Those who created the crisis walk away scot-free

After having recklessly pushed the governments of many countries of the South into prematurely adopting a policy of of financial liberalisation (and thus exposing their financial markets and currencies to the ravages of financial speculators), it has now dawned upon some Bretton Woods officials and their institutions that this policy was wrong. Unfortunately, this belated realisation is no comfort for the millions of people whose lives were blighted by such mistaken policy advice.

by Chakravarthi Raghavan

PRIME Minister Mahathir Mohamad of Malaysia, with his flair for hard-hitting language, may have hit the headlines over the 'failure of the market system', in announcing wide-ranging capital and currency controls in his country.

But the portents that governments everywhere might be moving away from the norms of the Washington Consensus and its neo-mercantilist economic orthodoxies beneficial to the industrial centres, and taking steps to curb the excesses of the market, have been aplenty.

Paul Krugman, who has advocated controls, has claimed 'responsibility' for Malaysia's re-institution of exchange and capital controls (in that he advocated it as a way out for the ASEAN countries in his recent Fortune article).

However, it is clear from the article of Noordin Sopiee (a Mahathir confidant and member of the executive committee of the country's National Economic Advisory Council) in the Wall Street Journal of 3 September, that the Malaysian decision to reverse gears had been taken as early as 6 August (but kept a closely guarded secret).

While it is easy for countries, big and small, that did not liberalise and open up their financial sectors and capital markets not to liberalise, those which have done so but which need to claw back some regulatory powers, like Malaysia and others similarly placed, in their efforts to separate their current and capital account transactions, have to do it carefully lest people become too nervous, experts in international institutions say.

Countries like Malaysia have to tread a delicate path of fine-tuning and tightrope walking, taking account of the particularities (economic, political and social) of each country, experts who have been opposed to the orthodox liberalisation policies caution even when offering support and understanding for the about-turn.

The citadels of financial capital, and those who have been benefiting from the 'market jungle' and making their kill would not stay quiet, but wait to take advantage of any mis- step and pounce on the 'new heterodox' countries, these experts caution.

But outsiders, even those supporting, need to be careful in their private and public advice - whether it be to Malaysia, Russia or others - some of the international financial experts say.

Mr Yilmaz Akyuz, the United Nations Conference on Trade and Development's (UNCTAD) chief macro-economist and author of the Trade and Development Reports, who have long advised developing countries against premature financial liberalisation, said that countries having to institute controls have to walk a fine line in distinguishing between current account and capital account transactions and transfers. It is not always an easy thing to do, he notes.

They have to be flexible enough to ensure that they do not impede, but facilitate and encourage, trade and trade-related credits and foreign flows and exchange transactions for the real economy, while preventing and discouraging transactions related to arbitrage in the financial economy and markets.

The countries need to ensure that their currencies do not appreciate, so that their tradeable sectors could take advantage and export competitively. With clear guidelines and regulations, banks and authorised currency dealers would be able to buy or sell foreign currency related to such authorised transactions, without allowing a foreign currency black market to emerge. There may be some leakages through parallel markets, but these would not amount to much.

No longer risk-free

Nearly 15 months into the crisis, from its initial outbreak in Bangkok with the devaluation of the baht, the turmoil in the international financial and monetary 'system' is now sweeping from country to country, region to region, and from the periphery to the centre, with even the 'safe havens' for footloose and fancy-free capital no longer risk-free anywhere.

And whether the world will avoid another 'great depression' or find the history of the 1930s repeating itself, remains a question mark, given the self-serving and third-rate leadership in the powerful countries and institutions.

From Bangkok, through neighbouring South-East Asian countries, South Korea, Hong Kong and reverberations in Latin America (that were initially shrugged off), Russia and other transition economies, the poor everywhere have been battered since mid-July in 1997 - while those who created the crisis have been walking away from the ruins they have created, often with the International Monetary fund (IMF) having ensured full repayment.

It is not as if the current outcomes are unexpected events, caused by endogenous elements.

Respectable economists, and some professionals inside the UN system, put their career opportunities at risk in hoisting cautionary signals and giving public warnings for several years now.

As early as 1990, in its Trade and Development Report, UNCTAD raised cautionary signals over developing countries liberalising and opening up their financial sectors, often ahead of reform and restructuring of their real economies.

Financial-sector liberalisation should be the last, and not the first, step in the liberalisation of economies, UNCTAD's chief macro-economist Yilmaz Akyuz has been saying since 1990 - in several academic and other conferences and meetings, and in writings and publications.

But all such advice and caution were ignored, not only by the IMF and the World Bank (before the advent of Joseph Stiglitz as its chief economist), but by developing countries too; all embraced, some willingly and others reluctantly, the 'Washington Consensus' (a consensus of Washington-based institutions which was presented as a global consensus).

Preaching their dogma, the IMF management and staff criss- crossed the world (travelling always in first class, and justifying it by equating themselves to Wall Street bankers, although, unlike the latter, not facing the 'sack' for failures).

Just a few months ago, church figures in the United States who expressed concern at the price the poor everywhere are paying and the further sacrifices they are asked to make under the IMF policies, were told by IMF Managing Director Michel Camdessus that it would require a generation of sacrifice by developing countries and transition economies before the present policies can bear fruit.

And those calling for strong regulatory institutions and structures to be put in place before the institution of financial liberalisation measures, were either ridiculed or ignored.

