Globalization and Its Discontents Revisited

by Joseph E. Stiglitz

  * I saw this forcefully in my discussions in Korea. Private owners showed an enormous social conscience in letting their workers go; they felt that there was a social contract, which they were reluctant to abrogate, even if it meant that they themselves would lose money.

  CHAPTER 8

  THE EAST ASIA CRISIS

  How IMF Policies Brought the World to the Verge of a Global Meltdown

  WHEN THE THAI baht collapsed on July 2, 1997, no one knew that this was the beginning of the greatest economic crisis since the Great Depression—one that would spread from Asia to Russia and Latin America and threaten the entire world. For ten years the baht had traded at around 25 to the dollar; then overnight it fell by about 25 percent. Currency speculation spread and hit Malaysia, Korea, the Philippines, and Indonesia, and by the end of the year what had started as an exchange rate disaster threatened to take down many of the region’s banks, stock markets, and even entire economies. The crisis is over now, but countries such as Indonesia will feel its effects for years. Unfortunately, the IMF policies imposed during this tumultuous time worsened the situation. Since the IMF was founded precisely to avert and deal with crises of this kind, the fact that it failed in so many ways led to a major rethinking of its role, with many people in the United States and abroad calling for an overhaul of many of the Fund’s policies and the institution itself. Indeed, in retrospect, it became clear that the IMF policies not only exacerbated the downturns but were partially responsible for the onset: excessively rapid financial and capital market liberalization was probably the single most important cause of the crisis, though mistaken policies on the part of the countries themselves played a role as well. Today the IMF acknowledges many, but not all, of its mistakes—its officials realize how dangerous, for instance, excessively rapid capital market liberalization can be—but its change in views comes too late to help the countries afflicted.

  The crisis took most observers by surprise. Not long before the crisis, even the IMF had forecast strong growth. Over the preceding three decades East Asia had not only grown faster and done better at reducing poverty than any other region of the world, developed or less developed, but it had also been more stable. It had been spared the ups and downs that mark all market economies. So impressive was its performance that it was widely described as the “East Asia Miracle.” Indeed, reportedly, so confident had the IMF been about the region that it assigned a loyal staff member as director for the region, as an easy preretirement posting.

  When the crisis broke out, I was surprised at how strongly the IMF and the U.S. Treasury seemed to criticize the countries—according to the IMF, the Asian nations’ institutions were rotten, their governments corrupt, and wholesale reform was needed. These outspoken critics were hardly experts on the region, but what they said contradicted so much of what I knew about it. I had been traveling to and studying the area for three decades. I had been asked by the World Bank, by Lawrence Summers himself when he was its vice president for research, to participate in a major study of the East Asia Miracle, to head the team looking at the financial markets. Almost two decades before, as the Chinese began their transition to a market economy, I had been called upon by them to discuss their development strategy. In the White House, I continued my close involvement, heading, for instance, the team that wrote the annual economic report for APEC (the Asia-Pacific Economic Cooperation, the group of countries around the Pacific rim, whose annual meetings of heads of states had come increasingly into prominence as the economic importance of the region grew). I participated actively in the National Security Council in the debates about China—and indeed, when tensions over the administration’s “containment” policy got too heated, I was the cabinet member sent to meet with China’s premier, Zhu Rongji, to calm the waters. I was one of the few foreigners ever invited to join the country’s top leaders at their yearly August retreat for policy discussions.

  How, I wondered, if these countries’ institutions were so rotten, had they done so well for so long? The difference in perspectives, between what I knew about the region and what the IMF and the Treasury alleged, made little sense, until I recalled the debate that had raged over the East Asia Miracle itself. The IMF and the World Bank had almost consciously avoided studying the region, though presumably, because of its success, it would have seemed natural for them to turn to it for lessons for others. It was only under pressure from the Japanese that the World Bank had undertaken the study of economic growth in East Asia (the final report was titled The East Asian Miracle) and then only after the Japanese had offered to pay for it. The reason was obvious: The countries had been successful not only in spite of the fact that they had not followed most of the dictates of the Washington Consensus, but because they had not. Though the experts’ findings were toned down in the final published report, the World Bank’s Asian Miracle study laid out the important roles that the government had played. These were far from the minimalist roles beloved of the Washington Consensus.

  There were those, not just in the international financial institutions but in academia, who asked, was there really a miracle? “All” that East Asia had done was to save heavily and invest well! But this view of the “miracle” misses the point. No other set of countries around the world had managed to save at such rates and invest the funds well. Government policies played an important role in enabling the East Asian nations to accomplish both things simultaneously.1

  When the crisis broke out, it was almost as if many of the region’s critics were glad: their perspective had been vindicated. In a curious disjunction, while they were loath to credit the region’s governments with any of the successes of the previous quarter century, they were quick to blame the governments for the failings.

