Current IMF/WB Controversies
|Washington Post October 7, 1998||The president of the World Bank delivered an impassioned call yesterday
for devoting more attention and money to the "human crisis" stemming from
the turmoil besetting developing countries, warning that an excessive focus
on "sound budgets" and "technocratic fixes" would lead to even more economic
instability in the long run.
James D. Wolfensohn's remarks, which came in a speech to the annual meeting of the World Bank and its sister institution, the International Monetary Fund, constituted thinly veiled criticism of the IMF. The criticism highlighted a growing rift between the two institutions that stems from the view of many bank staffers, notably chief economist Joseph Stiglitz, that the fund has mishandled the global crisis by requiring financially strapped countries to adopt painful austerity measures.
Although "appropriate" economic policies are necessary, Wolfensohn said, "we have learned that when we ask governments to take the painful steps to put their economies in order we can create enormous tension."
"When we redress budget imbalances," he continued, "we must recognize that programs to keep children in school may be lost, that programs to ensure health care for the poorest may be lost, that small and medium enterprises, which provide income to their owners and employment to many, may be starved of credit, and fail."
The Australian-born Wolfensohn cited "dark, searing images of desperation, hopelessness and decline" that he had seen as a result of the crisis: "The mother in Mindanao [the Philippines], pulling her child out of school, haunted by the fear that he will never return. The family in Korea, with a mid-size scrap metal business, made destitute through lack of credit. The father in Jakarta, paying a money lender three times in interest what he can make that day, falling deeper and deeper into debt."
At the core of his argument was a plea that the effort to address the crisis "must go beyond financial stabilization" -- the IMF's prime concern -- to anti-poverty activities of the sort the bank specializes in, to counter an enormous increase in human misery in crisis-stricken countries that threatens to spawn social and political unrest.
And he issued his strongest warning yet that the bank's capital shouldn't be overused to help bolster the IMF's multibillion-dollar bailouts, fretting that "there will be less to lend for our long-term development mission."
The friction between the fund and the bank has become a source of frustration for the Clinton administration, which fears that a public spat could undermine efforts to resolve the crisis. Some Wolfensohn critics contend that his pique stems from envy of the IMF's crisis management role, which has overshadowed the bank. On Monday, Treasury Secretary Robert E. Rubin admonished the fund and the bank to "put aside institutional rivalries unbefitting public institutions with the same shareholders."
In a bow toward harmony, Wolfensohn said he would "like to pay tribute to the work that the fund has done in a year that has been characterized by great turmoil," and he referred to Michel Camdessus, the IMF's managing director, as "my colleague and friend."
But in a barbed comment, he warned against letting development needs go unmet, and failing to counter an alarming rise in poverty, while the international community devotes its energies to the creation of a "new architecture" for international finance -- that is, a new system for regulating the vast flows of capital that have both helped and destabilized many countries. This is -- a high priority for both the IMF and the Clinton administration.
"We may build a new international financial architecture. But it will be a house built on sand," Wolfensohn declared, if it is done without adequate attention to meeting social needs.
Since the global financial crisis erupted in Thailand in July 1997, the bank-- traditionally a lender for projects to promote education, health, nutrition and infrastructure-building -- has made about two-fifths of its loans for crisis-fighting purposes to countries such as South Korea and Indonesia. With the IMF's coffers badly depleted, the United States and other major industrialized countries recently called on the bank to provide even more emergency loans -- and although Wolfensohn has agreed, he made clear yesterday that he has strong reservations.
"There are trade-offs that we cannot ignore," he said. "New demands made on us will require a very careful assessment of possible needs for new resources" -- a hint that if the bank is pushed too far it will ask its shareholder countries to provide more capital, which would be politically unpopular on Capitol Hill.
Camdessus, who also addressed the IMF-World Bank meetings, used some of his bleakest rhetoric to date in assessing the crisis. "We are speaking not just of countries in crisis, but of a system in crisis, a system not yet sufficiently adapted to the opportunities and risks of globalization," he said.
He acknowledged: "We did not anticipate the strength of this virus, which has struck far and wide -- for instance, attacking Latin America because Russia ran into trouble."
