Jan 30, 1998

FINANCE: LESSONS FROM THE 1970S, AS THE BANK SUPPORTS IMF

 

Geneva, 29 Jan (Chakravarthi Raghavan) -- World Bank President James Wolfensohn begins Friday a week-long trip through South-East and North-East Asia, where he would be peddling the Washington recipes for getting over the economic crises in Asia, endorsing the IMF-US Treasury view of the causes of the crisis (failure of local policies) but sugar-coating them with talk of social protection for the poor.

While he will switch on all his charm (of the John F. Kennedy era 'beautiful people') to present the "human face" of the Washington-twins, his hosts in Asia believing (after the criticism of Fund policies from Bank Chief Economist Joseph Stiglitz) that the Bank's fundamental approach is different, and hope for a different 'advice' than that from the Fund, would be in for serious disappointment.

For the Fund and the Bank now are not the solution for Asia, but part of the problem of neo-mercantalist globalization process being pushed by the US.  

Mr. Wolfensohn is as much a part, as the IMF's Camdessus and Stanley Fischer, and Secretary Robert Rubin of the Treasury-Wall St. complex of which Jagdish Bhagwati has recently warned.  

This is clear from an 8-page policy paper put out by the Bank's European office in Paris Wednesday, and previewed to the Washington press corps on Tuesday by the Bank's vice-President for East Asia and the Pacific, Jean-Michel Severino, and the buildup for the visit on the ground by Bank staffers, who are promoting the view of Wolfensohn's commitment against poverty, and the Bank's views as being different from those of the Fund.  

But Wolfensohn's visit, coming after the virtual 'silencing' of the Bank's Chief Economist, Joseph Stiglitz, who dared to speak out against the ill-advised Fund policies in Asia, it is not at all certain that the Bank President could pull off this 'good cop' image, even if his hosts, as is traditional in Asia, politely listen to him or hope to get some money out of his.

 But the Fund -- whose conditionality packages for the region has been indistinguishable from Washington's neo-mercantalist trade demands on these countries, and which has been blaming the Asian governments and their purported policy failures for the crisis -- turned on the markets last week.  

'IMF criticizes Markets', said a heading in the International Herald Tribune on a story (report by Bloomberg News) about the views of IMF Deputy Managing Director, Stanley Fischer, the US national actually running policy agendas at the IMF.  

The story was appropriately perhaps tucked into the part of the IHT which carried reports of market quotations, including of the international futures (of commodities and currencies).  

The World Bank's press release (to promote the Wolfensohn visit) spoke of the remarkable economic and social achievements of the region, but that the financial crisis had "exposed weaknesses in Asian economies" that must be addressed to return the region to its high growth rates. 

But it made clear that Wolfensohn's support is to ensure that the Asian governments carry out the IMF policies (that advance US and European TNC interests), "to build the foundations for restoring growth and raising incomes by adopting wide-ranging reforms in the financial sector, in corporate governance and competition and in managing external debt" -- though describing it as 'this builds on the IMF-led rescue efforts in the region'.

But lest it undermine the attempts of Wolfensohn to keep on his side those Northern NGOs (who had been previously been critical of the Fund/Bank structural programs in Africa) who have been since 'charmed' by Wolfensohn's talk, the Bank policy statement also talks of Wolfensohn's objective including 

* "to strengthen social protection for the poor and other vulnerable groups to help cushion the impact of the crisis"; and

"to improve the quality and transparency of key government institutions, including helping governments address problems of corruption and accountability."

The Fund and the Bank and its professionals, in trying to promote remedies for East and South-East Asia, have been dusting up the experiences of Latin America of the last decade or so, including the Mexican crisis.

For the Fund-Bank economists, like the Washington army generals, are always fighting the last wars.  

Both for their own future, and that of their profession, they should look rather at the experience of the southern cone of Latin America in the early 70s, the advice that the Fund gave to those countries about liberalization, including to Pinochet's Chile, and the grief that followed for those countries.  

And perhaps two writings they should read are about the experience of Chile between 1973-85 (by Carlos Fortin, 'The Failure of Monetarism', in Development Policy Review, SAGE, Vol 3, 1985) and by Carlos Diaz-Alejandro, another eminent Latin American economist who was at Colombia University, who wrote of that period and its experience in the Journal of Development Economics under the title 'Good-by Financial Repression, Hello Financial Crash'. 