  Whether one calls it a miracle or not is beside the point: the increases in incomes and the reductions in poverty in East Asia over the last three decades have been unprecedented. No one visiting these countries can fail to marvel at the developmental transformation, the changes not only in the economy but also in society, reflected in every statistic imaginable. Thirty years ago, thousands of backbreaking rickshaws were pulled for a pittance; today, they are only a tourist attraction, a photo opportunity for the camera-snapping tourists. The combination of high savings rates, government investment in education, and state-directed industrial policy all served to make the region an economic powerhouse. Growth rates were phenomenal for decades and the standard of living rose enormously for tens of millions of people. The benefits of growth were shared widely. There were problems in the way the Asian economies developed, but overall, the governments had devised a strategy that worked, a strategy which had but one item in common with the Washington Consensus policies—the importance of macrostability. As in the Washington Consensus, trade was important, but the emphasis was on promoting exports, not removing impediments to imports. Trade was eventually liberalized, but only gradually, as new jobs were created in the export industries. While the Washington Consensus policies emphasized rapid financial and capital market liberalization, the East Asian countries liberalized only gradually—some of the most successful, like China, still have a long way to go. While the Washington Consensus policies emphasized privatization, government at the national and local levels helped create efficient enterprises that played a key role in the success of several of the countries. In the Washington Consensus view, industrial policies, in which governments try to shape the future direction of the economy, are a mistake. But the East Asian governments took that as one of their central responsibilities. In particular, they believed that if they were to close the income gap between themselves and the more developed countries, they had to close the knowledge and technology gap, so they designed education and investment policies to do that. While the Washington Consensus policies paid little attention to inequality, the East Asian countries focused on reducing poverty and limiting inequality, believing that such policies were important for maintaining social cohesion, and that social cohesion was necessary
to provide a climate favorable to investment and growth. Most broadly, while the Washington Consensus policies emphasized a minimalist role for government, in East Asia, governments helped shape and direct markets.

  When the crisis began, those in the West did not realize its severity. Asked about aid for Thailand, President Bill Clinton dismissed the collapse of the baht as “a few glitches in the road” to economic prosperity.2 The confidence and imperturbability of Clinton was shared by the financial leaders of the world, as they met in September 1997 in Hong Kong for the annual meeting of the IMF and World Bank. IMF officials there were so sure of their advice that they even asked for a change in its charter to allow it to put more pressure on developing countries to liberalize their capital markets. Meanwhile, the leaders of the Asian countries, and especially the finance ministers I met with, were terrified. They viewed the hot money that came with liberalized capital markets as the source of their problems. They knew that major trouble was ahead: a crisis would wreak havoc on their economies and their societies, and they feared that IMF policies would prevent them from taking the actions that they thought might stave off the crisis, at the same time that the policies they would insist upon should a crisis occur would worsen the impacts on their economy. They felt, however, powerless to resist. They even knew what could and should be done to prevent a crisis and minimize the damage—but knew that the IMF would condemn them if they undertook those actions and they feared the resulting withdrawal of international capital. In the end, only Malaysia was brave enough to risk the wrath of the IMF; and though Prime Minister Mahathir’s policies—trying to keep interest rates low, trying to put brakes on the rapid flow of speculative money out of the country—were attacked from all quarters, Malaysia’s downturn was shorter and shallower than that of any of the other countries.3

  At the Hong Kong meeting, I suggested to the ministers of the Southeast Asian countries with whom I met that there were some concerted actions which they could take together; if they all imposed capital controls—controls intended to prevent the damage as the speculative money rushed out of their countries—in a coordinated way, they might be able to withstand the pressures that would undoubtedly be brought down upon them by the international financial community, and they could help insulate their economies from the turmoil. They talked about getting together later in the year to map out a plan. But hardly had their bags been unpacked from the trip to Hong Kong than the crisis spread, first to Indonesia, and then, in early December, to South Korea. Meanwhile, other countries around the world had been attacked by currency speculators—from Brazil to Hong Kong—and withstood the attack, but at high cost.

  There are two familiar patterns to these crises. The first is illustrated by South Korea, a country with an impressive track record. As it emerged from the wreckage of the Korean War, South Korea formulated a growth strategy which increased per capita income eightfold in thirty years, reduced poverty dramatically, achieved universal literacy, and went far in closing the gap in technology between itself and the more advanced countries. At the end of the Korean War, it was poorer than India; by the beginning of the 1990s, it had joined the Organisation for Economic Co-operation and Development (OECD), the club of the advanced industrialized countries. Korea had become one of the world’s largest producers of computer chips, and its large conglomerates, Samsung, Daewoo, and Hyundai, produced goods known throughout the world. But whereas in the early days of its transformation it had tightly controlled its financial markets, under pressure from the United States it had reluctantly allowed its firms to borrow abroad. But by borrowing abroad, the firms exposed themselves to the vagaries of the international market: in late 1997, rumors flashed through Wall Street that Korea was in trouble. It would not be able to roll over the loans from Western banks that were coming due, and it did not have the reserves to pay them off. Such rumors can be self-fulfilling prophecies. I heard these rumors at the World Bank well before they made the newspapers—and I knew what they meant. Quickly, the banks which such a short time earlier were so eager to lend money to Korean firms decided not to roll over their loans. When they all decided not to roll over their loans, their prophecy came true: Korea was in trouble.

