The extraordinary rise of global finance has been the single most outstanding economic development in the last quarter of this century. The breakdown in the early 1970s of the global system of fixed exchange rates established at the Bretton Woods conference has unleashed a series of booms—foreign exchange markets in the 1970s, bond markets in the 1980s, and global equity markets in the 1990s.[1] Each boom has been encouraged by technological innovation, especially in information and communications technology and deregulation to remove barriers to capital flows.
In 1975, about 80% of foreign-exchange transactions were connected to the real economy of trade and direct investment in the production of goods and services. By 1998, only 2.5% of such transactions were real, while pure financial flows accounted for fully 97.5% of all transactions. In the words of Belgian academic and financier Bernard Lietaer, "What had been the frosting has become the cake. The real economy has become just a small percentage of total financial currency activity."[2]
The increase in financial flows has destabilized financial markets and made them much more volatile. Volatility also spread to the stock market. In 1993 it was reported that the typical stock was held for an average of just over two years, compared to over four years ten years ago, and seven years in 1960.[3]
Volatility has created a world of sudden capital surges that can be enough to overwhelm even a large Third World economy. Banking crises have become a feature of the new globalized finance markets. The past 20 years have seen more than 90 serious banking crises around the world, each of which resulted in bank losses that, in proportion to gross domestic product (GDP), exceeded the costs of the U.S. banking collapse during the Great Depression.[4]
Often these surges have more to do with the "herd behavior" of investors who copy (and try to anticipate) each other's investment decisions than with the real economy. "Irrational exuberance," in U.S. Federal Reserve Chairman Alan Greenspan's words, is the order of the day. Paradoxically, what may be "irrational" for the market as a whole makes a lot of sense for individual traders in derivative, foreign-exchange, equity or bond markets who can stay ahead of the curve—there are profits and promotions to be made out of volatility. "The biggest concern today," notes Greenspan's predecessor, Paul Volcker, "is the growing constituency for instability."[5]
Walden Bello, a Filipino economist and one of the strongest critics of the West's handling of the East Asian crisis, has assailed what has become known as the "Wall Street-Treasury complex" that directs the U.S. financial system. This "complex"—exemplified by Greenspan and recently retired Treasury Secretary Robert Rubin, both former successful Wall Street financiers—involves a "revolving door" exchange of key personnel that helps ensure that Treasury policies are dominated by Wall Street's business agenda. This constituency, Bello argues, is likely to be a formidable obstacle to any attempt to reduce volatility by reforming the international financial system.[6]
According to Cambridge University economist John Eatwell, the regulatory system for this new paradigm is a "patched together" combination of measures which has not proved up to the job. Eatwell believes the result has been to undermine the global economy. He points out that the fall-off in global growth figures in the 1970s coincides almost exactly with the end of the Bretton Woods system. In all the Group of Seven economies, growth has slowed to around two-thirds of the 1960s rate, while unemployment has risen. In developing countries taken as a whole, the average rate of growth has also slowed by roughly the same extent. There are several causal links between financial market volatility and lower growth. First, as governments scrapped regulations on capital flows, they were left with little more than interest rates to manage the economy, forcing interest rates up and making them more variable. Second, market volatility and the greatly increased dangers of contagion have led governments to pursue "sound money" policies to avoid antagonizing the markets. This has meant cutting public spending in favor of less expansionary policies. Third, increased uncertainty has deterred private-sector investment. Finally, in order to defend their currencies against raiders, governments are forced to assemble large war chests of hard-currency reserves. This is money that cannot be spent on health, education or any social need.
Higher interest rates and lower government spending resulting from currency volatility have obvious negative impacts on the ability of national governments to invest in their people and to pursue policies that encourage economic growth. Although such problems are dwarfed by the impact of the currency crises that have afflicted Asia in the past two years, the important point is that liberalization and volatility are detrimental to human development, even when spectacular crashes do not occur.
The globalization of finance is often presented as both inevitable and beneficial, but it has been a comparatively recent event. In any historical sense it has certainly not been "integral to global trade in goods and services," as Rubin and others have claimed.[7] Rather it has been the result of a combination of financial and technical innovation, on the one hand, and intense political pressure on developing countries to open up their economies to international financial flows, especially since the early 1990s, on the other. The IMF has spearheaded this effort, ceaselessly pressing governments to reduce or liberalize regulations on foreign direct investment and other capital flows such as mutual funds and stock and bond markets, as well as on foreign borrowing by both governments and local businesses. Often such measures have been included as part of the structural-adjustment packages signed by the Fund and local governments. This activity goes well beyond the IMF's own Articles of Agreement, which limit its mandate to working on current account issues such as trade and services.
