President Jim Wolfensohn in giving me opportunities to serve my country and the peoples of the developing world also gave me an opportunity rela tively rare for an academic to glimpse decision making that affcct all of our lives I am indebted to hundreds of colleagues at the World Bank not only for the vigorous discussions that we had over the years abom all the issues discussed in this book but for sharing with me their years of experience in the field They also helped arrange the many trips through which I could get unique perspectives on what was happening in the developing countries I hesitate to single out anyone lest I slight others but at the same time I would be remiss if I did not acknowledge at least some of those with whom I worked most closely including Masood Ahmed Lucie Albert Amar Bhattacharya Francois Bourgignon Gerard Caprio Ajay Chhlbher Uri Dadush Carl Dahlman Bill Easterly Giovanni Ferri Coralie Gevers Nocmi Giszpenc Maria lonata Roumeen Islam Anupanl Khanna Lawrence MacDonald Ngozi OjonjoIweala Guillermo Perry Boris Pleskovic Jo Ritzen Halsey Rogers Lyn Squire Vinod xnl XVIII ACKNOWLEDGMENTS Thomas Maya Tudor Mih Walton Shahid Yusuf and Hassan Zaman Othtrs It tht World Bank whom I would like to thank include Martha Ainsworth Myrna Alexander Shaida Badiee Stijn Claessens Pllti Collier Kemal Dervis Dennis de Tray Shanta Devarajan Ishac Diwan David Dollar Mark DutzAlan Gelb Isabel Guerrero Cheryl Gray Robert Holzman Ish rat Husain Greg Ingram Manny Jimenez 1vhts Karlsson Danny Kaufman Ioannis Kessides Horni Kharas Aart Kray Sarwar Lateef Danny Leipziger Brian Levy Johannes Linn Oey Astra MeesookJeanClaude Milleron Pradeep Mitra Mustapha Nabli Gobind Nankani John Nellis Akbar Noman Fayez Omar John Page Guy Pfeffermann Ray Rist Christof RuehlJessica Sed don Marcelo Selowski Jean Michel Severino Ibrahim Shihata Ser gio Shmuckler Andres Solimano Eric Swanson Marilou Uy Tara Viswanath Debbie Wetzel David Wheeler and Roberto Zagha am also indebted to the many people in the other international economic organizations with whom I discussed the numerous issues that are reflected upon hereincluding Rubens Ricupero at UNCTAD the UN Conference on Trade and Development Marc Malloch Brown at the UNDP Enrique Iglesias Nancy Birdsall and Ricardo Haussman at the InterAmerican Development Bank Jacques de Larosiere the former head of the European Bank for Reconstruction and Development and a host of others at the UN regional otfIces and the Asian and African Development Banks Next to my colleagues at the World Bank I perhaps interacted more with those at the ME and while it will be clear from the ensuing pages that I often disagreed with much of what they did and how they went about doing it I learned much from them and the long discus ions we had not the least of which was a better understanding of heir mindsets I should also be clear while am highly critical I also appreciate the hard work that they put in the difficult circumstances under which they work and their willingness at a personal level to have tlr mOTe open and free discussions than they can at an official level I H11 liso grateful to the nUlllerous government officials in the developing countries from large countries like China and India to lull cOllntrils like Uganda and Bolivia from prime ministers and ACKNOWLEVGMNTS XIX heads of state to finance ministers and central bank governors to education ministers and other cabinet officials on down who will ingly shared their time to discuss with me their visions for their countries as well as the problems and frustrations they faced In our long meetings they often talked to me in confidence Many of th05e such as Vaclav Klaus the former prime minister of the Czech Repub lic would disagree with much that I have to say yet I learned a great deal from talking to them Others such as Andrei lllarionov cur rently Putins chief economic adviser and Grzegorz W Kolodko for mer deputy prime minister and finance minister of Poland Meles Zenawi prime minister of Ethiopia or Yoweri Museveni president of Uganda would be sympathetic with much if not most of what 1 have to say Some of those at the international economic organiza tions who have been helpful have also asked me not to thank them and I have honored their request While much of my time was spent in discussions with government officials I was also able to meet large numbers of businessmen who also gave of their time as they described the challenges that they faced and provided their interpretations of what was going on in their countries While it is difficult to single out any single individual I should mention Howard Golden whose detailed descriptions of experiences in a multitude of countries were particularly insighttid As an academic I had my own entree into the countries 1 visited so I could see matters from perspectives that were not dictated by official positions This book owes a great deal to this global net work of academic colleaguesone of the healthier aspects of global ization I am particularly indebted to my colleagues at Stanford Larry Lau at the time head of the Asia Pacific Center Masa Aoki currently research director at the Ministry of Economics and International Trade in Japan and Yingyi Qian not only for the insights that they provided into Asia but for the many doors they opened Over the years academic colleagues and former students such as Jungyoll Yun in Korea Mrinal Datta Chaudhuri in India K SJomo in Ma1aysia Justin Lin in China and Amar Siamwalla in Thailand helped me see and understand their countries The hectic years at the World Bank and the Council of Economic Advisers have been followed by a more eRective period of research xx ACKNOWLIiDGMENTS and t aching I am d ply indebt d to the Brookings Institution StJnloni Jud Columbiaand my students and colleagues at those institutionslor invaluabl discussions on the ideas contained here and to my JSSociat s Ann FIorini and Tim Kessler who worked with m to cr at th Initiative for Policy Dialogue originally centered at Stanlord Uniwrsity and the Carnegie Endowment for Peace now 10CJt d at Columbia Uniwrsity wwwgsbeduipd to promote the kind of inlorm d d mocratic discussion of alternative policies that I call lor in this book During this period financial support has also b en provided by the Ford MacArthur and Rockefeller Founda tions th UNDp th Canadian International Development Agency md th UNDP In writing a book like this while I have relied mostly on my own exp ri nces those have been amplified not only by my colleagues but by a host of reporters A theme in this book that I hope has some resonance is the importance of open access to information many of the problems I describe arise because so much goes on behind closed doors I have always believed that an active and free press is a critical check on these abuses and is necessary for democracy and many of the reporters with whom I dealt regularly were dedicated to that mission I learned much from them as we shared our interpretation of the events that were occurring Again at the risk of singling out a couple when so many should be recognized Chrystia Freeland was a huge help with the Russia chapter and Paul Blustein and Mark Clif ford provided valuable insights on the East Asian experience Economics is the science of choice From the wealth of insights and information on the subjects as complicated and fascinating as those discussed here volumes could be written Unfortunately that was one of my main challenges in writing this book the volumes I did write had to be shaped into a far shorter narrative I had to let go of some of the ideas and skip some of the qualifications as important as I thought they were I had grown accustomed to two forms of writing serious academic tomes and brief popular speeches This work represents for me a new genre It could not have been pub lished vithollt the tireless efforts of Anya Schiffrin who spent months working with me on the writing and the revisions helping me make those hard choices as painful as they sometimes seemed ACKNOWUUGMtNTS XXI Drake McFeelymy editor for twenty yearsncouraged and sup ported me throughout Sarah Stewarts edits were terrific Jim Wade worked tirelessly to pull the final manucript together and Eve Lazovitz offered important support at several key stages Nadia Roumani has been my righthand woman for years Noth ing would be possible without her Sergio Godoy and Monica Fuentes diligently checked the facts and found the statistics I needed Leah Brooks helped a lot with the earlier drafts Niny Khor and Ravi Singh my research assistants at Stanford worked hard on the penulti mate version This work rests on a considerable body of academic work both my own in conjunction with a large number of coauthors and clut of others again too numerous to cite I have also benefited from innumerable discussions with colleagues around the world I should mention Professor Robert Wade of the London School of Econom ics a former World Bank staff member who has written insightfully not only about the general problems of the international economic institutions but also about several of the specific topics covered here East Asia and Ethiopia The transition from Communism to a market economy has been a subject that has engaged the interest of acade mic economists greatly over the past fifteen years I have benefited in particular from Janos Kornais insights I should also mention four other leading scholars Peter MurrellJan Svejnar Marshall Goldman and Gerard RolandA central theme of this book is the value of open debate and I have learned much from discussions with and reading those whose interpretations of events I sometimes perhaps often dis agree within particular Richard Layard Jeff Sachs Anders AsIund and Andrei Shleifer I have also benefited from discussions with a multitude of academicians in the economies in transition including Oleg Bogomolov and Stanislav Menshikov in Russia Steve Lewis Peter Eigen and Charles Harvey all provided me with insights into Botswana from their firsthand experiences and Charles Harvey gave me detailed comments on chapter 2 Over the years work and discussions with Nick Stern who succeeded me at the World Bank after serving as chief economist at the EBRD Partha Dasgupta Ravi Kanbur who was responsible for the land mark World Developll1tnt Report on Poverty of 200t initiated XXII ACKNOWLEDGMBNTS whilt I vas still chitf economist at the World BankAvi Braverman now president of BenGurion University but a longtime researcher It the World Bank Karla Hoff Raaj Sah David Bevan Mark Gerso vitz David NewberyJim MirrleesAmarrya Sen and David Ellerman lue been particularly influential in shaping my thinking I am par ticularly indebted to Andy Weiss for his practical insights into the problems of transition for his empirical analyses of the consequences of privatization and for his broader insights into capital market impertections My earlier work on East Asia for the World Bank done with Marilou Uy in conjunction with among others Howard Pack Nancy Birdsall Danny Leipziger and Kevin Murdoch pro vided me with insights into the region that put me in good stead in dealing with the crisis when it occurred lowe an especial debt of gratitude to Jason Furman who worked with me both at the White House and at the World Bank for all his work but especially that on East Asia and the critique of the Washington Consensus Thanks are due to Hal Varian for suggesting the title Anyone who reads this book will also see clearly the influence of ideas concerning imperfect information and marketscentral I believe for understanding how any market economy works but especially developing ones Work with Carl Shapiro Michael Rothschild Sandy Grossman Steve Salop and Richard Arnott helped provide insights into unemploy ment capital market imperfections the limitations of competition and the importanceand limitationsof institutions At the end of it all there is always Druce Greenwaldmy collaborator and friend for more than twentyfive years CHAPTER THE PROMISE OF GLOBAL INSTITUTIONS I NTERNATIONAL BUREAUCRATSTHE faceless symbols of the world economic orderare under attack everywhere Formerly uneventful meetings of obscure technocrats discussing mundane subjects such as concessional loans and trade quotas have now become the scene of raging street battles and huge demonstrations The protests at the Seattle meeting of the World Trade Organization in 1999 were a shock Since then the movement has grown stronger and the fury has spreadVirtually every major meeting of the Interna tional Monetary Fund the World Bank and the World Trade Organi zation is now the scene of conflict and turmoil The death of a protestor in Genoa in 2001 was just the beginning of what may be many more casualties in the war against globalization Riots and protests against the policies of and actions by institu tions of globalization are hardly new For decades people in the developing world have rioted when the austerity programs imposed on their countries proved to be too harsh but their protests were largely unheard in the West What is new is the wave of protests in the developed countries It used to be that subjects such as structural adjustment loans the programs that were designed to help countries adjust to and weather crises and banana quotas the limits that some European countries GLOBALIZATION AND iTS DISCONTENTS impose on the importing of bananas from countries other than their tor mer colonies were of interest to only a few Now sixteenyear old kids from the suburbs have strong opinions on such esoteric treaties as GATT the General Agreement on Tariffs and Trade and NAFTA the North American Free Trade Area the agreement signed in 1992 berween Mexico United States and Canada that allows for the freer movement of goods services and investtnentbut not peopleamong those countries These protests have provoked an enormous amount of soulsearching from those in power Even con servative politicians such as Frances president Jacques Chirac have expressed concern that globalization is not making life better for those most in need of its promised benefits t It is clear to almost everyone that something has gone horribly wrong Almost overnight globalization has become the most pressing issue of our time some thing debated from boardrooms to oped pages and in schools all over the world WHY HAS GLOBALIZATIONa force that has brought so much goodbecome so controversial Opening up to international trade has helped many countries grow far more quickly than they would otherwise have done International trade helps economic develop ment when a countrys exports drive its economic growth Export led growth was the centerpiece of the industrial policy that enriched much of Asia and left millions of people there far better off Because of globalization many people in the world now live longer than before and their standard of living is far better People in the West may regard lowpaying jobs at Nike as exploitation but for many people in the developing world working in a factory is a far better option than staying down on the farm and growing rice Globalization has reduced the sense of isolation felt in much of the developing world and has given many people in the developing countries access to knowledge well beyond the reach of even the wealthiest in any country a century ago The antiglobalization protests themselves are a result of this connectedness Links berween activists in different parts of the world particularly those links forged through Internet communication brought about the pressure that resulted in the international landmines treatydespite the opposi THE PIIOMIj OF GLOIIAL INSTITUTIONS tion of many powerful governments Signed by 121 countries as of 1997 it reduces the likelihood that children and other innocent vic tims will be maimed by mines Similar wellorchestrated public pres sure forced the international community to forgive the debts of some ofthe poorest countries Even when there are negative sides to glob alization there are often benefits Opening up the Jamaican milk market to US imports in 1992 lIlay have hurt local dairy farmers but it also meant poor children could get milk more cheaply New for eign firms may hurt protected stateowned enterprises but they can also lead to the introduction of new technologies access to new mar kets and the creation of new industries Foreign aid another aspect of the globalized world for all its f still has brought benefits to millions often in ways that have almost gone unnoticed guerrillas in the Philippines were provided jobs by a World Bankfinanced project as they laid down their arms irrigation projects have more than doubled the incomes of farnltrs lucky enough to get water education projects Iuve brought literacy to the rural areas in a few countries AIDS projects have helped contain the spread of this deadly disease Those who vilify globalization too often overlook it benefits But the proponents of globalization have been if anything even more unbalanced To them globalization which typically is associated with accepting triumphant capitalism American style is progress del oping countries must accept it if they are to grow and to fight poverty effectively But to many in the developing world globaliza tion has not brought the promised economic benefits A growing divide between the haves and the havenots has left increasing numbers in the Third World in dire poverty living on less than a dollar a day Despite repeated promises of poverty reduction made over the last decade of the twentieth century the actual num ber of people living in poverty has actually increased by almost 100 million 2 This occurred at the same time that total world ircome actually increased by an average of25 percent annually V In Africa the high aspirations following colonial independence have been largely unfulfilled Instead the continent plunges deeper into misery as incomes tll1 and standards of living decline The bard won improvements in life expectancy gained in the past fLW decades GLOIIALIZATION AND ITS iJISCONTENTS hJt begun to reVtrse While the scourge of AIDS is at the center of this decline poVtrty is also a killer Even countries that have aban doned Atiican socialism managed to install reasonably honest gov ernments balanced their budgets and kept inflation down find that they simply cannot attract private investors Without this investment they cannot have sustainable growth If globalization has not succeeded in reducing poverty neither has it succeeded in ensuring stability Crises in Asia and in Latin America have threatened the economies and the stability of all developing countries There are fears of financial contagion spreading around the world that the collapse of one emerging market currency will mean that others fall as well For a while in 1997 and 1998 the Asian crisis appeared to pose a threat to the entire world economy Globalization and the introduction of a market economy has not produced the promised results in Russia and most of the other economies making the transition from communism to the market These countries were told by the West that the new economic sys tem would bring them unprecedented prosperity Instead it brought unprecedented poverty in many respects for most of the people the market economy proved even worse than their Communist leaders had predicted The contrast between Russias transition as engineered by the international economic institutions and that of China designed by itself could not be greater While in 1990 Chinas gross domestic product GDP was 60 percent that of Russia by the end of the decade the numbers had been reversed While Russia saw an unprecedented increase in poverty China saw an unprecedented decrease The critics of globalization accuse Western countries of hypocrisy md the critics are right The Western countries have pushed poor countries to eliminate trade barriers but kept up their own barriers preventin developing countries from exporting their agricultural products and so depriving them of desperately needed export Incomc Thc United States was of course one of the prime culprits md this was m iue about which I felt intensely When I was chair man of the Council of Economic Advisers I fought hard against this hypocrisy It not only hurt the developing countries it also cost Americans hoth as consumers in the higher prices they paid and as THI PIOMISE Of GLOBAL INSTlTUTlON5 taxpayers to finance the huge subsidies billions of dollars My trUg gles were all too often unsuccessful Special conunercial and finan cial interests prevailedand when I moved over to the World Bank I saw the consequences to the developing countries all too dearly But even when not guilty of hypocrisy the West has driven the globalization agenda ensuring that it garners a disproportionate share of the benefits at the expense of the developing world It was not just that the more advanced industrial countries declined to open up their markets to the goods of the developing countriesfor instance keeping their quotas on a multitude of goods from textiles to sugar while insisting that those countries open up their markets to the goods of the wealthier countries it was not just that the more advanced industrial countries continued to subsidize agriculture making it difficult for the developing countries to compete while insisting that the developing countries eliminate their subsidies on industrial goods Looking at the terms of tradethe prices which developed and less developed countries get for the products they produceafter the last trade agreement in 1995 the eighth the ntt effect was to lower the prices some of the poorest countrie5 in the world received relative to what they paid for their imports The result was that some of the poorest countries in the world were actu ally made worse off Western banks benefited from the loosening of capital market controls in Latin America and Asia but those regions suffered when inflows of speculative hot money money that comes into and out of a country often overnight often little more than betting on whether a currency is going to appreciate or depreciate that had poured into cOllntries suddenly reversed The abrupt outflow of money left behind collapsed currencies and weakened banking systems The Uruguay Round also strengthened intellectual property rights This eighth agement was the sult of netiation called the UrIIKY RiIJ because the negotiation began in 19H6 in Punt del Este Uruguay The round was concluded in Marrakech on Decemer 15 1993 when 117 countries joined in this trade Iiberalization agement Thr ag ement was finally igned for the United State by President Clinton on December H 1994 The World Trade Oqtanization came imo formal effect on Janulry 11915 and over IOU nti had igned on by July One proviion of the agemcnt entailed ronVlrting rhe GATT into the WTo GLOHALLlATION AND ITS DISCONTENTS Amtrican lIId other Western drug companies could now stop drug lompanits in India and Brazil from stealing their intellectual prop trty But thest drug companies in the developing world were making thtst litesaving drugs available to their citizens at a fraction of the prict at which the drugs were sold by the Western drug companies Thtre wtre thus two sides to the decisions made in the Uruguay Round Profits of the Western drug companies would go up Advo catts said this would provide them more incentive to innovate but tht increased protits from salts in the developing world were small since tew could afford the drugs and hence the incentive effect at best might be limited The other side was that thousands were effec tively condemned to death because governments and individuals in developing cOllntries could no longer pay the high prices demanded In the case of AIDS the international outrage was so great that drug companies had to back down eventually agreeing to lower their prices to sell the drugs It cost in late 2001 But the underlying prob lemsthe tact that the intellectual property regime established under the Uruguay Round was not balanced that it overwhelmingly reflected the interests and perspectives of the producers as opposed to the users whether in developed or developing countriesremain Not only in trade liberalization but in every other aspect of globalization even seemingly wellintentioned efforts have often backfired When projects whether agriculture or infrastructure rec ommended by the West designed with the advice of Western advis ers and tinanced by the World Bank or others have failed unless there is some form of debt forgiveness the poor people in the devel oping world still must repay the loans If in too many instances the benefits of globalization have been Ie than its advocates claim the price paid has been greater as the environment has been destroyed as political processes have been cor rupted and as the rapid pace of change has not allowed countries time for cultural adaptation The crises that have brought in their wake maive unemployment have in turn been followed by longer term problems of social dissolutionfrom urban violence in Latin America to ethnic conflicts in other parts of the world such as Indonesia Thee problem are hardly newbut the increasingly vehement TH PROMISE O GLOIIAL INSTITUIIONS I worldwide reaction against the policies that drive globalization is a significant change For decades the cries of the poor in Africa and in developing countries in other parts of the world have been largely unheard in the West Those who labored in the developing countries knew something was wrong when they saw financial crises becom ing more commonplace and the numbers of poor increasing But they had no way ro change the rules or to influence the international financial institutions that wrote them Those who valued democratic processes saw how conditionalitythe conditions that interna tional lenders imposed in return for their assistanceundermined national sovereignty But until the protestors came along there was little hope for change and no outlets for complaint Soml of the pro testors went to excesses some of the protestors were arguing for higher protectionist barriers against the developing countries which would have made their plight even worse But despite these prob lems it is the trade unionists students environmentalistsordinary citizensmarching in the streets of Prague Seattle Washington and Genoa who have put the need for reform on the agenda of the developed world Protestors see globalization in a very different light than the trea sury secretary of the United States or the finance and trade ministers of most of the advanced industrial countries The differences in views are so great that one wonders are the protestors and the policy mak ers talking about the same phenomena Are they looking at the same data Are the visions of those in power so clouded by special and par ticular interests What is this phenomenon of globalization that has been subject at 0 the same time to such vilification and such praise Fundamentally it is the closer integration of the countries and peoples of theW9M which has been brought about by the lnormous reduction of costs of transportation ad ClIlicatioll and the bt cial barriersto oVsof goodsservic capil knowledgio1 to a lesser extent people across borders Glohalization ha beCn accCpanielbY the ration of new intitutins t1laLhavC jQillQ with existing ones to work across borders In thl arena of interna tional ciirociety gnups like t1Jubilee movement pushing for debt reduction for the pOOTest countries haw joined 10n1 10 GL01lALlZATION AND ITS DISCONTENTS lStablishtd organizations likt tht International Red Cross Globaliza tilln is pOwrfully driven by international corporations which movt not only capital and goods across borders but also technology Globalization has also led to renewed attention to longestablished inttrnational illltrgJl1ernmelltai institutions the United Nations which Jtttmpts to maintain peace the International Labor Organization ILO originally created in 1919 which promotes its agenda around tht world undtr its slogan decent work and the World Health Organization WHO which has been especially concerned with improving health conditions in the developing world Many perhaps most of these aspects of globalization have been wticomtd everywhtre No one wants to see their child die when knowltdge and medicines are available somewhere else in the world It is the more narrowly defined economic aspects of globalization that have been the subject of controversy and the international institu tions that have written the rules which mandate or push things like liberalization of capital markets the elimination of the rules and reg ulations in many developing countries that are designed to stabilize the flows of volatile money into and out of the country To understand what went wrong its important to look at the three maininstittions that govern globalization the IMF the World Bank and the WTo There are in addition a host of other institu tions that playa role in the international economic systema num ber of regional banks smaller and younger sisters to the World Bank and a large number of UN organizations such as the UN Develop ment Program or the UN Conference on Trade and Development UNCTADThese organizations often have views that are markedly different from the IMF and the World Bank The ILO for example worries that the IMF pays too little attention to workers rights while the Asian Development Bank argues for competitive plural ism whereby developing countries will be provided with alternative view of development strategies including the Asian modelin which governments while relying on markets have taken an active role in creating shaping and guiding markets including promoting new technologies and in which firms take considerable responsibility for the Kial welfare of their employeeswhich the Asian Develop THIi PIHlMISI Of GLOIIAI INSTITUTIONS II ment Bank sees as distinctly different from the American model pushed by the Washingtonbased institutions V In this book I focus mostly on the IMF and the World Bank largely because they have been at the center of the major economic issues of the last two decades including the financial crises and the transition of the former Communist countries to market economies The IMF and the World Bank both originated in World War II as a result of the UN Monetary and Financial Conference at Bretton Woods New Hampshire in July 1944 part of a concerted effort to finance the rebuilding of Europe after the devastation of World War II and to save the world from future economic depressions The proper name of the World Bankthe International Bank for Recon struction and Developmentreflects its original mission the last part Development was added almost as an afterthought At the time most of the countries in the developing world were still colonies and what meager economic development efforts could or would be undertaken were considered the responsibility of their European masters The more difficult task of ensuring global economic stability was assigned to the IMF Those who convened at Bretton Woods bad the global depression of the 1930s very much on their minds Almost three quarters of a century ago capitalism faced its most severe crisis to date The Great Depression enveloped the whole world and led to unprecedented increases in unemployment At the worst point a quarter of Americas workforce wa unemployed The British econo mist John Maynard Keynes who would later be a key participant at Bretton Woods put forward a simple explanation and a correspond ingly simple set of prescriptions lack of sufiicient aggregate demand explained economic downturns government policies could help stimulate aggregate demand In cases where monetary poliy is inef fective governments could rely on fiscal policies either by increasing expenditures or cutting taxes While the models underlying Keynes5 analysis have subsequently been criticized and refined bringing a deeper understanding of why market torces do not work quicldy to adjust the economy to full employment the basic lessons remain valid I GWIIAllZATlUN AND ITS DISCONTENTS Th Intrnational Montary Fund was charged with prevnting anothr global dpression It would do this by putting international pressure on countris that wre not doing their fair share to maintain global aggregat demand by allowing their own economies to go into a slump When necssary it would also provide liquidity in the torm of loans to thos countries facing an economic downturn and unabl to stimulat aggregate demand with their own resources In its original conception then the IMF was based on a recogni tion that markts often did not work wellthat they could result in massiv unemployment and might fail to make needed funds avail abl to countris to help them restore their economies The IMF was tounded on the belief that there was a need for collective action at the global level for conomic stability just as the United Nations had been founded on th belief that there was a need for collective action at the global level for political stability The IMF is a public institution established with money provided by taxpayers around the world This is important to remember because it does not report directly to either the citizens who finance it or those whose lives it affects Rather it reports to the ministries of finance and the central banks of the governments of the world They assert their control through a complicated voting arrangement based largely on the economic powr of the countries at the end of World War II There have been some minor adjustments since but the major developed countries run the show with only one country the United States having effec tive veto In this sense it is similar to the UN where a historical anachronism determines who holds the vetothe victorious powers of World War IIbut at least there the veto power is shared among five countries Over the years since its inception the IMF has changed markedly Founded on the belief that markets often worked badly it now champions market supremacy with ideological fervor Founded on the belief that there is a need for international pressure on countries to have more expansionary economic policiessuch as increasing expenditures reducing taxes or lowering interest rates to stimulate the economytoday the IMF typically provides funds only if coun tries engage in policies like cutting deficits raising taxes or raising THE PROMISE Of GLOllAI I NHITUTJONS 13 interest rates that lead to a contraction of the economy Keynes would be rolling over in his grave were he to ee what h happened to his child The most dramatic change in thee iJltitutions occurred in the 1980s the era when Ronald ReaglJl and Margaret Thatcher preached free market ideology in the United States and the United Kingdom The IMF and the World Bank became the new missionary institutions through which these ideas were pushed on the relucunt poor countries that often badly needed their loans and grants The ministries of finance in poor countries wen willing to become con verts if necessary to obtain the funds though the vt majority of government officials and more to the point people in these coun tries often remained skeptical In the early 1980s a pUIbe occurred inside the World Bank in its research department which guided the Banks thinking and direction Hollis Chenery one of Americas most distinguished development economists a professor at Harvard who had made fundamental contributions to research in the economics of development and other areas as well had been Robert McNamaras confidant and adviser McNamara had been appointed president of the World Bank in 1968 Touched by the poverty that he saw throughout the Third World McNamara had redirected the Banks effort at its elimination and Chenery assembled a firstclass group of economists from around the world to work with him But ith the changing of the guard came a new president in 198 t William Clausen and a new chief economist Ann Krueger an international trade specialist best known for her work on rent seekinghow special interests use tariffi and other protectionist measures to increase their incomes at the expense of others While Chenery and his team had focused on how markets failed in developing coun tries and what governments could do to improve markets and reduce poverty Krueger saw government a the problem Free mar kets were the solution to the problems of dcwloping countries In the new ideological fervor many of the firstrate economists that Chenery had assembled left Although the missions of the two institutions rcmained distinct it was at this time that their activities becamc incrcaingly intcrtWined GL08ALlATlON AND ITS DISCONTENTS In tht 1980s the Bank went beyond just lending for projects like roads Jnd dJllls to providing broadbased support in the form of stnwuml iusrllletit los but it did this only when the IMP gave its Jppronland with that approval came IMPimposed conditions on the country The IMP was supposed to focus on crises but develop ing countries were always in need of help so the IMP became a per manent part of life in most of the developing world The fall of the Berlin Wall provided a new arena for the IMP managing the transition to a market economy in the former Soviet Union and the Communist bloc countries in Europe More recently as the crises have gotten bigger and even the deep coffers of the IMP seemed insufficient the World Bank was called in to provide tens of billions of dollars of emergency support but strictly as a junior part ner with the guidelines of the programs dictated by the IMF In prin ciple there was a division of labor The IMP was supposed to limit itself to matters of lIIacroecorlOmics in dealing with a country to the governments budget deficit its monetary policy its inflation its trade deficit its borrowing from abroad and the World Bank was supposed to be in charge of slnlClural issueswhat the countrys government spent money on the countrys financial institutions its labor markets its trade policies But the IMP took a rather imperialistic view of the matter since almost any structural issue could affect the overall per tormance of the economy and hence the governments budget or the trade deficit it viewed almost everything as falling within its domain It often got impatient with the World Bank where even in the years when free market ideology reigned supreme there were frequent controversies about what policies would best suit the conditions of the country The IMF had the answers basically the same ones for every country didnt see the need for all this discussion and while the World Bank debated what should be done saw itself as stepping into the vacuum to provide the answers The two institutions could have provided countries with alterna tive perspectiws on some of the challenges of development and tran sition and in doing so they might have strengthened democratic processes But they were both driven by the collective will of the G7 the governments of the sevcn most important advanced industrial THE PROMISE OF GLOBAL INSTITUTIONS countries and especially their finance ministers and treasury secre taries and too often the last thing they wanted was a lively democra tic debate about alternative strategies A half century after its founding it is clear that theJMfhasfailed in its missiORIt has not done what it was supposed to doprovide funds for countries facing an economic downturn to enable the country to restore itself to close to full employment In spite of the fact that our understanding of economic processes has increased enormously during the last fifty years and in spite of IMFs effortS during the past quarter century crises around the world have been more frequent and with the exception of the Great Depression deeper By some reckonings close to a hundred countries have faced crises3 Worse many of the policies that the IMF pushed in particu lar premature capital market liberalization have contributed to global instability And once a country was in crisis IMF funds and programs not only failed to stabilize the situation but in many cases actually made matters worse especially for the poor The IMF failed in its original mission of promoting global stability it has also been no more successful in the new missions that it has undertaken such as guiding the transition of countries from communism to a market economy The Bretton Woods agreement had called for a third international economic organizationa World Trade Organization to govern international trade relations a job similar to the IMFs governing of international financial relations Beggarthyneighbor trade policies in which countries raised tariff to maintain their own economies but at the expense of their neighbors were largely blamed for the spread of the depression and its depth An international organization was required not just to prevent a recurrence but to encourage the rree flow or goods and services Although the General Agreement on Thee are the United States Japan Germany Canach Italy Fromee and the UK Today the G7 typically meet together with Russia the GRThe seVll1 eountrie are no longer he even Iarget economies in the world Membership in the G7 like permanent membership in the UN Security Council is partly a matter ofhi5 torical accident GLOlliUIZATlON AND ITS DISCONTENTS TlrillS Illd Tradt GATT did succted in lowtring tariffs enormously it WlS ditlicult to rtach tht tinal accord it was not until 1995 a half tntury ltir tht tnd of tht war and two thirds of a century after the Grtat Depression that the World Trade Organization came into being l3ut the WTO is marktdiy different from the other two orga nizations It does not set rules itsdf rather it provides a forum in which trddt negotiations go on and it ensures that its agreements are liwd up to The idtls and intentions behind the creation of the international tconomic institutions wtre good ones yet they gradually evolved ovtr the ytars to become something very different The Keynesian orientation of tht lMF which emphasizeLmarkelfai1uIthe rolt for government in job creation was replaced by the free marke mantra of the 1980s part of a new Washington Consensuaco stnsus between the IMF the World Bank and the us Treasury about the right policies for devdoping countriesthat signaled a radi cally dilferent approach to economic devdopment and stabilization Many of the ideas incorporattd in the constnsus were devdoped in response to the problems in Latin America where governments had let budgets get out of control while loose monetary policies had led to rampant inflation A burst of growth in some of that regions countries in the decades immediatdy after World War II had not been sustained allegedly because of excessive state intervention in the economy The ideas that were developed to cope with problems arguably specitic to Latin American countries and which I will out lint lattr in the book subsequently been deemed applicable to coun trie around the world Capital market liberalization has been pushed despite the fact that there is no evidenct showing it spurs economic growth In other cases the economic policies that evolved into the Wahll1gton Consensus and were introduced into developing countrie were not appropriate for countries in the early stages of dewloplllent or early stage of transition To take Jmt a few examples most of the advanced industrial coun triesIlcluding the United States and Japanhad built up their economics hy wisely and selectively protecting some of their indus tries until they were trong enough to compete with foreign compa nies While hlanket protectionism has often not worked for countries TilE PROMISE OF GLOBAL INSTITUTIONS 17 that have tried it neither has rapid trade liberalization Forcing a developing country to open itself up to imponed products that would compete with those produced by certain of its industries industries that were dangerously vulnerable to competition from much stronger counterpart industries in other countries can have disastrous consequencessocially and economically Jobs have sys tematically been destroyedpoor farmers in developing countries simply couldnt compete with the highly subsidized goods from Europe and Americabefore the countries industrial and agricul tural sectors were able to grow strong and create new jobs Even worse the IMPs insistence on developing countries maintaining tight monetary policies has led to interest rates that would make job creation impossible even in the best of circumstances And because trade liberalization occurred before safety nets were put into place those who lost their jobs were forced into poverty Liberalization Ius thus too often not been followed by the promised growth but by increased misery And even those who have not lost their jobs have been hit by a heightened sense of insecurity Capital controls are another example European countries banned the free flow of capital until the seventies Some might say its not fair to insist that developing countries with a barely functioning bank system risk opening their market But putring aside such notions of fairness its bad economics the influx of hot money into and out of the country that so frequently follows after capital market liberaliza tion leaves havoc in it wake Small developing countries are like small boats Rapid capital market liberalization in the manner pushed by the IMF amounted to setting them off on a voyage on a rough St before the holes in their hulls have been repaired before the cap tain has received training before life vest have been put on board Even in the best of circumstances there was a high likelihood that they would be overturned when they were hit broadside by a big wave The application of mistaken economic theories would not be such a problem if the end of first colonialism and then communism had not given the IMF and the World Bank the opportunity to greatly expand their respective original mandates to vastly extend their reach Today these institutioll have become dominant players in the IOIIUITION AND ITS DISCONTENTS orld tnlllllllly Not only countries seeking their help but also those sltkin thtir slal of approval so that they can better access inter nHilllld clpital Illarkets must tollow their economic prescriptions prlscriptilllls which reflect thtir tree market ideologies and theories Th rtsult tor many people has been poverty and for many coun tries social and political chaos The IMf has made mistakes in all the Ireas it Ius b en involved in development crisis management and in LOumries making the transition from communism to capitalism Structural adjustment programs did not bring sustained growth even 0 those like Bolivia that adhered to its strictures in many countries excessive austerity stifled growth successful economic programs require extreme care in seqlletlcillgthe order in which reforms occurand pacing If for instance markets are opened up for com petition too rapidly before strong financial institutions are estab lished then jobs will be destroyed faster than new jobs are created In many countries mistakes in sequencing and pacing led to rising unemployment and increased poverty4 After the 1997 Asian crisis IMf policies exacerbated the crises in Indonesia and Thailand free market rdorms in Latin America have had one or rwo successes Chile is repeatedly citedbut much of the rest of the continent has still to make up for the lost decade of growth following the socalled successful IMf bailout of the early 1980s and many today have per sistently high rates of unemploymentin Argentina for instance at doubledigit levels since 1995even as inflation has been brought down The collapse in Argentina in 2001 is one of the most recent of a series of failures over the past few years Given the high unemploy ment rate for almost seven years the wonder is not that the citizens eventually rioted but that they suffered quietly so much for so long Even those countries that have experienced some limited growth have seen the benefits accrue to the welloff and especially the Icry welloffthe top 0 percentwhile poverty has remained high and in some cases the income of those at the bottom has even fallen Underlying the problems of the IMf and the other international economic institutions is the problem of governance who decides what they do The institutions are dominated not just by the wealthi est industrial countries but by commercial and financial interests in those countries and the policies of the institutions naturally reflect TilE PROMISE Of GIOIIAL INSTITUTIONS this The choice of heads for these institutions symbolizes the institu tions problem and too often has contributed to their dysfunction While almost all of the activities of the IMF and the World Bank today are in the developing world certainly all of their lending they are led by representatives from the industrialized nations By custom or tacit agreement the head of the IMF is always a European that of the World Bank an American They are chosen behind closed doors and it has never even been viewed as a prerequisite that the head should have any experience in the developing world The institutions 1Stheyve The problems also arise from who speaks for the country At the IMF it is the finance ministers and the central bank governors At the WTO it is the trade ministers Each of these ministers is closely aligned with particular constituencies within their countries The trade ministries reflect the concerns of the business community both exporters who want to see new markets opened up for their products and producers of goods which compete with new imports These constituencies of course want to maintain as many barriers to trade as they can and keep whatever subsidies they can persuade Congress or their parliament to give them The fact that the trade barriers raise the prices consumers payor that the subsidies impose burdens on taxpayers is of less concern than the profits of the pro ducersand environmental and labor issues are of even less concern other than as obstacles that have to be overcome The finance minis ters and central bank governors typically are closely tied to the flllan cial comlllunity they cOllle from financial tirms and after their period of government service that is where they return Robert Rubin the treasury secretary during much of the period described in this book came from the largest investment bank Goldman Sachs and returned to the firm Citigrnup that controlled the largest com mercial bank Citibank The numbertwo person at the lMF during this period Stan Fischer went straight from the IMF to Citigroup These individuals naturally see the world through the eyes of the financial commlOity The decisions of any institution nnyid1t the perspectives and interests of those who make the decision not surprisingly as we shall see repeJtedly in the following chapters the policies of the international economic institutions are all too often UlOAlILHION ANI ITS DISCONTENTS dosdy liigned with the commercial and financial interests of those in the advanced industrial countries For the pelsants in denloping countries who toil to payoff their countries IMF debts or the businessmen who suffer from higher valueadded taxes upon the insistence of the IMP the current system run by the IMF is one oftaxation without representation Disillusion with the international system of globalization under the aegis of the lJlF grows as the poor in Indonesia Morocco or Papua New Guinea have fud and food subsidies cut as those in Thailand see AIDS increase as a result of IMFforced cutbacks in health expendi tures and as families in many developing countries having to pay for their childrens education under socalled cost recovery programs make the painful choice not to send their daughters to school Lett with no alternatives no way to express their concern to press tor change people riot The streets of course are not the place where issues are discussed policies formulated or compromises forged But the protests have made government officials and economists around the world think about alternatives to these Washington Consensus policies as the one and true way for growth and development It has become increasingly clear not to just ordinary citizens but to policy makers as well and not just those in the developing countries but those in the developed countries as well that globalization as it has been practiced has not lived up to what its advocates promised it would accomplishor to what it can and should do In some cases it has not even resulted in growth but when it has it has not brought benefits to all the net effect of the policies set by the Washington Consensus has all too often been to benefit the fewaqhe xpense of the many the welloff at the expense of the poor In many cases commercial interests and values have superseded concern for the environment democracy human rights and social justice Qlobalization itself is flithegc29f1Qr bad It has the pouler to do enormous good and for the countries of East Asia who have embraced globalization under their own terms at their own pace it has been an enormous benefit in spite of the setback of the 1997 crisis But in much of the world it has not brought comparable benefits For many it seems closer to an unmitigated disaster TII PIIOMISE Of GLOIlAL INSTlUflON 21 The experience of the United States during the nineteenth cen tury makes a good parallel for todays g1obalizationand the contrast helps illustrate the successes of the past and todays failuTts At that time when transportation and conununication costs fell and previ ously local markets expanded new national economies formed and with these new national economies came national companies doing business throughout the country Dut the markets were not left to develop willynilly on their own government played a vital role in shaping the evolution of the economy The US government obtained wide economic latitude when the courts broadly interpreted the constitutional provision that allows the federal government to regu late interstate commerce The federal government began to regulate the financial system set minimum wages and working conditions and eventually provided unemployment and welfare systems to deal with the problems posed by a market system The federal government also promoted some industries the first telegraph line for example was laid by the federal government between Baltimore and Washing ton in 1842 and encouraged others like agriculture not just helping set up universities to do research but providing extension services to train farmers in the new technologies The federal government played a central role not only in promoting American growth Ewn if it did not engage in the kind of active redistribution policies at least it had programs whose benefits were widely sharednot just those that extended education and improved agricultural productiv ity but also land grants that provided a minimum opportunity for all Americans Today with the continuing decline in transportation and commu nication costs and the reduction of manmade barriers to tht flow of goods services and capital though there remain serious harrilrs to the free flow oflabor we have a process of globalization analogous to the earlier processes in which national economies were furmld Unfortunately we have no world government accountable to chI people of every country to oversee the globalization process in a fashion comparable to the way national governmlnts guided the nationalization process Instead we have a system that might be caJlld flobIrIIIC IIjthollrxJl1lgne in which a ftw institu ClllMlILT1llN ND iTS DlSCONTENTS tionsthe World thnk the IMF the WTOand a few playersthe tinlIlet elIIlIlltret 1Ild trade IIlinistries closely linked to certain tinlIleitl Jnd eOIlllllerlial interestsdominate the scene but in whleh IIllIly of those atlted by their decisions are left almost voice Itss Its tiIlle to change some oi the rules governing the international ecOlllmic order to think once again about how decisions get made Jt the international leveland in whose interestsand to place less emphJsis on ideology and to look more at what works It is crucial that the sllccesstiI1 development we have seen in East Asia be lchieed elsewhere There is an enormous cost to continuing global instability Globalization can be reshaped and when it is when it is properly fairly run with all countries having a voice in policies JtIecting them there is a possibility that it will help create a new global economy in which growth is not only more sustainable and less volatile but the fruits of this growth are more equitably shared CHAPTER 2 BROKEN PROMISES O N MY FIRST day February 131997 as chief economist and senior vice president of the World Bank as I walked into its gigantic modern gleaming main building on 19th Street in Washington DC the institutions motto was the first thing that caught my eye Gllr dream is a world withollt poverty In the center of the thirteenstory atrium there is a statue of a young boy leading an old blind man a memorial to the eradication of river blindness onchocerciasis Before the World Bank the World Health Organiza tion and others pooled their efforts thousands were blinded annually in Africa from this preventable disease Across the street stands another gleaming monument to public wealth the headquarters of the International Monetary Fund The marble atrium inside graced with abundant flora serves to remind visiting finance ministers from countries around the world that the IMF representli the centers of wealth and power These two institutions often confused in the public mind present marked contrasts that underline the differences in their cultures styles and missions one is devoted to eradicating poverty one to maintaining global stability While both have teams of economistli fly ing into developing countries for threeweek missions the World 23 lLlIHIILHlllN Nll ITS ISCONTNTS UllIk Ius workld hrd 0 make surl hat a substantial Iraction of its llnin plrmllItndy in tht couIHry they are trying to assist the IMF enlrillv Ius lnlv 1 single resident representative whose powers are limied IiF prorams art typically dictated fwm Washington and sl1lped lw ht short missions during which its staff members pore owr numbas in ht finance ministries and central banks and make helllsehes comfortable in fivestar hotels in the capitals There is more dun svmbolism in this difference one cannot come to learn Ibout and love a nHion unless one gets out to the countryside One should no see unemployment as just a statistic an economic body LOUIH he unintended casualties in the fight against inflation or to tnsure hat Western banks get repaid The unemployed are people with families whose lives are affectedsometimes devastatedby rhe economic policies that outsiders recommend and in the case of the ME etfectively impose Modern hightech warfare is designed to remove physical contact dropping bombs from 50000 feet ensures that one does not feel what one does Modern economic manage ment is similar from ones luxury hotel one can callously impose policies about which one would think twice if one knew the people whose lives one was destroying Statistics bear out what those who travel outside the capital see in the villages of At rica Nepal Mindanao or Ethiopia the gap between the poor and the rich has been growing and even the number in absolutely poverryliving on less than a dollar a dayhas increased Even where river blindness has been eliminated poverry endures this despite all the good intentions and promises made by the devel oped nations to the developing nations most of which were once the colonial possessions of the developed nations Mindsets are not changed overnight and this is as true in the developed as in the developing countries Giving developing coun tries their freedom generally after little preparation for autonomy often did not change the view of their former colonial masters who continued to feel that they knew best The colonial mentalitythe white mans burden and the presumption that they knew what was best for the developing countriespersisted America which came to dominate the global economic scene had much less of a colonial heritage yet Americas credentials too had been tarred not so much BROKEN PROMISES lS by its Manifest Destiny expansionism as by the cold war in which principles of democracy were compromised or ignored in the all encompassing struggle against communism THE NIGHT BEFORE I started at the Bank I held my last press con ference as chairman of the Presidents Council of Economic Advis ers With the domestic economy so well under control I felt that the greatest challenges for an economist now lay in the growing problem of world poverty What could we do about the 12 billion people around the world living on less than a dollar a day or the 28 billion people living on less than 52 a daymore than 45 percent of the worlds population What could I do to bring to reality the dream of a world without poverty How could I embark on the more modest dream of a world with less poverty I saw my task as threefold think ing through what strategies might be most effective in promoting growth and reducing poverty working with governments in the developing countries to put these strategies in place and doing everything I could within the developed countries to advance the interests and concerns of the developing world whether it was push ing for opening up their markets or providing more effective assis tance I knew the tasks were difficult but I never dreamed that one of the major obstacles the developing countries faced was manmade totally unnecessary and lay right across the streetat my sister institution the IME I had expected that not everyone in the interna tional financial institutions or in the governments that supported them was committed to the goal of eliminating poverty but I thought there would be an open debate about strategiesstrategies which in so many areas seem to be failing and especially failing the poor In this I was to be disappointed Ethiopia and the Struggle Between Power Politics and Poverty After four years in Washington I had become used to the strange world of bureaucracies and politicians But it wa not until I traYeled to Ethiopia one of the poorest countries in the world in March 1997 barely a month into the World Bank job that I became fully immersed in the astonishing world of IMF politics and arithmetic CI OlIHION NIl I rs IJISrONTNTS EthiopiIs pr clpitJ incllIIe was I I a year and the country had mtkrd trlllll succssiw dmughts and talllines that had killed 2 mil lion pcopl I Wllt to 1IIttt Prillle Minister Mdes Zenawi a man wllll Iud cd 1 swlltttnyear guerrilla war aglinst the bloody Marx ist rtg i lilt of Mengistu Haile Mariam Mdess forces won in 1991 lIId then the gowrnlllent began the hard work of rebuilding the country A doctor by training Mdes had formally studied economics btcllIse he knew that to bring his country out of centuries of pOtfty would require nothing less than economic transformation Jnd he delllonstrated a knowledge of economicsand indeed a cre Jriitythat would have put him at the head of any of my university dlsses He showed a deeper understanding of economic principles Jnd cercainly a greater knowledge of the circumstances in his coun trythan many of the international economic bureaucrats that I had to deJI with in the succeeding three years Mdes combined these intellectual attributes with personal integrity no one doubted his honesty and there were few accusations of cor ruption within his government His political opponents came mostly from the longdominant groups around the capital who had lost political power with his accession and they raised questions about his commitment to democratic principles However he was not an old iashioned autocrat Both he and the government were generally committed to a process of decentralization bringing government closer to the people and ensuring that the center did not lose touch vith the separate regions The new constitution even gave each region the right to vote democratically to secede ensuring that the political elites in the capital city whoever they might be could not risk ignoring the concerns of ordinary citizens in every part of the country or that one parr of the country could not impose its views on the rest The government actually lived up to its commitment when Eritrea declared its independence in 1993 Subsequent eventssuch as the governments occupation of the university in Addis Ababa in the spring of 2000 with the imprisonment of some students and professorsshow the precariousness in Ethiopia as else where of basic democratic rights When I arrived in 1997 Meles was engaged in a heated dispute with the IMF and the Fund had suspended its lending program UIIOKloN IIMIE Ethiopias macroeconomic resultsupon which the Fund was supposed to focuscould not have been better There was no infla tion in fact prices were falling Output had been growing steadily since he had succeeded in ousting Mengistu 1 Mele showed that with the right policies in place even a poor African country could experience sustained economic growth After years of war and rebuilding international assistance was beginning to return to the country But Meles was having problems with the IME What was at stake was not just 127 million of IMF money provided through its socalled Enhanced Structural Adjustment Facility ESAF program a lending program at highly subsidized rates to help very poor coun tries but World Bank monies as well The IMF has a distinct role in international assistance It is sup posed to review each recipients macroeconomic situation and make sure that the country is living within its means If it is not there is inevitably trouble down the road In the short run a country can live beyond its means by borrowing but eventually a day of reckoning comes and there is a crisis The IMF is particularly concerned about inRation Countries whose government spend more than they take in in taxes and foreign aid often will f1ce inRation especially if they finance their deficits by printing money Of course there arc other dimensions to good macroeconomic policy besides inRation The term macro refers to the aregatc behavior the overall levels of growth unemployment and inRation and a country can hae low inRation but no growth and high unemployment To most econo mists such a country would rate as having a disastrous macroeco nomic framework To most economists inRation is not so much an end in itself but a means to an end it is because lwlssilc1 high infla tion often leads to low growth and low growth lead to high unel11 ployment that inRation is so frowned upon But the IMF often seel11s to confuse means with ends thereby losing sight of what is ultimately of concern A country like Argentina can get an A grade een if it has doubledigit unemployment for years so long as it budglt seems in balance and its inRation seems in control If a country does not come up to certain minimum standani me IMF suspends assistance and typically when it docs so do mhlr donors Understandably the World Bank and thl IMF dont lend to llulltrits ulllss dlty hl l good macrotramwork in place If coun trics hln hugt ittiits llld soaring inflation there is a risk that mOlllY will Illlt ht wdl Spl1r Governments that fail to manage their lw11I lonomy gtnrall typically do a poor job managing foreign Iid Uur if thl macrocol1omic indicatorsinflation and growth Ir solid IS thtY wre in Ethiopia surely the underlying macroeco nomic tramork must be good Not only did Ethiopia have a sound l1Jcrocol1omic tramwork but the World Bank had direct evidence of tht cOl11ptence of the government and its commitment to the poor Ethiopia had formulated a rural development strategy focusing its Jtttntion on the poor and especially the 85 percent of the popula tion living in the rural sector It had dramatically cut back on military expendituresremarkable for a government which had corne to power through military meansbecause it knew that funds spent on weapons were funds that could not be spent on fighting poverty Surely this was precisely the kind of government to which the inter national community should have been giving assistance But the IMF had suspended its program with Ethiopia in spite of the good macroeconomic performance saying it was worried about EthiopiaS budgetary position Tht Ethiopian government had two revenue sources taxes and tonign assistance A governments budget is in balance so long as its revenue Iources equal its expenditures Ethiopia like many devel oping countries derived much of its revenues from foreign assistance The IMF worried that if this aid dried up Ethiopia would be in trouble Hence it argued that Ethiopias budgetary position could only be judged solid if expenditures were limited to the taxes it collected The obvious problem with the IMFs logic is that it implies no poor country can ever spend money on anything it gets aid for If Sweden say gives money to Ethiopia to build schools this logic dic tates that Ethiopia should instead put the money into its reserves All countries have or should have reserve accounts that hold funds for the proverbial rainy day Gold is the traditional reserve but today it has been replaced by hard currency and its interestbearing relatives The most common way to hold reserves is in US Treasury bills But this is not why international donors give aid In Ethiopia the donors BROKEN IUOMISES who were working independently and not beholden to the IMF wanted to see new schools and health clinics built and so did Ethiopia Meles put the matter more forcefully He told me that he had not fought so hard for seventeen years to be instructed by some international bureaucrat that he could not build schools and clinics for his people once he had succeeded in convincing donors to pay for them The IMF view was not rooted in a longheld concern about pro ject sustainability Sometimes countries had used aid dollars to con struct schools or clinics When the aid money ran out there was no money to maintain these facilities The donors had recognized this problem and built it into their assistance programs in Ethiopia and elsewhere But what the IMF alleged in the case of Ethiopia went beyond that concern The Fund contended that international assis tance was too unstable to be relied upon To me the IMfs position made no sense and not just because of its absurd implications I knew that assistance was often far more stable than taX revenues which can vary markedly with economic conditions When I got back to Wash ington I asked my staff to check the statistics and they confinned that international assistance was more stable than taX revenues Using the IMF reasoning about stable sources of revenue Ethiopia and other developing countries should have counted foreign aid but not included tax revenues in their budgets And if neither taxes nor for eign assistance were to be included in the revenue side of budgets every country would be considered to be in bad shape But the IMfs reasoning was even more flawed There are a num ber of appropriate responses to instability of revenues such as setting aside additional reserves and maintaining flexibility of expenditures I f revenues from any source decline and there are not reSlrves to draw upon then the government ha to be prepared to cut back expenditures But for the kind of assistance that constitute so much of what a poor country like Ethiopia receives there is a builtin flex ibility if the country does not receive money to build an additional school it simply docs not build the school Ethiopias government officials understood what was at issue they understood the concern about what might happen if eitller tax revenues or foreign asi5tanT should fall and they had desiglltd policies to deal with thest contin C IIHlllN NIl ITS DISCllNTENTS gc Vh1t tht CllLddllt ullderstandand I couldnt under lIhlI wl1 tht 1M couldnt Slt the logic of their position And llIuch IS It Ike clwlls lIld health clinics tor some of the poorest ptpk III tht rld III IIlitWII to the disareelllent over how to treat foreign aid I Ill beCllIIt illllllediately entangled in another IMFEthiopia dispute ll Irk 10111 repJYlllent Ethiopia had repaid an American bank ltun elr using some of its reserves The transaction made perfect IIlIli StllSt III spite of the quality of the collateral an airplane EthiopiJ JS PJyillg J far higher interest rate on its loan than it was receiing on its reserves I too would have advised them to repay pmiculJr since in the event that tunds would later be required the gowrnI11ent could presumably readily obtain funds using the plane as oUJterJl The United States and the IMF objected to the early repJymellt They objected not to the logic of the strategy but to the tJct that Ethiopia had undertaken this course without IMF approval Bur why should a sovereign country ask permission of the IMF for ewrY action which it undertakes One might have understood if Ethiopias action threatened its ability to repay what was owed the 1IF but quite the contrary because it was a sensible financial deci ion it enhanced the countrys ability to repay what was due For years the mantra at the 19th Street headquarters of the IMF in Washington had been accountability and judgment by results The results of Ethiopias largely selfdetermined policies should have demonstrated convincingly that it was a capable master of its own destiny But the IMF felt countries receiving money from it had an obligation 0 report everything that might be germane not to do so was grounds for suspension of the program regardless of the reason ableness of the action To Ethiopia such intrusiveness smacked of a new form of colonialism to the IMF it was just standard operating procedure There were other sticking points in IMFEthiopia relations con cerning Ethiopian financial market liberalization Good capital mar kets are the hallmark of capitalism but nowhere is the disparity between developed and less developed countries greater than in their capital markets Ethiopias entire banking system measured for instance by the size of its assets is somewhat smaller than that of BHOKN PHOMISIS 31 Bethesda Maryland a suburb on the outskirts of Washington with a population of55277The IMF wanted Ethiopia not only to open up its financial markets to Western I competition but also to divide its largest bank into several pieces In a world in which US megafman cial institutions like Citibank and Travelers or Manufacturers Hanover and Chemical say they have to merge to compete effectively a bank the size of North East Bethesda National Bank really has no way to compete against a global giant like Citibank When global financial institutions enter a country they can squelch the domestic competi tion And as they attract depositors away from the local banks in a country like Ethiopia they may be far more attentive and generous when it comes to making loans to large multinational corporations than they will to providing credit to small businesses and farmers The IMF wanted to do more than just open up the banking sys tem to foreign competition It wanted to strengthen the financial system by creating an auction market for Ethiopias government Treasury billsa reform as desirable as it might be in many coun tries which was completely out of tune with that countrys state of development It also wanted Ethiopia to liberalize its financial mar ket that is allow interest rates to be freely determined by market forcessomething the United States and Western Europe did not do until after 1970 when their markets and the requisite regulatory apparatus were far more developed The IMF was confusing ends with means One of the prime objectives of a good banking system is to provide credit at good terms to those who will repay In a largely rural country like Ethiopia it is especially important for farmers to be able to obtain credit at reasonable terms to buy seed and fertilizer The task of providing such credit is not easy even in the United States at critical stages of its development when agriculture was more important the government took a crucial role in prooiding needed credit The Ethiopian banking system was at least seemingly quite efficient the difference between borrowing and lending rates being far lower than those in other developing countries that had followed the IMFs advice Still the Fund was unhappy simply because it believed interest rates should be freely determined by international market forces whether those markets were or were not competitive To the Fund a liheralized financial system was an end in llllllULHlllN AND I 1S OISCONTNTS ilsdf lIS nlin tJllh m llllrktls lIlade it contident that a liberalized tinmcitl sysltm would lower inttrest rates paid on loans and thereby lIuke lIlllrl timds Iailtbk The IMF was so certain about the cor rtCtlltSS llf its dllglllltic position that it had little interest in looking at ltu1 tptritncts Etlllllpil rtsisted tht IMfs demand that it open its banking sys ttlIl tlr good rtISOIl It had seen what happened when one of its Elst i ricm neighbors glVt in to IMF demands The IMF had insisted on tiruncial market liberalization believing that competition llllOllg bJllks would lead to lower interest rates The results were dis lstrouS the move was followed by the very rapid growth oflocal and indigenous commercial banks at a time when the banking legislation Jnd bank supervision were inadequate with the predictable results tourteen banking tailures in Kenya in 1993 and 1994 alone In the end interest rates increased not decreased Understandably the gov ernment of Ethiopia was wary Committed to improving the living standards of its citizens in the rural sector it feared that liberalization would have a devastating effect on its economy Those farmers who had previously managed to obtain credit would find themselves umble to buy seed or fertilizer because they would be unable to get cheap credit or would be forced to pay higher interest rates which thev could ill afford This is a country wracked by droughts which result ill massive starvation Its leaders did not want to make matters worse The Ethiopians worried that the IMfs advice would cause tarmers incomes to fall exacerbating an already dismal situation Faced with Ethiopian reluctance to accede to its demands the IMF suggested the government was not serious about reform and as I have said suspended its program Happily other economists in the World Bank and I managed to persuade the Bank management that lending more money to Ethiopia made good sense it was a country desperately in need with a firstrate economic framework and a gov ernment committed to improving the plight of its poor World Bank lending tripled eYen though it took months before the IMF finally relented on its position In order to turn the situation around I had with the invaluable help and support of colleagues mounted a deter mined campaign of intellectual lobbying In Washington my col leagues and I held conferences to encourage people at both the IMF BROKEN PHOM1jS 33 and the World Bank to look again at isues of fmancial sector liberal ization in very underdeveloped nations and the consequence of unnecessarily imposed budgetary austerity in foreign aiddependent poor countries as in Ethiopia I attempted to reach enior managen at the Fund both directly and through colleagues at the World Bank and those at the Bank working in Ethiopia made similar efforts 10 persuade