INSTITUTE FOR DEVELOPMENT POLICY AND MANAGEMENT: Events   Joseph Stiglitz Lecture   Globalisation and its Discontents: How to Fix What's Not Working   IDPM, University of Manchester, UK 4 April 2001   Download MS Word Version (126KB) 
  What I want to talk in particular about is the global movement toward protest about globalisation, that perhaps got crystallised most recently in the riots that occurred in Seattle in December of 1999, at the occasion of the beginning of a new round of trade negotiations. Those of you who follow this know that those protests were followed last spring by protests in Washington and this September in Prague, and were all concerned with various aspects of globalisation and the impact on the developed poor and especially poor in developing countries.
  What I want to try to argue is that, in fact, there is much to what the protesters argue that has a lot of merit to it and that one needs to pay a considerable amount of attention to the underlying grievances that are being brought out. The central thesis that I am going to put forward is that globalisation can be a very powerful and positive force for the poor and for the poor countries. But the way that globalisation has impinged in the last quarter of a century on the developing countries and particularly the poor has been markedly to their disadvantage. One needs therefore to rethink the system that we currently have, and if that re-thinking is done in the right way then in fact globalisation can live up to its potentials. 
  The protesters against globalisation have had a number of complaints. They have said that the system is unfair, that the system is one which has advantaged the developed countries at the expense of the less developed. The rich at the expense of the poor. That the system is undemocratic. That the system is non-transparent. That special interest have prevailed over general interest and that even the interests of the more developed countries have often not been well served. It has been the interests of special interest within the developed countries that have primarily been the beneficiaries. And the view is that the way that globalisation has proceeded, the policies that have been put into place, reflects a combination of the special interests in a particular perspective of an ideology which have not worked well to a broader set of interests. I think each of these charges has a great deal of validity to it. Mixed in with these complaints are a number of other complaints, which have
 less validity and one should not confuse the fact that, whenever you have a mass demonstration you attract all kinds of people to those demonstrations and that some of the people are no more than modern versions of Luddites, not wanting technical change to occur, not wanting change to occur, not wanting to open up markets, and wanting to pursue protectionist policies. But the fact that there are, mixed in with the legitimate complaints, some illegitimate ones, should not make us lose sight of what are the fundamental concerns. It is also the case that a protest movement in the street is not a place where you are going to have meaningful dialogue on what should be done. The purpose of the street protests was merely to say that there were some values and concerns that political leaders in the developed as well as the developing countries were not putting enough emphasis on and that they ought to think through how the policies that they were pursuing had the effects that I just
 described. 
  In that sense, I think the protests have actually been remarkably successful. There has been a fundamental rethinking, they did succeed in gaining mass media press to put a lot of attention to describing what was going in developing countries. So, it is one of the cases when people feel that the ordinary channels of communicating with elected leaders are not working very effectively, that protest movements can be quite effective in mobilising public opinion and in changing the course of the debate.
  Now as I said, my own view is that globalisation can be a very powerful, positive force. That is nowhere illustrated more effectively than if you look at the region of the world in which there has been the most successful development, namely, East Asia. East Asia’s growth has been largely based on taking advantage of globalisation. But they have taken advantage of globalisation on their own terms and have developed their own policies. An example of this is China. China has for the last twenty years been growing at double digit growth rates. The benefits of growth in China have been very widespread so that the poverty rate in China has plummeted enormously, the number of people in poverty has been reduced more than probably anywhere else in the world in such a short span of time. In countries like Korea, even after the crisis, per capita incomes are something like eight fold what they were thirty years ago. Thirty years ago Korea’s per capita income was actually lower than that of
 India. Today Korea is a member of the OECD and a major economic country. The remarkable thing is that each of these countries’ growth was based on exports – exports to the United States, to Europe – and in that sense they were partaking of globalisation, of the opportunities that were afforded by global markets. But the countries of East Asia set the terms on which they engage the rest of the world themselves. They do not have the terms set by the IMF or by any other international financial institutions and that, I would argue, is the major difference between their success and the failures of much of the rest of the world.
  The second theme that I am going to try to bring out is that the reason for the failures that are so pervasive around the world, is that the way the global decisions have been made determining how the global economic system works, have primarily been made within a set of institutions which are non-transparent, non-democratic and reflect special interests. And so, in that sense, the outcome is almost a predictable outcome of the way the system of governance has been established. One way of thinking about the problem is globalisation as a generic term that we use to refer to the fact that over the last ten, twenty years there has been an enormous reduction in transportation costs, communication costs and the artificial barriers to trade and that has led to huge increases of trade, capital flows and knowledge flows. So it has many dimensions – capital labour knowledge – in some cases, even labour. 