Under pressure from the IMF, backed by the U.S. Treasury Department and other major trading partners, numerous governments, especially in Asia and Latin America, introduced capital-account liberalization measures—the deregulation of capital flows—from the late 1980s onwards. Along with other measures such as the privatization of state-owned industries, this helped create a boom in capital inflows. In Latin America, income from bond issues alone rose from $7.2 billion in 1991 to $54.4 billion in 1997.[8]
But in such a deregulated system, inflows can rapidly turn into outflows, leading to a catastrophic emptying of a country's reserves and forcing local governments to devalue and/or raise interest rates to try to keep capital from leaving. In the hyper-liberalized global economy of the 1990s, the first country to experience this sudden reversal was Mexico, which had to be bailed out by Washington and the IMF after a massive run on the peso in 1994. The real fragility of the new financial system was only fully exposed, however, when currency crises hit Thailand in 1997, swiftly followed by Indonesia and Korea. Russia and Brazil followed suit in 1998.
In Mexico, Washington led the rescue effort for its newly anointed partner in NAFTA. Thereafter, it was left to the IMF to coordinate the West's response. Ever since Thailand, the IMF's actions have prompted a chorus of criticism, both from the left and from former allies such as George Soros, the hedge-fund wizard, and Harvard economist Jeffrey Sachs. Critics have raised a number of issues that fundamentally challenge the way the IMF has handled the current wave of crises, and called for substantial changes in the way the organization is structured and how it operates on the ground.
The most recent and ferocious round of criticisms have focused on the Fund's insistence on government austerity and high interest rates during the initial period of adjustment, which have had a deeply deflationary impact. Indeed, the IMF has insisted on such policies even in financially strapped countries which were running fiscal surpluses. But with the growing criticism of its handling of the Asian crisis, the notoriously impervious Fund has acknowledged that its demands for spending cuts have made matters worse and revised its approach. In Korea, Thailand and Indonesia, it has become an advocate of deficit spending, urging governments to spend more on health, education and social safety net schemes such as emergency job creation. In essence, the IMF is now pursuing a policy of Keynesian reflation—a dramatic departure from its hard-line policies in Latin America.
In Brazil, for example, which was running a large fiscal deficit prior to its $41.5 billion IMF "rescue" package in November 1998, the Fund has continued to insist on savage cuts, amounting to 20% of the total government budget.[9] The structural-adjustment package accompanying the IMF's "rescue" of the Brazilian real was intended to prevent devaluation, but the currency crashed anyway. By then, the Brazilian government had already made a number of commitments with a potentially devastating effect on the 60 million Brazilians living below the poverty line.[10]
In February, for example, the government cut the amount allocated for food rations from $48 million in 1998 to $23 million in 1999. About eight million people rely on these supplies of rice, beans, sugar and oil. The subsidy on school lunches was cut by 35%. Brazil's letter of intent to the IMF contains nine dense pages of analysis. Social policy is contained in a short paragraph promising targeted and efficient spending, with priority for primary education and basic health. When referring to cuts, there is a vague, one-line commitment "to spare as much as possible spending on health, education and social protection." The environment is not mentioned at all. In January the government reduced the 1999 land reform budget by 43% in relation to the 1998 budget. And the budget of Brazil's much-praised "bolsa escola" program, aimed at encouraging child workers back to school, was cut in half.[11] As the Brazilian economy "recovers," life for the poor in the world's most unequal society is getting even harder.
The second major set of criticisms focuses on the question of whether the Fund should be trying to carry out structural adjustment and currency stabilization simultaneously. Some question whether it should be involved in structural adjustment at all. Until the Asia crisis, financial-sector reform was the mandate of the World Bank, but the IMF used the crisis as an opportunity to assume a major role in pushing through financial reforms, arguing that the Bank's response was too slow. And so it should be, because Fund-style stabilization and long-term adjustment work at a completely different rhythm, as the Fund has learned to its cost. Stabilization, especially when the problem is one of liquidity, requires rapidly restoring confidence through a combination of rescheduling a country's debt and providing a bridging loan with few strings attached. It means acting fast and providing large sums of money up front. Instead, the IMF continues to insist on shopping lists of "conditionalities," setting out detailed economic reforms covering everything from changing the bankruptcy laws to privatizing state companies, which must be achieved before each new "tranche" of the loan is handed over.