their counterparts at the Fund I used what influence I could through my connections with the Clinton administration including talking to Americas representative on the Fund In short I did everything I could to get the IMF program reinstated Assistance was restored and I would like to think that my efforts helped Ethiopia I learned however that immense time and effort are required to effect change even from the inside in an international bureaucracy Such organizations are opaque rather than transparent and not only does far too little information radiate from inside to the outside world perhaps even less information from outside is able to penetrate the organization The opaqueness also means that it is hard for information from the bottom of the organization to percolate to the top t A I r The ussle over lending to Ethiopia taught me a lot about how the IMF works There was clear evidence the IMF was wrong about financial market liberalization and Ethiopias macroeconomic posi tion but the IMF had to have its way It seemingly would not listen to others no matter how well informed no matter how disinterested Matters of substance became subsidiary to matters of process Whether it made sense for Ethiopia to repay the loan was less impor tant than the f1ct that it failed to consult the 1M E Financial market liberalizationhow best this should be done in a country at Ethiopias stage of developmentwas a matter of substance and expert could have been asked for their opinion The fact that outside experts were not called in to help arbitrate what wa clearly a con tentious issue is consonant with the style of the IMF in which the Fund casts itself as the monopoly supplier of so lind advice Even matters like the repayment of the loanthough properly not some thing on which the IMF should have taken a position at all so long as Ethiopias action enhannd rather than subtracted from its ability to repay what was owcdcould have been referred to olltsiders to hcthn th ldi11 IS rlsonahlt Uut doing so would have bn 1IIlhcm1 t rill 1111 LkIUS so much of its decision making 1 111 bhilld dsd doorsthae was virtually no public discus i11 llf th islIs just rlistdthe IMF Idt itself open to suspicions rhu nr flitis spial interests or other hidden reasons not fclutd tl th IMFs mandate and stated objectives were influencing its illsImioll1I poliies and conduct It is lurd wn tor a moderatesized institution like the IMF to knw 1 rtlt dtal about ewry economy in the world Some of the b t IMF eonomists were assigned to work on the United States m when I sened as chairman of the Council of Economic Advisers Itttn tilt that the IMFs limited understanding of the US economy Iud led it to make misguided policy recommendations for America The IMF economists felt for instance that inflation would start ris in in rhe United Stares as soon as unemployment fell below 6 per cenr Ar rhe Council our models said they were wrong but they were nor terribly interested in our input We were right and the IMF was wrong unemployment in the United States fell to below 4 per cel Jnd still inflation did not increase Based on their faulty analysis ot the US economy the IMF economists came up with a misguided policy prescription raise interest rates Fortunately the Fed paid no memion 0 the IMF recommendation Other countries could not Ignore it so easily Bur 0 the 1M F the lack of detailed knowledge is of less moment btclus it tends to take a onesizefitsall approach The problems ot this approach become particularly acute when facing the chal knges ot the devdoping and transition economies The institution does not rtally claim expertise in developmentits original mandate is supporting global economic stability as I have said not reducing poverty in devdoping countriesyet it does not hesitate to weigh in and weigh in htavily on development issues Development issues are complicated in many ways developing countries present far greattr difficulties than more dcvdopcd countries This is because in dcvdoping nations markets are often absent and when present often work imperfecrly Information problems abound and cultural mores may significantly affect economic behavior Unfortunately 00 often the training of the macroeconomists does UJIOKnN PHMJSI not prepare them well for the problems that they haw to confront in devdoping countries In some of the universities from which the IMF hires regularly the core curricula involw lI10dds in which there is never any unemployment After all in the standard competitive modelthe model that underlies the IMFs market fundamental ismdemand always equals supply If the demand for labor equals supply there is never any involJltrlary unemployment Someone who is not working has evidently chosen not to work In this interpreta tion unemployment in the Great Depression when one out of four people was out of work would be the result of a sudden increase in the desire for more leisure It might be of some interest to psycholo gists why there was this sudden change in the desire for leisure or why those who were supposed to be enjoying this leisure seemed so unhappy but according to the standard model these questions go beyond the scope of economics While these models might provide some amusement within academia they seemed particularly ill suited to understanding the problems of a country like South Africa which has been plagued with unemployment rates in excess of 25 percent since apartheid was dismantled The IMF economists could not of course ignore the existence of unemployment Because under market fundamentalismin which by assumptioll markets work perfectly and demand must equal supply for labor as for every other good or factorthere cannot be unem ployment the problem cannot lie with markets It must lie e1se wherewith greedy unions and politicians interfering with the workings of free markets by demandingand gettingexcesively high wages There is an obvious policy implicationif there is unemployment wages should be reduced But even if the training of the typical IMF macroeconomist had been better suited to the problems of developing countries its unlikely that an IMF mission on a threeweek trip to Addis Abaha Ethiopias capital or the capital of any other developing countr could really develop policies appropriate tor that country Such poli cies are far more likely to be crafted by highly educated firstrate economists already in the country deeply knowledgeable about it and working daily on solving that countrys problems Outsiders can play a role in sharing the explriencls of other countries and in CLlIOL LLUtON NL ITS DISCNTNTS otltrilL llttrIIltiw illttrprttatiolLs of the ecolLomic forces at play But thl 1111 did ILlt VlIlt to takt OIL the mere role of an adviser compltilL with lthas who miht be otTering their ideas It wanted 1 mOrt cllItral mit ill shJpilL policy And it could do this because its positiolL WJS blsed OIL aIL ideologymarket fundamentalismthat requirtd little if JILY cOlLsideration of a countrys particular circum stalLces lIld ilLllllediate problellls lMF economists could ignore the shortterm etlcts their policies might haw on the country content ill the bdief that ill tile II nlll the country would be better off any adverse shortrun impacts would be merely pain that was necessary JS part of the process Soaring interest fdtes might today lead to star vation but market efficiency requires free markets and eventually efficiency leads to growth and growth benefits all Suffering and pain became part of the process of redemption evidence that a country was on the right track To me sometimes pain is necessary but it is not a virtue in its own right Welldesigned policies can often avoid much of the pain and some forms of painthe misery caused by abrupt cuts in food subsidies for example which leads to rioting urban violence and the dissolution of the social fabricare counter productive The IMF has done a good job of persuading many that its ideo logically driven policies were necessary if countries are to succeed in tht long run Economist always focus on the importance of scarcity and the IMF otten says it is simply the messenger of scarcity coun tries cannot persistently live beyond their means One doesnt of course need a sophisticated financial institution staffed by PhD economists to tdl a country to limit expenditures to revenues But IMF retorm programs go well beyond simply ensuring that countries live within their means THERE ARE ALTERNATIVES to IMFstyle programs other pro grams that may involve a reasonable level of sacrifice which are not based on market fundamentalism programs that have had positive outcomes A good example is Botswana 2300 miles south of Ethiopia a small country of t5 million which has managed a stable democracy since independence At the time Botswana became fully independent in t 966 it was a BROKEN PROMISES 31 desperately poor country like Ethiopia and mon of the other coun tries in Africa with a per capita annual income of StoO It 100 was largely agricultural lacked water and had a rudimentary infrastruc ture But Botswana is one of the success stories of development Although the country is now suffering from the ravages of AIDS it averaged a growth rate of more than 75 percent from 1961 to 1997 Botswana was helped by having diamonds but countries like Congo Republic formerly Zaire Nigeria and Sierra Leone were also rich in resources In those countries the wealth from this abundance fueled corruption and spawned privileged elites that engaged in internecine struggles for control of each countrys wealth Botswanas success rested on its ability to maintain a political consensus based on a broader sense of national unityThat political consensus nec essary to any workable social contract between government and the governed had been carefully forged by the government in collabora tion with outside advisers from a variety of public institutions and private foundations including the Ford Foundation The ad1sers helped Botswana map out a program for the countrys future Unlike the IMF which largely deals with the finance ministry and central banks the advisers openly and candidly explained their policies as they worked with the government to obtain popular support for the programs and policies They discussed the program with senior Botswana officials including cabinet ministers and members of Par liament with open seminars as well as onetoone meeting Part of the reason tor this success was that the senior people in Botswanas government took great care in selecting their advisers When the IMF offered to supply the Bank of Botswana vith a deputy governor the Bank of Botswana did not automatically accept him The banks governor flew to Wahington to interview him He turned out to do a splendid job Of course no success is without blemishes On another occasion the Bank of Botswana allowed the IMF to pick somebody to be director of research and that turned out at least in the view of some to he far less successful The differences in how the two organizations approachld devel opment were reflected not just in performance While tht IMF is vil ified almost everywhere in the developing world the warm relationship that was created lwtween Botswana and its advisers wa lllHiIIr1nN Nt ITS DISCONTENTS SIlIlbltlt1 bv tht llrding of that lHlntrys highest medal to Steve Llwis wlw It th tilllc h advised 130tswana was a professor of devel llPIlltllt llllllllllics at Villiams He later became president of Car kton ellkg Thlt lui consensus was threatened two decades ago when 13 0 tS1 nl hld ll1 economic crisis A drought threatened the liveli hood of the many people engaged in raising cattle and problems in the diamond industry had put a strain on the countrys budget and its foreign exchange position Botswana was suffering exactly the kind of liquidity crisis the IMF had originally been created to deal with a crisis that could be eased by financing a deficit to forestall recession and hardship However while that may have been Keyness intent when he pushed tor the establishment of the IMF the institution does not now conceive of itself as a deficit financier committed to maintaining economies at full employment Rather it has taken on the preKeynesian position of fiscal austerity in the face of a down turn doling out funds only if the borrowing country conforms to the iJvfs views about appropriate economic policy which almost lhays entail conrractionary policies leading to recessions or worse Bmswana recognizing the volatility of its two main sectors cattle and dilIllonds had prudently set aside reserve funds for just such a crisis 5 it saw its reserves dwindling it knew that it would have to take further measures Botswana tightened its belt pulled together and got through the crisis But because of the broad understanding of economic policies that had been developed over the years and the consensusbased approach to policy making the austerity did not ClUSe the kinds of cleavages in society that have occurred so fre quentlv elsewhere under IMF programs Presumably if the IMF had done what it should have been doingproviding funds quickly to countries with good economic policies in times of crisis without searching around for conditionalities to imposethe country would have been able to wend its way through the crisis with even less pain The IMF mission that came in 1981 quite amusingly found it very difficult to impose new conditions because Botswana had already done so many of the things that they would have insisted upon Since then Botswana has not turned to the IMF for help The assistance of outside advisersindependent of the interna BROKEN PROMISlS tional financial institutionshad playcd a role in Botswanas success cvcn earlier Botswana would not have fared as well as it did if its original contract with the South African diamond cartel had been maintained Shortly after independence the cartel paid Botswana 20 million for a diamond concession in 1969 which reportedly returned 60 million in profits a year In other words the payback period was four months A brilliant and dedicated lawyer seconded to the Botswana government from the World Bank argued forcefully for a renegotiation of the contract at a higher price much to the consternation of the mining interests De Beers the South African diamond cartel tried to tell people that Botswana was being greedy They used what political muscle they could through the World Bank to stop him In the end they managed to extract a letter from the World Bank making it clear that the lawyer did not speak for the Bank Botswanas response That is precisely why we are listening to him In the end the discovery of the second large diamond mine gave Botswana the opporrunity to renegotiate the whole relation ship The new agreement has so far served Botswanas interests well and enabled Botswana and De Beers to maintain good relations Ethiopia and Botswana are emblematic of the challenges facing the more successful countries of Africa today countries with leaders dedicated to the wellbeing of their people fragile and in some cases imperfect democracies attempting to create new lives for their peo ples from the wreckage of a colonial heritage that left them without institutions or human resources The two countries are also emblem atic of the contrasts that mark the developing world conrrast between success and failure between rich and poor between hopes and reality between what is and what might have been I IlECAME AWARE of this contrast when I first went to Kenya in the late 1960s Here was a rich and fertile country with some of the mos valuable land still owned by old colonial settlers When I arrived the colonial civil servants were also still there now they were called advisers As I watched developll1ent in East Africa over the ensuing years and returned for several visit after becoming chief economist of the World Bank the contrast bctwln the aspirations in the 19605 and l I OULItHIlIN ND ITS DISCONTENTS tht sUbstquelf lltWllPlIltlfS were striking When I first went the spirit of IIi thl Swlhili word tor freedom and Iyallla the word for sdthdp Wtrt in till air When I returned the overnment offices were stariid by wdlspoktn and welltrained Kenyans but the economy 1111 blln sinking tor years Some of the problemsthe seemingly rllupalf corruptionwere of Kenyas own making But the high inter est rates which had resulted from its following IMF advice as well as Lther problems could rightly be blamed at least in part on outsiders Ugll1d1 had begun the transition in perhaps better shape than any of he others a relatively rich cotfeegrowing country but it lacked trained native administrJtors and leaders The British had allowed only WO Africans to rise to the level of a master sergeant in their own army One of them unfortunately was a Ugandan named Idi Amin who ultimately became General Amin in Ugandas army and oerchrew Prime Minister Milton Obote in 1971 Amin enjoyed a certain measure of British confidence thanks to his service in the Kings African Rifles in World War II and in Britains struggle to sup press he MauMau revolt in Kenya Amin turned the country into a lJughterhouse as many as 300000 people were killed because they wae considered opponents of the President for Life as Amin proclaimed himself in 1976 The reign of terror by an arguably psy chopathic dictator ended only in 1979 when he was toppled by Ugandan exiles and forces from neighboring Tanzania Today the country is on the way to recovery led by a charismatic leaderYoweri Museveni who has instituted major reforms with remarkable success reducing illiteracy and AIDS And he is as interesting in talking about political philosophy as he is in talking about development strategies B 1 T THE 1M F is not particularly interested in hearing the thoughts of its c1ient countries on such topics as development strategy or fis cal austerity All too often the Funds approach to developing coun tries has had the feel of a colonial ruler A picturecanbewortha thollsand words and a single picture snapped in 1998 shown throughout the world has engraved itself in the minds of millions particularly those in the former colonies The IMPs managing direc tor Michel Camdessus the head of the IMF is referred to as its Managing Director a short neatly dressed former French Trea 13110JEN PROMISES 41 sury bureaucrat who once claimed to be a Socialist is tanding with a stern face and crossed arms over the seated and humiliated presi dent of Indonesia The haplefs president was being forced in effect to turn over economic soveteignty of his country to the IMF in return for the aid his country needed In the end ironically much of the money went not to help Indonesia but to bailout the colonial powers private sector creditors Officially the ceremony was the signing of a letter of agreement an agreement effectively dictated by the lMF though it often still keeps up the pretense that the letter of intent comes from the countrys government Defenders of Camdessus claim the photograph was unfair that he did not realize that it was being taken and that it was viewed out of context But that is the pointin daytoday interactions away from cameras and reporters this is precisely the stance that the IMF bureaucrats take from the leader of the organization on down To those in the developing countries the picture raised a very disturbing question Had things really changed since the official ending of colonialism a half cenrury ago When I saw the picrure images of other signings of agreements came to mind I wondered howsimi lar this scene was to those marking the opening up of Japan with Admiral Perrys gunboat diplomacy or the end ofthe Opium Wars or the surrender of maharajas in India The stance of the IMF like the stance of its leader was clear it wiS the font of wisdom the purveyor of an orthodoxy too subtle to be grasped by those in the developing world The message conveyed was all too often clear in the best of cases there was a member of an elitea minister of finance or the head of a central bankwith whom the Fund might have a meaningful dialogue Outsid of this circle there was little point in even trying to talk A quarter of a cenrury ago those in the developing counrries might rightly have given some deference to the experts from the IMF But just as there has been a shift in the military balance of power there has been an even more dramatic shift in the intellCctual balance of power The developing world now has its own econo mistsmany of them trained at the worlds best academic institu tions These economists have the significant advantage of lifelong familiarity with local politics conditions and trends Th IMF is likC IIIIlUILHlllN NI ITS ISCNTNTS SO 111111 bllltllIlTJilS i has npcatcdly sought to extend what it dllls btllnd til Pllllllds of he oPjeniVts originally assigned to it As 1 Fs lIIissilll lrttp gradually proug it outside its core area of OIllPlllIn in 1IIIlrOlllmlllUics into structural issues such as priva izaioll labor lIIarkts ptnsion rdorms and so forth and into brollkr lrtlS of dlwlopment strategies the intellectual balance of pOtr btclml lven morc tilted Thl lME ot course claims that it newr dictates but always negoti UtS ht lrmS ot any loan agreement with the borrowing country Btl htst are ontsided negotiations in which all the power is in the hlIIds ot he IMF largdy because many countries seeking IMF help Ire in desperue need of till1ds Although I had seen this so clearly in EthiopiJ and the other devdoping countries with which I was illLllwd it was brought home again to me during my visit to South Korea ill Dccember 1997 as the East Asia crisis was unfolding South Koreas ecollomists knew that the policies being pushed on their country by the IMF would be disastrous While in retrospect even the IMF agreed that it imposed excessive fiscal stringency in prospect fiw economists outside the IMF thought the policy made SIIS2 Vt Koreas economic officials remained silent I wondered why thy had kept this silence but did not get an answer from offi cials inside the gowrnment until a subsequent visit two years later whn the Korean economy had recovered The answer was what giVtn past experience I had suspected all along Korean officials reluctantly explained that they had been scared to disagree openly The IMF could not only cut offits own fund but could use its bully pulpit to discourage investments from private market funds by telling priate sector tinancial institutions of the doubts the IMF had about Korea conom So Korea had no choice Even implied criticism by Korea oithe IMF program could have a disastrous effect to the IMF it would suggest that the government didnt fully understand IMF economic that it had reservations making it less Iikdy that it would actually carry Ollt the program The IMF has a special phrase for describing slich situations the country has gone off track There is one right way and any deviation is a sign of an impending derail ment A public announcement by thc IMF that negotiations had broken otT or even been postponed would send a highly negative BIIOKEN PIIlMISES 43 signal to the markets This signal would at best lead to higher interest rates and at worst a total cutoff from private funds Even more seriou for some of the poorest countries which have in any case little access to private funds is that other donors the World Uallk the European Union and many other countries make access to their funds contin gent on MF approval Recent initiatives for debt rdief have effec tively given the MF even more power because unless the MF approves the countrys economic policy there will be no debt relief This gives the MF enormous leverage as the lMF well knows The imbalance of power between the lMF and the client coun tries inevitably creates tension between the two but the MFs own behavior in negotiations exacerbates an already difficult situation In dictating the terms of the agreements the IMF effectively stifles any discussions within a client governmentlet alone more broadly within the countryabout alternative economic policies n times of crises the MF would defend its stance by saying there simply wasnt time But its behavior was little different in or out of crisis The MFs view was simple questions particularly when raised vociferously and openly would be viewed as a challenge to the inviolate orthodoxy f accepted they might even undermine its authority and credibility Government leaders knew this and took the cue they might argue in private but not in public The chance of modifying the Funds views was tiny while the chance of annoying Fund leaders and provoking them to take a tougher position on other issues was far greater And if they were angry or annoyed the MF could postpone it loansa scary prospect for a country facing a crisis But the fact that the gov ernment officials seemed to go along with the IMFs recommendation did not mean that they really agreed And the MF kill it Even a casual reading of the terms of the typical agrelmen between the MF and the developing countries showed the lack of trust between the Fund and its recipient The MF stafr monitored progress not just on the relevant indicators for sound macmmanagt mentinflation growth and unemploymentbut on intermediate variables such as the money supply often only loosely connected to the variables of ultimate concern Countries were put on strict tar getswhat would be accol1lplished in thirty days in sixty days in ninety days n some cases tht agreements stipulated what laws tht lUIHllLllllN NIl ITs DlSCONTNTS oumrv larlilllltm would IlJw to pass to meet IMF requirements r tlretsIlld bv when 1hse rtquireIllents are rdtrred to as conditions and condi tillllJlitv is J hod dtblted topic in the development world Every loan ddIIlltnt specitits basic conditions of course At a minimum a il1II JretIlItm says tht loan goes out on the condition that it will be repid usually with a schedule attached Many loans impose condi tions designed to increase the likelihood that they will be repaid Conditionality refers to more forceful conditions ones that often Urn the loan into a policy tool If the IMF wanted a nation to liber liizt its tllUncial markets for instance it might payout the loan in installments tying subsequent installments to verifiable steps toward liberalization I personally believe that conditionality at least in the manner and extent to which it has been used by the IMF is a bad idea there is little evidence that it leads to improved economic pol icy but it does have adverse political effects because countries resent having conditions imposed on them Some defend conditionality by aying that any banker imposes conditions on borrowers to make it more likely that the loan will be repaid But the conditionality Imposed by the IMF and the World Bank was very different In some cases it eYen reduced the likelihood of repayment For instance conditions that might weaken the economy in the short run whatever their merits in the long run the risk of exacer bating the downturn and thus making it more difficult for the coun tr to repay the shortterm IMF loans Eliminating trade barriers monopolies and tax distortions may enhance longrun growth but the disturbances to the economy as it strives to adjust may only deepen its downturn While the conditionalities could not be justified in terms of the Funds fiduciary responsibility they might be justified in terms of what it might have perceived as its moral responsibility its obligation to do everything it could to strengthen the economy of the countries that had turned to it for help But the danger was that even when well intentioned the myriad of conditionsin some cases over a hundred each with its own rigid timetabledetracted from the countrys ability to address the central pressing problems The conditions went beyond economics into areas that properly DIWKliN PROMISES 4S belong in the realm of politics In the case of Kona for instance the loans included a change in the charter of the Central Bank to make it more independent of the political process though there was scant evidence that countries with more independent central banks grow faster3 or have fewer or shallower fluctuations There is a wide spread feeling that Europes independent Central Bank exacerbated Europes economic slowdown in 2001 as like a child it responded peevishly to the natural political concerns over the growing unem ployment Just to show that it was independent it refused to allow interest rates to fall and there was nothing anyone could do about it The problems partly arose because the European Central Bank has a mandate to focus on inflation a policy which the IMF has advocated around the world but one that can stifle growth or exacerbate an economic downturn In the midst of Koreas crisis the Korean Cen tral Bank was told not only to be more independent but to focus exclusively on inflation although Korea had not had a problem with inflation and there was no reason to believe that mismanaged mone tary policy had anything to do with the crisis The IMF simply used the opportunity that the crisis gave it to push its political agenda When in Seoul I asked the IMF team why they were doing this I found the answer shocking though by then it should not have come as a surprise We always insist that countries have an independent central bank focusing on inflation This was an issue on which I felt strongly When I had been the presidents chief economic adviser we beat back an attempt by Senator Connie Mack of Florida to change the charter of the US Federal Reserve Bank to focus exclusively on inflation The FedAmericas central bank has a mandate to focus not just on inflation but also on employment and growth The president opposed the change and we knew that if anything the Americ1n people thought the Fed already focused too muct on inflation The president made it clear that this was an issue he would tight and as soon as this was made clear the proponents backed of Yet here was the IMFpartially under the influence of the USTreasuryimpos ing a political condition on Korea that most Americans would haVl found unacceptable for themselves Sometimes the conditions scmd little more than a simple exer cis of power in its 1997 lending agreement to Korea th IMF lllllIIIUlllN AND ITS DISCONTENTS insistld llll 1Illling Up the datt of opening Koreas markets to certain JpJnlSe goods llthough this could not possibly help Korea address the prllhltlIIs of the crisis To SOllie these actions represented seizing the window of opportunity using the crisis to leverage in changes that the IMF and World Bank had long been pushing but to others thest were silllply Jets of pure political might extracting a conces sion of limited value simply as a demonstration of who was running the show While conditionality did engender resentment it did not succeed in engendering development Studies at the World Bank and else where showed not just that conditionality did not ensure that money was well spent and that countries would grow faster but that there was litde evidence it worked at all Good policies cannot be bought THERE ARE SEVERAL reasons for the failure of conditionality The simplest has to do with the economists basic notion of fungibility which simply refers to the fact that money going in for one purpose frees up other money for another use the net impact may have noth ing to do with the intended purpose Even if conditions are imposed which ensure that this particular loan is used well the loan frees up resources elsewhere which mayor may not be used well A country may have two road projects one to make it easier for the president to get to his summer villa the other to enable a large group of farmers to bring their goods to a neighboring port The country may have funds for only one of the two projects The Bank may insist that its money go for the project that increases the income of the rural poor bur in providing that money it enables the government to fund the other There were other reasons why the Funds conditionality did not enhance economic growth In some cases they were the wrong con ditions financial market liberalization in Kenya and fiscal austerity in East Asia had adverse effects on the countries In other cases the way conditionality was imposed made the conditions politically unsus tainable when a new government came into power they would be abandoned Such conditions were seen as the intrusion by the new colonial power on the countrys own sovereignty The policies could not withstand the vicissitudes of the political process UIHIKEN PROMISES 47 There was a certain irony in the stance of the MF It tried to pre tend that it was above politics yet it was clear that its lending pro gram was in part driven by politics The IMF made an issue of corruption in Kenya and halted its relatively small lending program largely because of the corruption it witnessed there Yet it maintained a flow of money billions of dollars to Russia and Indonesia To some it seemed that while the Fund was overlooking grand larceny it was taking a strong stand on petty theft It should not have been kinder to Kenyathe theft was indeed large relative to the economy it should have been tougher on Russia The issue is not just a matter offairness or consistency the world is an unfair place and no one really expected the IMF to treat a nuclear power the same way that it treated a poor African country of little strategic importance The point was far simpler the lending decisions were politicaland political judgments often entered into IMF advice The IMF pushed privatization in part because it believed governments could not in managing enterprises insulate themselves from political pressures The very notion that one could separate economics from politics or a broader understanding of society illustrated a narrowness of per spective If policies imposed by lenders induce riots as has happened in country after country then economic conditions worsen as capital flees and businesses worry about investing more of their money Such policies are not a recipe either for successful development or for eco nomic stability The complaints against the IMF imposition of conditions extended beyond what conditions and how they were imposed but were directed at how they were arrived at as well The standard IMF pro cedure before visiting a client country is to write a draft report first The visit is only intended to finetune the report and its recommen dations and to catch any glaring mistakes In practice the draft report is often what is known as boilerplate with whole paragraphs being borrowed from the report of one country and inserted into another Word processors make this easier A perhaps apocryphal story has it that on one occasion a word processor failed to do a search and replace and the name of the country from which a report had been borrowed almost in its entirety was left in a document that was circu lated It is hard to know whether this was a oneoff occurrence dont lllHIILHlllN ANI ITS DISCONTNTS 1I11dtr rimt prtSSlIn bur rhe lllegld toulup continued in the minds lf nuny rht illugc lf lHllsizttirsall reports Enn eOllnrrits nor borrowing money from the IMF can be Jtrcttt by irs itws Ir is nor jusr through conditionality that the Flind imposts irs ptrsplcriws throughout the world The IMF has an 11II11I1I ollSlIlratioll with tvery country in the world The consulta tions rderrtd to as Article 4 consultations after the article in its ehlna rhlt Juthorized them are supposed to ensure that each coun try is Idhtring to tht articlts of agreement under which the IMF was tstJblishtd tundamtntaUy tnsuring txchange rate convertibility for tracit purposts Mission creep has affected this report as it has other JSptcts of lMF activity the real Article 4 consultations are but a minor pm of the entire surveillance processIhe report is really the IFs grJding 9f the nations economy Whilt small countries often had to listen to the Article 4 evalua tions the United States and other countries with developed econo milS could basically ignore them For instance the IMF suffered tiom inflation paranoia even when the United States was facing the lowest inflation rates in decades Its prescription was therefore pre dictable increase interest rates to slow down the economy The IMF mply had no understanding of the changes that were then occur ring Jnd had been occurring over the preceding decade in the US economy that allowed it to enjoy faster growth lower unemploy ment Jnd low inflation all at the same time Had the IMFs advice been tollowed the United States would not have experienced the boom in the American economy over the 1990sa boom that brought unprecedented prosperity and enabled the country to turn around its massive fiscal deficit into a sizable surplus The lower unemployment also had profound social consequencesissues to which the MF paid little attention anywhere Millions of workers who had been excluded tiom the labor force were brought in reduc ing poverty and welfare roles at an unprecedented pace This in turn brought down the crime rate All Americans benefited The low unemployment rate in turn encouraged individuals to take risks to accept jobs without job security and that willingness to take risks has proven an essential ingredient in Americas success in the socalled New Economy BHOKEN PJlOMIStS The United States ignored the IMFs advice Neither the Clinton administration nor the Federal Reserve paid much attention to it The United States could do so with impunity because it wa not dependent on the IMF or other donors for assistance and we knew that the market would pay almost as little attention to it as we did The market would not punish us for ignoring its advice or reward us for following it But poor countries around the world are not so lucky They ignore the Funds advice only at their peril There are at least two reasons why the IMF should consult widely within a country as it makes its assessments and designs its programs Those within the country are likely to know more about the econ omy than the IMF staffersas I saw so clearly even in the case of the United States And for the programs to be implemented in an effec tive and sustainable manner there must be a commitment of the country behind the program based on a broad consensus Such a consensus can only be arrived at through discussionthe kind of open discussion that in the past the IMF shunned To be fair to the IMF in the midst of a crisis there is often little time for an open debate the kind of broad consultation required to build a consensus But the IMF has been in the African countries for yearslfit is a cri sis it is a permanent ongoing crisis There is time for consultations and consensus buildingand in a few cases such as Ghana the World Bank while my predecessor Michael Bruno was chief economist succeeded in doing that and these have been among the more suc cessful cases of macroeconomic stabilization At the World Bank during the time I was there there wa an increasing conviction that participation mattered that policies and programs could not be imposed on countries but to be successful had to be owned by them that consensus building was essential that policies and development strategies had to be adapted to the situa tion in the country that there should be a shift from conditionality to selectivity rewarding countries that had proven track records fur using funds well with more timd trusting them to continue to make good use of their funds and providing them with strong incentives This was reflected in the new Bank rhetoric articulated forcefully by the Banks presidentJames n Wolfensohn The country should be put in the drivers seat Even 50 many critics say this process has not 1 tIIltIIN NL ITS lISCONTNTS lllll tlr elllluh llhl thlt the UllIk still expects to remain in control They WllIT hlt till clHllItry llIay be in the driVtrs seat of a dual cllltmi clr ill which thl controls are really in the hands of the illrUdllr l hllltS ill mitudes md operating procedures in the L1llIk will illtitlbly be slow proceeding at different paces in its pro rllIlS ill ditlrellt countries But there remains a large gap between whert ht l3mk is on these matters and where the IMF is both in mitudts llld procedures s much as it might like the IMF in its public rhetoric at least Lould not be completdy oblivious to the widespread demands for reHtr ptrticipation by the poor countries in the formulation of dewlopmem strategies and for greater attention to be paid to pmem As a result the IMF and the World Bank have agreed to con duct plrticipltory poverty assessments in which client countries JOili the two institutions in measuring the size of the problem as a first step This was potentially l dramatic change in philosophybut its ttlll import seemed to escape the IME On one recent occasion recob11izing that the Bank was supposed to be taking the lead on poverty projects just before the initial and theoretically consultative IMF nllSsion to a certain client country prepared to depart the IMF sent an imperious message to the Bank to have a draft of the client countrys participatory poverty assessment sent to IMF headquar ters asap Some of us joked that the IMF was confused It thought the big phtlosophical change was that in joint BankIMF missions the Bank could actually participate by having a say in what was writ ten The Idea that citizens in a borrowing country might also partici pate was simply too much Stories of this kind would be amusing vere they not so deeply worrying Even if however the participatory poverty assessments are not perfectly implemented they are a step in the right direction Even if there remains a gap between the rhetoric and the reality the recogni tion that those in the developing country ought to have a major voice in their programs is important But if the gap persists for too long or remains too great there will be a sense of disillusionment Already in some quarters doubts are being raised and increasingly loudly While the participatory poverty assessments have engendered far more pub lic discussion more participation than had previously been the case J3110KUj PJlOMISES in many countries expectations of participation and openneSlO have not been fully realized and there is growing dicontent In the United States and other successful democracies citizens regard transparency openness knowing what government is doing as an essential part of government accountability Citizens regard these as rights not favors conferred by the government The freedom of Information Act of 1966 has become an important part of American democracy By contrast in the IMf style of operation citizens an annoyance because they all too often might be reluctant to go along with the agreements let alone share in the perceptions of what is good economic policy were not only barred from discussions of agreements they were not even told what the agreements were Indeed the prevailing culture of secrecy was so strong that the IMf kept much of the negotiations and some of the agreements secret from World Bank members even in joint missions The IMf staff provided information strictly on a need to know basis The need to knowlist was limited to the head of the IMf mission a few peo ple at IMF headquarters in Washington and a few people in the client countrys government My colleagues at the Bank frequently complained that even those participating in a mission had to go to the government of the country who leaked what was going on On a few occasions I met with executive directors the title for represen tatives that nations post to the IMf and the World Bank who had apparently been kept in the dark One recent episode shows how far the consequences of lack of transparency can go The notion that developing countries might have little voice in the international economic institutions is widdy recognized There may be a debate about whether this is just a histor ical anachronism or a manifestation of realpolitik But we should expect that thc US governmentincluding the US Congress should have somc say at least in how its executive director the one who represents the United States at the IMF and the World Bank votes In 2001 Congress passed and the president signed a law requiring the United States to oppose proposals for the international financial institutions to charge fees for elementary school a practicc that goes under the scemin innocuous namc of cost recovery Vct the us executive director simply ignored the law and thc sccrecy of CIOUAIILUllIN ND ITS DISCONTENTS the instituciollS 1IIlde it ditli ult for Congressor anyone elseto stt wlllt WIS going on Only be ause of a leak was the matter discov crtd gntrating outrage etn among congressmen and women lustolllcd to bURlIlerati lIIaneuvering TOliJy in spitt of the rcpeated discussions of openness and trans plrency the IMF still does not formally recognize the citizens basic right to know there is no Freedom of Information Act to which lI Americln or a citizeJl of any other country can appeal to find out what this international public institution is doing I should be c1ear all of these criticisms of how the IMF operates do not mean the IMFs money and time is always wasted Sometimes money has gone to governments with good policies in placebut not necessarily because the IMF recommended these policies Then the money did make a difference for the good Sometimes condi tionality shifted the debate inside the country in ways that led to bet ter policies The rigid timetables that the IMF imposed grew partly trom a multitude of experiences in which governments promised to make certain reforms but once they had the money the reforms were not forthcoming sometimes the rigid timetables helped force tht pace of change But all too often the conditionality did not ensure either that the money was well used or that meaningful deep and longlasting policy changes occurred Sometimes conditionality was even counterproductive either because the policies were not well suited to the country or because the way they were imposed engendered hostility to the reform process Sometimes the IMF pro gram left the country just as impoverished but with more debt and an even richer ruling elite The international institutions have thus escaped the kind of direct accountability that we expect of public institutions in modern democracies The time has come to grade the international eco nomic institutions performance and to look at some of those pro gramsand how well or poorly they did in promoting growth and reducing poverty CHAPTER 3 FREEDOM TO CHOOSE F ISCAL AUSTERITY PRIVATIZATION and market liberaliza tion were the three pillars of Washington Consensus advice throughout the 1980s and 19905 The Washington Consensus policies were designed to respond to the very real problems in Latin America and made considerable sense In the t 980s the govern ments of those countries had often run huge deficits Losses in ineffi cient government enterprises contributed to those deficits Insulated from competition by protectionist measures inefficient private firms forced customers to pay high prices Loose monetary policy led to inflation running out of control Countries cannot persistently run large dcticits and sustained growth is not possible with hyperinfla tion Some level of fiscal discipline is required Most countries would be better off with goveTllments focusing on providing essential pub lic services rather than running enterprises that would arguably per form better in the private sector and so privatization otten makes sense When trade liberalizationthe lowering of tarifF and elimina tion of other protectionist measuresis done in the right way and at the right pace so that new jobs are created as inefticient jobs arc destroyed there can be significant etlicitncy gains The problem was that many of these policies became nd in themselves rather than meam to more equitable and sustainable l1 lKUlHhIN AND ITS DISCNTNTS gfllwch III dill SO thtSt plllicils wert pushed too far too fast and tl thl lxdusilII lf thlr policies that were needed The rtsults hl blllI tlr tWill those imended Fiscal austerity pushed to tlr ulldlr the wrong circumstances can induce reces silIs lilt high imertsc rattS may impede fledgling business enter prists Tht 11 F vigorously pursued privatization and liberalization at I Plet lilt in a manner that often imposed very real costs on coun tries illequipped to incur them Privatization In Illany devdopingand devdopedcountries governments all roo otcen spend too much energy doing things they shouldnt do This disrracts them from what they should be doing The problem is not so much that the government is too big but that it is not doing the right thing Governments by and large have little business run ning sted mills and typically make a mess of it Although the most efficient sted mills in the world are those established and run by the Korean and Taiwanese governments they are an exception In gen eral competing private enterprises can perform such functions more efficiently This is the argument for privatizationconverting state run industries and firms into private ones However there are some important preconditions that have to be satisfied before privatization can contribute to an economys growth And the way privatization is accomplished makes a great deal of difference Unfortunatdy the IMF and the World Bank have approached the issues from a narrow ideological perspectiveprivatization was to be pursued rapidly Scorecards were kept for the countries making the transition from communism to the market those who privatized faster were given the high marks As a result privatization often did not bring the benefit that were promised The problems that arose from these failures have created antipathy to the very idea of privatization In 1998 I visited some poor villages in Morocco to see the impact that projects undertaken by the World Bank and nongovernmental organizations NGOs were having on the lives of the people there I saw for instance how communitybased irrigation projects were increasing farm productivity enormously One project however had FIIEUOM TO CWIISE fliled An NGO had painstakingly instructed local villager 011 raising chickens an enterprise that the village women could perform as they continued more traditional activities Originally the women obtained their sevendayold chicks from a goVtrnment enterprise But when I visited the village this new enterprise had collapsed I discussed with villagers and government officials what had gone wrong The answer was simple The government had been told by the IMF that it should not be in the business of distributing chicks so it ceased selling them It was simply assumed that the private sector would immediately fill the gap Indeed a new private supplier arrived to provide the villagers with newborn chicks The death rate of chicks in the first two weeks is high however and the private firm was unwilling to provide a guarantee The villagers simply could not bear the risk of buying chicks that might die in large numbers Thus a nascent industry poised to make a difference in the lives of these poor peasants was shut down The assumption underlying this failure is one that I saw made repeatedly the IMF simply assumed that markets arise quickly to meet every need when in fact many government activities arise because markets have failed to provide essential services Examples abound Outside the United States this point often seems obvious When many European countries created their social security systems and unemployment and disability insurance systems there were no wellfunctioning private annuity markets no private firms that would sell insurance against these risks that played such an important role in individuals lives Even when the United States created its social security system much later in the depths of the Great Depres sion as part of the New Deal private markets for annuities did not work welland even today one cannot get annuities that insure one against inflation Again in the United States one of the reasons for the creation of the Federal National Mortgage Association Fannie Mae was that the private market did not provide mortgages at rea sonable terms to low and middleincome families In developing countries these problems are even worse eliminating the govern ment enterprise may leave a huge gapand even if eventually the private sector enters there call be enormous suftering in the meall while GlOIIlItT1N IND ITS DISCNTNTS III Cote dlvoire the tdephone company was privatized as is so ottell the lase brfrt either all adequate regulatory or competition trallltwork was put into place The government was persuaded by the Frellch tina thJt punhased the states assets into giving it a monop oly Iwt ollly 011 the existing telephone services but on new cellular senis IS wdl The private firm raised prices so high that for instIIKe university students reportedly could not afford Internet lollllelCions essential to prevent the already huge gap in digital JCcess between rich and poor from widening even further The lMF Jrgues that it is far more important to privatize quickly one can deal with the issues of competition and regulation later But the danger here is that once a vested interest has been created it has JJ1 incentive and the money to maintain its monopoly position squelching regulation and competition and distorting the political process along the vay There is a natural reason why the IMF has been less concerned about competition and regulation than it might have been Privatizing an unregulated monopoly can yield more rev enue co the government and the IMF focuses far more on macro economic issues such as the size of the governments deficit than on structural issues such as the efficiency and competitiveness of the industry Whether the privatized monopolies were more efficient in production than government they were often more efficient in exploiting their monopoly position consumers suffered as a result Privatization has also come not just at the expense of consumers but at the expense of workers as well The impact on employment has perhaps been both the major argument for and against privatiza tion with advocates arguing that only through privatization can unproductive workers be shed and critics arguing that job cuts occur with no sensitivity co the social costs There is in fact considerable truth in both positions Privatization often turns state enterprises om losses co profil by trimming the payroll Economists however are supposed to focus on overall efficiency There are social costs associated with unemployment wlJich private firms simply do not take into account Given minimal job protections employers can dismiss workers with little or no cost including at best minimal severance pay Privatization has been so widely criticized because unlike so called Greenfield investmentsinvestments in new firms as opposed FREEDOM TO CHOOSE S7 to private investors taking over existing firms privatization of jebG tAtF tRBIl ert8eing Rew opes In industrialized countries the pain oflayoffs is acknowledged and somewhat ameliorated by tht safety net of unemployment insurance In less developed countries the unemployed workers typically do not become a public charge since there are seldom unemployment insurance schemes There can be a large social cost nonetheless manifested in its worst forms by urban violence increased crime and social and political unrest But even in the absence of these prob lems there are huge costs of unemployment They include wide spread anxiety even among workers who have managed to keep their jobs a broader sense of alienation additional financial burdens on family members who manage to remain employed and the with drawal of children from school to help support the family These kinds of social costs endure long past the inunediate loss of a job They are often especially apparent in the case when a firm is sold to foreigners Domestic firms may at least be attuned to the social con text and be reluctant to fire workers if they know there are no alter native jobs available Foreign owners on the other hand may feel a greater obligation to their shareholders to maximize stock market value by reducing costs and less of an obligation to what they will refer to as an overbloated labor force It is important to restructure state enterprises and privatization is often an effective way to do so But moving people from lowpro ductivity jobs in state enterprises to unemployment does not increase a countrys income and it certainly does not increase the welfare of the workers The moral is a simple one and one to which I shall return repeatedly Privatization needs to be part oLa moreoompl hensivc RJ1gram which entails creatingjQb uJrIt1he inevitallle jobdestructionprivaticionumTrentn1s Macroeco nomic policies including low interest rates that help create jobs have to be put in place Timing and sequencing is everything These art w this forcefully in my dicu ions in Korea Private owners shod an enormous social conscience in letting their workers go they felt that there was ocial contract which they we reluctant to abrogate even if it mant that mr themselves would Ime 1110ney 1 HIIllllN NIl ITs DISCONTENTS not just issuts llf prlIIIltics ofilllplellllntation these are issues of principle Ptrhlps tht nwst siolls concern with privatization as it has so fttn bttn praltiltd is corruption The rhetoric of market funda IIItIItdiSIll Isserts that privatizatioll will reduce what economists call the rllItsttkin activity of governmellt officials who either skim otr tht prlltits of governnltnt tlIttrprists or award contracts and jobs 0 their tritnds 13ut ill contrast to what it was supposed to do priva rizJtioll 1115 nudt matttrs so much worse that in many countries wdI privatization is jokingly rtierrtd to as briberization If a gov rnmtnt is corrupt thtre is little evidence that privatization will ioln tht problem After all the same corrupt government that mis lIIallagtd the tirm will also handle the privatization In country after country governllltnt officials have realized that privatization meant rhJr thty 110 longer needed to be limited to annual profit skimming Bv selling J government enttrprise at below market price they could get 1 signiticant chunk of tht asset value for themselves rather than leaing it tor subsequent officeholders In effect they could steal wday much of what would have been skimmed offby future politi CIJns Not surprisingly the rigged privatization process was designed to Illaximizt the amount government ministers could appropriate for themsthts not the amount that would accrue to the governments rrtlsury Itt alont the overall efficiency of the economy As we will stt Russil provides a devastating case study of the harm ofprivati zation at lll costs Privatizltion advocates naively persuaded themselves these costs could be overlooked because the textbooks seemed to say that once private property rights were clearly defined the new owners would ensure that the assets would be efficiently managed Thus the situa tion would improve in the long term even if it was ugly in the short term They failed to realize that without the appropriate legal struc tures and market institutions the new owners might have an incen tive to strip assets rather than use them as a basis for expanding industry As a result in Russia and many other countries privatiza tion failed to be as effective a force for growth as it might have been Indeed sometimes it was associated with decline and proved to be a FIIHIJOM TO CHOUSIi SII powerful force for undermining confidence in democratic and mar ket institutions Liberalization Liberalizationthe removal of government interference in financial markets capital markets and of barriers to tradehas many dimen sions Today even the IMF agrees that it has pushed that agenda too farthat liberalizing capital and financial markets contributed to the global financial crises of the 1990s and can wreak havoc on a small emerging country The one aspect of liberalization that does have widespread sup portat least among the elites in the advanced industrial coun triesis trade liberalization But a closer look at how it has worked out in many developing countries serves to illustrate why it is so often so strongly opposed as seen in the protests in Seattle Prague and Washington DC Trade liberalization is supposed to enhance a countrys income by forcing resources to move from less productive uses to more produc tive uses as economists would say utilizing comparative advantage But moving resources from lowproductivity uses to zerl productiv ity does not enrich a country and this is what happened all too often under IMF programs It is easy to destroy jobs and this is often the immediate impact of trade liberalization as inefficient industries close down under pressure from international competitionIMF ide ology holds that new more productive jobs will be created as the old inefiicient jobs that have been created behind protectionist walls are eliminated But that is simply not the caseand few economists have believed in instantaneous job creation at least since the Great Depression It takes capital and entrepreneurship to create new tirms and jobs and in developing countries there is often a shortage of the latter due to lack of education and of the former due to lack of bank financing The IMF in many countries has made matters worse because its austerity progralJL often also entailed such high interest ratessometimes exceeding 20 percent sometimes exeedinl 50 percent sometimes even exceeding 100 percentthat joh and enter G 1llItT10N NII ITS DISCNTNTS prisl lrllti1l wOllld hln been an impossibility even in a good eco Illllllil llIinlllmt1 SIKh JS the Unittd States The necessary capital Illr growth is simply too costly Tht II111St SIIlltsslill devdoping countries those in East Asia opelItd dlemsdws to the outside world but did so slowly and in a seljutlIced WJy These countries took advantage of globalization to txpllld their exports Jlld grew faster as a result But they dropped prottnie bJrriers cardillly and systematically phasing them out only when lie jobs were created They ensured that there was capital lnibble lor new job and enterprise creation and they even took an cmrepreneuriJI role in promoting new enterprises China is just dis mlllriing its trade barriers twenty years after its march to the market begJn J period in which it grew extremely rapidly Those in the Unired States and the advanced industrialized coun tries should have lound it easy to grasp these concerns In the last tWO us presidential campaigns the candidate Pat Buchanan has exploired American workers worries about job loss from trade Iiber 1Iizarion Buchanans themes resonated even in a country with close to full employment by 1999 the unemployment rate had fallen to under percent coupled with a good unemployment insurance sys tem Jnd a variety of assistance to help workers move from one job to Jnother The fact thar even during the booming 1990s American worker could be so worried about the threat of liberalized trade to thtir jobs hould have led to a greater understanding of the plight of worktr in poor devdoping countries where they live on the verge of ubsisrtnce often on S2 a day or less with no safety net in the lorm of savinbS much less unemployment insurance and in an econ omy wirh 20 ptrcenr or more unemployment The fan that rrade liberalization all too often fails to live up to its promisebur instead simply leads to more unemploymentis why it provokes strong opposition Bur the hypocrisy of those pushing for trade liberalizationand the way they have pushed ithas no doubt reinforced hostility to trade liberalization The Western countries pushed trade liberalizarion for the products that they exported but at the same time continued to protect those sectors in which com perition from developing countries might have threatened their economies This was one of the bases of the opposition to the new fREEDOM TO CHOOSE 6J round of trade negotiations that was suppostd to be launched in Seattle previous rounds of trade negotiations had protected the interests of the advanced industrial countriesor more accurately special interests within those countrieswithout concomiunt bene fits for the lesser developed countries Protestors pointed out quite rightly that the earlier rounds of trade negotiations had lowered trade barriers on industrial goods from automobiles to machinery exported by the advanced industrial countries At the same time negotiators for these countries maintained their nations subsidies on agricultural goods and kept closed the markets for these goods and for textiles where many developing countries have a comparative advantage In the most recent Uruguay Round of trade negotiations the sub ject of trade in services was introduced In the end however markets were opened mainly for the services exported by the advanced coun triesfinancial services and information technologybut not for maritime and construction services where the developing countries might have been able to gain a toehold The United States bragged about the benefits it received But the developing countries did not get a proportionate share of the gains One World Bank calculation showed that SubSaharan Africa the poorest region in the world saw its income decline by more than 2 percent as a result of the trade agreement There were other examples of inequities that increasingly became the subject of discourse in the developing world though the issues seldom made it into print in the more developed nations Bolivia not only brought down its trade barriers to the point that they were lower than those in the United StatLS but also cooperated with the United States in virtually eradicating the growth of coca the basis of cocaine even though this crop provided a higher income to its already poor farmers than any alternative The United States responded however by keeping its markets closed to the alternatiY agriculture products like sugar that Bolivias farmers might haY pro duced for exporthad Americas markets been open to them Developing countries get especially angry over this sort of double standard because of the long history of hypocrisy and inequities In the nineteenth century the Western powersmany of which had grown through using protectionist policieshad pushed unfair rrade C8II N NU ITS DISCONTENTS feHits Tht nllSt olltratOllS perhJPs ollowed the Opium Wars whtn tht Unittd KindoIII Jnd France ganged up against a weak Chinl Jnd toethr with Russia and the United States forced it in thtTreH otTiellsin in 1858 not just to make trade and territorial contssions lnsuring it would export the goods the West wanted at low prices but to open its markets to opium so that millions in China Ould becoIlle addicted One might call this an almost diabolical JPproJch to a balance of trade Today the emerging markets are not torced open under the threat of the use of military might but through economic power through the threat of sanctions or the withholding ot needed assistance in a time of crisis While the World Trade Organization was the forum within which international trade Jgreements were negotiated US trade negotiators and the IMF have otten insisted on going further accelerating the pace of trade liberal ization The IMF insists on this faster pace of liberalization as a con dition tor assistanceand countries facing a crisis feel they have no choice but to accede to the Funds demands Matters are perhaps worse still when the United States acts unilat rally rather than behind the cloak of the IME The US Trade Rep rsentative or the Department of Commerce often prodded by special interests within the United States brings an accusation against a foreign country there is then a review processinvolving only the US governmentwith a decision made by the United States after which anctions are brought against the offending country The United States sets itself up as prosecutor judge and jury There is a quasijudicial process but the cards are stacked both the rules and the judges favor a finding of guilty When this arsenal is brought against other industrial countries Europe and Japan they have the resources to defend themselves when it comes to the developing countries even large ones like India and China it is an unfair match The ill will that result is far out of proportion to any possible gain for the United States The process itself does little to reinforce confi dence in a just international trading system The rhetoric the United States uses to push its position adds to the image of a superpower willing to throw its weight around for it own special interests Mickey Kantor when he was the US Trade Repre sentative in the fIrSt Clinton administration wanted to push China to FllHOOM TO CHOOSE open its markets faster The 1994 Uruguay Round negotiations in which he himself had played a major role established the WTO and set ground rules for members The agreement had quite righdy pro vided a longer adjustment period for developing countries The World Bank and every economist treats Chinawith its per capita income ofS4Snot only as a developing country but also as a low income developing country But Kantor is a hard negotiator He insisted that it was a developed country and should therefore Iuve a quick transition Kantor had some leverage because China needed us approval in order to join the WTo The United StatesChina agreement tlut eventually led to Chinas being admitted to the WTO in November 2001 illustrates two aspects of the contradictions ofthe US position While the United States dragged out the bargaining with its unrea sonable insistence that China was really a developed country China began the adjustment process itself In effect unwittingly the United States gave China the extra time it had wanted But the agreement itself illustrates the double standards and inequity at play here Ironi cally while the United States insisted that China adjust quickly as if it were a developed countryand because China had used thl prolonged bargaining time well it was able to accede to those demandsthe United States also demanded in effect that America be treated as if it were a Ilss developed country that it be given not just the ten years of adjustment for lowering its barrier against textile imports that had been part of the 1994 negotiations but an addi tional four years What is particularly disturbing is how special interests can under mine both US credibility and broader national interests This wa seen Illost forcefully in April 1999 when Premier Zhu Rongji came to the United States partly to finish off negotiations for Chinas admission to the World Trade Organization a move that was essential for the world trading regimehow could one of the last trading countries be excludedbut alo for the market reforms in China itself Over the opposition of the US Trade Representative and the State Department the us Treasury insisted on a provision for faster liberalization of Chinas financial markets China was quire rightly worried it was precisely such liheralization that had led to the finan GUIIULT10N ioN ITS LISCONTNTS ialaists in ntihborin countris in East Asia at such costs China had betn splred bellIse 01 its wise policies This AlIlericl1I dellland tor liberliization of financial markets in Chin1 luld not hdp secur global economic stability It was made to strYe the narrow intrests of th financial community in the Unittd States which Treasury vigorously represents Wall Street rightly bdiewd that China represented a potential vast market for its tinlI1cial svices and it vas important that Wall Street get in estab lish I strong toehold betore others How shortsighted this was It was delr thlt ChinJ would eventually be opened up Hurrying the process up by a year or two can surely make litde difference except th1t Wlll Street worries that its competitive advantage may disappear oyer time JS tinancial institutions in Europe and elsewhere catch up 0 the shortterm advantages of their Wall Street competitors But the potential cost was enormous In the immediate aftermath of the Asian tinancial crisis it was impossible for China to accede to Trea sUs demands For China maintaining stability is essential it could not risk policies that had proved so destabilizing elsewhere Zhu Rongji was torced to return to China without a signed agreement There had long been a struggle inside China between those pushing tor Jnd against reform Those opposing reform argued that the West was seeking 0 weaken China and would never sign a fair agreement successful end to the negotiations would have helped to secure the pmitions of the reformers in the Chinese government and added menrth 0 the reform movement As it turned out Zhu Rongji and the reform movement for which he stood were discredited and the retormists power and influence were curtailed Fortunately the dam age was only temporary but still the US Treasury had shown how much it was willing to risk to pursue its special agenda EVE THO UGH A N unfair trade agenda was pushed at least there was a considerable body of theory and evidence that trade liberaliza tion would if implemented properly be a good thing The case for financial market liberalization was far more problematic Many coun trits do have financial regulations that serve little purpose other than to impede the flow of capital and these should be stripped away But all countries regulate their financial markers and excessive zeal in FIIEEDOM TO CHOOSE deregulation has brought on massive problems in capital markcu even in developed countries around the world To cite one example the infamous savingsandloan debacle in the United States while it was a key factor in precipitating the 1991 recession and cost Ameri can taxpayers upward of 200 billion was one of the least expensive as a percentage of GDP bailouts that deregulation has brought on just as the us recession was one of the mildest compared to ones in other economies that suffered similar crises While the more advanced industrialized countries with their sophisticated institutions were learning the hard lessons of financial deregulation the IMF was carrying this ReaganThatcher message to the developing countries countries which were particularly ill equipped to manage what has proven under the best of circum stances to be a difficult task fraught with risks Whereas the more advanced industrial countries did not attempt capital market liberal ization until late in their developmentEuropean nations waited until the 1970s to get rid of their capital market controlsthe devel oping nations have been encouraged to do so quickly The consequenceseconomic recessionof banking crises brought on by capital market deregulation while painful for devel oped countries were much more serious for developing countries The poor countries have no safety net to soften the impact of reces sion In addition the limited competition in financial markets meant that liberalization did not always bring the promised benefits of lower interest rates Instead farmers sometimes found that they had to pay higher interest rates making it more difficult for them to buy the seed and fertilizer necessary to eke out their bare subsistence living And as bad as premature and badly managed trade liberalization was for developing countries in many ways capital market liberaliza tion was even worse Capital market liberalization entails stripping away the regulations intended to control the Row of hot money in and out of the countryshortterm loans and contracts that are usu ally no more than bets on exchange rate movements This speculative money cannot be used to build factories or create jobscompanies dont make longterm invcstl11enl using money that can be pulled out on a moments noticlalld indeed the risk that such hot money 11 IlIIIIlHllIN Nl ITS lISCNTNTS brill illl it lIuks IOllgttr111 inlstmnts in a dvdoping country WII Its lttractin TIll Idnrs dltcts on growth ar vn grater To lIIlII gc th risks 1SlIilted with thtS volatil capital flows countries Irl fllutilld Ihisd III st sidl in thir rsrvs an amount equal to thir llllrttlnn tortigndnominatd loans To see what this implies lSSUIII thlt 1 tirm ill a small dvdoping country accepts a short tcrm 1 It I million loan trom an American bank paying 18 percent illtlrcsL Prudtmill policy on th part of the country would require dut it Ould add S 100 million to resrves Typically reserves are held ill US Trelsury bills which today pay around 4 percent In effect the oumr is simultanously borrowing from the United States at 18 pan1It and Inding to the United States at 4 percent The country as I hol has no more resources available for investing American bmks IIl1y nlJk a tidy protit and the United States as a whole gains S I million a year in interest But it is hard to see how this allows the dedoping country to grow faster Put this way it clearly makes no ens There is a turther problem a mismatch of incentives With cap itll marklt liberalization it is firms in a countrys private sector that t to dcid whether to borrow shortterm funds from the Ameri CJn banks but it is the government that must accommodate itself ldding to its reserves if it wishes to maintain its prudential standing The IME in arguing for capital market liberalization relied on Simplistic rasoning Free markets are more efficient greater effi cienc Illowed tor faster growth It ignored arguments such as the one just given and put forward some further specious contentions for instanc that without liberalization countries would not be able to mract toreign capital and especially direct investment The Funds economists have nver laid claim to being great theorists its claim to expertise lay in its global experience and it mastery of the data Yet strikingly not even th data supported the Funds conclusions China whic h recived the largest amount of foreign investment did not fol low any of the Western prescriptions other than macrostability prudently forestalling full capital market liberalization Broader statistical studies confirmed the finding that using the IMFs own definitions of liberalization it did not entail faster growth or higher investment While China demonstrated that capital market liberalization was FUECIJM TO CIHjUSE not needed to attract funds the fact of the matter wa that given the high savings rates in East Asia 3040Yu of GJI in contrast to 1 B in the United States and 1730Yu in Europe the region hardly needed additional funds it already faced a daunting challenge in investing the flow of savings well The advocates of liberalization put forth another argument one that looks particularly laughable in light of the global financial crisi that began in 1997 that liberalization would enhance stability by diversifying the sources of funding The notion was that in times of downturn countries could call upon foreigners to make up for a shortfall in domestic funds The IMF economists were supposed to be practical people well versed in the ways of the world Surely they must have known that bankers prefer to lend to those who do not need their funds surely they must have seen how it is when countries face difficulties that foreign lenders pull their money outexacer bating the economic downturn While we shall take a closer look at why liberalizatione5pecially when undertaken prematurely before strong financial institutions are in placeincreased instability one fact remains clear instability is not only bad for economic growth but the costs