  One hundred and fifty years ago in many other parts of the world there was a process that was in some ways analogous to the process of globalisation. In the United States there was the formation of the national economy, the building of the rail roads, the development of the telegraph, all of which reduced transportation costs and communication cost within the United States, and as that process of what you might call nationalisation occurred there was a national government that could take a role in oversight, in supervising and regulating and making sure that things were done in a reasonable way, that there were not too many adverse consequences of this very large change in economic structure. So for instance, in 1863 the US government established the first financial banking regulatory authority – the office of the controller – because it was important to have national banks, and if you are going to have strong national banks you have to have strong regulation. 
  The United States set up other policies – we established an industrial policy, the beginning of the telecommunications industry with the first telegraph line between Baltimore and Washington funded by the federal government. And it is a tradition that has continued with the federal government in the US founding the Internet. Agriculture, the central industry of the United States at that time, was vastly supported by an Act, the Morell Act, which established extension and teaching programmes in agriculture. That system worked quite well. The contrast is that at the current time we have this process of globalisation but we have a system of what I call global governance without global government. We have a set of international institutions like the WTO, the IMF, The World Bank, and a number of other international institutions. They provide an ad hoc system of global governance but it is a far cry from global government. It works in some ways and in some cases it works better than not
 having any system of global governance. But the very nature of the way it is set up results, I would argue, in it being both non democratic and non transparent and reflecting special interests and it is because of that that the system that we have today has worked so badly.
  What I want to do now is to try to give an appraisal of why it is that I think it has worked so badly, why I think that the complaints and the marchers have some legitimacy. One can look at it from two different perspectives. There have been three issues that have dominated discussions in the last decade. One is development, another is the transition from communism to a market economy, and the third is crisis – the global financial crisis of 1997 being the most important. In each of these areas, things have not worked as well as one would have liked. Let me very briefly try to summarise the ways in which I think that they have not worked well. 
  In the context of development, the example of East Asia shows very dramatically that development is possible, but if you look around the world we also see clearly that development is not inevitable, that in fact, the number of people in poverty has actually increased over the last decade. The good news is that the percentage is down but the increase in population has more than swamped that. And so the absolute number of people in poverty has actually increased. 
  There have been, as I said, some remarkable successes not only in East Asia. There is one country in Africa that has grown at close to double digit rates for thirty years and that is Botswana. You might ask, what do Botswana and China have in common? The simple answer is neither of them have ever had an IMF programme! But when I say that, some people say that Botswana has diamonds and all you need is diamonds. But there is another country in Africa which has diamonds and that is Sierra Leone. In fact, if you look across Africa, across other countries like Russia, what you see is that there is a negative correlation between resources and growth. That seems very strange to an economist because for an economist more resources means more wealth and you ought to be growing, you ought to be doing better. How do we have this seeming inconsistency that says that what we talk about all the time doesn’t seem to be the most important thing. We wish it weren’t true but how do you explain that.
 One way is to ignore it. The way you would explain it is that when you have lots of natural resources there is a tendency to fight over those natural resources – to fight over the rents. You can do just as well by fighting over the rents privately as you can from wealth creation. It is a lot easier to try to divide a pie than to create a bigger pie. And that is what you have seen in Nigeria, in Sierra Leone, that is what you are seeing in Russia today. So the access to more resources, the availability of more resources is not a sure-fire recipe, in fact, it’s a recipe for disaster. 
  What did Botswana do that was different? Well, Botswana had advisors who were, to tell the story very briefly, from the Ford Foundation, who early on took the view that an essential part of the strategy was building a national consensus in democratic development. Whenever they went into the country, rather than just talking to the finance minister they would have seminars and they would talk to large groups of people. One of the things that they recommended was that the country start building up reserves because it was very dependent on two natural resources, diamonds and cattle, both of which were subjected to high volatility. When you have highly volatile industries you want to build up reserves and so they did that and then they had the bad year. Seven good years followed by seven lean years – they had read the biblical story – and now they had the reserves they were supposed to draw from to get through this bad patch. But the IMF said ‘no, your reserves are there because you
 need reserves’. And they said ‘why do we need reserves except for when we want to use them?’ The IMF said ‘no you have to suffer’. I know it may not be politically correct but I think it was part of this protestant ethic of salvation through suffering! So they said that you have to do all these things which will put your economy into recession and that people will really feel the pain and that will be good for you. But Botswana had correctly said, ‘we’re a young democracy, if we do that some people are going to suffer more than others. Then our whole social consensus will fall apart and it will be a disaster’. So they told the IMF to go packing and they said ‘we would rather tighten the belt ourselves, do it ourselves, use up some of our reserves and then get through this and at least create a sense of national unity.’ And they did that and they have grown now for the eighteen years after that. I told that story partly because it shows the importance of the link between society and
 economic development that cannot be ignored and I will come back to that theme in talking about the next two issues.
