by Chakravarthi Raghavan

Geneva, 12 Apr 2000 -- Non-governmental activists demonstrating and protesting the policies of the International Monetary Fund and the World Bank at their spring meetings in Washington have received some support in two critical views of the IMF from leading US academics -- from Joseph Stiglitz, who recently stepped down as Vice-President of the World Bank and David Felix, Professor Emeritus at Washington University in St. Louis.

As trade negotiators and officials meet and consider further liberalisation of 'trade in services', and in particular financial and other related services, they might do well to read and absorb the views of Stiglitz (about the origins of the Asian crisis in the financial market liberalization that was undertaken in the 1990s), Felix and others, and not be carried away by the secretariat advices and ideological baggage of the liberalizers.

In some sharp criticism of the IMF and the US Treasury, in an article in Washington-based journal, 'The New Republic', Stiglitz says: "Next week's meeting of the International Monetary Fund will bring to Washington, D.C., many of the same demonstrators who trashed the World Trade Organization in Seattle last fall. They'll say the IMF is arrogant. They'll say the IMF doesn't really listen to the developing countries it is supposed to help. They'll say the IMF is secretive and insulated from democratic accountability. They'll say the IMF's economic 'remedies' often make things worse--turning slowdowns into recessions and recessions into depressions. And they'll have a point."

Stiglitz is highly critical of the IMF secrecy, and pricks the bubble of IMF staff belief that they are brighter and more educated (than economists of IMF borrowing countries) and says the IMF staff "frequently consist of third-rank students from first-rate universities."

In a policy-brief posted on NGO websites <>, Prof Felix says that while the Asian Financial crisis has eased, its reverberations have enmeshed the IMF in a major legitimacy crisis over its assumed mission and its ability to implement it. That new mission - promoting free capital mobility around the global - paralleled US policy, though deviating sharply from the IMF's original function. The IMF's crisis is thus also a US policy crisis, says Felix.

As chief economist at the World Bank from 1996 until last November, during the gravest global economic crisis in a half-century, says Stiglitz in the New Republic article, he was appalled to see how the IMF, in tandem with the U.S. Treasury Department, had responded to the crisis.

While the global economic crisis had begun in Thailand in July 1997, the seeds of that calamity, Stiglitz says, had been already been planted, in the early '90s, when East Asian countries had liberalized their financial and capital markets -- not because they needed to attract more funds, but because of international pressure, including some from the U.S. Treasury Department. These changes had provoked a flood of short-term capital -- the kind of capital that looked for the highest return in the next day, week, or month, as opposed to long-term investment in things like factories. In Thailand, this short-term capital helped fuel an unsustainable real estate boom. And as people around the world (including Americans) have painfully learnt, every real estate bubble eventually bursts, often with disastrous consequences. Just as suddenly as capital flowed in, it flowed out, causing a big economic problem.

But basing themselves on their experience of the 1980s in Latin America, when bloated public deficits and loose monetary policies led to runaway inflation, requiring fiscal austerity and tighter monetary policies, the IMF in 1997 imposed on Thailand similar austerity policies to restore confidence. And even as the crisis spread to other Asian countries, and the evidence of policy failures mounted, the IMF "barely blinked" and delivered the same medicine.

Stiglitz thought this was a mistake, since Thailand was running large government surpluses and starving the economy of much-needed investments in education and infrastructure, and feared that austerity measures would not revive the economies of East Asia. He therefore began lobbying the economists at the IMF, including deputy managing director Stanley Fischer, and the economists at the World Bank who might have contacts or influence within the IMF bureaucracy.

But while convincing the people at the Bank proved easy, says Stiglitz, changing minds at the IMF proved virtually impossible. When he talked to senior IMF officials how high interest rates would increase bancrupticies, at first they resisted his views. Then, unable to come up with counter-arguments, they would turn around and give another response, implying they were under considerable pressure from their Executive Directors.