of the instability are dis proportionately borne by the poor The Role of Foreign Investment Foreign investment is not one of the three main pillars of the Wash ington Consensus but it is a key part of the new globalization According to the Washington Consensus growth occurs through lih eralization freeing up markets Privatization liberalization and macrostability are supposcd to create a climate to attract investment including from abroad This investment creatcs growth Fonign busi ness brings with it technical expertise and access to foreign markets creating new employment possibilities Foreign companies also hav access to sources of finance especially important in thosc kCloping countries where local financial institutions are weak Foreign direct investment has played an important rolt in manybut lint allof the most successful developmcnt stories in countries such as Singa pore and Malaysia and even China lUIIIlIL ON AND ITS DISCONTENTS HJving SJid this thert are sOllie real downsides When foreign busilltsses Hlle in thty otten destroy local competitors quashing the Jlllbitions f the SIllJIl businesslllen who had hoped to develop hOlllegrown industry There Jre many examples of this Soft drinks I1lJnutJccurers Jround the world have been overwhelmed by the entfJlCe of COCJCola and Pepsi into their home markets Local ice creJI1l I1lJIlutJcturers find they are unable to compete with Unilevers ice crtJm products One way to think about it is to recall the controversy in the United States over the large chains of drugstores and convenience stores When WaIMart comes into a community there are often srrong protests from local firms who fear rightly that they will be displaced local shopkeepers worry they wont be able to compete ith WalMart with its enormous buying power People living in small towns worry about what will happen to the character of the community if all local stores are desrroyed These same concerns are a thousand times srronger in developing countries Although such con cerns are legitimate one has to maintain a perspective the reason that WalMart is successful is that it provides goods to consumers at lower prices The more efficient delivery of goods and services to poor mdividuals within developing counrries is all the more important given hOv close to subsistence so many live But critics raise several points In the absence of strong or effec tively enforced competition laws after the international firm drives out the local competition it uses its monopoly power to raise prices The benefits of lowprices were shortlived Part of what is at stake is a matter of pacing local businesses claim that if they are given time they can adapt and respond to the compe tition that they can produce goods efficiently that preserving local businesses is important for the strengthening of the local community both economically and socially The problem of course is that all too often policies first described as a temporary protection from foreign competition become permanent Many of the multinationals have done less than they might to improve the working conditions in the developing countries Only gradually have they come to recognize the lessons that they learned all too slowly at home Providing better working conditions may FREEUOM TO CHOOSE actually enhance worker productivity and lower overall costsr at least not raise costs very much Banking is another area where foreign companies often overrun local ones The large American banks can provide greater security for depositors than do small local banks unless tht local government provides deposit insurance The US government has been pushing for opening up of financial markets in developing nations The advantagts are clear the incrtastd competition can lead to improved services The greater financial strength of the foreign banks can enhance financial stability Still the threat foreign banks pose to the local banking sector is very real Indeed there was an extended debate in the United States on the same issue National banking was resisted until the Clinton administration under Wall Street influ ence reversed the traditional position of the Democratic Pany for fear that funds would flow to the major money centers like New York starving the outlying areas of nteded funds Argentina shows the dangers There before the collapse in 2001 the domestic banking industry had become dominated by foreignowned banks and while the banks easily provide funds to multinationals and tven large domestic firms small and mediumsize firms complaintd of a lack of access to capital International banks expertiseand information baseIies in lending to their traditional client EvenTUally they rnay expand into these other niches or new financial instiTUtions may arise to address these gaps And the lack of growthto which the lack of finance contributedwas pivotal in that countrys collapse Within Argentina the problem was widely rtcognizcd the govern ment took some limited steps to fill the credit gap But government lending could not make up for the markets failure Argentinas experience illustrates some basic lessons The IMF and the World Dank have been stressing the importance of bank st1bility It is tasy to creatt sound banks banks that do not lose money because of bad loanssimply require them to invest in US Treasury bills The challenge is not just to create sound banks but also to create sound banks that provide credit for growth Argentina has shown how the failure to do tim may itelflead to macroinstability Because of a lack of growth it has had mounting fiscal deticits and as the IMF forced cutbacks in expenditures and increases in taxes a icious 0 l I l1IIILHllIN NIl ITS ISCNTNTS dlllwan1 spir1 of tlOIlOlllil dtdillt and social unrest was set in Illltioll Ulllivi1 pnlvidts ytt allothtr Ixalllpll whlre foreign banks have lomribmtd to IUlrollonomic instability In 2001 a foreign bank that loollltd argt ill thl Bolivian Iconomy suddenly decided given tht inlrtIstd global risks to pull back on lending The sudden chll1gt ill thl crldit supply hdped plunge the economy into an even dttptr tconolllic downturn than falling commodity prices and the glob11 tcollomic slowdown were already bringing about Thtrt art additional concerns with respect to the intrusion of for tign bmks Domtstic banks art more sensitive to what used to be cllltd window guidanctsubtlt forms of influence by the central blnk tor txampit to expand credit when the economy needs stimu lus Illd contract it when there are signs of overheating Foreign banks 3rt tlr Itss Iikdy to be responsive to such signals Similarly domestic banks art tlr mort Iikdy to be responsive to pressure to address basic holts in tht crtdit systemunserved and underserved groups such IS minoritits and disadvantaged regions In the United States with ant of the most devdoped credit markets these gaps were felt to be 0 important that the Community Reinvestment Act CRA was passtd in 1977 which imposed requirements on banks to lend to rhest undtrserved groups and areas The CRA has been an impor tant if controversial way of achieving critical social goals Finance however is not the only area in which foreign direct invlstment has been a mixed blessing In some cases new investors ptrsuJdtd often with bribes governments to grant them special privileges such as tariff protection In many cases the US French or governments of other advanced industrial countries weighed in rtintorcing the view within developing countries that it was per ftctly appropriate for government to meddle in and presumably rtceive payments from the private sector In some cases the role of governmlnt seemed relatively innocuous although not necessarily uncorruptWhln US Secretary of Commerce Ron Brown traveled abroad he was accompanied by US business people trying to make contacts with and gain entry into these emerging markets Presum ably the chances of getting a seat on the plane were enhanced if one made significant campaign contributions hlEOM TO CHOOSE 71 In other cases one government was called in to countervail dle weight of another In Cote dIvoire while the French government supported the French Telecoms attempt to exclude competition from an independent American cell phone company the US gov ernment pushed the claims of the American firm But in many Clies governments went well beyond the realm of what Wli relionable In Argentina the French government reportedly weighed in pushing for a rewriting of the terms of concessions for a water utility Aguli Argentinas after the French parent company Suez Lyonnaise that had signed the agreements found them less profitable than it had thought Perhaps of greatest concern has been the role of governments including the American government in pushing nations to live up to agreements that were vastly unfair to the developing countries and often signed by corrupt governments in those countries In Indone sia at the 1994 meeting of leaders of APEC AsiaPacific Economic Cooperation held at Jakarta President Clinton encouraged Ameri can firms to come into Indonesia Many did so and often at highly favorable terms with suggestions of corruption greasing the wheelsto the disadvantage of the people of Indonesia The World Bank similarly encouraged private power deals there and in other countries such as Pakistan These contracts entailed provisions where the government was committed to purchasing large quantities of electricity at very high prices the socalled take or pay clauses The private sector got the profits the government bore the risk That was bad enough But when the corrupt government were overthrovol1 Mohammed Suharto in Indonesia in 1998 Nawaz Sharif in Pakistan in 1999 the US government put pressure on the government to fulfill the contract rather than default or at least renegotiate the terms of the contract There is in fact a long history of unfair con tracts which Western governments have used their muscle to enforce l There is more to the list of legitimate complaints against fortign direct investment Such investment often flourishes only because of special privileges extracted from the government While standard economics focuses on the disoriolls of incentives that rtsult from such privileges there is a far more illSidious aspect otten those privi l LllaU ItUllIN ANI ITS DISCONTENTS Igls ar th rslIlt llf corruption the bribery of government officials Thl toreign dirct inVtstmenc comes only at the price of undermin ing democratic pnlCtSSes This is particularly true for investments in mining oil 1111 other naturJ rsources where foreigners have a real inctmiVt co obtain the concessions at low prices MoroVtr SlKh inVtstmnts haY other adverse effectsand often do not prol1lo growth The income that mining concessions brings can be illaluJbl but devdopment is a transformation of society An invstl1lm in a l1Iinsay in a remote region of a countrydoes lit d 0 Issist th dvdopmnt transformation beyond the resources that it genrJts t can hdp create a dual economy an economy in which thr ar pockets of wealth But a dual economy is not a ddopd conomy Indeed the inflow of resources can sometimes JCtually il1lpde devdopment through a mechanism that is called the Dutch DislseThe inflow of clpitalleads to an appreciation of the currncy making imports cheap and exports expensive The name COI1lS from th Netherlands experience following the discovery of gas in th North Sea Natural gas sales drove the Dutch currency up riously hurting the countrys other export industries t presented a challnging but solvable problem for that country but for developing councris th problem may be especially difficult Wors still th availability of resources can alter incentives as we aw in chaptr 2 rather than devoting energy to creating wealth in many countris that are wellendowed with resources efforts are directd at appropriating the income which economists refer to as rnts 00 associated with the natural resources The international financial institutions tended to ignore the prob lems havt outlined Instead the MFs prescription for job creation whtn it toe used on that issuewas simple Eliminate government inttrvention in the form of oppressive regulation reduce taxes get inflation as low as possible and invite foreign entrepreneurs in In a sense even hert policy reflected the colonial mentality described in the previous chapter of course the developing countries would have to rely on foreigners for entrepreneurship Never mind the remark able successes of Korea and Japan in which foreign investment played no role n many cases as in Singapore China and Malaysia which kept the abuses of foreign investment in check foreign direct invest rREEDOM TO CHOOSE 73 mtnt played a critical role not so much for tht capital which given tht high savings rate was not really needed or even for the entrepre neurship but for tht acctss to markets and new technology that it brought along Sequencing and Pacing Perhaps of all the IMFs blunders it is tht mistakes in sequtncing and pacing and tht failure to be sensitive to the broader social context that have received the most atttntionforcing libtralization before safety nets were put in place before there was an adequate rtgulatory framework before the countries could withstand the adverse conse quences of the sudden changes in market sentiment that are part and parcel of modern capitalism forcing policies that led to job destruc tion before the essentials for job creation were in place forcing priva tization before there were adequate competition and regulatory frameworks Many of the sequencing mistakes reflected fundamental misunderstandings of both economic and political processes misun derstandings that were particularly associated with those who believed in market fundamentalism They argued for instance that once private property rights were established all else would follow naturallyincluding the institutions and the kinds of legal SITUctultS that make market economies work Behind the free market ideology there is a model often amibuted to Adam Smith which argues that market forcesthe profit motive drive the economy to efficient outcomes as f b all illlisiMe rand One of the great achievements of modern economics is to show the sense in which and the conditions under which Smiths conclusion is correct It turns out that these conditions are highly rcstrictive2 Indeed more recent advances in economic theoryironically occur ring precisely during the period of the most relentless pursuit of the Washington Consensus policieshave shown that whenever intor mation is imperfect and markets incomplete which is to say always mid especially ill dee1opill 1ll11lric then the invisible hand works most imperfectly Significantly there arc desirable government interven tions which in principle can improve upon the efficiency of the lIUHIII O ANt ITS ISCONTENTS llurktL rhest restritllnS 1I1 tht conditions under which markets rlsult III driIellcV Ire importlIltmany of tht key activities of gov lnllllel llIl be understood as responses to the resulting market fail lireS It inllInHiln Wlre ptrlct we now know there would be little mk Ir linlIlitl marketsll1d little role for financial market regula tim If lmpetitilln wtrt automatically perfect there would be no wk lr 1IHHrust authorities The Ishington Conscnsus policies however were based on a ullplistic model cf the market economy the competitive equilib rium model ill which Adam Smiths invisible hand works and works PlrIltiY 13ecause in this model there is no need for government thH is Iree unlettered liberal markets work perfectlythe Wash ington Consensus policies are sometimes referred to as neoliberal based llil market fundamentalism a resuscitation of the laissezfaire poliLies that were popular in some circles in the nineteenth century In the atternuth of the Great Depression and the recognition of other failings of the market system from massive inequality to unliv able cities marred by pollution and decay these free market policies hac been videly rejected in the more advanced industrial countries though within these countries there remains an active debate about the appropriate balance between government and markets E E IF Sl1 IT H s invisible hand theory were relevant for advanced II1dustrlalized countries the required conditions are not satisfied in developing countries The market system requires clearly established propert rights and the courts to enforce them but often these are abscnt in developing countries The market system requires competi tion and pertect information But competition is limited and infor mation is far from perfectand wellfunctioning competitive markets cant be established overnight The theory says that an efficient mar ket economy requires that all of the assumptions be satisfied In some cases reforms in one area without accompanying reforms in others may actually make matters worse This is the issue of sequencing Ide ology ignores these matters it says simply move as quickly to a mar ket economy as you can But economic theory and history show how disastrous it can be to ignore sequencing The mistakes in trade capital market liberalization and privatiza fllEDM TO CHOOSE 75 tion described earlier represent sequencing errors on a grand scale The smallerscale sequencing mistakes are even less noticed in the Western press They constitute the daytoday tragedies of IMF poli cies that affect the already desperately poor in the developing world For example many countries have marketing boards that purchase agricultural produce from the farmers and market it domestically and internationally They often are a source of inefficiency and corrup tion with farmers getting only a fraction of the ultimate price Even though it makes little sense for the government to be engaged in this business if the government suddenly gets out of it it does not mean a vibrant competitive private sector will emerge automatically Several West African countries got out of the marketing board business under pressure from the IMF and World Bank In some cases it seemed to work but in others when the marketing board disappeared a system of local monopolies developed Limited capital restricted entry into this market Few peasants could afford to buy a truck to carry their produce to market They couldnt borrow the requisite funds either given the lack of wellfunctioning banks In some cases people were able to get trucks to transport their goods and the market did function initially but then this lucrative business became the provenance of the local mafia In either situation the net benefits that the IMF and the World Bank promised did not materi alize Government revenue was lowered the peasants were little if any better off than before and a few local businessmen mafiosi and politicians were much better off Many marketing boards also engage in a policy of uniform pric ingpaying farmers the same price no matter where they are located While seemingly fair economists object to this policy because it effectively requires those farmers near markets to subsidize those far away With market competition farmers farther away from the place where the goods are actually sold receive lower prices in effect they bear the costs of transporting their goods to the market The IMF forced one African country to abandon its uniform pricing before an adequate road system was in place The price received by those in more isolated places was suddenly lowered markedly as they had to bear the costs of transportation As a result incomes in some of the poorest rural regions in the country plummeted and wide CUlliALllATIlIN ANll ITS DISCONTENTS spreJd hardship ellsLltd Tht IMF pricillg scheme may have had some slight belldits ill ternts llf increased dliciency but we have to weigh these bendits JgJinst tht sodal costs Proper sequencing and pacing might IlJe enJbbl olle 0 grJdually achieve the efficiency gains without thest costs Thtre is J l1Iort timdamental criticism of the IMFWashington COIlStIlSUS approach It does not acknowledge that development requires a transtormation of society Uganda grasped this in its radical diminJtioll of all school fees something that budget accountants tocusillg soldy on rtvenues and costs simply could not understand Pan of the mantra of development economics today is a stress on universal primary education including educating girls Countless studies hJve shown that countries like those in East Asia which have inVtsted in primary education including education of girls have done better But in some very poor countries such as those in Africa it has been very difficult to achieve high enrollment rates especially tor girls The reason is simple poor families have barely enough to survive they see little direct benefit from educating their daughters Jnd the education systems have been oriented to enhancing oppor tunities mainly through jobs in the urban sector considered more suitable tor boys Most countries facing severe budgetary constraints have tollowed the Washington Consensus advice that fees should be charged Their reasoning statistical studies showed that small fees had little impact on school enrollment But Ugandas President Museveni thought otherwise He knew that he had to create a culture in which the expectation was that everyone went to school And he knew he couldnt do that so long as there were any fees charged So he ignored the advice of the outside experts and simply abolished all school fees Enrollments soared As each family saw others sending all of their children to school it too decided to send its girls to school What the simplistic statistical studies ignored is the power of systemic change If IMF strategies had simply failed to accomplish the full potential of development that would have been bad enough But the failures in many places have set back the development agenda by unnecessar ily corroding the very fabric of society It is inevitable that the FREEUOM TO CHOOSE 77 process of development and rapid change puts enormous SUCS5eS on society Traditional authorities are challenged traditional relationships are reassessed That is why successful development pays careful atten tion to social stabilitya major lesson not only of the story of Botswana in the previous chapter but also of Indonesia in the next where the IMP insisted on abolishing subsidies for food and kerosene the fuel used for cooking by the poor just as IMf policies had exac erbated the countrys recession with incomes and wages falling and unemployment soaring The riots that ensued tore the countrys social fabric exacerbating the ongoing depression Abolishing the subsidies was not only bad social policy it was bad economic policy These were not the first IMfinspired riots and had the IMf advice been followed more broadly there surely would have been more In 1995 I was in Jordan for a meeting with the crown prince and other senior government officials when the IMf aq1Ied for cut ting food subsidies to improve the governments budget They had almost succeeded in getting abTeement when King Hussein inter vened and put a stop to it He enjoyed his PO was doing a velous job and wanted to keep it In the highly volatile Middle East foodinspired riots could well have overturned the government and with that the fragile peace in the region Weighed against the meager possible improvement in the budget situation these events would have been far more harmful to the goal of prosperity The 1M fs nar row economic view made it impossible for it to consider these issues in their broader context Such riots are however like the tip of an iceberg they bring to everyones attention the simple fact that the social and political con text cannot be ignored But there were other problems While in the 1980s Latin America needed to have its budgets brought into better balance and inflation brought under control excessive austerity led to high unemployment without an adequate safety net which in turn contributed to high levels of urban violence an environment hardly conducive to investment Civil strife in Africa has been a major factor setting back its development agenda Studies at the World Bank show that such strife is systematically related to adverse economic factors including unemployment that can be produced lllIHIILHION NIl ITS DISCONTENTS I lxllssiw Iusttrity Mlldtrltl inflation may not be ideal for creat ing Ill tlliwnllllnt rllr investment but violence and civil strife are lt11 llrSt Wt relllgnizt wdlY thlt there is a social contract that binds citi ItnS tl1gethtr lIld with their government When government policies JbnlgJtt th1t social contract citizens may not honor their contracts with tJch other or with the government Maintaining that social comrJlt is particularly important and difficult in the midst of the sociJI upheavals that so trequencly accompany the development trJllstorIllltion In the green eyeshaded calculations of the IMF macroeconomics there is too often no room for these concerns TrickleDown Economics Part of the social contract entails fairness that the poor share in the gains of society as it grows and that the rich share in the pains of society in times of crisis The Washington Consensus policies paid lit tle attention to issues of distribution or fairness If pressed many of its proponents would argue that the best way to help the poor is to make the economy grow They believe in trickledown economics EIellCIIlllly it is asserted the benefits of that growth trickle down even to the poor Trickledown economics was never much more thanjust a belief an article of faith Pauperism seemed to grow in nineteenth ccmury England even though the country as a whole prospered Growth in America in the 1980s provided the most recent dramatic example while the economy grew those at the bottom saw their real incomes decline The Clinton administration had argued strongly against trickledown economics it believed that there had to be active programs to help the poor And when I left the White House to go to the World Bank I brought with me the same skepticism of trickledown economics if this had not worked in the United States why would it work in developing countries While it is true that sus tained reductions in poverty cannot be attained without robust eco nomic growth the converse is not true growth need not benefit all It is not true that a rising tide lifts all boats Sometimes a quickly rising tide especially when accompanied by a storm dashes weaker boats against the shore smashing them to smithereens FMEFOM TO CHOOS 70J In spitl of the obvious problems confronting trickledown eco nomics it has a good intellectual pedigree One Nobel Prize winner Arthur Lewis argued that inequality was good for development and economic growth since the rich save more than the poor and the key to growth was capital accumulation Another Nobel Prize win ner Simon Kuznets argued that while in the initial stages of develop ment inequality increased later on the trend was reversed3 THE HISTORY Of the past fifty years has however not supported these theories and hypotheses As we will see in the next chapter East Asian countriesSouth Korea China Taiwan Japanshowed that high savings did not require high inequality that one could achieve rapid growth without a substantial increase in inequality Because the governments did not believe that growth would automatically bene fit the poor and because they believed that greater equality would actually enhance growth governments in the region took active steps to ensure that the rising tide of growth did lift most boats that wage inequalities were kept in bounds that some educational opportunity was extended to all Their policies led to social and political stability which in turn contributed to an economic environment in which businesses flourished Tapping new reservoirs of talent provided the energy and human skills that contributed to the dynamism of the region Elsewhere where governments adopted the Washington Consen sus policies the poor have benefited less from growth In Latin America growth has not been accompanied by a reduction in inequality or even a reduction in poverty In some cases poverty has actually increased as evidenced by the urban slums that dot the land scape The IMF talks with pride about the progress Latin America ha made in market reforms over the past decade though somewhat more quietly after the collapse of the star student Argentina in 2001 and the recession and stagnation that have afflicted many of the reform countries during the past five years but has said less about the numbers in poverty Clearly growth alone does not always improve the lives of all a countrys people Not surprisingly the phrase trickledown has dis appeared from the policy debatt But in a slightly mutated torm the IUIIlILHION Nll ITS ISCONTNTS iitl is scill JIiVt I 111 cht ntW variJIH IrikltdolltIplus It hold that mwch is ntnSSln 1nd Iitllsl sutlicient for reducing poverty implvlll clut tht best strJtq is simply to focus on growth while mtllCilllin issuts likt telllJlt tducJtion and health But proponents llf trickledcmnplus tliled to implement policies that would effec tinl lddrlss either broader concerns of poverty or even specific Issues such JS the education of women In practice the advocates of trickledownplus continued with much the same policies as before with much the same adwrse effects The overly stringent adjustment policies in country atter country forced cutbacks in education and hellth in Thailand as a result not only did female prostitution inaese but expenditures on AIDS were cut way back and what had been one of the worlds most successful programs in fighting aids had 1 major setback The irony was that one of the major proponents of trickledowIl plus was the US Treasury under the Clinton administration Within the administration in domestic politics there was a wide spectrum of iews from New Democrats who wanted to see a more limited role for government to Old Democrats who looked for more govern ment intervention BU the central view reflected in the annual Eco nomic Report of the President prepared by the Council of Economic Advisers argued strongly against trickledown econom icsor even trickledownplus Here was the US Treasury pushing policies on other countries that had they been advocated for the United States would have been strongly contested within the adminis CTHOIl and almost surely defeated The reason for this seeming incon sistency was simple The IMF and the World Bank were part of Treasurys rurt an arena in which with few exceptions they were allowed to push their perspectives just as other departments within their domains could push theirs PRIORITIES AND STRATEGIES It is important not only to look at what the IMF puts on its agenda bU what it leaves off Stabilization is on the agenda job creation is off Taxation and its adverse effects are on the agenda land reform is fHEEOM TO CHJOSl 81 off There is money to bail out banks but nOl to pay for improved education and health services let alone to bailout worken who are thrown out oftheir jobs as a result of the IMFs macroeconomic mis management Many of the items that were not on the Washington Consensus might bring both higher growth and greater equality Land reform itself illustrates the choices at stake in many countries In many devel oping countries a few rich people own most of the land The vast majority of the people work as tenant farmen keeping only half or less of what they produce This is termed sharecropping The share cropping system weakens incentiveswhere they share equally with the landowners the effects are the same as a 50 percent tax on poor farmers The IMF rails against high tax rates that are imposed against the rich pointing out how they destroy incentives but nary a word is spoken about these hidden taxes Land reform done properly peace fully and legally ensuring that workers get not only land but access to credit and the extension services that teach them about new seeds and planting techniques could provide an enormous boost to out put But land reform represents a fundamental change in the struc ture of society one that those in the elite that populates the finance ministries those with whom the international financial institutions interact do not necessarily like If these institutions were really con cerned about growth and poverty alleviation they would have paid considerable attention to the issue land reform preceded several of the most successful instances of development such as those in Korea and Taiwan Another neglected item was financial sector regulation Focusing on the Latin American crisis of the early 19805 the IMF maintained that crises were caused by imprudent fiscal policies and loose mone tary policies But crises around the world had revealed a third source of instability inadequate financial sector regulation Yet the IMF pushed for reducing regulationsuntil the East Asia crisis forced it 0 change course If land reform and financial sector regulation were underemphasized by the IMF and the Washington Consensus in many places inflation was overemphasized Of course in regions like Latin America where in Ration had been rampant it deserved attention But an excessir foclis on inRation by the IMF led to high GLOIlAlIZATIllN AND ITS OISCONTENTS illtrtst rlts Jnd high xchang rates creating unemployment but not growth Financial markets may have been pleased with the low inbtion numbers but workersand those concerned with povrtywrt not happy with the low growth and the high unem ploYIII1It numbers Fortunatdy poverty reduction has become an increasingly impor tJIIt dvdopment priority We saw earlier that the trickledownplus strJtgies have not worked Still it is true that on average countries thJt have grown faster have done a better job of reducing poverty as China and East Asia amply demonstrate It is also true that poverty eradication requires resources resources that can only be obtained with growth Thus the existence of a correlation between growth and poverty reduction should come as no surprise But this correlation does not prove that trickledown srrategies or trickledownplus constitute the best way to attack poverty On the conrrary the statis tics show that some countries have grown without reducing poverty and some countries have been much more successful in reducing poverty at any given growth rate than others The issue is not whether one is in favor of or against growth In some ways the growthpoverty debate seemed pointless After all almost everyone believes in growth The question has to do with the impact of particular policies Some policies promote growth but have little effect on poverty some pro mote growth but actually increase poverty and some promote growth and reduce poverty at the same time The last are called pro poor growth strategies Sometimes there are policies which are win win policies like land reform or better access to education for the poor which hold out the promise of enhanced growth and greater equality But many times there are tradeoffs Sometimes trade liber alization might enhance growth but at the same time at least in the short run there will be increased povertyespecially if it is done rapidlyas some workers are thrown out of a job And sometimes there are loselose policies policies for which there is little if any gain in growth but a significant increae in inequality For many countries capital market liberalization represents an example The growth poverty debate is about development strategierrategies that look FREEDOM TO CHOOSE for policies that reduce poverty as they promote growth that dum policies that increase poverty with little if any gain in growth and that in assessing situations where there are tradeoflS put a heavy weight on the impact on the poor Understanding the choices requires understanding the causes and nature of poverty It is not that the poor are lazy they often work harder with longer hours than those who are far better off Many are caught in a series of vicious spirals lack of food leads to ill health which limits their earning ability leading to still poorer health Barely surviving they cannot send their children to school and without an education their children are condemned to a life of povertyEoveay is p3sed along from one generation to another Poor farmers cannot afford to pay the money for the fertilizers and highyielding seeds that would increase their productivity This is but one of many vicious cycles facing the poor Partha Das gupta of Cambridge University has emphasized another In poor countries like Nepal the impoverished have no source of energy other than the neighboring forests but as they strip the foresa for the bare necessities of heating and cooking the soil erodes and as the environment degrades they are condemned to a life of everincreas ing poverty Along with poverty come feelings of powerlessness For its 2000 World DevelopmllIt Report the World Bank interviewed thousands of poor in an exercise that was called 7711 lIOicls of thl PClor Several themeshardly unexpectedemerge The poor feel that they are voiceless and that they do not have control over their own destiny They are buffeted by forces beyond their control And the poor feel insecure Not only is their income uncertain changes in economic circumstances beyond their control can lead to lower real wages and a loss of jobs dramatically illustrated by the East Asia crisisbut they face health risks and continual threats of vio lence sometimes from other poor people trying against all odds to meet the needs of their family sometimes from police and others in positions of authority While those in developed countries fret about the inadequacies of health insurance those in developing counaies must get by without any firm of insuranceno unemployment C 1lU IZT10N ANI ITs DISCONTENTS IIlSlIralK IIll hellth illsurallce no retirelllem insurance The only sattty lIet is pnwided by tamily and cOllllllunity which is why it is so impl1rtlIlt ill th process of devdopmem to do what one can to pre serve these bllnds To JmdiorJte the insecuritywhether the capriciousness of an exploitative boss or the capriciousness of a market increasingly buf ttted by imernJrional stormsworkers have fought for greater job security But as hard as workers have fought for decent jobs the IMF has tought tor what it euphemistically called labor market flex ibility which sounds like little more than making the labor market work better but as applied has been simply a code name for lower uges and less job protection Not all the downsides of the Washington Consensus policies for the poor could have been foreseen but by now they are clear We have seen how trade liberalization accompanied by high interest rates is an almost certain recipe for job destruction and unemployment cre ationat the expense of the poor Financial market liberalization IIl1accompanied by atl appropriate regulatory strllcture is an almost certain recipe for economic instabilityand may well lead to higher not lower interest rates making it harder for poor farmers to buy the seeds and fertilizer that can raise them above subsistence Privatiza tion IlIIaccompallied by competitioll policies and oversight to ensure that monopoly powers are not abused can lead to higher not lower prices for consumers Fiscal austerity pursued blindly in the wrong circum stances can lead to high unemployment and a shredding of the social contract If the IMF underestimated the risks to the poor of its development strategies it also underestimated the longterm social and political costs of policies that devastated the middle class enriching a few at the top and overestimated the benefits of its market fundamentalist policies The middle classes have traditionally been the group that has pushed for the rule of law that has pushed for universal public educa tion that has pushed for the creation of a social safety net These are essential elements of a healthy economy and the erosion of the mid dle class has led to a concomitant erosion of support for these impor tant reforms FREDOM TO CHOOSE 8S At the same timc that it underestimated thl costs of its programs the 1M F overestimatld the benefits Take the problem of unlmploy ment To the IMF and others who believe that when markets func tion normally demand must equal supply unlmployment iii a symptom of an interference in the free workings of the market Wages are too high for instance because of union power The obvi ous remedy to unemployment was to lower wages lower wages will increase the demand for labor bringing more people onto employ ment roUs While modern economic theory in particular theories based on asymmetric information and incomplete contracts has explained why even with highly competitive markets including labor markets unemployment can persistso the argument that says that unemployment must be due to unions or government minimum wages is simply wrongthere is another criticism of the strategy of lowering wages Lower wages might lead some firms to hire a few more workers but the number of newly hired workers may be rela tively few and the misery caused by the lower wages on all the other workers might be very grave Employers and owners of capital might be quite happy as they see their profits soar These will endorse the IMFmarket fundamentalist model with its policy prescriptions with enthusiasm Asking people in developing countries to pay for school is another example of this narrow worldview Those who said charges should be imposed argued that there would be little effect on enroUment and that the government needed the revenue badly The irony here was that the simplistic models miscalculated the impact on enrollment of eliminating school fees by failing to take into account the systemic effects of policy not only did they fail to take into account the broader impacts on society they even failed in the mo narrow attempts to estimate accurately the consequences for school enrollment If the IMF had an overly optimistic view of the market it had an overly pessimistic view of government if government wa not the root of all evil it certainly was more part of the problem than the solution But the lack of concern about the poor was not just a mat ter of views of market and government views that said that markets would take care of everything and government would only make 1lILHIN NU ITS DISCONTENTS IIImas wnrse i WIS tlsn t nttUtr of valueshow concerned we should be Ibllu ht poor alld who should bear what risks Til E II E SL 1 r S 0 f the policies elliorced by Washington Consensus Illt Illlt betll tncouraging lor most countries embracing its tenets ktknttnt Ius beell slow and where growth has occurred the belldits IlJ not been shared equally crises have been mismanaged ht trlI1sition tiom communism to a market economy as we shall set hts bten l disappointment Inside the developing world the questions run deep Those who lollowed the prescriptions endured the lusterity are asking When do we see the fruits In much of Latin America ltter a short burst of growth in the early 1990s stagnation mel recession have set in The growth was not sustainedsome might say not sustainable Indeed at this juncture the growth record of the socalled postreform era looks no better and in some coun tries much worse than in the prereform import substitution period when counrries used protectionist policies to help domestic indus tries compete against imports of the 1950s and 1960s The average annual growth rate in the region in the 1990s at 29 percent on annual average after the reforms was just more than half that in the 1960s at 54 percent In retrospect the growth strategies of the 1950s and 1960s were not sustained critics would say they were unsustain able but the slight upsurge in growth in the early 1990s also did not last these also critics would say were unsustainable Indeed critics of the Washington Consensus point out that the burst of growth in the early nineties was little more than a catchup not even making up for the lost decade of the eighties the decade after the last major crisis during which growth stagnated Throughout the region people are asking has reform failed or has globalization failed The distinc tion is perhaps artificialglobalization was at the center of the reforms Even in the countries that have managed some growth such as Mexico the benefits have accrued largely to the upper 30 percent and have been even more concentrated in the top 10 percent Those at the bottom have gained little many are even worse off The Washington consensus reforms have exposed countries to greater risk and the risks have been borne disproportionately by fREEVOM TO CHOOSE 7 those least able to cope with them Just as ill many countries the pac ing and sequencing of reforms has resulted in job destruction out matching job creation so too has the exposure to risk outmatched the ability to create institutions for coping with risk including effec tive safety nets There were of course important messages in the Washington Consensus including lessons about fiscal and monetary prudence lessons which were well understood by the countries that succeeded but most did not have to learn them from the IMF Sometimes the IMF and the World Bank have unfairly taken the blame for the messages they deliverno one likes to be told that they have to live within their means But the criticism of the interna tional economic institutions goes deeper while there was much that was good on their development agenda even reforms that are desir able in the long run have to be implemented carefully Its now widely accepted that pacing and sequencing cannot be ignored But even more important there is more to development than these lessons suggest There are alternative strategiestrategies that differ not only in emphases but even in policies strategies fOT instance which include land reform but do not include capital market liberal ization which provide for competition policies before privatization which ensure that job creation accompanies trade liberalization These alternatives made use of markets but recognized that there was an important role for government as well They recognized the importance of reform but that reforms needed to be paced and sequenced They saw change not just as a matter of economics but as part of a broader evolution of society They recognized that for longterm success there had to be broad support of the reform and if there was to be broad support the benefits had to be broadly distributed We have already called attention to some of these successes the limited successes in Africa for instance in Uganda Ethiopia and 13otswana and the broader successes in East Asia including China In chapter 5 we shall take a closer look at some of the successes in tran sition such as Poland The successes show that development and tran sition are possible the successes in development are well bljOnd that ss LlllIlllATltlN ANI I TS DISCONTENTS which Illlillst lIlyonl illlagind a half cntury ago The fact that so lllJn If Ihe SlICSS CJSS tollowd strategies that were markedly dif fntllI ILllll thos of th Washington Consensus is telling Elch tillll lIld ach country is different Would other countries hIt 1lll1 the sallle SUCSS if thy had followed East Asias strategy ould Ihe strJtegis which workd a quarter of a century ago work ill 10 d IV S global onomy Economists can disagree about the JlIswers 0 ths qustions But countries need to consider the alter lIJtiws md through dmocratic political processes make these hoiLs tor thlllselvs It should beand it should have beenthe sk ot th international economic institutions to provide the coun Iris th whrwithal 0 make these informed choices on their own with an undrstanding of the consequences and risks of each The tssnce of frdom is the right to make a choiceand to accept the responsibility that comes with it CHAPTER 4 THE EAST ASIA CRISIS How IMF Policies Brought the World to the Verge of a Global Meltdown W HEN THE THAI baht collapsed onJuly 21997 no one knew that this was the beginning of the greatest eco nomic crisis since the Great Depressionone that would spread from Asia to Russia and Latin America and threaten the entire world For ten years the baht had traded at around 25 to the dollar then overnight it fell by about 25 percent Currency specula tion spread and hit Malaysia Korea the Philippines and Indonesia and by the end of the year what had started as an exchange rate disas ter threatened to take down many of the regions banks stock mar kets and even entire economies The crisis is over now but countries such as Indonesia will feel its effects for years Unfortunately the IMF policies imposed during this tumultuous time worsened the situa tion Since the IMF was founded precisely to avert and deal with crises of this kind the fact that it failed in so many ways kd to a major rethinking of its role with many people in the United States and abroad calling for an overhaul of many of the Funds policies and the institution itself Indeed in retrospect it became clear that the IMF policies not only exacerbated the downturns but were partially responsible for the onset excessively rapid financial and capital mar ket liberalization was prohably the single most important cause of tht crisis though mistaken policies on the part of the countries rhtm lIIIHIN ANP ITS ISCNTNTS hc plllcd 1 wit IS wtll Today the IMF acknowledges many but llcH 111 cI S mistlkesits otllcials realize how dangerous for IllSllC lcssiwly rapid colpital market liberalization can bebut S LhlIlc 1II vicws lllleS 00 late to help the countries afflicted rhl risis tonk most obserwrs by surprise Not long before the TisIS clcll tht IMF hold forecast strong growth Over the preceding three decolcies Eolst Asia had not only grown faster and done better at rcllIlil plwercy than any other region of the world developed or less dtdoped but it had also been more stable It had been spared dIe lipS lIld downs that mark all market economies So impressive IS its pertormance that it was widely described as the East Asia ilirJcle Indeed reportedly so confident had the IMF been about the regioll thlt it assigned a loyal staff member as director for the region IS an easy preretirement posting When the crisis broke out I was surprised at how strongly the IMF and the US Treasury seemed to criticize the countries Jccording to the IMF the Asian nations institutions were rotten their governments corrupt and wholesale reform was needed These out spoken critics were hardly experts on the region but what they said contradicted so much of what I knew about it I had been traveling to and srudying the area for three decades I had been asked by the World Bank by Lawrence Summers himself when he was its vice president for research to participate in a major study of the East Asia Miracle to head the team looking at the financial markets Almost rwo decades before as the Chinese began their transition to a market economy I had been called upon by them to discuss their develop ment strategy In the White House I continued my close involve ment heading for instance the team that wrote the annual economic report for APEC the AsiaPacific Economic Cooperation the group of cOllntries arollnd the Pacific rim whose annual meetings of heads of states had come increasingly into prominence as the economic importance of the region grew I participated actively in the National Security Council in the debates about Chinaand indeed when tensions over the administrations containment policy got too heated I was the cabinet member sent to meet with Chinas pre mier Zhu Rongji to calm the waters I was one of the few foreigners THE EAST ASIA CRISIS III ever invited to join the countrys top leaders at their yearly August retreat for policy discussions How I wondered if these countries institutions were so rotten had they done so well for so long The difference in perspectives between what I knew about the region and what the IMF and the Treasury alleged made little sense until I recalled the debate that had raged over the East Asia Miracle itself The IMF and the World Bank had almost consciously avoided studying the region though presum ably because of its success it would have seemed natural for them to turn to it for lessons for others It was only under pressure from the Japanese that the World Bank had undertaken the study of economic growth in East Asia the final report was tided The East Asian Miracle and then only after the Japanese had offered to pay for it The reason was obvious The countries had been successful not only in spite of the fact that they had not followed most of the dictates of the Wash ington Consensus but because they had not Though the expem findings were toned down in the final published report the World Banks Asian Miracle study laid out the important roles that the gov ernment had played These were far from the minimalist roles beloved of the Washington Consensus There were those not just in the international financial institu tions but in academia who asked was there really a miracle AU that East Asia had done was to save heavily and invest well But this view of the miracle misses the point No other set of countries around the world had managed to save at such rates and invest the funds well Government policies played an important role in enabling the East Asian nations to accomplish both things simultaneously When the crisis broke out it was almost as if many of the regions critics were glad their perspective had been vindicated In a curious disjunction while they were loath to credit the regions governments with any of the successes of the previous quarter century they were quick to blame the governments for the failings Whether one calls it a miracle or not is beside the point the increases in incomes and the reductions in poverty in East Asia over the last three decades have been unprecedented No onc visiting these countries can fail to marvel at the dcvelopmental transfonna J lllllLIIrtllN ANI Irs DISCONTENTS tlOIl thl hlllgtS 1I0t onl in the economy but also in society rdictli III tnr qltistic inaginabk Thirty years ago thousands of bldbrllklll rtbhIWS Wtre pulled for a pittance today they are only a tOUrIst mrITiln 1 photo opportunity for the camerasnapping tourists tiklll t tht re ion Tht combination of high savings rates govern llltH iwsnllent l education and statedirected industrial policy all sefwd tl nuke tht region an economic powerhouse Growth rates were phtIIlIelltl tor decades and the standard of living rose enormously for ns of millioIls of people The benefits of growth were shared widely There tre problems in the way the Asian economies developed but lerill the govenunents had devised a strategy that worked a strategy which Iud bur OIle item in common vith the Washington Consensus policiesthe importance of macrostability As in the Washington Con seIlSUS trade was important but the emphasis was on promoting exports lIot nmoing impediments to imports Trade was eventually liberalized but only gradually as new jobs were created in the export industries While the Washington Consensus policies emphasized rapid financial and capital market liberalization the East Asian countries liberalized only graduallysome of the most successful like China still have a long way to go While the Washington Consensus policies emphasized privatiza tion government at the national and local levels helped create efficient enterprises that played a key role in the success of several of the coun tries In the Washington Consensus view industrial policies in which gowrnments try to shape the future direction of the economy are a mis take But the East Asian governments took that as one of their central responsibilities In particular they believed that if they were to close the income gap berween themselves and the more developed countries they had to close the knowledge and technology gap so they designed educa tion and investment policies to do thatWhile the Washington Consensus policies paid littie attention to inequality the East Asian governments worked actively to reduce poverty and limit the growth of inequality believing that such policies were important for maintaining social cohe sion and that social cohesion was necessary to provide a climate favor able to investment and growth Most broadly while the Washington Consensus policies emphasized a minimalist role for government in East Asia governments helped shape and direct markets When the crisis began those in the West did not realize its sever THE EAST ASIA CRISIS 93 ityAsked about aid for Thailand President Bill Clinton dismissed the collapse of the baht as a few glitches in the road to economic pros perity2 The confidence and imperturbability of Clinton was shared by the financial leaders of the world as they met in September 1997 in Hong Kong for the annual meeting of the IMF and World Bank IMF officials there were so sure of their advice that they even asked for a change in its charter to allow it to put more pressure on develop ing countries to liberalize their capital markets Meanwhile the lead ers of the Asian countries and especially the finance ministers 1 met with were terrified They viewed the hot money that came with lib eralized capital markets as the source of their problems They knew that major trouble was ahead a crisis would wreak havoc on their economies and their societies and they feared that IMF policies would prevent them from taking the actions that they thought might stave off the crisis at the same time that the policies they would insist upon should a crisis occur would worsen the impacts on their econ omy They felt however powerless to resist They even knew what could and should be done to prevent a crisis and minimize the dam agebut knew that the IMf would condellUl them if they under took those actions and they feared the resulting withdrawal of international capital In the end only Malaysia was brave enough to risk the wrath of the IMF and though Prime Minister Mahathirs policiestrying to keep interest rates low trying to put brakes on the rapid Row of speculative money out of the countrywere attacked from all quarters Malaysias downturn was shorter and shallower than that of any of the other countries3 At the Hong Kong meeting I suggested to the ministers of the Southeast Asian countries with whom I met that there were some concerted actions which they could take together if they all imposed capital controlscontrols intended to prevent the damage as the speculative money rushed out of their countriesin a coordinated way they might be able to withstand the pressures that would undoubtedly be brought down upon them by the international financial community and they could help insulate their economies from the turmoil They talked about getting together later in the year to map out a plan But hardly had their bags been unpacked from the trip to Hong Kong than the crisis spread first to Indonesia and then UBIILHlllN AND ITS DISCONTENTS III Ifh I knlllDtf 0 South KOfta Meanwhile other countries lfl1ulld rile rld Iud Dttll tucktd by currellcy speculatorsfrom Bflzil w HlllI KlIlllld withstood tht attack but at high cost Thtft 1 ft two Illniliar patttrns to these crists The first is illus trJttd D SlHlth KortI a country with an impressiVt track record As it tllltftd IrulII the wreckagt of the Korean War South Korea for llluLued 1 rowth stltegy which increased per capita income eight Ild in thirty yem reduced poverty dramatically achieved universal litercto md wtnt far in closing the gap in technology between itself md the mort advanced countries At tht end of the Korean War it Ins poorer than India by the beginning of the 1990s it had joined the Organization tor Economic Cooperation and Development OECD the club of the advanced industrialized countries Korea had become one of the worlds largest producers of computer chips and its large conglomerates Samsung Daewoo and Hyundai pro duced goods known throughout the world But whereas in the early days of its transformation it had tightly controlled its financial mar kets under pressure from the United States it had reluctantly allowed its firms to borrow abroad But by borrowing abroad the firms exposed themselves to the vagaries of the international market in late 1997 rumors flashed through Wall Street that Korea was in trou ble It would not be able to roll over the loans from Western banks that were coming due and it did not have the reserves to pay them otT Such rumors can be selffulfilling prophecies I heard these rumors at the World Bank well before they made the newspapers and I knew what they meant Quickly the banks which such a short time earlier were so eager to lend money to Korean firms decided not to roll over their loans When they all decided not to roll over their loans their prophecy came true Korea was in trouble The second was illustrated by Thailand There a speculative attack combined with high shortterm indebtedness was to blame Specu lators believing that a currency will devalue try to move out of the currency and into dollars with free convertibilitythat is the ability to change local currency for dollars or any other currencythis can easily be done But as traders sell the currency it value is weak enedconfirming their prophecy Alternatively and more com monly the government tries to support the currency It sells dollars TilE EAST ASIA CRISIS liS from its reserves money the country holds often ill dollars against a rainy day buying up the local currency to sutain its value But eventually the government rullS out of hard currency There are no more dollars to sell The currency plummets The speculaton are sat isfied They have bet right They can move back into the currcncy and make a nice profit The magnitude of the returllS can be enormous Assume a speculator goes to a Thai bank borrows 24 bil lion baht which at the original exchange rate can be converted into 1 billion A week later the exchange rate falls instead of there being 24 baht to the dollar there are now 40 baht to the dollar He takes 600 million converting it back to baht getting 24 billion baht to repay the loan The remaining 400 million is his profita tidy return for one weeks work and the investment of Iitde of his own money Confident that the exchange rate would not appreciate that is go from 24 baht to the dollar to say 20 to the dollar there was hardly any risk at worst if the exchange rate remained unchanged he would lose one weeks interest As perceptions that a devaluation is imminent grow the chance to make money becomes irresistible and speculators from around the world pile in to take advantage of the situation If the crises had a familiar pattern so too did the IMFs responses it provided huge amounts of money the total bailout packages including support from G7 countries was 95 billion4 so that the countries could sustain the exchange rate It thought that if the mar ket believed that there was enough money in the coffen there would be no point in attacking the currency and thus confidence would be restored The money served another function it enabled the countries to provide dollars to the firms that had borrowed from Western bankers to repay the loans It was thus in part a bailout to the internatiohal banks as much as it was a bailout to the country the lenders did not have to face the full consequences of having made bad loans And in country after country in which the IMF money was used to sustain the exchange rate temporarily at an unsustainable level there was another consequence rich people inside the country took advantage of the opportunity to convert their money into dol lars at the favorable exchange rate and whisk it abroad As we shall note in the next chapter the most egregious example oClurrcd in tLIlIIALll llN AND ITS DISCONTtiNTS Russil llttr ht IMF It1It it money in July 1998 But this phenome 11011 whid1 is slulletillles given the more neutral sounding name of lIPllliiIH llso pLayed l key role in the previous important crisis ill l oxilll durillg 19l95 TIlt IIF cOlllbined the money with conditions in a package which IS supposed to rectitY the problems that caused the crisis It is thtst llthtr ingredients as much as the money that are supposed to ptrsuldt mlrkets to roll over their loans and to persuade speculators to Itllk dsewhere tor easy targets The ingredients typically include hihtr interest rJtesin the case of East Asia much much higher inttrtst rlttsplus cutbacks in government spending and increases ill 1XtS They also include structural reforms that is changes in the structurt of the tconomy which it is believed lies behind the coun trys problems In the case of East Asia not only were conditions impostd that mandated hikes in interest rates and cutbacks in spend ing additional conditions required countries to make political as well as economic changes major reforms such as increased openness and transparency and improved financial market regulation as well as minor reforms like the abolition of the clove monopoly in Indonesia The IMF would claim that imposing these conditions was the responsible thing to do It was providing billions of dollars it had a responsibility to make sure not just that it was repaid but that the countries did the right thing to restore their economic health If rructural problems had caused the macroeconomic crisis those prob Itms had to be addressed The breadth of the conditions meant that he countries accepting Fund aid had to give up a large part of their economic sovereignty Some of the objection to the IMF programs was based on this and the resulting undermining of democracy and some were based on the fact that the conditions did not and arguably were not designed to restore the economies health But as we noted in chapter 2 some of the conditions had nothing to do with the problem at hand The programswith all of their conditions and with all of their moneyfailed They were supposed to arrest the fall in the exchange rates but these continued to fall with hardly a Ricker of recognition by the markets that the IMF had come to the rescue In each case embarrassed by the failure of its supposed medicine to work the IMF THE EAST ASIA CIIISIS 17 charged the country with failing to take the necessary reforms seri ously In each case it announced to the world that there were funda mental problems that had to be addressed before a true recovery could take place Doing so was like crying fire in a crowded theater investors more convinced by the diagnosis of the problems than by the prescriptions Red5 Rather than restoring confidence that would lead to an inRow of capital into the country IMF criticism exacer bated the stampede of capital out Because of this and the other rea sons to which I turn shortly the perception throughout much of the developing world one I share is that the IMF itself had become a part of the countries problem rather than part of the solution Indeed in several of the crisis countries ordinary people as well as many government officials and business people continue to refer to the economic and social storm that hit their nations simply as the IMFthe way one would say the plague or the Great Depres sion History is dated by before and after the IMFjust as coun tries that are devastated by an earthquake or some other natural disaster date events by before or after the earthquake As the crisis progressed unemployment soared GDP plummeted banks closed The unemployment rate was up fourfold in Korea threefold in Thailand tenfold in Indonesia In Indonesia almost 15 percent of males working in 1997 had lost their jobs by August 1998 and the economic devastation was even worse in the urban areas of the main island Java In South Korea urban poverty almost tripled with almost a quarter of the population falling into poverty in Indonesia poverty doubled In some countries like Thailand people thrown out of jobs in the cities could return to their rural homes However this put increasing pressure on those in the rural sector In 1998 GDP in Indonesia fell by 131 percent in Korea by 67 per cent and in Thailand by 108 percent Three years after the crisis Indonesias GDP was still 75 percent below that before the crisis Thailands 23 percent lower In some cases fortunately outcomes were less bleak than was widely anticipated Communities in Thailand worked together to ensure that their childrens education was not imcrrupted with peo ple voluntarily contributing to help keep their neighbors kid in school They also made sure tlut rveryone had enough fOod and t lUIIIIIZTlON AND ITS DISCONTENTS btlllSt of this tht incidtlllt of malnutrition did not increase In IlldnlsiI I orld l3Jnk program sttmtd to succttd in arresting the llltiliplttd Idtrst ttlects on tducation It was poor urban work trshmll wdl otr by any standardswho wtre made most desti tut by tht crisis Tht trosion of the middle class caused by usurious inrtrtst flttS which thrtw small busintsses into bankruptcy will have the klllgtst lasting drtcts on the social political and economic life of tht rtgion Dettrioflting conditions in one country helped bring down its lltighbors Tht slowdown in the region had global repercussions global tconomic growth slowed and with the slowing of global growth commodity prices fell From Russia to Nigeria the many elIltrging countries that depended on natural resources were in deep dtep troubltAs investors who had risked their money in these coun tries saw their wealth plummeting and as their bankers called in their loans they had to cut back their investments in other emerging mar kts Brazil dependent neither on oil nor on trade with the countries in deep trouble with economic features far different from these countries was brought into the unfolding global financial crisis by the generalized fear of foreign investors and the retrenchment in their lending Eventually almost every emerging market even Argentina which the IMF had long held up as the poster child of reform largely for its success in bringing down inflation was atfected HOW IMFUS TREASURY POLICIES LED TO THE CRISIS The disturbances capped a half decade of an Americanled global tri umph of market economics following the end of the cold war This period saw international attention focus on newly emerging markets from East Asia to Latin America and from Russia to India Investors saw these countries as a paradise of high returns and seemingly low risk In the short space of seven years private capital flows from the developed to the less developed countries increased sevenfold while public flows foreign aid stayed steady6 THE EAST ASIA CRISIS International bankers and politicians were confident that thi was the dawn of a new era The IMF and the US Tnasury believed or at least argued that full capital account liberalization would help the region grow even faster The countries in East Asia had no need for additional capital given their high savings rate but still capital account liberalization was pushed on these countries in the late eighties and early nineties I believe that capital account liberalization was the single most importallt Jactor leadillg 10 the crisis I have come to this conclusion not just by carefully looking at what happened in the region but by looking at what happened in the almost one hundred other economic crises of the last quarter century Because economic crises have become more frequent and deeper there is now a wealth of data through which one can analyze the factors contribut ing to crises7 It has also become increasingly clear that all too often capital account liberalization represents risk without a reward Even when countries have strong banks a marure stock market and other institutions that many of the Asian countries did not have it can impose enormous risks Probably no country could have withstood the sudden change in investor sentiment a sentiment that reversed this huge inflow to a huge outflow as investors both foreign and domestic put their funds elsewhere Inevitably such large reversals would precipitate a crisis a recession or worse In the case ofThailand this reversal amounted to 79 percent of GDP in 1997 123 percent of GDP in 1998 and 7 percent of GDP in the first half of 1999 It would be equivalent to a reversal in capital flows for the United States of an average 765 bil lion per year between 1997 and 1999 While developing countries ability to withstand the reversal was weak so too was their ability to cope with the consequences of a major downrurn Their remarkable economic performanceno major economic recession in three decadesmeant that the East Asian countries had not developed unemployment insurance schemes But even had they turned their mind to the task it would not have been easy in the United States unemployment insurance for those who are selfemployed in agri culture is far from adequate and this is precisely the sector that dom inates in the developing world The complaint against the 1M I however runs deeper it is not just IL lOIlHIIHIllN NIl ITs DISCONTENTS thJt tht Iulld push d tht libtrJlization policies which led to the cri SIS but th1t tht pushtd thtst policies even though there was little tidellct thlt such plicits promoted growth and there was ample tidtIlCt dut thtv impostd huge risks on developing countries Htrt was J tnlt ironyif such a gentle word can be used In Octobr 1lj7 at tht wry beginning of the crisis the Fund was IcinKlting tht txplIIsion of precisely those polices which underlay tht infeJsing frequency of crises As an academic I was shocked that tht IMF and tht US Treasury would push this agenda with such torce in the face of a virtual absence of theory and evidence suggest ing that it vas in the economic interests of either the developing ounrries or global economic stabilityand in the presence of evi knce ro the contrary Surely one might have argued there must be ic1l11t basis for their position beyond serving the naked selfinterest of tinancial markets which saw capital market liberalization as just mother torm of market accessmore markets in which to make more money Recognizing that East Asia had little need for additional capital the advocates of capital market liberalization came up with an argument that even at the time I thought was unconvincing but in retrospect looks particularly strangethat it would enhance the counrries economic stability This was to be achieved by allowing greater diversification of sources of funding 8 It is hard to believe that these advocates had not seen the data that showed that capital flows were procyclical That is to say that capital flows out of a country in a recession precisely when the country needs it most and flows in during a boom exacerbating inflationary pressures Sure enoughjust at the time the countries needed outside funds the bankers asked for their money back Capital market liberalization made the developing countries sub ject to both the rational and the irrational whims of the investor community to their irrational exuberance and pessimism Keynes was well aware of the often seemingly irrational changes in sentiments In The General Theory of ElIlploYlllem merest and Money 1935 he referred to these huge and often inexplicable swings in moods as animal spirits Nowhere were these spirits more evident than in East Asia Slightly before the crisisThai bonds paid only 085 percent higher interest than the safest bonds in the world that is they were THE EAST ASIA CalSls 101 regarded as extremely safe A short while later the rik premium on Thai bonds had soared There was a second hardly more credible argument that the advo cates of capital market liberalization put forwardagain without evidence They contended that capital market controls impeded eco nomic efficiency and that as a result countries would grow better without these controls Thailand provides a case in point for why this argument was so flawed Before liberalization Thailand had severe Limitations on the extent to which banks could lend for speculative real estate It had imposed these limits because it was a poor country that wanted to grow and it believed that investing the countrys scarce capital in manufacturing would both create jobs and enhance growth It also knew that throughout the world speculative real estate lending is a major source of economic instability This type of lending gives rise to bubbles the soaring of prices as investors clamor to reap the gain from the seeming boom in the sector these bubbles always burst and when they do the economy crashes The pattern is familiar and was the same in Bangkok as it was in Houston as real estate prices rise banks feel they can lend more on the basis of the collateral as investors see prices going up they want to get in on the game before its too lateand the bankers give them tIle money to do it Real estate developers see quick profits by putting up new buildings until excess capacity results The developers cant rent their space they default on their loans and the bubble bursts The IMF however contended that the kinds of restraints that Thailand had imposed to prevent a crisis interfered with the efficient market allocation of resources rf the market says build otlice build ings commercial construction musl Ilf the highest return activity If the market says as it rfrclively did after liberalization build empty office buildings then so be it again according to IMF logic the mar ket musl know best While Thailand was desperate for more public investment to strengthen il infrastructure and relatively weak Sel ondary and university education systems billions were squandtTed on commercial real estate These buildings TCmain empty today testi mony to the risks posed by excessive market exuberlllcc and the PlT vasive market failures that can arise in the presence of inadequate government regulation of financi1 institutions Q llllilIT111N ANI ITS DISCONTENTS Thl IME llf ourst was lI11t alollt ill plshing for liberalization Thl US TrlISUr whidl as tht lMFs largest shareholder and the llll llllt with 0 pOwr hJS a IJrgt role in determining IMP poli its pushtd liDtrJlizcltillll 00 I WJS ill IrtsicitIH Clintons Council of Economic Advisers in I lNJ whtll Somh Koreas trade relations with the United States allle up tor discussion The negotiations included a host of minor issutssuLh JS opening up South Koreas markets to American lusagslnd th important issue of financial and capital market lib rilizJrion For three decades Korea enjoyed remarkable economic rowth without significant international investment Growth had 0111 basd on th nations own savings and on its own firms man 19d by its own people It did not need Western funds and had dn1onstratd an altcrnative route for the importation of modern tLhnology and market access While its neighbors Singapore and Malaysia had invited in multinational companies South Korea had Cfatd its own enterprises Through good products and aggressive markering South Korean companies had sold their goods around the world South Korea recognized that continued growth and integra rion in the global markets would require some liberalization or dregulation in the way its financial and capital markets were run South Korea was also aware of the dangers of poor deregulation it had seen what happened in the United States where deregulation had culminated in the 1980s savingsandloan debacle In response South Korea had carefully charted out a path of liberalization This path was too slow for Wall Street which saw profitable opportunities and did not want to wait While Wall Streeters defended the principles of free markets and a limited role for government they were