  Let me talk about transition. Transition, in a way, for an economist was the most interesting set of ideas because everybody recognised how terrible communism was and how inefficient an economic system it was. Clearly, the information required for making an economy work could not be centralised. The system of public ownership deprived everybody of incentives, so there was a lack of incentives. Finally, they had all kinds of distortions – the trade with COMECON, the whole energy prices were low and everything was a completely distorted economy. So the Washington consensus which focuses on privatisation and liberalisation along with macro stability was supposed to be a sure-fire guarantee for increases in income. You get rid of these distortions, you put in incentives and the theory was you move out. They were operating well below the production possibility schedule, well below their potential. In the long run the gains would be even greater because right now they had inherited a
 very distorted capital stock. In the long run they would start re-directing their capital stock so that their production possibility schedule would go up and they would attract investment from abroad, all kinds of things would go on that would start a resurgence of economic growth.
  Moreover, because in Russia they have been spending such a large fraction of their GDP on military, by cutting back on military, standards of living would go up even more because they are moving along their production possibilities from ‘guns to butter’ as we sometimes say, to more consumption. So, the prediction was very clear that there would be marked increases in standards of living. Some people were worried that there would be a short transition recession. It is difficult to move/reallocate resources and that might mean that things would go down for a little while, but the experience in other countries moving out of wartime situations, with a huge reallocation of resources such as in the United States, showed that you could actually do transition with very little or no significant transitional recession, if it’s done well. 
  What has happened in the decade eight years since the beginning of the transition? Lets talk about Russia for instance where it is most dramatic. Russia’s GDP today is down 40 per cent from what it was eight years ago. No war has ever lead to that magnitude of destruction in GDP in a major country. But its not only that their GDP is lower, it is much more unequally distributed. People thought that there would be some inequality that would increase but they said at least they have the advantage of not having the feudal heritage like Latin America where you have a long standing inequality coming from hundreds of years. They are beginning from a more equal base. But in eight years they were able to do what took other countries centuries to do in creating an equality, and so they now have a level of inequality that is comparable to Latin America. It’s a remarkable achievement in some ways. 
  But if you focus on poverty the achievement is even greater because ten years ago 2 per cent of the population was in poverty. Ten years later the numbers in poverty, depending on how you measure it, are somewhere between 20 and 40 per cent and more than one out of two children live in families in poverty. There has been a complete devastation of the middle class. The government has not been able to pay pensions for the poor but meanwhile it has turned over state resources to a few oligarchs who have become billionaires. I often say that, actually, Russia has shown the power of incentives but what it says is that if you get the wrong incentives, the market system without rules does not create wealth. So the incentive system that they had under what you might call the ‘Mafia’ capitalism, was an incentive system for asset stripping, not for wealth creation. So one can understand what has happened precisely in terms of the incentive structures that were created. People were responding
 to the incentives that were provided but they were perverse, and again the economic reforms that were part and parcel of Russia and the other countries transition, were the reforms that were dictated or driven/recommended by the IMF and the Washington Consensus. One can trace the problems precisely to the kinds of recommendations that they put forward. Just to give you one example: they recommended very rapid privatisation and they also recommended capital market liberalisation, allowing people to take out capital freely. The notion is that if you allow people to take capital out freely it makes it more attractive for capital to move in. But it was a one way street. Think of yourself as one of these guys who is smart enough to persuade the Yeltzin Russian government to give you these billions of dollars in state assets for millions and then you are told you can invest this money anywhere you want to, in the United States which is having a boom market or in Russia which is in a deep
 recession. And if you are bright enough to get that much money out of the Russian government you should be bright enough to figure out where it probably pays to invest your money. And they did what was perfectly rational for virtually anybody and as they all took their money out the economy went into deeper recession. I could go on and describe other details of that transition process but I think the outcomes are clear and the relationship between the policies that were advised and the outcomes is also clear.
  The third aspect is crises. The fact is that we’ve had more crises in the last twenty five years, and deeper crises than we’ve ever had before. For an economist this is a great thing. You’ve got about one hundred countries that have had a crisis in the last twenty-five years. The reason why I say this is a great thing is it gives us a big statistical database from which we can understand what causes crises. For the people of the country, of course, it’s a disaster. What do we learn from these statistical studies of this mass of dataset? Well what we learned is that the policies that the IMF pursued in encouraging capital market liberalisation are among the central features that cause the financial crises. So the institution that was created by Keynes in part to promote global economic stability became the institution that promoted global economic instability. I sometimes think that Keynes must be rolling over in his grave. Actually, I recently came across a quotation where Keynes
 recognised that he may have created a monster and was worried and I’ll come back to say why he should have worried about it more and why there were structural flaws. But my friends tell me that it wasn’t Keynes’ or Britain’s fault. There was an intensive debate between Britain and the US Treasury in which Keynes lost and the US Treasury won and it was that that has as much to do with the failures as anything else, so maybe that was why Keynes was so depressed at the time. 
