It seems like Jeff Sachs (somewhat belatedly) has learnt a lot of lessons
from his shock therapy adventures! A very worthwhile article. Greetings!
Arno
-----Original Message-----
From: owner-pkt@csf.colorado.edu [mailto:owner-pkt@csf.colorado.edu] On
Behalf Of Zhiyuan Cui
Sent: Sunday, September 20, 1998 5:51 AM
To: POST-KEYNESIAN THOUGHT
Subject: Sachs's G-16 proposal
Making it work
Jeffrey Sachs
from "The Economist" 12-Sep-98
THE collapse of the emerging markets and its ricochet effect on advanced
economies may not be the end of globalisation. But it is certainly the end
of an era. Since the miraculously peaceful fall of communism, Washington has
aspired to stage-manage the transition to global capitalism. America, in
concert with Europe and Japan, would ensure security and arrange deals on
world trade and regional stability; the International Monetary Fund would do
the financial plumbing, to connect Russia, Africa, Latin America and South
Asia, back to the world economy.
This approach is rapidly collapsing. In the short term, there is now a
crying need for globally co-ordinated interest-rate cuts to shore it up. But
in the longer term, if the current crisis is used creatively, a sounder
basis for globalisation is required. If neither of these things is done, we
may be entering a highly dangerous new period
of confusion and confrontation.
At the simplest level, the story is an old one: you just can't find a good
plumber when you need one. The IMF, and the institutions that it
co-ordinated (the World Bank, the regional development banks, the Paris Club
of creditors), have proved technically ill-equipped for the challenge. But
the IMF was having too much fun running 80 countries in the world to take
heed. Organised as a secretive institution, all of its programmes carefully
stamped "confidential" until recently, the IMF has lacked moderation,
outside review, and the competitive pressures needed to keep it up to date.
The American government has found it a handy instrument of financial
diplomacy and quick-disbursing funds, but did not realise that its repeated
technical failures could threaten the greater vision.
At a deeper level, the problem is one of basic approach. America has wanted
global leadership on the cheap. It was desperate for the developing world
and post-communist economies to buy into its vision, in which globalisation,
private capital flows and Washington advice would overcome the obstacles to
shared prosperity, so that pressures on the rich countries to do more for
the poorer countries could be contained by the dream of universal economic
growth. In this way, the United States would not have to shell out real
money to help the peaceful reconstruction of Russia; or to ameliorate the
desperate impoverishment and illness in Africa. In essence, America has
tried to sell its social ethos: the rich need not help the poor, since the
poor can enjoy rising living standards and someday become rich themselves.
Washington became skittish at anything or anybody that challenged this
vision. When developing-country leaders pointed out that development was
much harder than it looked; that their economies were falling further behind
in technology; that they were being destabilised by financial flows they
could neither track nor understand; that falling commodity prices were
taking them further from the shared prosperity that they had been promised;
that unattended disease was ravaging their societies; that the wreckage of
Soviet communism would take real aid, not just short-term loans to overcome;
or that they were still drowning in debt ten years after America
acknowledged the need for debt relief; all these honest reflections were
taken as hostile challenges to the vision of shared prosperity, because they
put at risk the notion of cost-free American leadership.
Time for a G16
As a result, for a decade we have had a phony Washington consensus on how to
achieve shared prosperity-and almost no real discussions between rich and
poor countries on the challenges facing a world of greater income inequality
than ever before in history. The Americans seem to fear the potential
budgetary costs of being honest about the manifold obstacles to global
development, and they fear the consequences of stirring up isolationists in
Congress and in the wider public. Such fears are overblown. The American
people, no less than any others, are deeply worried about a world
increasingly lacking convincing answers on the way forward.
Instead of the next G8 summit, we should immediately begin preparations for
a G16 summit: the G8 plus eight counterparts from the developing world. Such
a meeting would not seek to dictate to the world, but to establish the
parameters for a renewed and honest dialogue. One standard should apply for
participation: democratic governance, since the only reliable way to build
for the future is through participatory political processes. Four core
members of the eight developing countries would be Brazil, India, South
Korea and South Africa. We can hope that soon a democratic Nigeria will be
in place to help represent the 200m people of West Africa. Smaller
democratic countries that carry disproportionate credibility in the world,
such as Chile and Costa Rica, would be valued participants.
A sense of shared stewardship between rich and poor could do a great deal to
calm panicky financial markets. Part of the problem is that naive
25-year-old investment bankers who do not know much about world politics
think that the will to reform hangs by a thread in emerging markets; that
Russia will bolt from the world scene; that India has turned inward; that
Malaysia is irredeemably xenophobic; and that South Africa lacks the stomach
to reform. These are all false propositions-these countries deserve the
benefit of the doubt. But there is no convincing way to prove this. Getting
them to pay obeisance to the IMF has not worked, since IMF dictates from
Washington rile up local politics.