Liberalisation - a conditionality

As late as December 1997 - when senior officials of the Bank for International Settlement were cautioning developing countries on the need for regulatory and supervisory mechanisms and cultures along with financial liberalisation - the US Treasury, and, at its behest, the World Trade Organisation (WTO) and the IMF, and others were advocating quick liberalisation of trade in financial services (a time span of 2-5 years was considered more than adequate for full liberalisation of banking, insurance and other financial sectors).

The IMF made financial-sector liberalisation a part of its conditionality package for the rescue of the Thai, South Korean and Indonesian economies.

The WTO leadership used these leverages to persuade developing economies to make concessions in the financial services negotiations - with the WTO head, Mr Renato Ruggiero, publicly and by telephone to key capitals, arguing that financial-services liberalisation was the solution to the crisis that was battering Asian economies.

It is now clear that the liberalisation of trade in financial services (with an agreement to come into force in early 1999 if ratified by the countries that signed it - and some developing countries are beginning to look at it anew) is a problem to their solutions, and not a solution to their problems.

And the Organisation for Economic Cooperation and Development (OECD) and the WTO (and some sections of UNCTAD) were promoting and pushing multilateral investment rules (whether they be called 'agreement' or 'framework') to enable all kinds of foreign capital to enter and exit countries, and promote 'global welfare' through 'efficient use' of capital.

And lest anyone be left in doubt, the OECD's Development Assistance Committee (in its 1997 DAC report) made clear that the IMF's moves for capital account liberalisation, the OECD's Multilateral Agreement on Investment and opening it for signatures by the emerging markets, and financial-services liberalisation, were all instruments to achieve the same objective.

But now that the chickens are coming home to roost, the once-disdainful top officials of the IMF (Stanley Fischer in his recent appearance on Brazilian TV, for example) are talking about their 'good intentions' and giving the best policy advice they can in the circumstances and with their 'limited resources', and the 'flexibility' they are showing in the conditionality packages for countries.

A belated confession

Having pushed developing countries and transition economies to liberalise and open up to financial markets, the Belgian Finance Minister, Philippe Maystadt, who for years headed the IMF Interim Committee (where these policies were pushed) and who retired this year from that office, in his letter of resignation from the chairmanship (published in the IMF Review of July) talks of the need for the IMF to adjust itself to changes underway in the global economy, particularly globalisation of markets and the growing mobility of capital.

Somewhat belatedly, he confesses, 'In particular, we will have to improve our knowledge on how international financial markets are functioning, to find ways to reduce the risks posed by abrupt short-term capital flows, and to modernise the system of regulating and supervising bank and non-bank financial activities.'

There is no apology or regret that without knowing how the markets function, the developing and transition economies had been pushed to open up and rely on these markets.

Under Maystadt's leadership, the Interim Committee and the IMF Managing Director pushed at the 50th anniversary meeting in Spain for capital account convertibility, and managed to get some backing for continued work at the 1997 Hong Kong meetings. However, Maystadt says now, 'The crisis in Asia also underlines the importance of orderly and properly sequenced liberalisation of capital movements, particularly those of a short-term nature. There is a need to proceed cautiously and with good advice. No country should be forced to liberalise immediately, or to remove controls when they are justified by legitimate reasons....'

Having foisted the Washington Consensus on the Latin American countries throughout this decade, the World Bank's chief economist for Latin America, Guillermo Perry, is quoted in the World Bank News of 2 July as saying: '...Clearly, the Bank was part of the Washington Consensus ...clearly, the Washington Consensus was incomplete.' It wasn't entirely wrong. 'Almost all the things that were outlined there were a priority... But there was probably one thing that I would call a mistake. In the financial sector, the emphasis was almost exclusively on deregulation. But it should have gone hand-in- hand with improvement of financial institutions. Because it is too risky to do one without the other.

'It was incomplete in ways we didn't realise at the time.

'Now, we know that the incentive structure - critical for the behaviour of people and firms - is not only indicated in prices. Prices are critical, markets are absolutely essential, but they are not the only things that create the incentive structure of the economy. It's institutions as well.'

The peoples, and the poor among them, of Latin America, Asia and Eastern Europe (and Africa for a very long time) are paying the price for the belated wisdom that has dawned on the Bretton Woods officials and their institutions - without the institutions or their overpaid staff paying any price that their peers in the markets would have had to.

UNCTAD's caution

Around the time UNCTAD was cautioning against premature financial sector liberalisation in the developing world, the UN's Economic Commission for Europe, in 1990, voiced its doubts over the 'big-bang' approach to converting the centrally planned economies of the former Soviet Union overnight into 'market economies'. It spoke of the need to first create the necessary institutions themselves and climate for a market economy, for inculcating among producers, consumers, buyers and sellers, a 'market culture' that had taken the West over 100 years to build.

The ECE advocated a Marshal Plan for the East - not suddenly pouring in a lot of funds, but funds that come with Western technical assistance to create institutions, while helping the structures and mechanisms of mutual trade in east Europe to continue even as these economies move slowly towards multilateral trade and exchanges.

But these were dismissed in the drive of Washington and Brussels to dismantle the communist system and lock these countries into the world capitalist system. But if the transition economies, particularly Russia, where many have been pushed back into barter economy, have a nostalgic view of the failed centrally planned economies or, worse still, slip into anarchy and fascism, when the IMF and the US and West Europe walk away, the latter may be called upon to pay a heavier price.

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