not above asking help from government to push their agenda for them And as we shall see the Treasury Department responded with force At the Council of Economic Advisers we werent convinced that South Korean liberalization was an issue of US national interest though obviously it would help the special interests of Wall Street Also we were worried about the effect it would have on global sta bility We wrote a memorandum or think piece to layout the THE EAST ASIA CIIISIS 13 issues stimulate a debate and help focus attention on the matter We prepared a set of criteria for evaluating which marketopening mea sures are most vital to US national interests We argued for a system of prioritization Many forms of market access are of little benefit to the United States While some specific groups might benefit a great deal the country as a whole would gain little Without prioritization there was a risk of what happened during the previous Bush admin istration one of the supposedly great achievements in opening up Japans market was that Toys uR Us could sell Chinese toys to Japan ese childrengood for Japanese children and Chinese workers but of little benefit to America Though it is hard to believe that such a mildmannered proposal could be greeted with objections it was Lawrence Summers at the time undersecretary of the Treasury adamantly opposed the exercise saying such prioritization was unnec essary It was the responsibility of the National Economic Council NEC to coordinate economic policy to balance the economic analysis of the Council of Economic Advisers with the political pres sures that were reflected in the various agencies and decide what issues to take to the president for final decision The NEC then headed by Robert Rubin decided the issue was of insufficient importance to be brought to the president for consid eration The real reason for the opposition was only too transparent Forcing Korea to liberalize faster would not create many jobs in America nor would it likely lead to significant increases in American GDPAny system of privatization would therefore not put these mea sures high on the agenda 10 But worse it was not even clear that the United States would as a whole even benefit and it was clear that Korea might in fact be worse off The US Treasury which argued to the contrary both that it was important for the United States and that it would not lead to instability prevailed In the final analysis such matters are the Department of the Treasurys province and it would be unusual for the position of the Treasury to be overridden The fact that the debate was conducted behind closed doors meant that other voices could not be heard perhaps if they had if there had been more transparency in American decision making the outcome would have been different Instead Treasury won and the United 104 GUIIIUILT111N ANII ITS DISCONTtiNTS StJts KORI IId th global lonomy lost Treasury would probably dlim that th Iibralization itsdf was not at fault the problem was tlllt lib ralizatillll was dOIlt ill th wrong way But that was precisely Ollt of th points that th Council of Economic Advisers raised It was vtrv Iikdy thlt a quick librJlization would be done poorly THE FIRST ROUND OF MISTAKES ThtR is little doubt that IMF and Treasury policies contributed to an tllvironment that enhanced the likelihood of a crisis by encouraging in some CJSts insisting on an unwarrantedly rapid pace toward finan cial Ind capital market liberalization However the IMF and Treasury made their most profound mistakes in their initial response to the crisis Of the many failures outlined below today there is widespread agreement on all bur the criticism of IMF monetary policy At the onset the IMF seemed to have misdiagnosed the problem It had handled crises in Latin America caused by profligate govern ment spending and loose monetary policies that led to huge deficits and high inflation and while it may not have handled those crises vellthe region experienced a decade of stagnation after the so called successfuliMF programs and even the creditors had eventually to absorb large lossesit at least had a game plan that had a certain coherency East Asia was vastly different from Latin America govern ment had surpluses and the economy enjoyed low inflation but cor porations were deeply indebted The diagnosis made a difference for two reasons First in the highly inflationary environment of Latin America what was needed was a decrease in the excess demand Given the impending recession in East Asia the problem was not excess demand but insufficient demand Dampening demand could only make matters worse Second if firms have a low level of indebtedness high interest rates while painful can still be absorbed With high levels of indebtedness imposing high interest rates even for short periods of time is like signing a death warrant for many of the firmsand for the economy In fact while the Asian economies did have some weaknesses that needed to be addressed they were no worse than those in many other countries and surely nowhere near as bad as the IMF sug THIO EAST ASIA CIIlSIS gested Indeed the rapid recovery of Korea and Malayia howed that in large measure the downturns were not unlike the dozens of recessions that have plagued market economies ill the advanced industrial countries in the two hundred years of capiulism The countries of East Asia not only had an impressive record of growth as we have already noted but they had had fewer downturns over the previous three decades than any of the advanced industrial countries Two of the countries had had only one year of negative growth two had had no recession in thirty years In these and other dimensions there was more to praise in East Asia than to condemn and if East Asia was vulnerable it was a newly acquired vulnerabilitylargely the result of the capital and financial market liberalization for which the IMF was itself partly culpable Hooverite Contractionary Policies An Anomaly in the Modern World For more than seventy years there has been a standard recipe fur a country facing a severe economic downturn The government must stimulate aggregate demand either by monetary or fiscal policycut taxes increase expenditures or loosen monetary policy When I was chairman of the Council of Economic Advisers my main objective was to maintain the economy at full employment and mamize longterm growth At the World Bank I approached the problems of the countries in East Asia with the same perspective evaluating poli cies to see which would be most effective in both the short and long term The crisis economies of East Asia were clearly threatened with a major downturn and needed stimulation The IMF pushed exactly the opposite course with consequences precisely of the kind that one would have predicted At the time of the onset of the crisis East Asia was in rough mac robalanccwith low inflationary pressures and government budgetli in balance or surplus This had two obvious implications First th collapse of the exchange rate and the stock markets the breaking of the real estate bubbles accompanied by falling investment and con sumption would send it into a recession Second the economic col lapse would result in collapsing tax revenues and leave a budget gap Not since Herbert Hoover have respol1ible economists argued thaI 1110 lllHALlIHHlN AND ITs DISCONTENTS lnt Sllllllid tiXllS Oil the Iltual ddicit rather than the structural ddiIt cl1Jt is tht ddicit thlt would have been there had the econ ellll bt1l ptrJtill It IllH elllployment Yet this is precisely what the IMf ldOCltl rLt the IMF Idmits that the lis cal policy it recommended was excSlwlv I llstt rt I I The policies made the recession far worse thJn It needed 0 be During the crisis however in the Financial Till the IMFs first deputy managing director Stanley Fischer ddtnded the IMFs policies writing in effect that all the IMF was Jsking of che countries was to have a balanced budgetP2 Not for ixtv WJrs hJye respectable economists believed that an economy going into a recession should have a balanced budget I Idc intensely about this issue of balanced budgets While I was at che Council of Economic Advisers one of our major battles was over che babnced budget amendment to the Constitution This amend ment would have required the federal government to limit its expen dirures to ics revenues We and Treasury were against it because we believed chat it was bad economic policy In the event of a recession ic would be all the more difficult to use fiscal policy to help the economy recover As the economy goes into a recession tax revenues decrease and the amendment would have required the government to cut back expenditures or increase taxes which would have depressed the economy further Passing the amendment would have been tantamount to the gov ernment walking away from one of its central responsibilities main taining che economy at full employment Despite the fact that expansionary fiscal policy was one of the few ways out of recession and despite the administrations opposition to the balanced budget amendment che US Treasury and the IMF advocated the equivalent of a balanced budget amendment for Thailand Korea and other East Asian countries BeggarThyself Policies Of all the mistakes the IMF committed as the East Asian crisis spread from one country to another in 1997 and 1998 one of the hardest to fathom was the Funds failure to recognize the important interactions TilE EAST ASIA C11IS1S 107 among thc policils pursuld in the difflrlnt countries Contrac tionary policils in onl country not only dlprlssed that countrys economy bue had adverse dfects on its nlighbors By continuing 0 advocate contractionary policies thl IMF exacerbared thl contagion the spread of the downturn from onl country to the next As Iach country weaklned it reduced its imports from its neighbors thlrlby pulling its neighbors down The beggarthyneighbor policils of the 1930s arl glnerally thought to have played an important role in thl sprlad of the Great Depression Each country hit by a downturn tried to bolster its own economy by cutting back on exports and thus shifting consumer demand to its own products A country would cut back on exports by imposing tariffs and by making competitive devaluations of irs currency which made its own goods cheaper and other countries more expensive However as each country cut back on imports it succeeded in exporting the economic downturn to its Illighbors Hence the term beggarIhyneighbor The IMF devised a strategy that had an effect which waS even worse than the beggarthyneighbor policies that had devastated countries around the world during the depression of the 1930s Countries were told that when facing a downturn they must cut back on their trade deficit and even build a trade surplus This might be logical if the central objective of a countrys macroeconomic pol icy were to repay foreign creditors By building up a war chest offor eign currency a country will be better able to pay its billsnever mind the cost to those inside the country or elsewhere Today unlike thl 1930s enormous pressure is put on a country not to increase tar iffs or other trade barriers in order to decrease imports even if it faces a recession The IMF also inveighed strongly against filrther devaluation Indeed the whole point of the bailouts was to pmCfll a further decrlase in the exchange rate This itself might seem peculiar given the IMFs otherwise seeming faith in markets why not let mar ket mechanisms determine exchange rates just as they determine other prices Bue intellectual consistency has never been the hall mark of the IMP and its singleminded worries aboue inflation being set offby devaluation have always prevailed With tariffi and devalua tions ruled out there were but two ways to build a trade surplus One lOS GlllIUIIlHION ANn ITS DISCONTENTS WIS W illnIst tXpllrts but this is 1I0t tasy and cannot be done quikly pminlllrly whllI tht tconomits of your major trading plrmtrs art wtlk Jnd your on tinancial markets are in disarray so txportlrs c IlInot obtain tinalllt to expand The other was to reduce importsby utting irllomts that is inducing a major recession UnlilrtulIltdy lor tht countries and the world this was the only llptillll lett And this is what happened in East Asia in the late 1990s orHrationlry tiscal and monetary policies combined with mis guidtd tirllncial policies led to massive economic downturns cut ting irllomes which reduced imports and led to huge trade surplusts giving the countries the resources to pay back foreign Cfldirors It onls objective was to increase the size of reserves the policy was J success But at what expense to the people in the country and their nlighbors Hence the name of these policiesbeggarthyself The consequence for any countrys trading partners was exactly the same as if beggarthyneighbor policies had actually been pursued Each countrys imports were cut back which is the same as other counrries exports being cut From the neighbors perspectives they couldnt care less why exports were cut what they saw was the conse quence a reduction of sales abroad Thus the downturn was exported around the region Only this time there was not even the saving grace that as the downturn was exported the domestic economy was strengthened As the downturn spread around the world slower growth in the region led to a collapse in commodity prices like oil and the collapse in those prices wrought havoc in oilproducing countries like Russia Of all the failures of the IMF this is perhaps the saddest because it represented the greatest betrayal of its entire raison detre It did worry about contagioncontagion from one capital market to another transmitted through the fears of investorsthough as we saw in the last section the policies it had pushed had made the countries far more vulnerable to the volatility of investor sentiment A collapse in the exchange rate in Thailand might make investors in Brazil worry about markets there The buzzword was confidence A lack of confidence in one country could spread to a lack of confidence in emerging markets But more generally the IMFs performance as THE EAST ASIA CRISIS 101 market psychologist left something to be desired Creating deep recessions with massive bankruptcies andor pointing out deep seated problems in the best performing region of the emerging mar kets are policies hardly designed to restore confidence But even had it done better in restoring confidence questions should have been raised in focusing on protecting investors it had forgonen about those in the countries it was supposed to be helping in focus ing on financial variables like exchange rates it had almost forgotten about the real side of the economy It had lost sight of its original mission Strangling an Economy with High Interest Rates Today the IMF agrees that the fiscal policies those relating to the lev els of government deficits it pushed were excessively contractionary but it does not own up to the mistakes of monetary policy When the Fund entered East Asia it forced countries to raise interest rates to what in conventional term would be considered astronomical lev els I remember meetings where President Clinton was frustrated that the Federal Reserve Bank headed by Alan Greenspan an appointee from past administrations was about to raise interest rates one quarter or onehalf percentage point He worried that it would destroy his recovery He felt he had been elected on a platform of Its the economy stupid and 10bs jobs jobs and he didnt want the Fed to hurt his plans He knew that the Fed was concerned with inflation but thought those fears were excessivea sentiment which I shared and which the subsequent events bore out The president worried about the adverse effect interest rate increases would have on unemployment and the economic recovery just getting under way And this in the country with one of the best business environ ments in the world Yet in East Asia IMF bureaucrats who were even less politically accountable forced interest rate increases not ten but fifty times greaterinterest rate increases of more than 25 percent age points If Clinton worried about the adverse effects of a half point increase on an economy experiencing a nascent recovery he would have been apoplectic about the effect of those huge increases in interest rates on an economy plunging into a recession Korea first II CUIIIUILHIlIN iNU ITS IISCONTNTS raistd its imtnst ratls 0 25 PInIIIC but was told that to be serious it IIIl1st lIlllw imtrtst fJttS 0 ll still highlr Indonesia raised its interest rlttS ill 1 prlllIIptil 11101 bdorl thl crisis but was told that that was 1It lllld tIIlUh NOlllinal illClrest rates soared Thl rtlsollill behind thlsl policies was simple if not simplistic If J loumry flisld illClrlst fJtes it would make it more attractive for lJpital 0 liow into that country Capital flows into the country would hdp support the exchange rate and thus stabilize the currency End ot Jrgllllllnt At tirst glance this appears logical However consider the case of South Korea as an example Recall that in South Korea the crisis was stJrtld by torlign banks refusing to roll over their shortterm loans They refused because they worried about South Korean firrns ability to repay Bankruptcydefaultwas at the center of the discussion But in the IMF modelas in the models of most of the macroeco nomics textbooks written two decades agobankruptcy plays no role To discuss monetary policy and finance without bankruptcy is like Hamlet without the Prince of Denmark At the heart of the analysis of the macroeconomy should have been an analysis of what an increase in interest rates would do to the chances of default and to the amount that creditors can recover in the event of default Many of the firms in East Asia were highly indebted and had huge debt equity ratios Indeed the excessive leverage had repeatedly been cited as one of South Koreas weaknesses evetl by the IMP Highly lever aged companies are particularly sensitive to interest rate increases especially to the extremely high levels urged by the IME At very high interest rate levels a highly leveraged company goes bankrupt quickly Even if it does not go bankrupt its equity net worth is quickly depleted as it is forced to pay huge amounts to creditors The Fund recognized that the underlying problems in East Asia were weak fmancial institutions and overleveraged firms yet it pushed high interest rate policies that actually exacerbated those problems The consequences were precisely as predicted The high interest rates increased the number of firms in distress and thereby increased the number of banks facing nonperforming loans 13 This weakened the banks further The increased distress in the corporate THE EAST ASIA Clml III and financial sectors exacerbated the downturn that the contrac tionary policies were inducing through the reduction in aggregate demand The IMF had engineered a simultaneous contraction in aggregate demand and supply In defending its policies the IMF said they would help restore market confidence in the affected countries But clearly countries in deep recession did not inspire confidence Consider a Jakarta busi nessman who has put almost all of his wealth into East Asia As the regional economy plummetsas contractionary policies take hold and amplify the downturnhe suddenly realizes that his portfolio is hardly sufficiently diversified and shifts investment to the booming US stock market Local investors just like international investors were not interested in pouring money into an economy going into a tailspin Higher interest rates did not attract more capital into the country On the contrary the higher rates made the recession worse and actually drove capital 0111 of the country The IMF came up with another defense of no more validity They argued that if interest rates were not greatly increased the exchange rate would collapse and this would be devastating to the economy as those who had dollardenominated debts would not be able to pay them But the fact was that for reasons that should have been appar ent raising interest rates did not stabilize the currency the countries were thus forced to lose on both accounts Moreover the IMF never bothered to look at the details of what was going on inside the coun tries In Thailand for instance it was the already bankrupt real estate firms and those that lent to them who had the most foreign denominated debt Further devaluations might have harmed the tor dgn creditors but would not have made these firms any more dead In effect the IMF made the small businesses and other innocent bystanders pay for those who had engaged in excessive dollar bor rowingand to no avail When I pleaded with the IMF for a change in policies and pointed Ollt the disaster that would ensue if the current course were to be continued there was a curt reply If I were proven correct the Fund would change its policies I was appalled by this waitandsee attitude All economist know there are long lags in policy The hene II CIOHIIHION Nll ITs DISCONTENTS tits of Chlllll CllurSt will llot bt telt til six to eighteen months wluk LllllrlllllllS dallllt Cllllid bt dOllt in the meantime Th dllllle was dOllt ill East Asia Because many firms were hlhh kerld 1lIIllY lre torced into bankruptcy In Indonesia an ttlllllttd 75 perclt of all businesses were put into distress while in rtllilllld dose to 5ll percent of bank loans became nonperforming Ulltirrlllltdy it is tar easier to destroy a firm than to create a new lllL Lowering interest rates would not unbankrupt a firm that had been toned into bankruptcy its net worth would still have been iped out The IMFs mistakes were costiy and slow to reverse Nlie geopolitical reasoning vestiges of Kissingerstyle realpolitik compounded the consequences of these mistakes In 1997 Japan uttered S lUll billion to help create an Asian Monetary Fund in order to tinance the required stimulative actions But Treasury did every thlIlg it could to squelch the idea The IMF joined in The reason for the IJI Fs position was clear While the IMF was a strong advocate of competition in markets it did not want competition in its own domain and the Asian Monetary Fund would provide that The us Treasurys motivations were similar As the only shareholder of the IIF with veto power the United States had considerable say in IMF policies I t was widely known that Japan disagreed strongly with the IMFs actionsI had repeated meetings with senior Japanese officials in which they expressed misgivings about IMF policies that were lmost identical to my own H With Japan and possibly China as the likely major contributors to the Asian Monetary Fund their voices would predominate providing a real challenge to American leader shipand control The importance of controlincluding control over the media was brought home forcefully in the early days of the crisis When World Bank Vice President for East Asia Jean Michel Severino pointed out in a widely discussed speech that several countries in the region were going into a deep recession or even depression he received a strong verbal tonguelashing from Summers It was simply unacceptable to use the R for recession or D for depression words even though by then it was clear that Indonesias GDP was likely to fall between 10 to 15 percent a magnitude that clearly war ranted the me of those harsh terms THe EAST ASIA CISIS II Eventually Summers Fischer Treasury and the IMF could not ignore the depression Japan once again made a generous offer to help under the Miyazawa Initiativ named after Japans finance min ister This time the offer was scaled down to 30 billion and wai accepted But even then the United States argued that the money should be spent not to stimulate the economy through fiscal expan sion but for corporate and financial restructuringeffectively to help bailout American and other foreign banks and other creditors The squashing of the Asian Monetary Fund is still resented in Asia and many officials have spoken to me angrily about the incident Three years after the crisis the countries of East Asia finally got together to begin quietly the creation of a more modest version of the Asian Monetary Fund under the innocuous name of the Chang Mai Initiative named after the city in northern Thailand where it was launched THE SECOND ROUND OF MISTAKES BUMBLING RESTRUCTURING As the crisis worsened the need for restructuring became the new mantra Banks that had bad loans on their books should be shut down companies that owed money should be closed or taken over by their creditors The IMF focused on this rather than simply per forming the role it was supposed to fill providing liquidity to finance needed expenditures Alas even this focus on restructuring failed and much of what the IMF did helped push the sinking economies down further Financial Systems The East Asia crisis was first and foremost a crisis of the financial system and this needed to be dealt with The financial system can be compared to the brain of the economy It allocates scarce capital among competing uses by trying to direct it to where it is most effective in other words where it yields the highest returns The financial system also monitors the tilllds to ensure that they are USN lq tlllIITllN NIl ITS DISCONTENTS III ti WI prmised If tht tinlIleial system breaks down firms can 1l1 l till rklll elpiral they need to continue existing levels of PWiUlllll Ill dllIt tinIIK txpansion through new investment A TIS 111 ll risl III 1 viious eirelt whertin banks cut back on their tillIIItl kdlll tirllls to cut back on thtir production which in turn lelis tl Itlr lllltput lIld 100ver incomes As output and incomes flulIlIlI pmtils till Jnd some firms are even forced into bank rUplcY htn tirms declare bankruptcy banks balance sheets become wors Jlld Ihe banks cut back lending even further exacerbating the cllllomic dowllturn I f enough tirms tJil to repay their loans banks may even collapse Lolbpse of even a single large bank can have disastrous conse LjUtIICtS Financial institutions determine creditworthiness This intorlllJion is highly sptcific cannot easily be transmitted and is tmbtddtd in the records and institutional memory of the bank or othtr tillJncid institution When a bank goes out of business much of tht Lrtditworthiness information it has on its borrowers is dtstroyd and that information is expensive to recreate Even in more advanced countries a typical small or mediumsized enterprise may obtain crdit from at most two or three banks When a bank goes out of business in good times many of its customers will have difficulty tinding an alternative supplier of credit overnight In devel oping countries where sources of finance are even more limited if the bank that a business relies upon fails finding a new source of fundsespecially during an economic downturnmay be nearly Impossible Fears of this vicious circle have induced governments throughout the world to strengthen their financial systems through prudent reg ulation Repeatedly free marketeers have bridled against these regu lations When their voices have been heeded the consequences have been disastrous whether in Chile in t 98283 in which Chilean gross domestic product fell by 137 percent and one in five workers was unemployed or the United States in the Reagan era where as we noted earlier deregulation led to the savingsandIoan debacle costing American taxpayers S200 billion A recognition of the importance of maintaining credit flows has similarly guided policy makers in trying to deal with the problems of TIIF EAST ASIA ClllIS financial restructuring Fears about the adverse effects of this destruction of informational capital partially explain why the United States during the SL debacle closed down very few banlu outright Most of the weak banks were taken over by or merged into other banks and customers hardly knew of the switch In this way the information capital was preserved Even so the SL crisis was an important contributing factor to the 1991 recession Inducing a Bank Run Although financial system weaknesses were far more pervasive in East Asia than in the United States and the IMFs rhetoric continu ally focused on these weaknesses as underlying the East Asia crisis the IMF failed to understand how financial markets work and their impact on the rest of the economy Its crude macromodels never embraced a broad picture of financial markets at the aggregate level but were even more deficient at the microlevelthat is at the level of the firm The Fund did not adequately take into account the cor porate and financial distress to which its socalled stabilization poli cies including the high interest rates contributed so strongly As they approached the problem of restructuring IMF teams in East Asia focused on shutting down weak banks it was as if they had a Darwinian model of competition in mind so the weak banks musl not survive There was some basis for their position Elsewhere allowing weak banks to continue to operate witllout 11111 SIIpcrvisioll resulted in their making highly risky loans They gambled by making highrisk highreturn loansif they were lucky the loans would be repaid and the higher interest rates would bring them back to sol vency If they were unlucky they would go out of businesswith the government picking up the piecesbut that is what would happen to them in any case if they did not embark on the risky loan strategy But too often such risky loans indeed turn out to be bad loans and when the day of reckoning comes the government faces an L Cn bigger bailout than if the bank had been shut down earlier This was one of the lessons that had merged so clearly from the US savings andloan debacle the refusal of the Reagan administration to deal with the problem for years meant that when the crisis could no II lllllIHIIHHlN Nl ITs DISCONTENTS lontr be inrtd the cost to the taxpayer was far larger But the llvlF verlooktd anclther critical lesson the importance of keeping crtdit tlowin Its strJteY tor tinlIlcial restructuring involved triageseparating out the reallv sick bJnks which should be dosed immediately from the healthy blIIks A third group were those that were sick but repJrJble UJnks are required to have a certain ratio of capital to their outstJnding 10Jns and other assets this ratio is termed the capital ade iJ rHitl Not surprisingly when many loans are nonperforming IllJII banks fail to meet their capital adequacy ratio The IMF insisted that bmks either shut down or quickly meet this capital ade quacy ratio But this insistence on banks quickly meeting capital ade quacy standards exacerbated the downturn The Fund made the kind of mistJke that we warn students about in the first course in eco nomics called the fallacy of composition When only one bank has a problem then insisting on its meeting its capital adequacy standards makes sense But when many or most banks are in trouble that pol icy can be disastrous There are two ways of increasing the ratio of capital to loans increasing capital or reducing loans In the midst of a downturn especially of the magnitude of that in East Asia it is hard to raise new capital The alternative is to reduce outstanding loans But as each bank calls in its loans more and more firms are put into distress Without adequate working capital they are forced to cut back on their production cutting into the demand for products from other tirms The downward spiral is exacerbated And with more t1rms in distress the capital adequacy ratio of banks can even be worsened The attempt to improve the financial position of the banks backfIred With a large number of banks shut down and with those manag ing to survive facing an increasingly large number ofloans in distress and unwilling to take on new customers more and businesses found themselves without access to credit Without credit the one glimmer of hope for a recovery would be squashed The depreciation of the currency meant that exports should have boomed as the goods from the region became cheaper by 30 percent or more But while export volumes increased they did not increase nearly as much as expected and for a simple reason to expand export firms needed to have TilE EAST ASIA CRISIS IJ7 working capital to produce more As banks shut down and cut back on their lending fmus could not even get the working capital required to maintain production let alone to expand Nowhere was the IMFs lack of understanding of financial markeu so evident as in its policies toward dosing banks in Indonesia There some sixteen private banks were closed down and notice was given that other banks might be subsequently shut down as well but depositors except for those with very small accounts would be left to fend for themselves Not surprisingly this engendered a run on the remaining private banks and deposits were quickly shifted to state banks which were thought to have an implicit government guaran tee The effects on the Indonesia banking system and economy were disastrous compounding the mistakes in fiscal and monetary policy already discussed and almost sealing that countrys fate a depression had become inevitable In contrast South Korea ignored outside advice and recapitalized its two largest banks rather than closing them down This is part of why Korea recovered relatively quickly Corporate Restructuring While attention focused on financial restructuring it was clear that the problems in the financial sector could not be resolved unless the problems in the corporate sector were effectively addressed With 75 percent of the tirms in Indonesia in distress and half of the loans in Thailand nonperforming the corporate sector was entering a stage of paralysis Firms that are facing bankruptcy are in a state oflimbo it is not dear who really owns them the current owners or the credi tors Issues of ownership are not fully resolved until the firm emerges from bankruptcy But without clear owners there is always a tempta tion for current management and the old owners to strip assets and such asset stripping did occur In the United States and other coun tries when companies go into bankruptcy trustees are appointed by the courts to prevent this Dut in Asia there were neither the legal frameworks nor the personnel to implement trusteeships It was thus imperative that bankruptcies and corporate distress be resolved quickly before stripping could occur Unfortunately IMFs mis I IS mdtd ltllWlllies hlill llllltributtd to tht mess through the high illtlrts rltts whidl trnd so lIIall tirms into distress conspired with Idttlt md spial intlrtsts to dampen the pace of restructuring nit 11 Fs strlttgy tir corporlte restructuringrestructuring the tirms tlllt wrt dltltivdy in bankruptcywas no more successful tlUII its strqy tor restructuring banks It confused linanrial restruc curingtIItlilillg straighttning out who really owns the firm the dischlrgt ttdebt or its conversion to equitywith real restructuring tht lIutsalldbolts decisions what the firm should produce how it should product its output and how it should be organized In the prselKe of the massive economic downturn there were real mac robenetits from rapid financial restructuring Individual participants in the bargaining surrounding bankruptcy workouts would fail to take into account these systemic benefits It might pay them to drag their feetand bankruptcy negotiations are often protracted taking more than a year or two When only a few firrns in an economy are bankrupt this delay has little social cost when many firms are in dis cress the social cost can be enormous as the macroeconomic down turn is prolonged It is thus imperative that the government do whatever it can to facilitate a quick resolution I took the view that the government should play an active role in pushing this financial restructuring ensuring that there were real owners My view was that once ownership issues were resolved the new ovners should set about the task of deciding the issues of real restructuring The IMF took the opposite view saying that the gov ernment should lIot take an active role in financial restructuring but push for real restructuring selling assets for instance to reduce South Koreas seelllillg excess capacity in chips and bringing in outside typ ically foreign management I saw no reason to believe that interna tional bureaucrats trained in macromanagement had any special insight into corporate restructuring in general or the chip industry in particular While restructuring is in any case a slow process the governments of Korea and Malaysia took an active role and suc ceeded within a remarkably short period of time two years in com pleting the fmancial restructuring of a remarkably large fraction of the firms in distress By contrast restructuring in Thailand which fol lowed the IMF strategy languished THE EAST ASIA CIlSIS 111 THE MOST GRIEVOUS MISTAKES RISKING SOCIAL AND POLITICAL TURMOIL The social and political consequences of mishandling the Asian crisu may never be measured fully When the IMFs managing director Michel Camdessus and G22 finance ministers and central bank governors the finance ministers and central bank governors from the major industrial countries plus the major Asian economies including Australia met in Kuala Lumpur Malaysia in early December 1997 I warned of the danger of social and political unrest especially in countries where there has been a history of ethnic division as in Indonesia where there had been massive ethnic rioting some thirty years earlier if the excessively contractionary monetary and fIScal policies that were being imposed continued Camdessus calmly responded that they needed to follow Mexicos example they had to take the painful measures if they were to recover Unfortunately my forecasts turned out to be all too right Just over five months after I warned of the impending disaster riots broke out While the IMF had provided some 23 billion to be used to support the exchange rate and bailout creditors the far far smaller sums required to help the poor were not forthcoming In American parlance there were billions and billions for corporate welfare but not the more modest millions for welfare for ordinary citizens Food and fuel subsidies for the poor in Indonesia were drastically cut back and riots exploded the next day As had happened thirty years earlier the Indonesian businessmen and their families became the victims It was not just that IMF policy might be regarded by softheaded liberals as inhumane Even if one cared little for those who faced star vation or the children whose growth would be stunted by malnutri tion it was simply bad economics Riots do not restore business confidence They drive capital out of a country they do not attract capital into a country And riots are predictablelike any social phe nomenon not with certainty but with a high probability It was clear Indonesia was ripe for such socitl upheaval The IMF itself should have known this around the world the IMF has inspired riots when its policies cut off food subsidies After the riot in Indonesia thl IMF reversed its position food IU lllllIILHlllN ANU ITS DISCONTENTS sulhidits trt rtsto nd But agJin tht IMF showed that it had not kJrlld thl blsic Itssllll irreversibility Just as a firm that was bank rupted bv thl hih inteflst rates does not become unbankrupted whtn the illttrtst fJttS Wtrt lowered a society that is rendered asun dlr lw riots induced by cuttin out food subsides just as it is plunging lIltO itprtssiln is not brought together when the food subsidies are rtstllred Indeed in some quarters the bitterness is all the greater if the tid subsidies could have been afforded why were they taken la in the tirst pbce I hld the opportunity Q talk Q Malaysias prime minister after the riots in Indonesia His country had also experienced ethnic riots in tht Plst Malaysia had done a lot to prevent their recurrence includ ing putting in a program Q promote employment for ethnic Malays NlhJthir kntw that all the gains in building a multiracial society could be lost had he let the IMF dictate its policies to him and his country and then riots had broken out For him preventing a severe recession was not just a matter of economics it was a matter of the sUrval of the nation RECOVERYVINDICATION OF THE IMF POLICIES As this book goes to press the crisis is over Many Asian countries are growing again their recovery slightly stalled by the global slowdown that began in 2000 The countries that managed Q avoid a recession in 1998 Taiwan and Singapore fell into one in 2001 Korea is doing far better With a worldwide downturn affecting the United States and Germany as well no one talked about weak institutions and poor governments as the cause of recessions now they seemed to have remembered that such fluctuations have always been part of market economies But although some at the IMF believe their interventions were successful its widely agreed that serious mistakes were made Indeed the nature of the recovery shows this Almost every economic down turn comes to an end But the Asian crisis was more severe than it should have been recovery took longer than it needed to and prospects for future growth are not what they should be THE EAST ASIA CHIMS II On Wall Street a crisis is over as soon as financial variabla begin to turn around So long as exchange rates are weakening or stock prices falling it is not clear where the bottom lia But once the bot tom has been reached the losses are at least capped and the worst is known However to truly measure recovery stabilization of exchange rates or interest rates is not enough People do not live off exchange rates or interest rates Workers care about jobs and wages Although the unemployment rate and real wages may have bottomed out that is not enough for the worker who remains unemployed or who has seen his income fall by a quarter There is no true recovery until workers return to their jobs and wages are restored to precrisis lev els Today incomes in the countries of East Asia affected by the crisis are still 20 percent below what they would have been had their growth continued at the pace of the previous decade In Indonesia output in 2000 was still 75 percent lower than in 1997 and even Thailand the IMFs best pupil had not attained its precrisis level let alone made up for the lost growth This is not the first instance of the IMF declaring victory prematurely Mexicos crisis in 1995 was declared over as soon as the banks and international lenders statted to get repaid but five years after the crisis workers were just getting back to where they were beforehand The very fact that the IMF focuses on financial variables not on measure of real wages unem ployment GDp or broader measures of welfare is itself telling The question of how best to manage a recovery is difficult and the answer clearly depends on the cause of the problem For many downturns the best prescription is the standard Keynesian one expansionary fiscal and monetary policy The problems in East Asia were more complicated because parI of the problem was weaknesses in financeweak banks and firms with excess leverage But a deep ening recession makes these problems worse Pain is not a virtue in its own right pain by itself does not help the economy and the pain caused by lMF policies deepening recession made recovery more difficult Sometimes as in Latin America in Argentina Brazil and a host of other countries during the 1970s crises are caused by profli gate governments spending beyond their means and in those caes the government will need to ClIt back ellpenditures or inLreae taxesdecisions which are painfill at least in the political sense But I l1 llHIILTlllN NU ITS I ISCllNTNTS btllIse ElSt Asil Iud Iltither loost monttary policies nor profligate public sedllrsintlltion was low and smblt and budgets prior to the aisis Wtn in surplusthost were not tht right measures for dealing with Elst Asils aisis Tht pmbltm with the IMFs mistakes is that they are likely to be Illnlisting The IMF otten talked as if what the economy needed WIS 1 gllld purgltive Take the pain the deeper the pain the stronger the subsqutnt growth In the IMF theory then a country con trIItd bout its hgnlll prospectssay twenty years from now should swJJlow hard and accept a deep downturn People today would sutTer but their children at least would be better off Unfortu l1Jtdy the evidence does not support the IMFs theory An economy whih has J deep recession may grow faster as it recovers but it never makes lip for the lost time The deeper todays recession the lower the Iikdy income even twenty years from now It is not as the IMF claims that they are likely to be better off The effects of a recession are longlasting There is an important implication The deeper the recession today not only is output lower today but the lower output is likely 0 be for years to come In a way this is good news since it means that the best medicine for todays health of the economy and the best medicine for tomorrows coincide It implies that economic policy should be directed at minimizing the depth and duration of Jny economic downturn Unfortunately this was neither the inten tion nor the impact of the IMF prescriptions Malaysia and China By contrasting what happened in Malaysia and in China two nations that chose not to have IMF programs with the rest of East Asia which did the negative effects of the IMF policies will show clearly Malaysia was severely criticized during the crisis by the international financial community Though Prime Minister Mahathirs rhetoric and human rights policies often leave much to be desired many of his economic policies were a sllccess Malaysia was reluctant to join the IMF program partly because officials there did not want to be dictated to by olltsiders but also because they had little confidence in the 1M F Early on in the 1997 THf EAST ASIA CUI SIS U crisis lMF chief Michael Camdessus announced that Malayw banks were in a weak position An lMFWorid Bank team was quickly dispatched to look at thl countrys banking system While there was a high level of non performing loans 15 Malaysias Cen tral Bank had imposed strong regulations which had resulted in banks making adequate provisions for these losses Moreover Malaysia strong regulatory stance had prevented banks from expo sure to foreign exchange volatility the danger of borrowing in dol lars and lending in ringgit and had even limited the foreign indebtedness of the companies to which these banks lent precau tionary prescriptions which were at the time not part of the IMF standard package The standard way to assess the strength of a banking system is to subject it in simulation exercises to stress tests and evaluate its response under different economic circumstances The Malaysian banking system fared quite well Few banking systems could survive a long recession or a depression and Malaysias was no exception but Malaysias banking system was remarkably strong During one of my many visits to Malaysia I saw the discomfort of the IMF staffers writ ing the report how to formulate it without contradicting the manag ing directors assertions and yet remain consistent with the evidence Within Malaysia itself the issue of the appropriate respome to the crisis was hotly debated Finance Minister Anwar Ibrahim proposed an lMF program without the lMF that is raising interest rates and cutting back on expenditures Mahathir remained skeptical Eventu ally he dumped his finance minister and economic policies were reversed As the regional crisis grew into a global crisis and international capital markets went into a seizure Mahathir acted again In Septem ber t 998 Malaysia pegged the ringgit at 380 to the dollar cut inter est rates and decreed that all offihore ringgit be repatriated by the end of the month The government also imposed tight limits on transfers of capital abroad by residents in Malaysia and troze the npa triation of foreign portfolio capital for twelve months These mea sures were announced as short term and were carefully designed to make it clear that the country W1S not hostile to longterm foreiWJ investment Those who had investld money in Malaysia and had lllllIHlHHlN ND ITS DISCONTENTS protits were l110Wtd to Ike thelll out 011 September 7 1998 in a nowtllllcHIS clulllll ill hrwllt magazine the noted economist Paul KrlllIllIl urtd Maluthir to impose capital controls But he was in the lIlillCrirv Illiysias Central Bank governor Ahmad Mohamed 11 lIlel his dtpury FOlIg WtlIg Phak both resigned reportedly btClllSt the disagrted wirh rhe imposirion of the controls Some ecollclIlimthose from Wall Street joined by the IMFpredicted JiSlst Whtll the controls were imposed saying foreign investors culd he sartd off tor years ro come They expected foreign invest Illent 0 plummtr rht stock market to fall and a black market in the rillgir wirh irs accompanying distortions to form And they arntd whilt the controls would lead to a drying up of capital Illris rhty would be ineffective in stopping capital ouiflows Capital Highr would occur anyway Pundits predicted that the economy 0uld sutfer growth would be halted the controls would never be litrtd and rhar Malaysia was postponing addressing the underlying problems Evtn Treasury Secretary Robert Rubin usually of such quitr dtmtanorjoined in the communal tonguelashing In tacr rhe outcome was far different My team at the World Bank worked with Malaysia Q convert the capital controls into an exit tax Since rapid capital flows into or out of a country cause large distur bances they generate what economists call large externalities tffecLs on orher ordinary people not involved in these capital flows Such flOvs lead ro massive disturbances to the overall economy Gov ernmtnt has the right even the obligation to take measures to lddress such disturbances In general economists believe that market blsed interventions such as taxes are more effective and have fewer adverse side effects than direct controls so we at the World Bank encouraged Malaysia to drop direct controls and impose an exit tax Moreover the tax could be gradually lowered so that there would be no large disrurbance when the interventions were finally removed Thin6S worked jusr as planned Malaysia removed the tax just as it had promised one year after the imposition of controls In fact Malaysia had once before imposed temporary capital controls and had removed them as soon as things stabilized This historical experi ence was ignored by those who attacked the country so roundly In the oneyear interim Malaysia had restructured its banks and corpo TilE EAST ASIA CNISIS rations proving the critics who had said that it was only with the discipline that comes from free capital markets that governments ever do anything serious wrong once again Indeed it had made far more progress in that direction than Thailand which followed the IMF prescriptions In retrospect it was clear that Malaysias capital conuob allowed it to recover more quickly with a shaDower downturn I and with a far smaller legacy of national debt burdening future growth The controls allowed it to have lower interest rates than it could oth erwise have had the lower interest rates meant that fewer firms were put into bankruptcy and so the magnitude of publicly funded corpo rate and financial bailout was smaller The lower interest rues meant too that recovery could occur with less reliance on fiscal policy and consequently less government borrowing Today Malaysia stands in a far better position than those countries that took IMF advice There was little evidence that the capital control dicouraged foreign investors Foreign investment actually increased16 Because investors are concerned about economic stability and because Malaysia had done a far better job in maintaining that stability than many of its neighbors it was able to attract investment CHINA WAS THE other country that followed an independent course It is no accident that the two large developing countries spared the ravages of the global economic crisisIndia and China both had capitl controls While developing world countries with lib eralized capital markets actually saw their incomes decline India grew at a rate in excess of 5 percent and China at close to 8 perrent This is all the more remarkable given the overall slowdown in world growth and in trade in particular during that period China achieved this by following the prescriptions of economic orthodoxy These were not the Hooverite IMF prescriptions but the standard pre scriptions that economists have been teaching for more than half a century When faced with an economic downturn respond with expansionary macroeconomic policy China seized the opportunity to combine its shortrun needs with longrun growth objectjves The rapid growth over the preceding decade anticipated to continue into the next cennlry created enormOllS dcmands on infrastructure There wcre large opportunities for public investments with high returns Il llllHILUlllN AND ITS DISCONTENTS includin PfLljlcrS undefway th3t wefe sped up and projects that Il tiftld dlsinld hut had been put 011 the shelf for lack of tilllds Thl stmdlrli lIIediLillls workld and China awrted a growth slowdLIl khilt 111lkill economic policy dlcisions China was aware of tht link hltwll1l lIIacrostability alld its microeconomy It knew that It neeLkd to continue flstructuring its corporate and financial sec Wf HOWllf it 31so flcognized that an economic slowdown would Jllkl it ill thl morl ditIicult to procled with a reform agenda An economic slowdown would throw more firms into distress and Juke morl loans nonperforming thereby weakening the banking system An lconomic slowdown would also increase unemploy mlnt and rising unemployment would make the social costs of flstructuring the state enterprises much higher And China recog niZld thl links between economics and political and social stability It had in its recent history all toO often experienced the conse quences of instability and wanted none of that In all respects China fully appreciated the systemic consequences of macroeco nomic policies consequences that the IMF policies habitually over looked This is not to say that China is out of the woods The restructuring of its banking and stateowned enterprises still represents a challenge fOf it in the years ahead But these are challenges that can be far bet ter addressed in the context of a strong macroeconomy Though the differences in individual circumstances make the rea sons either for the occurrence of a crisis or for quick recovery hard to ascertain I think it is no accident that the only major East Asian country China to avert the crisis took a course directly opposite that advocated by the IMF and that the country with the shortest down turn Malaysia also explicitly rejected an IMF strategy Korea Thailand and Indonesia Korea and Thailand provide further contrasts After a short period of policy vacillation from July through October 1997 Thailand fol lowed IMF prescriptions almost perfectly Yet more than three years after the beginning of the crisis it was still in recession with a GDP TilE EAST ASIA CRISIS 117 approximately 23 percent below the precrisis level Litde corporate restructuring had taken place and dose to 40 percent of the loans were still non performing In contrast Korea did not close down banks according to the stan dard IMF prescription and the Korean government like Malaysias took a more active role in restructuring corporations Moreover Korea kept its exchange rate low rather than letting it rebound This was ostensibly to enable it to reestablish its reserves since by buying dollars for its reserves it depressed the value of the won Actually Korea kept the exchange rate low in order to sustain exports and limit imports Moreover Korea did not follow the IMFs advice con cerning physical restructuring The IMF acted as if it knew more about the global chip industry than these firrns who had made it their business and argued that Korea should quickly get rid of the excess capacity Korea smartly ignored this advice As the demand for chips recovered the economy recovered Had the IMFs advice been followed the recovery would have been far more muted In evaluating the recoveries most analysts put Indonesia aside simply because the economy has been dominated by political events and social turmoil However the political and social turmoil are themselves attributable in no small measure to IMF policies as we have seen No one will know whether there could have been a more gracful transition from Suharto but few would doubt that it could have been more tumultuous Effects on the Future Despite the many hardships the East Asian crisis has had salutary effects East Asian countries will undoubtedly develop better financial regulatory systems and better financial institutions overall Though ItS firms had already demonstrated a remarkable ability to compete in the global marketplace Korea is likely to emerge with a more compet itive economy Some of the worst aspects of corruption the socalled crony capitalism will have been checked However the manner in which the crisis was addressedparticu larly the use of higb interest ratcsis likely to have a significantly adverse effect on the regions intermcdiate and possibly longterm IS IOIlL1L nON ND ITS DISCONTENTS lollomi mwth TIllrt is I clrtun irony in the central reason for this WlJk ulldtrrlulattd tlnancial institutions art bad because they kld ll bld rlSUflt allocations Whill East Asias banks were far from ptrttd lltr till prtclding thrll dlcadls thlir achievements in allo Itill tlw lllormous rlows of capital were in fact quite impressive this IS whJt sustainld thlir rapid growth Although the intention of tlwst pushing lor rdorms in East Asia was to improve the ability of cllt tlnJllcitl systlm to allocate resources in fact the IMFs policies Irl likdy to haw impaired the overall efficiency of the market Around the world Vlry little new investment is financed by raising nlW lquiry sdling shares of stock in a company Indeed the only ountries with widely diversified share ownership are the United Statls the Unitld Kingdom and Japan all of which have strong legal systlms and strong shareholder protections It takes time to develop thlSl Itgal institutions and few countries have succeeded in doing so In thl mlantime firms around the world must rely on debt But debt is inherently risky IMF strategies such as capital market liberalization and raising interest rates to exorbitant levels when a crisis occurs make borrowing even riskier To respond rationally firms will engage in lower levels of borrowing and force themselves to rely more heav ily on retained earnings Thus growth in the future will be con strained and capital will not flow as freely as it otherwise would to tht most productive uses In this way IMF policies lead to les effi citnt resource allocation particularly capital allocation which is the Care est resource in developing countries The IMF does not take this Impairment into account because its models do not reflect the reali ties of how capital markets actually work including the impact of the imperfections of information on capital market EXPLAINING THE MISTAKES While the IMF now agrees it made serious mistakes in its fiscal pol icy advice in how it pushed bank restructuring in Indonesia in perhaps pushing capital market liberalization prematurely and in underestimating the importance of the interregional impacts by which the downfall of one country contributed to that of its neigh TilE EAST ASIA CRISIS lli bors it has not admitted to the mistakes in its monetary policy nor has it even sought to explain why its models failed so mi5erably in predicting the course of events It has not sought to develop an alter native intellectual frameimplying that in the next crisis it may well make the same mistakes In January 2002 the lMF chalked up one more failure to its creditArgentina Part of the reason is its insis tence once again on contractionary fiscal policy Part of the explanation of the magnitude of the failures has to do with hubris no one likes to admit a mistake especially a mistake of this magnitude or with these consequences Neither Fischer nor Summers neither Rubin nor Camdessus neither the IMF nor the US Treasury wanted to think that their policies were misguided They stuck to their positions in spite of what I viewed as over whelming evidence of their failure When the IMF finally decided to support lower interest rates and reversed its support for fiscal con traction in East Asia it said it was because the time was right I would suggest that it reversed courses partly due to public pressure But in Asia other theories abound including a conspiracy theory that I do not share which views the policies either as a deliberate attempt to weaken East Aiathe region of the world that had shown the greatest growth over the previous forty yearsor at least to enhance the incomes of those on Wall Street and the other money centers One can understand how this line of thinking developed The IMF first told countries in Asia to open up their markets to hot shortterm capital The countries did it and money flooded in but just as suddenly flowed out The IMF then said interest rates should be raised and there should be a fiscal contraction and a deep reces sion was induced As asset prices plummeted the IMF urged affected countries to sell their assets even at bargain basement prices It said the companies needed solid foreign management conveniently ignoring that these companies had a most enviable record of growth over the preceding decades hard to reconcile with bad management and that this would only happen if the companies were sold to for eignersnot just managed by them The sales were handled by the same foreign financial institutions that had pulled out their capital precipitating the crisis These banks then got large commissions from their work selling the troubled companies or splitting them upjust as Illl GLlIlUllUIllN AND ITS DISCONTENTS thtY hld got iJrge wuunissions when they had originally guided the UIlIUe into tht countries in the tlrst place As the events unfolded clliilII rew even greater some of these American and other tiIllIKi11 clIIplnies didnt do much restructuring they just held the JSets until the economy recovered making profits from buying at he tire stle prices and selling at more normal prices I believe thac chere is a simpler set of explanationsthe IMF was noc plrticipacing in a conspiracy but it was reflecting the interests JIld ideology of che Wescern financial community Modes of opera ion which were secretive insulated the institution and its policies from che kind of intensive scrutiny that might have forced it to use models md adopt policies that were appropriate to the situation in Easc Asia The failures in East Asia bear much in common with those in development and in transition and in chapters 8 and 9 we will cake J closer look at the common causes AN ALTERNATIVE STRATEGY In response to the complaints I continue to raise about the IMF Treasury strategy my critics have righdy asked what I would have done This chapter has already hinted at the basic strategy Maintain the economy at as close to full employment as possible Attaining that objective in turn entails an expansionary or at least not contrac tionary monetary and fiscal policy the exact mix of which would depend on the country in question I agreed with the IMF on the importance of financial resttucturingaddressing the problems of weak banksbut I would have approached it totally differendy with a primary objective of maintaining the flow of finance and a stand still on existing debt repayment a debt restructuring such as that which eventually worked for Korea Maintaining the flow of finance in turn would require greater efforts at restructuring existing institu tions And a key part of corporate restructuring would entail the implementation of a special bankruptcy provision aimed at the quick resolution of distress resulting from the macroeconomic disturbances that were well beyond the normal The US bankruptcy code has provisions which allow for relatively quick reorganization of a firm TilE EAST ASIA CRISIS 131 rather than liquidation called ChapleT 11 Bankruptcy induced by macroeconomic disturbances as in East Asia call for an even faster resolutionin what I refer to as a superChapleT 11 With or without such a provision strong intervention of govern ment was required But the intervention of the government would have aimed at financial restructuringestablishing clear ownership of firms enabling them to reenter credit markets That would have enabled them to take full advantage of the opportunities for expon that resulted from their lower exchange rate It would have elimi nated the incentive for asset stripping it would have provided them with strong incentives to engage in any real restructuring that was requiredand the new owners and managers would have been in a far better position to guide this restructuring than international or domestic bureaucrats who as the expression goes had never met a payroll Such financial restructuring did not require huge bailouts The disillusionment with the large bailout strategy is now almost universal I cannot be sure that my ideas would have worked but there is little doubt in my mind that the chance of success with this strategy was far greater than with the IMFs plan which failed in ways that were perfectly predictable at huge costs The IMF did not learn quickly from its failures in East Asia With slight variants it repeatedly tried the large bailout strategy With the failures in Russia Brazil and Argentina it has become clear chat an alternative strategy is required and there is today increasing suppon for at least some of the key elements of the approach I have just described Today five years after the onset of the crisis the IMF and the G7 are all talking about giving greater emphasis to bankruptcy and standstills shortterm freezes on payment and even the tempo rary use of capital controls We will return to these reforms later in chapter 9 THE ASIAN CRISIS has brought many changes that will stand the countries in good stead in the future Corporate governance and accounting standards have improvedin some cases putting these countries toward the top of the emerging markets The new constitu tion in Thailand promises a stronger democracy including a provi sion embracing the citizens right to know not even incJudtd in I Jl CLOIIM ILHION ND ITS ISCNTNTS tht US CClIlstituriclLl promising a levd of transparency certainly bcHmd tlut Lttht inttfIlJtional financial institurions Many of these dlJncs pur in pIJc conditions lor cVtn more robust growth in the tlaurc Ula otlScin these ains are some real losses The way the IMF JpproJhed the crisis has lett in most of the countries a legacy of pri ate JIld public debt It has not only frightened firms off the exces id hih debt that characterized Korea but even off more cautious debt leels the exorbitant interest rates forcing thousands of firms into bJnkruptcy showed how even moderate levels of debt could be highly risky As a result firms will have to rely more on selffinance In dfect capital markets will work less efficientlya casualty too of the IMFs ideological approach to improving market efficiency And most important growth ofliving standards will be slowed The IMF policies in East Asia had exactly the consequences that have brought globalization under attack The failures of the interna tional institutions in poor developing countries were longstanding but these failures did not grab the headlines The East Asia crisis made viid to those in the more developed world some of the dissatisfac tion that those in the developing world had long felt What took place in Russia through most of the 1990s provides some even more arresting examples why there is such discontent with international institutions and why they need to change CHAPTER 5 WHO LOST RUSSIA W ITH THE FAll of the Berlin Wall in late 1989 one of the most important economic transitions of all COle began It was the second bold economic and social experiment of the century I The first was Russias transition to com munism seven decades earlier Over the years the failures of this first experiment became apparent As a consequence of the 1917 Revolu tion and the Soviet hegemony over a large part of Europe afterWorld War II some 8 percent of the worlds population that lived under the Soviet Communist system forfeited both political freedom and eco nomic prosperity The second transition in Russia as well as in Eat ern and Southeastern Europe is far from over but this much is clear in Russia it has fallen far short of what the advocates of the market economy had promised or hoped for For the majority of those liv ing in the former Soviet Union economic life under capitalism has been even worse than the old Communist leaders had said it would be Prospects for the future are bleak The middle class has been dev astated a system of crony and mafia cdpitalism has been creactd and the one achievement the creation of a democracy with meaningful freedoms including a free press appears fragilc at best particularly a formerly independent TV statiom are shut down onc by one While those in Russia must bear mllch of the blame for what has happened IU lLlllIIIlHlllN Nll ITS DISCONTIiNTS hl VlSlrI Idvistrs tsptcially from the United States and the IMf who IIl1rchtd ill so quickly 0 preach the gospd of the market econ ellllY lIIust lIstl tJkt sOllle blame At the very least they provided sup pel ttl theISt who led Russia and many of the other economies dowlI he PJths hey tollowed arguing for a new religionmarket tlllldlmentlIimlas a substitute for the old oneMarxismwhich Iud proed so dcticient Russia is an evcruntolding drama Few anticipated the sudden dissolution of the Soviet Union and few anticipated the sudden res ignation of Boris Ydtsin Some see the oligarchy the worst excesses of the Ydtsin years as already curbed others simply see that some of the oligarchs have fallen from grace Some see in the increases in output hJt hJve occurred in the years since its 1998 crisis as the beginning of J renaissance one which will lead to the recreation of a middle class others see it as taking years just to repair the damage of the past decade Incomes today are markedly lower than they were a decade ago and poverty is much higher The pessimists see the country as a nuclear power wavering with political and social instability The opti mists see a semiauthoritarian leadership establishing stability but at the price of the loss of some democratic freedoms Russia experienced a burst of growth after 1998 based on high oil prices and the benefits of the devaluation which the IMF so long opposed But as oil prices have come down and the benefits of the devaluation have been reaped growth too has slowed Today the eco nomic prognosis is somewhat less bleak than it was at the time of the 199H crisis but it is no less uncertain The government barely made ends meet when oil pricesthe countrys main exportswere high If oil prices fall as they seem to be as this book goes to press it could spell real trouble The best that can be said is that the future remains cloudy It is not surprising that the debate over who lost Russia has had sllch resonance At one level the question is clearly misplaced In the United States it evokes memories of the debate a half century ago about who lost China when the Communists took over that coun try But China was not Americas to lose in 1949 nor was Russia Americas to lose a half century later In neither case did America and the Western European countries have control over the political and WHO LOST RussJ social evolution At the same time it is clear that something ha5 dearly gone wrong not only in Russia but also in most of the more than twenty countries that emcrged from the Soviet empire The IMF and other Western leaders claim that matters would have been far worse were it not for their help and advice We had then and we have now no crystal ball to tell us what would happen if alternative policies were pursued We have no way of running a con trolled experiment going back in time to try an alternative strategy We have no way of being certain of what might have been But we do know that certain political and economic judgment calls were made and we know that the outcomes have been disas trous In some cases the link between the policies and the conse quences is easy to see The IMF worried that a devaluation of the ruble would set off a round of inflation Its insistence on Russia maintaining an overvalued currency and its supporting that with bil lions of dollars of loans ultimately crushed the economy When the ruble was finally devalued in 1998 inflation did not soar as the IMF had feared and the economy experienced its first significant growth In other cases the links are more complicated But the experiences of the few countries that followed different policies in managing their transitions help guide us through the maze It is essential that the world make an informed judgment about the IMF policies in Russia what drove them and why they were so misguided Those myself included who have had an opportunity to see firsthand how deci sions were made and what their consequences were have a special responsibility to provide their interpretations of relevant events There is a second reason for a reappraisal Now over ten years atier the fall of the Berlin Wall it is clear that the transition to a market economy will be a long struggle and many if not m05t of the isues that seemed settled only a few years ago will need to be resited Only if we understand the mistakes of the past can we hope to dtsign policies that are likely to be effective in the future The leaders of the 1917 Revolution recognized that what was at stake was more than a change in economics it was a change in soci ety in all of its dimensions So loO the transition trom communism to a market economy was morc thtn just an economic experiment it was a transformation of societies and of social and political stm ctu res lil1I1UILHION ANU ITS LISCONTNTS Pari III the rllSlllI tllr th dislllal results of the economic transition IS th tlilurt tll rlllllIize the nlrality of thtse other components TIl tirsr Rlliurillll rtcolIiZtd how difficult the task of transfor lIIuillll as lIld thl rtvolurionarits believed that it could not be llyomplisllt1 by dtmllcrJtil 1IItIIS it had to be led by the dictator hip of thl pmittJriu Some of the leaders of the second revolution ill tht NO u tirst thought that freed from the shackles of commu nism tht Russi1ll people would quickly appreciate the benefits of the lIurktt Bur some of the Russian market reformers as well as their estcrn supporters and advisers had very little faith or interest in dtmocrJcy tearing that if the Russian people were allowed to hllllSt they would not choose the correct that is their economic llIodd In Eastern Europe and the former Soviet Union when these nIJrktt rdorm benefits failed to materialize in country after coun try democratic elections rejected the extremes of market reform and put sOliJI democratic parties or even reformed Communist parties IlIJny with former Communists at the helm into power It is not sur prising that many of the market reformers showed a remarkable ltTinity to the old ways of doing business in Russia President Yeltsin ith enormously greater powers than his counterparts in any West ern democracy was encouraged to circumvent the democratically dected Duma parliament and to enac market reforms by decree2 It is as if the market Bolsheviks native true believers as well as the Wetern txpert and evangelists of the new economic religion who Ntw into the postSocialist countries attempted to use a benign ver sion of Ltnin s methods to steer the postcommunism democratic transirion THE CHALLENGES AND OPPORTUNITIES OF TRANSITION As the transition began III the early 1990s it presented both great challenges and opportunities Seldom before had a country deliber ately set out to go from a situation where government controlled vir tually every aspect of the economy to one where decisions occurred through markets The Peoples Republic of China had begun its tran WHO LUST RUSSIA J 37 sition in the late 1970s and was still far from a fullfledged nurket economy One of the most successful transitions had been Taiwan 100 miles off the shore of mainland China It had been a Japanese colony since the end of the nineteenth century With Chinas 1949 revolution it became the refuge for the old Nationalist leadership and from their base in Taiwan they claimed sovereignty over the entire mainland keeping the namethe Republic of China They had nationalized and redistributed the land established and then par tially privatized an array of major industries and more broadly cre ated a vibrant market economy Mter 1945 many countries including the United States moved from wartime mobilization to a peacetime economy At the time many economists and other experts feared a major recession would follow wartime demobilization which entailed not only a change in how decisions were made end ing versions of command economies in which wartime governments made the major decisions about production and returning to private sector management of production but also an enormous reallocation of production of goods for example from tanks to cars But by 1947 the second full postwar year production in the United States was 96 percent higher than 1944 the last full war year By the end of the war 37 percent of GOP 1945 was devoted to defense With peace this number was brought down rapidly to 74 percent 1947 There was one important difference between the transition from war to peace and from communism to a market economy as I will detail later Before World War II the United States had the basic mar ket institutions in place even though during the war many of these were suspended and superseded by a command and control approach In contrast Russia needed both resource redeployment alld the wholesale creation of market institutions But Taiwan and China faced similar problems to the economies in transition Both faced the challenge of a major transformation of their societies including the establishment of the instirutions that underlay a market economy Both have had truly impressive suc cesses Rather than prolonged transition recession they had close to doubledigit growth The radical economic reformers who sought to advise Russia and many of the other countries on transition paid scant attention to these experiences Jnd the lessons that could be GlllHHILHION AND ITS UISCONTENTS Ielflled It was not btcJuse thy bdiwd that Russian history or the history 01 thl other countries making th trlIlsition made these lessons inlpplicJblt They studiously ignord th advice of Russian scholars whthr thy wr xprts in its history conomics or soci et tllr J simpl rason thy bdieved that th market revolution which JS lbout to occur mad all of th knowledge available trom thse other disciplins irrdvant What th market fundamen talists prJChd was txtbook conomicsan owrsimplified version of nurket conomics which paid scant attention to the dynamics of chang Consider th problems facing Russia or the other countries in lJ8lJ Thr wr institutions in Russia that had names similar to thos in th West but they did not perform the same functions There wre banks in Russia and the banks did garner savings but they did not