Even more important than calming panicked markets is giving poorer countries
a stake in a shared future. Global capitalism genuinely is the best chance
for the developing world to gain a foothold on the economic-growth ladder;
but with current institutions, global capitalism will not succeed widely
enough or credibly enough to create a stable world system. Giving the
developing world (that is, 85% of humanity) a serious role in shaping the
new global institutions is the surest way to achieve that end. As Paul
Samuelson once said, the best way to convince somebody of something is to
give them a half-finished theorem, and let them fill in the rest.
A development agenda
Precisely because intensive discussion is needed more than diktats, there is
no merit in offering a detailed blueprint for global reform: the process of
discussion is part of the solution. Yet the G16 summit would need an opening
agenda, a basis for reflection, debate, and negotiation. So herewith, a
modest pair of proposals.
The first concerns global financial markets. The summit should take up the
question of international financial reform. Washington's dream of a quick
move to global financial liberalisation is in ruins. It is hard to believe
that just a year ago the IMF was trumpeting a new global commitment to
unfettered capital flows. Almost all observers now concede that premature
liberalisation of capital markets (often pushed by the IMF itself) was one
cause of the current crisis. It was financial-market "reform" that allowed
Thai and South Korean banks to tap into short-term international loans in
the early 1990s, thereby bringing these banks together with excited young
investors who were happy to be in Bangkok and Seoul for the first time.
Hundreds of billions of dollars of loans flooded in. Now, the panicked
flight of such loans is at the root of the emerging-markets debacle.
The IMF worked mightily, and wrongheadedly, to make the world safe for these
short-term money managers. The IMF bought into the investment bankers'
mantra: exchange-rate stability above all else. The Wall Street Journal
parroted an even stronger line in favour of wholly fixed exchange rates.
After all, if central banks devote their reserves to a defence of the
exchange rate, and if the IMF dedicates its funds to the defence of central
banks, lending to emerging markets is like shooting fish in a barrel. Or so
it seemed-until a stampede began in the other direction.
The IMF encouraged central banks from Jakarta to Moscow to Brasilia to raise
interest rates to stratospheric levels to protect their currencies, lest
they lose the confidence of the money managers. Of course the money managers
could see one step beyond the IMF: investors do not gain confidence when
short-term rates are pushed to dozens of percent, as they have been in
Russia, South Korea, South Africa and Brazil at some points this year. The
more these economies tried to defend their currencies, the more they incited
panic.
Milton Friedman was right, as usual, about two big things. First, let
exchange rates float. It is neither worthwhile nor feasible to twist
monetary policy to soothe panicky investors, especially at the cost of
internal depression. (The only real exception to floating rates comes at the
start of stabilisation from extreme inflations, when exchange-rate targeting
is more efficient than monetary targeting). Second, small shocks can have
huge effects when they destabilise fractional-reserve banking systems. In
his classic monetary history of the United States, Professor
Friedman argued that banking panic, unattended by the Fed, created the Great
Depression. So this free-marketeer has long championed government-mandated
deposit insurance as a protection against bank runs.
We now need an international equivalent, to forestall panics in
international lending. The best idea around is that developing countries
should impose their own supervisory controls on short-term international
borrowing by domestic financial institutions. To avoid panicky capital
outflows, it is best to prevent banks from exposing themselves to excess
short-term indebtedness in the first place. Chile does this by taxing
short-term flows; other approaches may be worth exploring.
We also need vastly improved ways for creditors and debtors to extricate
themselves from trouble once a crisis has begun. Otherwise East Asia is
going to be buried in bad debt for half a decade or more. Already,
Washington is complacently writing down its medium-term forecasts of Asian
growth. This is wrongheaded.
Asian factories, which fuelled two decades of rapid growth, have not
suddenly vanished. They have been smothered in bad debts, which prevent
companies from getting working capital to keep producing. The IMF has no
answers, other than case-by-case bankruptcy proceedings, which already look
like a recipe for a lost decade of growth. Much bolder approaches are
needed, such as across-the-board debt write-downs and mass conversions of
debt to equity.
The second proposal concerns conditionality and foreign aid. 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 country 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 developing countries, especially since the IMF is often happy to
conspire with governments to make end runs around parliaments in the
interests of "reform". The contents of IMF programmes are too flawed to be a
standard of good or bad performance. Markets are realising this, so IMF
programmes do less and less to rally them. Publicly breaking with the IMF,
however, still carries a huge cost in market panic.
Help and self-help
A G16 summit should take up fundamental reform of the international
assistance process itself. The aim should be to restore legitimacy to local
politics, and abandon the misguided belief that the IMF and World Bank can
micro-manage the process of economic reform.
