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East
Asia crisis no refutation of East Asia miracle GENEVA: The East Asian crisis is no refutation of the East Asian miracle, and the more dogmatic versions of the "Washington Consensus" do not provide the right framework for understanding both the success of these economies and their current troubles. This is according to Joseph Stiglitz, the World Bank's Chief Economist and Senior Vice-President. In challenging some of the views (from the IMF and the US treasury) about the crisis in East Asia, Mr. Stiglitz, a leading American academic and former economic official of the Clinton administration, suggests in his 1998 WIDER Annual Lecture at Helsinki in January, that the time has now come for re-examination of the socalled "Washington Consensus". This 'consensus', he points out, was catalyzed by the experience of Latin American countries in the 1980s, and was a "consensus of US economic officials, the IMF and the World Bank, and 'now is a good time' to re-examine this consensus." "Post-Washington Consensus" In calling for a "Post-Washington Consensus", Stiglitz emphasizes that such an emerging consensus "cannot be based on Washington." For policies to be sustainable, they must receive ownership by developing countries. While it is relatively easier to monitor and set conditions for inflation rates and current account balances, doing the same for financial sector regulation or competition policy is neither feasible nor desirable. A second principle of the emerging consensus, he added, "is a greater degree of humility, the frank acknowledgement that we do not have all of the answers." "Continued research and discussion not just between the World Bank and the IMF, but throughout the world is essential if we are to better understand how to achieve our many goals," Stiglitz declared. The "Washington Consensus" held that good economic performance required "liberalized trade, macro-economic stability and getting the prices right", and once the government handled these issues, essentially by getting out of the way, "private markets would produce efficient allocations and growth." But the policies advanced by the "Washington Consensus" to make markets work were hardly complete and "sometimes misguided". "Making markets work," Stiglitz says, "requires more than just low inflation; it requires sound financial regulation, competition policy, and policies to facilitate the transfer of technology, and transparency to name some of the issues neglected by the Washington Consensus." On the transfer of technology issue, Stiglitz highlighted concerns of developing countries, small businesses in the industrial world, and academic community everywhere, that in tightening the standards of IPR protection (as under TRIPs in the WTO), the balance between innovation and dissemination may have been upset, and may have created incentives for privatizing public knowledge. This last issue, that of transnational pharmaceutical and agro-chemical firms, roaming the world and appropriating public community knowledge and biodiversity of countries through monopoly patent claims, has been highlighted by public interest groups in their campaign for changes in the TRIPS regime. At the same time, said Stiglitz, the international community has improved its understanding of the instruments to promote well-functioning markets and broadened the objectives of development to include other goals of development like sustainable development, egalitarian development and democratic development - objectives and goals that involve inevitable trade-offs. In addressing the implications of the East Asian crisis, Stiglitz noted that the success of these East Asian economies had been one of the motivations for moving beyond the Washington Consensus. For, this regional cluster of economies had not closely followed the Washington Consensus, but had somehow managed the most successful development in history. While they had practised low inflation and fiscal prudence, they had not followed the consensus in the financial sector. But following the financial crisis, the East Asian economies have gone from being cited for their remarkable success in development to being widely condemned for their misguided economic policies, seen as being responsible for the mess they now find themselves in. "Some ideologues," Stiglitz said, "have taken advantage of the current problems besetting East Asia to suggest that the system of active state intervention is the root of the problem." These critics point to the government-directed loans and the cosy relations with large chaebol in Korea, forgetting "the not inconsiderable successes of the past three decades, to which the government, despite its occasional mistakes, has certainly contributed." "These achievements are real, they are not a house of cards. No temporary financial turmoils can or should detract from these achievements, which include not only large increases in per capita GDP, but also extended life-spans, widespread education, and dramatically reduced poverty." "Even when governments directly undertook the actions themselves, they had notable achievements: they created efficient steel plants - contrary to privatization ideologues who suggested that such successes are at best a fluke, and at worst impossible..." While governments should focus on what it alone could do, leaving production of commodities like steel to the private sector, Stiglitz added, "the heart of the current problem in most cases is not that government