make decisions about who got loans nor did they have the rsponsibiliry tor monitoring and making sure that the loans were rpaid Rathr thy simply provided the funds as dictated by the governments cntral planning agcmcy There were firms enterprises producing goods in Russia but the nterprises did not make deci sions they producd what they were told to produce with inputs raw material labor machines that were allocated to them The nlajor scope for entrepreneurship lay in getting around problems posed by the government the government would give enterprises quotas on output without necessarily providing the inputs needed but in some cases providing more than necessary Entrepreneurial managers engaged in trades to enable themselves to fulfill their quo tas in the meanwhile getting a few more perks for themselves than they could have enjoyed on their official salaries These activities which had llways been necessary to make the Soviet system merely functionled to the corruption that would only increase as Russia moved to a market economy3 Circumventing what laws were in force if not breaking them outright became part of the way of life a precursor to the breakdown of the rule of law which was to mark the transition As in a market economy under the Soviet system there were prices but the prices were set by government fiat not by the market Some prices such as those for basic necessities were kept artificially WHO LOST RUSSIA IlY lowenabling even those at the bottom of the income distribution to avoid poverty Prices for energy and natural resources also WcK kept artificially lowwhich Russia could only afford because of its huge reservoirs of these resources Oldfashioned economics textbooks often talk about market eco nomics as if it had three essential ingredients prices private propert and profits Together with competition these provide incentives coordinate economic decision making ensuring that firms produce what individuals want at the lowest possible cost But there has also long been a recognition of the importance of institutions Most important are legal and regulatory frameworks to ensure that con tracts are enforced that there is an orderly way of resolving commer cial disputes that when borrowers cannot repay what is owed there are orderly bankruptcy procedures that competition is maintained and that banks that take depositors are in a position to give the money back to depositors when they ask This framework of laws and agencies helps ensure that securities markets operate in a fair manner that managers do not take advantage of shareholders nor majority shareholders of minority shareholders In the nations with mature market economies the legal and regulatory frameworks had been built up over a century and a half in response to problems encoun tered in unfettered market capitalism Bank regulation came into place after massive bank failures securities regulation after major episodes in which unwary shareholders were cheated Countries seeking to create a market economy did not have to relive these dis asters they could learn from the experiences of others But while the market reformers may have mentioned this institutional infrastruc ture they gave it short shrift They tried to take a shortcut to capiul ism creating a market economy without the underlying institutions and institutions without the underlying institutional infrastructure Before you set up a stock market you have to make sre there are real regulations in place New firms need to be able to raise new cap ital and this requires banks that are real banks not the kinds of banks that characterized the old regime or banks that simply lend money to government A real and effective banking system requires strong banking regulations New firms need to be able to acquire land and this requires a land market and land regitration CUllIIILATION AND iTs DISCONTENTS Silllilirly in Switttr1 agriculmre tarnlers used to be given the Sttds Ind 1trtiliZtr they needed They did not have to worry about gttting thtst 1111 ther inputs such as tractors or marketing their lHltpUt Undtr 1 mlrktt economy markets for inputs and outputs had to bt lrtlttll IlId this required new firms or enterprises Social insti tutions Irt lIso important Under the old system in the Soviet Union thtre was no unemployment and hence no need for unem ploYIllent insurlnce Workers typically worked for the same state tnterprise lor their entire lives and the firm provided housing and retirelllent bendits In post1989 Russia however if there were to be J bbor market individuals would have to be able to move from firm co tirm But if they could not obtain housing such mobility would be almost impossible Hence a housing market was necessary A min imallevel of social sensitivity means that employers will be reluctant to tire workers if there is nothing for them to fall back on Hence there could not be much restructuring without a social safety net Unformnately neither a housing market nor a real safety net existed in the new Russia of 1989 The challenges facing the economies of the former Soviet Union and the other Communist bloc nations in transition were daunting they had to move from one price systemthe distorted price system that prevailed under communismto a market price system they had to create markets and the institutional infrastructure that under lies it and they had to privatize all the property which previously had bdonged to the state They had to create a new kind of entrepre neurshipnot just the kind that was good at circumventing govern ment ruts and lawsand new enterprises to help redeploy the resources that had previously been so inefficiently used No matter how one looked at it these economies faced hard choices and there were fierce debates about which choices to make The most contentious centered on the speed of reform some experts worried that if they did not privatize quickly creating a large group of people with a vested interest in capitalism there would be a rever sion to communism But others worried that if they moved too quickly the reforms would be a disastereconomic failures com pounded by political corruptionopening up the way to a backlash WHO LOST RUSSIA either from the extreme left or right The former chool was called shock therapy the latter gradualist The views of the shock therapistsstrongly advocated by the us Treasury and the IMFprevailed in most of the coumries The grad ualists however believed that the transition to a market economy would be better managed by moving at a reasonable speed in good order sequencing One didnt need to have pNjec institutions but to take one example privatizing a monopoly before an effective competition or regulatory authority was in place might simply replace a government monopoly with a private monopoly even more ruthless in exploiting the consumer Ten years later the wisdom of the gradualist approach is at last being recognized the tonoises have overtaken the hares The gradualist critics of shock therapy not only accurately predicted its failures but also outlined the reasons why it would not work Their only failure was to underestimate the magnitude of the disaster If the challenges posed by transition were great so were the opportunities Russia was a rich country While three quarters of a century of communism may have left its populace devoid of an understanding of market economics it had left them with a high level of education especially in technical areas so important for the New Economy After all Russia was the first coumry to send a man into space The economic theory explaining the failure of the communism was clear Centra1ized planning was doomed to failure simply because no government agency could glean and process all the rele vant information required to make an economy function well Without private property and the profit motive inceiltivesespe cially managerial and entrepreneurial incentiveswere lacking Th restricted trade regime combined with huge subsidies and arbitrarily set prices meant the system was rife with distortions It followed that replacing centralized planning with a decentral ized market system replacing public ownership with private prop erty and eliminating or at least reducing the distortions by liberalizing trade would cause a burst of economic output The CUt back in military expenditureswhich had absorbed a huge share of tlllllllLHlllN Nll ITs DISCONTENTS 1 W wl111 tht USSR was still in existence tive times larger than in he Pllstcld war trlpnwided even more room for increases in stlIIiJrds f Iivill Illstead however the standard of living in Russia llId IllJIIV ftht ther East European transition countries fell THE REFORM STORY The tirsc mistakes occurred almost immediately as the transition began In the enthusiasm to get on with a market economy most prices were freed overnight in 1992 setting in motion an inflation thlt wiped out savings and moved the problem of macrostability to the top of the agenda Everybody recognized that with hyperinfla tion intiation at doubledigit rates per month it would be difficult to have a successful transition Thus the first round of shock therapy instantaneous price liberalizationnecessitated the second round bringing inflation down This entailed tightening monetary policy raising interest rates While most of the prices were completely freed some of the most important prices were kept lowthose for natural resources With the newly declared market economy this created an open invita tion If you can buy say oil and resell it in the West you could make millions or even billions of dollars So people did Instead of making mony by creating new enterprises they got rich from a new form of th old entrepreneurshipexploiting mistaken government poli cis And it was this rentseeking behavior that would provide the basis of the claim by reformers that the problem was not that the reforms had been too quick but that they had been too slow If only all prices had been freed immediately There is considerable validity in this argument but as a defense of the radical reforms it is disingen uous Political processes never give the technocrat free rein and for good reason as we have seen technocrats often miss out on impor tant economic social and political dimensions Reform even in wellfunctioning political and economic systems is always messy Even if it made sense to push for instantaneous liberalization the more relevant question is how should one have proceeded with lib WHO LOST RUSSIA 143 eralization if one could not succeed in getting important sectorslike energy prices liberalized quickly Liberalization and stabilization were two of the pillars of the radi cal reform strategy Rapid privatization was the third Hut the first two pillars put obstacles in the way of the third The initial high infu tion had wiped out the savings of most Russians so there were not enough people in the country who had the money to buy the enter prises being privatized Even if they could afford to buy the enter prises it would be difficult to revitalize them given the high interest rates and lack of financial institutions to provide capital Privatization was supposed to be the first step in the process of restructuring the economy Not only did ownership have to change but so did management and production had to be reoriented from producing what firms were told to produce to producing what con sumers wanted This restructuring would of course require new investment and in many cases job cuts Job cuts help overall effi ciency of course only if they result in workers moving from low productiviry jobs to highproductiviry employment Unfortunately too little of this positive restructuring occurred partly because the strategy put almost insurmountable obstacles in the way The radical reform strategy did not work gross domestic product in post1989 Russia fell year after year What had been envisioned as a short transition recession turned into one of a decade or more The bottom seemed never in sight The devastationthe loss in GDP was greater than Russia had suffered in World War II In the period 194046 the Soviet Union industrial production fell 24 percent In the period 199099 Russian industrial production fell by almost 60 percenteven greater than the fall in GDP 54 Those familiar with the history of the earlier transition in the Russian Revolution 10 communism could draw some comparisons betwetn that socioeconomic trauma and the post1989 transition farm livestock decreased by half investment in manufacturing came almost ro a stop Russia was able to attract some foreign investment in narural resources Africa had shown long ago that if you price narural resources low enough it is easy to attract foreign investment in them The stabilizationliberalizationprivatization program was of course not a growth program It was intended to set the precondi IlOL1LHION Nl ITS UISCllNTENTS rillllS Illr rllwth nsrtII it stt tht preconditions for decline Not lIIh was inHsrllllm hlrlI bm capital was ustd upsavings vapor iud lw inlbrilln It procttis of privatization or foreign loans largely lIIislpprllprilrt1 IriJtizJtion accompanied by the opening of the lpir1I nlJrktrs Itd nor to wealth creation but to asset stripping It WJS ptrtcrlv loicJ An oligarch who has just been able to use polit ill intlutIKt 0 gJrner assets worth billions after paying only a pit UlKt would naturJlly want to get his money out of the country Kttping money in Russia meant investing it in a country in deep dtprcssion Jnd risking not only low returns but having the assets eized by the next government which would inevitably complain quitt rightly about the illegitimacy of the privatization process Anmnt smJrt enough to be a winner in the privatization sweep stJkts would be smart enough to put their money in the booming us stock market or into the safe haven of secretive offihore bank Jccounts It vas not even a close call and not surprisingly billions poured om of the country Tht IMF kept promising that recovery was around the corner By 1997 it had reason for this optimism With output having already tJlltn 41 percent since 1990 how much further down could it go lksidts the country was doing much of what the Fund had stressed It had liberalized if not completely it had stabilized if not com pltttiy inflation rates were brought down dramatically and it had privatized Bm of course it is easy to privatize quickly if one does not pay my attention to hOIll one privatizes essentially give away valuable statt property to ones friends Indeed it can be highly profitable for governments to do sowhether the kickbacks come back in the form of cash payment or in campaign contributions or both But the glimpses of recovery seen in t 997 were not to last long Indeed the mistakes the IMF made in a distant part of the world vere pivotal In 1998 the fallout from the East Asian crisis hit The crisis had led to a general skittishness about investing in emerging markets and investors demanded higher returns to compensate them for lending capital to these countries Mirroring the weaknesses in GDP and investment were weaknesses in public finance the Russian government had been borrowing heavily Though it had difficulty making budget ends meet the government pressured by the United WHO LOST RUSSIA J4S States the World Uank and the IMF to privatize rapidly had turned over its state assets for a pittance and done so before it had put in place an effective tax system The government created a powerful class of oligarchs and businessmen who paid but a fraction of what they owed in taxes much less what they would have paid in virtually any other country Thus at the time of the East Asia crisis Russia was in a peculiar position I t had an abundance of natural resources but its govern ment was poor The government was virtually giving away its valu able state assets yet it was unable to provide pensions for the elderly or welfare payments for the poor The government was borrowing billions from the IMF becoming increasingly indebted while the oli garchs who had received such largesse from the government were taking billions out of the country The IMF had encouraged the gov ernment to open up its capital accounts allowing a free flow of capi tal The policy was supposed to make the country more amactive for foreign investors but it was virtually a oneway door that facilitated a rush of money out of the country The 1998 Crisis The country was deeply in debt and the higher interest rates that the East Asia crisis had provoked created an enormous additional strain This rickety tower collapsed when oil prices fell Due to recessions and depressions in Southeast Asia which IMF policies had exacer bated oil demand not only failed to expand as expected but actually contracted The resulting imbalance between demand and supply of oil turned into a dramatic fall in crude oil prices down over 40 in the first six months of 1998 compared to the average prices in 1997 Oil is both a major export commodity and a source of governmert tax revenue for Russia and the drop in prices had a predictably dev astating effect At the World Bank we became aware of the problem early in 1998 when prices looked ready to fall even below Russias cost of extraction plus transportation Given the exchange rate at the time Russias oil industry could cease being profitable A devaluation would then be inevitable It was clear that the ruble was overllued Russia was flooded with 140 illlpnS lIld dlllltSCi pmductrs wtrt having a hard time compet ill Tht swich Cl I lIIarktc tClmomy and away from the military was sUpptd Cl Illow I rtlkploymtnt of resources to produce more con SUlIItr llds or 1II0rt machines to produce consumer goods But iIlWSCllll 11Id huctd and tht country was not producing consumer oods TIlt onrvalutd txchangt ratecombined with the other lIIJfltonollli policits toisttd on the country by the IMFhad Tushtd cht tconomy and whilt the official unemployment rate rtnllintd subdued thtrt was massive disguised unemployment The m1Il1gtrS of many tirms were reluctant to fire workers given the JItIKt of an adequate safery net Though unemployment was dis uistd ic was no less traumatic while the workers only pretended to work cht tirrns only pretended to pay Wage payments fell into mas sive arrtars and when workers were paid it was often with bartered goods rather than rubles If tor these people and for the country as a whole the overvalued txchangt rJte was J disaster for the new class of businessmen the overvalued exchange rate was a boon They needed fewer rubles to buy their Mercedes their Chanel handbags and imported Italian gourmet foods For the oligarchs trying to get their money out of the country too the overvalued exchange rate was a boonit meant that chty could get more dollars for their rubles as they squirreled away thtir protics in foreign bank accounts Dtspice this suffering on the part of the majoriry of Russians the reformers and their advisers in the IMF feared a devaluation believ ing that it would set off another round of hyperinflation They strongly resisted any change in the exchange rate and were willing to pour billions of dollars into the country to avoid it By May and cer tainly by June of 1998 it was clear Russia would need outside assis tance to maintain its exchange rate Confidence in the currency had eroded In the belief that a devaluation was inevitable domestic inter est rates soared and more money left the country as people converted their rubles for dollars Because of this fear of holding rubles and the lack of confidence in the governments abiliry to repay its debt by June 1998 the government had to pay almost 60 percent interest rates on its ruble loans GKOs the Russian equivalent of us Treasury bills That figure soared to 150 percent in a matter of weeks Even WHO LOST RJSIA 147 when the government promised to pay back in dollars it faced high interest rates yields on dollardenominated debt issued by the Russ ian government rose from slightly over 10 to almost 5010 45 per centage points higher than the interest rate the us government had to pay on its Treasury bills at the time the market thought there was a high probability of default and the market was right Even that rate was lower than it might otherwise have been because many investors believed that Russia was too big and too important to fail As the New York investment banks pushed loans to Russia they whispered about how big the IMF bailout would have to be The crisis mounted in the way that these crises so frequently do Speculators could see how much in the way of reserves was left and as reserves dwindled betting on a devaluation became increasingly a oneway bet They risked almost nothing betting on the rubles crash As expected the IMF came to the rescue with 548 billion in July 19984 In the weeks preceding the crisis the IMF pushed policies that made the crisis when it occurred even worse The Fund pushed Russia into borrowing more in foreign currency and less in rubles The argument was simple The ruble interest rate was much higher than the dollar interest rate By borrowing in dollars the government could save money But there was a timdamental flaw in this reason ing Basic economic theory argues that the difference in the interest rate berween dollar bonds and ruble bond should reflect the expec tation of a devaluation Markets equilibrate so that the riskadjusted cost of borrowing or the return to lending is the same I have much less confidence in markets than does the IMF so I have much less faith that in fact the riskadjusted cost of borrowing is the same reb3rdless of currency But I aLo have much less confidence than the Fund that the Funds bureaucrat can predict exchange rate moVl lI1ents better than the market In the cae of Russia the lMF bureau crat believed that they were smarter than the marketthey were willing to bet Russias money that the market was wrong This wa a misjudgment that the Fund was to repeat in varied forms time and time again Not only was the judgment flawed it exposed the COlIn try to enormous risk if the rubk did devalue Rusia would find it far more difficult to repay the dollardenominated loanss The IMF 1 llIHIIIHION AND ITS IJISCllNTtiNTS chost w ignort this risk By inducing greater foreign borrowing by 1IIlking Russils pllsition once it devalued so much less tenable the IMF was ptrtly culptblt tor the eventual suspension of payments by Russit llli its dobts The Rescue Vhcll thc crisis hit the lMF led the rescue efforts but it wanted the World BJnk to provide 6 billion of the rescue package The total rcscue PJbge was tor 5226 billion The IMF would provide 112 billion of this total as I stated before the World Bank would lend 6 billion md the rest would be provided by the Japanese government This was hody debated inside the World Bank There were many of us who had been questioning lending to Russia all along We questioned whether the benefits to possible future growth were large enough 0 justify loans that would leave a legacy of debt Many thought that the IMF was making it easier for the government to put otf meaningful reforms such as collecting taxes from the oil compa nies The evidence of corruption in Russia was clear The Banks own study of corruption had identified that region as among the most corrupt in the world The West knew that much of those billions would be diverted from their intended purposes to the families and associates of corrupt officials and their oligarch friends While the Bank and the IMF had seemingly taken a strong stance against lend ing 0 corrupt governments it appeared that there were two stan dards Small nonstrategic countries like Kenya were denied loans because of corruption while countries such as Russia where the cor ruption was on a far larger scale were continually lent money Apart from these moral issues there were straightforward eco nomic issues The IMFs bailout money was supposed to be used to support the exchange rate However if a countrys currency is over valued and this causes the countrys economy to suffer maintaining the exchange rate makes little sense If the exchange rate support works the country suffers But in the more likely case that the sup port does not work the money is wasted and the country is deeper in debt Our calculations showed that Russias exchange rate was overvalued so providing money to maintain that exchange rate was WHO LOST RUSSIA 1411 simply bad economic policy Moreover calculations at the World Bank before the loan was made based on estimates of government revenues and expenditures over time strongly suggested that me July 1998 loan would not work Unless a miracle brought interest rates down drastically by the time autumn rolled around Russia would be back in crisis There was another route by which I reached the conclusion mat a further loan to Russia would be a great mistake Russia was a naturally resourcerich country If it got its act together it didnt need money from the outside and if it didnt get its act together it wasnt clear that any money from the outside would make much difference Under either scenario the case against giving money seemed compelling In spite of strong opposition from its own staff the Bank was under enormous political pressure from the Clinton administration to lend money to Russia The Bank managed a compromise publicly announcing a very large loan but providing the loan in tranches installments A decision was taken to make 300 million available immediately with the rest available only later as we saw how Russias reforms progressed Most of us thought that the program would fail long before the additional money had to be forthcoming Our pre dictions proved correct Remarkably the lMF seemed able to over look the corruption and the attendant risks with what would happen with the money It actually thought that maintaining the exchange rate at an overvalued level was a good trung and that the money would enable it to do this for more than a couple months It provided billions to the country The Rescue Fails Three weeks after the loan was made Russia announced a unilateral suspension of payments and a devaluation of the ruble The ruble crashed By January 1999 the ruble had declined in real effective terms by more than 45 percent from its July 1998 leveP The August 17 announcement precipitated a global financial crisis Interest rates to emerging market soared hiJther than they had been at the peak of the East Asian crisis Even developing coulltries that had Len pursu ing sound economic policitJ found it impossible to raise fund lLllBL LLllllN ND ITS DISCONTENTS UrClltls rSSlllll dttptntd and tvtntually it too faced a currency risls rgtmina lIld lHha Lltin American countries only gradually rtllltring trlllll prtious crists were again pushed nearer the brink Elllldllr lIlll Cllklllbi1 wtllt over tht brink and into crisis Even the Unittd SUtts did not rtmain untouched The New York Federal RtStt UlIlk tninttred a private bailout of one of the nations Ilrgtst htdgt tlll1ds Long Term Capital Management since the Fed telrtd its tlilure could precipitate a global financial crisis The surprise about the collapse was not the collapse itself but the tlCt that it really did take some of the IMF officialsincluding some of the most senior onesby surprise They had genuinely believed that their program vould work Our own forecasts proved only partially correct we thought that the money might sustain the exchange rate for three months it lasted three weeksWe felt that it would take days or even weeks for the oli garchs to bleed the money out of the country it took merely hours and days The Russian government even allowed the exchange rate to appreciate As we have seen this meant the oligarchs would need to spend fewer rubles to purchase their dollars A smiling Viktor Gerashchenko the chairman of the Central Bank of Russia told the president of the World Bank and me that it was simply market forces at workWhen the IMF was confronted with the factsthe billions of dollars that it had given loaned Russia was showing up in Cypriot and Swiss bank accounts just days after the loan was made it claimed that these werent their dollars The argument demonstrated either a remarkable lack of understanding of economics or a level of disingenuousness that rivaled Gerashchenkos or both When money is sem to a country it is not sent in the form of marked dollar bills Thus one cannot say it is my money that went anywhere The IMF had lent Russia the dollarsfunds that allowed Russia in turn to give its oligarchs the dollars to take out of the country Some of us quipped that the IMF would have made life easier all around ifit had simply sent the money directly into the Swiss and Cyprus bank accounts It was of course not just the oligarchs who benefited from the rescue The Wall Street and other Western investment bankers who had been among those pressing the hardest for a rescue package WHO LOST RUSSIA knew it would not last they too took the short respite provided by the rescue to rescue as much as they could to flee the country with whatever they could salvage By lending Russia money for a doomed cause IMF policies led Russia into deeper debt with nothing to show for it The cost of the mistake was not borne by the lMF officials who gave the loan or America who had pushed for it or the Western bankers and the oli garchs who benefited from the loan but by the Russian taXpayer There was one positive aspect of the crisis The devaluation spurred Russias import competing sectorsgoods actually produced in Russia finally took a growing share of the home market This unintended consequence ultimately led to the longawaited growth in Russias real as opposed to black economy There was a certain irony in this failure macroeconomics was supposed to be the IMFs strength and yet even here it had failed These macroeconomic fail ures compounded the other failures and contributed mightily to the enormity of the decline THE FAILED TRANSITIONS Seldom has the gap between expectations and reality been greater than in the case of the transition from communism to the market The combination of privatization liberalization and decentralization was supposed to lead quickly after perhaps a short transition reces sion to a vast increase in production It was expected that the bene fits from transition would be greater in the long run than in the short run as old inefficient machines were replaced and a new generation of entrepreneurs was created Full integration into the global econ omy with all the benefits that that would bring would also come quickly if not immediately These expectations for economic growth were not realized not only in Russia but in IIIOS of the economies in transition Only a few of the former Communist countriessuch as Poland Hungary Slovenia and Slovakiahave a GDP equal to that of a decade aRO For the rest the magnitudes of the declines in incomes are so large that they are hard to fathom According to World Bank data Russia I 1 lIllllTlIIN INI ITS 1ISCONTNTS todl 20110 hls 1 taw tht is Itss thall twothirds of what it was in lIIlI loldwJs dtliilll is tht most dramatic with output today less Iun 1 third f wh1 it IS a dtcadl ago Ukraints 2000 GDP is just I third of wh1 it was ttlI ytrs ago Undnlnng thl dJta Wtrt trul symptoms of Russias malady Rus si1 Iud llIickly blllI trJlISforrmd tWill an industrial gianta coun try th1 Iud mallagd with Sputnik to put the first satellite into orbitllIlll a lIamral rsourc xportr resources and especially oil llI IS JCcounttd for over half of all exports While the Western rdorm Jdvisrs wtrt writing books with titles like The Coming Boom ill RIIi1 or HII Russia Bemme a ilarket Economy the data itself was nlJking it hard co tlk sriously the rosy pictures they wre painting Jnd mor dispassionat observrs were writing books like The Sale if ril CIIur Russias Wild Ridefrom Communism to Capitalism8 Th magnimd of GDP declin in Russia not to mention other torlllr Communist countris is the subject of controversy and some Jrbll that bcaus of the growing and critical informal sectorfrom trt ndors to plumbers painters and other service providers whos conoillic activities are typically hard to capture in national incom statisticsthe numbers represent an overestimate of the size oi th dc1in However others argue that because so many of the transactions in Russia entail barter over 50 of industrial sales9 and btC1US th markt prices are typically higher than these barter pric th statistics actually underestimate the decline TJking all this into account there is still a consensus that most indIviduals have experienced a marked deterioration in their basic mndard oi living reflected in a host of social indicators While in the rtt oi tht world life spans were increasing markedly in Russia they wrt over thr years shorter and in Ukraine almost three years shorttr Survty data of household consumptionwhat people eat how much they sptnd on clothing and what type of housing they live incorroborates a marked decline in standards of living on par with thos suggested by the fall in GDP statistics Given that the gov rnment was spending less on defense standards ofliving should have increased even more than GDP To put it another way assume that somehow previous expenditures on consumption could have been preserved and a third of the expenditures on military could have WHO LoST RusslI 153 been shifted into new production of consumption goods and that there had been no restructuring to increase efficiency or to take advantage of the new trade opportunities Consumptionliving standardswould then have increased by 4 percent a small amount but far better than the actual decline Increased Poverty and Inequality These statistics do not tell the whole story of the transition in Russia They ignore one of the most important successes How do you value the benefits of the new democracy as imperfect as it might be But they also ignore one of the most important failures The increase in poverty and inequality While the size of the national economic pie was shrinking it was being divided up more and more inequitably so the average Russian was getting a smaller and smaller slice In 1989 only 2 percent of those living in Russia were in poverty By late 1998 that number had soared to 238 percent using the 2 a day standard More than 40 percent of the country had less than S4 a day according to a survey conducted by the World Bank The statistics for children revealed an even deeper problem with more than 50 percent living in families in poverty Other postCommunist countries have seen comparable if not worse increases in povertylO Shortly after I arrived at the World Bank I began taking a closer look at what was going on and at the strategies that were being pur sued When I raised my concerns about these matters an economist at the Bank who had played a key role in the privatizations responded heatedly He cited the traffic jams of cars many of them Mercedes leaving Moscow on a summer weekend and the stores filled with imported luxury goods This was a far different picrure from the empty and colorless retail establishments under the former regime I did not disagree that a substantial number of people had been made wealthy enough to cause a traffic jam or to create a demand for Gucci shoes and other imported luxury itel1L sufficient for certain stores to prosper At many European resorts the wealthy Russian has replaced the wealthy Arab of two decades ago In somC street signs arc even given in Russian along with the natiC language lLllaL ILHIllN AND ITS DISCONTENTS But 1 trLltic JIIIl lf Ivkrctdts in a country with a per capita income of S4 7311 IS it IS in 1l7 is a sign of a sickness not health It is a c1tlr sign of 1 slier that concentrltes its wealth among the few rHha th1Il distributing it IlIlong the many llIle the transition has greatly increased the number of those in plncrt 1Ilj led J few at the top to prosper the middle class in Rus l1 Ius pal1lps been the hIrdest hit The inflation first wiped out their IIltJger sIvings IS we have seen With wages not keeping up with intiJtion their real incomes fell Cutbacks in expenditures on educJtion Ind health turther eroded their standards of living Those ho could emigrated Some countries like Bulgaria lost 10 or IIlore of their population and an even larger fraction of their edu cHcd workforce The bright students in Russia and other couIltries of the former Soviet Union that Ive met work hard with one ambi tion in mind to migrate to the West These losses are important not Just for what they imply today for those living in Russia but for what they portend for the future historically the middle class has been central to creating a society based on the rule oflaw and democratic nlues The magnirude of the increase in inequality like the magnirude dnd duration of the economic decline came as a surprise Experts did expect some increase in inequality or at least measured inequality Under the old regime incomes were kept similar by suppressing wage differences The Communist system while it did not make for JI1 eay lite avoided the extremes of poverty and kept living standards relatively equal by providing a high common denominator of quality tor cducation housing health care and child care services With a witch to a market economy those who worked hard and produced well would reap the rewards for their efforts so some increase in inequality was inevitable However it was expected that Russia would be spared the inequality arising from inherited wealth With out this legacy of inherited inequality there was the promise of a more egalitarian market economy How differently matters have turned out Russia today has a level of inequality comparable with the worst in the world those Latin American societies which were based on a semi feudal heritage I I WHO LOST RUSSIA 155 Russia has gotten the worst of all possible worldsan enormous decline in output and an enormous increase in inequality And the prognosis for the future is bleak extremes of inequality impede growth particularly when they lead to social and political instability HOW MISGUIDED POLICIES LED TO THE FAILURES OF TRANSITION We have already seen some of the ways that the Washington consen sus policies contributed to the failures privatization done the wrong way had not led to increased efficiency or growth but to asset strip ping and decline We have seen how the problems were compounded by interactions between reforms as wdl as their pace and sequenc ing capital market liberalization and privatization made it easier to take money out of the country privatization before a legal infratrUc ture was in place enhanced the ability and incentive for asset strip ping rather than reinvesting in the countrys future A full description of what went on and a full analysis of the ways in which MF pro grams contributed to the decline of the country is a book in itself Here want to sketch three examples n each case defenders of the MF will say that things would have been worse but for their pro grams n some casessuch as the absence of competition policies the MF will insist that such policies were part of the program but alas Russia did not implement them Such a defense is ingenuous with dozens of conditions nJeryrhil1g was in the MF program Russia knew however that when it came to the inevitable charade in which MF would threaten to cut off aid Russia would bargain hard an agreement not often fulfilled would be reachtd and the money spigot opened up again What was important were the monetary tar gets the budget deficits and the pace of privatizationthl number of firms that had been turned over to the private Slctor never mind how Almost everything else was secondary muchlike competition policywas virtually windowdressing a defense against CTitin who said they were leaving out important ingredients to a successtu tran sition strategy As repeatedly pushed for stronger competition poi lIllHHllATlllN ANO ITS DISCONTENTS IC thusl iIlSIdl Russia who agreed with me who were trying to stlhlish I rrue Ilurker economy who were trying to create an effec riw lllllplritilJl Juthority repeatedly thanked me I kLIdiIl whJt 0 elllphasize establishing priorities is not easy ixtbl1llk lOIlOlIlis otten provides insufficient guidance Economic r1lury SIS thJt tor lIlarkets to work well there must be both compe titillIl 1lId private property If reform was easy one would wave a lllJI wlIId llld have both The IMF chose to emphasize privatiza til1ll iing short shrift to competition The choice was perhaps not surprising corporate and tinancial interests often oppose competi tion policies far these policies restrict their ability to make profits The consequences of IMFs mistake here were far more serious thJn just high prices privatized firms sought to establish monopo lies Jnd cartels to enhance their profits undisciplined by effective Jntitrust policies And as so otten happens the profits of monopoly proe especially alluring to those who are willing to resort to r11ltialike techniques either to obtain market dominance or to ntaree collusion Inflation Earlier we saw how the rapid liberalization at the beginning had led to the burst of inflation The sad part of Russias story was that each mistake was followed by another which compounded the conse quences Having set off the rapid inflation through abrupt price liberaliza tion in 1 92 it was necessary for the IMF and the Yeltsin regime to contain it But balance has never been the strong suit of the IMF and its excessive zeal led to excessively high interest rates There is little evidence that lowering inflation below a moderate level increases growth The most successful countries like Poland ignored the IMFs pressure and maintained inflation at around 20 percent through the critical years of adjustment IMFs star pupils like the Czech Repub lic which pushed inflation down to 2 percent saw their economy stagnate There are some good reasons to believe that excessive zeal in ftghting inflation can dampen real economic growth The high inter est rate clearly stifled new investment Many of the new privatized WHO LOST RUSSIA IS7 firms even those who began without an eye to looting them saw that they could not expand and switched to asset stripping The IMF driven high interest rates led to an overvaluation of the exchange rate making imports cheap and exports difficult No wonder then that any visitor to Moscow after 1992 could see the stores filled with imported clothing and other goods but would be hardpressed to find much with a Made in Russia label And this was true even five years after the transition began The tight monetary policies also contributed to the use of barter With a shortage of money workers were paid in kindwith what ever it was that the factory produced or had available from toilet paper to shoes While the Rea markets that were established every where throughout the country as workers tried to get cash to buy the bare necessities of life gave a semblance of entrepreneurial activ ity they masked huge inefficiencies High rates of inRation are cosdy to an economy because they interfere with the workings of the price system But barter is every bit as destructive to the effective workings of the price system and the excesses of monetary stringency simply substituted one set of inefficiencies for a possibly even worse set Privatization The IMF told Russia to privatize as fast as possible how privatization was done was viewed as secondary Much of the failure of which I wrote earlierboth the decline in incomes and the increase in inequalitycan be direcdy linked to this mistake In a World Bank review of the tenyear history of tranition economies it became apparent that privatization in the absence of the institutional infra structure like corporate governance had no positive effect on growth 12 The Washington Consensus had again just gotten it wrong It is easy to see the links between the way privatization was done and the failures For instance in Russia and other countries the lack oflaws ensur ing good corporate governance meant that those who could gct control of a corporation had an incentive to steal assets om the minority shareholders and managers had similar incentives visavis shareholders Why expend energy in creating wealth when it was so lBULIT1llN ND ITS DISCONTENTS Illllch lSia tn SII il Other asptns of the privatization process as hll SII lIhIIItd Ihl illcentives as well as opportunities for Cllrpelfllt tllttt Priltizltion in Russia turned over large national ntrpriss Iypiclll III their old managers Those insiders knew how lInctrtlin 111 ditlicult was the road ahead Even if they were predis pllsed c iL so they dared not wait tor the creation of capital markets 1111 the hosls of other changes that would be required for them to rtlp Ihl ti1l1 alul of any investments and restructuring They focused on h1t Ihey could get out of the firm in the next few years and all 100 otten this was maximized by stripping assets PriJtization was also supposed to eliminate the role of the state in the economy but those who assumed that had a far too naive view of the role of the state in the modern economy It exercises its influence in J mvriad of ways at a myriad oflevels Privatization did reduce the power of the central government but that devolution left the local md regional governments with far wider discretion A city like say St Petersburg or an oblast regional government like Novgorod could use a host of regulatory and tax measures to extort rents from firms that operated in their jurisdiction In advanced industrial coun tries there is a rule of law which keeps local and state governments from abusing their potential powers not so in Russia In advanced industrial countries competition among communities makes each tf to make itself more attractive to investors But in a world in which high interest rates and an overall depression make such invest ments unlikely in any case local governments spent little time creat ing attractive environments for investment and focused instead on seeing how much they could extract from existing enterprisesjust as the mvners and managers of newly privatized firms themselves did And when these privatized firms operated across many jurisdic tions authorities in one district reasoned that they had better take what they could grab before others took their own bites out of assets And this only reinforced the incentive of managers to grab whatever they could as quickly as possible After all the firms would be left destitute in any case It was a race to the bottom There were incen tives for asset stripping at every level Just as the radical shock therapy reformers claim that the problem with liberalization was not that it was too slow but that it was not fast WHO LoST RUSSIA enough so too with privatization While the Czech Republic for example was praised by the IMF even as it faltered it became clear that the countrys rhetoric had outpaced its performance it had left the banks in state hands If a government privatizes corporations but leaves banks in the state hands or without effective regulation that government does not create the hard budget constraints that lead to efficiency but rather an alternative less transparent way of subsidizing firmsand an open invitation to corruption Critics of Czech priva tization claim the problem was not that privatization was too rapid but that it was too slow But no country has succeeded in privatizing everything overnight well and it is likely that were a government to try to do instantaneous privatization there would be a mess The task is too difficult the incentives for malfeasance too high The failures of the rapid privatization strategies were predictableand predicted Not only did privatization as it was imposed in Russia as well as in far too many of its former Soviet bloc dependencies not con tribute to the economic success of the country it undermined confi dence in government in democracy and in reform The result of giving away its rich narural resources before it had in place a system to collect narural resource taxes was that a few friends and associates ofYeltsin became billionaires but the country was unable to pay pen sioners their S 15 a month pension The most egregious example of bad privatization was the loans forshare program In 1995 the government instead of rurning to the Central Bank for needed funds turned to private banks Many of these private banks belonged to friends of the government who had been given bank charters In an environment with underregulated banks the charters were effectively a license to print money to make loans either to themselves or their friends or to the government As a condition of the loan the government put up shares of its own enter prises as collateral Thensurprisethe government defaulted on its loans the private banks took over the companies in what might be viewed as a sham sale though the government did go through a cha rade of having auctions and a few oligarchs became instant bil lionaires These privatizations had no political legitimacy And as noted previously the fact that they had no legitimacy made it even more imperative that the oligarchs take their funds quickly out of the 10 IOLIfHIN ANI ITS DISCONTENTS ounrrybdill 1 ntw government that might try to reverse the priltilltillns llr undermine their position came to power Tillst who bellditld from the largesse of the state or more accu rltd tn1ll Ydtills lJrgesse worked hard to ensure Yeltsins reelec tiln Ironillly while there was alwdYs a presumption that part of Ydtsins ginJw3Y went 0 t1n3nce his campaign some critics think thlt thl oligJnhs were far 00 smart to use their money to pay for the cbtioll 3mp3ign there was plenty of government slush funds chlt could be used The oligarchs provided Yeltsin with something clut W3S tar more valuablemodern campaign management tech niques Illd positive treatment by the TV networks they controlled The loansforshare scheme constituted the final stage of the enrichment of the oligarchs the small band of people some of whom owed their origins reportedly at least pardy to mafialike con nections who carne 0 dominate not just the economic but the political lite of the country At one point they claimed to control 50 percent of the countrys wealth Defenders of the oligarchs liken them to Americas robber barons the Harrimans and Rockefellers But there is a big difference between the activities of such figures in nineteenthcentury capitalism even those carving out railway and mining baronies in Americas Wild West and the Russian oligarchys exploitation of Russia what has been called the Wild East Americas robber barons created wealth even as they accumulated fortunes They left a country much richer even if they got a big slice of the larger pie Russias oligarchs stole assets stripped them leaving their country much poorer The enterprises were left on the verge of bankruptcy while the oligarchs bank accounts were enriched The Social Context The otflcials who applied Washington Consensus policies failed to appreciate the social context of the transition economies This was especially problematic given what had happened during the years of communism Market economies entail a host of economic relationships exchanges Many of these exchanges involve matters of trust An WHO LOST RussA JtJJ individual lends another money trusting that he will be repaid Hack ing up this trust is a legal system If individuals do not live up to their contractual obligations they can be forced to do so If an individlUl steals property from another he can be brought to court Hut in countries with mature market economies and adequate institutional infrastructures individuals and corporations resort only occasionally to litigation Economists often refer to the glue that holds society together as social capital Random violence and Mafia capitalism are often cited as reflections of the erosion of social capital but in some of the countries of the former Soviet Union that I visited one could see everywhere in more subtle ways direct manifestations of the erosion of social capital It is not just a question of the misbehavior of a few managers it is an almost anarchic theft by all from all For instance the landscape in Kazakhstan is dotted with greenhousesmissing their glass Of course without the glass they fail to function In the early days of the transition there was so little confidence in the future that each individual took what he could each believed that others would take the glass out of tht greenhousein which case the greenhouse and their livelihood would be destroyed But if the greenhouse was in any case fattd to be destroyed it made sense for each to take what he couldeven if the value of the glass was small The way in which transition procteded in Russia served to erode this social capital One got wealthy not by working hard or by invest ing but by using political connections to get state property on the cheap in privatizations The social contract which bound citizens together with their government was broken as pensioners saw the government giving away valuable state assets but claiming that it had no money to pay their pensions The IMFs focus on macroeconomicsand in particular on infla tionled it to shunt aside issues of poverty inequality and social cap ital When confronted about this myopia of focus it would say Inflation is especially hard on the poor But its policy framework was not designed to minimize the impact on the poor And by ignor ing the impacts of its policies 011 the poor and on social capital the IMF actually impeded mamWMIlJ sliccess The erosion of social I LOIIAlIlHIllN AND ITS ISCONTENTS lLpit1I cr It d lI1 minmmlnt that was not conducive to invest lIlllIt Thl RussiL1l olrnm nts and thl IMFs lack of attention to 1 lIlinilllll slttty n t sloWld down the process of restructuring as Vln hmih ld d plant managers often found it difficult to fire work as kllcin th n was Iitd standing betw en their fired workers lI1d xtrtm hLrdship if not starvation Shock Therapy The greLt d bat owr r form strategy in Russia centered on the pace of reform Who vas right in the endthe shock therapists or the grLdualistS Economic theory which focuses on equilibrium and idea1iud modds has less to say about dynamics the order timing Lnd pacing of reforms than one would likethough IMF econo mistS ott n tried to convince client countries otherwise The debaters r sort d to metaphors to convince others of the merits of their side Th rapid r formers said You cant cross a chasm in two leaps while the gradualists argued that it took nine months to make a baby and talked about crossing the river by feeling the stones In some cases what separated the two views was more a difference in per spective than reality I was present at a seminar in Hungary where one participant said We must have rapid reform It must be accom plished in five years Another said We should have gradual reform It will take us five years Much of the debate was more about the manner of reform than the speed We have already encountered two of the essential critiques of the gradualists Haste makes wasteit is hard to design good reforms well and sequencing matters There are for instance important pre requisites for a successful mass privatization and creating these prerequisites takes time 3 Russias peculiar pattern of reforms demonstrates that incentives do matter but that Russias kind of ersatz capitalism did not provide the incentives for wealth creation and economic growth but rather for asset stripping Instead of a smoothly working market economy the quick transition led to a dis orderly Wild East WHO LOST RUSSIA 163 The Bolshevik Approach to Market Reform Had the radical reformers looked beyond their narrow focus on eco nomics they would have found that history shows that most of the experiments in radical reform were beset by problems This is true from the French Revolution in 1789 to the Paris Commune of 1871 to the Bolshevik Revolution in Russia in 1917 and to Chinas Cultural Revolution of the 1960s and 1970s It is easy to understand the forces giving rise to each of these revolutions but each produced its own Robespierre its own political leaders who were either cor rupted by the revolution or took it to extremes By contrast the suc cessful American Revolution was not a true revolution in society it was a revolutionary change in political structures but it represented an evoilltionary change in the structure of society The radical reformers in Russia were trying simultaneously for a revolution in the eco nomic regime and in the structure of society The saddest commen tary is that in the end they failed in both a market economy in which many old party apparatchiks had simply been vested with enhanced powers to run and profit from the enterprises they for merly managed in which former KGB officials still held the levers of power There was one new dimension a few new oligarchs able and willing to exert immense political and economic power In effect the radical reformers employed Bolshevik strategies though they were reading from different texts The Bolsheviks tried to impose communism on a reluctant country in the years following 1917 They argued that the way to build socialism was for an elite cadre to lead often a euphemism for force the masses into the correct path which was not necessarily the path the masses wanted or thought best In the new postConununist revolution in Russia an elite spearheaded by international bureaucrats similarly attempted to force rapid change on a reluctant population Those who advocated the Bolshevik approach not only seemed to ignore the history of such radical reforms but also postulated that political processes would work in ways for which history provided no evidence For instance economist such as Andrei Shleifer who recognized the importance of the institutional infrastructure for a market economy believed that privatization no matter how imple CLlllIL1lHION NLl ITS DISCONTENTS 1I1tlIttd HlUld kad 0 a political dtmand lor the institutions that gotrn pritl pnpaty Shltittrs argulI1ent can be thought of as an unwarranted exten sil1I 01 COIStS theorem The economist Ronald H Coase who was awarded a Nobd Prize lor his work argued that in order to achieve etlicitny wdldetined property rights are essential Even if one dis tributed ass ts co someone who did not know how to manage them wdl in a society with wdlddined property rights that person would have an incentive to sell to someone who could manage the JSs ts dtici ndy That is why advocates of rapid privatization argued one didnt really need to pay close attention to how privatization was lccomplished It is now recognized that the conditions under which Coas s conjecture is valid are highly restrictivel4and certainly werent satisfied in Russia as it embarked on its transition Shleifer and company however took Coases ideas further than Coase himself would have done They believed that political processes were governed in the same way as economic processes If a group with vested interests in property could be created it would demand the establishment of an institutional infrastructure necessary to make a market economy work and its demands would be reflected in the political process Unfortunately the long history of political reforms suggests that the distribution of income does matter It has been the middle class that has demanded the reforms that are often referred to as the rule oflawThe very wealthy usually do far better for themselves behind closed doors bargaining special favors and privileges Certainly it has not been demands from the Rocke fellers and the Bill Gates of the world that have led to strong compe tition policies Today in Russia we do not see demands for strong competition policy forthcoming from the oligarchs the new monop olists Demands for the rule of law have come from these oligarchs who obtained their wealth through behindthescenes special deals within the Kremlin only as they have seen their special influence on Russias rulers wane Demands for an open media free from concentration in the hands of a few came from the oligarchs who sought to control the media in order to maintain their powerbut only when the government sought to use its power to deprive them of theirs In most democratic WHO LOST RUSSIA and developed countries such concentrations of economic power would not long be tolerated by a middle class forced to pay monop oly prices Americans have long been concerned with the dangers of concentration of media power and concentrations of power in the United States on a scale comparable to that in Russia today would be unacceptable Yet US and IMF officials paid little attention to the dangers posed by the concentration of media power rather they focused on the rapidity of privatization a sign that the privatization process was proceeding apace And they took comfort indeed even pride in the fact that the concentrated private media was being used and used effectively to keep their friends Boris Yeltsin and the so called reformers in power One of the reasons that it is important to have an active and criti cal media is to ensure that the decisions that get made reflect not just the interests of a few but the general interest of society It was essen tial for the continuation of the Communist system that there not be public scrutiny One of the problems with the failure to create an effective independent and competitive media in Russia was that the policiessuch as the loansforshare schemewere not subjected to the public critique that they deserved Even in the West however the critical decisions about Russian policy both at the international eco nomic institutions and in the US Treasury went on largely behind closed doors Neither the taxpayers in the West to whom these insti tutions were supposed to be accountable nor the Russian people who paid the ultimate price knew much about what was going on at the time Only now are we wrestling with the question of Who lost Russiaand why The answers as we are beginning to see are not edifYing CHAPTER 6 UNFAIR FAIR TRADE LAWS AND OTHER MISCHIEF T HE 1M F I S a political institution The 1998 bailout was dictated by J concern to maintain Boris Yeltsin in power though on the basis of all the principles which should have sUided lending it made little sense The quiet acquiescence if not outright support to the corrupt loansforshare privatization was plrrially based on the fact that the corruption too was for good pur poeto get Yeltsin reelected IMF policies in these areas were Inextricably linked to the political judgments of the Clinton admin htrJtion Treasury Vithin the administration as a whole there were in fact misgiv Ins about Treasurys strategy After the defeat of the reformers in I ecember 1993 Strobe Talbott at the time in charge of Russia pol icy later 0 become deputy secretary of state expressed the wide pread lpprehemive view of the shock therapy strategy Had there been 00 much shock and too little therapy We at the Council of Economic Advisers felt strongly that the United States was giving bad advice to Russia anclusing taxpayers money to induce them to accept it But Treasury claimed Russian economic policy as its own turf turned aside any attempts to have an open dialogue either within government or outside and stood stubbornly by its commit ment to shock therapy and rapid privatization UNIAW FAW TIIADf LAWS AND OTlllll MISCHIH 167 Political judgments as much as economics lay behind the stances of the people at the Treasury They worried about the imminent dan ger of backsliding into communism The gradualists worried that the real danger was the failure of shock therapy increasing poverry and falling incomes would undermine support for market reforms Again the gradualists proved right The Moldova elections in February 2000 in which the old Communists got 70 percent of the seats in the Duma were perhaps the most extreme case but disillusionment with radical reform and shock therapy is now common among the economies in transition2 Seeing the transition as the last round in the battle between good and evil between markets and communism led to one further problem the IMF and US Treasury treated most of the exCommunists with disdain and distrust except for a few chosen ones who became their allies There were of course some diehard Communists but some perhaps many of those who had served in the Communist governments were far from true believers Instead they were pragmatists who wanted to get ahead in the sys tem If the system required that they join the Communist Parry that did not seem an overly excessive price to pay Many were as happy as anyone else to see the end of the Communist domination and the restoration of democratic processes If these people carried over any thing from their Communist days it was a belief that the state bore a responsibility for taking care of those in need and a belief in a more egalitarian society In fact many of these exConullunists became what in European terms are called Social Democrats of various persuasions In Ameri can political terms they might range anywhere from the old New Deal Democrats to the more recent New Democrats though most would have been closer to the former than the latter It vas ironic that the Democratic Clinton administration seemingly embracing views highly consonant with these Social Democrats would so often ally itself in the economies in transition with reformers who leanecd to the right the disciples of Milton Friedman and of radical market reforms who paid too little attention to the social and distributional consequences of policy In Russia there was no one but exCommunists to be dealt with lOS llllLILHIN AND ITS DISCONTENTS YllrslIl hllllStlf WClS Ill txCommunista candidate member of the Illlirbllfll 111 Illlssia the Communists were never really ousted from PllWr AIIlHlst Ill of Ilussias rdormers were wellconnected ex COllllllllmsrs Dill tillie it seellled the fault line would lie between rhllsl who were dosdy connected to the KGB and Gosplanthe tl1ters llf fLllitical and economic control under the old regimeand lWllllt de The good guys were the apparatchiks who had run bllSilltses like Viktor Chernomyrdin the head of Gazprom who succeeded Gaidar as prime minister practical men with whom we lldJ ded While some of these practical men were ready to steal as I1uch of rhe sutes wealth tor themsdves and their friends as they lLLdd get Jway with they were clearly no leftwing ideologues hik mimken or not judgments about who would likely lead IlUSSll into rhe promised land of free markets may have guided deci sions about whom the United States and the IMF should ally itself with in the early days of the transition by 2000 a hard pragmatism had set in I f there had been idealism in the beginning the failings of Ydtsin and many of those around him had led to cynicism Putin was embraced with seeming warmth by the Bush administration as someone we could work with his KGB credentials of little moment It had taken a long time for us finally to stop judging people by whether they were or were not Communists during the old regimeor even by what they did under the old regime If mistaken ideo lat may have blinded us in dealing with emerging leaders and parties in Eastern Europe as well as the design of economic policies mistaken political judgments played no less a role in Russia Many of those with whom we allied ourselves were less interested in creating the kind of market economy that has worked so well in the West than in enriching themselves As time went on and the problems with the reform strategy and the Yeltsin government became clearer the reactions of people both in the IMF and the US Treasury proved not unlike those of officials earlier inside the US government as the failures of the Vietnam War became clearer to ignore the facts to deny the reality to suppress the discussion to throw more and more good money after bad Russia was about to turn a corner growth was about to occur the next loan would enable Russia finally to get going Russia had now UNFAIR FAIR TRADE LAWS AND OTHER MISCHIU 169 shown that it would live up to the conditions of the loan agreements and so on and so forth As the prospects of success looked incre ingly bleak as the crisis looked increasingly around still another cor ner the rhetoric changed the emphasis switched from confidence in Yeltsin to fearing the threat of the alternative The sense of anxiety was palpable I received a call one day from the office of a very senior adviser to the Russian government He wanted to organize a brainstorming session in Russia on what the country might do to get itself going The best that the IMF had been able to provide in years of advice was stabilization it had nothing to offer in the way of growth And it was clear that stabilizationat least as presented by the IMFdid not lead to growth When the IMF and the US Treasury got wind of this they leaped into action Trea sury reportedly at the most senior level called the president of the Bank and I was ordered not to go But while Treasury would like to think of the World Bank as its own property other countries tan when carefully orchestrated outflank even the US Treasury secre tary And so it happened here with the appropriate calls and letters from Russia I proceeded to Russia to do what the Russians had askedto open a discussion unfettered by either IMF ideology or US Treasurys special interests My visit was fascinating The breadth of the discusions was impressive There were a number of bright people struggling to craft a strategy for economic growth They knew the numbersbut to them the decline in Russia was not just a matter of statistics Many people I talked to recognized the importance of what had been lett out of or given insufficient attention in the IMF programs They knew that growth requires more than stabilization privatization and liberalization They worried that the pressure from the IMF tor rapid privatization which they were still feeling would lead to still more problems Some recognized the importance of creating strong com petition policies and bemoaned the lack of support that they were receiving But what struck me most was the incongruity between the spirit in Washington and in Moscow In Moscow there was at the time a healthy policy debate Many were concerned for instance that the high exchange rate was suppressing growthand they YlIl right Others worried that a devaluation would set otT inRationand CLlllIIILUIIlN Nll ITS DISCONTENTS tht llll wtrt right Thest an complicated matters and in democra itS tht IIttd ll bt litbated and discussed Russia was trying to do dut tring to llptn up the discussion to ditferent voices It was Wash ingtl1nl1r IIwrt Kcuratdy the IMF and the U S Treasurythat trt llrlid llt dt1I10aKY that wanted to suppress debate I could not bur nlHe lIId ttd sad about the irony s tht tideIKt of the failures mounted and as it became increas inglv Ielr that the United States had been backing a weak horse the US IdministrJtion tried ewn harder to clamp down on criticisms and public discussion Treasury tried to eliminate discussions from within the lhnk with the press to be sure that only their interpreta tions 01 what was going on would be heard Yet it was remarkable how een as evidence on possible corruption unfolded in US news papers the Treasury Department hardly wavered in its strategy For many the loansforshare privatization scheme discussed in chapter in which a few oligarchs got control of a vast portion of the countrys rich natural resources became the critical point at which the United States should have spoken out Within Russia the United States was not unjustly perceived as having allied itself with corruption In what would have been perceived as a public display of support Depury Treasury Secretary Lawrence Summers invited to his hOUSe Anatoly Chubais who had been in charge of privatization who organized the loansforshare scam and who not surprisingly has become one of the least popular public officials in all Russia The US Treasury and the IMF entered into the political life of Russia By siding so tirrnly for so long with those at the helm when the huge inequality was created through this corrupt privatization process the United States the IMF and the international communiry have indeli bly associated themselves with policies that at best promoted the interests of the wealthy at the expense of the average Russian When us and European newspapers finally exposed the corrup tion publicly Treasurys condemnation had a hollow and disingenu ous ring The reality is that the Dumas inspector general brought these charges to Washington long before the news stories broke Within the World Bank I was urged not to meet with him lest we give credence to his charges If the extent of corruption was not known it was because ears and eyes were covered UNIAIR FAIR TRADE LAWS AND OTHER MICHIH 171 WHAT SHOULD HAVE BEEN DONE The Wests longterm interests would have been far better served had we stayed out of close involvement with particular leaders and pro vided broadbased support to democratic processes This could have been done by supporting young and emerging leaders in MoscOY and in the provinces who were against corruption and who were try ing to create a true democracy I wish there had been an open debate about Americas Russian strategy at the beginning of the Clinton administration a debate more reflective of the discussion going on in the outside world I believe that if Clinton had been confronted with the arguments he would have adopted a more balanced approach He would have been more sensitive to the concerns of the poor and more aware of the importance of political processes than the people at Treasury But as is so often the case the president was never given a chance to hear the full range of issues and views Treasury viewed the issue as too iPlpor tant to let the president have an important role in making the deci sions Perhaps because of the lack of interest from the American people Clinton himself did not feel that this issue was important enough for him to demand an accounting in greater detail US INTERESTS AND RUSSIAN REFORM There are many in Russia and elsewhere who believe the failed policies were not just accidental the failures were deliberate intended to eviscerate Russia to remove it as a threat for the indefi nite future This rather conspiratorial view credits those at the IMF and the US Treasury with both greater malevolence and greater wis dom than I think they had I believe that they actually thought the policies they were advocating would succeed They believed that a strong Russian economy and a stable Russian reformoriented gov ernment were in the interests of both the United States and global peace But the policies were not totally altruistic US economic inter cstsor more accurately US tinancial and commercial market inter I llnHll ll NU ITS DISCONTIlNTS csts wcr rttieltc1 in tht plicies For instance the July 1998 bII1HIt WIS lht IS Illulh I bailout of Western banks that stood to lose bilhHlS f 1lbrs JIId ttntulIly did lose billions as it was a bailout 11 RllSSl1 But It WIS not just Wall Streets direct interests that influ tlIlt1 flil it IS the ideoloY that prevailed in the financial com IlIunlt rr instant Wall Street regards inflation as the worst thing III the rld It erodes tht real value of what is owed to creditors hih kld 0 inlreases in interest rates which in turn lead to ledints in bond prices To financiers unemployment is far less of a tcern For Wall Street nothing could be more sacrosanct than pri Jtt property no wonder then the emphasis on privatization Their L111l1llitI11ent to competition is far less passionateafter all it is the Lurrent US secretary of the Treasury Paul ONeill who engineered the tlobli aluminum cartel and has worked to suppress competition Hh the global steel market And notions of social capital and politi LJI participation may not even appear on their radar screen they feel far more comfortable with an independent central bank than one whose actions Jre more directly under the control of political processes In the case of Russia there was a certain irony in this stance in the aftermath of the 1998 crisis it was Russias independent centrli banker that threatened to push a more inflationary policy thJn the IMFand some members of the governmentwanted and It WJS the independence of the Central Bank that partly accounted for its ability to ignore charges of corruption Broader special economic interests in the United States affected policies in ways that conflicted with broader national interests and 11Iade the country look more than a little hypocritical The United Sutel supports free trade but all too often when a poor country does manage to tind a commodity it can export to the United States domestIC American protectionist interests are galvanized This mix of labor and business interests uses the many trade lawsofficially referred to as fair trade laws but known outside the United States as unfair fair trade lawsto construct barbedwire barriers to imports These laws allow a company that believes a foreign rival is selling a product below cost to request that the government impose special tariffs to protect it Selling products below cost is called dumping and the duties are called dumping duties Often however the US government determines costs on the basis of little evidence UNIAIU FAIJI THAlll LAWS AND OTHI MISCHIH 173 and in ways which make little sense To most economists the dump ing duties are simply naked protectionism Why they ask would a rational firm sell goods below cost The Aluminum Case During my term in government perhaps the most grievous instance of us special interests interfering in tradeand the reform processoccurred in early 1994 just after the price of alwninwn plummeted In response to the fall in price US aluminum producers accused Russia of dumping aluminum Any economic analysis of the situation showed clearly that Russia was not dumping Russia was simply selling aluminum at the international price which was low ered both because of a global slowdown in demand occasioned by slower global growth and because of the cutback in Russian alu minum use for military planes Moreover new soda can designs used substantially less aluminum than before and this also led to a decline in the demand As I saw the price of aluminum plummet I knew the industry would soon be appealing to the government for some form of relief either new subsidies or new protection from foreign com petition But even I was surprised at the proposal made by the head of Alcoa Paul ONeill a global aluminum cartel Cartels work by restricting output thereby raising prices ONeills interest was no surprise to me what did surprise me was the idea that the US gov ernment would not only condone a cartel but actually playa pivotal role in setting one up He also raised the specter of using the antidumping laws if the cartel was not created These laws allow the United States to impose special duties on goods that arc sold at below a fair market value and particularly when they are sold below the cost of production The issue of course was not whether Russia was or was not dumping Russia was selling its aluminum at international prices Given the excess capacity in its industry and the low price of Russian electricity much if not all of what it Va selling on international markets was being sold above its costs of production However the way the dumping laws arc