Session 8
Joseph Stiglitz, Globalization and Its Discontents, 2002
Chapters 3 and 4
Chapter 3 – “Freedom to Choose?”
 The three pillars of the Washington Consensus – fiscal austerity, privatization and liberalization –
“became ends in themselves, rather than means towards more equitable and sustainable
growth.”
Privatization
 The IMF insisted on selling off state-run enterprises rapidly – countries that privatized fast
received praise. Fast, of course, did not mean more efficiently and at a lower social cost –
because of the negative results of many a blind privatization, the very idea gained notoriety.
 The IMF “simply assumed that markets arise quickly to meet every need, when in fact, many
government activities arise because markets have failed to provide essential services.”
 The IMF stance is that it is far more important to privatize quickly and deal with competition and
regulation issues later on. They fail to understand that once a vested interest has come to
dominate, it will use its power and influence to maintain its privileged position.
 The IMF also has a policy bias – its foremost concern is macroeconomic stability (e.g. budget
deficits). It does not seem to give a very high priority to matters of efficiency and
competitiveness.
 Usually, privatization destroys jobs in the short-term. The new private owners (particularly if they
are foreign) are not much concerned with the overall social cost of dismissing workers – they aim
to maximize their own profits.
 “Privatization needs to be part of a more comprehensive program, which entails creating jobs in
tandem with the inevitable job destruction that privatization often entails.” You need
macroeconomic policies that stimulate job creation (e.g. low interest rates).
 Corruption is also a massive problem – privatization becomes ‘briberization.’
 If you don’t have the “appropriate legal structures and market institutions,” the new private owners
“might have an incentive to strip assets rather than use them as a basis for expanding industry.”
Liberalization
 Even the IMF has started to acknowledge that its insistence of swift liberalization (of capital
markets) has been a cause of the financial crisis of the 1990s and has negatively affected a
number of small states.
 Liberalization (of trade) aims to develop a country’s comparative advantage but frequently results
in job loss alone, as low-productivity industries are eliminated. Sometimes, it is IMF’s own
austerity package that prevents the creation of new jobs (interest rates are too high).
 Advanced industrialized countries are often hypocritical; they demand worldwide liberalization of
industries that form the core of their export might, while at the same time they fail to dismantle
barriers in sectors that could be threatened by foreign competition.
 The Uruguay Round of trade negotiations was yet another example of a double standard – the
advanced countries insisted on liberalizations in financial services and IT (where they will be the
primary beneficiaries) but did not acquiesce to liberalize maritime, construction, and other
services (where LDCs [Less Developed Countries] could have gained a toehold).
 “Matters are perhaps even worse still when the USA acts unilaterally; [it] sets itself up as
prosecutor, judge, and jury.”
 Special interests undermine U.S. credibility and broader national interests.
 Premature, badly managed trade liberalization was bad for LDCs; capital market liberalization
was probably worse.
 IMF experts thought that capital liberalization would enhance stability by diversifying the sources
of funding. In light of the global financial crisis (which started in 1997), it is evident that this claim
is laughable.
 “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
 FDI does play an important role in creating growth.
 But… local firms cannot compete with the multinationals.
 After locals go bust, in the absence of strong and effectively enforced competition laws, the
internationals use monopoly power to hike up prices.
 Banking sector – if banks are foreign-controlled they tend to deprive local firms of much-needed
capital. (Argentina) “The challenge is not just to create sound banks but also to create sound
banks that provide credit for growth.”
 “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
stimulation and contract it when there are signs of overheating.”
 Sometimes foreigners coaxed governments into granting them special privileges, e.g. tariffs.
 In other cases, one government was called in to countervail the weight of another.
 Western governments have pushed “nations to live up to agreements that were vastly unfair to
the developing countries, and [were] often signed by corrupt governments in those countries.”
 Sometimes, FDI “comes only at the price of undermining democratic processes.”
 “Dutch Disease” – the inflow of investment can be harmful to development. (Inflow of capital
leads to currency appreciation – exports become too expensive and imports too cheap.)
Sequencing and Pacing
 Greatest IMF blunder – Washington’s belief in the market’s invisible hand is all too extreme. It
has been demonstrated that the conditions under which the invisible hand theory works are
“highly restrictive.” (Stiglitz received the 2001 Nobel Prize because of his analysis of ‘markets
with asymmetric information.’)
 In principle, “there are desirable government interventions which can improve the efficiency of the
market.”
 Issue of sequencing – “in some cases, reforms in one area, without accompanying reforms in
others, may actually make matters worse.”
 The IMF “does not acknowledge that development requires a transformation of society.” “The
power of systemic change” is severely underestimated. “Successful development pays careful
attention to social stability.” IMF ignored this and actually set back development in a number of
states.
