Globalization and Its Discontents Revisited

by Joseph E. Stiglitz

  There were other gestures to reform, halfhearted or half-baked.8 As criticism of the large bailouts in the 1990s mounted, there was a succession of failed reforms. First came the precautionary lending package—lending before a crisis actually had occurred—to Brazil, which forestalled that country’s crisis but for a few months, and at great cost. Then there was the contingent credit line, another measure designed to have money ready when a crisis erupted.9 That too didn’t work, mainly because no one seemed interested in it on the proposed terms.10 It was recognized that the bailouts may have contributed to moral hazard, to weak lending practices, and so a bail-in strategy whereby creditors would have to bear part of the costs was put into place, though not for major countries like Russia, but rather for the weak and powerless, like Ecuador, Ukraine, Romania, and Pakistan. As I explained in chapter 12, by and large the bail-in strategies were a failure. In some cases, such as Romania, they were abandoned, though not until after considerable damage to that country’s economy; in other cases, like Ecuador, they were enforced, with even more devastating effects. The new U.S. Treasury secretary and the IMF’s new managing director both expressed reservations about the overall effectiveness of the large bailout strategy, but then went ahead with more of the same—$11 billion and $21.6 billion lent to Turkey and Argentina in 2000 and 2001, respectively. The eventual failure of the Argentine bailout seems to have finally forced the beginning of a rethinking of strategy.

  Even when there was widespread, but not universal, consensus on reforms, resistance arose from those in financial centers, sometimes supported by the U.S. Treasury. In the East Asia crisis, as attention was focused on transparency, it became clear that to know what was going on in emerging markets, one had to know what hedge funds and offshore banking centers were doing. Indeed, there was a worry that more transparency elsewhere would lead to more transactions going through these channels, and there would overall be less information about what was going on. Secretary Summers took the side of the hedge funds and the offshore banking centers, resisting calls for increased transparency, arguing that excessive transparency might reduce incentives for gathering information, the “price discovery” function in the technical jargon. Reforms in the offshore banking centers, established as tax and regulatory avoidance havens, only took on momentum after September 11. This should not come as a surprise; these facilities exist as a result of deliberate policies in the advanced industrial countries, pushed by financial markets and the wealthy.

  Other, even seemingly minor reforms faced strong resistance, sometimes from the developing as well as developed countries. As it became clear that short-term indebtedness played a key role in the crisis, attention focused on bond provisions that allowed what seemed to be a long-term bond to be converted into a short-term indebtedness overnight.11 And as demands for bail-in of creditors grew, so too did demands for provisions in bonds that would facilitate their “forced” participation in workouts, so-called collective action clauses. The bond markets have, so far successfully, resisted both reforms—even as these reforms have seemingly received some support from the IMF. The critics of these reforms argued that such provisions might make credit more costly to the borrowing country; but they miss the central point. Today, there are huge costs to borrowing, especially when things go badly, but only a fraction of those costs are borne by the borrower.

  What Is Needed

  The recognition of the problems has come a long way. But the reforms of the international financial system have only just begun. In my mind, among the key reforms required are the following:

  1. Acceptance of the dangers of capital market liberalization, and that short-term capital flows (“hot money”) impose huge externalities, costs borne by those not directly party to the transaction (the lenders and borrowers). Whenever there are such large externalities, interventions—including those done through the banking and tax systems12—are desirable. Rather than resisting these interventions, the international financial institutions should be directing their efforts to making them work better.

  2. Bankruptcy reforms and standstills. The appropriate way of addressing problems when private borrowers cannot repay creditors, whether domestic or foreign, is through bankruptcy, not through an IMF-financed bailout of creditors. What is required is bankruptcy reform that recognizes the special nature of bankruptcies that arise out of macroeconomic disturbances; what is needed is a super-Chapter 11, a bankruptcy provision that expedites restructuring and gives greater presumption for the continuation of existing management. Such a reform will have the further advantage of inducing more due diligence on the part of creditors, rather than encouraging the kind of reckless lending that has been so common in the past.13 Trying to impose more creditor-friendly bankruptcy reforms, taking no note of the special features of macro-induced bankruptcies, is not the answer. Not only does this fail to address the problems of countries in crises; it is a medicine which likely will not take hold—as we have seen so graphically in East Asia, one cannot simply graft the laws of one country onto the customs and norms of another. The problems of defaults on public indebtedness (as in Argentina) are more complicated, but again there needs to be more reliance on bankruptcies and standstills, a point that the IMF too seems belatedly to have accepted. But the IMF cannot play the central role. The IMF is a major creditor, and it is dominated by the creditor countries. A bankruptcy system in which the creditor or his representative is also the bankruptcy judge will never be accepted as fair.