Structural-adjustment packages, on the other hand, can only work when there is a sense of local ownership of their contents, something that can only be achieved through time-consuming dialogue and negotiation. Since the threat of suspending loan disbursements is the Fund's way of exerting leverage on governments, loans are handed over in small amounts over prolonged periods of time. The doubt surrounding whether the country will qualify for the next round is exactly the opposite of what is required to restore confidence in the short term.
A third major criticism of the IMF focuses on the question of resources. The Fund is simply not equipped to provide the volume of money needed to see currencies through balance-of-payments crises. Global capital markets are growing at an astonishing rate—some $1.5 trillion changes hands in foreign-exchange transactions daily, and the amount is rising constantly.[12] Despite its recent injection of funds from member countries, the IMF will continue to fight a losing battle against the tidal waves of finance hurtling around the global economy.
The IMF has also been criticized for its dogmatic attachment to liberalization. When it comes to the role of states and markets, the Fund is a true believer rather than an empiricist. The Asia crash provides ample evidence of the perils of capital-account liberalization, but the Fund merely concedes that solid domestic financial institutions and regulations should be in place before liberalization occurs. It grudgingly accepts that countries should in some circumstances briefly follow the Chilean model of placing restrictions on capital inflows to discourage short-term investment. But it does not positively advocate such a step, even though the Chilean system, introduced in 1991 and widely discussed in the aftermath of the Asia crash, appears to have been successful in filtering out short-term speculation in favor of longer-term investment. One Fund insider commented that many staff still see capital controls as "the next thing to original sin."[13] IMF Managing Director Michel Camdessus demonstrated the triumph of dogma over experience last March when he told the Institute of International Bankers: "To optimize the opportunities and reduce the risks of globalization, we must head towards a world with open and integrated capital markets."[14]
Other questions have emerged over burden sharing in the wake of structural adjustment and "moral hazard," the idea that investors are likely to take undue risks when they know that they are likely to get bailed out. Fund staff in fact concede that while foreign investors and local elites enjoyed most of the gains of the precrisis period, they have had to bear very little of the costs of the crash. Instead, these have fallen on the poor, in the form of recessions, accompanied by public spending cuts, job losses and falling wages. Beside the simple but important point that this asymmetric distribution of pain and gain is unjust, there are some important moral hazard implications. All along, both lenders and borrowers are seeing that they have nothing to fear from rash decisions. At an international level, foreign investors have found that they will be bailed out by the international financial institutions—i.e. Western taxpayers—when the going gets rough. At a national level, elites have seen that debts can be socialized—passed on in turn to their own taxpayers and workers. The issue of how to ensure that creditors assume some of the risk in debt rescheduling—which means, inherently, some of the cost if things go awry—is unlikely to go away, despite its unpopularity on Wall Street.
Another major critique is that the Fund is not an impartial body. There is little doubt that the U.S. government exercises enormous influence over the IMF. Their reform agendas for Third World economies are almost identical. But the Asia crash may mark a new low in the Fund's reputation as a vehicle for U.S. aspirations. The Korean rescue package, for example, included a series of conditions, such as opening up the economy to imported auto parts, which had precious little to do with the country's balance-of-payments problems, but had been persistent U.S. demands in bilateral trade negotiations for much of the 1990s. One negotiator reportedly told economist Robert Wade that the U.S. government had achieved more in six months of crisis bailout talks than in ten years of bilateral trade negotiations.[15]
More generally, the Fund continues to assume that Western business practices are inherently superior to anyone else's. This in spite of the clear evidence that East Asia has outperformed the rest of the world for much of the last 40 years, and has done so in a relatively inclusive and equitable fashion which has clearly eluded Latin America (or indeed the United States). In Mexico, the much-vaunted post-1995 recovery has failed to "trickle down" to the poor. In 1998, for example, real manufacturing wages were still 22% below their precrash levels.[16]
The IMF recipe now being prescribed in Asia makes no effort to learn from the region's past successes, but merely seeks to introduce a number of "Anglo-Saxon" business practices through conditionalities on IMF loans. "Are we witnessing the decline of the various Asian models, their end hastened by the Asian crisis?" asked Korean economist Ha-joon Chang in a recent issue of the Cambridge Journal of Economics. "Will Anglo-Saxon governance practices come to prevail throughout East Asia, either because they are perceived as the most rational, or because they are forced on the countries which accept IMF assistance?"[17] A similar effort at "Anglo-Saxonization" took place after World War II, but as the author points out, the Japanese and German models that emerged from a period of direct U.S. occupation and occupation-led institutional and legal reforms bore little resemblance to those of the United States.
