CHAPTER 6
1. Mengistu’s regime is blamed for killing at least 200,000 persons, according to Human Rights Watch, and for forcing about 750,000 citizens to become refugees.
2. For a more extensive discussion of the Ethiopia episode, see Robert Hunter Wade, “Capital and Revenge: The IMF and Ethiopia,” Challenge 44 (5) (September 1, 2001), pp. 67–75.
3. T. Lane, A. Ghosh, J. Hamann, S. Phillips, M. Schulze-Ghattas, and T. Tsikata, “IMF-Supported Programs in Indonesia, Korea, and Thailand: A Preliminary Assessment,” Occasional Paper 178, International Monetary Fund, January 1999.
4. The list of criticisms of conditionality discussed below is not meant to be comprehensive. See, for instance, M. Goldstein, “IMF Structural Conditionality: How Much Is Too Much,” revision of the paper presented at the 2000 NBER conference on “Economic and Financial Crises in Emerging Market Economies,” Woodstock, Vermont, October 19–21. The IMF and the World Bank have come to question conditionality, both its effectiveness and the consequences of excessive conditions. See, e.g., IMF, “Strengthening Country Ownership of Fund-Supported Programs,” December 5, 2001, and World Bank, Assessing Aid: What Works, What Doesn’t Work, and Why (Oxford: Oxford University Press, 1998).
5. There is considerable controversy about whether central banks should or should not be more independent. There is some evidence (based on cross-country regressions) that inflation rates may be lower, but there is little evidence that real variables, like growth or unemployment, are improved. My point here is not to resolve these disputes, but to emphasize that, given that there is such controversy, a particular view should not be imposed on the country.
CHAPTER 7
1. To take one example, see Peter Waldman and Jay Solomon, “How U.S. Companies and Suharto’s Circle Electrified Indonesia—Power Deals That Cut in First Family and Friends Are Now Under Attack,” Wall Street Journal, December 23, 1998, p. 1.
2. Adam Smith put forward the idea that markets by themselves lead to efficient outcomes in his classic book, The Wealth of Nations, written in 1776, the same year as the Declaration of Independence. The formal mathematical proof—specifying the conditions under which it was true—was provided by two Nobel Prize winners, Gerard Debreu of the University of California at Berkeley (Nobel laureate in 1983) and Kenneth Arrow of Stanford University (Nobel laureate in 1972). The basic result, showing that when information is imperfect or markets are incomplete, competitive equilibrium is not (constrained Pareto) efficient, is due to B. Greenwald and J. E. Stiglitz, “Externalities in Economies with Imperfect Information and Incomplete Markets,” Quarterly Journal of Economics 101 (2) (May 1986), pp. 229–64.
3. See W. A. Lewis, “Economic Development with Unlimited Supplies of Labor,” Manchester School 22 (1954), pp. 139–91, and S. Kuznets, “Economic Growth and Income Inequality,” American Economic Review 45(1) (1955), pp. 1–28.
CHAPTER 8
1. For some contrasting views, see Paul Krugman, “The Myth of Asia’s Miracle: A Cautionary Fable,” Foreign Affairs (November 1994), and J. E. Stiglitz, “From Miracle to Crisis to Recovery: Lessons from Four Decades of East Asian Experience,” in J. E. Stiglitz and S. Yusuf, eds., Rethinking the East Asian Miracle (Washington, DC, and New York: World Bank and Oxford University Press, 2001), pp. 509–26; or J. E. Stiglitz, “Some Lessons from the East Asian Miracle,” World Bank Research Observer 11 (2) (August 1996), pp. 151–77. See also World Bank, The East Asian Miracle: Economic Growth and Public Policy (New York: Oxford University Press, 1993); Alice Amsden, The Rise of “the Rest”: Challenges to the West from Late-Industrialization Economies (New York: Oxford University Press, 2001); and, Masahiko Aoki, Hyung-Ki Kim, Okuno Okuno-Fujiwara, and Masahjiro Okuno-Fjujiwara, eds., The Role of Government in East Asian Economic Development: Comparative Institutional Analysis (New York: Oxford University Press, 1998). For an extremely readable account of the East Asia crisis, see Paul Blustein, The Chastening: Inside the Crisis that Rocked the Global Financial System and Humbled the IMF (New York: Public Affairs, 2001). More technical discussions are provided, e.g., in Morris Goldstein, The Asian Financial Crisis: Causes, Cures, and Systemic Implications (Washington, DC: International Institute for Economics, 1998), and Jason Furman and Joseph E. Stiglitz, Brookings Papers on Economic Activity, presented at Brookings Panel on Economic Activity, Washington, DC, September 3, 1998, vol. 2, pp. 1–114.