  3. Less reliance on bailouts. With increased use of bankruptcies and standstills, there will be less need for the big bailouts, which failed so frequently, with the money either going to ensure that Western creditors got paid back more than they otherwise would, or that exchange rates were maintained at overvalued levels longer than they otherwise would have been (allowing the rich inside the country to get more of their money out at more favorable terms, but leaving the country more indebted). As we have seen, the bailouts have not just failed to work; they have contributed to the problem, by reducing incentives for care in lending, and for covering of exchange risks.

  4. Improved banking regulation—both design and implementation—in the developed and the less developed countries alike. Weak bank regulation in developed countries can lead to bad lending practices, an export of instability. While there may be some debate whether the design of the risk-based capital adequacy standards adds to the stability of the financial systems in the developed countries, there is little doubt that it has contributed to global instability, by encouraging short-term lending. Financial sector deregulation and the excessive reliance on capital adequacy standards has been misguided and destabilizing; what is required is a broader, less ideological approach to regulation, adapted to the capacities and circumstances of each country. Thailand was right to have restricted speculative real estate lending in the 1980s. It was wrong to encourage the Thais to eliminate these restrictions. There are a number of other restrictions such as speed limits (restrictions on the rate of increase of banks’ assets), which are likely to enhance stability. Yet the reforms cannot, at the same time, lose sight of the broader goals: a safe and sound banking system is important, but it must also be one that supplies capital to finance enterprise and job creation.14

  5. Improved risk management. Today, countries around the world face enormous risk from the volatility of exchange rates. While the problem is clear, the solution is not. Experts—including those at the IMF—have vacillated in the kinds of exchange-rate systems that they have advocated. They encouraged Argentina to peg its currency to the dollar. After the East Asia crisis, they argued that countries should either have a freely floating exchange rate or a fixed peg. With the disaster in Argentina, this advice is likely to change again. No matter what reforms occur to the exchange rate mechanism, countries will still face enormous risks. Small countries like Thailand buying and selling goods to many countries face a difficult problem, as the exchange rates among the major currencies vary by 50 percent or mo
re. Fixing their exchange rate to one currency will not resolve the problems; it can actually exacerbate fluctuations with respect to other currencies. But there are other dimensions to risk. The Latin American debt crisis in the 1980s15 was brought about by the huge increase in interest rates, a result of Federal Reserve Chairman Paul Volcker’s tight money policy in the United States. Developing countries have to learn to manage these risks, probably by buying insurance against these fluctuations in the international capital markets. Unfortunately, today the countries can only buy insurance for short-run fluctuations. Surely the developed countries are much better able to handle these risks than the less developed countries, and they should help develop these insurance markets. It would therefore make sense for the developed countries and the international financial institutions to provide loans to the developing countries in forms that mitigate the risks, e.g., by having the creditors absorb the risks of large real interest fluctuations.

  6. Improved safety nets. Part of the task of risk management is enhancing the capabilities of the vulnerable within the country to absorb risks. Most developing countries have weak safety nets, including a lack of unemployment insurance programs. Even in more developed countries, safety nets are weak and inadequate in the two sectors that predominate in developing countries, agriculture and small businesses, so international assistance will be essential if the developing countries are to make substantial strides in improving their safety nets.

  7. Improved response to crises. We have seen the failure of the crisis responses in the 1997–98 crisis. The assistance given was badly designed and poorly implemented. The programs did not take sufficiently into account the lack of safety nets, that maintaining credit flows was of vital importance, and that collapse in trade between countries would spread the crisis. The policies were based not only on bad forecasts but on a failure to recognize that it is easier to destroy firms than to recreate them, that the damage caused by high interest rates will not be reversed when they are lowered. There needs to be a restoration of balance: the concerns of workers and small businesses have to be balanced with the concerns of creditors; the impacts of policies on domestic capital flight have to balance the seemingly excessive attention currently paid to outside investors. Responses to future financial crises will have to be placed within a social and political context. Apart from the devastation of the riots that happen when crises are mismanaged, capital will not be attracted to countries facing social and political turmoil, and no government, except the most repressive, can control such turmoil, especially when policies are perceived to have been imposed from the outside.

  Most important, there needs to be a return to basic economic principles; rather than focusing on ephemeral investor psychology, on the unpredictability of confidence, the IMF needs to return to its original mandate of providing funds to restore aggregate demand in countries facing an economic recession. Countries in the developing world repeatedly ask why, when the United States faces a downturn, does it argue for expansionary fiscal and monetary policy, and yet when they face a downturn, just the opposite is insisted upon. As the United States went into a recession in 2001, the debate was not whether there should be a stimulus package, but its design. By now, the lessons of Argentina and East Asia should be clear: confidence will never be restored to economies that remain mired in deep recessions. The conditions that the IMF imposes on countries in return for money need not only to be far more narrowly circumscribed but also to reflect this perspective.