(October 2, 1998)
|The IMF has been attacked for its handling of the world’s economic
and financial troubles. Here its deputy managing director, Stanley Fischer,
WHEN finance ministers and central-bank governors gather in Washington this weekend for the annual meetings of the IMF and the World Bank, the global economic crisis will dominate the agenda. The role of the IMF will come in for close examination. Three issues will feature prominently: the design of IMF-supported programmes in Asia and Russia, the international financial architecture, and how to respond to the immediate crisis without doing further damage to the international system. I consider these in turn.
The IMF programmes in Thailand, Indonesia and South Korea were designed to restore macroeconomic stability and growth, and to remedy structural weaknesses in each country. Early in each programme interest rates had to be raised temporarily to stabilise currencies. That was achieved in South Korea and Thailand, whose currencies are now stable in ranges about 35-40% below pre-crisis levels, with short-term interest rates of around 8-9%, also below pre-crisis levels.
Those who criticised temporary high interest rates fail to see that further depreciation caused by lower rates would have raised the burden of dollar-denominated debts. And while the burdens imposed by higher interest rates were temporary, those created by deeper devaluations would have been permanent.
Thailand embarked on its IMF programme with a current-account deficit
of 8% of GDP. To shrink that, the programme included an increase in the
budget surplus of 3% of GDP. Fiscal contractions suggested for Indonesia
and South Korea were smaller, designed to cover only the expected interest
costs of financial restructuring. Had we known, when the Thai programme
was signed in August 1997, that Asia, including Japan, was heading for
major economic slowdown, less fiscal contraction would have been recommended.
As growth in South Korea, Thailand and Indonesia has slowed, the agreed
fiscal deficit has increased; each country is running a sizeable deficit.
More fiscal expansion, including additional social spending for the poor,
The inclusion of structural measures in these programmes has been criticised. But financial and corporate inefficiencies were at the epicentre of the economic crisis, and have to be dealt with to restore durable growth. Indeed, the priority now should be to accelerate restructuring. Some argue that because this will take a long time to have its effects, it was a mistake to try to move so rapidly. But delay does not make banking problems go away: as seen in Japan, it makes them worse.
If their design was right, why have the IMF programmes worked less well than hoped? There are two answers. First, governments were initially reluctant to implement them. In each of the three countries the programme began to take hold and the currency to stabilise only after a new government took office. And second, the external economic environment has worsened, due especially to the Japanese recession.
The consequences have been most visible in the three countries’ exports. Rapid export growth to the United States helped bring Mexico out of its 1994-95 crisis.This time, the value of exports from Thailand, Indonesia and South Korea to both Europe and America did indeed rise in the year to the second quarter, but the value of their exports to Japan has declined sharply, by about 25%. So exports have not, so far, served as a source of growth.
Where do these countries stand today, a year after the start of their IMF programmes? Remember that the average American recession lasts about a year, and that a year into the Mexican crisis, there was a period of severe jitters. There are important signs of progress in both South Korea and Thailand, in the stabilisation of their currencies, the fall in interest rates and the start of bank and corporate-debt restructuring (see chart 1). Growth could still resume this year, though much depends on the external environment. A year from now each country is likely to be growing again and to have made more progress in structural reform than most of its neighbours—a good basis for sustainable recovery.
The problems in Indonesia are deeper, for the civil unrest that accompanied the end of the Suharto regime led to massive capital flight and a loss of investor confidence that will take time and careful political and economic management to repair. Critics blame the closing of 16 banks at the start of Indonesia’s IMF programme for the collapse of the rupiah and investor confidence. But a careful look at the timing suggests the main culprits were President Suharto’s illness in December, perceptions that the government would not carry out the programme, and excessive creation of liquidity by the central bank.
Indonesia has made some progress in recent months. The rupiah has strengthened, as foreign assistance has started flowing in. But attempts to keep food prices below world levels have failed and rice prices have risen. So the government, with the assistance of the World Bank, is removing general subsidies on food and switching to the provision of subsidised rice and other essentials for the poor. A start has been made in dealing with the linked problems of internal and external corporate debt and the banking sector, though more needs to be done.
