When it comes to economies in general and financial crises in particular, it’s remarkable how little we actually understand. While global financial actors struggle to restructure Greece’s debt and to avoid contagion throughout Europe’s periphery, we should recall the lessons of the Asian-Russian crisis 15 years ago. As the writings of Joseph Stiglitz and Martin Wolf remind us – and those events illustrate – crises are part of an evolutionary process, and the afflicted economies often emerge with surprising vigor.
The developed world is still reeling from the global financial crisis of 2007-2009. Before the recent crisis, a sense prevailed that in the waning years of the 20th century, the global embrace of free markets and financial innovation had not only super-powered expanding prosperity, but economic stability as well. Post-financial crisis, however, there’s a widespread feeling that infatuation with free markets and financial innovation actually undermined economic stability and may have threatened prosperity, not just in the short term but in the long run.
How could such a huge shift in perceptions of economic reality take place so quickly – resulting from events over a period of only a few months, if not weeks? This shift occurred in the views of seasoned analysts, commentators and theorists of many persuasions. Are our concepts and models of economic processes still so fragile after all these years that an event of a kind that has occurred frequently throughout history (as Carmen Reinhart and Kenneth Rogoff show in their recent book, This Time Is Different) could throw them into complete disarray?
The answer to the latter question is clearly “Yes.”
And yet the last serious financial crisis occurred a scant 10 years before the 2007-2009 event, in 1997-98. It hit the emerging economies of Asia, and Russia, not the major industrial countries; its only clearly visible impact on the U.S. economy was the collapse of the large hedge fund, Long-Term Capital Management (LTCM). But that crisis set off a long-running debate on globalization. The after-effects of that crisis may have helped cause the more recent crisis, by prompting developing countries to amass enormous cushions of foreign reserves. And the concerns over the LTCM failure should have increased awareness of systemic risks posed by the complex interlocking commitments of international finance. What’s more, less than 10 years before the Asian crisis, the U.S. experienced its own crisis in the savings and loan industry, with massive government intervention and a large bailout.
We should have known about financial crises.
Globalization and financial crises
Before the global financial crisis, globalization was a hot topic. World government and corporate leaders gathered at the World Economic Forum in Davos to discuss its limitless opportunities, while protesters gathered to argue its downsides. More recently, global leaders are sounding less triumphal, especially leaders in the financial realm, because since 2007 the globalization discussion has turned to financial crises – and those leaders’ roles in them.
Globalization has been hotly debated, celebrated – and in certain circles, scorned. The globalization debate subsumed the 1997-98 financial crises that it was thought to have caused. Globalization would, some argued, open up endless opportunities, steal jobs, threaten national sovereignty, increase the pace of progress by orders of magnitude, widen the gap between rich and poor, destabilize national economies, destroy the environment – in short, turn things topsy-turvy.
In his 2002 book Globalization and Its Discontents (which I reviewed previously), the Nobel-laureate economist Joseph E. Stiglitz gave voice to some of the globalization protesters’ objections, though far from all of them. In particular, Stiglitz argued that actions of global financial institutions during the 1997-1998 Asian and Russian crises – especially the International Monetary Fund (IMF) – made things worse and not better.
Stiglitz felt that because it did not know – and perhaps did not care – about local conditions, the IMF insisted on measures that were a shock to Southeast Asian countries and to Russia, creating misery by imposing budgetary austerity and too-abrupt privatization.
The complaints of globalization protesters, however, went far beyond that. They included charges that globalization takes jobs away from developed world workers, replacing them with mercilessly exploited developing-country laborers, who are bereft of basic human rights. Globalization also promotes a race to the environmental bottom by moving polluting industries to wherever they can get away with it, instead of reforming them.
Wolf’s response
Martin Wolf, the venerable chief economics commentator for London’s Financial Times, set out to respond to these criticisms with the dense argumentation of his 2004 book, Why Globalization Works. Wolf employed an unassailable Sherlock Holmesian method in each chapter, first clearly laying out the claims of objectors; then discussing them in learned depth; and finally relisting them, enumerating which have thereby been shown to be false, which true, and which only partly true or indeterminate.