typically implemented countries can be charged with dumping even when they weJ from an economic point of viewnot dumping The US estimates costs of production using a peculiar methodology which if applittl to AIIIfil11l tirllls Wluld probably conclude that most American tirllls ft Iulllpin IS wdl but worse the Department of Com IIItflt hih ldS sillluitaneously as judge jury and prosecutor esti 1IIlItS llStS blse on what it calls I3IA best information available which is typicLly that provided by the American firms trying to keep LlIt the t0rtign competition In the case of Russia and the other for llItr Communist countries it often estimates costs by looking at costs in I comparlble country In one case Poland was charged with dumping golf carts the supposedly comparable country was Canada In tht case of aluminum had dumping charges been brought there was a reasonable chance that sufficiendy high duties would be imposed so that Russia would not be able to sell its aluminum in the United States It might be able to sell its aluminum elsewhere unless other countries followed the US lead in which case international aluminum prices would have continued to have been depressed For Alcoa a global cartel was thus preferable it offered a better chance of getting the high prices that Alcoa wanted I opposed the cartel What makes market economies work is com petition Cartels are illegal inside the United States and they should be illegal globally The Council of Economic Advisers had become a strong ally of the Antitrust Division of the US Justice Department in pushing tor strong enforcement of competition laws For the United States now to help create a global cartel was a violation of every principle Here however more was at stake Russia was struggling to create a market economy The cartel would hurt Russia by restricting its sab of one of the few goods that it could market internationally And creating the cartel would be teaching Russia the wrong lesson about how market economies work On a quick trip to Russia I talked to Gaidar then the first deputy prime minister in charge of economics he and I both knew that Russia vas not dumpingin the sense in which that word would be used by economistsbut we both knew how the US laws work Were dumping charges brought there was a good chance that dump ing duties would be levied Nonetheless he knew how bad a cartel would be for Russia both economically and in terms of the impact on the reforms he was trying to put into place He agreed that we UNIAlII FAil TIIADE LAWS ANIJ OHILU MISCIIIH 175 should resist as strongly as we could He wa willing to face the risk of the imposition of dumping duties3 I worked hard to convince those in the National Economic Council that it would be a mistake to support ONeills idea and I made great progress But in a heated subcabinet meeting a decision was made to support the creation of an international cartel People in the Council of Economic Advisers and the Deparrment of Justice were livid Ann Bingaman the assistant attorney general for antitrust put the cabinet on notice that there might have been a violation of the antitrust laws in the presence of the subcabinet Reformers within the Russian government were adamantly opposed to the establishment of the cartel and had communicated their feelings directly to me They knew that the quantitative restrictions that the cartel would impose would give more power back to the oldline ministries With a cartel each country would be given certain quotas amounts of aluminum they could produce or export The ministries would control who got the quotas This was the kind of system with which they were familiar the kind of system that they loved I wor ried that the excess profits generated by the trade restrictions would give rise to a further source of corruption We did not fully grasp that in the new Mafiaized Russia it would also give rise to a bloodbath in the struggle over who got the quotas While I had managed to convince almost everyone of the dangers of the cartel solution two voices dominated The State Department with its close connections to the oldline state ministries supported the establishment of a cartel The State Department prized order above all else and cartels do provide order The oldline ministries of course were never convinced that this movement to prices and mar kets made sense in the first place and the experience with aluminum simply served to confirm their views Rubin at that time head ofthC National Economic Council played a decisive role siding with StatC At least for a while the cartel did work Prices were raised The prot its of Alcoa and other producers were enhanced The American con sumersand consumers throughout the worldlost and indeCd the basic principles of economics which teach the value of competitiVe markets show that the losses to consumers outweigh the gains to lllUILTlllN Nl ITS DISCONTENTS prcduccrs But ill tht S I poim mort was at issut wt wtrt trying tel ttKh RussII Ibut mrktt tconomics Thty Itarned a lesson but it IS tht TlHlg itSSlHl a IessOIl that was to cost them dtarly ovtr the ilIccttchng tlrs tht way to do wdl in marktt tconomics was to go tel tht glwtrIImtm Wt did not intend to ttach cronycapitalism 101 lIId thc prcbably did not nted to takt cronycapitalism 101 from us thc prcblbl could hat learntd all that was required on their own Uut Wt unwittingly providtd them with a bad example 4 National Security for Sale Tht tuminum cast was not the first nor would it be the last instlI1ct what special interests dominated over the national and global goal of a successful transition At the end of the Bush adminis tfation JIld the beginning of the Clinton administration a historical swords to plowshares agreement was made between Russia and the United Statts A US government tnterprise called the United States Enrichmtnt Corporation USEC would buy Russian uranium from deactivated nuclear warheads and bring it to the United States The uranium would bt deenriched so that it could no longer be used for nuc ar weapons and would thtn be used in nuclear power plants The sale would provide Russia with nteded cash which it could use to bttter keep its nuclear material under control Unbelievable as it may seem the fair tradt laws were again invoked to impede this transfer The American uranium producers arb1led that Russia was dumping uranium on US markets Just as in the case of aluminum there was no economic validity to this charge Howewr tht US unfair fair trade laws are not written on the basis of economic principles They exist solely to protect American indus tries adversdy affected by imports When the US governments import of uranium for purposes of disarmament was challenged by American uranium producers under the fair trade laws it became clear that a change in these laws was needed The Department of Commerce and the US Trade Repre sentative werewith highlevel coaxingfmally persuaded to pro pose changes in the laws to Congress Congress turned the proposals down It has remained unclear to mt whether Commerce and the UNIAIR FAIR TRADE LAWS AND OTHEII MIIHIEt 177 US Trade Representative sabotaged efforts at getting a change in the laws by presenting the proposal to Congress in a way that made the outcome inevitable or whether they fought against a Congress which always has taken a strong protectionist stand Equally striking was what happened next in the midt 9905 Much to the embarrassment of the Reagan and Bush administrations the United States was far behind in the sweepstakes on privatization in the t 980s Margaret Thatcher had privatized billions while the United States had privatized only a 2 million helium plant in Texas The difference of course was that Thatcher had far more and far larger nationalized industries that she could privatize At last privati zation advocates in the United States thought of something that few others would or could privatize USEC which not only enriches uranium for nuclear reactors but also for atomic bombs The privati zation was beset by problems USEC had been entrusted with bring ing in the enriched uranium from Russia as a private firm this was a kind of monopoly power that would not have passed scrutiny of the antitrust authorities Worse still we at the Council of Economic Advisers had analyzed the incentives of a privatized USEC and had shown convincingly that it had every incentive to keep the Russian uranium out of the United States This was a real concern there were major worries about nuclear proliferationabout nuclear material getting into the hands of a rogue state or a terrorist organization and having a weakened Russia with enriched uranium to sell to any one willing to pay was hardly a pretty picture USEC adamantly denied that it would ever act counter to broader US interests and affirmed that it would always bring in Russian uranium as fast as the Russians were willing to sell bllt the very week that it made these protestations I got hold of a secret agreement between USEC and the Russian agency The Russians had offered to triple their deliver ies and USEC had not only turned them down but paid a handsome amount in what could only be termed hush money to keep tlle offer and USEes refusal secret One might have thought that this itclf would have becn enough to stop thc privatization but not so the US Treasury was as adamant about privatization at home as it was in Russia Interestingly this Americas only major privatization of the LllIIAlILHIllN AN ITS DISCONTENTS Itldl Ius bttll beset with problems almost as bad as those that have bddltll priJtizJtioll elstwhere so much so that bipartisan bills have btlll illtwIUltd into COllgress to renationalize the enterprise Our tortllsts dut tht privatization would interfere with the importation Lf rht tllflched uranium trom Russia proved all too prescient Illdet1 Jr LHie poine it looked as if all exports to the United States llllhr be held up In the end USEC asked for huge subsidies to con rllllle wirh the importation The rosy economic picture painted by USEe and the US Treasury proved false and investors became lIlgrv IS they saw share prices plummet There was nervousness about I tirm wirh bare financial viability in charge of our nations produc rion of enriched uranium Within a couple of years of privatization quesrions were being raised about whether Treasury could with a strlighr tace give the financial certification required by the law for USEC to continue to operate LESSONS FOR RUSSIA Russia had a crash course in market economics and we were the reachers And what a peculiar course it was On the one hand they were given large doses of free market textbook economics On the other hand what they saw in practice from their teachers departed markedly from this ideal They were told that trade liberalization was necessary tor a successful market economy yet when they tried to export aluminum and uranium and other commodities as well to the United States they found the door shut Evidently America had succeeded without trade liberalization or as it is sometimes put trade is good but imports are bad They were told that competi tion is vital though not much emphasis was put on this yet the US government was at the center of creating a global cartel in alu minum and gave the monopoly rights to import enriched uranium to the US monopoly producer They were told to privatize rapidly and honestly yet the one attempt at privatization by the United States took years and years and in the end its integrity was ques tioned The United States lectured everyone especially in the after math of the East Asia crisis about crony capitalism and its dangersYet UNFAIR FAIR TRADE LAWS AND OTHEJI MISCHIEt 179 issues of the use of influence appeared front and center not only in the instances described in this chapter but in the bailout of Long Term Capital Management described in the last If the Wests preaching is not taken seriously everywhere we should understand why It is not just past injuries such as the unfair trade treaties referred to in earlier chapters It is what we are doing today Others look not only at what we say but also at what we do Ir is not always a pretty picture CHAPTER 7 BETTER ROADS TO THE MARKET A s THE FAILURES of the radical reform strategies in Russia and elsewhere have become increasingly evident those who pushed them claim that they had no choices But there were alternative strategies available This was brought home forcefully at a meeting in Prague in September 2000 when former government officials from a number of the Eastern European countriesboth those that were experiencing success and those whose performance was disappointingreappraised their experiences The government of the Czech Republic headed by Vaclav Klaus initially got high marks from the lMF because of it policy of rapid privatization but its management of the overall transition process resulted in a GDP that by the end of the 1990s was lower than the countrys 1989 level OtTicials in his government said they had no choice in the poli cies adopted But this contention was challenged by speakers from the Czech Republic and those from the other countries There were alternatives other countries made different choicesand there is a clear link betveen the different choices and the different outcomes Poland and China employed alternative strategies to those advo cated by the Washington Consensus Poland is the most successful of the Eastern European countries China has experienced the fastest rate of growth of any major economy in the world over the past twenty years Poland started with shock therapy to bring hyperin flation down to more moderate levels and its initial and limited use 180 BETTEI ROADS TO TilE MAIIKH of this measure has led many to think that this was one of the shock therapy transitions But that is totally wrong Poland quickly realized that shock therapy was appropriate for bringing down hyperinfla tion but was inappropriate for societal change It pursued a gradlUfut policy of privatization while simultaneously building up the basic institutions of a market economy such as banks that actually lend and a legal system that could enforce contracts and process bankrupt cies fairly It recognized that without those institutions a markrt economy cannot function In contrast to Poland the Czech Repub lic privatized corporations before it privatized the banks The state banks continued to lend to the privatized corporations easy money flowed to those favored by the state and privatized entities were not subjected to rigorous budgetary constraint which allowed them to put off real restructuring Polands former depury premier and finance minister Grzegorz W Kolodko has argued that the success of his nation was due to its explicit rejection of the doctrines of tbe Washington Consensus l The country did not do what the IMF rec ommendedit did not engage in rapid privatization and it did not put reducing inflation to lower and lower levels over all other macro economic concerns But it did emphasize some things to which the IMF had paid insufficient attentionsuch as the importance of democratic support for the reforms which entailed trying to keep unemployment low providing benefits for those who were unem ployed and adjusting pensions for inflation and creating the institu tional infrastructure required to make a market economy function The gradual process of privatization allowed restructuring to take place prior to privatization and the large firms could be reorganized into smaller units A new vibrant small enterprise sector was thus cre ated headed by young managers villing to invest for their future 2 Similarly Chinas success over the past decade stands in markfd contrast to Russias failure While China grew at an average ratf of over 10 percent in the 1990s Russia declined at an average annual rate of 56 percent By the end of the decade real incomes socallfd purchasing power in China were comparable to those in Rusia Whereas Chinas transition has entailed the largest reduction in poverry in history in such a short time span Tom 358 million in llllIIInlN NI ITS DISCONTENTS Ill I ll tI 11111i1l11 III t l7 usil1g Chinas admittedly lower poverty sUIIimt f t I dJ RussiJs transition has entailed one of the ItrglS IIIrll 111 plWlrrV ill history in such a short span of time Hltsid f 11lr Ill limil1e rh lIHrb blween Chillas strategy and that of Russia could I1l bl klrlr Ill it began trom the very first moves along the path w lthlti11 Chins rdorms began in agriculture with the move mll Illln the commune collective system of production in agri Lulmrl 0 the indiidull responsibility systemeffectively partial pmJClZJtion It was not complete privatization individuals could not bUI Jlld sell bnd treely but the gains in output showed how much oule be gained from even partial and limited reforms This was an llIormous achievlmlnt involving hundreds of millions of workers accomplished in a few years But it was done in a way that engen dered widespread supporr a successful trial in one province followed by trials in several others equally successful The evidence was so compelling that the central government did not have to force this change it was willingly accepted But the Chinese leadership recog nized that they could not rest on their laurels and the reforms had to extend to the entire economy At this juncture they called upon several American advisers including Kenneth Arrow and myself Arrow had been awarded the Nobel Prize pardy for his work on the foundations of a market economy he had provided the mathematic underpinnings that explained why alld wizen market economies work He had also done pathbreaking vork on dynamics on how economies changed But unlike those transition gurus who marched into Russia armed with textbook economics Arrow recognized the limitations of these text book models He and I each stressed the importance of competition of creating the institutional infrastructure for a market economy Pri vatization was secondary The most challenging questions that were posed by the Chinese were questions of dynamics and especially how to move from distorted prices to market prices The Chinese came up with an ingenious solution a twotier price system in which what a firm produced under the old quotas what it was required to produce under the old commandandcontrol system is UTTER ROAUS TO IHt MAliK priced using old prices but anything produced in excess of the old quota is priced using free market prices The system allowed full incentives al lire marginwhich as economists arc well aware is where they matterbut avoided the huge redistributions that would have occurred if the new prices were instantaneously to prevail over the entire output It allowed the market to grope for the undis torted prices a process that is not always smooth with minimal dis turbance Most important the Chinese gradualist approach avoided the pitfall of rampant inflation that had marked the shock therapies of Russia and the other countries under IMF tutelage and all the dire consequences that followed including the wiping out of savin accounts As soon as it had accomplished its purpose the twotier price system was abandoned In the meanwhile China unleashed a process of crealive destruc tion of eliminating the old economy by creating a new one Millions of new enterprises were created by the townships and villages which had been freed from the responsibility of managing agriculture and could turn their attention elsewhere At the same time the Chinese government invited foreign firms into the country to participate in joint ventures And foreign firms came in drovesChina became the largest recipient of foreign direct investment among the emerging markets and number eight in the world below only the United States Belgium United Kingdom Sweden Germany the Nether lands and France3 By the end of the decade its ranking was even higher It set out simultaneously to create the institutional infra structurean effective securities and exchange commission bank regulations and safety nets As safety nets were put into place and new jobs were created it began the task of restructuring the old stateowned enterprises downsizing them as well as the government bureaucracies In a short span ofa couple of years it privatized much of the housing stock The tasks are far from over the future far from clear but this much is undisputed the vast majority of Chinese li far better today than they did twenty years ago The transition from the authoritarianism of the ruling Commu nist Party in China however is a morc dillicult problem Economic growth and development do not automatically confer personal free llI8LlLHION AND ITS OISCONTtiNTS dom llld iil rights ThL inttrplay bttween politics and economics is llmpltx Fite YLlrs lU thert was a widespread view that there was 1 trldtlltr bLtwLtn gmwth and democracy Russia it was thought might ht lhlt to grow taster than America but it paid a high price Wt JlOW know that the Russians glve up their treedom but did not Iill tollomically Thtrt are cases of successful reforms done under litlcorshipPinochet in Chile is one example But the cases of dic tltorships destroying their economies are even more common Stlbility is imponant tor growth and anyone familiar with Chinas hiscory rediizes that the fear of instability runs deep in this nation of Otr 1 billion people Ultimately growth and prosperity widely hlrtd Ire necessary if not sufficient for longrun stability The demouies of the West have in turn shown that free markets often disciplined by governments succeed in bringing growth and pros peri in J climate of individual freedom As valid as these precepts are tor the past they are likely to be even more so for the New Economies of the future In its quest for both stability and growth China put creating com petition new enterprises and jobs before privatization and restruc turing existing enterprises While China recognized the importance of macrostabilization it never confused ends with means and it never took fighting inflation to an extreme It recognized that if it was to maintain social stability it had t oid sivt1YWfPt J9 creation had to go iI andtth restructuring Many bf its policies can be interpreted in this light While China liberalized it did so gradually and in ways which ensured that resources that were dis placed were redeployed to more efficient uses not left in fruitless unemployment Monetary policy and financial institutions facilitated the creation of new enterprises and jobs Some money did go to sup pon inetTlcient state enterprises but China thought that it was more important not only politically but also economically to maintain social stability which would be undermined by high unemployment Although China did not rapidly privatize its state enterprises as new enterprises were created the state ones dwindled in importance so much so that twenty years after the transition began they accounted for only 282 percent of industrial production It recognized the dan BETTEN ROADS CO THl MAIIKH gers of full capital market liberalization while it opened itself up to foreign direct investment The contrast between what happened in China and what Ius hap pened in countries like Russia which bowed to IMF ideology could not be starker In case after case it seemed that China a newcomer to market economies was more sensitive to the incentive effects of each of its policy decisions than the IMF was to its Township and village public enterprises were central in the early years of transition IMF ideology said that because these were publit enterprises they could not have succeeded But the IMF was wrong The township and village enterprises solved the governance prob lem a problem to which the IMF gave scant attention but which underlay many of the failures elsewhere The townships and villages channeled their precious funds into wealth creation and there was strong competition for success Those in the townships and villages could see what was happening to their funds they knew whether jobs were being created and incomes increased Although there may not have been democracy there was accountability New industries in China were sited in rural areas This helped to reduce the social upheaval that inevitably accompanies industrialization Thus China built the foundation of a New Economy on existing institutions maintaining and enhancing its social capital while in Russia it eroded The ultimate irony is that many of the countries that have taken a more gradualist policy have succeeded in making deeper reforms more rapidly Chinas stock market is larger than Russias Much of Russias agriculture today is managed little differently than it was a decade ago while China managed the transition to the individual responsibility system in less than five years The contrasts I have depicted between Russia on the one hand and China and Poland on the other could be repeated elsewhere in the economies in transi tion The Czech Republic received accolades carlyon from the IMF and the World Bank for il rapid reforms it later became apparent that it had created a capital market which did not raise money fur new investment but allowed a few smart money managers more accurately whitecollar criminalsif they did what they did in the ISO UIIIL1lHION Nll ITS DISCUNTENTS Cudl Rtpubli in tht United States they would be behind bars to WJlk otr with llIillillllS llf dollJrs of others money As a result of these Illd Lltha llIistJkts in its transition reative to where it was in 1989 the rqlubh Ius tllell behindin spite of its huge advantages in location Illd tht 11lh Itvel of education of its populace In contrast Hungarys printizliLlll llIay hJve bUtten off to a slow start but its firms have been rtstruetured Illd Jre now becoming internationally competitive lollI1d lI1d China show that there were alternative strategies The pLllitiu sociu and historical context of each country differs one Jnnot be sure that what worked in these countries would have mrked in Russia and would have been politically feasible there By the lIne token some argue that comparing the successes is unfair ivell the markedly different circumstances Poland began with a stronger nurket tradition than Russia it even had a private sector during the Communist era But China began from a less advanced position The presence of entrepreneurs in Poland prior to the transi tion might have enabled Poland to undertake a more rapid privatiza tion strategy yet Poland as well as China chose a more gradualist approach Poland is alleged to have had an advantage because it was more industrialized China because it was less so China according to these critics was still in the midst of industrialization and urbanization Russia faced the more delicate task of reorienting an already indus trialized but moribund economy But one could argue just the con verse development is not easy as the rarity of successes clearly demonstrates If transition is difficult and development is difficult it is not obvious why doing both simultaneously should be easy The ditTerence between Chinas success and Russias failure in reforming agriculture was if anything even greater than the two countries suc cess in reforming industry One attribute of the success cases is that they are homegrown designed by people within each country sensitive to the needs and concerns of their country There was no cookiecutter approach in China or Poland or Hungary These and all the other successful tran sitioning countries were pragmaticthey never let ideology and simple textbook models determine policy UfTTHI ROAUS TO Tin MAIIKIT Science even an imprecise science like ecollomics is concerned with predictions and analyzing causal links The pndictions of the gradualists were borne outboth in the cOUlJtrie that followed their strategies and in the shock therapy countries that followed the alter native course By contrast the predictions of the shock therapists were not In my judgment the successes in countries that did not follow IMF prescriptions were no accident There was a clear link berween the policies pursued and the outcomes berween the successes in China and Poland and what they did and the failure in Russia and what it did The outcomes in Russia were as we have noted what the critics of shock therapy predictedonly worse The outcomes in China were precisely the opposite of what the IMF would have pre dictedbut were totally consonant with what the gradualists had suggested only better The excuse of the shock therapists that measures called for by their prescription were never fully implemented is not convincing In economics no prescription is followed precisely and policies and advice must be predicated on the fact that fallible individuals work ing within complex political processes will implement them If the IMF failed to recognize this that itself is a serious indictment What is worse is that many of the failures were foreseen by independent observers and expertsand ignored The criticism of the IMF is not just that its predictions were not borne out After alI no one not even the IMF could be sure of the consequences of the farranging changes that were entailed by the transition from communism to a market economy The criticism is that the Funds vision was too narrowit focused only on the eco nomicsand that it employed a particularly limited economic model We now have far more evidence about the reform process than we did five years ago when the IMF and the World 13ank rushed to the judgment that their strategies were working 4 Just as matters look strikingly different today than they did in the mid1990s so too in another decade we may given outcomes of reforms now underway have to revise our judgments From the current vantage point how ever some things seem clear The IMF said that those who engaged ISS GlOIIHIZUION AND ITS DISCONTINTS in shock thtrapy while they might fed more pain in the short run would be more sllccesstul in the long Hungary Slovenia and Poland have shown that gflduliist policies lead Q less pain in the short run greHer Slcill llld political stability and faster growth in the long In the fJee bttween the tortoise and the hare it appears that the tortoise hls won Igain The radical reformers whether the star pupils like the Czech Republic or the slightly unruly ones like Russia have lost5 THE ROAD TO THE FUTURE Those who are responsible for the mistakes of the past have had scant advice tor where Russia should go in the future They repeat the same mantrasthe need Q continue with stabilization privatization ll1d liberalization The problems caused by the past now have forced them to recognize the need for strong institutions but they have little advice to otfer on what that means or how it is to be achieved At meeting atter meeting on Russian policy I was struck by the absence of a strategy either for attacking poverty or enhancing growth Indeed the World Bank discussed scaling back on its programs in the rural sector This made sense for the Bank given the problems that its previous programs in this area had caused but it made no sense for Russia given that this was where much of the countrys poverty lay The only growth strategy proposed was that the country had to adopt policies that would repatriate the capital that had Red the country Those who held this position overlooked that this recom mendation could mean making a permanent fixture of the oligarchs and the kleptocracy and cronyMafia capitalism that they repre sented There was no other reason for them to bring their capital back when they could earn good returns in the West Moreover the IMF and US Treasury never addressed the fact that they were sup porting a system that lacked political legitimacy where many of those with wealth had obtained their money by stealth and political con nections with a leaderBoris Yeltinwho too had lost all credibil ity and legitimacy Sadly for the most part Russia must treat what has happened as pillage of national assett a theft for which the nation can UETTEJI ROADS TO THI MARKH 1119 never be recompensed Russias objective in the future J11U5t be to try to stop further pillage to attract legitimate investors by creating a rule oflaw and more broadly an attractive business climate The 1998 crisis had one benefit to which I referred earlier the devaluation of the ruble spurred growth not so much in exports but in import substitutes it showed that the IMF policies had indeed been stifling the economy keeping it below its potential The devalu ation combined with a stroke ofluckthe enormous increase in oil prices in the late 1990sfueled a recovery from an admittedly low base There are lasting benefits from this growth spurt some of the enterprises that took advantage of the favorable circumstances seem on the road to new opportunities and continued growth There are other positive signs some of those who took advantage of the system of ersatz capitalism to become very wealthy are working for a change in the rules to make sure that what they did to others cannm be done to them There are moves in some quarters for better corporate governancesome of the oligarchs while they are not willing to risk all of their money in Russia would like to entice others to risk more of theirs and know that to do so they have to behave better than they have in the pat But there are other less positive signs Even in the heyday of very high oil prices Russia was barely able to make its budget balance it should have been putting money aside tor the like lihood of a rainy day when oil prices come down As this book goes to press the recovery is uncertain Oil prices have come down from their peak and as usual the impacts of dtvaIuation are 1Il0sdy felt in the first two ytars But at the lower growth rates that are now emerging Russia will need another decade or two or more just to catch up to where it was in 1990unkss thert are some marked changes Russia has learned many lessons In the aftermath of communism many of its people swung from the old religion of Marx to the new religion of free markets The sheen has been taken off this new reli gion and a new pragmatism has settled in There are some policies that might make a difference In cata loging what was to be done it is natural to begin by thinking about the mistakes of the pat the lack of attention to the underpinnings of llllU ILUION ND I rs DISCONTENTS J IIIJrket eCtHIllIIIVIIIl1II tinancial institutions that lend to new tnterprists tll tS thJt tnlrce contracts and promote competition tll In IIldeptnlknt lIId honest judiciary Russil llIust o beyond its locus on macrostabilization and tlltllurIe eonolllic growth Throughout the 1990s the IMF tllCused 011 Ilukin countries work on getting budgets in order and cOllmllill the growth of money supplies Although when con ducted in Idalfi this stabilization may be a prerequisite to rowth it is hardly a growth strategy In fact the stabilization strategy has contracted aggregate demand This decrease in aggregate demand has interJcted with misguided restructuring strategies to contract aggregate supply In 1998 there was an active debate about the role of demand and supply The IMF argued that any increase in aggregate demand would be inflationary If this is true it is a terrible admission of failure In six years Russias productive capacity had been cut by more than 40 percentfar deeper than the reduction in defense a far greater loss in capacity than occurs in any but the worst wars I knew that the IMF policies had contributed greatly to the reduction in productive capacity but I believed that lack of aggregate demand still remained a problem As it turned out the IMF again proved to be wrong when the devaluation occurred at last domestic producers could compete with foreign imports and they were able to meet the new demands Production increased There had indeed been excess capacity which IMF policies had left idle for years Growth will only succeed if Russia creates an investmentfriendly environment This entails actions at all levels of government Good policies at the national level can be undone by bad policies at the local and regional level Regulations at all levels can make it difficult to establish new businesses Unavailability of land can be an impedi ment just as lack of availability of capital can be Privatization does little good if local government officials squeeze firms so hard that they have no incentive to invest This implies that issues of federalism have to be attacked headon A federalist structure that provides compatible incentives at all levels has to be put into place This will be difficult Policies aimed at curtailing abuses at lower levels of gov ernment can themselves be abused to give excessive power to the center and deprive local and regional authorities of the capacity to UETTEK ROAIJS TO THE MAIKEl 191 devise creative and entrepreneurial growth strategie Although Rus sia has stagnated overall there has been progress in a few localities and there is concern that the Kremlins recent attempts at reining in local authorities will in fact stiRe these local initiatives But there is one factor essential to establishing a good business cli mate something which will prove particularly difficult to achieve given what has happened over the past decade political and social stability The huge inequality the enormous poverty which has been created over the past decades provides fertile ground for a variety of movements from nationalism to populism some of which may not only be a threat to Russias economic future but to global peace It will be difficultand likely take considerable timeto reverse the inequality that was created so quickly Finally Russia must collect taXes Collections should be least diffi cult in Russias dominant natural resource businesses since revenues and output in the natural resources sector are in principle easily moni tored so taXes should be easy to collect Russia must put firms on notice that if taXes are not paid in say sixty days their property will be seized If taXes are not paid and the government does seize the property it can reprivatize it in a way that has more legitimacy than the discredited loansforshare privatization under Yeltsin On the other hand if the businesses do pay their taxes Russia the Russian government will have the resources to attack some of the important outstanding problems And just as those who owe taxes must pay what they owe those who owe money to banksespecially the banks that are now in the hands of the government as a result of defaultsmust be made to pay those debts Again this may entail an effective renationalization of the enterprise a renationalization to be followed by a more legitimate privatization than had occurred previously The success of this agenda is predicated on there being a relatively honest government interested in improving the common weal We in the West should realize this there is relatively little that we can do to bring that about The hubris of those in the Climon administration and the IMP that they could pick those to support push reform programs that worked and usher in a new day for Russia ha been shown for what it was the arrogant attempt hy those who knew little II lllllUllHIllN AND ITS DISCONTNTS lf tht lHlner using J nlrrow s t of conomic concptions to hJng tht lHlrsl lf history an acc mpt that was doomed to failure We c1ll help support tht kinds of institutions that are the underpin Ilifl of Jlllloraci sbuilding up think tanks creating space for publi JitigUt supporting indptndtnt media helping to educate a IllW glIeLnion thlt undtrstands how democracies work At the lIJtiolial regionJl lIId provinciall vel th re ar many young officials whl woulJ Iik to s th ir country take a different course and tmldbJs d supportint ll ctual as much as financialcould make J dit1r nce If th d vastation of its middle class represents the longestttrm thrtat to Russia th n while we cannot fully reverse the dJIllIge that has be n dont at least we can work to stop its further lroSton Gtorge Soros has shown that the assistance provided by a single indiidual cJn lllakt a diff rence surely the concerted efforts of the Wlst if well dir cttd could do even more As we forge broader dtmocratic int ractions w should distance ourselves from those that art allitd to the power structures of the past as well as the newly lmtrging pOVtr structures of the oligarchsat least as far as realpoli cik will allow This above all else We should do no harm IMF loans to Russia w r harmful It is not only that these loans and the policy decisions behind them have left the country more indebted and impoverished and maintained exchange rates at high levels that squelched the economy they were also intended to maintain the lxisting groups in power as corrupt as it was clear they were so to the extent that they succeeded in this deliberate intervention in the political life of the country they arguably set back a deeper reform ag nda that went beyond creating a particular narrow vision of a market economy to the creation of a vibrant democracy My conclu sion as I sat in the meetings debating the 1998 loan remains as true today as it was then If Russia an oil and natural resourcerich country is able to get its act together it will not need these loans and if it does not the loans will be of little benefit It is not money that Russia needs It is something else something the rest of the world can give but it will require a very different kind of program BCTTEI ROADS TO TH MAIIKU DEMOCRATIC ACCOUNTABILITY AND THE FAILURES J91 I have painted a bleak picture of Russia in transition massive poverty a few oligarchs a devastated middle class a declirung population and disillusionment with market processes This indictment should be balanced with a recognition of the achievements Russia now has a fragile democracy far better than the totalitarian regime of the past It suffers from a largely captive mediaformerly too much under the control of a few oligarchs now too much under the control of the statebut a media that still presents a diversiry of viewpoints far wider than under the state control system of the past Young well educated dynamic entrepreneurs while they too often seek to migrate to the West rather than face the difficulties of doing business in Russia or the other former Soviet republics represent the prornise of a more vibrant private sector in the future In the end Russia and its leaders must be held accountable for Russias recent history and its fate To a large extent Russians at least a small elite created their countrys predicament Russians made the key decisionslike the loansforshare privatization Arguably the Russians were far better at manipulating Western institutions than the Westerners were at understanding Russia Senior government officials like Anatoly Chubais have openly admitted how they rnisled or worse lied to the IMF They felt they had to to get the money they needed But we in the West and our leaders have played a far from neutral and not insignificant role The IMF let itself be misled because it wanted to believe that it programs were working because it wanted to continue lending because it wanted to believe that it was reshap ing Russia And we surely did have some influence on the course of the country we gave our imprimatur to those who were in power When Chubais was 1Skd if the Russian government has the right to lie to the IMF about the true fiscal situation he literaU said In slIch situtions the authori ties have to do it We ought to The financial institution undentand dpire the fact that we conned them out ofS20 billion that we had no other way out See R C Paddock Russia Lied to Get Loam Sav Aide to Ycltsin LlJ AnJltN JimN Sep tember 9 1998 lllLlLUIN AND ITS DISCONTENTS Th the West stellltd willing to dtal with thembig time with bil Iwns f dIlrsJvt tht1II redibility the fact that others might not be Iblt tll tiiit suh support clearly counted against them Our tacit SUpPLrt tor tht loanstorshart program may have quieted criticisms Itter II the I iI F VJS the expert on transition it had urged privatiza tion JS rapidly JS possible and the loansforshare was if nothing else rapid ThJt it was corrupt was evidently not a source of concern The mpporr the policiesand the billions of dollars of IMF money IIIIV not just have enabled the corrupt government with its corrupt poliies to remain in power they may even have reduced pressure for rtILre meaningtul rdorms We have placed our bets on favored leaders and pushed particular trategies of transition Some of those leaders have turned out to be incompetent others to have been corrupt and some both Some of those policies have turned out to be wrong others to have been cor rupt Jlld some both It makes no sense to say that the policies were right and simply not implemented well Economic policy must be predicated not on an ideal world but on the world as it is Policies must be designed not for how they might be implemented in an ideal world but for how they will be implemented in the world in which we live Judgment calls were made not to investigate more promising alternative strategies Todayjust as Russia begins to hold its leaders accountable for the consequences of their decisions we too should hold our leaders accountable CHAPTJJ TEEIJkfFJ CTFfER ACLATL A4JVETAny FLJJ70S ess rh r 980 ar70 99CJ r3JS rl rr rIEE IrrTERIVATIC3AI cessul efCcrts i t1Je q estions abouc the yay che F17d ses rh pJfJ7ccs GB alizatioTlhovv it sees irs obJeccives 170 hovv re SCoCK rC7 acCGJr7A clJcsc objCcjVes as part ofici Ie aI70177issJCII7 he FInd beiCvc1I it ii rJfiJlil7g hc caiKS 7sJgr7cd rp7rJ gluobnl sClIbiJi 17lclpirllg dccJcpig c rrrcf In rr7 oIrIOJ7 7II c1lZ 7r cOlIJly sraliJiey bLt 1Ils gVVt LJrtif rrCCl7rfy cJ h7r tIh J 1 lld bC cccrllcd vvitl71 prtyJ71t s rJC s7Ihr rh rld U kL c tcJdny it 1 1119 ckcor rJ7Ic r h7I r I a rlCriIly I lciC IIVr rJ 1IJc it J7 e I i ri hcr1IJJ Le e1c ccoICc711e IJ I c hcCI46r I1r t lic Cc e I A4c I c Irc IL hc cr pri 1 7c A iLg0ifrTijfiJ52fi00 CIlllIIILATlllN AND ITS DISCONTENTS its itHtrIsts is JltuJily not btClUSt tht prevJitnt tfte market ideology blurs dtlr thinking lbout how btst to addrtss an economys ills Losing Intellectual Coherency From Keyness IMF to Todays IMF Thtrt was J ctrtain cohtrency in Keyness the intellectual godfather ot the IlvlF conctption of the Fund and its role Keynes identified a mlrket tiilurta reason why markets could not be left to them sdvesthat might benefit from collective action He was concerned that nlJrkets might generate persistent unemployment He went fur ther He showed why there was a need for global collective action because the actions of one country spilled over to others One coun trys imports Jre another countrys exports Cutbacks in imports by one country for whatever reason hurt other countries economies There was another market failure he worried that in a severe downrurn monetary policy might be ineffective but that some countries might not be able to borrow to finance the expenditure increases or compensate for tJX cuts needed to stimulate the econ omy Even if a country was seemingly creditworthy it might not be able to get money Keynes not only identified a set of market failures he explained why an institution like the IMF could improve matters by putting pressure on countries to maintain their economy at full employment and by providing liquidity for those countries facing downrurns that could not afford an expansionary increase in govern ment expendirures global aggregate demand could be sustained Today however market fundamentalist dominate the IMF they bdieve that markets by and large work well and that governments by and large work badly We have an obvious problem a public institu tion created to address certain failures in the market but currently run by economist who have both a high level of confidence in mar kets and little confIdence in public institutions The inconsistencies at the IMF appear particularly troubling when viewed from the per spective of the advances in economic theory in the last three decades The economics profession has developed a systematic approach to the market failure theory qgovermnetilal action which attempts to iden tify why markets might not work well and why collective action is THE IMFs OTHER AENUA 117 necessary At the international level the theory identifies why indi vidual governments might fail to serve global economic welfare and how global collective action concerted action by governmenlS working together often through international institutions would improve things Developing an intellectually coherent view of inter national policy for an international agency such as the IMF thus requires identifying important instances in which markets might fail to work and analyzing how particular policies might aven or mini mize the damage done by these failures It should go funher showing how the particular interventions are the bm way to attack the market failures to address problems before they occur and to remedy them when they do As we have noted Keynes provided such an analysis explaining why countries might not pursue sufficiently expansionary policies on their ownthey would not take into account the benefits it would bring to other countries That was why the Fund in its original con ception was intended to put international pressure on countries to have more expansionary policies than they would choose of their own accord Today the Fund has reversed course putting pressure OD countries particularly developing ones to implement more contrac tionary policies than these countries would choose of their own accord But while seemingly rejecting Keyness views todays IMF has in my judgment not aniculated a coherent theory of market fail ure that would justify its own existence and provide a rationale for its particular interventions in the market As a result as we have seen all too often the IMF forged policies which in addition to exacerbating the very problems they sought to address allowed these problems to play out over and over again A New Role for a New Exchange Rate Regime Some thirty years ago the world switched to a system of flexible exchange rates There was a coherent theory behind the switch exchange rates like other prices should be determined by market forces Attempt by government to intervene in the determination of this price are no more successttll than attempts to intervene in the determination of any other price Ylt as have seen the IMF has lLlKLlLHlllN NU ITS DISCNTNTS rtelHlY IIlhknlktll Illlssivt interventions Billions of dollars were pell tnlll tl IIStlill the lxchange rates of Brazil and Russia at llllSlhtlllllbk leHls The IMF justifies these interventions on the frllllllds thlt SIrilllt markets exhibit excessive pessirrtismthey lwrslwcHlIId the calmer hand of the international bureaucrat lJIl thell help stabilize markets It struck me as curious that an insti tutilIl lommitted to the doctrine that markets work well if not pertltl should decide that this one marketthe exchange rate IllJrketrequirts such massive intervention The IMF has never put forward a good explanation either for why this expensive interven tion is dtsirlble in this particular marketor for why it is undesirable in other markets I Jree with the IMF that markets may exhibit excessive pes simism But I lisa believe that markets may exhibit excessive opti mism lnd that it is not just in the exchange rate market that these problems occur There is a wider set of imperfections in markets and especially capital markets requiring a wider set of interventions For instance it was excessive exuberance that led to Thailands real estate and stock market bubble a bubble reinforced if not created by hot speculative money flowing into the country The exuberance was followed by excessive pessirrtism when the flow abruptly reversed In fact this change in the direction of speculative capital was the root cause of the excessive volatility in exchange rates If this is a phenom enon comparable to a disease it makes sense to treat the disease rather than just its manifestation exchange rate volatility But IMF free mar ket ideology led the Fund to make it easier for speculative hot money to flow into and out of a country In treating the symptoms directly by pouring billions of dollars into the market the IMF actu ally made the underlying disease worse If speculators only made money otT each other it would be an unattractive gamea highly risky activity which 011 average made a zero return as the gains by some were matched by equal losses from others What makes specula tion profitable is the money coming from governments supported by the IME When the IMF and the Brazilian government for instance spent some 55 billion maintaining the exchange rate at an overval ued level in late I 99H where did the money go The money doesnt THE IMFs OTHER AGENDA disappear into thin air It goes into somebodys pocketmuch of it into the pockets of the speculators Some speculators may win some may lose but speculators as a whole make an amount equal to what the government loses In a sense it is the IMF that keeps the specula tors in business Contagion There is another equally striking example of how the IMFs lack of a coherent and reasonably complete theory can lead to policies which exacerbate the very problems the IMF is supposed to solve Consider what happens when the Fund attempts to quarantine contagion In essence the Fund argues that it must intervene and quickly if it deter mines that an ongoing crisis in one countty will spill over to others that is the crisis will spread like an infectious contagious disease If contagion is a problem it is important to understanding the workings of the mechanism through which it occurs just as epidemiologists in trying hard to contain an infectious disease work hard to understand its transmission mechanism Keynes had a coher ent theory the downturn in one country leads that country to import less and this hurts its neighbors We saw in chapter 4 how the IMF while talking about contagion took actions in the Asian finan cial crisis that actually accelerated transmission of the disease as it forced country after countty to tighten their belts The reductions in incomes led quickly to large reductions in imports and in the closely integrated economies of the region these led to the successive weak ening of neighboring countries As the region imploded the declin ing demand for oil and other commodities led to the collapse of commodity prices which wrought havoc in other countries thou sands of miles away whose economies depended on the export ot those commodities Meanwhile the IMF clung to fiscal austerity as the antidote claim ing that was essential to restore investor contldence The East Aian crisis spread from there to Russia through the collapse of oil prices not through any mysterious connection between confidence on the part of investors foreign 1ld domestic in the East Asia Miracle lllllllILHIllN AND iTS DISCONTENTS Lll1l01l1its md th Illtia capitalism of Russia Because of the lack of a llhalIt md prsuasive theory of contagion the IMF had spread th disls ratha thall 011tailld it When Is a Trade Deficit a Problem Probkllls of oherence plague not only the IMFs remedies but also its dia1lOSes IMF economists worry a lot about balance of payments ddicits such ddicits are in their calculus a sure sign of a problem in the otting But in railing against such deficits they often pay little attention to what the money is actually being used for If a govern ment has a fiscal surplus as Thailand did in the years before the 1997 crisis then the balance of payments deficit essentially arises from pri 1lIt investment exceeding private savings If a firm in the private sec tor borrows a million dollars at 5 percent interest and invests it in something that yields a 20 percent return then its not a problem for it to have borrowed the million dollars The investment will more than pay back the borrowing Of course even if the firm makes a mistake in judgment and the returns are 3 percent or even zero there is no problem The borrower then goes into bankruptcy and the creditor loses part or all of his loan This may be a problem for the creditor but it is not a problem that the countrys governmentor the IMFneed worry about A coherellC approach would have recognized this It would have also recognized that if some country imports more than it exports ie it has a trade deficit another country must be exporting more than it imports it has a trade surplus It is an unbreakable law of interna tional accounting that the sum of all deficits in the world must add up to the sum of all surpluses This means that if China and Japan insist on having a trade surplus then some countries must have deficits One cannot just inveigh against the deficit countries the sur plus countries are equally at fault If Japan and China maintain their surpluses and Korea converts its deficit into a surplus the problem of deficit mllst appear on somebody elses doorstep Still large trade deficits can be a problem They can be a problem because they imply a country has to borrow year after year And if those who are providing the capital change their minds and stop THE IMFs OTHElI AGENUA 201 making loans the country can be in big troublea crisis It is spend ing more to buy goods from abroad than it gets from selling its goods abroad When others refuse to continue to finance the trade gap the country will have to adjust quickly In a few cases the adjustment can be made easily if a country is borrowing heavily to finance a binge of car buying as was the case recently in Iceland then if foreigners refuse to provide the financing for the cars the binge stops and the trade gap closes But more typically the adjustment does not work so smoothly And problems are even worse if the country has borrowed short term so that creditors can demand back now what they have lent to finance previous years deficits whether they were used to finance consumption splurges or longterm investments Bankruptcy and Moral Hazard Such crises occur for instance when a real estate bubble bursts as it did in Thailand Those who borrowed from abroad to finance their real estate ventures could not repay their loans Bankruptcy became widespread How the IMF handles bankruptcy represents still another arena where the Funds approach is plagued with intellecrual inconsistencies In standard market economics if a lender makes a bad loan he bears the consequence The borrower may well go into bankruptcy and countries have laws on how such bankruptcies should be worked out This is the way market economies are supposed to work Instead repeatedly the IMF programs provide funds for governments to bail out Western creditors The creditors anticipating an IMF bailout have weakened incentives to ensure that the borrowers will be able to repay This is the infamous moral hazard problem welJ known in the insurance industry and now in economics Insurance reduces your incentive to take care to be prudent A bailout in the evem of a crisis is like free insurance If you are a lender you take less care in screening your applicantswhen you know you will be bailed out if the loans go sour Meanwhile prudent tirms that lace toreign exchange volatility can insure against it in complicated but readily accessible ways Butas we saw earlierif borrowers in a country dont buy insurance to minimizl their risk or exposun but they lllUIHlllN AND ITS LJISCONT8NTS kllllW elr bdll dut all IMF bailout is likely then borrowers are bill tIlLurad to illCur excess riskand not worry about it This is whlt Illpptlltd ill the leadup to the ruble crisis in Russia in 1998 III thlt illstlllce evell JS the Wall Street creditors were making loans w RussII they were letting it be known how large a bailout they thluht WIS nteded and given Russias nuclear status they believed Russil would get The IMF tocusing on the symptoms tries to defend its interven tions by saying that without them the country will default and as a result it will not be able to get credit in the future A coherent approach would have recognized the fallacy in this argument if capi tIl llllrkets work wellcertainly if they worked anywhere near as well as the IMF market timdamentalists seem to arguethen they Jre torwardIooking in assessing what interest rates to charge they look at the risk 5tjllg fonvard A country that has discharged a heavy overhang of debt even by defaulting is in better shape to grow and thus IIIOTe able to repay any additional borrowing That is part of the rationale for bankruptcy in the first place the discharge or restruc turing of debt allows firmsand countriesto move forward and grow Eighteenthcentury debtor prisons may have provided strong incentives for individuals not to go into bankruptcy but they did not help debtors get reestablished Not only were they inhumane but they did not enhance overall economic efficiency History supports this theoretical analysis In the most recent instance Russia which had a massive debt default in 1998 and was widely criticized for not even consulting creditors was able to bor row trom the market by 2001 and capital began to flow back to the country Likewise capital started flowing back to South Korea even though the nation effectively forced a restructuring of its debt giving foreign creditors a choice of rolling over loans or not being repaid Consider how the IMF if it had developed a coherent model might have approached one of the most difficult problems in East Asia whether or not to raise interest rates in the midst of the crisis Raising them of course would force thousands of firms into bank ruptcy The contention of the IMF was that failing to raise rates would lead to a collapse of the exchange rate and the collapse of the exchange rate would lead to even more bankruptcy Put aside for the THE IMFs OTHER AGENDA moment the question of whether raiing interest rates with the resulting exacerbation of the recession would lead to a stronger exchange rate in real life it did not Put aside too the empirical question of whether more firms would be hurt by raising interest rates or the fall in the exchange rate at least in Thailand the evi dence strongly suggested that the damage from a further fall in the exchange rate would be smaller The problem of economic disruption caused by exchange rate devaluations is caused by the firms that choose not to buy insurance against the collapse of the exchange rate A coherent analysis of the problem would have begun by asking why the seeming market failurewhy do firms not buy the insur ance And any analysis would have suggested that the IMF itself was a big part of the problem IMF interventions to support the exchange rate as noted above make it less necessary for firms to buy insurance exacerbating in the future the very problem the intervention was supposed to address From Bailout to BailIn As the IMFs failures became increasingly evident it sought new strategies but the lack of coherency ensured that its quest for viable alternatives had little chance of success The extensive criticism of its bailout strategy induced it to try what some have called a bailin strategy The IMF wanted the private sector institutions to be in on any bailouts It began to insist that before it lent money to a country in a bailout there had to be extensive participation by the private sector lenders they would have to take a haircut forgiving a sub stantial part of the debt that was owed Not surprisingly this new strategy was first tried not on major countries like Brazil and Russia but on powerless countries like Ecuador and Romania too weak to resist the IME The strategy quickly proved to be both problematic in conception and flawed in implementation with highly negative con sequences for the countries targeted for the experimtnt Romania was a particularly mystitYing example It wa not threat ening a default it only wanted new money Tom the IMF to signal that it was creditworthy which would help to lowtr the interest rates it paid But new lenders will only lend if they get an interest rate l1 llllHllHION ANU ITs DISCONTENTS cOlllllllnsllrltt with tht risk they tace New lenders cannot be forced tll tlke 1 luircur If the IMF had based its policies on a coherent theclrv of welltulKtioning capital markets it would have realized thi Uur there was J more serious problem which goes to the IMFs nlrt mission The Fund was created to deal with the liquidity crises clused bv the credit markets occasional irrationality its refusal to knd to countries that were in fact creditworthy Now the IMF was hlllding power over its lending policies to the same individuals and institutions that precipitated crises Only if they were willing to lend could it be willing to lend These lenders quickly saw the profound implications of the change even if the IMF did not If creditors rduse to lend the client country money or to go along with a settle ment the borrowing country will not be able to get fundsnot just Tom the IMF but from the World Bank and other institutions which made their lending contingent on IMF approval The creditors sud denly had enormous leverage A twentyeightyearold man in the Bucharest branch of an international private bank by making a loan of a few million dollars had the power to decide whether or not the IMF the World Bank and the EU would provide Romania with more than a billion dollars of money In effect the Fund had dele gated its responsibility for assessing whether to lend to the country to this twentyeightyearold Not surprisingly the twentyeightyear old and other thirty and thirtyfiveyearold bankers in the branches of the other international banks in Bucharest quickly grasped their newly granted bargaining powers Each time the Fund lowered the amount of money it demanded that the private banks put up the private banks lowered the amount that they were willing to offer At one point Romania appeared to be only S36 million of private sector loans short to receive the billiondollar aid package The private banks assembling the money required by the IMF demanded not only top dollar high interest rates but at least in one case some discreet relaxation of Romanias regulatory rules This regulatory forbearance would allow the creditor to do things he might otherwise not be able to doto lend more or to make riskier higher interest rate loansincreasing his profits but increasing the riskiness of the banking system and undermining the very reason for THh IMfs OTHeR AUWh regulation Less compttent or more corrupt governmtnts might haw been tempted but Romania did not acctpt tht offer partly because it was not really that desperate for money in the fmt plact The issue can bt seen another way Tht IMFs deciion to make a loan is supposed to be based on how a country is addressing its fun damental macroeconomic problems Under the participatory strat egy a country could have a perfectly satisfactory set of macropolicies but if it could not raise the amount that the IMF said it had to raise from the private banks it might not be able to receive funds from any of the sources The IMF is supposed to have the expertise on these questions not the twentyeightyearold bank officer in Bucharest Eventually at least in the case of Romania the failings of the strat egy became evident even to the IMF and it proceeded to provide funds to the country even though the private sector had not pro vided the amounts the IMF had insisted upon The Best Defense Is an Offense Expanding the Role of the IMF as Lender of Last Resort In the light of increasing perceptions of the Funds failures and grow ing demands that its scope be cut back in 1999 the IMFs first deputy manager Stanley Fischer proposed that the Fund expand its role to make it a lender of last resort Given that the IMF had failed to use the powers it had well the proposal to increase its power was quite bold It was based on an appealing analogy Inside countries central banks act as a lender of last resort lending money to banks which are solvent but not liquid that is which have a positive net worth but which cannot obtain funds from elsewhere The IMF would perform the samc role for countries Had the IMF had a coherent view of the capital market it would have quickly seen the flaw in the idea 1 Under the perfect market theory if a business i solvent it should be able to borrow money from the market any firm that is solvent is liq uidJust as IMF economists who normally seem to have such faith in markets believe that thc can judge better than the market what the exchange rate should be so too do they seem to think that they can judge better than the market whether the borrowing country is creditworthy l1 uIHIILHIN AND ITS DISCONTENTS dUIlt hclIl clpit1I l1Iarktts work ptrtectly Ironically while thlllk thc lrk tlr lcss wdl than IMF economists typically suggest I thlllk rllIt thc Irt sOl1lcwhat more rational than the IMF seems to belllc hlll It intcrvenes There are advantages to IMF lending lIcn thc FUlld lends when the capital markets simply refuse to do so 13m It the sal1le til1le I recognize that the country pays dearly for the chtJpl1Ioney it gets frOI1l the IME Ifa national economy goes sour Jlld detJult looms the lMF is the preferred creditor It gets paid back 11rsteven if others such as foreign creditors do not These get hars lett over They might get nothing So a rational private sector tll1J11cial institution is going to insist on a risk premiuma higher interest rare to cover the higher likelihood of not getting paid back If more of a countrys money goes to the IMF there is less to go to pri vare sector toreign lenders and these lenders will insist on a com mensurardy higher interest rate A coherent theory of the capital nlJrket would have made the IMF more aware of thisand made it more rductant to lend the billions and billions it has provided in bailout packages A more coherent theory of markets would have had the IMP in times of crisis looking harder for alternatives like those we discussed in chapter 4 THE IMFS NEW AGENDA The fact that a lack of coherence has led to a multitude of problems is perhaps not surprising The question is why the lack of coherence Why does it persist on issue after issue even after the problems are pointed our Part of the explanation is that the problems that the IMP has to confront are difficult the world is complex the Funds economists are practical men striving to make hard decisions quickly rather than academics calmly striving for intellectual coherence and consistency But I think that there is a more fundamental reasonThe IMP is pursuing not just the objectives set out in its original man date of enhancing global stability and ensuring that there are funds for countries facing a thrtat of recession to pursue expansionary policies It is also pursuing the interests of the financial community THE IMFs OTHER AGIONUh 207 This means the IMF has objectives that are often In conflict with each other The tension is all the greater because this conflict cant be brought out into the open if the new role of the IMF were publicly acknowl edged support for that institution might weaken and those who have succeeded in changing the mandate almost surely knew this Thus the new mandate had to be clothed in ways that setl1led at least superficially consistent with the old Simplistic free market ideology provided the curtain behind which the real business of the new mandate could be transacted The change in mandate and objectives while it may have been quiet was hardly subtle from serving global economic interests to serv ing the interests of global finance Capital market liberalization may not have contributed to global economic stability but it did open up vast new markets for Wall Street I should be clear the IMF never officially changed its mandate nor did it ever formally set out to put the interests of the financial com munity over the stability of the global economy or the welfare of the poor countries they were supposed to be helping We cannot talk meaningfully about the motivations and intentions of any instirution only of those who constitute and govern it Even then we otten can not ascertain true motivationsthere may be a gap between what they say are their intentions and their true motivations As social sci entists we can however attempt to describe the behavior of an insti tution in terms of what it appears to be doing Looking at the IMF as ifit were pursuing the interests of the financial community provides a way of making sense of what might otherwise seem to be contradic tory and intellectually incoherent behaviors Moreover the IMFs behavior should come as no surprise it approached the problems from the perspectives and ideology of the financial community and these narurally werc closely though not perfectly aligned with its interests As we havc noted before many of its key personnel came from the financial community and many of its key personnel having served these interests well left to wellpaying jobs in the financial community Stan Fischer the deputy managing director who played such a roll in the episodes described in this lllIHIILT111N ND ITS DISCONTENTS blllk WlI directly trum the IMF to become a vice chairman at Cit igrLlup thl ISt t1nlncial tirm that includes Citibank A chairman of Citigroul hairmJn of tht Executive Committee was Robert Kubin who as secretary of Treasury had had a central role in IMF Iolicits One could only ask Was Fischer being richly rewarded for hling tJithtully executed what he was told to do 13ut one does not need to look for venality The lMF or at least manv of its senior officials and staff members believed that capital nurket liberlization would lead to faster growth for the developing countries believed it so strongly that it did not need to look at any evidence and gave little credence to any evidence that suggested oth erwise The lMF never wanted to harm the poor and believed that the policies it advocated would eventually benefit them it believed in trickledown economics and again did not want to look too closely at evidence that might suggest otherwise It believed that the disci pline of the capital markets would help poor countries grow and therefore it believed that keeping in good stead with the capital mar kets was of firstorder importance LOOKING AT THE IMF policies this way its emphasis on getting foreign creditors repaid rather than helping domestic businesses remain open becomes more understandable The IMF may not have become the bill collector of the G7 but it clearly worked hard though not always successfully to make sure that the G7 lenders got repaid There was an alternative to its massive interventions as we saw in chapter 4 an alternative that would have been better for the developing nations and in the longer run better for global stability The IMF could have facilitated the workout process it could have tried to engineer a standstill the temporary interruption of pay ments that would have given the countriesand their firmstime to recoup to restart their stalled economies It could have tried to create an accelerated bankruptcy process2 But bankruptcy and standstills were not and are still not welcome options for they meant that the creditors would not be repaid Many of the loans were uncol lateralized so in the event of bankruptcy little might be recovered The IMF worried that a default by breaking the sanctity of con trace would undermine capitalism In this they were wrong in several THE IMFs OTHM AGfNDA respects Bankruptcy is an unwritten part of every credit contnct the law provides for what will happen if the debtor cannot pay the cred itor Because bankruptcy is an implicit part of the credit contI2ct bankruptcy does not violate the sanctity of the credit conrnet But there is another equally important unwritten contract that between citizens and their society and government what is sometimes called the social contract This contract requires the provision of basic social and economic protections including reasonable opportunities for employment While rnisguidingiy working to preserve what it saw as the sanctity of the credit contract the IMF was willing to tear apart the even more important social contract In the end it 13 the IMF policies which undermined the market as well as the longrun stability of the economy and society IT IS UNDERSTANDABLE then why the IMF and the StI2tegies it foists on countries around the world are greeted with such hostility The billions of dollars which it provides are used to maintnn exchange rates at unsustainable levels for a short period during which the foreigners and the rich arc able to get their money out of the country at more favorable terms through the open capital Imr kets that the IMF has pushed on the countries For each ruble for each rupiah for each cruzeiro those in the country get more dollars as long as the exchange rates are sustained The billions too are often used to pay back toreign creditors even when the debt was private What had been private liabilities were in effect in many instances nationalized In the Asian financial crisis this was great for the American and European creditors who were glad to get back the money they had lent to Thai or Korean banks and businesses or at least more of it than they otherwise would have But it was not so great for the workers and other taxpayers of Thailand and Korea whose tax money is used to repay the IMF loans whether or not they got much benefit from the money But adding insult to injury after the billions are spent to maintain the exchange rate at an unsustainable level and to bailout the foreign creditors after their governments have knuckled under to the pressure of the IMF to nit back on expenditures so that the countries face 3 recession in which millions of workers lose their lllIHIILHION NIl ITS DISCONTENTS jllbs thcrt secllls tu be liD 1Il01lty aroulld when it comes to finding tht tlr 111 0 rt IIwdtst SlllllS to pay subsidies for lood or fuel for the POI N wlIdtr that that is such anger aglinst the IMF If Ill SCtS tht IMF IS an illstitution pursuing policies that are in thc IIlttrtsts lt creditors other IMF policies also become more ulIlitrstlIhLlblt We lIoted earlier the focus on the trade deficit After tilt crisis the massive contractionary policies imposed on the East sillI coulltries led to quick reductions in imports and a massive rebuilding ot reserves From the perspective of an institution worried abour the ability to repay creditors this made sense without reserves the countries would not be able to repay the dollar loans that they Jnd the linns in their country owed But if one had focused more on the issue of global stability and the economic recovery of the coun tries and the region one would have taken a more lax approach to the rebuilding of reserves and at the same time instituted other poli cies to insulate the countries from the effects of the vagaries of inter national speculators Thailand had run out of reserves because they had been used in 1997 to fight off speculators Once it was decided that Thailand needed quickly to rebuild reserves it was inevitable that it would have a deep recession The IMFs beggarthyself poli cies which as we saw in chapter 4 have replaced the beggarthy neighbor policies of the Great Depression were even worse in spreading the global crisis From the perspective of the creditors the policies sometimes worked and remarkably quickly In Korea reserves went from essentially zero to almost 97 billion by July 20 1 in Thailand from essentially