has done too much, but that it has done too little." In Thailand, for example it was not that the government directed investment into real estate, but that government regulators failed to halt it. Similarly, in Korea there was a big problem of lending to companies with excessively high leverage as well as corporate governance issues including widespread cross-subsidization. "The fault is not government misdirected credit - in fact the problem faced by so many US, European and Japanese banks suggest that they also may have seriously misdirected credit." "Instead, the problem was government's lack of action, the fact that the government underestimated the importance of financial regulation and corporate governance." In East Asia, many governments have been running government surpluses and inflation is low and, prior to devaluation, was falling. The origins of the current financial crises are elsewhere and the solutions, like those of the problems of many other countries, will not be found in the Washington Consensus either. Important ingredients of growth ignored The focus on freeing up markets, in the case of financial market liberalization, Stiglitz said, "may actually have had a perverse effect, contributing to macro-instability through weakening of the financial sector." More broadly, he added, the focus on trade liberalization, deregulation, and privatization ignored other important ingredients required to make an effective market economy - most notably, competition which, in the end, may be as or more important than other ingredients in determining long-term economic success. Other ingredients essential to economic growth too were left out or under-emphasized by the Washington Consensus. One such, education, has been recognized by the development community. But others such as improvement of technology have perhaps not received the attention they deserve. The success of the intellectual doctrine of the Washington Consensus rested on its simplicity - its policy recommendations could be administered by economists using little more than simple accounting frameworks, looking at a few economic indicators, and forming a picture of the whole economy and a set of recommendations. "Indeed," commented Stiglitz, "there have been cases where economists would fly into a country, look at and attempt to verify these data, and make macro-economic recommendations for policy reforms all in the spate of a couple of weeks." There are important advantages to the Washington Consensus approach to policy advice, but it does not offer the most important answers for every question in development and "deluding ourselves into thinking that it does can lead to misguided policies." Knocking down some IMF concepts Knocking down some of the pet concepts applied by IMF economists in prescribing conditionalities, Stiglitz cited studies that show that while high inflation, say of more than an annual 40%, is costly there is no evidence that it is costly below that level. Low levels of inflation may even improve economic performance. And while large budget deficits are deleterious for economic performance, there is no simple optimum level of budget deficit - "the optimum level depends on circumstances, including cyclical state of the economy, prospects for future growth, and the uses of government spending." The optimum level of current account deficit is also indeterminate in general. In many countries the rate of return on investment far exceeds cost of international capital and, in such cases, current account deficits are sustainable. The form of financing of that deficit also matters. Generally, short-term debt and portfolio flows can bring the costs of high volatility without the benefits of knowledge spill-overs. The macro-economic stability of the Washington Consensus also downplays the most fundamental sense of stability - stabilizing output or unemployment. Variability of output almost certainly contributes to uncertainty, and that discourages investment. Underlining the need to build "robust financial systems", Stiglitz said well-functioning financial systems do a very good job of selecting the most productive recipients for resources, while poorly functioning systems would often allocate capital to low-productivity investment. But selecting projects for financing is only the first stage. There is need for continuous monitoring of use of funds - ensuring their productive use - and performing other functions like reducing risk, increasing liquidity, and conveying information. "Left to themselves, financial systems will not do a very good job in fulfilling these functions... Incomplete information, incomplete markets and incomplete contracts are all particularly severe in the financial sector... A sound legal framework combined with regulation and oversight is necessary to mitigate these informational problems and foster conditions for efficient financial markets...." "In successful financial markets, regulations ... maintain safety and prudence ... promote competition, protect consumers and ensure that under-served groups have some access to capital," Stiglitz said, citing the US Community Reinvestment Act, the Federal National Mortgage Association and US Small Business Administration. "All too often, the dogma of liberalization became an end in itself, not a means to a better financial system." Outlining some general points for such a system, Stiglitz said: "First, the key issue should not be liberalization or deregulation, but the construction of a regulatory framework to ensure