Wolf is successful in most of his rebuttals. We can see the precedent – and perhaps source material – for the 2009 book by Bruce C. Greenwald and Judd Kahn, “Globalization n. the irrational fear that someone in China will take your job” (which I also reviewed, along with the Stiglitz book).
In that book, Greenwald and Kahn argued that American workers should not fear that someone in China will take their jobs, because American workers are more productive – and most determinants of productivity are local, not global. They say the “mystery ingredient” in enhanced productivity is “the steady accumulation of small operational improvements, taking place in a largely decentralized fashion within individual establishments throughout the economy. It works through the steady diffusion of seasoned technologies and their increasingly effective application.”
Wolf, similarly – citing World Bank data showing, amazingly, that American workers are almost 30 times as productive as Chinese workers – says, “Chinese labour is cheap because it is unproductive.” And why? In part because “there are increasing returns to activities in specific locations. Agglomerations of skill raise returns on all those skills. But skill also begets knowledge, which begets more knowledge, which then begets more skill. These increasing returns are location-specific.” It takes time, capital and resources to raise productivity by agglomerating skills and knowledge in a specific location; China’s experience in this process is short, while America’s is long.
Greenwald and Kahn also agreed that manufacturing will employ less people and become a smaller part of the economy as – like agriculture 100 years ago – it becomes more and more automated. For his part, Wolf, echoing – or presaging – Greenwald and Kahn calls manufacturing “the new agriculture.”
Wolf unearthed some surprising statistics to back up his claims. If Chinese workers’ productivity increases, he says, their wages will too, reducing their ability to compete with American workers. “They have done just that in other rapidly growing East Asian countries, such as South Korea,” he adds. “Today, South Korea’s wages are fifteen times as high as China’s.” Indeed, we do not hear of U.S. workers being concerned that their jobs will be taken by South Koreans.
Disposing of the anti-globalization arguments
Wolf disposes of some oft-repeated, but dead-wrong anti-globalization slogans. Answering the charge that companies exploit workers by putting them in harsh conditions, he says, “contemporary westerners judge the developing countries by the standards they are lucky enough to enjoy. They compare what is happening in a still desperately poor developing country not with the alternatives enjoyed by its residents, but with their own.”
As to the claim that globalization increases inequality, the data don’t agree. Globally, in fact, differences between rich and poor have declined since the 1970s, but that is because differences between rich and poor nations have declined – mainly because of the increased prosperity of China and India – while differences within nations have, on average, modestly increased.
Responding to Stiglitz
Wolf is at his most interesting when he is responding to Stiglitz, the best-known of the establishment critics of official global finance and trade institutions like the IMF. Stiglitz had argued that by imposing shock therapy instead of gradualism, the IMF did substantial damage to developing countries.
Wolf basically agrees that the IMF committed errors. “Nobody would now doubt, for example, that the Fund failed to warn adequately of the dangers of liberalization,” he writes. “It is universally accepted that the initial requirement that fiscal policy be tightened was an inappropriate throwback to standard IMF remedies. It was a blunder. … Equally, it is now widely agreed that the Christmas tree of loan conditions imposed by the IMF – some at the behest of the US Treasury, some even at the urging of economic reformers in the afflicted countries – was a mistake.”
But he also defends the IMF, saying that it was not responsible for the “absurd decisions” of policy-makers in its client countries.
The fact that these countries borrowed only on very short timeframes, for example, was widely cited as a major cause of the crisis. This turns out to be a problem of the countries’ own making.: Says Wolf, “Several countries, for example, actively encouraged short-term foreign currency borrowing. South Korea, astoundingly, permitted only such short-term borrowing, principally via the banking system.”
Wolf also appears to agree with Stiglitz that gradualism is better than shock therapy. He says, “The right answer is not to avoid liberalizing forever, but to carry it through in a carefully thought-out and disciplined manner.” He adds, “For a host of reasons, emerging-market economies should ultimately plan to integrate into the global capital markets, with emphasis on the words ‘ultimately’ and ‘plan.’” Wolf endorsed China’s recently announced go-slow policy of financial liberalization in a February Financial Times article.