There is a better model of conditionality than the current Washington-based
approach. A large part of foreign aid should be channelled through regional
organisations (such as ASEAN in South-East Asia, Mercosur in Latin America,
or the SADC in Southern Africa) that would put peer pressure rather than
Washington pressure on their members. This is essentially the mechanism that
underlay the most successful aid programme in history, the Marshall Plan.
TheAmericans told the Europeans to work out the details on allocating aid.
Countries watched each other; they prevented backsliding; they channelled
funds into collective infrastructure; they deepened institutions of regional
co-operation.
Even more fundamental questions need to be asked about aid. What function
does it fulfill, when long-term capital is available to build roads,
telecoms networks, ports and power plants? It cannot be merely to keep the
World Bank in operation or to lend governments new money to pay off old
debts. The answer is that there is a continuing need for aid, almost
certainly on a bigger scale than ever before-but of a completely different
kind to today's.
Many current aid programmes could be scaled back by following three steps.
First, the agony of the debt crisis that began 20 years ago should be ended,
by simply cancelling most of the debt owed by the poorest countries. The
current strategy, known as the Highly Indebted Poor Country (HIPC)
initiative, is too slow and too stingy. Under the HIPC, debts are cancelled
after years of delay and only to a point that leaves the countries still
heavily in the red (post-cancellation debt is meant to equal 200% of
exports). Maybe it is the Washington bureaucrats' ideal: countries do not
collapse, but they never get better.
Second, all infrastructure aid that can be privately financed with long-term
capital (ie, most big projects) should be ended. The World Bank could then
privatise a large part of its operations. And third, IMF bailouts of the
sort that have failed in Asia and Russia should be ended. They do not work.
And they would not be needed if exchange rates floated, if supervisory
standards limited short-term capital inflows and if orderly private workouts
rather than public bailouts were encouraged.
This would then enable aid flows to be redirected. Aside from humanitarian
emergencies, and special cases like post-conflict countries or the end of 75
years of Soviet communism, the main function of aid should be to respond to
the fact that private markets do not attend to many international public
goods-goods that heavily influence the success or failure of the poorest
countries. Much of the developing world is burdened by disease and
environmental stresses that are deeply debilitating the lives of millions of
people. Malaria, for instance, afflicts around 500m a year, but global
public spending on a vaccine has been less than ten cents per case in recent
years. The WHO has wisely launched a renewed anti-malaria effort, but it
must be financed. Similarly, hookworm undermines the health of millions of
people throughout the tropics, but almost no public money is spent on basic
epidemiology or vaccine research. The developing world lacks basic
scientific and technical means to address the environment, health,
population and agriculture. Ever more hard economic evidence suggests that
development problems in the poorest countries come not merely from a lack of
political will, as fondly believed in Washington, but also from a lack of
knowledge of what to do. The heady technological advances of the rich
economies do not automatically translate into benefits for the impoverished
tropics.
So we need the World Bank not as yet another bank, but as our pre-eminent
international institution for mobilising the knowledge to address the
problems of the developing world. Yet the World Bank currently makes its
money from loans. It finds itself stuck in a banking business where it is
little needed, and not in the knowledge business where it could truly serve
the world. Restructuring the Bank, so that it had the means to mobilise real
knowledge creation, would cost a lot. This is part of the price tag feared
by the American government. The world will have to decide whether to remain
on the cheap, or to make the investments in knowledge that could promote a
more prosperous future.
Getting there
Do the developing countries want to change the system?
The current one has, after all, become a relationship of mutual dependency.
Developing-country governments, even those that recognise the shortcomings
of the Washington advice, wait patiently for the IMF and World Bank to send
their next team of experts. They are addicted to aid flows, partly to
refinance old debts; they are resigned to having little voice and little
scope for initiative. Washington will not easily cede the initiative either.
Yet in the end, the developing countries must become masters of their own
fate, or they will be dragged under in a widening spiral of financial
distress.
Even with all of the turbulence and value destruction of the past year; even
with the failures of IMF-World Bank programmes in Africa in the past decade;
even with the collapse of the post-communist transition in Russia; even with
all of these things, no developing countries are closing the doors on
markets and globalisation. In Malaysia
and Russia, certainly, there has been a backlash. But even there,
policymakers know they cannot get by without the outside world. They know
that technology and capital can come only from outside; and they know that
only markets can deliver the chance of sustained growth.
In short, developing countries are not trying to overturn Washington's
vision of global capitalism, but rather to become productive players in it.
Only if they are shut out might they change their minds. But the developed
world should not fear dialogue with the developing world. It should join it
urgently, for our mutual well-being.
* Jeffrey Sachs is professor of international trade at Harvard and director
of the Harvard Institute for International Development. He has long argued
that the IMF is mishandling the emerging-markets crisis.