Even within its Anglo-Saxonizing mission, the IMF stands accused of double standards over which parts of the U.S. and European experience it intends to introduce in crisis countries. UN Conference on Trade and Development (UNCTAD) economist Yilmaz Akyüz has pointed out that economic recovery in the United States in the 1980s was driven by a debt-financed consumer boom and government deficit spending. Financial institutions increased their risky lending on real estate and mergers and acquisitions. After the bubble burst with the 1987 stock market crash, the Federal Reserve raised interest rates, sparking one of America's deepest postwar recessions. The Fed swiftly responded by lowering interest rates almost to negative levels in real terms, leading to a strong recovery by the end of 1993. "The U.S. economy is unlikely to have enjoyed one of the longest postwar recoveries,"Akyüz concludes, "if the kind of policies advocated in East Asia had been pursued in the early 1990s in response to debt deflation."[18]
The industrialized countries scrapped their own capital controls only very recently, with Britain leading the way in 1979. Many people in the Third World reasonably ask why this level of economic sovereignty is being denied them as they in turn struggle for development. Capital controls, they argue, allow governments to defend small, vulnerable economies against the kind of surges that overwhelmed the Mexican and Brazilian currencies. They would also enable governments to channel investment towards priority areas of the economy, as Korea did for decades during its high growth period prior to the liberalization of the 1990s.
The Fund also stands accused of excessive arrogance in its certainty that its policies alone are the solution to crises in diverse parts of the world. Jeffrey Sachs has been particularly vehement in this respect: "The IMF and the World Bank have behaved with stunning arrogance in developing countries. The sequence is familiar: the IMF's negotiating positions are settled in Washington; the mission team goes to the client country to convey Washington's conclusions; the financial markets wait breathlessly to see whether the countries will comply; the American government repeats the mantra 'obey the IMF'; and journalists assess the 'seriousness' of reforms according to whether countries bite the bullet to carry out the IMF dictates, whatever they are. This process is out of hand. It has undermined political legitimacy in dozens of countries."[19]
Paul Krugman, an M.I.T. economist who works closely with the Fund, maintains that the brittleness in the way it deals with criticism stems from the simple fact that "even as they lay down the law to their clients, they are groping frantically for models and metaphors to make sense of this thing.... They are making it up as they go along."[20] This is a truly alarming picture—IMF economists pretending a certainty that they do not in fact possess, forcing ill-considered policies on numerous governments whose populations are already caught in the middle of an economic crisis.
The Fund's unwillingness to listen to criticism is exacerbated by its reluctance to have its performance independently evaluated, as the World Bank now does with its programs. The Fund's own assessment of its performance in Asia is probably the best single argument for establishing an independent evaluation unit. According to IMF-Supported Programs in Indonesia, Korea and Thailand: A Preliminary Assessment, which was published last January, anything that went wrong was either unforeseeable or the fault of the governments concerned and has since been rectified. There is no consideration of whether institutions other than the IMF might have been more effective at different parts of the job, or of what organizational defects might have prevented the IMF from getting it right.
Numerous reform proposals are currently being discussed both to the international financial system and to the IMF itself.[21] They were barely visible, however, at the IMF's spring meeting in Washington last April. In response to what Bill Clinton has called "the biggest financial challenge facing the world in a half-century," the Fund came up with little more than minor tinkering.[22]
Some of the broader proposals largely missing from the official debate include crucial issues of participation—the IMF remains a highly exclusive body that deters public participation in designing economic policies. Democratization should start with the Fund itself. Industrialized countries account for over 60% of the voting strength at the IMF and World Bank, compared with just 17% in various UN bodies (roughly proportional to their share of the world's population). A first step to improve the IMF's representativity should be to overhaul the Fund's power structure to give a fairer voice to developing countries, especially those most affected by its operations.