Ever since 1992 the IMF has been the world’s main vehicle for assisting Russia and promoting economic reform. This was difficult from the start, for reformers never had full control over economic policy. Nevertheless, the world’s stake in Russian reform was too critical not to make the effort.
Some progress was made: the rouble was stabilised and inflation cut to single figures, and positive growth was recorded in 1997 (see chart 2). On the structural side, privatisation took off. But little was done to restructure the military-industrial complex. And the government, unable to collect enough revenues, was often in arrears on wage and pension payments. The banking system was ill-regulated and heavily exposed to the risks of devaluation. And corruption was a huge problem for the economy and for foreign investors.
The extent of Russia’s fiscal problem is hard to overstate. In 1997, federal tax receipts amounted to 9.7% of GDP, less than $4 billion a month. The budget deficit was 6.9% of GDP. Since 1996 the Russian government has been in a race between its need to collect more taxes and a rising interest bill on its growing debt. This year tax collection improved. In the second quarter, for the first time, federal revenues covered non-interest spending. But falling oil and commodity prices reduced export revenues, interest rates rose, and the government had to roll over $1 billion a week of GKOs, or short-term rouble-denominated debt.
In July the international community faced a hard choice: whether to help Russia try to prevent devaluation. The adverse effects of a devaluation were clear and the reformist Kiriyenko government was making progress on taxes and in other areas. So the decision was made to help, recognising that this was a calculated risk. An official package of $22 billion was assembled, on condition that the Russians undertake major tax reforms; and a voluntary debt restructuring scheme for GKO holders to switch to longer-term dollar obligations was introduced.
The take-up of this offer was, however, small. The programme could still have been viable if GKO holders had been ready to roll over their maturing holdings. But after the Duma rejected two tax measures (though it passed most of the legislation submitted to it), and with doubts about the ability of the government to deliver on policy commitments growing, this did not happen. So the government was faced with an unenviable choice between devaluation, debt restructuring or both. It chose both: the rouble was devalued, the GKO restructuring was imposed unilaterally and a temporary moratorium was put on private debt payments
The contagion following Russia’s actions has been serious. The realisation that Russia was, after all, not too big to fail shook investor confidence—although it is hard to credit that sophisticated investors who had earned an average of 50% a year on GKOs since 1994 really believed these investments were safe. Investors were concerned that other countries might follow suit and unilaterally restructure their debts, although almost all have rejected this.
Much of the contagion was caused by technical factors. Highly leveraged investors have had to realise assets to meet margin calls; investors seeking to move out of emerging markets have sold in the most liquid markets to raise cash. The shocks are now reaching rich-country markets too.
The new Russian government is in an extremely difficult situation. In the short run it may employ a mixture of money printing and more controls. But these approaches will not work; sooner or later a Russian government will have to return to the tasks of stabilising and reforming the economy. At that point the world may be able to re-engage financially. In the meantime we should encourage the authorities to try to agree with creditors how to restructure the GKOs and how to lift the 90-day moratorium on private debt payments.
What went wrong in Russia? Fundamentally, although progress was made over the years, successive governments have been too weak to implement their desired policies. The international community, through the IMF, was right to try to support reform in Russia. And the IMF was right from early on to stress the need to sort out the fiscal mess. Eventually, as a weak internal situation combined with external shocks, the crisis came. Its effects will take time to overcome, but the story of Russian reform is not yet over.
There is no shortage of suggestions for reshaping the international financial system. Among the main ones are plans to strengthen national banking and financial systems; mechanisms to reduce contagion; capital controls; the need to minimise moral hazard; new exchange-rate regimes; and reform of the IMF itself.
Banking weaknesses have either caused or aggravated all the recent crises. Most of these weaknesses were identified in advance by the IMF, but efforts to get countries to take pre-emptive action were not successful. The development of international banking standards, the Basle core principles, is an advance. But although we are starting to strengthen surveillance of banking systems, enforcement mechanisms are lacking. One option among others might be to impose differential provisioning requirements against loans to different countries, depending on the standards met by their banking systems.