Trickle-Down Economics
 The Washington Consensus was not concerned about fairness. The credo of market
fundamentalists was trickle-down economics – the idea that “eventually, the benefits of growth
will trickle down even to the poor.”
 The theory does have respectable intellectual origins.
o Arthur Lewis (a Nobel laureate) claimed that inequality was good for development
because the rich save more than the poor and it is capital accumulation that drives
growth.
o Simon Kuznets (another Nobel Prize winner) believed that in the initial stages of
development inequality was likely to rise. Later on the trend would reverse.]
 Empirical results from the last half a century have disproved these hypotheses. Not true that ‘a
rising tide lifts all boats.’
Priorities and Strategies
 IMF’s agenda – stabilization; taxation and its adverse effects. Ignores job creation and land
reform. “There is money to bail out banks but not to pay for improved education and health
services.”
 Land reform is a fundamental change in a society, one that “the elite that populates the finance
ministries” that the IMF works with does not necessarily like.
 Inadequate financial sector regulation. The pursuit of low inflation has sometimes been
‘overemphasized.’ (Latin America – the “excessive focus on inflation led to high interest rates and
high exchange rates, creating unemployment not growth.”
 The poverty vs. growth debate, in some ways, “seem[s] pointless. After all, almost everyone
believes in growth. The question has to do with the impact of particular policies.”
 There are some ‘win-win’ policies but many times there are trade-offs. A wise choice would
require an understanding of the “causes and the nature of poverty.”
 What is clear by now?
o “Trade liberalization accompanied by high interest rates is an almost certain recipe for job
destruction and unemployment creation – at the expense of the poor.
o Financial market liberalization unaccompanied by an appropriate regulatory structure is
an almost certain recipe for economic instability;” it can lead to higher interest rates, i.e.
poor will find it increasingly difficult to borrow and pull themselves by their own
bootstraps.
o Fiscal austerity, pursued blindly, in the wrong circumstances, can lead to high
unemployment and a shredding of the social contract.
 IMF policies, time and again, have destroyed the middle class, which is traditionally supportive of
the rule of law, universal public education, and the creation of a social safety net.
 IMF had “an overly optimistic view of the markets, it had an overly pessimistic view of
government.”
Chapter 4 – “The East Asia Crisis”
 “IMF policies not only exacerbated the downturns but were partially responsible for the onset:
excessive rapid financial and capital market liberalization was probably the single most important
cause of the crisis.”
 For a long time, IMF and WB “avoided” doing research in East Asia. WB’s The East Asian
Miracle was done only because of Japanese pressure and only “after the Japanese had offered
to pay for it.” The reason was “obvious” – East Asia developed because they had not followed
the advice of the Bretton Woods institutions.
 East Asian (EA) governments shared only one belief with Washington Consensus (WC) policies –
the importance of macrostability. Otherwise, while WC policies “emphasized a minimalist role for
government, in East Asia, governments helped shape and direct markets.
 EA governments did open up to trade but only gradually, as new jobs were created in the export
industries, which they heavily promoted. Capital market liberalization was also approached
without haste. Governments spearheaded the effort to modernize industry.
 Two pattern of the crises
o Korea – “self-fulfilling prophesy.” At first, there are rumors that Korea will not be able to
roll over its loans from Western banks. It does not have the reserves to repay them,
either. As a consequence of the growing uncertainty, banks refuse to reschedule
payments – Korea is in trouble.
o Thailand – “speculative attacks (combined with high short-term indebtedness).”
Speculators believe that a currency will devalue; they sell that currency for dollars,
flooding the market; the currency crashes. The government can use its foreign exchange
reserves to stop this (buying up the local currency) until its FOREX reserves run out.
 IMF provided enormous amounts of money (total bailout package was $95 billion) to “restore
confidence.” Alas, much of the money was used to “provide the firms that had borrowed from
Western bankers [with dollars] to repay the loans. It was, 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.” IMF cash to (temporarily) sustain a currency also had
another consequence – capital flight (rich people within a state exchange their cash into dollars
and move it abroad).
 In return for the rescue package, the IMF imposed strict conditions, undermining the economic
sovereignty of EA states.
 As the IMF’s programs failed, the Fund blamed the states. It claimed that fundamental problems
would have to be addressed before a true recovery can take place. “IMF criticism exacerbated
the stampede of capital out. [It] had become part of the problem rather than part of the solution.”
How IMF / U.S. Treasury Policies Led to the Crisis
 Capital liberalization was “the single most important factor leading to the crisis.” It was the IMF
and the U.S. Treasury that pushed for liberalization policies with all their might, even though
“there was little evidence that such policies promoted growth, and there was ample evidence that
they imposed huge risks on developing countries.”
