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BANK DATA DON’T SUPPORT GLOBALIZATION CLAIMS

A recent World Bank study claiming that Fund/Bank policies promoting growth in the developing and transition economies has benefited the poor has been strongly criticised by CEPR, a Washington-based non-governmental think-tank. Its well-documented critique points out that the last two decades of rigid application by the Fund/Bank of orthodox economic theory has been a failure, in terms of economic performance. Rather, "there will have to be an honest debate over what has gone wrong over the last 20 years and the World Bank should begin to ask these questions and play a constructive role in finding answers", says CEPR.

by Chakravarthi Raghavan


Geneva, 10 Aug 2000 -- A World Bank research study claim of new data showing that Fund/Bank policies promoting growth in developing and transition economies has benefited the poor has been challenged in a new Washington-based think- tank’s study which says that the facts cited in the Bank’s study do not support the conclusions.

In a paper by Bank economists Messrs. David Dollar and Aary Kraay, and released last March by the World Bank’s Development Research Group, critics of the 'globalization thesis' and Fund/Bank policies (with the WTO) to promote globalization were slammed with claims of new research data showing that “growth generally does benefit the poor and that anyone who cares about the poor should favour the growth-enhancing policies of good rule of law, fiscal discipline and openness to international trade.”

In a well-documented critique of the Dollar-Kraay paper, the Washington-based non-governmental think-tank, “Center for Economic and Policy Research (CEPR),” says that the issue is not whether growth benefited the poor, but rather whether the IMF and World Bank policies are good for growth.

“There is no region of the world that the Bank or Fund can point to as having succeeded through adopting the policies that they (Fund and Bank) promote - or in many cases, impose on borrowing countries,” points out the CEPR, in a study by Mark Weisbrot, Dean Baker, Robert Naiman and Gila Neta and available on its website <www.cepr.net>.

“And even the relationship between economic growth and the incomes of the poor is not as close as portrayed by the Dollar and Kraay paper,” says the CEPR (not to be confused with the London-based group of the same acronym promoting neo-liberal policies).

The Dollar-Kraay study got wide media coverage and acclaim from the pro-corporate financial media, and was cited by a range of ‘free trade ideologues’ to bash NGO critics. And its underlying thesis (of free-trade corporate-led globalization being good for growth and of benefit to developing countries) has been used by the World Trade Organization to promote the ‘globalization thesis’ and bash its critics.

The Dollar-Kraay study has also provided a basis for a World Bank Group briefing paper on Globalization, and a WTO report released in June (‘Trade, Income Disparity and Poverty’) where two other economists recycled their World Bank research papers to promote the Fund/Bank/WTO thesis that open economies lead to growth and convergence of incomes and reducing disparity. The WTO study was timed to coincide with the World Social Summit and was widely used during the Social Summit to counter the well-documented and researched positions of NGOs who had brought out the increasing global poverty and inequalities. The Dollar-Kraay study also provided a basis for the “Better World for All” report that was jointly issued by the UN, OECD, World Bank and IMF, promoting the benefits of globalization and of developing countries opening their economies to (foreign) trade and investment.

The just released CEPR study points out that a closer look at the data and statistical tests of the Dollar-Kraay paper shows that except for the positive correlation between economic growth and incomes of the poor - which is not controversial - almost all of the tests in the paper lead to “statistically insignificant” results. On that basis it was not possible to conclude as Dollar and Kraay have done, that the IMF and World Bank policies, such as increased openness or anti-inflationary macroeconomic policies benefit the poor.

In just the three last years, CEPR points out, the IMF and its allied creditors have made serious policy errors that have undoubtedly reduced cumulative economic growth for hundreds of millions of people.

In the Asian financial crisis, the IMF’s drastically tight monetary policies (interest rates as high as 80% in Indonesia) and fiscal austerity deepened the recession and threw tens of millions of people into poverty. The Fund also helped to create the crisis in the first place by encouraging the opening up of financial markets to large inflows of portfolio investments, which subsequently flowed out even more rapidly, causing the currency collapses and financial panics that threw the region into a downward spiral.

In Russia and Brazil in 1998, the Fund’s support for overvalued exchange rates that ultimately collapsed also caused serious economic damage. And the IMF’s policies in the economies of the former Soviet Union have, over the last decade, contributed to one of the worst economic disasters in the history of the world - with Russia losing more than 40% of its national income.

“The past two decades have been mostly lost to the developing world,” says the CEPR.

“While there are undoubtedly economic gains to be had from international trade and foreign investment, there is clearly something wrong with the way these and other policies have been promoted in most developing and transition economies by the IMF and the World Bank."