The virulence of the recent contagion raises troubling questions about financial markets. Admittedly, contagion is rarely baseless: the markets treat countries in better shape more kindly than those in worse shape. Nonetheless, the technical factors contributing to contagion suggest it has been excessive—and that a way should be found to moderate it. That task will fall mainly to financial regulators, who should ensure greater transparency of positions being taken by investors, and consider when leverage can be excessive.
Fuller information should increase the efficiency of international capital flows. Through its special data dissemination standard, the IMF is prodding countries towards greater transparency. The standard needs strengthening, for instance by providing more timely data on foreign-exchange reserves and complete data on forward transactions by central banks. We also need better information on short-term debt, on which the Bank for International Settlements and others are working.
Malaysia’s decision to impose controls on capital outflows—and support for the idea among some academics—raises the question of whether such controls will once again become widespread. The IMF’s position has long been that capital-account liberalisation should proceed in an orderly way: countries should lift controls on outflows only gradually as the balance of payments strengthens; liberalisation of inflows should start at the long end and move to the short end only as banking and financial systems are strengthened. We have not opposed Chilean-style, market-based measures to regulate capital inflows at the short end, but they must be considered case-by-case (Chile has recently eased its controls).
Yet long experience shows that any short-term benefits that controls on outflows produce will be outweighed by their long-term disadvantages, as they encourage domestic evasion and capital flight, and discourage foreign investors. After Malaysia’s imposition of controls, other Asian countries have firmly rejected them, as has Latin America. We should, even so, recognise that the lure of isolation from the international system will increase unless market turbulence settles.
Next is the issue of moral hazard. It is hard to see evidence of this on the part of policymakers. Most countries do their utmost to avoid going to the IMF. The thornier issues arise on the side of investors. Some point to investors who take excessively risky positions on the back of an IMF safety net. Others are concerned that investors who should have paid a penalty may be bailed out by IMF lending.
These worries should now be mitigated as most investors in Asian countries, and especially investors in Russia who bet on the “moral-hazard play”, have taken very heavy losses. We need to balance concerns over moral hazard against the costs for the system of exacerbating instability by failing to assist countries in need. This issue is closely tied to the question of how to “bail in” the private sector (ie, get it to roll over its debts or provide new money rather than rushing for the exit). The IMF and other groups, including the G22, are working on this high-priority problem.
We also again need to appraise exchange-rate regimes for emerging market countries. The recent crises have all taken place in countries with fixed or semi-fixed exchange rates. Yet several countries, including Argentina, have benefited from a fixed rate; and currency crises also affect countries with flexible rates. The argument has been made that there are really only two stable exchange-rate systems: a freely floating rate, or the adoption (perhaps via a currency board) of another country’s currency. With the expected success of EMU, more currency blocks may develop. But for now, we are in an uncomfortable in-between world in which floating rates are sometimes too volatile and fixed rates sometimes too vulnerable to attack.
Lastly there is the question of reforming the IMF. Many of the changes discussed above will affect its role. There is also general support—including from the management of the IMF—for greater transparency in IMF operations. There has been much progress in recent years, as a visit to our website (www.imf.org) can show. More can be done, but only with the full support of the membership.
It is sometimes argued that the IMF is not accountable. That is not true. It is fully accountable to its membership, through the 24-member executive board that represents the 182 member countries. No loan or other big decision is taken without the board’s approval. Overall IMF policies are set by the 24-member interim committee, made up of finance ministers and central-bank governors, which meets twice a year. Most complaints about accountability are really about transparency. If more details of IMF operations were published, there would be more room for appraisal by outsiders—which would be to the good.
What to do now
While work on the international financial architecture moves ahead to prevent the next crisis, we need urgently to contain the present one. Four steps are needed.
First, as the balance of risks in the international economy has shifted, so should the stance of monetary policy in America and Europe. This week’s cut in American interest rates is welcome news. It is also good that European central bankers have suggested that European rates should converge to the low levels in France and Germany rather than meet in the middle.
Second, Japan’s continuing recession is a major problem, both for Japan and for the rest of the world. Rapid action to sort out its banks, and further fiscal stimulus, would go a long way to help Japan and the rest of Asia recover.