Fortin (now an Assistant Secretary-General of UNCTAD, but at the time of writing an academic at the Institute of Development Studies in Sussex) summed up the result of the Chilean experience (following the Chicago school monetarist theories), thus:  

"...even though there was some debate as to the orthodoxy of the policies (that Chile followed after the Pinochet military coup), when they appeared to be successful in 1977-81, they were hailed by monetarist sympathizers the world over as proof of the validity of their approach.

"By 1983, however, those policies had resulted in the worst economic disaster in recent Chilean history..."

Fortin described the policies followed (under North American and IMF advice) as one of freeing the economy from state intervention, elimination of price controls, reduction of public expenditure, privatization of state enterprises, stimulating the emergence of private capital markets and opening up the economy to the rest of the world by a process that included devaluation and tariff reductions.

There was also the effort to end 'financial repression' by freeing interest rates, following a monetarist view through the 'theory of rational expectations', with the original devaluation of the chilean peso followed by two successive revaluations (in July 1976 and May 1977) along with the reduction in tariffs -- a process that resulted in an enormous expansion of imports, particularly consumption items, that exceeded Chile's growth of copper exports and non-traditional exports, even though these last had expanded considerably.

But the crisis that came between 1979 Dec and Jun 1981, was sought to be countered by the 'Chicago boys' by restricting financial operations, while preserving the fixed exchange rate - precipitating a major rift with financial groups that campaigned for devaluation. The Finance Minister was replaced by another 'Chicago boy', but with no results or major change of policy until April 1984, when the government decided on a change of course with a new economic team headed by two 'non-Chicago former ministers', but again replacing (after a declaration of a state of siege by Pinochet in Nov 1984) by another Chicago-boy in Feb 1985.

While Fortin's analysis of Chilean experience is essentially factual, it drew the conclusion that if Chile which had enjoyed unlimited access to international finance, making up for low export revenues, had used those flows to expanding the productive base of the economy, instead of being devoted to catering to luxury consumption as it did, the interruption in the flows in 1982 would not have produced the catastrophic effects that it did.  

Despite that experience, the Fund, the Bank and the WTO still push the financial and trade liberalization on developing countries even now, with the Fund advocating and supporting the view of the US and others that developing countries should use short-term flows (that augment their reserves) to allow imports of luxury goods.  

Diaz-Alejandro, in his paper (published in 1984) looked at what the abstract describes as "some unintended consequences of financial liberalization in Latin America."

But with the 9000 professionals of the IMF (all with Ph.Ds, but with 90% of them acquired in North American academia), and the WTO and its head, pushing the same liberalization policies now in Asia, perhaps a legitimate question by the Asian public must be whether the policies and their consequences can be separated and described as 'unintended'.

The removal of financial repressions, freeing of domestic capital markets from usury laws and other alleged government-induced distortions, Diaz-Alejandro says, yielded by 1983, domestic financial sectors characterized by widespread bankruptcies, massive government interventions or nationalization of private institutions and low domestic savings. And the paradox was in Chile, which showed the world "another road to de facto socialized banking system", with Argentina and Uruguay showing similar trends, but detectable less neatly in other developing countries including Turkey.

Diaz-Alejandro's paper starts with the peculiarities and dilemmas faced in domestic financial markets, by posing the question whether "banks are all that different from butcher shops" -- in terms of a butcher selling all his stocks to a customer who turn up with cash, or a bank extending credit to customers wanting to borrow at going interest rate.

While he makes the points that banks are different in that they put ceilings on their borrowers, in the Asian experience now it is clear that the banks really were not that different, and in fact brought down their margins to push money on their borrowers, turning a blind when they were being lent to fuel a real-estate boom or stock-market bubble.

He however notes that while a predominantly laissez faire financial system was being promoted and pushed (at that time on Latin American countries) "no industrial country has come close to the laissez-faire vision, atleast since the 1930s...." 

After outlining the financial history of Latin-American and Southern cone experiments since the 1920s, Diaz-Alejandro points out that the Southern cone countries, coming out of sundry populist experiences around the mid-1970s, undertook financial reforms in a laissez-faire direction: returning fully nationalized banking sector to the private sector by auctioning them off, with generous credit arrangements, or returning them to previous owners and with financiers allowed to operate with no restrictions or supervision. 