But, says Stiglitz, his friends among the Executive Directors said they were the guys who were being pressured. "It was maddening" confesses Stiglitz, as everything was going on at the IMF behind closed doors, and it was impossible to know who was the real obstacle to change.

"Was the staff pushing the Executive Directors, or were the Executive Directors pushing the staff? I still do not know for certain," says Stiglitz.

Everyone at the IMF assured him they would be flexible and, if their policies proved too contractionary, they would reverse them. This sent more shudders down Stiglitz's spine, since most economists knew that it took 12-18 months for monetary policies to have full effect.

"To play catchup was the height of folly, but that was precisely what the IMF planned to do."

But this was not surprising since the IMF wanted to go about its policies without outsiders asking too many questions. In theory, the IMF supported democratic governance, and did not impose conditions, but in practice all the powers in the negotiations were on the side of the IMF.

Citing how the IMF sends "economists" to a country needing aid, economists who lacked experience of the country and drew their first-hand knowledge more "from the five-star hotels than of the country-side", and the hard work they put in and the "number-crunching" they do, Stiglitz says that the number-crunching rarely provided adequate insights into the development strategy for an entire nation, and even the number-crunching wasn't always that good.

And, while it would not be fair to say that IMF economists don't care about the people of developing countries, the older staff functioned as if they were shouldering Rudyard Kipling's whiteman's burdens. While IMF staff believed they are brighter and more educated, Stiglitz's own experience was that economic leaders from these countries were pretty good.

In many cases these economic leaders were "brighter and better-educated than the IMF staff, which frequently consist of third-rank students from first-rate universities." As one who had taught at Oxford, MIT, Stanford, Yale and Princeton, says Stiglitz, "the IMF almost never succeeded in recruiting any of the best students."

Most economists taught their graduate students for the last 60 years that in the face of recession, a little government deficit spending might be necessary. And any student who turned in the IMF's answer to the test question "What should be the fiscal stance of Thailand, facing an economic downturn?" would have got an F."

Seeing the spread of the crisis to Indonesia, Stiglitz recalls, he had given a statement at a Kuala Lumpur Conference, carefully vetted by the World Bank staff, that excessive contractionary policies in Indonesia could lead to a political problem. But the IMF stood its ground and its Managing Director, Michel Camdessus, said that East Asia had to grit it out as Mexico had done.

But the Mexican analogy, says Stiglitz, was absurd since Mexico had emerged out of the crisis not because of its actions strengthening the financial system - it remained weak years after the crisis - but because of exports to the booming US economy and NAFTA. In contrast, Indonesia's main trading partner, Japan, was in recession.

And by January 1998, when the World Bank vice-President for East Asia, Jean Michel Severino, invoked the dreaded r-word ("recession") and d-word ("depression") in describing the economic calamity in Asia, then US Deputy Treasury Secretary Laurence Summers, Stiglitz recalls, railed against Severino.

The IMF failed to restore confidence in East Asia, and in the summer of 1998 the crisis spread to Russia, where the calamity shared key characteristics with that in East Asia -- "not least among them the role that IMF and U.S. Treasury policies played in abetting it."

But the abetting of the crisis in Russia began much earlier, when following the fall of the Berlin Wall, there were two schools of thought concerning Russia's transition to a market economy. One of these, to which Stiglitz belonged, and consisting a melange of experts on the region -- Nobel Prize winners like Kenneth Arrow and others, who emphasized the importance of the institutional infrastructure of a market economy -- from legal structures that enforce contracts to regulatory structures that make a financial system work.

[Perhaps even ahead, the UN's Economic Commission for Europe in its 1990 (April) survey, after the fall of the Berlin Wall, had cautioned against big bang liberalisation and stressed the need for building institutional infrastructures and maintaining regional payment systems and trade, while moving gradually to a market economy. The IMF jumped on the ECE at that time and denounced its economists.]