  The link between capital market liberalisation and crises I think is now becoming widely recognised even the IMF Chief Economist in his speech at the Jackson Hall meeting of the Federal Reserve last August, pointed out that capital market liberalisation for countries that were at earlier stages of development than most of the world are very risky, very dangerous and can have very adverse effects. I think the body of research on this is fairly solid, that capital market liberalisation does lead to risk and instability for obvious reasons. You have these billions of dollars that can come in and out of a country very rapidly. In June 1997, right before the Thai crisis, capital markets had enormous confidence in Thailand and they were providing Thailand with funds at eighty-five basis points above the best rates available on the market. Two months later they were demanding one thousand two hundred basis points in compensation. So an enormous change in sentiment overnight. The amount of
 capital that switched was roughly equivalent to somewhere between 10 to 15 per cent of the GDP. No country no matter how strong their banking system could have withstood that change in sentiment. And the research that has been done by a number of people has shown that bad policies can be a source of people deciding to take their capital out. 
  Most of the disturbances in countries in their capital flows are not due to factors inside the country but factors outside the country. When Argentina was hit by a problem it wasn’t because of what Argentina did, but what happened in Russia. Argentina cannot be blamed for Russia’s crisis. So capital market liberalisation resulted in these countries being vulnerable to a whole host of changes, irrational and sometimes rational investor sentiment Small developing countries find it virtually impossible to withstand that. But not only had the IMF pushed a set of policies that were exposing countries to risk. One of the greatest ironies was that you would have thought that there would be a lot of evidence on the positive side that it did some good. This was one of the things that I found hardest when I came from academia to the public policy arena. I thought that all the research we were doing was supposed to be input to how policy people thought about the world and therefore to the
 policies. 
  In October 1997 the IMF went to its annual meetings and asked for a mandate to make capital market liberalisation, to push it around the world. The timing couldn’t have been worse because it was just then that the global financial crisis was breaking out. I met with all the finance ministers of East Asia at that time and they were all panicked. At that point only Thailand had gone under but Indonesia knew it was about to be hit, Malaysia was worried. They were all worried and not only were they worried they were also worried about how the IMF would respond. We put together a strategy of what to do but unfortunately events overtook us and Indonesia was hit by crisis within a couple of weeks of the IMF meeting and they weren’t able to implement that strategy. The point I’m making is that here they were trying to change a fundamental aspect of global economic architecture and there was not a single piece of research cited that argued that it was going to be good for economic growth
 for the developing countries. It was really quite striking. 
  The only solid piece of research that has been done is by Dani Rodrick at Harvard and that shows that there in no relationship between capital market liberalisation, as defined by the IMF, and economic growth. So while there was an enormous amount of research showing that a capital market liberalisation exposed you to increased risk, there was no evidence that it increased economic growth. The arguments at a theoretical level are obvious – you can’t build buildings, create factories, create jobs on the basis of money that is going to come in and out over night. You know a factory requires money that is going to stay there. One way of thinking about it, and this gives you a little hint about what may be going on here, is to go back to the developing country. Now, the general mantra is that countries need for prudential reasons to keep reserves equal to their short-term foreign denominee liabilities. So if firms in your economy borrow 100 million dollars more the government has to
 put 100 million dollars more into reserves. And that means that you have reserves available in case your international lenders decide they want to ask for the money back in dollars. So that is the general standard prudential behaviour of macro management today. 
  Well think of yourself now as a poor African country and some company in your country has borrowed 100 million dollars from a US bank, and they have to pay 18-20 per cent interest, which is not unusual. So what does the government have to do – it has to put 100 million dollars in reserves. 100 million dollars that could be spent to build schools, to build clinics, to do lots of other things. Ask the question, when countries hold reserves how do they hold reserves typically? Most countries hold reserves in the form of US Treasury Bills. What does that mean, that this poor African country is doing, when it holds US T-Bills? It’s lending money to the US government, to the United States. What interest is it getting from the United States? About 4%. So you can now understand why the US Treasury was very enthusiastic about capital market liberalisation. The US loans at 18% and borrows at 4%. It is good for US economic growth but remember what we are supposed to be talking about is
 economic growth in developing countries. How is this supposed to be good for economic growth in developing countries? The evidence is that it is not. So the point is not only the substance but also the process. The IMF tried to have its Charter changed without a single piece of concrete evidence that it was going to be good and with enormous amount of evidence that it was going to be bad. And when you see something like that happen you say something is wrong with the system. 
  When it then came time to manage the crisis they did a very bad job of it and that’s where I got into a lot of controversy with the IMF and the US Treasury. Where I got into trouble is I wrote something of the form ‘in the United States when the economy goes into a recession we do not believe in balanced budgets, we believe in expansionary fiscal policy’. I think they still teach that in most universities around the world but not on 19th Street in Washington which is where the IMF is! Their policy prescription, as Thailand, Indonesia and Korea were going into a recession, and we had absolutely no doubt that it was going to be a major recession, was raise interest rates and cut back on expenditure. So they did absolutely the opposite of what we would tell a first year undergraduate. When I said that I just asked it as a question, why? and they seemed to take offence and they seemed to think that I was getting at something more. The point was that it was very clear to everybody that
 these policies were not designed to help the countries in the region and yet that was why the IMF was created in the first place. The outcome was exactly as predicted. The outcome was that the economies went into recession and into depression. 