“To reverse these trends, there will have to be an honest debate over what has gone wrong over the last 20 years. We can only hope that the World Bank will begin to ask these questions, so that it can play a constructive role in finding the answers. And more important, that the Bank (and the IMF) will allow borrowing countries to pursue policies that allow for a restoration of past rates of growth, as well as increasing equality,” CEPR adds.

The Dollar-Kraay study claimed, on the basis of “new empirical research” on incomes in both developed and developing countries, that “growth generally does benefit the poor.”

CEPR notes that the paper’s main finding that there is generally a positive correlation between economic growth and the incomes of the poor is no surprise and it would be difficult to imagine who would argue that there were no such correlation.

“The most important question is: what has caused the dramatic slowdown in economic growth over the last decades, and how much of it is attributable to the policies of the IMF and the World Bank?”

The Dollar-Kraay paper misses the most important problem entirely: economic growth over the last 20 years, the period during which the policies advocated by the authors (and their institution) have been put into place, has been dramatically reduced.

It may well be true, CEPR says, that “to ignore the importance of growth-enhancing policies is an injustice to the poor.” But to assume that the World Bank and the Fund have brought ‘growth-enhancing policies’ to their client countries goes against the overwhelming weight of the evidence over the last two decades.  The relationship between economic growth and the income of the poor, CEPR points out, is not as close as it appears from the Dollar-Kraay presentation. “As it turns out, there are plenty of instances in which the poor, and the majority of the population have been left behind in the era of globalization - even where per capita income has grown.”

The regression analysis in the Dollar-Kraay research actually shows little or nothing about the relationship between most of the variables examined. “Aside from the correlation between economic growth and the income of the poor, almost all other tests in the paper are statistically insignificant. Given the large errors in the data, there is really no conclusion that can be drawn from the failure to find significant results in these tests. For example, we cannot conclude from these tests that there are no significant differences in the relation between growth and the income of the poor between the 1980s and 1990s and the previous decades."

“And there is certainly nothing in the (Dollar-Kraay) research to support their conclusion that ‘globalization is good for the poor’ or that anti-inflationary policies are ‘pro-poor’,” CEPR says.

The Dollar-Kraay research “mirrors what is wrong with the policy of the Bank and the IMF: the attempt to apply universal economic laws - concerning trade, capital flows, privatization, the size and scope of government - to the problems of economic development.”

By any measure of economic performance, the last two decades have shown these rigid applications of orthodox economic theory to be a failure.  “Rather than defending this record of failure, the Bank and Fund researchers should be trying to discover what has gone wrong. And most importantly, they should allow governments to pursue their own, country-specific paths to growth and development.”

As data in the UNDP Human Development Reports show, in every region of the world, except East Asia, the period since the 1980s shows remarkably slower growth compared to the two earlier decades.

In Latin America, per capital GDP grew by 75% from 1960-1980, while in the later period it rose only 6 percent. For sub-Saharan Africa, per capita GDP grew by 36% in the first period, and fell 15% since then.

“These are enormous differences by any standards of comparison, and represent the loss to an entire generation - of hundreds of millions of people - of any chance of improving its living standards. Even where growth was significant, as in Southeast Asia, it was still better in the earlier period.”

The only exception to the trend was East Asia, which grew faster from 1980 to 1998 than in the previous period. But this is due to the quadrupling of GDP, over the last 18 years, in China which has 83% of the population of East Asia.

“In short, there is no region of the world that the Bank or Fund can point to as having succeeded through adopting the policies that they promote - or in many cases impose - upon borrowing countries. They are understandably reluctant to claim credit for China, which maintains a non-convertible currency, state control over its banking system and other major violations of the IMF/Bank policy prescriptions.”

The debate over the Dollar-Kraay paper has simply assumed, as its authors did, that the IMF/Bank policies promote growth, and that the only question is how well the poor have fared under the growth resulting from those policies.

But this leaves a gaping hole in the debate over the Fund/Bank policies and allow the two to impose a whole cluster of failed policies repeatedly, without their competence or the policies themselves being called into question.

When prominent economists such as Jeffrey Sachs or former World Bank chief economist Joseph Stiglitz criticize the IMF’s macro-economic policies or when Harvard’s Dani Rodrik questions the institutional over-reaching on the question of openness, the Fund and the Bank pay no heed. The Fund simply repeats its assertions that it is helping the developing world to maintain macro-economic stability, and to grow; and perhaps it (and the Bank) could do more to fight poverty and protect the environment, although they are getting the fundamentals right so that countries will have the options to improve living standards for everyone. But this is exactly what they have not done.