2. Since the U.S. economy was not affected, the United States did not offer any assistance, in marked contrast to the generous treatment it had given Mexico in its last crisis. This gave rise to enormous resentment in Thailand. Especially after the strong support it had provided the United States during the Vietnam War, Thailand thought it deserved better treatment.
3. See E. Kaplan and D. Rodrik, “Did the Malaysian Capital Controls Work?,” working paper no. W8142 National Bureau of Economic Research, Cambridge, Mass., February 2001. It is possible to find this paper at Professor Rodrik’s Web site, http://ksghome.harvard.edu/~.drodrik.academic.ksg/papers.html).
4. Korea received $55 billion, Indonesia $33 billion, and Thailand $17 billion.
5. See J. Sachs, “The Wrong Medicine for Asia,” New York Times, November 3, 1997, and “To Stop the Money Panic: An Interview with Jeffrey Sachs,” Asiaweek, February 13, 1998.
6. In 1990, foreign direct investment ($ millions) was 24,130; in 1997, it was 170,258, and in 1998, 170,942; portfolio investment in 1990 ($ millions) was 3,935, rising to 79,128 in 1997, and 55,225 in 1998. Bank and trade related investment was 14,541 in 1990, 54,507 in 1997, and 41,534 in 1998. Total private capital flows (in $ millions) 42,606 in 1990, 303,894 in 1997, and 267,700 in 1998. From World Bank, Global Development Finance 2002.
7. On factors involved in financial and banking crises, see, e.g., D. Beim and C. Calomiris, Emerging Financial Markets (New York: McGraw-Hill/Irwin, 2001), chapter 7; A. Demirguc-Kunt and E. Detragiache, The Determinants of Banking Crises: Evidence from Developing and Developed Countries, IMF Staff Papers, vol. 45, no. 1 (March 1998); G. Caprio and D. Klingebiel, “Episodes of Systemic and Borderline Financial Crises,” World Bank, October 1999; and World Bank Staff, “Global Economic Prospects and the Developing Countries 1998/99: Beyond Financial Crisis,” The World Bank, February 1999.
8. M. Camdessus, “Capital Account Liberalization and the Role of the Fund,” remarks at the IMF Seminar on Capital Account Liberalization, Washington, DC, March 9, 1998.
9. The American slowdown of 2000–2001 too has been traced to excessive market exuberance, an overinvestment in Internet and Telecom brought on in part by soaring stock prices. Marked fluctuations in the economy can arise even in the absence of mismanagement of financial institutions and monetary policy.
10. The debate surrounding Korea was part of a broader debate about capital market liberalization and the bailouts that follow when things go wrong, as they inevitably do—a debate that was held within the IMF and the U.S. government almost completely behind closed doors. It occurred repeatedly, for instance, as we prepared for regional trade agreements and for G-7 meetings. On the one occasion (the Mexican 1995 crisis) when Treasury brought the issue of bailouts to Congress and Congress rejected the proposal, Treasury went back to its usual closed quarters, figured out a way of proceeding with the bailout without congressional approval, and strong-armed other governments to participate (in a manner that engendered large hostility in many European quarters—the full ramifications of the strongarm tactics of the U.S. Treasury have played out slowly over the ensuing years, as U.S. positions in a variety of contexts have subtly been opposed, e.g., the choice of the head of the IMF). The issues are complicated, but the U.S. Treasury almost seemed to revel in its ability to outsmart Congress.
11. In IMF, Annual Report of the Executive Board for the Financial Year Ended April 30, 1998 (Washington, DC), p. 25, some IMF directors doubted the need for strict fiscal policies during the Asian crisis because these countries did not experience fiscal imbalance. Interestingly, the IMF
in its similar report for 2000 recognized (p. 14) that an expansionary fiscal policy is behind the recovery from the crisis of Korea, Malaysia, and Thailand. See also T. Lane, A. Ghosh, J. Hamann, S. Phillips, M. Schulze-Ghattas, and T. Tsikata, “IMF-Supported Programs in Indonesia, Korea, and Thailand: A Preliminary Assessment,” Occasional Paper 178, International Monetary Fund, January 1999.
12. Stanley Fischer, “Comment & Analysis: IMF—The Right Stuff. Bailouts in Asia Are Designed to Restore Confidence and Bolster the Financial System,” Financial Times, December 16, 1997.
13. Over the years, I have never heard a coherent defense of the IMF’s strategy of raising interest rates in countries with highly leveraged firms from any IMF staffers. The only good defense I did hear was from Chase Securities chief economist John Lipsky, who focused explicitly on imperfections of capital markets. He observed that domestic businessmen typically kept large amounts of money abroad but borrowed domestically. The high interest rates on the domestic loans would “force” them to bring back some of their foreign funds in order to pay off the loans and avoid paying such rates. This hypothesis has not yet been evaluated. Certainly for several of the crisis countries, net capital flow moved in the opposite direction. Many business people assumed that they simply could not be “forced” to pay the high interest rates and that there would have to be renegotiation. In effect, the high interest rates were not credible.