And the second group consisted largely of macro-economists, whose faith in the market was unmatched by an appreciation of the subtleties of its underpinnings, namely, the conditions required for it to work effectively. These economists had little knowledge of the history or details of the Russian economy and didn't believe they needed any. And they put forward the doctrine of shock therapy, and that the stronger the medicine and the more painful the reaction, the quicker the recovery. This school won the debate in the Treasury and the IMF -and the Treasury made sure there was no open debate. Those opposed weren't consulted or allowed any inputs. The result was that in the 1993 Russian elections, the Russian voters gave a setback to the reformers. And Strobe Talbot, then in charge of non-economic aspects of Russian policy admitted that Russia had experienced too much shock and too little therapy.

Tracing the further course of reform in Russia, the rapid privatization, the rise of oligarchs who diverted funds to offshore banks, Stiglitz charges that the US was implicated in these, with Summers (soon to succeed Rubin as Treasury Secretary) making a public display of appearing with Anatoly Chubais, the chief architect of Russia's privatization, and thus the US seeming to align itself with the very forces impoverishing the Russian people. "No wonder anti-Americanism spread like wildfire."

Russia is now in desperate shape. High oil prices and the long-resisted rouble devaluation have helped it regain some footing, but standards of living remained far below where they were at the start of the transition. Russia is now beset by enormous inequality, and most Russians, embittered by experience, have lost confidence in the free market. A significant fall in oil prices would almost certainly reverse what modest progress has been made.

While East Asia is better off, it still struggles, too. Close to 40% of Thailand's loans are still not performing; Indonesia remains deeply mired in recession. Unemployment rates remain far higher than they were before the crisis, even in East Asia's best-performing country, Korea.

Ridiculing IMF boasts that the recession's end was a testament to the effectiveness of their policies, Stiglitz says every recession eventually ends; all that the IMF did was to make East Asia's recessions deeper, longer, and harder. "Indeed, Thailand, which followed the IMF's prescriptions most closely, has performed worse than Malaysia and South Korea, which followed more independent courses."

While bad economics and economic models of the IMF had played a part, these were only a symptom of the deeper problem at the IMF, namely, secrecy. Smart people, says Stiglitz, were more likely to do stupid things when they closed themselves off from outside criticism and advice. If the IMF and Treasury had invited greater scrutiny, their folly might have become much clearer, much earlier. The IMF policies had evoked criticisms also from critics on the right, such as Martin Feldstein, chairman of Reagan's Council of Economic Advisers, and George Shultz, Reagan's secretary of state, who joined Jeff Sachs, Paul Krugman, and Stiglitz in condemning the policies. But, with the IMF insisting its policies were beyond reproach -- and with no institutional structure to make it pay attention, the criticisms were of little use. More frightening, says Stiglitz, even internal critics, particularly those with direct democratic accountability, were kept in the dark.

The Treasury Department, says Stiglitz, is so arrogant about its economic analyses and prescriptions that it often keeps tight -- much too tight -- control over what even the US President sees.

Stiglitz is critical that many questions still receive little attention in the American press. For e.g., to what extent did the IMF and the Treasury Department push policies that actually contributed to the increased global economic volatility? Were some of the IMF's harsh criticisms of East Asia intended to detract attention from the agency's own culpability? Did America -- and the IMF -- push policies because they, believed the policies would help East Asia or because they believed these would benefit financial interests in the United States and the advanced industrial world? And, if the US believed the policies were helping East Asia, where was the evidence? As a participant in these debates, says Stiglitz, he got to see the evidence and "there was none."

Challenging the IMF claims and policy advises for financial market liberalisation and capital convertibility, Prof Felix (in a policy brief titled "IMF: Case of a Dead Theory Walking") says that typically, the IMF's pre-crisis assessments failed to foresee the impending crisis, while its "sound" crisis remedies concentrated the adjustment costs on the borrowers while protecting the lenders.

The IMF, Felix says, "tried to obscure the overt failures by ad hoc modification of its remedies". In the process, the optimistic performance targets of the initial policy package fade from view, along with clarity as to which fiscal, monetary, and exchange rate policies are indeed "sound." As a result, "mainstream economists have been defecting from the theoretical perspectives on financial market behaviour that underpinned the IMF's current mission - compounding the IMF's legitimacy crisis."

