Larry Elliott
The timing could not have been better. Everybody, but everybody, from the global financial community was in town for the spring meetings of the World Bank and the International Monetary Fund (IMF), and what happens? Shares go crashing on Wall Street.
For someone who has long argued that the United States has been dangerously gripped by a stock-market mania, there was something utterly compelling about watching the US TV channels that have been complicit in whipping up the frenzy, trying to explain to their viewers what had gone wrong. It was quite simple, the technology sector – and to a lesser extent the whole US stock market -was ludicrously over- valued and destined to fall.
Privately, some of the foreign officials in Washington consider the puncturing of the bubble a healthy development and are keen for the market to fall still further.
Wall Street’s tumble highlighted some of the vulnerabilities of the international financial system and forced those running it to explain exactly what they are doing.
The United Kingdom chancellor, Gordon Brown, said there should be no retreat into isolationism and protectionism, and he’s right about that. He also said that the world needs international institutions such as the IMF and the World Bank, and he’s right about that too.
Now, the IMF and World Bank need to rethink how to manage the global economy. For years, they have operated rather like the medieval Vatican, insisting on the one true faith. They are now faced with unruly heretics who not only refuse to believe but are prepared to resist.
The heretics are not all eco-warriors and anarchists. Perhaps the most wounding attack on the IMF came from Joseph Stiglitz, until recently the chief economist of the World Bank. The main thrust of Stiglitz’s article in the New Republic magazine was that the IMF had woefully mishandled the crises of 1997/1998, but he widened his argument with an attack on its secrecy, its arrogance and its policies, describing it as full of “third-rank students from first-rate universities”.
“When the IMF decides to assist a country, it dispatches a ‘mission’ of economists,” he said. “These economists frequently lack experience in the country; they are more likely to have knowledge of its five-star hotels than the villages.”
The second most compelling read of the week came from the IMF itself. In an overview of the world economy’s development in the 20th century, it said that the past 100 years has seen a stupendous increase in economic output. At the same time, however, inequality between the world’s rich and poor regions, measured by output per capita, has also increased dramatically. GDP per capita in Africa is lower today than it was in the rich countries in 1900.
The IMF then divides the 20th century into four distinct periods – the gold standard era, the two world wars and the great depression, the 1950-1973 boom and the period of globalisation.
What the IMF believes is that “modern financial markets promote the mutually beneficial exchange between net savers and users of capital for productive purposes over increasing numbers of economic agents and ever-larger territories, thus contributing to the optimal use of capital”. Its figures, however, show the most successful period of the past 100 years was 1950 to 1973, “characterised by exceptionally rapid output, per capita growth and the recovery of world trade under the Bretton Woods system of fixed exchange rates and widespread capital controls”. The IMF says that pegged but adjustable exchange rates and control of capital movements gave governments room to address domestic problems, while the IMF successfully oversaw the international system.
“During the Bretton Woods period, the stability of the real economy and of exchange rates reinforced each other. Wage pressures were moderate, reflecting the impact on labour markets of memories of unemployment in the 1930s and rapid non- inflationary real wage growth, made possible by high productivity growth. Finally, capital controls remained in place, limiting the instability from disruptive international financial flows.
It may have been that this golden age was a fluke. Some might say growth would have been still faster if trade and capital had been allowed to cross borders more easily. The alternative way of looking at it is to say that the policies that worked well once might work again.
The IMF fully accepts that a pegged exchange rate, independent national monetary policy and unrestricted international capital mobility cannot be achieved simultaneously. So, if one of the three has to be sacrificed, which? The argument in favour of liberalising capital flows is that more efficient markets enable money to flow where it is needed.
However, the tendency has been for removal of controls to be followed by a surge of capital inflows, much of which has been for speculation rather than long-term investment. The counterpart to a surplus on the capital account has been a deficit on the current account, which has precipitated a crisis, leading to capital flight and austerity programmes.
The IMF describes what happened: “Starting in the 1980s, controls on international capital movements were dismantled in many countries in pursuit of efficiency gains from deregulation. The resulting large increase in internationally mobile capital flows combined with domestic policy imbalances and volatile exchange rate expectations to generate repeated international financial crises.”
It seems a bit of a no-brainer. The IMF and the bank agree that the priority is to tackle poverty and global inequality. But governments find it hard to pursue growth and redistribution when in thrall to capricious global markets. The solution should be to maximise domestic opportunity and provide the environment for countries to develop their own domestic financial institutions and create a flourishing market economy.
One would have hoped some IMF eggheads would be proposing this. But maybe Stiglitz is right, and they’re not so clever after all.