Globalization and Its Discontents Revisited

by Joseph E. Stiglitz

  What is particularly disturbing is how special interests can undermine both U.S. credibility and broader national interests. This was seen most forcefully in April 1999, when Premier Zhu Rongji came to the United States partly to finish off negotiations for China’s admission to the World Trade Organization, a move that was essential for the world trading regime—how could one of the largest trading countries be excluded?—but also for the market reforms in China itself. Over the opposition of the U.S. Trade Representative and the State Department, the U.S. Treasury insisted on a provision for faster liberalization of China’s financial markets. China was quite rightly worried; it was precisely such liberalization that had led to the financial crises in neighboring countries in East Asia, at such costs. China had been spared because of its wise policies.

  This American demand for liberalization of financial markets in China would not help secure global economic stability. It was made to serve the narrow interests of the financial community in the United States, which Treasury vigorously represents. Wall Street correctly believed that China represented a potential vast market for its financial services, and it was important that Wall Street get in, establish a strong toehold, before others. How shortsighted this was! It was clear that China would eventually be opened up. Hurrying the process up by a year or two can surely make little difference, except that Wall Street worries that its competitive advantage may disappear over time, as financial institutions in Europe and elsewhere catch up to the short-term advantages of their Wall Street competitors. But the potential cost was enormous. In the immediate aftermath of the Asian financial crisis, it was impossible for China to accede to Treasury’s demands. For China, maintaining stability is essential; it could not risk policies that had proved so destabilizing elsewhere. Zhu Rongji was forced to return to China without a signed agreement. There had long been a struggle inside China between those pushing for and against reform. Those opposing reform argued that the West was seeking to weaken China, and would never sign a fair agreement. A successful end to the negotiations would have helped to secure the positions of the reformers in the Chinese government and added strength to the reform movement. As it turned out, Zhu Rongji and the reform movement for which he stood were discredited, and the reformists’ power and influence were curtailed. Fortunately, the damage was only temporary, but still, the U.S. Treasury had shown how much it was willing to risk to pursue its special agenda.

  EVEN THOUGH AN unfair trade agenda was pushed, at least there was a considerable body of theory and evidence that trade liberalization would, if implemented properly, be a good thing. The case for financial market liberalization was far more problematic. Many countries do have financial regulations that serve little purpose other than to increase the profits of some special interests, and these should be stripped away. But all countries regulate their financial markets, and excessive zeal in deregulation has brought on massive problems in capital markets even in developed countries around the world. To cite one example, the infamous savings-and-loan debacle in the United States, while it was a key factor in precipitating the 1991 recession and cost American 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 U.S. 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 Reagan-Thatcher message to the developing countries, countries which were particularly ill-equipped to manage what has proven, under the best of circumstances, to be a difficult task fraught with risks. Whereas the more advanced industrial countries did not attempt capital market liberalization until late in their development—European nations waited until the 1970s to get rid of their capital market controls—the developing nations have been encouraged to do so quickly.

  The consequences—economic recession—of banking crises brought on by capital market deregulation, while painful for developed countries, were much more serious for developing countries. The poor countries have no safety net to soften the impact of recession. 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 liberalization was even worse. Capital market liberalization entails stripping away the regulations intended to control the flow of hot money in and out of the country—short-term loans and contracts that are usually no more than bets on exchange rate movements. This speculative money cannot be used to build factories or create jobs—companies don’t make long-term investments using money that can be pulled out on a moment’s notice—and indeed, the risk that such hot money brings with it makes long-term investments in a developing country even less attractive. The adverse effects on growth are even greater. To manage the risks associated with these volatile capital flows, countries are routinely advised to set aside in their reserves an amount equal to their short-term foreign-denominated loans. To see what this implies, assume that a firm in a small developing country accepts a short-term $100 million loan from an American bank, paying 18 percent interest. Prudential policy on the part of the country would require that it would add $100 million to reserves. Typically reserves are held in U.S. Treasury bills, which in 2002 paid around 4 percent. In effect, the country was simultaneously borrowing from the United States at 18 percent and lending to the United States at 2 percent. The country as a whole has no more resources available for investing. American banks may make a tidy profit and the United States as a whole gains $16 million a year in interest. But it is hard to see how this allows the developing country to grow faster. Put this way, it clearly makes no sense. There is a further problem: a mismatch of incentives. With capital market liberalization, it is firms in a country’s private sector that get to decide whether to borrow short-term funds from the American banks, but it is the government that must accommodate itself, adding to its reserves if it wishes to maintain its prudential standing.

  The IMF, in arguing for capital market liberalization, relied on simplistic reasoning: Free markets are more efficient, greater efficiency allowed for faster growth. It ignored arguments such as the one just given, and put forward some further specious contentions, for instance, that without liberalization, countries would not be able to attract foreign capital, and especially direct investment. The Fund’s economists have never laid claim to being great theorists; its claim to expertise lay in its global experience and its mastery of the data. Yet strikingly, not even the data supported the Fund’s conclusions. China, which received the largest amount of foreign investment, did not follow any of the Western prescriptions (other than macrostability)—prudently forestalling full capital market liberalization. Broader statistical studies confirmed the finding that using the IMF’s own definitions of liberalization, it did not entail faster growth or higher investment.

  While China demonstrated that capital market liberalization was not needed to attract funds, the fact of the matter was that, given the high savings rates in East Asia (30–40 percent of GDP, in contrast to 18 percent in the United States and 17–30 percent 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 crisis 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 out—exacerbating the economic downturn.

  While we shall take a closer look at why liberalization—especially when undertaken prematurely, before strong financial institutions are in place—increased instability, one fact remains clear: instability is not only bad for economic growth, but the costs of the instability are disproportionately borne by the poor.