Third, the key to stopping the spread of the crisis is Latin America; and in Latin America it is Brazil. Latin American countries have made genuine progress in structural reforms this decade. They have reacted courageously to recent financial pressures by tightening monetary and fiscal policies. Brazil’s President Cardoso has left no doubt that he will take more fiscal action after the election.
The international financial system, which has sustained the world economy through 50 years of growth and prosperity, needs reform to ensure that this continues—and that the mistakes of the 1930s are not repeated. For the IMF, which has had a central role in the system, to continue to play its part, it needs the support of its membership as it adapts to a changing world economy—and it urgently needs the quota increase.
* Stanley Fischer is first deputy managing director at the International
Monetary Fund. The views expressed in this article are those of the author.
They are not necessarily shared by the International Monetary Fund’s executive
Street Journal October 13, 1998
[Emphases are mine - THD]
|The air is rife with proposals to reform the International Monetary
Fund, increase its funds and create new international agencies to help
guide global financial markets. Indeed, Congress and the Clinton administration
spent much of the last week's budget negotiations fine-tuning the details
of the U.S.'s latest $18 billion IMF subvention package. Such talk is on
a par with the advice to the inebriate that the cure for a hangover is
the hair of the dog that bit him. As George Shultz, William Simon and Walter
Wriston wrote on this page in February: "The IMF is ineffective, unnecessary,
and obsolete. We do not need another IMF. . . . Once the Asian crisis is
over, we should abolish the one we have." Centralized planning works no
better on the global than on the national level.
The IMF was established at Bretton Woods in 1944 to serve one purpose and one purpose only: to supervise the operation of the system of fixed exchange rates also established at Bretton Woods. That system collapsed on Aug. 15, 1971, when President Nixon, as part of a package of economic changes including wage and price ceilings, "closed the gold window"--that is, refused to continue the commitment the U.S. had undertaken at Bretton Woods to buy and sell gold at $35 an ounce. The IMF lost its only function and should have closed shop.
But few things are so permanent as government agencies, including international agencies. The IMF, sitting on a pile of funds, sought and found a new function: serving as an economic consulting agency to countries in trouble--an agency that was unusual in that it offered money instead of charging fees. It found plenty of clients, even though its advice was not always good and, even when good, was not always followed. However, its availability, and the funds it brought, encouraged country after country to continue with unwise and unsustainable policies longer than they otherwise would have or could have. Russia is the latest example. The end result has been more rather than less financial instability.
The Mexican crisis in 1994-95 produced a quantum jump in the scale of the IMF's activity. Mexico, it is said, was "bailed out" by a $50 billion financial aid package from a consortium including the IMF, the U.S., other countries and other international agencies. In reality Mexico was not bailed out. Foreign entities--banks and other financial institutions--that had made dollar loans to Mexico that Mexico could not repay were bailed out. The internal recession that followed the bailout was deep and long; it left the ordinary Mexican citizen facing higher prices for goods and services with a sharply reduced income. That remains true today.
The Mexican bailout helped fuel the East Asian crisis that erupted two years later. It encouraged individuals and financial institutions to lend to and invest in the East Asian countries, drawn by high domestic interest rates and returns on investment, and reassured about currency risk by the belief that the IMF would bail them out if the unexpected happened and the exchange pegs broke. This effect has come to be called "moral hazard," though I regard that as something of a libel. If someone offers you a gift, is it immoral for you to accept it? Similarly, it's hard to blame private lenders for accepting the IMF's implicit offer of insurance against currency risk. However, I do blame the IMF for offering the gift. And I blame the U.S. and other countries that are members of the IMF for allowing taxpayer money to be used to subsidize private banks and other financial institutions.
Seventy-five years ago, John Maynard Keynes pointed out that "if the external price level is unstable, we cannot keep both our own price level and our exchanges stable. And we are compelled to choose." When Keynes wrote, he could take free capital movement for granted. The introduction of exchange controls by Hjalmar Schacht in the 1930s converted Keynes's dilemma into a trilemma. Of the three objectives--free capital movement, a fixed exchange rate, independent domestic monetary policy--any two, but not all three, are viable. We are compelled to choose.
