There is more to the list of legitimate complaints against foreign direct investment. Such investment often flourishes only because of special privileges extracted from the government. While standard economics focuses on the distortions of incentives that result from such privileges, there is a far more insidious aspect: often those privileges are the result of corruption, the bribery of government officials. The foreign direct investment comes only at the price of undermining democratic processes. This is particularly true for investments in mining, oil, and other natural resources, where foreigners have a real incentive to obtain the concessions at low prices.
Moreover, such investments have other adverse effects—and often do not promote growth. The income that mining concessions brings can be invaluable but development is a transformation of society. An investment in a mine—say in a remote region of a country—does little to assist the development transformation, beyond the resources that it generates. It can help create a dual economy, an economy in which there are pockets of wealth. But a dual economy is not a developed economy. Indeed, the inflow of resources can sometimes actually impede development, through a mechanism that is called the “Dutch Disease.” The inflow of capital leads to an appreciation of the currency, making imports cheap and exports expensive. The name comes from the Netherlands experience following the discovery of gas in the North Sea. Natural gas sales drove the Dutch currency up, seriously hurting the country’s other export industries. It presented a challenging but solvable problem for that country; but for developing countries, the problem may be especially difficult.
Worse still, the availability of resources can alter incentives: as we saw in chapter 6, rather than devoting energy to creating wealth, in many countries that are well-endowed with resources, efforts are directed at appropriating the income (which economists refer to as “rents”) associated with the natural resources.
The international financial institutions tended to ignore the problems I have outlined. Instead, the IMF’s prescription for job creation—when it focused on that issue—was simple: Eliminate government intervention (in the form of oppressive regulation), reduce taxes, get inflation as low as possible, and invite foreign entrepreneurs in. In a sense, even here 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 remarkable successes of Korea and Japan, in which foreign investment played no role. In many cases, as in Singapore, China, and Malaysia, which kept the abuses of foreign investment in check, foreign direct investment played a critical role, not so much for the capital (which, given the high savings rate, was not really needed) or even for the entrepreneurship, but for the access to markets and new technology that it brought along.
Sequencing and Pacing
Perhaps of all the IMF’s blunders, it is the mistakes in sequencing and pacing, and the failure to be sensitive to the broader social context, that have received the most attention—forcing liberalization before safety nets were put in place, before there was an adequate regulatory framework, before the countries could withstand the adverse consequences of the sudden changes in market sentiment that are part and parcel of modern capitalism; forcing policies that led to job destruction before the essentials for job creation were in place; forcing privatization before there were adequate competition and regulatory frameworks. Many of the sequencing mistakes reflected fundamental misunderstandings of both economic and political processes, misunderstandings 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 naturally—including the institutions and the kinds of legal structures that make market economies work.
Behind the free-market ideology there is a model, often attributed to Adam Smith, which argues that market forces—the profit motive—drive the economy to efficient outcomes as if by an invisible hand. One of the great achievements of modern economics is to show the sense in which, and the conditions under which, Smith’s conclusion is correct. It turns out that these conditions are highly restrictive.2 Indeed, more recent advances in economic theory—ironically occurring precisely during the period of the most relentless pursuit of the Washington Consensus policies—have shown that whenever information is imperfect and markets incomplete, which is to say always, and especially in developing countries, then the invisible hand works most imperfectly. Significantly, there are desirable government interventions which, in principle, can improve upon the efficiency of the market. These restrictions on the conditions under which markets result in efficiency are important—many of the key activities of government can be understood as responses to the resulting market failures. If information were perfect, we now know, there would be little role for financial markets—and little role for financial market regulation. If competition were automatically perfect, there would be no role for antitrust authorities.
The Washington Consensus policies, however, were based on a simplistic model of the market economy, the competitive equilibrium model, in which Adam Smith’s invisible hand works, and works perfectly. Because in this model there is no need for government—that is, free, unfettered, “liberal” markets work perfectly—the Washington Consensus policies are sometimes referred to as “neo-liberal,” based on “market fundamentalism,” a resuscitation of the laissez-faire policies that were popular in some circles in the nineteenth century. In the aftermath of the Great Depression and the recognition of other failings of the market system, from massive inequality to unlivable cities marred by pollution and decay, these free-market policies have been widely rejected in the more advanced industrial countries, though within these countries there remains an active debate about the appropriate balance between government and markets.