“If the IMF and the Bank,” CEPR points out, “were simply research institutions, their errors could not be so damaging, since their analyses would compete in the market place of ideas and be judged by their success or failure. But in fact they control access to credit for countries with most of the populations of the developing world and transition economies. The Fund acts as the gatekeeper: most of the Bank’s lending is contingent on Fund approval, and therefore on the adherence of the borrowing country to IMF conditions. Most credit from other multilateral institutions, e.g. the Inter-American Development Bank, and even private sources is also contingent on the IMF’s seal of approval. As a result, the Fund and the Bank have the power to impose their policies on dozens of governments throughout the world.”

It is difficult to separate out the causal relationships between various economic policies (of the Washington Consensus) and the dramatically reduced growth of the last two decades, CEPR notes. Such regressions are not likely to be found in regressions of the type in the Dollar-Kraay paper, primarily because there is no simple or stable relationship between the policy variables they examined and the macro-economic results. But these can be seen in any number of case and country studies.

In just the last three years, the IMF and its allied creditors have made serious policy errors that have reduced cumulative economic growth for hundreds of millions of people. In the Asian financial crisis, the IMF’s tight monetary policies and fiscal austerity deepened recession and threw tens of millions into poverty. Though the regional economy has now recovered, the lost growth and increased poverty is still significant. And Indonesia, the largest of the five crisis countries, with more than 50% of their total population, is yet to recover, after a 13% decline in GDP in 1998.

In Russia, the IMF insisted on maintaining an overvalued fixed exchange rate, requiring that country to raise interest rates as high as 150 percent - leading not only to excessive foreign debt burdens, but maintaining a speculative bubble in the financial sphere, and drained the real economy of investment capital. The overvalued ruble kept imports artificially cheap, hobbling domestic production, and exports overly expensive - until the currency collapsed in 1998. A similar policy was supported in Brazil - with the government raising interest rates more than 50% and borrowing billions from the Fund to stabilize its overvalued currency, only to have it collapse just a few months later.

Was growth unnecessarily reduced in these economies?  The answer depends on counter-factual. And defenders of the status quo argue that without the IMF policies, things would have been worse. But would it?  In Indonesia, the extremely high interest rates failed to prevent the currency from losing more than three-quarters of its value. It is difficult to imagine how much further it could have fallen or how preventing a further slide would be worth the bankruptcies and economic collapse caused by the high interest rates.

In the counter-factual of Malaysia, instead of using sky-high interest rates to defend its currency, that country imposed currency controls.  Despite wide opposition to this move from both multilateral and private foreign creditors, and the lowering of its international credit rating, Malaysia emerged from the crisis with the smallest loss in output.

The Fund’s argument that without Russia and Brazil sacrificing output to defend the currency, devaluation would have led to inflation, has now been proved wrong. The inflation in Russia in the year after the devaluation was 36 percent, and is running at 25 percent this year. In Brazil, inflation was 8.9% in 1999 and is down to 1.4% for the first five months of 2000. The Russian devaluation helped jump-start its stagnant industrial sector - with manufacturing output increasing by 12.8% and the trade surplus increasing tenfold, since the collapse of the ruble.

All the errors of the Fund and the Bank are part of a pattern of macro-economic policies with a pronounced contractionary bias. Getting rid of a current account deficit by shrinking the domestic economy has been a Fund strategy for decades. However much fiscal discipline and containing inflation may have helped in some instances, the medicines are quite lethal when prescribed inappropriately or in overdose.

And the Fund-Bank economists don’t even necessarily know enough about specific country conditions, and they have multiple objectives that doesn't coincide with interests of borrowing countries.

It is now widely recognized that opening up of financial markets in East Asia was the primary cause of the Asian financial crisis. The IMF and its patron, the US Treasury, promoted the opening of capital markets, and even sought to amend the IMF charter to be able to exert authority over the capital accounts of member countries. But the crisis countries had no need for the huge inflows of portfolio investment that ended up destabilizing their economies: they had high domestic savings rates. As Stiglitz has pointed out, notes the CEPR, “the push for capital account liberalization may have more to do with the search by US mutual funds for foreign investment outlets than it did with needs of the borrowing countries.”

As for growth and distribution, the Dollar-Kraay paper cites some 236 observations from the developed and developing countries and says that there were 108 episodes in which GDP per capita grew at a rate of at least 2% a year, and in 102 episodes, the incomes of the poor also rose.