14. The Ministry of Finance official in charge, Eisuke Sakakibara, has subsequently written his own interpretation of the events in E. Sakakibara, “The End of Market Fundamentalism,” Speech delivered at Foreign Correspondents Club, Tokyo, January 22, 1999.
15. For further details, see E. Kaplan and D. Rodrik, “Did the Malaysian Capital Controls Work?,” op. cit.
16. During this crisis period, foreign direct investment to Malaysia showed a pattern similar to other countries affected by the crisis and in the region. Nonetheless, the evidence is still too preliminary to draw solid conclusions. A deeper econometric study (and more data) is required in order to disentangle the effect of capital controls on foreign direct investment from other factors that affect foreign direct investment.
CHAPTER 9
1. Much of this and the next two chapters is based on work reported more extensively elsewhere. See the following papers: J. E. Stiglitz, “Whither Reform? Ten Years of the Transition” (Annual World Bank Conference on Development Economics, 1999), in Boris Pleskovic and Joseph E. Stiglitz, eds., The World Bank (Washington, DC, 2000), pp. 27–56; J. E. Stiglitz, “Quis Custodiet Ipsos Custodes? Corporate Governance Failures in the Transition,” in Pierre-Alain Muet and J. E. Stiglitz, eds., Governance, Equity and Global Markets, Proceedings from the Annual Bank Conference on Development Economics in Europe, June 1999 (Paris: Conseil d’Analyse economique, 2000), pp. 51–84. Also published in Challenge 42 (6) (November/December 1999), pp. 26–67. French version: “Quis custodiet ipsos custodes? Les defaillances du gouvernement d’entreprise dans la transition,” Revue d’Economie du Developpement 0 (1–2) (June 2000), pp. 33–70. In addition, see D. Ellerman and J. E. Stiglitz, “New Bridges Across the Chasm: Macro- and Micro-Strategies for Russia and other Transitional Economies,” Zagreb International Review of Economics and Business 3(1) (2000), pp 41–72, and A. Hussain, N. Stern, and J. E. Stiglitz, “Chinese Reforms from a Comparative Perspective,” in Peter J. Hammond and Gareth D. Myles, eds., Incentives, Organization, and Public Economics. Papers in Honour of Sir James Mirrlees (Oxford and New York: Oxford University Press, 2000), pp. 243–77.
For excellent journalistic accounts of the transition in Russia, see Chrystia Freeland, Sale of the Century (New York: Crown, 2000); P. Klebnikov, Godfather of the Kremlin, Boris Berezovsky and the Looting of Russia (New York: Harcourt, 2000); R. Brady, Kapitalizm: Russia’s Struggle to Free Its Economy (New Haven: Yale University Press, 1999); and John Lloyd, “Who Lost Russia?,” New York Times Magazine, August 15, 1999.
A number of political scientists have offered analyses broadly agreeing with the interpretations provided here. See, in particular, A. Cohen, Russia’s Meltdown: Anatomy of the IMF Failure, Heritage Foundation Backgrounders No. 1228, October 23, 1998; S. F. Cohen, Failed Crusade (New York: W. W. Norton, 2000); P. Reddaway, and D. Glinski, The Tragedy of Russia’s Reforms: Market Bolshevism Against Democracy (Washington, DC: United States Institute of Peace, 2001); Michael McFaul, Russia’s Unfinished Revolution: Political Change from Gorbachev to Putin (Ithaca, N.Y.: Cornell University Press, 2001); Archie Brown and Liliia Fedorovna Shevtskova, eds., Gorbachev, Yeltsin and Putin: Political Leadership in Russia’s Transition (Washington, DC: Carnegie Endowment for International Peace, 2000); and Jerry F. Hough and Michael H. Armacost, The Logic of Economic Reform in Russia (Washington, DC: Brookings Institution, 2001).
Not surprisingly, a number of reformers have provided accounts that differ markedly from those presented here, though such interpretations were more frequent in the earlier, more hopeful days of the transition, some with titles that seem to jar with subsequent events. See, e.g., Anders Aslund, How Russia Became a Market Economy (Washington, DC: Brookings Institution, 1995) or Richard Layard and John Parker, The Coming Russian Boom: A Guide to New Markets and Politics (New York: The Free Press, 1996). For more critical perspectives, see Lawrence R. Klein and Marshall Pomer, eds. (with a foreword by Joseph E. Stiglitz), The New Russia: Transition Gone Awry (Palo Alto, Calif.: Stanford University Press, 2001).
Data cited in this chapter come largely from the World Bank, World Development Indicators and Global Development Finance (various years).
2. Janine R. Wedel, “Aid to Russia,” Foreign Policy in Focus 3 (25), Interhemispheric Resource Center and Institute Policy Studies, September 1998, pp. 1–4.