  The second was illustrated by Thailand. There, a speculative attack (combined with high short-term indebtedness) was to blame. Speculators, believing that a currency will devalue, try to move out of the currency and into dollars; with free convertibility—that is, the ability to change local currency for dollars or any other currency—this can easily be done. But as traders sell the currency, its value is weakened—confirming their prophecy. Alternatively, and more commonly, the government tries to support the currency. It sells dollars from its reserves (money the country holds, often in dollars, against a rainy day), buying up the local currency, to sustain its value. But eventually, the government runs out of hard currency. There are no more dollars to sell. The currency plummets. The speculators are satisfied. They have bet right. They can move back into the currency—and make a nice profit. The magnitude of the returns can be enormous. Assume a speculator goes to a Thai bank, borrows 24 billion baht, which, at the original exchange rate, can be converted into $1 billion. A week later the exchange rate falls; instead of there being 24 baht to the dollar, there are now 40 baht to the dollar. He takes $600 million, converting it back to baht, getting 24 billion baht to repay the loan. The remaining $400 million is his profit—a tidy return for one week’s work, and the investment of little of his own money. Confident that the exchange rate would not appreciate (that is, go from 24 baht to the dollar to, say, 20 to the dollar), there was hardly any risk; at worst, if the exchange rate remained unchanged, he would lose one week’s interest. As perceptions that a devaluation is imminent grow, the chance to make money becomes irresistible and speculators from around the world pile in to take advantage of the situation.

  If the crises had a familiar pattern, so too did the IMF’s responses: it provided huge amounts of money (the total bailout packages, including support from G-7 countries, was $95 billion)4 so that the countries could sustain the exchange rate. It thought that if the market believed that there was enough money in the coffers, there would be no point in attacking the currency, and thus “confidence” would be restored. The money served another function: it enabled the countries to provide dollars to the firms that had borrowed from Western bankers to repay the loans. It was thus, in part, a bailout to the international banks as much as it was a bailout to the country; the lenders did not have to face the full consequences of having made bad loans. And in country after country in which the IMF money was used to sustain the exchange rate temporarily at an unsustainable level, there was another consequence: rich people inside the country took advantage of the opportunity to convert their money into dollars at the favorable exchange rate and whisk it abroad. As we shall note in the next chapter, the most egregious example occurred in Russia, after the IMF lent it money in July 1998. But this phenomenon, which is sometimes given the more neutral sounding name of “capital flight,” also played a key role in the previous important crisis, in Mexico during 1994–95.

  The IMF combined the money with conditions, in a package which was supposed to rectify the problems that caused the crisis. It is these other ingredients, as much as the money, that are supposed to persuade markets to roll over their loans, and to persuade speculators to look elsewhere for easy targets. The ingredients typically include higher interest rates—in the case of East Asia, much, much higher interest rates—plus cutbacks in government spending and increases in taxes. They also include “structural reforms,” that is, changes in the structure of the economy which, it is believed, lies behind the country’s problems. In the case of East Asia, not only were conditions imposed that mandated hikes in interest rates and cutbacks in spending; additional conditions required countries to make political as well as economic changes, major reforms, such as increased openness and transparency and improved financial market regulation, as well as minor reforms, li
ke the abolition of the clove monopoly in Indonesia.

  The IMF would claim that imposing these conditions was the responsible thing to do. It was providing billions of dollars; it had a responsibility to make sure not just that it was repaid but that the countries “did the right thing” to restore their economic health. If structural problems had caused the macroeconomic crisis, those problems had to be addressed. The breadth of the conditions meant that the countries accepting Fund aid had to give up a large part of their economic sovereignty. Some of the objection to the IMF programs was based on this, and the resulting undermining of democracy; and some were based on the fact that the conditions did not (and arguably were not designed to) restore the economies’ health. But, as we noted in chapter 6, some of the conditions had nothing to do with the problem at hand.

  The programs—with all of their conditions and with all of their money—failed. They were supposed to arrest the fall in the exchange rates; but these continued to fall, with hardly a flicker of recognition by the markets that the IMF had “come to the rescue.” In each case, embarrassed by the failure of its supposed medicine to work, the IMF charged the country with failing to take the necessary reforms seriously. In each case, it announced to the world that there were fundamental problems that had to be addressed before a true recovery could take place. Doing so was like crying fire in a crowded theater: investors, more convinced by the diagnosis of the problems than by the prescriptions, fled.5 Rather than restoring confidence that would lead to an inflow of capital into the country, IMF criticism exacerbated the stampede of capital out. Because of this, and the other reasons to which I turn shortly, the perception throughout much of the developing world, one I share, is that the IMF itself had become a part of the countries’ problem rather than part of the solution. Indeed, in several of the crisis countries, ordinary people as well as many government officials and business people continue to refer to the economic and social storm that hit their nations simply as “the IMF”—the way one would say “the plague” or “the Great Depression.” History is dated by “before” and “after” the IMF, just as countries that are devastated by an earthquake or some other natural disaster date events by “before” or “after” the earthquake.