  I want to come back to the theme that one can’t separate economics from the social political context in as the IMF began to force these recession policies, depression policies on Indonesia. I met in Kuala Lumpur with the finance ministers from all the countries in the region in G7 including Canussus, who was the head of the IMF at that time and I spoke more strongly than is wanted from an international diplomat or a civil servant, but I said very strongly that not only were these policies going to cause a recession/depression but if they maintained those policies given the history of ethnic fractionation in Indonesia, the probability of social/political turmoil was very high. Canussus came back with his usual speech ‘the countries must feel the pain and they must stick with the course’. It was really quite astounding and then to make sure that they really understood the pain when real wages had fallen about 25/30%, unemployment had increased by a factor of 10, the IMF decided they
 ought to cut out food and fuel subsidies to the poor. The next day there were riots. Now you can say they may not have any compassion but that’s not what I want to point out – it was bad economics. Even if you had no heart, it was bad economics, because after the riots what happened was the capital fled the country. The theory was raising interest rates and showing that you are good, is going to attract capital into the country. Depressions, economies in depression, economies with riots, do not attract foreign or domestic investment. So rather than attracting money into the country it leads to capital flight. It will take years for Indonesia to fully recover. 
  The basic picture is that in all three areas, development, transition and crises, the way things have gone on have not been good for many of the developing countries and for many of the poor in the developing countries. I could look at the issues slightly differently and look at the markets, capital markets, labour markets, goods markets and so forth. Let me just talk about one aspect because it is a central one in the current globalisation debate and that is trade. Because that is where in some sense the riots began in Seattle, over the trade negotiations. The basic point I want to emphasise is that there has been enormous bringing down of artificial trade barriers over the last fifty years and all that has been for the most part to the good. But if you look at the overall trade agenda, it has been dictated by the special interest in the advanced countries and if you look at the outcomes of that process it reflects those interests. The result of that has been that the
 disproportionate part of the gains have accrued to the advanced industrial countries and in some cases the less developed countries have actually been worse off. Let me just cite two examples. After the last round of trade negotiations, the Uruguay Round that ended in 1984, a calculation was made by the World Bank of the gains or losses to each of the regions of the world. United States gained enormously, Europe gained enormously but Sub-Saharan Africa, the poorest region of the world, actually lost by about two per cent because of terms of trade effects. The point is quite obvious that what the trade negotiations did was open up their markets to manufactured goods produced by the industrialised countries but it did not open up the markets of Europe and USA to the agricultural goods which are often a comparative advantage in the less developed countries. When I was sitting in the Clinton administration and you participate in these debates it is almost mind-boggling. They’ll say
 something like ‘you have to understand we have political problems in our agricultural sector’ as if developing countries don’t have political problems in every sector. It is mind-boggling this process in which people can understand their own political problems but simply could not have any understanding of the political problems in other countries. 
  In the last round of negotiations with China, for Chinese accession to the WTO, there was the same kind of surrealistic aspect to it. At the beginning of the debate the US Trade Representative, chief negotiator for the United States insisted that China was a developed country. The World Bank is supposed to keep the tables of who’s developed and not developed, and this is based not on wishful thinking, because China wishes they were a developed country, it wishes it had that per capita income. But its based on per capita income, and on that basis China is a less developed country. Now it is true that China has a lot of per capita’s and so you take a lot of people and you multiply it by a little you still can get a large number and so China is a big economy but China is a developing economy. Yet the United States insisted that China be treated like a developed country! The big difference is how fast you take down your trade barriers for accession into the WTO. And China to its credit
 said okay if you’re going to be so silly we’ll go along with you, and they agreed to do faster than the normal developing country treatment and accession. But meanwhile, the United States asked for developing country status. It said ‘we are a weak economy, it’s hard for us to adjust and we need longer time, we have only been given ten years notice.’ In 1994 part of the agreement was that they would take down the MFA Agreement which are the restrictions of textiles imports into the United States. So they got a ten-year notice because they said it was too fast for them to adjust and they got a concession from China to allow them the possibility of going more than ten years. So when you see something like that, you realise what kind of an unlevel playing field it is. In terms of the agenda you can see it again in lots of service industries. What were the service industries that the United States said were very important? – financial services – industries that the US Wall Street has a
 comparative advantage at. Talk about construction industries, that was not services, or maritime services – that was not on the agenda because the developing countries would have a comparative advantage in that. So it is no wonder then that given the way the agenda of globalisation has been set and the outcomes, that there are a lot of people who feel that it is unfair and that its not been done well. 
  Again, I could go on and give you lots of examples but I think the point is clear. Actually I had seen many of these problems before the East Asia crisis brought all these issues to the fore. I had had to deal with them and in a way I was sort of happy that the world was getting a better picture of what was going on, because in my work in the developing countries in Africa I saw time and time again where policies were being pushed that were absolutely inappropriate for the country and the countries were being hurt and yet no one was paying attention. You just can’t get a front page story about Ethiopia, or about most African countries. You can when Western or US interests are threatened. But as people started looking at what was going on in East Asia then people began to say well maybe something like this is going on elsewhere.
