Globalization and Its Discontents Revisited

by Joseph E. Stiglitz

  In addition to the disagreement over how to treat foreign aid, I also became immediately entangled in another IMF-Ethiopia dispute over an early loan repayment. Ethiopia had repaid an American bank loan early, using some of its reserves. The transaction made perfect economic sense. In spite of the quality of the collateral (an airplane), Ethiopia was paying a far higher interest rate on its loan than it was receiving on its reserves. I, too, would have advised them to repay, particularly since in the event that funds would later be required, the government could presumably readily obtain funds using the plane as collateral. The United States and the IMF objected to the early repayment. They objected not to the logic of the strategy, but to the fact that Ethiopia had undertaken this course without IMF approval. But why should a sovereign country ask permission of the IMF for every action which it undertakes? One might have understood if Ethiopia’s action threatened its ability to repay what was owed the IMF; but quite the contrary, because it was a sensible financial decision, it enhanced the country’s ability to repay what was due.2

  For years, the mantra at the 19th Street headquarters of the IMF in Washington had been accountability and judgment by results. The results of Ethiopia’s largely self-determined 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 to report everything that might be germane; not to do so was grounds for suspension of the program, regardless of the reasonableness 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 IMF-Ethiopia relations, concerning Ethiopian financial market liberalization. Good capital markets are the hallmark of capitalism, but nowhere is the disparity between developed and less developed countries greater than in their capital markets. Ethiopia’s entire banking system (measured, for instance, by the size of its assets) is somewhat smaller than that of Bethesda, Maryland, a suburb on the outskirts of Washington with a population of 55,277. The IMF wanted Ethiopia not only to open up its financial markets to Western competition but also to divide its largest bank into several pieces. In a world in which U.S. megafinancial 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 competition. 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 system to foreign competition. It wanted to “strengthen” the financial system by creating an auction market for Ethiopia’s government Treasury bills—a reform, as desirable as it might be in many countries, which was completely out of tune with that country’s state of development. It also wanted Ethiopia to “liberalize” its financial market, that is, allow interest rates to be freely determined by market forces—something 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 providing 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 IMF’s 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 liberalized financial system was an end in itself. Its naive faith in markets made it confident that a liberalized financial system would lower interest rates paid on loans and thereby make more funds available. The IMF was so certain about the correctness of its dogmatic position that it had little interest in looking at actual experiences.

  Ethiopia resisted the IMF’s demand that it “open” its banking system, for good reason. It had seen what happened when one of its East African neighbors gave in to IMF demands. The IMF had insisted on financial market liberalization, believing that competition among banks would lead to lower interest rates. The results were disastrous: the move was followed by the very rapid growth of local and indigenous commercial banks, at a time when the banking legislation and bank supervision were inadequate, with the predictable results—fourteen banking failures in Kenya in 1993 and 1994 alone. In the end, interest rates increased, not decreased. Understandably, the government 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 unable to buy seed or fertilizer because they would be unable to get cheap credit or would be forced to pay higher interest rates which they could ill afford. This is a country wracked by droughts which result in massive starvation. Its leaders did not want to make matters worse. The Ethiopians worried that the IMF’s advice would cause farmers’ 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 first-rate economic framework and a government committed to improving the plight of its poor. World Bank lending tripled, even 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 determined campaign of “intellectual lobbying.” In Washington, my colleagues and I held conferences to encourage people at both the IMF and the World Bank to look again at issues of financial sector liberalization in very underdeveloped nations, and the consequences of unnecessarily imposed budgetary austerity in foreign aid–dependent poor countries, as in Ethiopia. I attempted to reach senior managers at the Fund, both directly and through colleagues at the World Bank, and those at the Bank working in Ethiopia made similar efforts to persuade their counterparts at the Fund. I used what influence I could through my connections with the Clinton administration, including talking to America’s 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.

  The tussle 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 Ethiopia’s macroeconomic position, 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 important than the fact that it fai
led to consult the IMF. Financial market liberalization—how best this should be done in a country at Ethiopia’s stage of development—was a matter of substance and experts could have been asked for their opinion. The fact that outside experts were not called in to help arbitrate what was clearly a contentious issue is consonant with the style of the IMF, in which the Fund casts itself as the monopoly supplier of “sound” advice. Even matters like the repayment of the loan—though properly not something on which the IMF should have taken a position at all, so long as Ethiopia’s action enhanced rather than subtracted from its ability to repay what was owed—could have been referred to outsiders, to see whether the action was “reasonable.” But doing so would have been anathema to the IMF. Because so much of its decision making was done behind closed doors—there was virtually no public discussion of the issues just raised—the IMF left itself open to suspicions that power politics, special interests, or other hidden reasons not related to the IMF’s mandate and stated objectives were influencing its institutional policies and conduct.

  It is hard even for a moderate-sized institution like the IMF to know a great deal about every economy in the world. Some of the best IMF economists were assigned to work on the United States, but when I served as chairman of the Council of Economic Advisers, I often felt that the IMF’s limited understanding of the U.S. economy had led it to make misguided policy recommendations for America. The IMF economists felt, for instance, that inflation would start rising in the United States as soon as unemployment fell below 6 percent. At the Council, our models said they were wrong, but they were not terribly interested in our input. We were right, and the IMF was wrong: unemployment in the United States fell to below 4 percent and still inflation did not increase. Based on their faulty analysis of the U.S. economy, the IMF economists came up with a misguided policy prescription: raise interest rates. Fortunately, the Fed paid no attention to the IMF recommendation. Other countries could not ignore it so easily.