This is a much weaker statement than appears at first glance. For, the majority of the data don’t meet the threshold of 2% per capita GDP growth. Thus, the statement only means that when the economy is growing rather rapidly, the incomes of the poor does rise. “It would indeed be shocking if this were not true.”

But according to the Dollar-Kraay data, there were 35 episodes where the incomes of the poor actually fell, even as per capita GDP rose over a period of at least five years. Two of these episodes were in the US -with per capita incomes of the poor falling from 1979-84 and 1989-94 while the per capita GDP rose. If the majority of the labour force is encompassed in the study, “it helps to explain the backlash against globalization (in the US) which the authors (Dollar and Kraay) dismiss as fundamentally misinformed,” CEPR comments.

The real median wage in the US, CEPR points out, is no higher today than it was in 1973. Real wages for the bottom quintile of the labour force actually dropped by about 9% between 1973 and 1997 - a period during which the US economy opened up fairly rapidly (with a doubling of trade as a share of GDP). Since 1973, per capita income in the US has risen by 70%, while the median wage and bottom-quintile wage actually fell during the same period.

In the first half of the post-World War II era, the wages of the bottom three quintiles increased roughly in step with the average (which rose 80% from 1946-73). It is thus a relatively recent phenomenon for the majority of the labour force in the US to be excluded from sharing the gains of economic growth.

The Dollar-Kraay study finds no significant variations over time, from the 1960s through the 1990s, in the relationship between income growth of the poor and per capita income growth.

But other research (by Juan Luis Londono and Miguel Szekely, Inter-American Development Bank working paper No 357, 1997) found that in Latin America income distribution was more equal in the 1970s, and worsened thereafter - with a general pattern of increasing income inequality in the 1980s and 1990s, after decreasing in 1970s. Eight of 13 countries studied showed worsening inequality, while only two showed improvement. In Russia, the gini coefficient doubled as the economy crashed during the last decade.

These changes did not perhaps show up in the Dollar-Kraay regressions because of the poor quality of their data, says CEPR. Almost all of the statistical tests in their paper, other than those showing a correlation between growth and per capita incomes of the poor, yield insignificant results. While it might be possible in some circumstances to make inferences from failure to find significant results, “it would not be appropriate to do so when the quality of the data is as poor as it is in the study,” comments CEPR.

Dollar and Kraay also draw more sweeping conclusions that do not follow from their regression results. For example, they conclude globalization is good for the poor - because their regression results show no relationship between openness and the income of the poor. And since they assume that openness increased growth, and growth is good for the poor, it follows that openness is good for the poor.

“But their regression results did not find that ‘globalization is good for the poor’; on the contrary they show no impact of globalization on the poor. Furthermore, the assumption that openness leads to higher growth is itself a matter of controversy within economic literature.” Over the past two and half decades, attempts to formulate development strategies specific to the needs of individual countries have been supplanted with simple, rigid formulae promoting openness to foreign trade and investment, overly tight monetary policies, and “structural adjustment” policies that often cause unnecessary economic harm. The static gains from comparative advantage, relatively very small, have been promoted at the expense of the much larger, dynamic gains accruing from shifting to higher-value added branches of production. The fiscal disciplines, and much more harmful monetary discipline, imposed by markets has been extolled and reinforced - even when these policies have led to economic crises as in the Asian, Brazilian and Russian cases.

“The fact that growth slowdown of the last two decades has coincided with increasing globalization should cause economists advocating indiscriminate opening to trade and financial flows at least some cause for reflection. It does not mean there are no gains to be had from increasing trade and foreign investment. But it may mean that some of the development strategies that have proved successful in the past will require a wider range of interventions and flexibility on a number of policies - including trade - than current orthodoxy allows. In an era when their economic choices have been restricted and very often, determined by outside agencies, it is not surprising that developing countries have shown dramatically poorer growth performances.”

As each decade passes, the growth of productivity and development of technology should make it easier for the poor countries to catch up with the richer ones. Yet there is no such trend, and the last two decades have been lost to most of the developing world, while the transition economies have mostly taken greater leaps backward.

To reverse these trends, there will have to be an honest debate over what has gone wrong over the last 20 years and the World Bank should begin to ask these questions and play a constructive role in finding answers. And more important, the Bank and the Fund, should allow borrowing countries to pursue policies that allow for a restoration of past rates of growth as well as increasing equality.

“It should not be surprising that globalization would be seen by the majority of the population as well as by labour unions and the public interest groups as a threat to the well-being of the less well-off,” CEPR concludes.-SUNS4727

The above article first appeared in the South-North Development Monitor (SUNS) of which Chakravarthi Raghavan is the Chief Editor.

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