The attempt by South Korea, Thailand, Malaysia and Indonesia to have all three--with the encouragement of the IMF--has produced the external financial crisis that has pummeled those countries and spread concern around the world, just as similar attempts produced financial crises in Britain in 1967, in Chile in the early 1980s, in Mexico in 1995 and in many other cases.
Some economists, notably Paul Krugman and Joseph Stiglitz, have suggested resolving the trilemma by abandoning free capital movement, and Malaysia has followed that course. In my view, that is the worst possible choice. Emerging countries need external capital, and particularly the discipline and knowledge that comes with it, to make the best use of their capacities. Moreover, there is a long history demonstrating that exchange controls are porous and that the attempt to enforce them invariably leads to corruption and an extension of goverment controls, hardly the way to generate healthy growth.
Either of the other alternatives seems to me far superior. One is to fix the exchange rate, by adopting a common or unified currency, as the states of the U.S. and Panama (whose economy is dollarized) have done and as the participants in the Euro propose to do, or by establishing a currency board, as Hong Kong and Argentina have done. The key element of this alternative is that there is only one central bank for the countries using the same currency: the European Central Bank for the Euro countries; the Federal Reserve for the other countries.
Hong Kong and Argentina have retained the option of terminating their currency boards, changing the fixed rate, or introducing central bank features, as the Hong Kong Monetary Authority has done in a limited way. As a result, they are not immune to infection from foreign-exchange crises originating elsewhere. Nonetheless, currency boards have a good record of surviving such crises intact. Those options have not been retained by California or Panama, and will not be retained by the countries that adopt the Euro as their sole currency.
Proponents of fixed exchange rates often fail to recognize that a truly fixed rate is fundamentally different from a pegged one. If Argentina has a balance of payments deficit--if dollar receipts from abroad are less than payments due abroad--the quantity of currency (high-powered or base money) automatically goes down. That brings pressure on the economy to reduce foreign payments and increase foreign receipts. The economy cannot evade the discipline of external transactions; it must adjust. Under the pegged system, by contrast, when Thailand had a balance of payments deficit, the Bank of Thailand did not have to reduce the quantity of high-powered money. It could evade the discipline of external transactions, at least for a time, by drawing on its dollar reserves or borrowing dollars from abroad to finance the deficit.
Such a pegged exchange rate regime is a ticking bomb. It is never easy to know whether a deficit is transitory and will soon be reversed or is a precursor to further deficits. The temptation is always to hope for the best, and avoid any action that would tend to depress the domestic economy. Such a policy can smooth over minor and temporary problems, but it lets minor problems that are not transitory accumulate. When that happens, the minor adjustments in exchange rates that would have cleared up the initial problem will no longer suffice. It now takes a major change. Moreover, at this stage, the direction of any likely change is clear to everyone--in the case of Thailand, a devaluation. A speculator who sold the Thai baht short could at worst lose commissions and interest on his capital since the peg meant that he could cover his short at the same price at which he sold it if the baht was not devalued. On the other hand, a devaluation would bring large profits.
Many of those responsible for the East Asia crises have been unable to resist the temptation to blame speculators for their problems. In fact, their policies gave speculators a nearly one-way bet, and by taking that bet, the speculators conferred not harm but benefits. Would Thailand have benefited from being able to continue its unsustainable policies longer?
Capital controls and unified currencies are two ways out of the trilemma. The remaining option is to let exchange rates be determined in the market predominantly on the basis of private transactions. In a pure form, clean floating, the central bank does not intervene in the market to affect the exchange rate, though it or the government may engage in exchange transactions in the course of its other activities. In practice, dirty floating is more common: The central bank intervenes from time to time to affect the exchange rate but does not announce in advance any specific value that it will seek to maintain. That is the regime currently followed by the U.S., Britain, Japan and many other countries.
Under a floating rate, there cannot be and never has been a foreign exchange crisis, though there may well be internal crises, as in Japan. The reason is simple: Changes in exchange rates absorb the pressures that would otherwise lead to crises in a regime that tried to peg the exchange rate while maintaining domestic monetary independence. The foreign exchange crisis that affected South Korea, Thailand, Malaysia and Indonesia did not spill over to New Zealand or Australia, because those countries had floating exchange rates.