  Let me just relate a story of my first visit to Ethiopia in March of 1997. I first visited as Chief Economist for the World Bank. Ethiopia had had one of the most repressive Marxist regimes. Its leader, who actually instituted policy that he called 'The Red Terror' to keep people in line. He would kill people in the street and thought that that was a good signal and that people would behave well. There was a guerrilla movement that eventually overthrew him in 1991. The head of this movement, was a very dynamic character, who while he was fighting in the Guerrilla war realised that firstly he believed he was going to win and he realised that when he won he needed to know economics – this is no advertisement for my field – but he needed to know economics in order to address the country’s problems. So he enrolled in the Open University in England to get a degree in Economics while he was fighting in the field. A striking guy and I can say from days of talking to him that he is a first
 class economist and he knew more economics, including economic theory, than the people he was talking to on the other side of some of the international financial institutions. I won’t say which! Since he took over the growth in the economy has been fantastic, growing at 5% a year. He had a policy that was directed towards the poor, to the rural sector, which is where 85% of the people lived. He knew that defence expenditures were taking away money from schools and health clinics so really it was dramatic for somebody coming into power to cut back on military expenditure to 2% of GDP which is one of the lowest than any country in the world. Not only did he talk a good show. He was actually doing a lot of these things. So when I went there I looked over their documents. Their budget was in balance. Their inflation was negative. The growth was high. Surely the IMF must be giving them triple A’s. So I went there and discovered that the IMF had suspended their programme. How is it
 possible for me to look at their data and say this is an A+ and for them to say it’s a F. Not even worth a programme. What they said is the budget was not in balance. How could it be their budget was not in balance, I looked at it and it was in balance, how could two people disagree? They said you shouldn’t include foreign aid in the budget. I said ‘Why?’ and their answer was that you couldn’t rely on it. That’s a stupid argument. I went back to Washington and did some calculations and we showed that actually tax revenue was more unreliable than foreign aid. So if you used their argument neither foreign aid nor tax revenue should be included in their budget and then I said, now every country has a problem and should be suspended. These are not programs that you need a ten year lead time. But when you are building a school – its bricks and mortar and it takes 3-6 months. Here’s the answer, Mellor’s view was ‘if we don’t get the money, we won’t build the schools. If we get the money
 we will build the schools and then very emotionally he said ‘I didn’t fight for seventeen years as a guerrilla to be told by some irrational civil servant that if I can’t get Britain to give me another school or give me a new health clinic that I can’t do it’.
  We at the World Bank thought that their economic policies were so good that we tripled our lending to Ethiopia even when the IMF had suspended it’s lending. And there were other aspects of complaints besides the macro that highlight the nature of the problems. For instance, one of them was the IMF wanted them to liberalise their financial markets and to create a Treasury bill auction market. Now you have to understand Ethiopia’s whole banking system is somewhat smaller than Bethesda, Maryland and Ethiopia knew what had happened in neighbouring Kenya when they were told by the IMF to liberalise their financial market, interest rates went up. Meles’ view was, if interest rates go up its going to cripple my poor farmers, I cannot do anything, I cannot risk anything that is going to have that adverse effect on my farmers, and so he refused. I again called a conference in Boston where I talked about financial market liberalisation in highly underdeveloped countries and in which the vast
 majority of academics said – don’t liberalise. It had virtually no effect on the policy perspective of the IMF. 
  Let me go on and talk about why are there these failures. One might say aren’t there some bright economists there? The answer is yes and that’s what makes it all the more puzzling, in a way that makes the question more difficult because it wasn’t for lack of kind of competence. I’m not completely sure but let me put forward a few possible explanations.
  First is that they really took seriously textbook economics. Now we do want all you students to take seriously textbook economics and learn your textbooks but when you come to apply it in developing countries, apply it with some thought. Don’t apply it mindlessly. The problem was that these guys had been teaching textbook economics for so long that they actually believed it. Let me give you an example, in the East Asia crisis that shows you how bad textbook economics can be. The IMF idea was very simple – textbook economics. When a country has a crisis, the exchange rate is falling down, in a typical kind of currency crisis. What do you want to do? You want money to come into the country and bring the currency back up. That’s a simplistic idea. How do you get people to bring money into your country? Well you raise the interest rates and that means that money is going to come back in. Well that sounds pretty persuasive. You probably all read that in your textbook and believed it.