  But to the IMF the lack of detailed knowledge is of less moment, because it tends to take a “one-size-fits-all” approach. The problems of this approach become particularly acute when facing the challenges of the developing and transition economies. The institution does not really claim expertise in development—its original mandate is supporting global economic stability, as I have said, not reducing poverty in developing countries—yet it does not hesitate to weigh in, and weigh in heavily, on development issues. Development issues are complicated; in many ways developing countries present far greater difficulties than more developed countries. This is because in developing nations, markets are often absent, and when present, often work imperfectly. Information problems abound, and cultural mores may significantly affect economic behavior.

  Unfortunately, too often the training of the macroeconomists who predominate the IMF does not prepare them well for the problems that they have to confront in developing countries. In some of the universities from which the IMF hires regularly, the core curricula involve models in which there is never any unemployment. After all, in the standard competitive model—the model that underlies the IMF’s market fundamentalism—demand always equals supply. If the demand for labor equals supply, there is never any involuntary unemployment. Someone who is not working has evidently chosen not to work. In this interpretation, 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 psychologists 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 fundamentalism—in which, by assumption, markets work perfectly and demand must equal supply for labor as for every other good or factor—there cannot be unemployment, the problem cannot lie with markets. It must lie elsewhere—with greedy unions and politicians interfering with the workings of free markets, by demanding—and getting—excessively high wages. There is an obvious policy implication—if 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, it’s unlikely that an IMF mission, on a three-week trip to Addis Ababa, Ethiopia’s capital, or the capital of any other developing country, could really develop policies appropriate for that country. Such policies are far more likely to be crafted by highly educated, first-rate economists already in the country, deeply knowledgeable about it and working daily on solving that country’s problems. Outsiders can play a role, in sharing the experiences of other countries, and in offering alternative interpretations of the economic forces at play. But the IMF did not want to take on the mere role of an adviser, competing with others who might be offering their ideas. It wanted a more central role in shaping policy. And it could do this because its position was based on an ideology—market fundamentalism—that required little, if any, consideration of a country’s particular circumstances and immediate problems. IMF economists could ignore the short-term effects their policies might have on the country, content in the belief that in the long run the country would be better off; any adverse short-run impacts would be merely pain that was necessary as part of the process. Soaring interest rates might, today, lead to starvation, 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. Well-designed policies can often avoid much of the pain; and some forms of pain—the misery caused by abrupt cuts in food subsidies, for example, which leads to rioting, urban violence, and the dissolution of the social fabric—are counterproductive.

  The IMF has done a good job of persuading many that its ideo-logically driven policies were necessary if countries are to succeed in the long run. Economists always focus on the importance of scarcity and the IMF often says it is simply the messenger of scarcity: countries cannot persistently live beyond their means. One doesn’t, of course, need a sophisticated financial institution staffed by Ph.D. economists to tell a country to limit expenditures to revenues. But IMF reform programs go well beyond simply ensuring that countries live within their means.

  THERE ARE ALTERNATIVES to IMF-style programs, other programs 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, 2,300 miles south of Ethiopia, a small country of 1.5 million, which has managed a stable democracy since independence.

  At the time Botswana became fully independent in 1966 it was a desperately poor country, like Ethiopia and most of the other countries in Africa, with a per capita annual income of $100. It too was largely agricultural, lacked water, and had a rudimentary infrastructure. 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 7.5 percent from 1961 to 1997.

  Botswana was helped by having diamonds, but countries like the Democratic Republic of the Congo, 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 country’s wealth. Bots­wana’s success rested on its ability to maintain a political consensus, based on a broader sense of national unity. That political consensus, necessary to any workable social contract between government and the governed, had been carefully forged by the governmen
t, in collaboration with outside advisers, from a variety of public institutions and private foundations, including the Ford Foundation. The advisers helped Botswana map out a program for the country’s 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 Parliament, with open seminars as well as one-to-one meetings.

  Part of the reason for this success was that the senior people in Botswana’s government took great care in selecting their advisers. When the IMF offered to supply the Bank of Botswana with a deputy governor, the Bank of Botswana did not automatically accept him. The bank’s governor flew to Washington 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 be far less successful.

  The differences in how the IMF and the advisers from the Ford Foundation and other agencies approach developing countries has a multiplicity of consequences. While the IMF is vilified almost everywhere in the developing world, the warm relationship that was created between Botswana and its advisers was symbolized by the awarding of that country’s highest medal to Steve Lewis, who at the time he advised Botswana was a professor of development economics at Williams.

  The vital consensus that underlay Botswana’s success was threatened two decades ago when Botswana had an economic crisis. One major sector, cattle raising, was threatened by drought, and problems in the diamond industry had put a strain on the country’s 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 Keynes’s intent when he pushed for 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 pre-Keynesian position of fiscal austerity in the face of a downturn, doling out funds only if the borrowing country conforms to the IMF’s views about appropriate economic policy, which almost always entail contractionary policies leading to recessions or worse. Botswana, recognizing the volatility of its two main sectors, cattle and diamonds, had prudently set aside reserve funds for just such a crisis. As 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 consensus-based approach to policy making, the austerity did not cause the kinds of cleavages in society that have occurred so frequently elsewhere under IMF programs. Presumably, if the IMF had done what it should have been doing—providing funds quickly to countries with good economic policies in times of crisis, without searching around for conditionalities to impose—the country would have been able to navigate 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.