And when this resulted in some early bankruptcies, more so after multi-purpose banking was allowed (as in Chile), there were repeated announcements that there would be no bailing out. Nevertheless Chile intervened when an important bank, the Banco Osorno was in serious trouble and there was fear that its bankruptcy would tarnish external and internal confidence in Chilean financial institutions -- an argument used by Rubin and his supporters to justify Washington's intervention to bail out US banks and Wall Street firms (by using the IMF to get Seoul, Jakarta and Bangkok to under-write private debts).

More tellingly, Diaz-Alejandro quotes the IMF wisdom conveyed (by its Director of the Western Hemisphere division, the all-powerful Walter Robichek in the IMF of those days) at a meeting in Santiago in January 1980:

"In the case of the private sector, I would argue that the difference between domestic and foreign debt is not significant - barring government interference with the transference of service payments or other clearly inappropriate public policies - if its exists at all. The exchange risks associated with foreign borrowing are presumably taken into account as are the other risks associated with borrowing, whether it be from domestic or foreign sources. More generally, private firms can be expected to be careful in assessing the net return to be derived from borrowing funds as compared with the net cost since their survival as enterprises is at stake..."

 

Robichek then went on to argue that overborrowing by the private sector, even with official guarantees, as very unlikely, provided official guarantees were given on a selective basis; only public borrowing on international financial markets was regarded as posing more serious debt service risks.

 

Diaz-Alejandro then analyzes at length the Chilean experience, including the use of Central Bank credit to 'bail out' private agents, the jailing (by the Pinochet regime) of many linked to international banks and associated companies, including some ex-ministers of the Pinochet regime, the subsequent involvement of the IMF in the debt rescheduling exercises, but without objecting to this 'threat to the Robichek doctrine' (private sector borrowing, whether domestic or foreign did not matter at all).

He also points out that the various ad hoc actions taken by the then Chilean government to handle the domestic and external financial crisis carried with them an enormous potential for wealth re-distribution.

Among the lessons he draws are:

* whether or not deposits are explicitly insured, the public expects governments to intervene to save most depositors from losses, when financial intermediaries run into trouble;  

* linkages between banks and firms, which were hardly at arms length, were responsible for high use of debt by private firms - with in the case of Chile private firms being more indebted than state enterprises, and extreme indebtedness among private firms that controlled banks;  

* freeing of interest rates and relaxation of controls over financial intermediation will not necessarily encourage intermediation beyond short-term maturities;  

* while end of financial repression encouraged many types of financial savings, paradoxically it did not increase total domestic savings;  

* aggregate investment performance showed no clear sign of either improving or becoming more efficient;

* the combination of pre-announced or fixed nominal exchange rate, relatively free capital movements, and domestic and external financial systems characterized by moral hazard (as when governments and central banks rescue major creditors on the ground of threat to the financial system) and other imperfections... set the stage for significant micro-economic misallocation of credit, macro-economic instability, including explosive growth of external debt by private banks, followed by abrupt cessation of capital inflows.  

It took Chile seven years to recover from that 'frenzy' of financial liberalization, and get back to the path of development. But learning from that experience, it imposed restrictions and penalties both on inflow of short-term capital as well as on borrowing abroad.

If there is one thing common between that Latin American experience, and the present South Korean and South-East Asian experience it is that these latter governments, while still wary of advice to domestic liberalization and removal of all controls and regulations with a 'big bang', nevertheless believed the theology about private borrowing and allowed their banks and private firms to borrow abroad, without even monitoring such borrowing and the use to which it is put.  

The price for this is being paid by the ordinary people of South Korea, Thailand and Indonesia - while the foreign banks and investors are being rescued by the IMF-led packages.  

Is there a way out, or are the Asians destined to repeat history?  

Perhaps there is a way out, one requiring thinking the unthinkable -- with the Asian countries having a de facto moratorium on debt servicing of the private debts, and demanding some serious changes and commitments to be set in motion at the May 1998 Ministerial meeting of the WTO or failing that not ratifying the financial services liberalization pact forced on them in December 1997.