  The Role of Foreign Investment

  Foreign investment is not one of the three main pillars of the Washington Consensus, but it is a key part of the new globalization. According to the Washington Consensus, growth occurs through liberalization, “freeing up” markets. Privatization, liberalization, and macrostability are supposed to create a climate to attract investment, including from abroad. This investment creates growth. Foreign business brings with it technical expertise and access to foreign markets, creating new employment possibilities. Foreign companies also have access to sources of finance, especially important in those developing countries where local financial institutions are weak. Foreign direct investment has played an important role in many—but not all—of the most successful development stories in countries such as Singapore and Malaysia and even China.

  Having said this, there are some real downsides. When foreign businesses come in they often destroy local competitors, quashing the ambitions of the small businessmen who had hoped to develop homegrown industry. There are many examples of this. Soft drinks manufacturers around the world have been overwhelmed by the entrance of Coca-Cola and Pepsi into their home markets. Local ice cream manufacturers find they are unable to compete with Unilever’s ice cream 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 Walmart comes into a community, there are often strong protests from local firms, who fear (rightly) that they will be displaced. Local shopkeepers worry they won’t be able to compete with 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 destroyed. These same concerns are a thousand times stronger in developing countries. Although such concerns 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 individuals within developing countries is all the more important, given how close to subsistence so many live.

  But critics raise several points. In the absence of strong (or effectively enforced) competition laws, after the international firm drives out the local competition it uses its monopoly power to raise prices. The benefits of low prices were short-lived.

  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 competition, 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 actually enhance worker productivity, and lower overall costs—or 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 the local government provides deposit insurance). The U.S. government has been pushing for opening up of financial markets in developing nations. The advantages are clear: the increased 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 influence, reversed the traditional position of the Democratic Party) for fear that funds would flow to the major money centers, like New York, starving the outlying areas of needed funds. Argentina shows the dangers. There, before the collapse in 2001, the domestic banking industry had become dominated by foreign-owned banks, and while the banks easily provide funds to multinationals, and even large domestic firms, small and medium-size firms complained of a lack of access to capital. International banks’ expertise—and information base—lies in lending to their traditional clients. Eventually, they may expand into these other niches, or new financial institutions may arise to address these gaps. And the lack of growth—to which the lack of finance contributed—was pivotal in that country’s collapse. Within Argentina, the problem was widely recognized; the government took some limited steps to fill the credit gap. But government lending could not make up for the market’s failure.

  Argentina’s experience illustrates some basic lessons. The IMF and the World Bank have been stressing the importance of bank stability. It is easy to create sound banks, banks that do not lose money because of bad loans—simply require them to invest in U.S. 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 that may itself lead to macroinstability. Because of a lack of growth it has had mounting fiscal deficits, and as the IMF forced cutbacks in expenditures and increases in taxes, a vicious downward spiral of economic decline and social unrest was set in motion.

  Bolivia provides yet another example where foreign banks have contributed to macroeconomic instability. In 2001, a foreign bank that loomed large in the Bolivian economy suddenly decided, given the increased global risks, to pull back on lending. The sudden change in the credit supply helped plunge the economy into an even deeper economic downturn than falling commodity prices and the global economic slowdown were already bringing about.

  There are additional concerns with respect to the intrusion of foreign banks. Domestic banks are more sensitive to what used to be called “window guidance”—subtle forms of influence by the central bank, for example, to expand credit when the economy needs stimulus and contract it when there are signs of overheating. Foreign banks are far less likely to be responsive to such signals. Similarly, domestic banks are far more likely to be responsive to pressure to address basic holes in the credit system—unserved and underserved groups, such as minorities and disadvantaged regions. In the United States, with one of the most developed credit markets, these gaps were felt to be so important that the Community Reinvestment Act (CRA) was passed in 1977, which imposed requirements on banks to lend to these underserved groups and areas. The CRA has been an important, if controversial, way of achieving critical social goals.

  Finance, however, is not the only area in which foreign direct investment has been a mixed blessing. In some cases, new investors persuaded (often with bribes) governments to grant them special privileges, such as tariff protection. In many cases, the U.S., French, or governments of other advanced industrial countries weighed in—reinforcing the view within developing countries that it was perfectly appropriate for governments to meddle in and presumably receive payments from the private sector. In some cases, the role of government seemed relatively innocuous (although not necessarily uncorrupt). When U.S. Secretary of Commerce Ron Brown traveled abroad, he was accompanied by U.S. business people trying to make contacts with and gain entry into these emerging markets. Presumably, the chances of getting a seat on the plane were enhanced if one made significant campaign contributions.

  In other cases, one government was called in to countervail the weight of another. In
Côte d’Ivoire while the French government supported the French Telecom’s attempt to exclude competition from an independent (American) cell phone company, the U.S. government pushed the claims of the American firm. But in many cases, governments went well beyond the realm of what was reasonable. In Argentina, the French government reportedly weighed in pushing for a rewriting of the terms of concessions for a water utility (Aguas 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 Indonesia, at the 1994 meeting of leaders of APEC (Asia-Pacific Economic Cooperation) held at Jakarta, President Clinton encouraged American firms to come into Indonesia. Many did so, and often at highly favorable terms (with suggestions of corruption “greasing” the wheels—to 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 so-called take or pay clauses). The private sector got the profits; the government bore the risk. That was bad enough. But when the corrupt governments were overthrown (Mohammed Suharto in Indonesia in 1998, Nawaz Sharif in Pakistan in 1999), the U.S. government put pressure on the governments 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” contracts, which Western governments have used their muscle to enforce.1