Wolf does defend capital mobility across borders, against Stiglitz’s claim that “It has become increasingly clear that all too often capital account liberalization represents risk without a reward.” Wolf argues, on the other hand, that “the possibility of capital mobility desirably constrains the state.” The external pressures exerted by globalization, he believes, can exert competitive influences that help curb such state excesses as currency manipulation and internal corruption.
What doesn’t kill you makes you stronger
What may be most interesting about Wolf’s posture on the IMF, however, is his “So what?” defense.
For example, when he takes stock of his position on the various charges against the IMF, he addresses one that for many people is all-important. Is the IMF – and are official global and national governmental structures in general – biased in favor of major creditors? Do they have all the clout, while borrowers have none – and therefore, is the deck stacked in favor of the bankers?
He answers that accusation this way: “The final charge against the IMF is that it is a tool of the G7, particularly of the US and, more particularly still, of Wall Street. The answer to this charge is obvious: guilty. The institution responds to the realities of power and the self-defined interests of its dominant player.”
It is astounding how cavalierly Wolf dismisses this charge as, simply, obviously true – old news. He seems wholly unconcerned with what can or should be done about it. It’s just the realities of life.
This line of thinking leads to another: Financial crises are also a reality of life. Wolf’s initial defense against Stiglitz’s and others’ attacks on the IMF is to say of the 1997 Southeast Asian crisis, “What is astonishing is not that these countries fell into a severe crisis during this period of adjustment, but that they coped at all. In fact, they managed astonishingly well. … By 2001, the aggregate GDP of the five countries [Indonesia, Malaysia, the Philippines, South Korea and Thailand] was already 13 percent higher than it had been in 1996. The GDP of the star performer, South Korea, was up 22 percent.”
Wolf even goes as far as to say, “Most informed Koreans would, for example, now agree that the 1997 crisis, however humiliating and painful at the time, was a necessary part of the maturation of their economy. Indeed, it is hard to think of any financial system that has not advanced through the fires of repeated crises.”
In other words, often a financial crisis is a good thing, something a country needs.
This is a side of the argument we don’t hear enough, perhaps because – when said outright – it is too brutal; it reeks of tough love and patronization; or worse yet, it’s the kind of callousness we expect from Wall Street.
We hear from Stiglitz and many others about the misery caused by the “Washington Consensus” – the policies fashioned by the troop of economists and banking executives who bounce from Wall Street to the US Treasury to the IMF and back again – which Stiglitz dubbed “market fundamentalism.” These policies and practices subject clients, as well as countries, to hardship – of that there can be little doubt.
But what we don’t know – and what protesters against these policies don’t talk about enough – is the counterfactual. How much worse would it be if the policies were different? Perhaps the misery is necessary to avoid worse misery later.
In the end it may be Stiglitz, an expert on bankruptcies, who has the best answer to the problem of nations in financial crisis. In the 1980s, Citibank made large loans to unstable Latin American and African countries, because, said its Chairman Walter Wriston, countries “don’t go bankrupt.” But, Stiglitz says, what is needed is to recognize when countries in crisis due to macroeconomic disturbances do need bankruptcy, with “a super-Chapter 11, a bankruptcy provision that expedites restructuring.” Such a provision might not be popular with creditors, and it would involve multilateral institutions more deeply in economic restructuring than do bailouts; but it would be less likely to create moral hazard and would allow bankrupt nations to re-emerge from the crisis more swiftly.
Europe – and the IMF – may need to recognize explicitly when a crisis is an incident in the normal process of creative destruction and work it through, not with bailouts, but using the bankruptcy template that has existed for centuries.
If the economy were an ecosystem, and if we observed an ecological phenomenon that occurred again and again, like a forest fire, that sometimes decimates species, we would regard it as normal and healthy – part of nature’s creative destruction. Why not similarly regard such phenomena in economies?
Read more articles by Michael Edesess