 Now think a minute though about why it was the countries were facing a problem. Take Korea, people had lent it money in the short term and said we want our money back. Why do they want their money back? Because they were afraid of Korea going bankrupt, default, not being able to get paid. So what you care about is not just the interest rate that the guy promises you but you care about also whether he actually pays you the amount that he promises you. That is to say you worry about probability of default. So the probability of default is a critical variable in the analysis and its an endogenous variable which is effected by policy and when you did the kind of things that the IMF did in East Asia you increased the probability of default enormously. So, yes, interest rates might have gone up but it was a less attractive place to put your money. So money fled the country, it didn’t go in. So that’s an example of what I mean by textbook economics being misleading. It may be okay in the
 main. Twenty five years ago economists started talking about bankruptcy probability, you would have thought that people would have learned it by now in these international financial institutions. But it is in my mind inexcusable. So it’s probably simplistic economists taking textbook economics too seriously. Its partly the model of the economy that I think is fundamentally wrong, its sometimes called market fundamentalism – it’s a simplistic model of the competitive market and one of the things that economic research has shown over the last twenty five years are the limitations of that competitive model. Its not that markets aren’t important, markets are important, they play a very important role but markets have some limitations and one has to understand those limitations. And if you don’t understand those limitations it is likely to lead to very seriously wrong policies. If you have capital market liberalisation in a country like Kenya where you don’t have well functioning
 financial institutions you may wind up with higher interest rates not lower interest rates which is what the IMF have predicted. 
  Now a second aspect of this is ideology. If you study what I call economics science, which is what we try to teach, you say well if I make a prediction and it turns out wrong I start re-thinking my assumptions. So if you go to Kenya and you say I’m going to liberalise the financial markets, capital markets and interest rates are going to go down, that’s the prediction and when they go up you say maybe something was wrong with my model. But in IMF ideology you go on to the next country and give them the same advice and you have a language that allows you to reconcile what you see with what happens. You say they didn’t do it right. So when it goes well they say they did it right and when it doesn’t happen you say they didn’t do it right. In my mind, it’s very much like medieval blood letting. In the middle ages doctors used to say that the way to cure a disease was to let out the blood and as they let out more and more of the blood the guy usually didn’t feel all that much better and
 quite often before long he was absolutely dead. The family would say this isn’t working we ought to stop and then the guy would die and then the doctors would say, we told you, if you had just continued the process he would have recovered or at least his probability of recovering would have been higher. You could never refute that kind of hypothesis. The IMF never puts forward refutable hypotheses. They have never been wrong: almost never – they finally did admit the mistake of excessive fiscal contraction in the East Asia crisis. But they never went the further step of saying why did we make that mistake? Where was our model wrong? Which you would think is part of the scientific process. They saw the obvious consequences that they were wrong and they couldn’t deny that any more so they agreed but they never asked where did our analysis go wrong. So ideology plays a very important role. 
  Thirdly, I think special interests play a very important role and the people who are involved, particularly the IMF, who sit on the board. There is a diversity of opinion on the board, there is the executive director which is the governing board of the IMF and then they have annual meetings in which the ‘real’ governors meet. They have a diversity of views which goes all the way from finance ministers to the governors of the central banks and so they see the world completely from that perspective and from those interests. So capital market liberalisation from the point of Wall Street is a great thing and the ideology of Wall Street, even when they don’t think of it as a special interest, the ideology is free markets. Actually, I need to qualify that, one of the things that I constantly saw when I was in the White House was everybody believes in free markets except for their own industry and its just like everybody believes in competition except for in their own industry. You see
 that, repeatedly, in the case of financial markets. They believe in free markets except for the one major exception which every Secretary of Treasury or Finance Minister around the world believes in, intervention in the exchange rates market. Why not let the free market do it? Well, you believe in free markets everywhere else except in your own industry which is the exchange rate market. 
  There are other aspects of the failures; one has to do with the organisational structure, which makes it difficult to adapt. A fifth aspect which I think is very important and its related to where the institution has come from, is that it works so much in secrecy so that it does not have the outside scrutiny in its specific policies that are associated with normal intellectual processes let alone democratic processes. 
  Finally, I would argue the fundamental problem has to do with governance and that in some sense is the most important reform. The international economic institutions have broad effects in the developing country. Any of you who are from developing countries will know this. These are not just technical working groups trying to work out the payment arrangements or the details of what goes on behind the scenes. The policies that the WTO and IMF set effect unemployment rates, effect how markets work, effect particular industries, have a profound effect on virtually everybody in the developing country. So these are not just issues related to finance, they are issues related to the entire economic policy. Yet, as I mentioned before, the people who are involved tend to be drawn from very special groups. In the case of the IMF it is the Finance Ministers and the Central Banks, all drawn from the financial community. In the case of the WTO, it’s the trade representatives that tend to
 represent the special trade interests. And so when they are trying to make policy they do not represent the countries that they represent – they represent special interests within those countries. 