As between the alternatives of a truly fixed exchange rate and a floating exchange rate, which one is preferable depends on the specific characteristics of the country involved. In particular, much depends on whether a given country has a major trading partner with a good record for stable monetary policy, thus providing a desirable currency with which to be linked. However, so long as a country chooses and adheres to one of the two regimes, it will be spared foreign-exchange crises and there will be no role for an international agency to supplement the market. Perhaps that is the reason why the IMF has implicitly favored pegged exchange rates.
The present crisis is not the result of market failure. Rather, it is
the result of governments intervening in or seeking to supersede the market,
both internally via loans, subsidies, or taxes and other handicaps, and
externally via the IMF, the World Bank and other international agencies.
We do not need more powerful government agencies spending still more of
the taxpayers' money, with limited or nonexistent accountability. That
would simply be throwing good money after bad. We need government, both
within the nations and internationally, to get out of the way and let the
market work. The more that people spend or lend their own money, and the
less they spend or lend taxpayer money, the better.
Mr. Friedman is a senior fellow at the Hoover Institution and a winner of the Nobel Prize in Economics.
October 14, 1998
|In Monday's Moneybox piece about the Long Term Capital bailout, I wrote,
somewhat skeptically: "Now, it's possible to explain almost everything
that's happened in the global economy over the last year as evidence not
of the failure of markets but rather of what happens when markets aren't
able to operate freely." On the Wall Street Journal's op-ed page the next
day, Nobel- Prize-winning economist Milton Friedman wrote, much less skeptically,
"The present crisis is not the result of market failure. Rather it is the
result of governments intervening in or seeking to supersede the market."
It's always nice when someone lives up to expectations so perfectly. As for Friedman's piece, it's an unsurprisingly well-stated argument for doing, well, nothing. However well-stated the argument is, though, the piece as a whole is unsatisfying precisely because it suggests that nothing that could happen in the real world could ever change Friedman's mind about anything. Certainly what's happened to the global economy in the last year has at least made plausible the idea that the movement of capital is different from the movement of goods and services, and that the essentially unimpeachable arguments in favor of free trade may not be quite so unimpeachable when applied to capital flows. But Friedman dismisses this argument in a sentence, and never even touches on the impact that speculation has had in devastating emerging-market economies.
Now, of course, it's very difficult to distinguish between capital and goods and services, since goods and services derive their value, in part, from their convertibility into money. And there is a strong case to be made that capital controls are doomed to failure, both because they isolate nations from the global economy by making foreign investment unlikely and because they lend themselves to corruption. But it's simply willful blindness to deny that "hot money" has played an essential role in destabilizing tottering economies and, more importantly, that it has been the key factor keeping those economies from returning to growth. Yes, Thailand, South Korea, Malaysia: These countries were living beyond their means and eventually had to pay their bills. But the contagion that has spread across the emerging markets is hardly evidence of rationality on the part of investors.
Along these lines, the most curious line in Friedman's piece is this: "Emerging markets need external capital, and particularly the discipline and knowledge that comes with it. ..." But what does "discipline" mean here? If it means simply that emerging-market economies will have to listen to external capital's dictates, then it's tautological and trivial. If it means, as Friedman wants it to, "efficiency" and "rationality," then it doesn't seem to describe the past few years very well. The real estate bubble in Hong Kong, the giant factories in South Korea, and the overbuilding in Thailand were all funded by external capital. And how much "knowledge" or "discipline" did Long Term Capital impart to the countries it invested in?
This isn't a call for central planning or for the resurgence of something like Japan's MITI. There's no guarantee that a group of government planners would make any better choices than foreign banks do. In no small part thanks to Milton Friedman, economists have spent the last 20 years reaffirming the virtues of free markets. That's been to much good effect. But the battle against central planning has been won. Now it's time to abandon the pretense that markets always function perfectly when left alone, and to think about the possibility that sometimes doing something is better, and more effective, than doing nothing.