negative to more than 31 billion by July 200 l For the creditors of course all of this was good news they could now rest assured that Korea had the dollars to repay any loans should the creditors demand it I would have taken a strategy that was sympathetic to the concerns of the debtors less focused on the interests of the creditors I would have said that it was more important to keep the economy going and to postpone building up reserves for a couple of years until the econ omy was back on track I would have explored other ways of provid ing shortterm stabilitynot only the standstills or bankruptcies to which I referred earlier but shortterm capitll controls and exit taxes of the kind that Malaysia used There are ways of protecting a coun 211 try against the ravages of speculators or even of shortterm lenders or investors who have suddenly changed their entiments No policy comes without its risks or price but these alternatives would almost surely have imposed lower costs and risks on those inside the crisis countries even if they had imposed higher costs on the creditors Defenders of the lMFs policies point to the fact that the creditors did have to bear some of the costs Many were not fully repaid But this misses the point on two counts The creditorfriendly policies attempted to reduce the losses from what they otherwise have been They did not engineer a full bailout but a partial one they did not stop the exchange rate from falling but they worked to prevent it from falling further Secondly the IMF did not always succeed in doing what it set out to do The IMF pushed contractionary policies in Indonesia too far so that in the end the interests of the creditors were not well served More broadly global financial stability was arguably not only in the interests of the global economy but also in the interests of the financial markets yet many of the IMFs poli ciesfrom the capital market liberalization to the massive bailouts almost surely contributed to global instability The fact that the IMF was concerned about and reRected the per spectives of the financial community also helps explain some of its defensive rhetoric In the East Asia crisis the IMF and the US Trea sury quickly sought to blame the problems on the borrowing coun tries and in particular on their lack of transparency Even then it was clear that lack of transparency does not cause crises nor can trans parency inoculate a COllntry against crises Prior to the East Asian cri sis the most recent financial crisis was the real estate crash in the late 1980s and early 19905 in Sweden Norway and Finland some of the most transparent nations in the world There were many countries that were far less transparent than Korea Malaysia and Indonesia and they did not have a crisis If transparency is the key to the eco nomic riddle then the countries of East Asia should have had morr crises earlier since the data showed that they were becoming more not less transparent Despite its alleged failures on the transparency front East Asia had not only shown remarkable growth but also remarkable stability If the Elst Asian countries were as highly vul nerable as the IMF and the Trtlsury claimed it was a newfound vul I lIlHlILATlllN AND ITS DISCONTENTS llerablhty blsed IWt Oil 1Il illcreased lack of transparency but on motha tlI1llliJr fKcor tht prtmacure capital and financial market hbatlizJtion dut the IMF had pushed on these countries In retmspcet there was a traIlSparent reason for this focus on trallspJrtnl it was important tor the financial community the IMF JIld tht US TreJsury to shitt blame The policies that the Fund and TrtJsurv hld pushed in East Asia Russia and elsewhere were to blJIIIe capitt1 nurket liberalization had led to destabilizing specula tion tinJllcial nnrket liberalization to bad lending practices As their reemtn programs failed to work as they said they would they had furrha incentive to try to say the real problem lay not with their progrms but elsewhere with the affiicted countries Clostr scrutiny however showed that the industrialized nations wtre at fault in many other ways weak banking regulation in Japan tor instJnce might have provided an incentive for banks to lend to ThJiland at such attractive rates that the borrowers could not resist borrowing more than was prudent Liberalized banking regulatory policies in the United States and other major industrialized countries llso encouraged unwise lendingbanks were allowed to treat short term toreign lending as safer than longterm This encouraged short term lending and the shortterm loans were among the important sources of instability in East Asia The major investment firms also wanted to exculpate their advis ers who had encouraged their clients to put their money into these countries Fully backed up by the governments in the United States and the other major industrialized nations investment advisers from Frankturt to London to Milan could claim that there was no way they could have been expected to know how bad things really were given the lack of transparency in East Asian countries These experts quietly slid over the fact that in a fully open and transparent market one with perfect information returns are low Asia had been an attractive investmentit produced high returnsprecisely because it was more risky The advisers belief that they had beller information and their clients thirst for high returnsdrove funds to the region The key problemsSouth Koreas high indebtedness Thailands huge trade defIcits and real estate boom that inevitably would bust TilE IMFs OTIlER ACUWA 213 Suhartos corruptionwen well known and the risks these posed should have been disclosed to investors The international banks too found it convenilnt to shift blame ThlY wanted to blame the borrowers and bad lending practices of the Thai and South Korean banks which they alleged were making bad loans with the connivance of the corrupt governments in their countriesand the IMF and the US Treasury again joined them in the attack From the start one should have been suspicious of the IMFTreasury arguments Despite their attempt to get the major international lenders off the hook the hard truth is that every loan has both a borrower and a lender If the loan is inherently bad the lender is as much at fault as the borrower Moreover banks in the Western developed countries were lending to the large Korean firms knowing full well how leveraged many Korean firms were The bad loans were a result of bad judgment not of any pressure from the United States or other Western governments and were made in spite of the Western banks allegedly good risk management tools No wonder then that these big banks wanted to shift the scrutiny away from themselves The IMF had good reason for supporting them fur the Fund itself shared in the culpability Repeated IMF bailouts else where had contributed to lack of due diligence on the part of the lenders There was an even more profound issue at stake The US T reasur had during the early 19905 heralded the global triumph of capitalism Together with the IMF it had told countries that followed the right policiesthe Washington Consensus policiesthey would be assured of growth The East Asia crisis cast doubt on this new world view ulliess it ould be sholllI that the problelll was IIOt 14th capitalism but lIitll tile Asian COIlIlInCS alld their bad policies The IMF and the US Treasury had to argue that the problem was not with the retorms implementing liberalization of capital markets above all that sacred article of faithbut with the fact that the reforms had not been car ried far enough 13y focusing on lhe weaknesses of the crisis coun tries they not only shifted blame away from their own failuresboth the failures of policy and the failures in Iendingbut they attempted to use the experience to push t heir anda still further CHAPTER 9 THE WAY AHEAD G LOBALIZATION TODAY IS not working for many of the worlds poor It is not working for much of the environ ment I t is not working for the stability of the global econ omy The rransition from communism to a market economy has been so badly managed that with the exception of China Vietnam and a few Eastern European countries poverty has soared as incomes have plummeted To some there is an easy answer Abandon globalization That is neither feasible nor desirable As I noted in chapter 1 globalization has also brought huge benefitEast Asias success was based on globalization especially on the opportunities for trade and increased access to markets and technology Globalization has brought better health as well as an active global civil society fighting for more democracy and greater social justice The problem is not with global ization but with how it has been managed Part of the problem lies with the international economic institutions with the IMF World Bank and WTO which help set the rules of the game They have done so in ways that all too often have served the interests of the more advanced industrialized countriesand particular interests within those countriesrather than those of the developing world 214 THE WAyAHUD llut it is not just that they have served those interests too often they have approached globalization from particular narrow mindseu shaped by a particular vision of the economy and sociery The demand for reform is palpablefrom congressionally appointed commissions and foundationsupported groups of eminent econo mists writing reports on changes in the global financial architecture to the protests that mark almost every international meeting In response there has already been some change The new round of trade negotiations that was agreed to in November 2001 at Doha Qatar has been characterized as the development round intended not just to open up markets further but to rectify some of the imbal ances of the past and the debate at Doha was far more open than in the past The IMF and the World Bank have changed their rhetoric there is much more talk about poverry and at least at the World Bank there is a sincere attempt to live up to its commitment to put the country in the drivers seat in its programs in many countries But many of the critics of the international institutions are skeptical They see the changes as simply the institutions facing the political realiry that they must change their rhetoric if they are to survive These critics doubt that there is real commitment They were not reassured when in 2000 the IMF appointed to its number two posi tion someone who had been chief economist at the World Bank dur ing the period when it took on market fundamentalist ideology Some critics are so doubtful about these reforms that they continue to call for more drastic actions such as the abolition of the IMF but I believe this is pointless Were the Fund to be abolished it would most likely be recreated in some other form In times of international crises government leaders like to feel there is someone in charge that an international agency is doing something Today the IMF fill that role I believe that globalization can be reshaped to realize its potential for good and I believe that the international economic institutions CQn be reshaped in ways that will help ensure that this is accomplished But to understand how these institutions should be reshaped we need to understand better why they have failed and faiJed so miserably IO lIOllLlZATION Nl ITS DISCONTENTS Interests and Ideology III tilt 11t dlJptr We saw how by looking at the policies of the IMF L frht orJIIizJtion was pursuing the interests of the financial mar kets ather than simpl y fultllling its original mission of helping coun trits ill criseS lIId tllrthering global economic stability one could lIuke seils of what otherwise seemed to be a set of intellectually incoherent Jnd inconsistent policies If tinJllcial interests have dominated thinking at the International Monetary Fund commercial interests have had an equally dominant roit Jt the World Trade Organization Just as the IMF gives short shrift to the concerIIs of the poorthere are billions available to bail out banks but not the paltry sums to provide food subsidies for those thrown our of work as a result of IMF programsthe WTO puts tolde oVtr all else Those who seek to prohibit the use of nets that harvest shrimp but also catch and endanger turtles are told by the WTO that such regulation would be an unwarranted intrusion on free trade They discover that trade considerations trump all others including the environment While the institutions seem to pursue commercial and financial interests above all else they do not see matters that way They gen uindy believe the agenda that they are pursuing is in the general inter cst n spite of the evidence to the contrary many trade and finance ministers and even some political leaders believe that everyone will eventually benefit from trade and capital market liberalization Many believe this so strongly that they support forcing countries to accept these reforms through whatever means they can even if there is lit de popular support for such measures The greatest challenge is not just in the institutions themselves but in mindsets Caring about the environment making sure the poor have a say in decisions that affect them promoting democracy and fair trade are necessary if the potential benefits of globalization are to be achieved The problem is that the institutions have come to reflect the mindsets of those to whom they are accountable The typical central bank governor begins his day worrying about inflation statis tics not poverty statistics the trade minister worries about export numbers not pollution indices THE WAY AHEAD 217 The world is a complicated place Each group in society focuses on a part of the reality that affects it the most Workers worry about jobs and wages financiers about interest rates and being repaid A high interest rate is good for a creditorprovided he or she gets paid back But workers see high interest rates as inducing an economic slowdown for them this means unemployment No wonder that they see the danger in high interest rates For the financier who has lent his money out long term the real danger is inflation Inflation may mean that the dollars he gets repaid will be worth less than the dollars he lent In public policy debates few argue openly in terms of their own selfinterest Everything is couched in terms of gelleral imeresl Assess ing how a particular policy is likely to affect the general interest requires a model a view of how the entire system works Adam Smith provided one such model arguing in favor of markets Karl Marx aware of the adverse effects that capitalism seemed to be hav ing on workers of his time provided an alternative model Despite its many welldocumented flaws Marxs model has had enormous influence especially in developing countries where for the billions of poor capitalism seemed not to be delivering on its promises But with the collapse of the Soviet empire its weaknesses have bCCome all too evident And with that collapse and the global economic dominance of the United States the market model has prevailed But there is not just me market model There are striking differ ences between the Japanese version of the market system and the German Swedish and American versions There are several countries with per capita income comparable to that of the United States but where inequality is lower poverty is less and health and other aspects of living standards higher at least in the judgment of those living there While the market is at the center of both the Swedish and American versions of capitalism government takes on quite different roles In Sweden the government takes on far greater responsibilities promoting social welfare it continues to provide far better public health far better unemployment insurance and far better retirement benefits than does the United States Yet it has been every bit as suc cessful even in terms of the innovations associatcd with the New Economy For many Americans hilt not all the American modc1 has l I llHlILUIN AND ITS DISCONTENTS Wllrked well tiJr nlllst SWtds the American model is viewed as llnILlptlbltthty bdieVt their model has served them well For Ilns 1 Jrittv elf AsilJI lIIodels has worked well and this is true for Idlll lJId Korea as well as China and Taiwan even taking into lLLllllllt tht tlbd tinancial crisis l wr the Plst titty years economic science has explained why and tilt elIlditions under which markets work well and when they do not It Ius shown why lIIarkets may lead to the underproduction of some hinIike basic researchand the overproduction of otherslike pllution The lIIost dramatic market failures are the periodic slumps ht recessions and depressions that have marred capitalism over the pJS VO hundred years that leave large numbers of workers unem ployed JlId a large fraction of the capital stock underutilized But while these are the most obvious examples of market failures there are J myriad of more subtle failures instances where markets failed to produce efficient outcomes Government can and has played an essential role not only in mit igating these market failures but also in ensuring sodal justice Market processes may by themselves leave many people with too few resources to survive In countries that have been most successful in the United States and in East Asia government has performed these roles and performed them for the most part reasonably well Gov ernments provided a highquality education to all and furnished much of the infrastructureincluding the institutional infrastruc ture such as the legal system which is required for markets to work dTectively They regulated the financial sector ensuring that capital markets worked more in the way that they were supposed tothey provided a safety net for the poor And they promoted technology from telecommunications to agriculture to jet engines and radar While there is a vigorous debate in the United States and elsewhere about what the precise role of government should be there is broad agreement that government has a role in making any society any economy function efficientlyand humanely There are important disagreements about economic and social policy in our democracies Some of these disagreements are about valueshow concerned should we be about our environment how much environmental degradation should we tolerate if it allows us to THE WAY AHEAD 211 have a higher GDP how concerned should we be about the poor how much sacrifice in our total income should we be willing to make it if allows some of the poor to move out of poverty or to be slightly better off or how concerned should we be about democ racy are we willing to compromise on basic rights such as the rights to association if we believe that as a result the economy will grow faster Some of these disagreements are about how the economy functions The analytic propositions are clear whenever there is imprr feet information or markets that is always there are in principle interventions by the governmenteven a goverrunent that suffers from the same imperfections of informationwhich can increase the markets efficiency As we saw in chapter 3 the assumptions underly ing market fundamentalism do not hold in developed economies let alone in developing countries But the advocates of market funda mentalism still argue that the inefficiencies of markets are relatively small and the inefficiencies of government are relatively large They see government more as part of the problem than the solution unemployment is blamed on government setting toohigh wages or allowing unions too much power Adam Smith was far more aware of the limitations of the market including the threat posed by imperfections of competition than those who claim to be his latterday followers Smith too 3S more aware of the social and political context in which all economies must function Social cohesion is important if an economy is to function urban violence in Latin America and civil strife in Africa create cm ronments that are hostile to invesonent and growth But while social cohesion can affect economic performance the converse is also true excessively austere policieswhether they be contractionary mone tary or fiscal policies in Argentina or cutting off food subsidies to the poor in Indonesiapredictably give rise to turmoil This is especially the case when it is believed that there are massive inequitiessuch as billions going to corporate and financial bailout in Indonesia leav ing nothing left for those forced into unemployment In my own workboth in my writings and in m role as the pres idents economic adviser and chief economist of the World BankI have advocated a balanced iew of the role of governmenl one which recognizes both the limitations and failures of markrts and ClOHALlIATlON AND ITS DISCONTENTS trnll m but which stts the two as working together in partner ship with tht precist nature of that partnership differing among CLHllltrits dtpellding 011 their stages of both political and economic LkvelLPllltllt jut It whateVlr stage of political and economic development a lHllltn is government makes a difference Weak governments and toLimrLlsivt governments have both hurt stability and growth The Sil tilwlCial crisis was brought on by a lack of adequate regulation Lf tht tinancial sector Mafia capitalism in Russia by a failure to tntone the basics of law and order Privatization without the neces an institutional infrastructure in the transition countries led to asset tripping rather than wealth creation In other countries privatized monopolies without regulation were more capable of exploiting consumtrs than the state monopolies By contrast privatization accompanied by regulation corporate restructuring and strong cor porate governance has led to higher growth My point here however is not to resolve these controversies or to push for my particular conception of the role of government and markets but to emphasize that there are real disagreements about these issues among even welltrained economists Some critics of economics and economists jump to the conclusion that economists always disagree and therefore try to dismiss whatever economists say That is wrong On some issueslike the necessity of countries living within their means and the dangers of hyperinflationthere is widespread agreement The problem is that the IMF and sometimes the other interna tional economic organizations presents as received doctrine proposi tions and policy recommendations for which there is not widespread agreement indeed in the case of capital market liberalization there was scant evidence in support and a massive amount of evidence against While there is agreement that no economy can succeed under hyperinflation there is no consensus about the gains from lowering inflation to lower and lower levels there is little evidence that pushing inflation to lower and lower levels yields gains commen surate with the costs and some economists even think that there are IIegative benefItS from pushing inflation too low2 The discontent with globalization arises not just from economics THE WAY AHEAD 11 seeming to be pushed over everything else but because a particular view of economicsmarket fundamentalismis pushed over all other views Opposition to globalization in many parts of the world is not to globalization per seto the new sources of funds for growth or to the new export marketsbut to the panicular set of doctrines the Washington Consensus policies that the international financial institutions have imposed And it is not just opposition to the policies themselves but to the notion that there is a single set of policies that is right This notion flies in the face both of economics which emphasizes the importance of tradeoffi and of ordinary common sense In our own democracies we have active debates on every aspect of economic policy not just on macroeconomics but on matters like the appropriate structure of bankruptcy laws or the privatization of Social Security Much of the rest of the world feels as if it is being deprived of making its own choices and even forced to make choices that countries like the United States have rejected But while the commitment to a particular ideology deprived countries of the choices that should have been theirs it also con tributed strongly to their failures The economic structures in each of the regions of the world differ markedly for instance East Asian firms had high levels of debt those in Latin America relatively little Unions are strong in Latin America relatively weak in much of Asia Economic structures also change over timea point emphasized by the New Economy discussions of recent years The advances in eco nomics of the past thirty years have focused on the role of financial institutions on information on changing patterns of global competi tion I have noted how these changes altered views concerning the dliciency of the market economy They also altered views concern ing the appropriate responses to crises At the World Bank and the IMF these new insightsand more important their implications for economic policywere resisted just as these institutions had resisted looking at the experiences of East Asia which had 1101 followed the Washington Consensus polides and had grown faster than any other region of the world This failure to take on board the lessons of modern economic science left these institutions illprepared to deal with the East Asia crisis when it occurred and less able to promote growth around the world lIlHUILHIlN ND ITS DISCONTENTS Th 11 F Idt it had little lleed to take these lessons on board llllls it klltw the lIlswers if economic science did not provide dllll Idellythe simple belief in free marketsdid Ideology fRlides I itIlS throllh which one sees the world a set of beliefs that Irt Iwld so Ilrmly that one hardly needs empirical confirmation Evi iellce dut contradicts those beliefs is summarily dismissed For the rlliters ill trel Jnd untettered markets capital market liberalization WJS lwiI desirable one didnt need evidence that it promoted rowth Evidence thu it caused instability would be dismissed as merely one of the adjustment costs part of the pain that had to be accepted in the transition to a market economy The Need for International Public Institutions We cannot go back on globalization it is here to stay The issue is how can we make it work And if it is to work there haveta global public institutions to help set therule These international institutions should ofcQlrse focus on issues where global collective action is desrabieOLevenver the past three decades there has been an increased understanding of the circumstances under which collectivim at whatever level is required Earlier I discussed how collective actionjLegliJedIhen markets by themselves do not resukifficint utcomes When there are externalitieswhen the actions of individuals have effects on others for which they neither pay nor are compensatedthe market will typically result in the overproduction of some goods and the underproduction of others Markets cannot be relied upon to produce goods that are essentially public in nature like defense3 In some areas markets fail to exist4 governments have provided student loans for instance because the market on its own failed to provide funding for investments in human capital And for a variety of rea sons markets are often not selfregulatingthere are booms and bustsso the government has an important role in promoting eco nomic stability Over the past decade there has been an increased understanding of the appropriate levellocal national or globalat which collec THE WAY AHIiAU tive action is desirable Actions the benefits of which accrue largely 10callYTSuChtions related to local pollution should be con ducted at the local level while those that benefit the citizens of an entire country should be undertaken at the national level Globaliza tion has meant that there is increasing recognition of arenas where impacts are global It is in these arenas where global collective action is requiredand systems of Jiobal governance are essential The recognition oftheas been paralleled by the creation of global institutions to address such concerns The United Nations can be thought of as focusing upon issues of global political security while the international financial institutions and in particular the IMF are supposed to focus on global economic stability Both can be thought of as dealing with externalities that can take on global dimensions Local wars unless contained and defused can draw in others until they become global conflagrations An economic down turn in one country can lead to slowdowns elsewhere In 1998 the great concern was that a crisis in emerging markets mightlead to a global economic meltdown But these are not the only arenas in which global collective action is essential There are global environmental issues especially those that concern the oceans and atmosphere Global warming caused by the industrial countries use of fossil fuels leading to concentrations of greenhouse gasses COz affects those living in preindustrial economies whether in a South Sea island or in the heart of Africa The hole in the ozone layer caused by the use of chlorofluorocarbons CFCs similarly affects everyonenot just those who made use of these chemicals As the importance of these international environ mental issues has grown international conventions have been signed Some have worked remarkably well such as the one directed at the ozone problem the Montreal Protocol of 1987 while others such as those that address global warming have yet to make a significant dent in the problem There are also global health issues like the spread of highly conta gious diseases such as AIDS which respect no boundaries The World Health Organization has succeeded in eradicating a few di5a5 notably river blindness and smallpox but in many areas of global LlIlHILT10N AND ITS DISCONTENTS public hcllth tht dlllltllgls ahtad art enormous Knowledge itself is 111 import11It glob31 public good the fruits of research can be of ben dit t IIlVllllt lIlywhtrt at essentially no additional cost llItlfIlltiolld hUlllanit3rian assistance is a form of collective action thlt sprin trOlll a shartd compassion for others As efficient as mar ktts mJ bt thty do not tnsure that individuals have enough food clothes to wtar or shdttr The World Banks main mission is to erad icltt pOtrty not so much by providing humanitarian assistance at tht tilllt of crisis as by tnabling countries to grow to stand on their own Although specialized institutions in most of these areas have tolnd in response to specific needs the problems they face are often interrdated Poverty can lead to environmental degradation JI1d environmental degradation can contribute to poverty People in poor countries like Nepal with little in the way of heat and energy resources are reduced to deforestation stripping the land of trees and brush to obtain fud for heating and cooking which leads to soil ero sion and thus to further impoverishment Globalization by increasing the interdependence among the peo ple of the world has enhanced the need for global collective action and the importance of global publig29s That the global institu tions which have been cesponse have not worked perfectly is not a surprise the problems are complex and collective action at any level is difficult But in previous chapters we have documented complaints that go well beyond the charge that they have not worked perfectly In some cases their failures have been grave in other cases they have pursued an agenda that is unbalancedwith some benefit ing from globalization much more than others and some actually being hurt Governance So far we have traced the failures of globalization to the fact that in setting the rules of the game commercial and financial interests and mindsets have seemingly prevailed within the international eco nomic institutions A particular view of the role of government and markets has come to prevaila view which is not universally TH WAY AHEAD accepted within the developed countries but which is being forced upon the developing countries and the economies in transition The question is why has this come about And the answer is not hard to find It is the finance ministers and central bank governors who sit around the table at the IMF making decisions the trade ministers at the WTO Even when they stretch to push policies that are in their countries broader national interests or occasionally stretching further to push policies that are in a broader global inter est they see the world through particular inevitably more parochial perspectives I have argued that there needs to be a change in mindset But the mindset of an institution is inevitably linked to whom it is dirtaly accountable Voting rights matter and who has a seat at the table even with limited voting rightsmatters It determines whose voices get heard The IMF is not just concerned with technical arrange ments among bankers such as how to make bank checkclearing sys tems more efficient The IMFs actions affect the lives and livelihoods of billions throughout the developing world yet they have little say in its actions The workers who are thrown out of jobs as a result of the IMF programs have no seat at the tahle while the bankers who insist on getting repaid are well represented through the finance ministers and central bank governors The consequences for policy have been predictable bailout packages which pay more attention to getting creditors repaid than to maintaining the economy at full employment The consequences for the choice of the institutions management have equally been predictable there has betn more of a concern with finding a leader whose views are congruent with the dominant shareholders than with finding one that has expertise in the problems of the developing countries the mainstay of the Funds business today Governance at the WTO is more complicated As at tht IMF it is the voices of trade ministers that are heard No wonder then that lit tle attention is often paid to conctrns about the environment Yet while the voting arrangements at the IMF ensure that the rich coun tries predominate at the WTO each country has a single vote and decisions are largely by consellS But in pracrice the United Statei Europe and Japan have dominatld in the past This may now be IIILHIN AND ITS DISCONTENTS lunging At thc Ltst lIlceting at I oha the developing countries insistll thlt illllotha round 01 trade negotiations was to be initi Itt thclr nlliCtTnS 11Id to bt heardand they achieved some Illltlbk ontssions With Chinas joining the WTO the developing Hllmics hl a powertttl voice on their sidethough the interests III hin1 llld those 01 many of the other developing countries do not tttlh coincide n 1I1sljilllddIllCIItil chtllllic that is required to lake globalization work III IhFur liI11 irsliirsialtgil govfrtwlUZTllis entails at the IMF lllt the World Bank a change in tilg right and in all of the inter Illtional economic institutions changes to ensure that it is not just the oicts 01 trade ministers that are heard in the WTO or the voices of tht finance ministries and treasuries that are heard at the IMF and World Bank Such changes are not going to be easy The United States is unlikely to give up its effective veto at the IME The advanced indus trial countries are not likely to give up their votes so that the devel oping countries can have more votes They will even put up specious arguments voting rights as in any corporation are assigned on the basis of capital contributions China would long ago have been will ing to increase its capital contribution if that was required to give it more voting rights US Treasury Secretary Paul ONeill has tried to give the impression that it is the American taxpayers its plumbers and carpenters who pay for the multibilliondollar bailoutsand because they pay the costs they ought to have the vote But that is wrong The money comes ultimately from the workers and other taxpayers in the developing countries for the IMF almost always gets repaid But although change is not easy it is possible The changes that the developing cOLlntries wrenched from the developed countries in November 20 I as the price for beginning another round of trade negotiations show that at least in the WTO there has been a change in bargaining power Still I am not sanguine that fundamental reforms in the formal governance of the IMF and World Bank will come soon Yet in the short run there are changes in practices and proccdlues that can have significant effects At the World Bank and the IMF there are twenty TilE WAY AHEAU lour seats at the table Each seat speaks for several countries In the present configuration Africa has very few Stal simply because it has so few votes and it has so few votes because as we noted votes an allocated on the basis of economic power Even without changing the voting arrangements one could have more Mrican scali their voice would be heard even if their votes were not counted Effective participation requires that the representatives of the developing countries be well informed Because the countries are poor they simply cannot afford the kinds of staff that the United States for instance can muster to support its positions at all the inter national economic institutions If the developed countries were seri ous about paying more attention to the voices of the developing countries they could help fund a think tankindependent from the international economic organizationsthat would help them for mulate strategies and positions Transparency Short of a fundamental change in their governance the most impor tant way to ensure that the international economic institutions are more responsive to the poor to the environment to the broader political and social concerns that I have emphaized is to increae openness and transparency We have come to take for granted the important role that an inlormed and free press ha in reining in even our democratically elected governments any mischief any minor indiscretion any favoritism is subject to scrutiny and public pressure works powerfully Transparency is even more important in public institutions like the IMF the World Bank and the WTO because their leaders are not elected directly Though they are public there is no direct accountability to the public But while this should imply that these institutions be even more open in tact they are even les transparent The problem of lack of transparency affects each of the interna tional institutions though in slightly different ways At the WTO the negotiations that lead up to arecll1ent are all done behind dosed doors making it difficultuntil it i too lateto see the influente of corporate and other special intercMs The deliberations of the WTO CLlIALlLT10N Nl ITs DISCONTENTS pands thlt mit on whtther there has been a violation of the WTO Jgrtelllents OcLur in secret I t is perhaps not surprising that the trade lawYers md xtrade otricials who often comprise such panels pay tor instanle little attention co the environment but by bringing the ddiberlCinns more out into the open public scrutiny would either nlJkt the pands more sensitive to public concerns or force a reform in the Jdjudication process The IMF comes by its penchant for secrecy naturally central banks though public institutions have traditionally been secretive Vithin the tinancial community secrecy is viewed as naturalin contrJst co academia where openness is the accepted norm Before September 1 I 2001 the secretary of treasury even defended the secrecy of the offshore banking centers The billions of dollars in the Caynun Islands and other such centers are not there because those islands provide better banking services than Wall Street London or Frankturt they are there because the secrecy allows them to engage in ta evasion money laundering and other nefarious activities Only after September 1 1 was it recognized that among those other nefari ous activities was the financing of terrorism But the IMF is not a private bank it is a public institution The absence of open discourse means that models and policies are not subjected co timely criticism Had the actions and policies of the IMF during the 1997 crisis been subject to conventional democratic processes and there had been a full and open debate in the crisis countries about the proffered IMF policies it is possible that they would never have been adopted and that far saner policies would have emerged That discourse might not only have exposed the faulty economic assumptions on which the policy prescriptions were based but also revealed that the interests of the creditors were being placed ahead of those of workers and small businesses There were alterna tive courses of actions where less of the risk was borne by these less powerful parties and these alternative courses of actions might have been given the serious consideration that they deserved Earlier in my days at the Council of Economic Advisers I had seen and come to understand the strong forces that drove secrecy Secrecy allows government officials the kind of discretion that they would not have if their actions were subject to public scrutiny THE WAY AHEAD Secrecy not only makes their life easy but allows special illternu full sway Secrecy also serves to hide tht mistakes whether innocent or not whether the result of a failure to think matters through or not As it is sometimes put Sunshine is the strongest antiseptic Even when policies are not driven by special interests secrecy engenders suspicionswhose interests are really being servedand sllch suspicions even when groundless undermine the political sus tainability of the policies It is this secrecy and the suspicions it gives rise to that has helped sustain the protest movement One of the demands of the protestors has been for greater openness and lrans parency These demands had a special resonance because the IMF itself emphasized the importance of transparency during the East Asia crisis One of the clearly unintrllded consequences of the IMFs rhetorical emphasis on transparency was that eventually when tbe transparency spodight was turned around to shine on the IMF itself it was found wanting 5 Secrecy also undermines democracy There can be democratic accountability only if those to whom these public institutions lin supposed to be accountable are well informed about what they are doingincluding what choices they confronted and how those deci sions were made We saw in chapter 2 how modern democracies had come to recognize the citizens baic right to kllOU implemented through laws such as Americas Freedom of Information Act We saw also however that while nominally espousing transparency and openness the IMF and the World Bank have not yet embraced these ideas They must REFORMING THE IMF AND THE GLOBAL FINANCIAL SYSTEM There are some common themes facing reform in all of the interna tional economic institutions but each institution has a set of prob lems of its own I begin with thl IMF partly because it hrings out more clearly some problems that are present to a Ieser extcnt in other institutions t1 ULUIUN AN ITS DISCONTENTS begllI thc prtVlllus chapter by asking How could an organiza tiull wHh SUdl ttlellttd JIld high paid government bureaucrats Iluke Sl 1ll11I Illlstakes I suggested that pdrt of its problems arose tiLllll d1t iSSlmIIKt bet wen its supposed objective the objective for whlh it was origintlly created promoting global economic stability lIId the Ilewer objectivessuch as capital market liberalization which did more to serve the interests of the financial community thJn of globJl stJbility This dissonance led to intellectual inco htrtnc JIld inconsistencies that were more than just matters of aca iemic interest No wonder then that it was hard to derive coherent policies Economic science was too often replaced by ideology an ideolotY that gave clear directions if not always guidance that worked and an ideology that was broadly consonant with the inter ests of the tinancial community even if when it failed to work those inrerests themselves were not well served One of the important distinctions between ideology and science is that science recognizes the limitations on what one knows There is always uncertainty By contrast the IMF never likes to discuss the uncatainries associated with the policies that it recommends but ratha likes to project an image of being infallible This posture and mindset makes it difficult for it to learn from past mistakeshow can it learn from those mistakes if it cant admit them While many organizations would like outsiders to believe that they are indeed infallible the problem with the IMF is that it often acts as if it almost believes in it infallibility The IMF has admitted to mistakes in the East Asia crisis acknowl edging that the conrractionary fiscal policies exacerbated the down turn and that the strategy for restructuring the financial system in Indonesia led to a bank run which only made matters worse But not surprisingly the Fundand the US Treasury which was respon sible for pushing many of the policieshas tried to limit the criti cisms and their discussion Both were furious when a World Bank report touched on these and other mistakes and got frontpage cov erage in the Nell York Times Orders to muzzle the critics were issued More tellingly the IMF never pursued the issues further It never asked why the mistakes had occurred what was wrong with the models or what could be done to prevenr a recurrence in the next THE WAY AHEAD ZI crisisand there surely will be another crisis in the future Ai of January 2002 Argentina is going through a crisis Once again the IMF bailout policies failed to work the contractionary fiscal policies that it insisted upon pushed the economy into an ever deeper reces sion The IMF never asked why its models systematically underesti mated the depth of recessionsor why its policies are systematiC4l1y excessively contractionary The Fund tries to defend its stance of institutional infallibility say ing that if it showed it was wavering in its conviction that its policies were correct it would lose credibilityand the success of its policies requires that markets give it credibility Here again there is real irony Does the IMF always praising the perfection and rationality of the market really believe that it enhances its credibility by making overly confident forecasts Predictions that repeatedly dont pan out make the Fund look rather less than infallible especially if the markets are as rational as it claims Today the IMF has lost much of its credibility not only in developing countries but also with its cherished con stituency the financial community Had the IMF been more honest more forthright more modest it would arguably be in a better stand ing today Sometimes IMF officials give another reason for their failure to discuss alternative policies and the risks associated with each They say that it would simply confuse the developing countriesa patron izing attitude that reflects a deep skepticism about democratic processes It would be nice if the IMF having had these problems pointed out would change its mindset and its modes of behavior But this is not likely to be the case Indeed the Fund has been remarkably slow in learning from its mistakespartly as we have seen because of the strong role of ideology and its belief in institutional infallibility partly because its hierarchical organizational structure is used to ensure its prevailing worldviews dominate throughout the institution The IMF is not in the jargon of modern business schools a learning organiza tion and like other organizations that find it difficult to learn and adapt it finds itself in difliculties when the environment around it changes Earlier in this chapter I argued that a fundamental chan in llllULUION AND ITS DISCONTENTS mindslt IS likdv w occur only with a change in governance but dlJt such chlllgts Ire unlikdy in the near term Increased trans plrtIICV llild htlp but tven thert meaningful reforms were being reSiQlli brold cOIlStnsusoutsidt the IMFhas developed that the lMF should limit itsdf to its core area managing crises that it should lie longtr bt involwd outside crises in development or the tcollomies of tfJnsition I strongly concurpartly because the other rdorms that would enable it to promote democratic equitable and msuilUblt devdopmem and transition are simply not forthcoming There are other dimensions to narrowing the focus The IMF cur nmly is responsible lor the collection of valuable economic statistics lnd though by and large it does a good job the data it reports are compromised by its operating responsibilities to make its programs 111 to work to make the numbers add up economic forecasts have to be adjusted Many users of these numbers do not realize that they are not like ordinary lorecasts in these instances GDP forecasts are not based on a sophisticated statistical model or even on the best estimates of those who know the economy well but are merely the numbers that have been negotiated as part of an IMF program Such conflict of interest invariably arise when the operating agency is also responsible lor statistics and many government have responded by creating an independent statistical agency Another activity of the Fund is surveillance reviewing a countrys economic performance under the Article 4 consultations discussed in chapter 2 This is the mechanism through which the IMF pushes its particular perspectives on developing countries that are not dependent on its aid Because an economic slowdown in one coun try can have adverse effects on others it does make sense for coun tries to put pressure on each other to maintain their economic strength there is a global public good The problem is the report card itself The IMF emphasizes inflation but unemployment and growth are equally important And its policy recommendations too reflect its particular perspectives on the balance of government and markets My direct experience with these Article 4 consultations in the United States convinces me that this too is a task that should be taken over by others l3ecause the most direct impact of one coun THE WAY AHEAD ZH trys slowdown is on its neighbors and the neighbors are much more attuned to the circumstances in the country regional surveillance is a viable alternative Forcing the IMF to return to its original missionnarrowing ill focusenables greater accountability We can anempt to ascertain whether it has prevented crises from happening creating a more sta ble global environment and whether it has resolved them well But clearly narrowing focus does not solve the institutions problem part of the complaint is that it has pushed policies such as capital market liberalization which have increased global instability and that its big bailout policies whether in East Asia or Russia or Latin America have failed Reform Efforts In the aftermath of the East Asian crisis and the failures of the IMF policies there was a general consensus that something was wrong with the international economic system something needed to be done to make the global economy more stable However many of those at the US Treasury and IMF felt that only minor changes were needed To compensate for the lack of grandness in the changes they conceived a grandiose title for the reform initiative reJonn of tilt global jlJalldal architecture The term was intended to suggest a major change in the rules of the game that would prevent another crisis Underneath the rhetoric there were some real issues But just as those in charge at the IMF did everything to shift the blame away from their mistakes and away from the systemic problems they did ewrything they could to curtail the reforms except to the extent that they result in more power and money to the IMF and morr obliga tOllS such as compliance with new standards set by the advanced industrial countries on the emerging markets These doubts are reinforced by the way discussions of reform have proceeded The official reform debate has been centered in the same institutions and dominated by the same governmentli that ha effectively run globalization for over fifty years Around the world today there is a great deal of lynicism about the reform debate Faced with the same people at the tablt who had been responsible for the LL LLULN AND ITS DISCONTENTS celLl tll LII ch kvlopill countries wondered if it was likely chLC rct lllllC would occur As tlr as these client countries were IIlTlIll LC WIS 1 dllradt ill which the politicians pretended to do lLllcchill Cll rtlrtss the problems while financial interests worked to prllTH IS lIIuch of the status quo as they could The cynics were mly rihc bur only partly so The crisis brought to the fore the sense clut sLllllechill was wrong with the process of globalization and this PlTctPCillll nwbilized critics across a wide landscape of issues from cransplrency co poverty to the environment to labor rights Inside tht organizations themselves among many influential tIIetllbas there is a sense of complacency The institutions have Llcertd their rhetoric They talk about transparency about poverty lbour participation Even if there is a gap between the rhetoric and the reality the rhetoric has an effect on the institutions behavior on transparency on the concern for poverty They have better Web sites md there is more openness The participatory poverty assessments hLt generated more involvement and a greater awareness of the poverty impacts of programs But these changes as profound as they seem to those inside the institutions appear superficial to outsiders The IMF and World Bank still have disclosure standards far weaker thLn those of governments in democracies like the United States or Sweden or Canada They attempt to hide critical reports it is only their inability to prevent leaks that often forces the eventual disclo sure There is mounting unhappiness in developing countries with the new programs involving participatory poverty assessments as th0e participating are told that important matters such as the macroeconomic framework are offlimits6 There are other instances where there has been more change in what IS said than in what is done Today the dangers of shortterm capital Rmn and premature capital and financial market liberalization are occasionally acknowledged even by senior officials at the IME This constitutes a major change in the official stance of the Fund though it is still too soon to see whether or how the change in rhetoric will be reRected in policies implemented within countries7 So far the evidence does not look promising as one simple episode illustrates Shortly after the new managing director Horst Kohler took office he undertook a tour of some member countries In a THE WAY AIHAD visit to Thailand at the end of May 20JO he noted what had by then become conventional wisdom outside the IMP and was beginning to seep into the IMF itself the dangers of capital nurket liberalization Neighboring Indonesia quickly picked up on the opening and by the time he visited there in June its government had announced plans to explore interventions into the capital market But quickly the Indonesiansand Kohlerwere set straight by the IMF staff The bureaucracy won again capital market liberalization might in theory be problematic but capital market interventions controls evidendy were not to be on the table for those seeking IMF assistance There were other gestures to reform halfhearted or lulfbaked8 As criticism of the large bailouts in the 1990s mounted there was a succession of failed reforms First came the precautionary lending packagelending before a crisis actually had occurredto Brazil which forestalled that countrys crisis but for a few months and at great cost Then there was the contingent credit line anodler mea sure designed to have money ready when a crisis erupted That too didnt work mainly because no one seemed interested in it on the proposed terms1O It was recognized that the bailouts may have con tributed to moral hazard to weak lending practices and so a bailin strategy whereby creditors would have to bear part of me costs was put into place though not for major countries like Russia but rather for the weak and powerless like Ecuador Ukraine Romania and Pakistan As I explained in chapter 8 by and large the bailin strate gies were a failure n some cases such as Romania they wen aban doned though not after considerable damage to that countrys economy in other cases like Ecuador they were enforced widl even more devastating etfect The new US Treasury secretary and the IMFs new managing director both expressed reservations about me overall effectiveness of the large bailout strategy but then went ahead with more of the same 11 billion and 216 billion lent to Turke and Argentina in 2000 and 200 I respectively The eventual failure of the Argentine bailout seems to have finally forced the blj of a rethinking of strategy Even when there was widespread but not universal consensus on reforms resistance arose from those in financial centtrs sometiml supported by the us Treasury In the East Asia crisis as atttntion was llllIUIIHIllN ANI ITS IJISCONTNTS Illll HI trlllsplflIKY it blClllll dlar that to know what was going II III lIllrill lIlarktts Olll had to know what hedge funds and off slwfl blllkill CllItlrS wre doing Indeed there was a worry that IIwrl trlllsplflIICY dSlwhlrl would lead to more transactions going thWllh tlllSl channds and there would overall be less information Ibllt whlt was going on Secretary Summers took the side of the hed funds md the otlshore banking centers resisting calls for incTeISld transparency arguing that excessive transparency might feduce incentiws tor glthering information the price discovery tUIKtion in the technical jargon Reforms in the offihore banking centlrs lstablished as tax and regulatory avoidance havens only took on momentum after September 11 This should not come as a surprise thesl 6cilities exist as a result of deliberate policies in the advanced industrial countries pushed by financial markets and the wealthy Othlr even seemingly minor reforms faced strong resistance sometimes trom the developing as well as developed countries As it became clear that shortterm indebtedness played a key role in the crisis attention focused on bond provisions that allowed what seemed to be a longterm bond to be converted into a shortterm indebtedness overnight I I And as demands for bailin of creditors grew so too did demands for provisions in bonds that would facilitate their forced participation in workouts socalled collective action clauses The bond markets have so far successfully resisted both reformseven as these reforms have seemingly received some sup POrt from the IME The critics of these reforms argued that such pro visions might make credit more cosdy to the borrowing country but they miss the central point Today there are huge costs to borrowing especially when things go badly but only a fraction of those costs are borne by the borrower What Is Needed The recognition of the problems has come a long way But the reforms of the international financial system have only just begun In my mind among the key reforms required are the following I Acceptance of the dangers of capital market liberalization and Z37 that shortterm capital flows hot money impose huge cxtcr nalities costs borne by those not directly party to the tranaction the lenders and borrowers Whenever there are such large externalities interventionsincluding those done through the banking and tax systems 12are desirable Rather than resisting these interventions the international financial institutions should be directing their efforts to making them work better 2 Bankruptcy reforms and standstills The appropriate way of addressing problems when private borrowers cannot repay credi tors whether domestic or foreign is through bankruptcy not through an lMFfinanced bailout of creditors What is required is bankruptcy reform that recognizes the special nature of bank ruptcies that arise out of macroeconomic disturbances what is needed is a superChapter 11 a bankruptcy provision that expe dites restructuring and gives greater presumption for the contin uation of existing management Such a reform will have the further advantage of inducing more due diligence on tne part of creditors rather than encouraging the kind of reckless lending that has been so common in the past 13 Trying to impose more creditorfriendly bankruptcy reforms taking no note of the spe cial features of macroinduced bankruptcies is not the answer Not only does this fail to address the problems of countries in crises it is a medicine which likely will not take holdas we have seen so graphically in East Asia one cannot simply graft the laws of one country onto the customs and norms of another The problems of defaults on public indebtedness as in Argentina are more complicated but again there needs to be more reliance on bankruptcies and standstills a point that the IMF too seem belatedly to have accepted But the IMF cannot play the central role The IMF is a major creditor and it is dominated by the creditor countries A bankruptcy system in which the creditor or his representative is also the bankruptcy judgment will never be accepted as fair 3 Less reliance on bailOlm With increased use of bankruptcies and standstills there will bl less need for the big bailouts which tailed so frequently with the nwl1ty either going to ensure that West ern creditors got paid back mOTe than they otherwist would or llllIIHIlN AND ITS IISCONTfNTS th1 eXlhmgt rates Wtre maintained at overvalued levds longer dUll tht dltlwiSt would have beell allowing the rich inside the ountr tLl get 1II0re of their money out at more favorable tf Il IS but kIillg the country 1II0re indebted As we have seen the blilouts hln not just fliled to work they have contributed to the probklll by reducing incentives for care in lending and for clwerillg 01 exchange risks IlIIproved banking regulationboth design and implementa ionin he devdoped and the less devdoped countries alike Weak bank regulation in devdoped countries can lead to bad knding practices an export of instability While there may be SOllle debate whether the design of the riskbased capital ade LJuacy standards adds to the stability of the financial systems in he developed countries there is little doubt that it has con tributed to global instability by encouraging shortterm lending Financial sector deregulation and the excessive rdiance on capital adequacy standards has been misguided and destabilizing what is required is a broader less ideological approach to regulation adapted to the capacities and circumstances of each country Thailand was right to have restricted speculative real estate lend ing in the 1980s It was wrong to encourage the Thais to elimi nate these restrictions There are a number of other restrictions such as speed limits restrictions on the rate of increase of banks assets which are likdy to enhance stability Yet the reforms can not at the same time lose sight of the broader goals a safe and sound banking system is important but it must also be one that supplies capital to finance enterprise and job creation 14 J Improved risk management Today countries around the world face enormous risk from thc volatility of exchange rates While the problem is clear the solution is not Expertsincluding those at the IMFhave vacillated in the kinds of exchangerate sys tems that they have advocated They encouraged Argentina to peg its currency to the dollar After the East Asia crisis they argucd that countries should either have a freely floating exchange rate or a fixed peg With the disaster in Argentina this advice is likely to change again No matter what reforms occur to the exchange rate mechanism countries will still face enor THE WhY AIIEh 2111 mous risks Small countries like Thailand buying and elling goods to many countries face a difficult problem as the exchange rates among the major currencies vary by 50 percent or more Fixing their exchange rate to one currency will not resolve the problems it can actually exacerbate fluctuations with respect to other currencies But there arc other dimensions to risk The Latin American debt crisis in the 1980s15 was brought about by the huge increase in interest rates a result of Federal Reserve Chairman Paul Volckers tight money policy in the United States Developing countries have to learn to manage these risks proba bly by buying insurance against these fluctuations in the interna tional capital markets Unfortunately today the countries can only buy insurance for shortrun fluctuations Surely the devel oped countries are much better able to handle these risks than the less developed countries and they should help develop these insurance markets It would therefore make sense for the devel oped countries and the international financial institutions to pro vide loans to the developing countries in forms that mitigate the risks eg by having the creditors absorb the risks of large real interest fluctuations 6 Improved safety nets Part of the task of risk management is enhancing the capabilities of the vulnerable within the country to absorb risks Most developing countries have weak safety nets including a lack of unemployment insurance programs Even in more developed countries safety nets are weak and inadequate in the two sectors that predominate in developing countries agri culture and small businesses so international assistance 11 be essential if the developing countries are to make substantial strides in improving their safety net 7 Improved response to crises We have seen the failure ot the crisis responses in the 19979H crisis The assistance given wa badly designed and poorly implemented The programs did not take sufficiently into account the lack of safety nets that maintaining credit flows was of vital importance and that collapse in trade between countries would spread the crisis The policies were based not only on bad flrlcast bur on a failure to recognize that it is easier to destroy firms thlI1 to recreate them that the danl lllIIT1N Nll ITs DISCONTENTS IUStd b hlh IIUtrtst rattS will not be reversed when they are Illwned Thtrt 1Ittds to bt a restoration of balance the concerns tlf WtlrKtrS md SIIlJll businesses have to be balanced with the tllIertlS tlf Cfttliwrs the impacts of policies on domestic capital tliht hIH to bllallce the seemingly excessive attention currently plid to outside illVtstors Responses to future financial crises will hIe to bt placed within a social and political context Apart trolll tht deastation of the riots that happen when crises are llliSl11alUed capital will not be attracted to countries facing social and political turmoil and no government except the most repressive can control such turmoil especially when policies are perceived Q have been imposed from the outside Most important there needs Q be a return to basic eco nomic principles rather than focusing on ephemeral investor psychology on the unpredictability of confidence the IMF needs Q return to its original mandate of providing funds to restore aggregate demand in countries facing an economic recession Countries in the developing world repeatedly ask why when the United States faces a downturn does it argue for expansionary fiscal and monetary policy and yet when they face a downturn just the opposite is insisted upon As the United States went into a recession in 2001 the debate was not whether there should be a stimulus package but its design By now the lessons of Argentina and East Asia should be clear confidence will never be restored to economies that remain mired in deep recessions The conditions that the IMF imposes on countries in return for money need not only to be far more narrowly circumscribed but also Q reflect this perspective There are other changes that would be desirable forcing the IMF to disclose the expected poverty and unemployment impact of its programs would direct its attention to these dimensions Coun tries should know the likely consequences of what it recommends If the Fund systematically errs in its analysesif for instance the increases in poverty are greater than it predictedit should be held accountable Questions can be asked Is there something systemati THI WAY AHFAD cally wrong with its models Or is it trying to deliberatdy mislead policy making REFORMING THE WORLD BANK AND DEVELOPMENT ASSISTANCE Part of the reason that I remain hopeful about the possibility of reforming the international economic institutions is that I haw seen change occur at the World Bank It has not been easy nor has it gone as far as I would have liked But the changes have been significant By the time I arrived the new president James Wolfensohn was well on his way to trying to make the Bank more responsive to the concerns of developing countries Though the new direction was not always clear the intellectual foundations not always firm and support within the Bank far from universal the Bank had begun seriously to address the fundamental criticisms levied at it Reforms involved changes in philosophy in three areas development aid in general and the Banks aid in particular and relationships between the Bank and the developing countries In reassessing its course the Bank examined how successful devel opment has occurred 16 Some of the lessons that emerged from this reassessment were ones that the World Bank had long recognized the importance of living within ones budget constraints the importance of education including female education and of macroeconomic sta bility However some new themes also emerged Success came not just from promoting primary education but also from establishing a strong technological basis which included support for advanced training It is possible to promote equality and rapid growth Qt dlc sallie lilll in lct more egalitarian policies appear to help growth Support for trade and openness is important 17 but it was the jobs created by export expansion not the job losses from increased import that gave rise to growth When governments took actions to promote exports and new enterprises liberalization worked othlr wise it often failed In East Asia government played a pivotal role in successful development by helping create institutions that promote lllllIL1LHlllN NIl ITS DISCONTeNTS SIlll 1Ild th dricitllC allocation of investment Successful coun tries tIs cmphlsizcd competition and enttrprise creation over priva CllHill 1Ilj tilt rtstructurin of txisting enterprises l trtIl tht succtsslul countries have pursued a comprehensive lppwlch tll detlopmtllCThirry years ago economists of the left and tht riht olttll stellled to agree that the improvement in the effi itllc lI resource allocation and the increase in the supply of capital Wt It the heart of devdopment They differed only as to whether thost clllnges should be obtained through governmentled planning r ulllettered lIlarkets In the end neither worked Development lllcompasses Ilot just resources and capital but a transformation of socitti Clearly the international financial institutions cannot be held responsible for this transformation but they can play an impor tlnt role And at the very least they should not become impediments to 1 successtlil transformation Assistance Bur rhe way assistance is often gIven may do exactly thatcreate impediments to etTecrive transitions We saw in chapter 2 that condi cillllZicyrhe imposition of a myriad of conditions some often polit ical in natureas a precondition for assistance did not work it did not lead to better policies to faster growth to better outcomes Countries that think reforms have been imposed on them do not really feel invested in and committed to such reforms Yet their par ticipation is essential if real societal change is to happen Even worse the conditionality has undermined democratic processes At last there is a glimmering of recognition even by the IMF that condi tionality has gone too far that the dozens of conditions make it diffi cult for developing countries to focus on priorities But while there has accordingly been an attempt to refme conditionality within the World Bank the discussion of reform has been taken further Some argue that conditionality should be replaced by seiectility giving aid to countries with a proven track record allowing them to choose for themselves their own development strategies ending the micro management that has been such a feature of the past The evidence is THl WAY AHAf 143 that aid given selectively can have ignificant impacts both in pro moting growth and in reducing poverty Debt Forgiveness The developing countries require not only that aid be given in a way that helps their development but also that there be more aid Rela tively small amounts of money could make enormous differences in promoting health and literacy In real terms adjusted for inflation the amounts of development assistance have actually been declining and even more so either as a percentage of developed country income or on a per capita basis for those in the developing countries There needs to be a basis for funding this assistance and other global public goods on a more sustained level free from the vagaries of domestic politics in the United States or elsewhere Several proposals have been put forward When the IMF was established it was given the right to create Special Drawing Rights SDRs a kind ofointerna tional money With countries today wisely putting aside billions of dollars into reserves cvery year to protect themselves against the vicissitudes of international markets some income is not being trans lated into aggregate dcmand The global economic slowdown of 2OI02 brought these concerns to the fore Issuing SDRs to finance global public goodincluding financing development assistance could help maintain the strength of the global economy at the same time that it helped some of the poorest countries in the world A sec ond proposal entails llSing the revenues from global economic resourcesthe minerals in the seabed and fishing rights in the oceansto help finance development asistance Recently attention has focused on debt forgiveness and for good reason Without the forgiveness of debt many of the devdoping countries simply cannot grow Huge proportions of their current exports go to repaying loans to the developed countries 19 The Jubilee 2000 mOVLl11ent mobilized enormous international support for debt forgiveness The movcment gained the backing of churches throughout the developed world To thelll it seemed a moral imprr ative a reRection of basic principlcs of economic justice CllllIUILHlllN AND ITS DISCONTENTS Tht ISSUt lf tilt 1II0ral rlsponsibility of the creditors was particu lirl lpplrtnt in tht 3St of cold war loansu When the IMF and Wlrld Ul1lk Itllt 1II0nty to the Democratic Republic of Congos IIllrIlHIS rukr Mobutu they knew or should have known that nwst f tht 1II0nty would not go to help that countrys poor people bllt rltha would be used to enrich Mobutu It was money paid to tnsurt thlt this corrupt leader would keep his country aligned with tht iitst To IIl3ny it doesnt seeIll fair for ordinary taxpayers in coun trits with corrupt governments to have to repay loans that were nudt to leelders who did not represent them The Jubilee movement was successful in getting much larger com mitments to debt forgiveness Whereas before 2000 there had been 1 debt relief program for the highly indebted countries few met the criteria that the IMF had erected By the end of 2000 as a result of international pressure twentyfour countries had passed the thrtshold But debt relief needs to go further as it stands now the agreements touch only the poorest of the countries Countries like Indonesia devastated by the East Asian crisis and the failures of the IMF policies there are still too well off to be brought in under the umbrella REFORMING THE WTO AND BALANCING THE TRADE AGENDA Tht global protests over globalization began at the WTO meetings in Seattle Washington because it was the most obvious symbol of the global inequities and the hypocrisy of the advanced industrial coun trits While these countries had preachedand forcedthe opening of the marktts in the developing countries to their industrial prod ucts they had continued to keep their markets closed to the products of the developing countries such as textiles and agriculture While they preached that developing countries should not subsidize their industries they continued to provide billions in subsidies to their own farmers making it impossible for the developing countries to compete While they preached the virtues of competitive markets the United States was quick to push for global cartels in steel and alu THE WAY AlllAIJ 4S minum when its domestic industries seemed threatened by imporu The United States pushed for liberalization of financial servicei but resisted liberalization of the service sectors in which the developing countries have strength construction and maritime services As we have noted so unfair has the trade agenda been that not only have the poorer countries not received a fair share of the benefin the poorest region in the world SubSaharan Africa was actually nude worse off as a result of the last round of trade negotiations These inequities have increasingly been recognized and that combined with the resolve of some of the developing countries resulted in the Doha development round of trade negotiations November 2001 which put on its agenda the redressing of some of these past imbalances But there is a long way to go the United States and the other advanced industrial countries only agreed to discus sions just to discuss redressing some of these imbalances 35 viewed as a concession One of the areas that was of particular concern at Doha was intel lectual property rights These are important if innovators are to have incentives to innovatethough much of the most crucial research such as that in basic science and mathematics is not patentable No one denies the importance of intellectual property rights But these rights need to balance out the rights and interests of producers with those of usersnot only users in developing countries but researchers in developed countries In the final stages of the Uruguay negotia tions both the Office of Science and Technology and the Council of Economic Advisers worried that we had not got the balance right the agreement put producers interests over users We worried that in doing so the rate of progress and innovation might actually be illlpeded after all knowledge is the most important input into research and stronger intellectual property rights can increase the price of this input We were also concerned about the consequenCe5 of the denial of lifesaving medicines to the poor This issue subse quently gained international attention in the contellt of the provision of AIDS medicines in South Africa The international outrage forced the drug companies to hack downand it appears that going tor ward the most adverse consequences will be circumscribed But it is worth noting that initially even the Democratic US administration tllllHliLHIllN ND ITS DISCONTNTS SUffHTed tite phlrlllamical companits What we were not fully lWlre f WIS llwtha daner what has come to be termed biopiracy illtlrllltilld ClllPlllits patenting traditional medicines or foods it is llt llll titlt tl1V Slk 0 make money from resources and knowl