Larry Elliott
The International Monetary Fund (IMF)is confused. That’s a surprise in itself, because the IMF thrives on certainty, with firm views about everything, even if most of them are wrong.
Stuck away in its half-yearly document, the world economic outlook, the IMF has a section called “Macro-economic stability and the forces of globalisation: lessons from the 1990s”. The 1990s have been marked by “unstable macro-economic conditions”, with global output growing by 3% a year, against 3,5% in the 1980s and 4,5% back in the bad old 1970s.
The IMF admits surprise that such instability has persisted, given the “improvement in macro-economic policies in most countries compared with the two preceding decades”.
The report then lists four recent developments in the global economy. First, there is the trend towards lower inflation, which the IMF believes is largely due to trade liberalisation, privatisation and the conduct of monetary and fiscal policy.
Second, there is the rapid integration of financial markets in the 1990s following the liberalisation of the 1970s and 1980s. This has resulted in “private capital flows to emerging countries unprecedented in scale at least since World War I”. The IMF says the large flows into developing countries in the build-up to the recent crisis in part reflected “unsustainable developments in the recipient countries”.
Third, economic and financial linkages and policy transmission mechanisms across countries have become more complex in the 1990s, with a tendency for capital to flow into dynamic countries and regions.
Finally, flexible exchange rates have become prevalent. “In the 1990s, short-term exchange rate volatility has remained high with no clear trend, which is somewhat surprising in view of the decline in worldwide inflation.”
Surprising? Trillions of dollars are zipping around the world every day without hindrance, so is it surprising that there is exchange rate volatility?
The IMF sums things up like this: “Developments in the global economy in the 1990s and the hypotheses to which they give rise are not particularly reassuring. They point to a global economic and financial system with great potential for allocating resources more efficiently within and among countries, but also with a potential for excesses to develop in asset markets and the private sector, and therefore for recurrent macro-economic instability, even when macro- economic policies are reasonably well disciplined.”
So, there you have it. The economic system so cleverly constructed over the past 25 years has resulted in lower levels of growth, asset price bubbles, foreign exchange volatility and permanent macro- economic instability. But inflation is lower, so what the hell.
Of course, not everybody has been surprised by these developments. John Maynard Keynes argued that flexible exchange rates and free international capital mobility are incompatible with global full employment and rapid economic growth in an era of free trade.
Professor Paul Davidson, the keeper of the Keynesian flame, says the problem was that Keynes’s analytical system was not incorporated into orthodox theory. Instead, the idea was implanted that either markets were efficient, which was the view of people such as Milton Friedman, or were only temporarily inefficient and could be made efficient, which was the view of a group known as neo-Keynesians.
Davidson argues that the logic of true Keynesianism is that the primary function of financial markets is to provide liquidity: “Since a liquid market must be an orderly one, rules and institutions must be developed to guarantee orderliness. If Keynes’s liquidity preference theory of orderly financial markets is relevant, financial markets can never deliver, in either the short or long run, the efficiency promises of efficient market theory. In the real world, efficient markets are not liquid and liquid markets are not efficient.”
Davidson argues that there needs to be a complete overhaul of the international financial system along the lines that Keynes wanted at Bretton Woods. However desirable that might be, the reality is that there is no political constituency – even among the parties of the left – for such reforms.
However, one thing that could be achieved is to ensure that the development strategies of poorer countries are not jeopardised by a continuation, and even an intensification, of the policies which have failed in the past.
In a study of the Asian crisis, Jeffrey Henderson of the Manchester Business School found there were distinct differences between those nations which felt the full heat of the meltdown and those, like Taiwan and Singapore, which emerged relatively unscathed.
‘Taiwan and Singapore have so far remained largely outside the web of the crisis because they continue to have effective developmental states. As a consequence they have been able to construct more robust economies than the others, partly by withdrawing property and stock markets as foci for speculative investment, partly by maintaining the institutional capacity and bureaucratic skill to – in the Singaporean phrase – ‘cane the speculators’, and partly by continuing to practise strategic economic planning.”
Henderson’s point is that there is something inimical between the long-term capital commitments and the patience needed for “late industrialisation”, and the speculative and short-term portfolio flows induced by the sort of capital-market liberalisation traditionally urged on developing nations by bodies such as the IMF.
This is what bodies such as Oxfam have been saying for some time: debt relief is not an end in itself, but should be channelled into laying the foundations for development through investment in the basic social infrastructure.
What this means is a more restricted role for the IMF, which should advise on the right conditions for macro-economic stability, but should do so within a framework that makes poverty reduction a priority.
What it does not mean is countries being force-fed structural adjustment programmes and bullied into ill-timed and self- defeating capital liberalisation.
The IMF says structural adjustment programmes are to be given an anti-poverty focus, with even the name changing from the “enhanced structural adjustment facility” to the “poverty reduction and growth facility”.
It is encouraging that, inside the IMF, people are having second thoughts about the wisdom of the prevailing orthodoxy. If that means the IMFreturns to doing what it was set up to do – creating the macro-economic conditions for growth and the advancement of human welfare – it is good news for us all, even if long overdue.