Under the original Bretton Woods charter, the IMF was to provide short-term financing to stabilize exchange rates, and its charter objective was to establish an economic order in which multilateral trade and investment (together with stable, convertible exchange rates) would be compatible with full employment, progressive taxation, and other components of welfare capitalism. Controlling international capital flows was judged essential for these goals to be sustainable - hence Article VI authorizing members to exercise controls to regulate international capital movements and for IMF to request tighter controls and deny emergency credits when used to meet large or sustained outflow of capital.

For the first three post-war decades, the IMF as a major source of emergency credits to the developing world was largely sidelined by foreign bilateral aid driven by cold war politics. But beginning 1970s, the US found the IMF useful in handling developing country debt crises and opening Third World asset markets to international capital. From a minor lender of last resort, the IMF became a major enforcer of foreign debt service and leading advocate of removing all obstacles to entry of foreign capital. It has attacked capital controls throughout the developing world, "moving from neglect to active violation of Article VI of its charter."

The IMF policy demands now include measures cutting deeply into socio-economic structures of borrowing countries and increased adjustment costs; requiring countries to ease capital controls and rely on raising interest rates to halt capital outflows and attract inflows.

By intensifying domestic bankruptcies, banking crises, and credit crunches, the IMF strategy often deepened declines of output and employment. To attract equity investment, the IMF also pressured borrowers to privatize state assets, reduce social expenditures, and repeal measures that protected wages and favoured domestic firms over foreign competition. These tougher IMF conditions and increased IMF meddling sparked popular unrest and political crises. Fearing popular reaction, many borrowing countries took IMF funds without fully implementing associated IMF demands. Mounting resistance to its austerity conditions and political meddling has contributed to the crisis currently enveloping the IMF, Prof Felix points out.

The IMF, he notes, is also under attack for its failure to provide adequate debt relief. In the past, when bilateral government loans constituted most developing country foreign debt, the IMF could ease the debt-servicing burden by persuading lender governments to stretch out repayment schedules. More recently, eager to keep private capital flowing and to promote increased global financial integration, the IMF has emphasized sustaining the full servicing of private loans as a core principle. To assuage panicky creditors, the IMF even required borrower governments to rewrite private debt contracts.

In the early 1980s, the IMF encouraged debtor governments in Latin America to guarantee the foreign liabilities of their domestic private banks, whose copious borrowing had helped bring on the crisis. To obtain bailout funds to mitigate its 1995 crisis, Mexico was required to pay out dollars to holders of its tesebonos, though contractually these treasury notes merely required repayment in pesos.

In compensation for such government guarantees, the IMF has been enlarging emergency credits. But as currency/banking crises have become more frequent and severe, there is mounting legislative resistance in the U.S. and other creditor countries to the rising fiscal burden of replenishing IMF coffers and providing supplemental bailout funding.

The $50-billion Mexican bailout of 1995 dwarfed previous packets, yet it was nearly quadrupled by the sum of the Asian-Russian-Brazilian bailout packets of 1997-98. Since 1995 the international bailout packets have amounted to over $250 billion, with around 35% supplied by the IMF. Its coffers nearly emptied, the IMF has been campaigning for enlarged replenishment quotas from its members to enable it to respond more expansively to future crises. "The campaign is falling flat."

The IMF is being buffeted as well by growing criticism that its "sound" crisis policies have had a low success rate and that the substance of what it dubs "sound" has evaporated in a fog of ad hocism. Typically, the IMF's pre-crisis assessments failed to foresee the impending crises.

Its "sound" crisis remedies concentrated the adjustment costs on the borrowers while protecting the lenders. The IMF tried to obscure overt failures by ad hoc modifications of its remedies. In the process, the optimistic performance targets of the initial IMF policy package fade from view, along with clarity as to which fiscal, monetary, and exchange rate policies are indeed "sound." (SUNS4647)

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

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