EVEN IF SMITH’S invisible hand theory were relevant for advanced industrialized countries, the required conditions are not satisfied in developing countries. The market system requires clearly established property rights and the courts to enforce them; but often these are absent in developing countries. The market system requires competition and perfect information. But competition is limited and information is far from perfect—and well-functioning competitive markets can’t be established overnight. The theory says that an efficient market 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. Ideology ignores these matters; it says simply move as quickly to a market 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 privatization described earlier represent sequencing errors on a grand scale. The smaller-scale sequencing mistakes are even less noticed in the Western press. They constitute the day-to-day tragedies of IMF policies 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 corruption, 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 couldn’t borrow the requisite funds either, given the lack of well-functioning 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 ma
fia. In either situation, the net benefits that the IMF and the World Bank promised did not materialize. 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 pricing—paying 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 widespread hardship ensued. The IMF pricing scheme may have had some slight benefits in terms of increased efficiency, but we have to weigh these benefits against the social costs. Proper sequencing and pacing might have enabled one to gradually achieve the efficiency gains without these costs.
There is a more fundamental criticism of the IMF/Washington Consensus approach: It does not acknowledge that development requires a transformation of society. Uganda grasped this in its radical elimination of all school fees, something that budget accountants focusing solely on revenues and costs simply could not understand. Part of the mantra of development economics today is a stress on universal primary education, including educating girls. Countless studies have shown that countries, like those in East Asia, which have invested 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 for girls. The reason is simple: poor families have barely enough to survive; they see little direct benefit from educating their daughters, and the education systems have been oriented to enhancing opportunities mainly through jobs in the urban sector considered more suitable for boys. Most countries, facing severe budgetary constraints, have followed the Washington Consensus advice that fees should be charged. Their reasoning: statistical studies showed that small fees had little impact on school enrollment. But Uganda’s 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 couldn’t 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 unnecessarily corroding the very fabric of society. It is inevitable that the process of development and rapid change puts enormous stresses on society. Traditional authorities are challenged, traditional relationships are reassessed. That is why successful development pays careful attention to social stability—a major lesson not only of the story of Botswana in the previous chapter but also of Indonesia in the next, where the IMF insisted on abolishing subsidies for food and kerosene (the fuel used for cooking by the poor) just as IMF policies had exacerbated the country’s recession, with incomes and wages falling and unemployment soaring. The riots that ensued tore the country’s 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 IMF-inspired 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 argued for cutting food subsidies to improve the government’s budget. They had almost succeeded in getting agreement when King Hussein intervened and put a stop to it. He enjoyed his post, was doing a marvelous job, and wanted to keep it. In the highly volatile Middle East, food-inspired 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 IMF’s narrow 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 everyone’s attention the simple fact that the social and political context 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 by excessive austerity. Moderate inflation may not be ideal for creating an environment for investment, but violence and civil strife are even worse.
We recognize today that there is a “social contract” that binds citizens together, and with their government. When government policies abrogate that social contract, citizens may not honor their “contracts” with each other, or with the government. Maintaining that social contract is particularly important, and difficult, in the midst of the social upheavals that so frequently accompany the development transformation. In the green eye–shaded calculations of the IMF macroeconomics there is, too often, no room for these concerns.
Trickle-Down 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 little 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 trickle-down economics. Eventually, it is asserted, the benefits of that growth trickle down even to the poor. Trickle-down economics was never much more than just a belief, an article of faith. Pauperism seemed to grow in nineteenth-century 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 trickle-down 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 trickle-down economics; if this had not worked in the United States, why would it work in developing countries? While it is true that sustained reductions in poverty cannot be attained without robust economic 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.
In spite of the obvious problems confronting trickle-down economics, 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 winner, Simon Kuznets, argued that while in the initial stages of development inequality increased, later on the trend was reversed.3
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 countries—South Korea, China, Taiwan, Japan—showed that high savings did not require high inequality, that one could achieve rapid grow
th without a substantial increase in inequality. Because the governments did not believe that growth would automatically benefit 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 Consensus 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 landscape. The IMF talks with pride about the progress Latin America has 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.
Globalization and Its Discontents Revisited Page 25