  That has brought me to another story. I was on one occasion having a conversation with the President and he said, he had read an article in the New York Times, about what the IMF was doing and he said isn’t it terrible what they are doing and I had to gently tell him that they were doing it because his US Treasury were telling them to do it. The other view of the US Treasury is that they shouldn’t bother the President with such details. It would only clutter his mind and he might actually have an opinion. So anybody who studies political processes should know that whoever sits at the table, their voices get represented, and its therefore not surprising that the interest in ideology perspective of financial communities get represented in IMF more than others. Within the United States, within the UK, within any other democracy when economic policies are made, they are made by broad cross cutting groups within the cabinets within the government. In the United States we have the
 National Economic Council, Secretary of Labour, Secretary of Commerce, Council of Economic Advisers, Treasury. Treasury is only one vote and Treasury often get voted down. But in the IMF, in the international arena only the voices of the financial community are heard. 
  There's a second problem that is equally as serious and that is who has votes, the votes are different countries. In the UN there are five countries that have veto power. In the IMF there is only one country that has veto power – it’s called the G1. The G1 is the United States. In most democracies, ever since a reform back in Britain in 1832, there is not a property qualification for voting and if you have more money you don’t get more votes. In the international financial institutions our system of global governance says the wealthier you are, the more votes you get. But its even more peculiar than that because its not based on your current wealth, its based on your wealth as of 1944, and remember in 1944 most of the developing world were colonies, they didn’t have a voice and so they couldn’t object. And that’s leaves this peculiar situation that we saw recently in the election of the Head of the IMF. I don’t want to speak anything of his personal qualifications but only about
 the process, which is very peculiar indeed. 
  At the time of the founding of the IMF and the World Bank there was an agreement between the United States and Europe that the United States gets to appoint unilaterally the head of the World Bank and Europe gets to appoint the head of the IMF. What about the rest of the world?. Well, they don’t count. It was sort of like the Pope dividing the world between Spain and Portugal, I guess that was in 1493, it wasn’t the Pope’s to divide but he did it anyway and it had profound effects. Anyway, today we know that the major line of business of the IMF is dealing with crises in the developing world. The last major time that the IMF got involved in a crisis in a developed country was in Britain in 1976. So it’s been twenty-five years since they gotten in any line of business in a developed country. For the last twenty-five years their whole business has been in the developing world. Now you would have thought that normally if your business is in the developing world, you want somebody who
 knows something about the developing world, who has spent some time there. That was never described as a qualification and the one candidate that was put forward who had experience in the developing world was argued against because he was too soft. The fact is that the system of global governance has some fundamental problem and I would argue that most of the other problems can be related to that.
  Well, that leads me to the reforms, which I am going to spend three minutes on. The reform that is most needed is obviously a solution of the ultimate problem which is the governance problem, but I do not think that that is going to happen. I do not see the United States saying we have too much power, we apologise to the democratic world, we’ll turn all our votes over to China now that its grown. Nor do I see the Secretary of Treasury saying you know you are dealing with a broad set of economic issues you ought to have a broad set of views. We ought to make sure that other voices get heard and have a seat at the table in a very influential way. There are, by the way, some Finance Ministers from the around the world, including a large number of GT finance ministers, who do have that view. So that being put aside, the question is what kinds of operational and what kinds of other changes would minimise the damage and would increase the probability of success. In order to minimise the
 damage, in my view, one of the critical things is to limit the scope of the IMF, to have a focus exclusively on crises. That’s not a solution, not a complete solution because they messed up in managing the crises but its at least part of the solution and that’s been supported by most of those who studied that. But the most important reforms, and this goes not only for the IMF, but the World Bank and the WTO, is to increase their transparency because given that its not like they’ve evolved systems of good direct governance, democratic governance. One needs to have indirect democratic governance and transparency is a way, that is to say, by making it public what they are doing ahead of time you expose them to public scrutiny, to the scrutiny of press, to the scrutiny of NGOs, to the scrutiny of all the people who may be effected by the policies. In democracies over and over again we have seen the power of that kind of transparency so it is not a perfect substitute but it is a
 reasonably effective substitute. That’s a solution that I think can make an enormous amount of difference to how the system of global governance works. In short, I want to return to the basic thesis. I really do believe that globalisation can be a very powerful force for improving the living standards of people in the developing countries. It has been in some cases, but the way that it has been implemented, the way it has been governed, the way its evolved over the last twenty five years has not lived up to its potential. So I think the real opportunity that one has now is really to take advantage of what the discontent with globalisation has brought to the fore and use that to leverage in some fundamental reforms in the system of global governance to make the system of globalisation realise more its potential.
  Top^
  | Section Menu | Related Links |
    Combining the strengths of UMIST and
The Victoria University of Manchester




		
---------------------------------
Yahoo! Photos – Showcase holiday pictures in hardcover
 Photo Books. You design it and we’ll bind it!

¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤
To unsubscribe/subscribe or view archives of postings, go to the Gambia-L Web interface
at: http://listserv.icors.org/archives/gambia-l.html

To Search in the Gambia-L archives, go to: http://listserv.icors.org/SCRIPTS/WA-ICORS.EXE?S1=gambia-l
To contact the List Management, please send an e-mail to:
[log in to unmask]
¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