cllc thlt rihtfully belonb to the developing countries but in so Iin thcv squelch domestic firms that have long provided the prod ucts hile it is not clear whether these patents would hold up in ClIlrt if they were etlectively challenged it is clear that the less devel Fcd coulltries may not have the legal and financial resources required to challenge the patent This issue has become a source of enormous emotional and potentially economic concern all around tht denloping world I was recently in an Andean village in Ecuador here the indigenous mayor railed against how globalization had led to biopirclCY Rdorming the WTO will require thinking further about a more balmced trade agendamore balanced in treating the interests of the developing countries more balanced in treating concerns like envi ronment that go beyond trade But redressing the current imbalances does not require that the world wait until the end of a new round of trade negotiations Inter national economic justice requires that the developed countries take lCtions to open themselves up to fair trade and equitable relation hip with developing countries without recourse to the bargaining ttble or attempts to extract concessions in exchange for doing so Tht European Union has already taken steps in this direction with its everything but Arms initiative to allow the free importing of all goods other than arms from the poorest countries into Europe It does not solve all the complaints of the developing countries they still will not be able to compete against highly subsidized European agriculture But it is a big step in the right direction The challenge now is to get the United States and Japan to participate Such a move would be of enormous benefit to the developing world and would even benefit the developed countries whose consumers would be able to obtain goods at lower prices THE WAY AHIAl TOWARD A GLOBALIZATION WITH A MORE HUMAN FACE The reforms I have outlined would help make globaliution Uirer Jnd more effective in raising living standards especially of the poor It is not just a question of changing institutional structures The mind set around globalization itself must change Finance and trade minis ters view globalization as largely an economic phenomenon but to many in the developing world it is far more than that One of the reasons globalization is being attacked is that it seem to undermine traditional values The conflicts are real and to some extent unavoidable Economic growthincluding that induced by globalizationwill result in urbanization undermining traditional rural societies Unfortunately so far those responsible for managing globalization while praising these positive benefits all too often have shown an insufficient appreciation of this adverse side the threat to cultural identity and values21 This is surprising given the awareness of the issues within the developed countries themselves Europe defends its agricultural policies not just in terms of those special interests but to preserve rural traditions People in small towns every where complain that large national retailers and shopping malls have killed their small businesses and their communities The pace of global integration matters a more gradual process means that traditional institutions and norms rather than being overwhelmed can adapt and respond to the new challenges Of equal concern is what globalization does to democracy Glob alization as it has been advocated often seems to replace the old dic tatorships of national elites with new dictatorships of international finance Countries are effectively told that if they dont tollo certain conditions the capital markets or the 1M F will refuse to lend them money They arc basically forced to give up part of their sovlreignty to let capricious capital markets including the speculators whose only concerns arc shortterm rather than the longterm growth of the country and the improvement of Jiving standards discipline them telling them what they should and should not do But countries do have choices and among those choices is th extent to which they wish to subject thtmselvcs to international cap iul 1lllrk Tlllls such IS in Easc Asia chac have avoided che stric ures f dll IIU hIe grown tlscer with greater equality and poverty rduriII dUll rhost who have obeyed its commandments Because drmli licitS atlicr ditTerent groups ditTerently it is the role of rh lirial PrlKtSSnor international bureaucratsto sort out the dwiCts Een it growth lIere adversely affected it is a cost many kwlnping countries may be willing to pay to achieve a more demo nHie 1111 equitable societyjust as many societies today are saying it is worrh sacriticing some growth for a better environment So long as globalizarion is presented in the way that it has been it represents a disenfranchisement No wonder then that it will be resisted espe Liall by those who are being disenfranchised TODAY GLOBALIZATION IS being challenged around the world There is discontent with globalization and rightfully so Globaliza tion can be a force for good the globalization of ideas about democ racy and of civil society have changed the way people think while global political movements have led to debt relief and the treaty on land mines Globalization has helped hundreds of millions of people attain higher standards of living beyond what they or most econo mists thought imaginable but a short while ago The globalization of the economy has benefited countries that took advantage of it by seeking new markets for their exports and by welcoming foreign investment Even so the countries that have benefited the most have been those that cook charge of their own destiny and recognized the role government can play in development rather than relying on the notion of a selfregulated market that would fix its own problems But for millions of people globalization has not worked Many have actually been made worse off as they have seen their jobs destroyed and their lives become more insecure They have felt increasingly powerless against forces beyond their control They have seen their democracies undermined their cultures eroded If globalization continues to be conducted in the way that it has been in the past if we continue to fail to learn from our mistakes globalization will not only not succeed in promoting development but will continue to create poverty and instability Without reform TilE WAY AllfA tbe backlash that has already started will mount and discontent with globalization will grow This will be a tragedy for all of us and especially for the billioru who might otherwise have benefited While mose in the developing world stand to lose the most economically there will be broader political ramifications that will affect the developed world toO If the reforms outlined in this last chapter are taken seriously men there is hope that a more humane process of globalization can be a powerful force for the good with the vast majority of those living in the developing countries benefiting from it and welcoming it If this is done the discontent with globalization would have served us all well The current situation reminds me of the world some seventy years ago As the world plummeted into the Great Depression advocates of the free market said Not to worry markets are selfregulating and given time economic prosperity will resume Never mind me mis ery of those whose lives are destroyed waiting for this socalled even tuality Keynes argued that markets were not selfcorrecting or not at least in a relevant time frame As he famously put it In me long run we are all dead Unemployment could persist for years and government intervention was required Keynes was pilloried attacked as a Socialist a critic of the market Yet in a sense Keynes was intensely conservative He had a fundamental belief in the mar kets if only government could correct this one failure me economy would be able to function reasonably efficiently He did not want a wholesale replacement of the market system but he knew mat unless these fundamental problems were addressed there would be enor mous popular pressures And Keyness medicine worked since World War II countries like the United States following Keynesian pre scriptions have had fewer and shorterlived downturns and longer expansions than previously Today the system of capitalism is at a crossroads just a it was dur ing the Great Depression In the 1930s capitalism was saved by Keynes who thought of policies to create jobs and rescue those sut J M Keynes A 7iwr 01 vImcrar Referm London MacmiUan 1924 lLOHHIZAriON AND ITS DISCONTENTS tir1Il tn1Il tht collaps of th global conomy Now millions of plopk 1roUlld thl world ar waiting to stt whtther globalization cm bt rdormd so that its btndits can bt mort widely shared Thl1lktiIly thtrt is a growing rtcognition of thtse problems and incrtlsin political will to do somtthing Almost evtryone involved in dtt0pllltnt twn thost in tht Washington establishment now Jrts that rapid capital market liberalization without accompanying rq 1tlation can bt dangtrous They agrte too that the excessive tight Iltss in tiscal policy in tht Asian crisis of 1997 was a mistake As Bolivia mowd into a recession in 2001 caused in part by the global economic slowdown there were some intimations that that country would not be torced to follow the traditional path of austerity and h1t to Cllt governmental spending Instead as of January 2002 it looks likt Bolivia will be allowed to stimulate its economy helping it to overcome the recession using revenues that it is about to receive from its newly discovered natural gas reserves to tide it over until the tconomy starts to grow again In the aftermath of the Argentina debacle the IMF has recognized the failings of the bigbailout strat tgy and is beginning to discuss the use of standstills and restructuring through bankruptcy the kinds of alternatives that I and others have been advocating for years Debt forgiveness brought about by the work of the Jubilee movement and the concessions made to initiate a nev development round of trade negotiations at Doha represent two more victorits Despite these gains there is still more to be done to bridge the gap between rhetoric and rtality At Doha the developing countries only agreed to begin discussing a fairer trade agenda the imbalances of the past havt yet to be redressed Bankruptcy and standstills are now on the agenda but there is no assurance that there will be an appropriate balanct of creditor and debtor interest There is a lot more participa tion by those in developing countries in discussions concerning eco nomic strategy but there is little evidence yet of changes in policies that reflect greater participation There need to be changes in institu tions and in mindsets The free market ideology should be replaced with analyses based on economic science with a more balanced view of the role of government drawn from an understanding of both market and government failures There should be more sensitivity THE WilY AHIoII about the role of outside advisers so they support democratic deci sion making by clarifying the consequences of different policia including impacts on different groups especially the poor rather than undermining it by pushing particular policies on reluctant countries It is clear that there must be a multipronged strategy of reform One should be concerned with reform of the international economic arrangements But such reforms will be a long time coming Thus the second prong should be directed at encouraging reforms that each country can take upon itself The developed countries have a special responsibility for instance to eliminate their trade barriers to practice what they preach But while the developed countries responsibility may be great their incentives are weak after all off shore banking centers and hedge funds serve interests in the devel oped countries and the developed countries can withstand well the instability that a failure to reform might bring to the developing world Indeed the United States arguably benefited in several ways from the East Asia crisis Hence the developing countries must assume responsibility for their wellbeing themselves They can manage their budgets so that they live within their means meager though that might be and elim inate the protectionist barriers which while they may generate large profits for a few force consumers to pay higher prices They can put in place strong regulations to protect themselves from speculators trom the outside or corporate misbehavior from the inside Most important developing countries need effective governments with strong and independent judiciaries democratic accountability open ness and transparency and freedom from the corruption that has sti fled the effectiveness of the public sector and the growth of the private What they should ask of the international community is only this the acceptance of their need and right to make their own choins in ways which reflect their own political judgments about who tor instance should bear what risks They should be encouraged to adopt bankruptcy laws and regulatory structures adapted to their own situ ation not to accept templates designed by and for the more devel oped countries 22 What is needed are policies fllr sustainable equitable and democ ratic growth This is the reason for deelopment Development is not CLlllUL Il ON NU ITS DISCONTENTS lboU hdpin I It ptoplt lt rkh or crtating a handful of pointless pwttcttd industrits that only btndit the countrys elite it is not olOllut brinin in Prada and Uenetton Ralph Lauren or Louis Vuit wn Illr tht urban rkh alld leaving the rural poor in their misery l3tin olblt 0 buy Gucci handbags in Moscow department stores did not llItoln tholt country had become a market economy Development is Ibom trlIlstorming societies improving the lives of the poor tnabling tveryone to have a chance at success and access to health lart olnd tducation This sort of devdopment wont happen if only a few people dic Wt tht policies a country must follow Making sure that democratic decisions are made mtans tnsuring that a broad range of economists officials lnd txperts from developing countries are actively involved in the debate It also means that there must be broad participation that goes well beyond the experts and politicians Developing coun erits must takt charge of their own futures But we in the West can not tscapt our rtsponsibilities Its not easy 0 change how things are done Bureaucracies like people fall into bad habits and adapting to change can be painful Bm the international institutions must undertake the perhaps painful changes that will enable them to play the role they should be playing 0 make globalization work and work not just for the well off and the industrial countries but for the poor and the developing nations The developed world needs to do its part to reform the interna tional institutions that govern globalization We set up these institu tions and we need to work to fix them If we are to address the legitimate concerns of those who have expressed a discontent with globalization if we are to make globalization work for the billions of people for whom it has not if we are to make globalization with a human face succeed then our voices must be raised We cannot we should not stand idly by NOTES CHAPTER 1 1 J Chirac The Economy Must Be Made to Serve People address at the International Labour Conference June 1996 2 In 19902718 billion people were living on less than 52 a day n 1998 the number of poor living on less than 2 a day is estimated at 2801 billionWorld Bank Global Economic Prospects and lilt DIIoping Coun tries 2000 Washington DC World Bank 2000 p 29 For additional data see VVord Dellelopmellt Report and World EcotlOmic IndilJJlorI annual publications of the World Bank Health data can be found in UNAIDSWHO Report on the HIVIAIDS Epidemic 1998 3 See Gerard Caprio Jr et al cds Preventing Bank Crises USIOIIS frlltfl Remit Global Balik Failures Proceedings if a Conjerelue CoSponsortd by lilt Federal Resenle Balik f Chicago and Ihe Ecollomic Delldpnrml Insrillllt if the VVorid Balik EDI Development Srudies Washington DC World Bank 998 4 While there have been a host of critiques of the strucrural adjustment program even the IMFs review of the program noted its many faults This review includes three parts internal review by the IMF stafr IMF Staff nre ESAF al Ten toarI Ecollomic Adjustment alld RrjClrm ill Lou brcollle COlllllries Occasional Papers 156 February 21998 external review by an independent reviewer K Botchwey et aI Report b a Group f rlldepcndcIII Experts Rerew External Emluatioll f the ES1F Washington DC IMF 998 and a report from IMF statfto the Board of Directors of the IMF distilling the lessons from the two revitws IMF Staff Distillini tire Usonsfrom fhe ESAF Rericu Washington DC IMF July J 998J 153 NOTES CHAPTER 2 I MlIlisU s rllllll is bblllld Ill killing at kast 200000 persons accord ill tll HUllllIl Rights Watch and lor lorcing about 750000 citizens to fllllC retiltts T Llnt A Chosh J Halnann S Phillips M SchulzeGhattas and T TSlkltl IMFSupported Programs in Indonesia Korea and Thailand A Prdimimry Assessment Occasional Paper 178 International Monetary Fund January 1999 There is considerable controversy about whether central banks should or should not be more independent There is some evidence based on crosscountry regressions that inflation rates may be lower but there is little evidence that real variables like growth or unemployment are improved My point here is not to resolve these disputes but to empha size that given that there is such controversy a particular view should not be imposed on the country CHAPTER 3 1 To take one example see P Waldman How US Companies and Suharws Cycle Electrified Indonesia Wall Street Journal December 23 1998 2 Adam Smith put forward the idea that markets by themselves lead to dflcient outcomes in his classic book The lMalth of Nations written in 1776 the same year as the Declaration of Independence The formal mathematical proofspecitying the conditions under which it was truewas provided by two Nobel Prize winners Gerard Debreu of the University of California at Berkeley Nobel laureate in 1983 and Ken neth Arrow of Stanford University Nobel laureate in 1972 The basic remit showing that when information is imperfect or markets are incomplete competitive equilibrium is not constrained Pareto effi cient is due to B Greenwald and J E Stiglitz Externalities in Economics with Imperfect Information and Incomplete Markets Quarterly Joual of Economics 101 2 May 1986 pp 22964 3 See W A lewis Economic Development with Unlimited Supplies of labor Iancirester School 22 1954 pp 13991 and S Kuznets Eco nomic Growth and Income Inequality American Ecollomic RieUJ 451 1955 pp 128 Nons 2SS CHAPTER 4 I For some contrasting views see Paul Krugman The Myth of Asia Miracle A Cautionary Fable ForeilAjJairs November 1994andjE Stiglitz From Miracle to Crisis to Recovery Lessons from Four Decades of East Asian Experience in j E Stiglitz and S Yusuf eds Retlinking the East Asia Miracle Washington DC and New York World Bank and Oxford Universiry Press 2001 pp 50926 See also World Bank The East Asia Miracle Economic Growth and Public Policy Ncw York Oxford Universiry Press 1993 Alice Amsden The Rise the Rest Chaletlges to tile Istfrom LateIndustrialization Economies New York Oxford Universiry Press 2001 and Masahiko Aoki HyungKi Kim Okuno OkunoFujiwara and Masahjiro OkunoFjujiwara cds The Role of Govemmellt in East Asian Economic Developmetlt Comparativt Institutional Analysis New York Oxford Universiry Press 1998 For an extremely readable account of the East Asia crisis see Paul Blustein The ChastenitJg Inside tlte Crisis tltat Rocked the Global Finanoal System and Humbled tlte IMF New York Public Affairs 2001 More technical dis cussions are provided eg in Morris Goldstein The Asian FinanatU Crisis Causes Cllres and Systelllic IlIlplicatiollJ Washington DC Interna tional Institute for Economics 1998 and Jason Furman and Joseph E Stiglitz Brookings Papers on Economic Actilit presented at Brookings Panel on Economic Activiry Washington DC September 3 1998 vol 2 pp 1114 2 Since the US economy was not affected the United States did not offer any assistance in marked contrast to the generous rreamlent it had given Mexico in its last crisis This gave rise to enormous resenrment in Thailand Especially after the strong support it had provided the United States during the Vietnam War Thailand thought it deserved better treatment 3 See E Kaplan and D Rodrik Did the Malaysian Capital Conrrols Work working paper no W8142 National Bureau ot Economic Research Cambridgl Mass February 2001 It is possible to find this paper at Professor Rodriks Web site httpksghomcharvardedu drodrikacademicksgpapershtml 4 Korea received 55 billion Indonesia 33 billion and Thailand S 17 bil lion S See J Sachs The Wrong Medicine for Asia iill rk Timrs Nowll1r 3 1997 and To Stop the Money Panic An Interview th Jdfiy Sachs Asialleck February 13 1 Nil n NTS h III I Ill trti1l dirtct inwstlllent millions was 24130 in 1997 it l 17l2S lIld III I l 17U912 portfolio inwstment in 1990 mil 1iIl IS 1915 riill to 79128 in 1997 and 55225 in 1998 Bank lIld trlk rd ld iIlVlSttll1l was 11511 in 19054507 in 1997 and 1151 III 19l Total privatI capital flows in millions 42606 in 19lllJ91 in 1997and 267700 in 1998 011 tKwrs involwd in financial and banking crises see eg D Beim lIld C cilomiris Emeillg Filldllcidl Harkets New York McGraw Hilli Irwin 200 I chapter 7 A DemirgucKuIlt and E Detragiache TIlt DcamilllIIts r Bdllkill Crises Evidence from Developing and Devel pd Cl1lrits IMF Staff Papers voL 45 no I March 1998 G Caprio Jnd D Klingebid Episodes of Systemic and Borderline Financial CristS Hrld 8mk October 1999 and World Bank Staff Global Eco nomic Prospects and the Developing Countries 199899 Beyond FinlIlcial CrisisThe World Bank February 1999 8 M Camdtssus Capital Account Liberalization and the Role of the Fund remarks at the IMF Seminar on Capital Account Liberalization Washington DC March 9 1998 9 The American slowdown of 20002001 too has been traced to exces sive market exuberance an overinvestment in Internet and Telecom brought on in part by soaring stock prices Marked fluctuations in the economy can arise even in the absence of mismanagement of financial institutions and monetary policy I n The debate surrounding Korea was part of a broader debate about capi tal market liberalization and the bailouts that follow when things go wrong as they inevitably doa debate that was held within the IMF md the US government almost completely behind closed doors It occurred repeatedly for instance as we prepared for rcgional trade agreements and for G7 meetings On thc one occasion thc Mcxican I 95 crisis when Treasury brought the issue of bailouts to Congress and Congress rejected the proposal Treasury went back to its usual closed qumers figured out a way of proceeding with the bailout with out congressional approval and strongarmed other governments to participate in a manner that engendered large hostility in many Euro pean quartersthe full ramifications of the strongarm tactics of the USTreasury have playcd out slowly ovcr the ensuing years as US posi tions in a variety of contcxts have subtly bcen opposed eg the choice of the head of the IMFThe issues are complicated but the USTrea sury almost seemed to revel in its ability to outsmart Congress Nons ZS7 II n MF AIIwal Report of the Executive Board for tire Firlandal Yt4r ENUd April 30 1998 Washington DC p 25 some MF direton doubted the need for strict fiscal policies during the Asian cri5 because thne countries did not experience fiscal imbalance Interestingly the IMF in its similar report for 2000 recognized p 14 that an expansionary iscaI policy is behind the recovery from the crisis of Korea Mabia and Thailand See also T Lane A Ghosh Hamann S Phillips M Schulze Ghattas and T Tsikata IMFSupported Programs in Indonesia Korea and Thailand A Preliminary Assessment Occasional Paper 178 Inter national Monetary FundJanuary 1999 12 Stanley Fischer Comment Analysis IMFThe Right Stuff Bailouts in Asia Are Designed to Restore Confidence and Bolster the Financial System Fillallcial Times December 16 1997 13 Over the years have never heard a coherent defense of the IMFs strat egy of raising interest rates in countries with highly leveraged firms from any IMF staffers The only good defense I did hear was from Chase Securities chief economist John Lipsky who focused explicitly on imperfections of capital markets He observed that domeStic busi nessmen typically kept large amounts of money abroad but borrowed domestically The high interest rates on the domestic loans would force them to bring back some of their foreign funds in order to pay off the loans and avoid paying such rates This hypothesis has not yet been evaluated Certainly for several of the crisis countries net capital Row moved in the opposite direction Many business people assumed that they simply could not be forced to pay the high interest rates and that there would have to be renegotiation In effect the high intenSt rates were not credible 14 The Ministry of Finance official in charge Eisuke Sakakibara has subse quently written his own intcrpretation of the events in E Sakakibara The End of Market Fundanlcntalism Speech delivered at Foreign Correspondents Club TokyoJanuary 22 1999 15 For lurther details see E Kaplan and D Rodrik Did the Mmian Capital Controls Work op cit 16 During this crisis period foreign direct investment to Malaysia showed a pattern similar to other countries affected by the crisis and in the region Nonetheless the cvidcnce is till too preliminary to draw solid conclusions A deeper econometric study and more data is required in ordcr to discntangle thc ctlct of capital controls on foreign dinct invcstment from other factors thlt affect foreign direct investmrnt s NOTS CHAPTER 5 I lIeII thi 1111 the lct two chapters is based on work reported more t clscwhere See the lollowing papers J E Stiglitz Whither Rdnll Tell Years of tilt Transition Annual World Bank Conference II eHtpmcnt Economics 9 in Boris Pleskovic and Joseph E Stiglitz cds The World lhnk Washington DC 2000 pp 2756 J E Stiglitz Quis Cstdiet Ipss Custdes vVho Is to Guard the Guards 17111 ill GlIemlIlCe Equality alld Global A1arkets The Annllal BlIlk Crcllcc II DeelopllltlIt Ecollomics EuropeJ E Stiglitz and Pierre Ilin Muet eds World Bank Washington DC 2001 pp 2254 In dclition see D Ellerman and J E Stiglitz New Bridges Across the Chasm Macro lnd MicroStrategies for Russia and other Transitional Economies Zgreb Imematiollal Review if Economics and Bllsiness 31 20tH pp 72 and A Hussain N Stern andJ E Stiglitz Chinese Rdorms from a Comparative Perspective in Peter J Hammond and Gareth D Myles eds Illcemives Orgatizatioll and Public Economics Papers ill HvIT 4 Sir JlIlles Vlirrlees Oxford and New York Oxford Univer sity Press 200 pp 23 277 For excellent journalistic accounts of the transition in Russia see Chrystia Freeland Sale if the Cmlllry New York Crown 2000 P Kleb nikov Goijather if the Kremlill Boris Berezovsky and the Lootillg of Russia New York Harcourt 2000 R Brady Kapitalizm Russias Struggle to Free Its Ecollomy New Haven Yale University Press 1999 and John Lloyd Who Lost Russia New York Times Magazine August 15 1999 A number of political scientists have offered analyses broadly lgneing with the interpretations provided here See in particular A Cohen Rllssias AIeltdoll Atlatomy if tile JvtF Failure Heritage Founda tion Backgrounders No 1228 October 23 1998 S E Cohen Failed Cnde New York W W Norton 2000 P Reddaway and D Glinski TIe YrJgedy of Rllssias Riforms A1arket Bolshevism Against Democracy Washington DC United States Institute of Peace 2001 Michael McFaul RlIsis Ufillished Revolution Political Changefrolll Gorbachev to Plltill Ithaca NY Cornell University Press 2001 Archie Drown and Liliia Fedorovna Shevtskova eds Gorbachev Yeltsin and Putin Political Leadership ill RlIssias Trallsitioll Washington DC Carnegie Endowment for International Peace 200 and Jerry E Hough and Michael H Armacost The 1olii of Ecollomic Reform ill Russia Washington DC Brookings Institution 201 NOTES lSII Not surprisingly a number of reformers have prmided accoUllll that differ markedly from those presented here though such interpata tions were more frequent in the earlier more hopeful days of the transi tion some with titles that seem to jar with subsequent events Sec eg Anders Aslund How Russia Became a Market Economy Washington DC Brookings Institution 1995 or Richard Layard and John Parker The Coming RllSsian Boom A Guide to New Mllrkets lind Polilics New York The Free Press 1996 For more critical perspectives see Lawtencc R Klein and Marshall Pomer eds with a foreword by Joseph E Stiglitz TIle New Russia Trallsition GOtle Au Palo Alto Calif Stanford Univer sity Press 2001 2J R Wedel Aid to Russia Foreign Policy 3 25 Interhemispheric Resource Center and Institute Policy Studies September 1998 3 For further reading see P Murrell Can NeoClassical Economics Underpin the Economic Reform of the Centrally Planned EconorniesJoumal if Economic Perspectiles 54 1991 pp 5976 4 See International Monetary Fund IMF Approves Augmentation of Russia Extended Arrangement and Credit Under CCFF Activates GAB Press release no 9831 Washington DC July 20 1998 5 There is an argument that the MF really did not ignore this n act some believe that the Fund was trying to close tile devaluation option by making the cost of devaluation so high that the country would not do it f this was indeed the argument the IMF miscalculated badly 6 There was of course more to the Russian governments announcement of August 17 but these were among the central features for our pur poses n addition the Russian government established temporary con trols of capital such as a prohibition on nonresidents investing in shortterm ruble assets and a ninetyday moratorium on foreign exchange credit and insurance payments The Russian government also announced its support to a payment pool set up by the largest Russian banks in order to maintain the payment stability and sent legislation Cor timely payments to government employees and for the rehabilitation of banks For details see the Web site wwwbisnisdocgovbisniscoun try980818ruhtm which provides the original texts of the two public announcements on August 17 1998 7 On Tuesday August 17 1998 on the Moscow Interbank Currency Exchange the ruble agaimt the dollar fell 19 compared to its level at August 16 but by end of the week Friday August 21 the depreciuion was 110 compared again to til August 16 level Howewr at August NOTES 17 1 l Oil th lIlWtliitl imerbank trading market the ruble had dldillcd 2ll by lUyS tnd See lhrysti Frtdmd of cit Richard Layard and John Parker op cit md dlrs Aslllnd Of cit l For thl illlflicuions nd costs that barter imposes on the Russian econ OIllY st C addy Jnd B W Ickes Russias Virtual Economy For II Wi 77 SptemberOctober 1998 Ill The tWlsitiHl has not appeared to benefit the poor For example the lowest qllintile of the population had a share of income equal to 86 1Il Russia in 998 88 in Ukraine in 1999 67 in Kazakhstan in 199h Vorld Bank orld Dewopmerlt bldicator 2001 I I Using a standard measure of inequality the Ginii coefficient by 1998 Russia had achieved a level of inequality twice that of Japan 50 greter than UK and other European countries a level comparable to Venezueb and Panama Meanwhile those countries that had under taken gradualist policies Poland and Hungary had been able to keep their level of inequality lowHungarys was even lower than Japans and Polands lower than the UKs 12 See Stiglitz Quis Custodiet Ipsos Custodes op cit 13 For instance If one liberalizes capital markets before an attractive invest ment climate is created at homeas the IMF recommendedone is inviting capital flight If one privatizes firms before an efficient capital market is created at home in a way that puts ownership andlor control in the hands of those who are nearing retirement there is no incentive tor longterm wealth creation there are incentives for asset stripping If one privatizes before creating a regulatory and legal structure for endur ing competition there are incentives to create monopolies and there are political incentives to prevent the creation of an effective competition regime If one privatizes in a federal system but leaves state and local authorities free to impose taxes and regulations at will one has not eliminated the power and incentives of public authorities to extract rents in a sense one has not really privatized at all jt for the Coase theorem itself sec R H Coase The Problem of Social Cost Joumal of Law alld Economics 3 1960 pp 144 This theorem holds only where there are no transactions costs and no imperfections of information Coase himself recognized the force of these limitations Moreover it is never possible fully to specify property rights and this was especially true for the economics in transition Even in advanced industrialized countries property rights arc circumscribed by concerns for the environment worker rights zoning and so forth Although the NOTES law may try to be a clear on these matters as pmsible dipu fre quently arise and have to be settled through legal proces furtunatdy given the rule of law there is general confidence that chi is done in a fair and equitable manner But not so in Russia CHAPTER 6 1 Though this was the supposed defense as we noted earlier even this defense was questionable The oligarchs did not use the funds to finance Yeltsins reelection But they did give him the organizational basis and the TV support he needed 2 The transition countries currently governed by former Communist parties or leaders are Albania Azerbaijan Belarus Croatia Kazakhstan Lithuania Moldova Poland Romania Russia Slovenia Tajikistan Turk menistan and Uzbekistan 3 I was put in an extremely uncomfortable position during my visit to Russia in later 1993 in a meeting with Yegor Gaidar the first deputy prime minister who was in charge of economics He knew his econom ics and he knew that Russia was not dumpingby any stretch ofbow that word is used in economics What was I to say 4 For details see M Du Bois and E Norton Foiled Competition Dont Call It a Cartel But World Aluminum Has Forged a New Order Wall Street JOllrtlalune 9 1994 This article noted the close relation between ONeill and Bowman Curter at that time Clintons deput director of the National Economic Council as instrumental in order to cook the deal The sweetener for the Russians was an equity investment worth 250 million guaranteed by tile OPIC The American aluminum barons did everything to take care of the appearances in order to avoid 1ntitrust prosecution and the American government included three antitrust lawyers to draft the agreement which according to this article was carefully vaguely worded in order to satisfr tile Justice Depamncnt In 1995 this cartel started to faU apart with the incrtae in world demand for aluminum and the difficulties of enforcing the cartd agTtt ment with the Russian producersee S Givens Stealing an Idea from Aluminum TIrc DiJIIlII1 SdClltistuly 242001 In addition Alcoa and other American aluminum producers were sued tor conspiring to restrain trade but the case was dismissed ill collmsec J Davidow Rules for the AntitrustTrade Interface Millcr ChM3lier Septem ber 29 1999 at wwwablondif tcrcomlibraryartideasppubid NOTFS 1 JhJJ2ll1 gwupid 12 For an tditorial expressing an opinion SlllIiltr du htrt st lm1 CllIlIlfn February 22 1994 rh sr dots nO tnd hre in April 2000 news emerged about Ill Russi1II oligarchs Boris Berezovsky and Roman Abramo idl n SIKCsstlllly forming a private monopoly to control 7580 tdlt Russi1lI ytJrly production crating tht second largest aluminum olllpJny in h world after Alcoa See Russian Aluminum Czars Joining Forees 71e Sytilley Moming Herald April 19 2000 and A Mitr Jnd Y ZarJkhovich Promises Promises Time Europe 15520 iby n 2000 See also R Behar Capitalism in a Cold Climate For tlll June 2000 Despite accounts to the contrary Boris Berezovsky whemntly denies any wrongdoing in relation to Russia CHAPTER 7 I In the ell York Times Kolodko wrote But there was another equally important facet of our success Poland did not look to the international tinancial communiry for approval Instead we wanted Polish citizens to go along with these reforms So salaries and pensions were paid and adjusted for inflation There were unemployment benefits We respected our own sociery while doing tough negotiating with international investors and financial institutions George W Kolodko Russia Should Put Its People First New York Times July 7 1998 2 Polalld also showed that one could maintain state ownership of the assets and not only prevent asset stripping but actually increase productiviry In the West the largest gains in productiviry were associated not with privatization but with corporatization ie imposing hard budget con straints and commercial practices on enterprises while they still remained stateowned See J Vickers and G Yarrow Privatization An Economic AnalYSis Cambridge MA MIT Press 1988 chapter 2 and J Vickers and G Yarrow Economic Perspectives on Privatization Jour nal of Economic Perspectives 52 Spring 1991 pp 11132 3 Chinas net private capital inflows were S8 billion in 1990 By 1999 Chinas capital inflows had soared to 41 billion more than ten times the amount of money attracted by Russia in that same year World Bank World Development Indicators 2001 4 See eg World Bank World Development Report 1996 From Plan to Mar ket London and New York Oxford University PressJune 1996 NOTES 5 The best defense that the radical reformers in Russia hav of their fail ure is this we do not know the cowllerfactual what might otherwise have been The options available in these other countries were simply not available By the time the radical reformers had taken over a centr3lly guided reform like the one in China was no longer posMble becaus central power in Russia had collapsed The takeover of the enterprises by the Iomenklatura the existing managers which occurred in nun cases anyway was the alternative On the conrrary I would argue that a recognition of these problems made it even more important not to con duct the privatization and liberalization srrategy in the way that it was done The breakup of central power should have made it easier and more important to break up the large national enterprises especially in natural resources into competing parts leading to greater diffusion of economic power It made it more imperative to ensure that a ooong tax system was in place before the sources of revenue generation were given away Chinas reforms involved enormous devolution of eco nomic decision making The alternative srrategies in the end might not have worked but it is hard to believe that matters could have ruined out worse CHAPTER 8 1 See S Fischer On the Need for an International Lender of Last Resort journal of Economic PcrspcctilJes 13 1999 pp 85104 Fischer like many others advocating the lender of last resort view makes an analogy between the role of a central bank within a country and the role of the Fund among countries But the analogy is deceptive A lender of last resort is required domestically because of the firstcome firstserved basis of deposits which contribute to the possibility of runssee D Diamond and P Dibvig Bank Runs Deposit Insurance and Liquidity jorrnal of Political Economy 91 1983 pp 40119 And even then it does not suffice to avoid runs as the elllerience in the United States demonsrrates forcefully Only when accompanied by strong banking regulation and deposit insurance does a lender of last resort suffice to fend off runs And no onenot even the most ardent supporters of the J M Fhas advocated that it provides anything analo gous to deposit insurance Moreover the rigidity with which the Fund has implemented many policies makes many countries wary of ceding to it much regulatory authority even if the appropriate domain of reg NOTES ullllry Juthllrity culd be ddilled and even if issues of national sover ei1uy did lIut blnlllle parlll1oum It is worth noting that US regula tury Uhlrities have often argued that wIdesigned policies of tirblrl1lLe lee l riticll part of macroeconomic management while the IJIIF hls typically argued against such forbearance Elsewhere I have Jrgud thlt ill doing so the IMF has often failed to take account of the blSi tallacy of composition in the presence of systemic problems the lbsence of lorbearance may be selfdefeating as each bank unable to raise additional capital calls in its loans leading to more widespread detaults and furthering the economic downturn 2 What I call a superChapter 11 For details see M Miller and J E Stiglitz Bankruptcy Protection Against Macroeconomic Shocks The Case tor a Super Chapter 11 World Bank Conference on Capital Flows Financial Crises and Policies April 151999 J While it is hard to blame the crisis on lack of transparency lack of trans pdrenc did have its cost Once the crisis had occurred the lack of inlormation meant that creditors withdrew their funds from all borrow ers regardless of quality Creditors simply did not have the information with which to distinguish between good and bad borrowers CHAPTER 9 I The term corporate governance refers to the laws that determine the rights of shareholders including minority shareholders With weak corporate governance management may effectively steal from shareholders and majority shareholders from minority shareholders 2 World Bank studies including those coauthored by my predecessor as chief economist at the World Bank Michael Bruno formerly head of Israels Central Bank helped provide the empirical validation of this perspctive See Michael Bruno and W Easterly Inflation Crises and Longrun Growth Journal of Monetary Economics 41 February 1998 pp326 3 Economist have analyzed what are the attributes of such goods they are good lor which the marginal costs of supplying the goods to an additional individual are small or zero and for which the costs of excluding them from the benefits are large 4 Economists have analyzed deeply why such markets may not exist eg as a result of problems of information imperfections information asym metries called adverse seiection and moral hazard NOTES 5 t was ironic that the calls for transparency were coming from the lMF long criticized for its own lack of openns and the US Treaury the most secretive agency of the US government where iaW thai eveo the White House often had trouble extracting information about wIw they were up to 6 The perception in some quarters is that those imide me country can decide on such issues as when the school year will begin and end 7 The MFs position of institutional infallibility makes these changes in position particularly difficult In this case senior people could seemingly claim trying to keep a straight face that they had been warning of the risks associated with capital market liberalization for a long time The assertion is at best disingenuous and itself undennines the credibility of the institution f they were aware of these risks it makes their policy stances even more unforgivable But to those who were subjected to their pressure these concerns were at most minor caveats matters to think about later what they were told was to proceed and to proceed rapidly with liberalization 8 As we noted in chapter 8 the multiple objectivesand the relUctance to discuss openly the tacit change in the mandate to reRect the interests of the financial communityled to many instances of inteUectuai inco herence this in turn made coming up with coherent reforms more dif ficult 9 As its name indicates a contingent credit line provides credit automati cally in certain contingencies those associated with a crisis 10 There were more profound problems While a contingent credit line could make sure that some new funds were made available in the pres ence of a crisis it could not prevent other shortterm loans from not being rolled over and the amount of exposure that the banks would be willing to take would presumably take into account the new loans that would be made under the contingent credit line facility Thus there W2S a concern that the net supply of funds available in the eVlnt of a crisis might not be affected that much II These provisions allow a creditor to demand payment under certain cir cUl11stancesgenerally precisely the circumstances in which other creditors are puUing back their money 12 n Europe a great deal of attention has focused on one particular taX proposal the socalled 1bin Taxon crossborder financial transac tions See for instance H Williamson Kohler Says IMF WiD Look Again at Tobin Tax Fillaruial jlllr September 102001 There is now a Nons In kh I hrrJUn JnJlYling th tax thoretically and empirically For In JOUIH 01 rhis htrature see th Web site wwwceedweborg ilr llbllllhtm Intrlsringly evn the former treasury secretary wrote 111 lrui thJr ollid bl interpreted as supporting the principles under Iill rh rJXl H Summers and V P Summers When Financial MJrkrs Work Too Well A Cautious Case for a Securities Transactions TJxJIIoIl 4 FitllmciJi Services Research 3 1989 pp 26186 But there nnu1I1 signiticant implementation problems especially in a world in whih the tax is not imposd universally and in which derivatives and other complicated tinancial instruments have become prevalent See Jiso J E Stiglitz Using Tax Policy to Curb Speculative ShortTerm Trading jmmal 1 Fitlancial Services Research 323 December 1989 pp Illl15 For the original proposal see J Tobin A Proposal for Inter nJtiona1 Monetary Reform Eastern Economic Journal 4 1978 pp 1535 and B Eichengreen J Tobin and C Wyplosz Two Cases for Sand in the Wheels oflnternational Finance EconomicJournall0S May 15 pp 16272 In addition see the collection of essays in M ul Haq I Kaul and I Grunberg eds TIle Tobitl Tax Coping with Financial Volatil ity London and New York Oxford University Press 1996 3 This reform is receiving increasing attention The Canadian govern ment partly as an outgrowth of its chairing the G8 and the G22 in 20012002 is holding a major conference focusing on such changes The IMFs discussion of bankruptcies and standstills is seen by some as a preemptive move in anticipation of initiatives by Canada and others 14 As we saw opening up a country to foreign banks may not lead to more lending especially to small and mediumsized domestic enterprises Countries need to impose requirements similar to those in Americas Community Reinvestment Act to ensure that as they open their mar ket up their small businesses are not starved of capital 15 The debt crisis hit Argentina in 1981 Chile and Mexico in 1982 and Brazil in 1983 Output growth remained very slow throughout the remainder of the decade 16 The reaessment as we have noted actually began earlier under pres sure from the Japanese and was reflected in the Banks publication in 193 of the landmark study The East Asian Miracle Economic Growth and Public Policy The changes in thinking were reflected in the annual reports on development called the World Development Report For instance the 1997 report reexamined the role of the state the 1998 report focused on knowledge including the importance of technology and information including the imperfections of markets associated Nons with imperfect information the 1999 and 2001 repom empha the role of institutions not just policies and the 2000 report took 3 much broader perspective on poverty 17 Not surprisingly the Bank still has not taken as seriously it should the theoretical and empirical critiques of trade liberalization uch as dut provided by E Rodriguez and D Rodrik Trade Policy and Economic Growth A Skeptics Guide to the CrossNatioll2l Evidence Ben Bernanke and Kenneth S Rogoff cds in MacroeiOlWma Annual 2000 Cambridge MA MIT Press for NBER 2001 Whatever the intellec tual merits of that position it runs counter to the official position of the United States and other G7 governments that trade is good 18 There are many dimensions to this transformationincluding the acceptance of change recognizing that things do not have be done in the way they have been done for generations of the basic tenets of sci ence and the scientific way of thinking of the willingness to accept me risks that are necessary for entrepreneurship I am convinced that such changes under the right circumstances can occur in a relatie1y short span of time For a more extensive articulation of this view of devd opment as transformation see J E Stiglitz Towards a New Paradigm for Development Strategies Policies and Processes 9th Raul Prebisch Lecture delivered at the Palais des Nations Geneva UNCTAD 0cto ber 19 1998 19 I n several of the countries debt service is more than a quarter of exports in a couple it is almost half 20 Such debts are sometimes referred to as odious debts 21 An important exception is Jim Wolfensohn who has pushed cultural initiatives at the World Bank 22 Recently developing countries have been increasingly pushed to com ply with st3IHbrds eg of banking that they have played little part in setting Indeed this is often heralded as one of tile few achievements of the efforts to reform the global economic architecture Whatever good they may do to improve global economic stability the way thry have been brought about has engendered enormous resentment in the developing world INDEX Page numbers beginning with 253 refer to notes Addis Ababa 26 35 Africa 9 23 24 39 49 77 87143227 effect of Uruguay Round on61245 worsening conditions in 56 7576 see also specific coulllries aggregate demand 1112 105 III 190 196 agriculrure 5 717545561758399 140184247 Chinas reforms in 182 Aguas Argentinas 71 Ahmad Mohamed Don 124 AIDS 6 8 20 37 40 80 223 245 Alcoa 17375 aluminum cartel 172 1737624445 26162 American Revolution 163 Amin Idi 40 analytic propositions 219 animal spirits investor moods as 100 annuities markets privole 55 antitrust laws 74 174 175 APEC AsiaPacific Economic Coopel2 tion 71 90 Argentina277198121150219231 235237238240 banking industry in 69 2001 economic coUapse of 186970 79129131 Arrow Kenneth 182 Article 4 consultations 48 232 Asia 4 7 218 see ao East Asian financial criSIS of 1997 specific counlrirs Asian Development Bank 1011 Asian model 1011 Asian Monetary Fund 112 113 AsiaPacific Economic Cooperation APEC 71 90 asset stripping 144 220 asymmetric information xi 85 austerity prognrns of IMF 53 5 777884 Australia 1 19 baht coUapse of 89 93 9495 bailins 2035 bailouts less reliance 0023738 banana quotas 34 Bangladesh xvi Bank of BotnYana 37 bankruptcy x 114117139181250 251 Chapter 11 provisions for 13031213 high inrerestl2tes and xii 98 109110 112120132 IMF and 2013 2089 237 263 reform of 237 266 banks 71024596781181204212 capital market deregulation and 115 in East Asian financial crisis 94 95 98 11011517123127128 12930213 in Ethiopia 3031 32 failu of 11415 global Iocal 31 6970 in Kenya 32 improved regultion of 23R 2611 Russian loansforshre program and 15960 INDEX pJuks aitlutJ Rl1ilJ1 llllrkC frJl1Siiln Jwi tn I SllSI 172251 ill SWlt Ullhll IJ tt JLll 1CI1rJ bJnks plfCCr l52 BduIll ISJ Berlin Will tJl ot 11 133 135 llehesJJ Md banking system ot 31 Bhuun xvi BI bes iniornution available 174 BinglIlun Ann 175 bioplracy devdoping world and 246 bhk economy 151 Bolivia 186170250 Bolsheiks 16365 bonru 1110101236 BOISma 3639 77 87 IMF and 37 38 oUlSide advisers used by 37 3839 political and economic conditions in 363738 Bourdieu Pierre x Brazil 8 94 98108121131150198 203235 Bretton Wooru conference 1944 II 15 briberization privatization as 58 Brown Ron 70 Bruno Michael 49 bubble 101 198201 Buchanan Pal 60 Bucharec 204 budgelS balancing of 614275377 1067189 Bulgaria emigration from 154 Bush George Hw administration 103 176177 Bush George w administration 168 CamdessusMiche14D41119 123129 Canada 4 15n 174234 capital adequacy ratio 116 capital allocation 128 capital conrrols 17659310112425 131 capital fligh 96100124260 capitalism xii 5 II 133 160 195208 21321724950 capital market liberalization 15 1644 465362677487155208 216222235 arguments for 64 67 in China 6364 6667 92 description of 10 6566 East Asian flllancial crisis and 8990 929394104105128 in Ethiopia 3034 risks and consequences of 1859 64656773828399104 2352363725026465 in South Korea 024256 cartels 24445 aluminum 172 17376 Cayman Islands financial secrecy in 228 central banks 216 European 45 G22 and 119 IMFs relationship with 12 192437 205225254263 of Malaysia 123 124 of Russia 150 159 172 secrecy of 228 of South Korea 45 or uS see Federal Reserve Bank US window guidance by 70 chain stores 68 Chang Mai Initiative 113 Chapter 11 bankruptcy 13031 263 Chemical Bank 31 Chenery Hollis 13 Chernomyrdin Viktor 168 Chile 18 114 184 China Imperial Opium Wars and 62 China Peoples Republic of 79112218 capital market liberalization in 6364 666792 Communist Revolution in 134 137 Culrural Revolution in 163 economic crisis avoided by 12526 foreign investment in 6667 7273 183262 gross domestic product of 6 income in 63181 market transition of xxi 6 90 136371801818518687214 poliical reform in 18384 INDIX poverty reduction in xvi 112 181112 privatization in 182 185 trade liberalization of 60 623 WTO membership of 63 266 Chi rae Jacques 4 chlorofluorocarbons 223 Chubais Anatoly 170 193 Citibank 1931 Citigroup 19208 Clausen William 13 Clinton Bill ix 7n 7193109171 Clinton administration xiii 33 49 62 69 7880102149166167171 176191 see lso Council of Economic Advisers Coase Ronald H 164260 Coases theorem 164 260 coca cocaine 61 CocaCola 68 cold war 25 98 Colombia 150 colonial eraII1724394D41 command and control system 137 182 Commerce Department US 62 70 174 176 communication costs 21 communism 1725133134136143 189 economic extremes avoided by 154 failure of 14142 transition from see market economy transition to Communistsformer 136 1678 261 Community Reinvestment Act CRA 197770 comparative advanuge trade liberalization and59 competition 74139172182 cartels and 17476 competitive markets needed for xi 56 8715556 between multinational and local brui nesses 689 102 privatization and xi 56 87 15556 competitive pluralism 10 computer chip 94 118 127 conditionality 14 435296 definition of 9 44 fadure of 44 4147 52 political conuol in 4445 47 shift to selectivity from 4950 24243 lafgets in 4344 confdenceI089111146IW200 Congo Republic 37 244 Congress US 19 5152 1 Urn 178 256 conspiracy cheori xv 129 171 Constirution Us 106 132 conugionlMF and 19200 contracts incomplete 85 corporate reslrUcruring 11718127 corruption 37 4047 75127138 18586213 in crony and mafia capitiliun 127 133 16117576178188200220 in foreign investment 70 7172 in privarization 58 in Russias market traruition 133 138 14814915758161166168 170 175 188200 cot recovery programs 20 5 I Cote dlvoire 56 7 I Council of Economic Advisers xi 80 1023104166177245 author as member and chairman of ix x xiii 6 25 34102 lOS 106 219228 composition and function of x Justice Department Antitrwt Division and 174 175 creative detruction 183 creditxi6970l141511617204 209 credit lines contingent 235 265 crime rateS 48 57 crisis response improvements in 23940 crony capiWism 127 133 17576 178 188 currency Dutch disease and 72 Stf Iso exchange rat currency peculation 19899 in East Asian financial crisis 89 93 9496 srf 1Jo hot money Cyprus 150 INDBX Czch RpubliL 156 159 1110 1111 11154111 11111 owoo 94 Oasgupu Ilrtha IIJ 0 Bn diamond cartL 39 dbt 1211 132 151221236 utin Amrican crisis in 239 266 debt equity ratios 110 debt forgiveness or reductionS 8 9 43 24344250267 dbtor prisons 202 driOnstation 224 democraq democratic processes xv 9 2025263913132219 corruptions effects on 72 CO nomic reform and 18H4 globalization and24748 IMF policies undermining of 96 170 247 in Russia 133 136167170192 19394 Democratic Party 69 8016724546 depressions xii 1112 123218 in Indonesia77 11213 see also Great Depression deregulation 72 in savings and loans dbacle 65 102 11415 Ste also capical market liberalization development reason for 25152 development assistance reform World Bank and 24144 development round 215 226 245 diamonds 373839 dictatonhip ofche prolecariat 136 digital ccess gap 56 Doha 215 226 245 250 drug compani R 24546 dual economies 72 Duma 136 167 170 dumping 17275 176 Dutch disease 72 East Africa 3940 East Ma 22 46 60 76 82 87 R8 21R 241248 economic growth in 9092 94 savings rates in 67 73 79 92 99 Set also spifo countrieJ East Asia Miracle 90 91 255 East Asian fmancial crisis of 1997 ix xii 618204264818389132 145 178 220 221 233 23536 240250251 alternative responses to 1226 13031 bailout packages in 95 119255 causes of 8990 99 110 129 lMF role in 8990 91 93 9597 981322091322122230 25657 initial Western response to 9293 95981049 interest rates and 93 96 98 104 10913 longterm effects of 12728 patterns followed by 9495 recovery process after 12028 restructuring erron made in 11318 social and political consequences of 11920127 spread of 89 9394 98107123 12829144199200 Treasury Department and 90 91 98104106113129211213 230 East Asian Miee Tho 91 266 Eastern Europe 133 136 142 168 180 214 economic crises causes of99 101 121256 recovery process after 121 22 textbook responses to lOS 125 J also East Asian financial crisis of 1997 Economic Report of che President 80 economics of information x xixii predictions in 187 trickledown 7880 82 208 trickledownplus 80 82 Ecuador 150 203 235 246 educationS 20 51 59 76 79 81 82 85 929798 154218 Enhanced Structural Adjustment Facility ESAF program of IMF 27 environmencal issues xiii 216 21819 22324 INDEX equity110 Erinea26 Ethiopia 35 36 37 39 87 capital market liberalization in 3034 IMF and 2S34 42 political and economic conditions in 262728 World Bank and 27283233 EuropeII1417195562646567 225247 European Union EU 43 204 246 everything but Arms 246 exchange rales IMF and 197992023209 risk mal12gemem and 23839 exil taX 124210 fair market value 173 fair trade law 172 176 fallacy of composition 116 Federal National Mortgage ociation Fannie Mae 55 Federal Reserve Bank US 34 45 49 109 150239 finance ministries 93 216 247 G22 and 119 IMFs relationship with 12 13 1922 2437255 financial market liberalization capital market liberalization financial sector regulation 81 financial system function of 11314 FillMal TImts 106 Finland 211 fiscal policy II definition of 109 Fischer Stan 19 106 113 129205 207ll FongWeng Phak 124 food and fuel subsidies 77 11920216 219 Ford Foundation 37 foreign aid 5 27 2829 30 JJ 98 foreign invesonenl6773 102 124 125 143257 banks and 6970 in China 667 7273183262 corruption and 70 7172 creating environmaJII for 158 W IKJ dawruid to 6873 governmcnll and 7071 19900 levels of 98 ZSS56 rok of 67 7273 FOrlulUl24 France 415n 627071183 Freedom ofloformationAct 196651 229 free market ideology set nwkrt fuoda mentaliun French Revolution 163 French Telecom 71 Friedman Millan 167 fungibility 46 G7 141595131208256 G815n G22119 GaidarYegor 168 17475 Gazprom 168 General Agreemenl on Tadlii and ndc GATT 4 7n 1516 general inteml 21617 General MOIOB 195 Gt1 ThrorJI oj Bmploymmt lnrnrn Mont Tht Keynes 100 Genoa 39 Gerashchenko Viktor 150 Germany 15n 120183217 Ghana 49 girl education of 76 241 global financial crim of 1997 It xii xv 6 5967 spread of 89 9812314420 global financial Item morm of 23341 globalization description of 910 governance and 22427 humanization of xvxvi 22 24752 interesIJ and ideology and 21 international pnblic instiU1iOftl md 22224 main institutions of 10 need for beltlt manlJled1ent of 21415 potential benefiIJ oflx 5 20 214 248 poverty exaba1d byx 214 248 INDEX g1bilizacion lnlltlluJ procests wcr xivx J4 9 244 rclSons tor olluoVersy llt 422 CrJllSpJrelhy Jnd22729 globll wumillg 22J old Goldnun Scru 11 Gospln 168 governnce 1820212222022427 oerrunnt economic role ot xi xii xiii II 13 21 5 55 771 87 91 92102118 I I 21722 22427 IMFs view of 858611819697 remventing of xiii Jiso budgets balancing of grtduilism 111 162 167 in Chinis market transition xxi 183 18118687 m Polands market Ir1nsition 181 18687188 Great Britain 13 15n 406278128 177183 Great Depression xii II IS 163555 59718997 0720249 Greenfield invesonents 5657 greenhouse gases 223 Greenspan Alan 09 growth slr1tegies 8283 haircuts 203 204 Harvard University 13 health issues 22324 hedge funds 150 helium plant 177 Hong Kong 93 94 Hoover Herbert OS 125 hot money 17 198237 capital market liberalization and 656693 definition of 7 effects of sudden withdrawal of7 Hungary lSI 162 186 188 Hussein King of Jordan 77 hyperinflation 53 142 146 18081 220 hypocrisy Western xii xv 67 6062 63 17217879244 Hyundai94 Ibrahim Anwar 123 icc cream manufacturers 68 Iceland 201 illiteracy 40 IMF see International Monetary Fund income globalS income gapS 24 92 India 8 41 62 94 98 125 individual responsibility system 182 185 Indonesia 81820414771219235 in East Asian financial crisis 89 93 96 9798110112117119121 12627244255 effects oflMFs policies on 77 inequality 15355 25960 inflation 6 1424535578104109 122183184 causes of 2799 135 Federal Reserve Bank and 45 hyper 5314214618081220 IMFs concern with 2728344548 728182107161220232 in Russias market transition 142 143 144146154 15657 16970 unemployment and 34 82 217 Wall Streets view of 172 information xvi 4 34 212 access to see transparency asymmetries of xi 85 consequences in lack of xiixiii economics of x xixii imperfect nature of 73 74 information capital 115 institutional infrastructure 138 139 181 183220 international 22224 insurance 8384 inteUectuailobbying 3233 inteUectuai property rights 78 246 interest rates 34 40 43 571212034 207240 in East Asian financial crisis 93 96 98 104109131 1512728129 132 effects of raising ofxii 1213 1736 54596065828498 04 0913120257 market determination of 3132 65 INDEX 171 Russias market transition and 145 14714915657 intergovernmenul institutions 10 International Labor Organization ILO 10 internationallandmines treaty 199745 International Monetary fund IMf xv 3102240159180195213 223244247 accountability of client nations to 30 23233 alternatives to programs of 3639 87 11712226 annual consultations conducted by48 bailin strategy of 2035 bankruptcy and 2013 2089 237 263 before and after 97 Botswana and 37 38 call for overhaul of 89 colonial attitude of 4D41 conditions imposed by 1ft condition ality consultations within client countri recommended for 49 contagion and 199200 contral of 12 1820 developing countries disregard for 37 9720910 in East Asian financial crisis 8990 91 93 9597 98132 20913 2212223025657 ESAf program of 27 Ethiopia and 2534 42 exchange rates and 197992023209 explaining mistakes of 12830 financial communitys interests served by 130 2078 21415 216 230 global financial system reform and 23341 governance and 225 2227 government role as viewed by 8586 headquarters of 23 ill effects brought by policie of xiv 40 4254596069707577 8182899810412028 lack of transparency of 3334 5152 22729234264 L lender oflat resort 205j 263 market fundamentalist ideokJgy of lDi xiiJxiv 1213 1631323536 54555965667211485134 18518719697215220230 231 mission oflID 1718232442 48108919596204215216 233 narrowing the focus of 23233 new agenda of 20613 onesizefitsall approach of 14 34 4748 origin of I 1 politics and 166 poverty exacerbated byxiv 1517 IS 367586 priorities and strategies of 8086 relationship of client countries to 3536 4052 resident representatives of 24 Russias market tranSition and 134 1351411445115616162 16516616716816970185 188190191193194 selfimage of 23031 Special DllIwing Rights and 243 timing of proglllmS of 1 sequenciJlg targets tide of client nations represenrama to 51 tide of head of 40 trade deficits and 200201 210 trade Iibellllization demanded by 62 Treasury Department and 45 80 102 166 US veto por in 12 102 112 226 vid as having failed in its miuion 1518 World Bank and 1314 16 2324 SO 51 International Red Cron 10 Internet 4 56 invirible hand 7374 254 irreversibility 120 Islcmic guerrillas in Philippines xvi 5 Italy 15 Jakarta 71111 Jmican milk marht 5 INDEX Jpoul 15 It 41 4t 02 72 71 JI 103 112111 121 137 1411212217 22520 ltl47 Jb Iln 57540072 IU t7 12 2311 onUn77 Jubilee movCment 9 244 250 usti Dpartmnt US Antitrust Divi sin o 174 175 IUntor Mickey 6263 Kazakhstan 161 Km xi 32 3910 46 47148 kerosn subsidies 77 KeynesJohn Maynard II 3 1638 1001211969719924950 KGBI68 Kissinger Henry A 112 KlausVacla180 k1tocracy 188 Kohler Horst 23435 Kaladka Grzegarz w 181 Korea Rublic of South Korea 42 454654 57n 727981202218 capital market librllizatian in 1024 256 in East Asian financial crisis 89 94 97 10510610910117118120 12627130132209210212 213255 economic growth of 94 102 Korean War 94 Krueger Ann 13 Krugman Paul 124 Kuala Lumpur 119 Kuznets Simon 79 labor market flexibility 84 labor unions 85 221 laissezfaire 74 land reform SOBl 82 87137 large externalities 124237 Latin America 6 7 8 81 89 98104 150154219221239 debt crisis in 239 266 increase in poverty in 79 response to economic problems in 16 121 stagnation and recession in 86 Washington Consensus policies designed for 53 Stt fils sptdJU courunes LninVI 36 leverage I 10 112 Lewis Arthur 79 Lewis Steve 38 liberllizatian 5967 of trade 1617 53 596465 84 92 102 241 266 types of 59 Stt also capital market liberalization life expectancy 4 56 liquidity 1238204 loansfarshare program Russian 15960 165166170191194 Long Term Capital Management ISO 179 Mack Connie 45 McNamara Robert 13 macroeconomics xii 49 5711012526 definition of 1427 IMPs concern with 1427284256 78161 and problems specific to developing countries 3435 macrostability92 mafia capitalism 133 161 175 188200 220 Mahathir bin Mohamed 93120122 123 124 Malaysia 67 7273102210218 in East Asian financial crisis 89 93 10511811912225126127 IMP program avoided by 12223 126 Manifest Destiny 25 Manufacturers Hanover 31 market economy transition to 14 1586 18094214 of China xxi 6 9013637180 1818518687 of Poland 15115618081185 18687188262 of Russia xi 613365180185187 1882575926263 ofTaiwm 137 see also privatization market fundamentalism free market INDEX ideology 1458102114138 189219221 as lMF ideology xii xiiixiv 1213 16 313235365455596566 72848513418518719697 215220230231 invisible hand and 7374 254 replacement analysis for 25051 market imperfections xi 12 13 1634 5573196198206218 marketing boards 7576 market reform Bolshevik approach to 16365 markets marketplace xi xii 249 essential ingredients of 139 governments role in xii xiii II 13 2154557374879192102 1181242172222427 models of21718 overshooting by 198 Marx Karl 217 Marxism 134189 mathematical economics x MallMall revolt 40 media power 16465 Mengisru Haile Mariam 26 27254 Mercedes 15354 Mexico 4 86 96119121255256 middle class 165 erosion of 84 98133154193 Middle East 77 military spending 28 14142 milk importsS Mindanao xvi mining concessions 72 Miyazawa Initiative 113 Moldova 152 167 monetary policy II 14 16 17 monopolies 56 75 96 141 higher prices and 68 Montreal Protocol 1987223 Morocco 20 5455 mortgoges 55 Moscow 153 157 169 multinational corporations 6869 Museveni Yoweri 40 76 National Economic Council NEC 103 175 nationalization 137 National Security Council 90 natural gas 72 neoliberal policia 74 Nepal xvi 83 224 Netherlands 72183 New Deal55 New Deal Democnll 167 New Democraa 80 167 New Economy 48 New York Fedcn1 Reserve Baok 150 New Yok TImtS 230 Nigeria 3798 Nike4 Nobel Prize 79 164 182 nongovernmentl organizatioru NGOs 5455 North American Free Trade Agreement NAFTA4 North Sea 72 Norway 211 Novgorod 158 nuclear proliferation 1 n obMIS privatization and 158 Obote Milton 40 Office of Science and Technology 245 off track 42 oil prices 108 134 145 189 199 oligarchy Russian 134144 146 15 164170188189261 ONeiD Paul 172 173 175226 Opium Wars 41 62 Organization for Economic Cooperation and Development OECD 94 overbloated labor force 57 ozone depletion 223 Pakistan 71 235 Papua New Guine 20 Paris Commune 163 pauperism 78 Pepsi68 Philippines xvi 5 in East Asian financial crisisII9 PinocherAugwlO 184 Poland87 174 market rransition of 151 lSI 18081 18518687188262 INDEX p lny Xl 12 4 2 t 7 21 y 111 Chill XVI 12 1I11 l2 1lbJlilUIII1 xJ rbJcion ot LX 214 21l b 11F lIKrn 115215240 IMFs urbnon ot xiv IS 17 IH Jo75 inLltJs ill 56 21 25 61 97134 167ISHI2253 proipcory assessments of 5051 231261 problems imendted with 224 reduction ot 82 9192 18182 248 III Russia 134 15355 18182 259J0 trikledown economics and 7880 C10US cycles and 83 JS World Bank concern 2324 195 215224 Prague 9 59180 price discovery 236 prices aluminum cartel and 175 barter and 152 marketing boards and 7576 monopolies and 68 of oil 08 134 145 189 199 in Russias market transition 142 III Soviet economy 13839 140 cwotier 18283 privatization 53 5459 7475 92 16364180190221 argument for 54 220 III China 182 185 effects of hasty implementation of 55 55758597318118586 220 IMFs PUlUlt of 5456 73 as part of comprehensive program 5758 regulation and 56 in Russias market cransition 58 14j I 143 14445 153 15760165166 in US 17778 productivity 69 property rights 58 73 74139164 imdlecrua1 78 24546 prostitution 80 protectionism 67 13 1517 1953 61627017278245 aluminum cartel and 172 17376 uranium and 17678 purchasing power 181 Putin Vlaclimir 168 Qatar 215 Reagan Ronald 1365 Reagan administration lIS 177 Reagan era 114 real estate 101 198211212 realpolilik 51112192 receions xii 38 123 137218 balanced budgets and 1067 capital flight in 100 causes of 54 65 77 99 in East Asia 104 107 109 112 120 12627 in Latin America 86 ISO 250 longterm effects of 122 of199165115 regulation of financial sector 81 privatization and 56 see also deregulation rents resources and 72 rent seeking 13 58 142 reserves 29 30 38 East Asian fmancial crisis and 9495 108210 form and function of 28 66 resource allocation 128 242 resources 72 82 83 98 143 145 149192 stripping of 144 right to know 13132 229 ringgit exchange rates and 123 riots xiv 3 20 36 47 77119 risk management 23839 river blindness 23 24 223 robber barons 160 Romania 2035 235 Rubin Robert 19 103 124 129 175 208 ruble 134 135 14548 149 16970 189198202 INDEX rule oflaw 84138260 rural credit schemes xvi Rwsia ix 47 899698108131132 13365198203212235 aluminum rade and 173762612 barer in 152 challenges and opportunities of mark transition in 13642 corruption in 133 138 148 149 15758161166168170175 188200220 currency devaluation in 135 14548 149 lSI 16970 189259 democracy and 133 136 167 170 19219394 differences in instirutional functions in 138 former Communists in 136 16 78 261 in G8 15n gross domestic product of 6143144 15253 inequality in 1535525960 loansforshare program in 15960 165166170191194 marke rransition of xi 6 13365 180 185187188 25759 2623 misguided market transition policies in 1555 1998 crisis in 14548 166 189 202 oligarchy in 134 144 146 15960 164170188189261 optimistic vs pessimistic views of 134 parliament of 136167170 poverty in 134 15355 IHI82 2590 privatization in 58 14041 143 14445 153 15760 165 166 recommendations for 18892 reform story in 14251 rescue package for 14849 shock therapy economic reform approach taken in 141 142 1585916216667 un 1117 social transformation in 13536 16062 uranium deal between US and 17678 US interests and 17178 Wrn dvscn and 13435 136 1411444516216516679 1118 Russia Imperial 62 Russian Revolution 33 1336 143 163 safety nelS 17 55 60 65 73 n 8 140 183239 St Petersburg 158 Sarnsung 94 savings ond loon debacle 65102 11415 savings raes comparison of 67 in EasAsia 67 73 79 92 99 scarcity IMF refortns ond 36 Seattle Wash 3 9 59 61 244 selectivity 4950 24243 selfemployment 99 selffinance 32 Seoul45 Sepember II terrorist attacks xv 22lI 236 sequencing 7378 87141 consequences in ignoring of 7475 definition of 1874 social rransformation ond778 Jte auo gradualism shock therapy services rrade in 61 Severino Jean Michel 112 sharecropping 81 share ownership 128 139 Sharif NaW2Z 71 Shleifer Andrei 16364 shock therapy 18081 in Russias market transition xi 141 14215859162 16H7 183 187 Sierra Leone 37 Singapore 67 727102 120 Slovakia lSI Slovenia lSI 188 smaIlpux 223 SmithAdam 7374 217 219 254 social cpital 1612 172 185 social cunrract 57 78209 Social Democrao 167 oeilim6 163 11 justice 218 INDtiX SoiJ SCuriy 22 t lKIJ iCUflt sysCms 55 SOI1I rllbtllrmltioll 7tr7S 242 26667 olill wdtJrt 217 st1 drmk TlllIlutJunrs 68 Soms CCllCgC t 11 Suuth riJ Republi 01 35 39 SoutheJst il 145 Siec Unin 14 1Jl39 110 143 154 217 Slt JiSl Russia Mh fiJnner membm of Spelll Dnwing Rights SDRs 243 Spumlk152 suhili b II 1523348092101102 115125184 Ill 195211223 sundlrd oiliing 4 92142153217 248 SUte DepJrmlOnt US 63 175 strucrunl adjustment loans 14 18 253 detininon of 3 strucrunl rdorms 96 1 1318 Suez Lyonnaise 71 SuhJIto Mohammed 71127213 Summer Lawrence 90 103 11213 129170236 SwJhili40 Sweden 2818321121718234 Siueriand 150 swords to plohares agreement 176 Taiwan 51 79 81120137218 T lbot Strobe 166 Tanzama40 tJrgets 4311 unffi 13 15165370 os II 12272969728081 lOS 10612419123726566 telegraph line fim 21 terms of trade 7 error ism fmancing of 228 Texas 177 Thailand 182080 198200201203 212235 23H 239 255 constirution of 13132 in East Asian financial crisis 8993 995979899 100101 106 10811111213117121125 12627209210213255 Thatcher Margaret 1365 177 Third WorldS 13 Tientsin Treaty of 1858 62 Tobin tax 26566 Toys R Us 103 ncr on Molary Riform A Keynes249 tradeS 7412516679216 a1unainum cartel and 172 17376 26162 balancing the agenda of24446 beggarmyneighbor policies in IS 107108210 beggarmyself policies in1069210 benefits of 4 dumping and 17275 176 inequities in xv 34 67 8 1617 60626317224445 international agreements on ix 4 78 1516616364215226245 250 liberalization of 1617 53 5964 65 8492102241266 in services 61 uranium and 17678 see aso protectionism trade deficits 14200201210 trade nainistries 247 WTO and 1922225 Trade Representatives US 6263 17677 transparency 9610313132234 consequences in lack of 5152 definition of x East Asian fmancial crisis and21112 23536264 IMFs lack of 3334 5152 importance of xiixiii 22729 transportation costs 21 75 Travelers 31 Treasury Department US xii 16 6364112177178208212 235256 East Asian fmancial crisis role of 90 9198104106113129211 213230 IMF and 45 80102 166 politics and 16667 Russia and 141 165167 168 16970 171188 World Bank and 80 INDEX aliI Treasury bills Ethiopian 31 US 28 66 6914647 rrickledown economics 7980 82 208 trickledownplus economics 80 82 Uganda 40 76 87 Ullll 40 ujama 40 Ukraine 152235 unemploymentxiiil1I2I5242781 114121219232240249 causes ofxixii1718 73 778485 87 East Asian financial crisis and 97 inllation and 34 82 217 privatization and 56 in Russias market rransition 146 social costs of5657 in standard competitive model 35 rrade liberalization and 59 60 Wall Srreets disregard for 172 unemployment insurance 55 57 60 838499217 unfair fair trade laws 172 176 U nilever 68 United Kingdom Stf Great Britain United Nations UN 10 12223 United Nations Conference on Trade and Development UNCTAD 10 United Nations Development Program 10 United Nations Monetary and Financial Bretton Woods Conference 1944 II 15 United Nations Securiry Council 15n United States Chinas capital market liberalization demanded by 6364 cold war mentaliry of 2425 economy of 45 4849 78109 11415120128137255256 in G7 15 IMF advice ignored by 45 4849 IMF veto power held by 12 102 112 226 market modd in 21718 nineteenthcenrury growth of 21 protectionist rrade polici of 67 1 616217276245 Rui narkd tramition as of 17178 VIU rate in67 uramum deal becwuD RWi md 17678 World Bank as led by penon om 19 United Stata Enrichment Corporariaa USEC17678 uranium 17678 Uruguay RDund 78 61 63 245 values 21819 247 267 Vietnam 214 ius of Ihr Poor Thr 83 Voleker Paul 239 wages 85 121 Wall Streetxv646994102 121124 129 ISO51 172202207228 WalMan68 Washinbfon Dc 59 Washington Consensus 20 67 8192 155157162213221 alternatives to 8788 91180 1Bl 186 description of 16 5354 effects of 84 8688 market fundamentalist ideology of 7374 social transformation and 7678 trickledown economics and 79110 West Africa 75 Western Europe 31 white mans burden 24 Wilson Charles E 195 window guidance 70 WolfensohnJarnes D 4950 241 women xvi workers rights 10 working conditions18 World Bnk x xi xiii v 3 5 7 R 10 172239434446546113 75777890105 112 123 157 11152042142272302M authors positions with ix 23 19 219 control of 19 devrlopment assistance refilMn and 24144 disclosure tandards at 234 Eat Asia Miracle repon of 91 2M WorlJ HlIlk tlmlttltcJ Eb lJll tiIlJIl1l1 lrlsis Jild l 94 lS221 EthlPI1 md 27 2S J2JJ hthtqUJrteN llt 2J IMfmd JIlo50s1 IlllItlll llt 1 I 224 195215224 11l0thl tlt 2J 14Slls purge ill U Jriul JnJ propcr oanlc of 11 rmJte P0Wef dem encouraged by 71 Russils mukcc cnnsitian and 145 18 19 150 15152 153 170 188 selectivity lnd 950 StrllCrunl issllcS as concern at 14 T reSuty Department and 80 World Development Report of 83 266 World Development Report 83 266 World Health Organization WHO 10 23223 World Trade Organization WTO 10 2262214 balancing the trade agenda and 24446 China admitted to 63 226 establishment of7 151663 governance and 22526 protests at meetings of 3 trade interests served by 216 transparency and 22728 World War II II 12 1640 133 143249 Yeltsin Boris 134 136 156 15O 165 166168169188191261 Zenawi Meles 26 27 29 Zhu Rongji 63 64 90 ISBN 0393051242 2495 USA 3599 Can T his insiders account of global eco nomic policy making will be hailed as much for its courage and hon esty as for its depth and insight Renowned economist and Nobel laureate Joseph E Stiglitz spent seven years in Washington serving as chairman of President Clintons Council of Economic Advisers and as chief economist for the World Bank Particularly concerned with the plight of the developing nations he became increasingly disillusioned as he saw the International Monetary Fund and other major institutions put the interests of Wall Street and the financial community ahead of the poorer nations Stiglitz had a ringside seat for most of the major economic events of the last decade including the Asian economic crisis and the transition of the former Soviet economies as well as the administration of development programs throughout the world Repeatedly he saw policy makers wedded to outdated economic models and using Washington Consensus doctrines based on them to design policies that had disastrously bad results He also discov ered within the major institutions of global ization a damaging desire for secrecy that exacerbates mistakes at the same time as it inhibits positive change This book recounts Stiglitzs experi ences opening a window on previously unseen aspects of global economic policy It is designed to provoke a healthy debate and will succeed in this goal even as it shows us in poignant terms why developing nations feel the economic deck is stacked against them There are few people better positioned than 1 11 r Stlrt to weigh in on the debate over globalization A leading academic econ omist whose work has dealt extensively with growth and development in the Third World he has also seen global economic policy making firsthand as a cabinet member in the Clinton administration and chairman of the Council of Economic Advisers and as senior vice president and chief economist of the World Bank Stiglitz shared the 2001 Nobel Prize in Economic Science and is currently professor of economics at Columbia University AC 1 01 lr4 A O JrMfT NtOTOGRl R ll ON AlfltfOR f1I0TOQ4H fll ti S Ntlll lIJBr fttJI SCoot fJINlrn IN THI UNlTrO lT or nt