3. For further reading, see P. Murrell, “Can Neo-Classical Economics Underpin the Economic Reform of the Centrally Planned Economies?” Journal of Economic Perspectives 5(4) (1991), pp 59–76.
4. See International Monetary Fund, “IMF Approves Augmentation of Russia Extended Arrangement and Credit Under CCFF, Activates GAB,” Press release no. 98/31, Washington, DC, July 20, 1998.
5. There is an argument that the IMF really did not ignore this. In fact, some believe that the Fund was trying to close the devaluation option by making the cost of devaluation so high that the country would not do it. If this was indeed the argument, the IMF miscalculated badly.
6. There was, of course, more to the Russian government’s announcement of August 17, but these were among the central features for our purposes. In addition, the Russian government established temporary controls of capital such as a prohibition on nonresidents investing in short-term ruble assets and a ninety-day moratorium on foreign exchange credit and insurance payments. The Russian government also announced its support to a payment pool set up by the largest Russian banks in order to maintain the payment stability and sent legislation for timely payments to government employees and for the rehabilitation of banks. For details, see the Web site www.bisnis.doc.gov/bisnis/country/980818ru.htm, which provides the original texts of the two public announcements on August 17, 1998.
7. See the Web site of the Institute for the Economy in Transition, at http://www.iet.ru/trend/12-99/3_e.htm.
8. See Chrystia Freeland, op. cit.; Richard Layard and John Parker, op. cit.; and Anders Aslund, op. cit.
9. For the implications and costs that barter imposes on the Russian economy, see C. G. Gaddy and B. W. Ickes, “Russia’s Virtual Economy,” Foreign Affairs 77 (September–October 1998).
10. The transition has not appeared to benefit the poor. For example, the lowest quintile of the population had a share of income equal to 8.6 percent in Russia (in 1998), 8.8 percent in Ukraine (in 1999), 6.7 percent in Kazakhstan (in 1996) (World Bank, World Development Indicators 2001).
11. Using a standard measure of inequality (the Ginii coefficient), by 1998 Russia had achieved a level of inequality twice that of Japan, 50 percent greater than UK and other European countries, a level comp
arable to Venezuela and Panama. Meanwhile, those countries that had undertaken gradualist policies, Poland and Hungary, had been able to keep their level of inequality low—Hungary’s was even lower than Japan’s and Poland’s lower than the UK’s. See Angus Maddison, The World Economy: A Millenial Perspective (Paris: Organisation for Economic Co-operation and Development, 2001).
12. See Stiglitz, “Quis Custodiet Ipsos Custodes?” op. cit.
13. For instance: If one liberalizes capital markets before an attractive investment climate is created at home—as the IMF recommended—one is inviting capital flight. If one privatizes firms before an efficient capital market is created at home, in a way that puts ownership and/or control in the hands of those who are nearing retirement, there is no incentive for long-term wealth creation; there are incentives for asset stripping. If one privatizes before creating a regulatory and legal structure for ensuring competition, there are incentives to create monopolies, and there are political incentives to prevent the creation of an effective competition regime. If one privatizes in a federal system, but leaves state and local authorities free to impose taxes and regulations at will, one has not eliminated the power, and incentives, of public authorities to extract rents; in a sense, one has not really privatized at all.
14. For the Coase theorem itself, see R. H. Coase, “The Problem of Social Cost,” Journal of Law and Economics 3 (1960), pp. 1–44. This theorem holds only where there are no transactions costs, and no imperfections of information. Coase himself recognized the force of these limitations. Moreover, it is never possible fully to specify property rights, and this was especially true for the economies in transition. Even in advanced industrialized countries, property rights are circumscribed by concerns for the environment, worker rights, zoning, and so forth. Although the law may try to be as clear on these matters as possible, disputes frequently arise, and have to be settled through legal processes. Fortunately, given the “rule of law,” there is general confidence that this is done in a fair and equitable manner. But not so in Russia. See A. Shleifer and R. Vishny, The Grabbing Hand: Government Pathologies and Their Cures (Boston: Harvard University Press, 1999) for an articulation of the view that once property rights are granted, there will be strong forces for the creation of the rule of law. For a more extended discussion of Coase’s theorem and the role it played in reasoning about appropriate privatization strategies, see J. E. Stiglitz, Whither Socialism (Cambridge: MIT Press, 1994); J. E. Stiglitz, “Whither Reform? Ten Years of the Transition,” op. cit; J. E. Stiglitz, Quis Custodiet Pisos Custodes, op. cit.; and J. Kornai, “Ten Years After ‘The Road to a Free Economy’, The Author Self-Evaluation,” in Boris Pleskovic and Nicholas Stern, eds., Annual World Bank Conference on Development Economics 2000 (Washington, DC: World Bank, 2001), pp. 49–66.
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