Nov 19, 2007
LESSONS FROM A CRISIS
The great Western bank deception
By Joseph E. Stiglitz
THIS year marks the 10th anniversary of the Asian financial crisis, which began in Thailand on July 2, 1997, and spread to Indonesia in October and to South Korea in December. Eventually, it became a global financial crisis, embroiling Russia and Latin American countries such as Brazil and unleashing forces that played out over the ensuing years. Argentina in 2001 may be counted as among its victims.
There were many innocent victims, including states that had not even engaged in the global capital flows that were at the root of the crisis. Indeed, Laos was among the worst-hit countries. Though every crisis eventually ends, no one knew then how broad, deep and long the ensuing recessions and depressions would be. It was the worst global crisis since the Great Depression, which started in 1929.
As the World Bank's chief economist and senior vice-president, I was in the middle of the conflagration and debates about its causes and the appropriate policy responses. Earlier this year, I revisited many of the affected countries, including Indonesia, Laos, Malaysia and Thailand, and it was heartwarming to see their recovery. These countries are now growing at 6 per cent or more - not quite as fast as in the days of the Asian miracle, but far more rapidly than many thought possible in the aftermath of the crisis.
Many countries have changed their policies but in directions markedly different from the reforms that the International Monetary Fund had earlier urged. The poor were among those who bore the biggest burden of the crisis, as wages plummeted and unemployment soared.
But as these countries emerged from the crisis, many placed a new emphasis on 'harmony' to try to redress the growing divide between rich and poor, urban and rural. They gave greater weight to investments in people, launching innovative initiatives to bring health care and access to finance to more of their citizens, and creating social funds to develop communities.
Looking back at the crisis a decade later, we can see more clearly how wrong the diagnosis, prescription and prognosis of the IMF and United States Treasury were. The fundamental problem was premature capital market liberalisation. It is therefore ironic to see the US Treasury Secretary once again pushing for capital market liberalisation in India - one of the two major developing countries (along with China) to emerge unscathed from the 1997 crisis.
It is no accident that those countries that had not fully liberalised their capital markets have done so well. Subsequent research by the IMF has confirmed what every serious study had shown: capital market liberalisation brings instability, but not necessarily growth. (India and China have, by the same token, been the fastest-growing economies.)
Of course, Wall Street (whose interests the US Treasury represents) profits from capital market liberalisation: it makes money as capital flows in and out, and in the restructuring that occurs in the resulting havoc. In South Korea, the IMF urged the sale of the country's banks to American investors, even though Koreans had managed their own economy impressively for four decades, with higher growth, more stability and without the systemic scandals that have marked US financial markets with such frequency.
In some cases, US firms bought the banks, held on to them until Korea recovered, and then resold them, reaping billions in capital gains. In its rush to have Westerners buy the banks, the IMF forgot one detail: to ensure that South Korea could recapture at least a fraction of those gains through taxation. Whether American investors had greater expertise in banking in emerging markets may be debatable; that they had greater expertise in tax avoidance is not.
The contrast between the IMF/US Treasury advice to Asia and what is happening in the sub-prime mortgage debacle in the US is glaring. Asian countries were told to raise their interest rates - in some cases to 25 per cent, 40 per cent or higher - causing a rash of defaults. In the current US crisis, the Federal Reserve and the European Central Bank cut interest rates.
Similarly, the countries caught up in the Asian crisis were lectured on the need for greater transparency and better regulation. But lack of transparency played a central role in the US credit crunch; toxic mortgages were sliced and diced, spread around the world, packaged with better products and hidden away as collateral, so no one could be sure who was holding what.
And there is now a chorus of caution about new regulations, which supposedly might hamper financial markets (including their exploitation of uninformed borrowers, which lay at the root of the problem).
Finally, despite all the warnings about moral hazard, Western banks have been partly bailed out of their bad investments.
Following the 1997 Asian crisis, there was a consensus that fundamental reform of the global financial architecture was needed. But while the current system may lead to unnecessary instability and impose huge costs on developing countries, it serves some interests well.
It is not surprising, then, that 10 years later, there has been no fundamental reform. Nor is it surprising that the world is once again facing a period of financial instability, with uncertain outcomes for all the economies.
The writer is a Nobel laureate in economics. His latest book is Making Globalisation Work.
Copyright: Project Syndicate