  There are other changes that would be desirable: forcing the IMF to disclose the expected “poverty” and unemployment impact of its programs would direct its attention to these dimensions. Countries should know the likely consequences of what it recommends. If the Fund systematically errs in its analyses—if, for instance, the increases in poverty are greater than it predicted—it should be held accountable. Questions can be asked: Is there something systematically wrong with its models? Or is it trying to deliberately mislead policy making?

  REFORMING THE WORLD BANK AND DEVELOPMENT ASSISTANCE

  Part of the reason that I remain hopeful about the possibility of reforming the international economic institutions is that I have seen change occur at the World Bank. It has not been easy, nor has it gone as far as I would have liked. But the changes have been significant.

  By the time I arrived, the new president, James Wolfensohn, was well on his way to trying to make the Bank more responsive to the concerns of developing countries. Though the new direction was not always clear, the intellectual foundations not always firm, and support within the Bank far from universal, the Bank had begun seriously to address the fundamental criticisms levied at it. Reforms involved changes in philosophy in three areas: development; aid in general and the Bank’s aid in particular; and relationships between the Bank and the developing countries.

  In reassessing its course, the Bank examined how successful development has occurred.16 Some of the lessons that emerged from this reassessment were ones that the World Bank had long recognized: the importance of living within one’s budget constraints, the importance of education, including female education, and of macroeconomic stability. However, some new themes also emerged. Success came not just from promoting primary education but also from establishing a strong technological basis, which included support for advanced training. It is possible to promote equality and rapid growth at the same time; in fact, more egalitarian policies appear to help growth. Support for trade and openness is important,17 but it was the jobs created by export expansion, not the job losses from increased imports, that gave rise to growth. When governments took actions to promote exports and new enterprises, liberalization worked; otherwise, it often failed. In East Asia, government played a pivotal role in successful development by helping create institutions that promote savings and the efficient allocation of investment. Successful countries also emphasized competition and enterprise creation over privatization and the restructuring of existing enterprises.

  Overall, the successful countries have pursued a comprehensive approach to development. Thirty years ago, economists of the left and the right often seemed to agree that the improvement in the efficiency of resource allocation and the increase in the supply of capital were at the heart of development. They differed only as to whether those changes should be obtained through government-led planning or unfettered markets. In the end, neither worked. Development encompasses not just resources and capital but a transformation of society.18 Clearly, the international financial institutions cannot be held responsible for this transformation, but they can play an important role. And at the very least, they should not become impediments to a successful transformation.

  Assistance

  But the way assistance is often given may do exactly that—create impediments to effective transitions. We saw in chapter 6 that conditionality—the imposition of a myriad of conditions, some often political in nature—as a precondition for assistance did not work; it did not lead to better policies, to faster growth, to better outcomes. Countries that think reforms have been imposed on them do not really feel invested in and committed to such reforms. Yet their participation is essential if real societal change is to happen. Even worse, the conditionality has undermined democratic processes. At last, there is a glimmering of recognition, even by the IMF, that conditionality has gone too far, that the dozens of conditions make it difficult for developing countries to focus on priorities. But while there has, accordingly, been an attempt to refine conditionality, within the World Bank the discussion of reform has been taken further. Some argue that conditionality should be replaced by selectivity, giving aid to countries with a proven track record, allowing them to choose for themselves their own development strategies, ending the micromanagement that has been such a feature of the past. The evidence is that aid given selectively can have significant impacts both in promoting growth and in reducing poverty.

  Debt Forgiveness

  The developing countries require not only th
at aid be given in a way that helps their development but also that there be more aid. Relatively small amounts of money could make enormous differences in promoting health and literacy. In real terms, adjusted for inflation, the amounts of development assistance have actually been declining, and even more so either as a percentage of developed country income or on a per capita basis for those in the developing countries. There needs to be a basis for funding this assistance (and other global public goods) on a more sustained level, free from the vagaries of domestic politics in the United States or elsewhere. Several proposals have been put forward. When the IMF was established, it was given the right to create Special Drawing Rights (SDRs), a kind of international money. With countries today wisely putting aside billions of dollars into reserves every year to protect themselves against the vicissitudes of international markets, some income is not being translated into aggregate demand. The global economic slowdown of 2001–02 brought these concerns to the fore. Issuing SDRs to finance global public goods—including financing development assistance—could help maintain the strength of the global economy at the same time that it helped some of the poorest countries in the world. A second proposal entails using the revenues from global economic resources—the minerals in the seabed and fishing rights in the oceans—to help finance development assistance.