an effective financial system. "Second, even when the design of the desired system is in place, due care has to be exercised in the transition. Attempts to initiate over-night deregulation, the 'big bang', ignores the very sensitive issues of sequencing." Thailand, he noted, used to have restrictions on bank lending to real estate, but in the process of liberalization, these were got rid of without establishing a more sophisticated risk-based regulatory regime. The result was large-scale misallocation of capital to fuel a real estate bubble, "an important factor in the financial crisis." Again, where a currency turmoil is the consequence of a failing financial sector, conventional policy response of raising interest rates may be counter-productive. In such cases, interest-rate rises can lead to substantial reductions in bank net worth - further exasperating a banking crisis. IMF and Bank staff studies, Stiglitz underlined, have confirmed that interest rate rises tend to increase probability of banking crisis and that currency devaluations have no significant effect. Governments should also be more sensitive to interest rate changes than exchange rate changes. Exchange rate mismatches simply represent speculative behaviour. Stressing the need for competition, Stiglitz noted that trade liberalization, eventually leading to free trade, was a key part of the Washington Consensus. This too was based on Latin American experience. But trade liberalization was "neither necessary nor sufficient for creating a competitive and innovative economy." The Washington Consensus had focused more on privatization than on competition. In the context of the transition economies, privatizing quickly and comprehensively, and fixing problems later on, seemed a reasonable gamble. In retrospect though, the advocates of privatization over-estimated the benefits of privatization and under-estimated the costs, particularly the political costs of the process and the impediments to further reform. Stiglitz contrasted the experiences of China and Russia. China had managed to maintain double-digit growth by extending the scope of competition, without privatizing state enterprises. Russia, in contrast, had privatized a large fraction of its economy without doing much to promote competition. The consequence of this and other factors has been a major economic collapse. Competition policy One of the important lessons of the contrast between China and Russia is for the political economy of privatization and competition. Privatizing monopolies create huge rents and it has proved difficult to administer privatization without encouraging corruption and other problems. Competition policy, Stiglitz noted has also important implications for trade policy. Most countries have separate rules governing domestic competition and international competition. With little, if any, justification rules on international competition, such as anti-dumping provisions and counter-vailing duties, are substantially stricter than domestic anti-trust laws. Another presumption of the Washington Consensus is that governments are worse than markets and hence the smaller the state the better. But "I do not believe in blanket statements like 'government is worse than markets'.. government has an important role in responding to market failure, which is a general feature of any economy with imperfect information and incomplete markets. The role of human capital in development has long been appreciated. But markets tend to under-provide human capital. It is very difficult to borrow against future earnings since human capital is not collaterizable. As for technology, evidence that markets under-provide technology is even more compelling. Also, technology has many externalities. Hence, benefits to society of increased investment in technology far outweigh the benefits to individual entrepreneurs. Without government action there will be too little investment in production and adoption of new technology. Referring to the role of technology leaders in transfer of technology, Stiglitz said there was a tension between incentives to produce knowledge and benefits from effective dissemination. In recent years, he added, many - including small firms in developed countries, the academic community throughout the world, and many in developing countries - have become concerned that the balance that developed countries have struck, often under pressure from special interest groups, under-emphasizes dissemination. The consequence, they argue, may slow both the overall pace of innovation and adversely affect living standards in both richer and poorer countries. "Knowledge, is an input, a key input, into production of knowledge; an increase in the 'price' of knowledge - as a result of stricter intellectual property standards - may thereby reduce the production of knowledge. There is also a concern that an excessive amount of expenditure on research is directed at trying to convert 'common knowledge' into a form which is appropriable." "While in principle 'novelty' standards (a requirement for patents) are intended to guard against this, in practice the line is never perfectly clear, and stricter intellectual property regimes are more likely to commit 'errors' or privatizing public knowledge, thereby creating incentives for misdirecting intellectual energies in that direction." - (Third World Economics No.179/180, 16 Feb-15 March 1998) Chakravarthi Raghavan is the Chief Editor of the SUNS.
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