 In essence, capital market liberalization subjects LDCs to “both the rational and the irrational
whims of the investor community, to their irrational exuberance and pessimism.” Keynes’s
“animal spirits” can run wild. Quick liberalization is very likely to be done poorly.
The First Round of Mistakes
 IMF misdiagnosed the problem – East Asia was not Latin America, i.e. dampening demand only
worsened the crises and did high interest rates.
 One way out of the crisis would have been to stimulate government spending (classical
Keynesian approach) and boost the overall level of demand – this is precisely what the IMF chiefs
argued against, insisting on the importance of balanced budgets. (Stiglitz – in a recessionary
period their stance is preposterous.)
 “By continuing to advocate contractionary policies the IMF exacerbated the contagion, the spread
of the downturn from one country to the next.”
 IMF recommended building up a trade surplus. This could not be achieved via tariffs or
devaluation (not welcomed by Washington) or increasing exports (virtually impossible considering
the region-wide recession).
 The only other option – cut imports by cutting income. This led to a deterioration of the regional
recession but also to “huge trade surpluses, giving the countries the resources to pay back
foreign creditors.”
 A severe letdown for those who believed that the IMF could maintain ‘confidence’ and stop
‘contagion.’ “The greatest betrayal of its entire raison d’être.”
 IMF now agrees that its “fiscal policies were excessively contractionary but it does not own up to
the mistakes of monetary policy.” IMF recommended high interest rates, which were supposed to
attract foreign capital and support the exchange rate.
 This was a simplistic argument. The Fund recognized that “the underlying problems were weak
financial institutions and overleveraged firms” but the high interest rates that it advocated actually
aggravated the problem – more firms went bust and, hence, banks had to deal with more
nonperforming loans. The IMF “engineered a simultaneous contraction in aggregate demand and
supply.”
 In addition to putting the economy into a tailspin, higher interest rates drove capital out of the
region.
The Second Round of Mistakes – IMF’s “restructuring” mantra
 As far as the financial sector is concerned, IMF’s mistake was to insist on shutting down weak
banks. Even in advanced industrialized countries, closing banks is an action of last resort – they
can be recapitalized, taken over by or merged into other banks.
 The “fallacy of composition” – when only one bank has a problem meeting the capital adequacy
ratio, such an approach may make sense. When most of the banks are in trouble, the policy is
disastrous – in a recession banks cannot just increase capital. They must, therefore, reduce
loans. As this happens, more and more firms are put into distress. The result is a downward
spiral.
 Corporate restructuring was also a disaster in countries that followed the IMF’s advice. Stiglitz
believes that, in a recessionary economy, the government should be involved in financial
restructuring (“straightening out who really owns the firm, the discharge of debt or its conversion
to equity”) rather than real restructuring (“the nuts-and-bolts decisions: what the firm should
produce, how it should produce and how it should be organized”). IMF had the opposite idea.
The Most Grievous Mistakes: Risking Social and Political Turmoil
 “IMF showed that it had not learned the basic lesson of ‘irreversibility.’” “A society that is
rendered asunder by riots induced by cutting out food subsidies just as it is plunging into
depression is not brought together when the food subsidies are restored.” (This occurred in
Indonesia).
Recovery: Vindication of the IMF Policies?
 It is painfully obvious that IMF policies were wrong because the more countries followed them,
the longer it took them to recover.
 “It is no accident that the only major East Asian country, China, to aver the crisis took a course
directly opposite that advocated by the IMF and that the country with the shortest downturn,
Malaysia, also explicitly rejected an IMF strategy.”
 Effects on the future – some positives, of course. States will now develop better financial
regulatory systems and better financial institutions overall. Corruption is likely to go down and
firms are expected to emerge even more competitive.
 Generally, however, “the IMF’s policies are likely to have impaired the overall efficiency of the
market. [They] lead to less efficient resource allocation, particularly capital allocation, which is
the scarcest resource in developing countries.”
Explaining the Mistakes
 The IMF was “not participating in a conspiracy but it was reflecting the interests and ideology of
the Western financial community.”
 Magnitude of failures is partially explained by the hubris of Fischer, Summers, Rubin, etc.
An Alternative Strategy
 Maintain the economy at as close to full employment as possible. This leads to an expansionary
(or at least not contractionary) fiscal and monetary policy.
 Maintain flow of finance; a stand-still on existing debt repayment.
 A special bankruptcy provision aimed at the quick resolution of distress.
 Strong government intervention to establish clear ownership of firms would eliminate incentives
for asset stripping.