Also missing was a discussion on rolling back the IMF's seemingly endless encroachment on national sovereignty. Governments must be made accountable to their own people, not to IMF officials, and should be able to design economic policies according to their national needs. Furthermore, the Fund should narrow its field of operation by returning to its original mandate and confining its attention to issues concerning markets for goods and services, rather than capital markets, of member countries. It should minimize its use of policy conditionality in favor of a process of participation and dialogue with all stakeholders in program countries.
Making the IMF work for (or at least not against) the poor requires institutional changes, but also a deep change in the institutional culture of the Fund. It must become open to the public, not closed; pluralist and open-minded, not dogmatic; it must listen, not lecture; and it must learn from its mistakes.
The global financial system is not working. Above all it is not working for the poor. If the governments of the rich nations are sincere in their desire to end world poverty and provide a decent life to all the world's people, they must start with a thorough overhaul of the international financial architecture, including the IMF. But reforms must go further, to a new economic model based on inclusion, justice and democracy. This is the challenge that faces world leaders during the last year of the millennium and against which their actions will be judged both by history and the world's poor.
ABOUT THE AUTHOR
Duncan Green is a Policy Analyst at the British aid agency CAFOD and a member of NACLA's editorial board. He is author of Silent Revolution: The Rise of Market Economics in Latin America (Monthly Review Press, 1995). His article, "Child Workers of the Americas" appeared in the January/February 1999 issue of NACLA Report.
NOTES
1. John Eatwell and Lance Taylor, The Performance of Liberalized Capital Markets, Center For Economic Policy Analysis, New School For Social Research, Working Paper (September 1998), p. 4.
2. Bernard Lietaer, "Global Currency Speculation and its Implications," Third World Resurgence, No. 87/88 (November/December 1997), p. 15.
3. Franklin Edwards, "Financial Markets in Transition—or the Decline of Commercial Banking," Federal Reserve Bank of Kansas Symposium, 1993.
4. Zanny Minton Beddoes, "Global Finance: Time for a Redesign?" The Economist (London), January 30, 1999, p. 6.
5. As cited in Bernard Lietaer, "Global Currency Speculation and its Implications," p. 15.
6. Walden Bello, "Strategies and Alliances for Effective Action," Paper presented at the Economic Sovereignty in a Globalizing World Conference, Bangkok, March 24-26, 1999.
7. Quoted in Jomo KS, "Introduction," in Jomo KS (ed.), Tigers in Trouble: Financial Governance, Liberalization and Crises in East Asia (London: Zed Books, 1998).
8. Comisión Económica para América Latina y el Caribe (CEPAL), Preliminary Overview of the Economies of Latin America and the Caribbean (Santiago: CEPAL, 1998), p. 97.
9. Aurélio Vianna Jr., "Social Expenditures and the Payment of External Debt Service," Rede Brasil sobre Institu?ões Financeiras Multilaterais, Mimeograph, 1999.
10. Michael Bailey, "The Brazilian Economic Crisis," Oxfam, Mimeograph, March 1999.
11. Michael Bailey, "The Brazilian Economic Crisis."
12. "Bank for International Settlements, 1998," quoted in Robert Blecker, Taming Global Finance: A Better Architecture for Growth and Equity (Washington, D.C.: Economic Policy Institute, 1999), p. 2.
13. Author interview, IMF, April 27, 1999.
14. See the IMF Website at .
15. Speech by Manfred Bienefeld, "Can Finance Be Controlled?" Economic Sovereignty in a Globalizing World Conference, Bangkok, March 24-26,1999.
16. CEPAL, Preliminary Overview, p. 87.
17. Ha-joon Chang, J. Gabriel Palma, and D. Hugh Whittaker, "The Asian Crisis: Introduction," Cambridge Journal of Economics, No. 22 (November 1998), p. 651.
18. Yilmaz Akyüz, "East Asian Financial Crisis: Back to the Future," in Jomo KS (ed.), Tigers in Trouble, p. 37.
19. Jeffrey Sachs, "Global Capitalism: Making it Work," The Economist, September 12, 1998, p. 24.
20. Paul Krugman, "Will Asia Bounce Back?" March 1998, .
21. For a fuller version of these proposals see Duncan Green, "Human Development and the Asia Crisis," .
22. Remarks to the Council on Foreign Relations, New York, September 14, 1998, as cited in Robert Blecker, Taming Global Finance, p. 2.
