Battle within Bretton Woods

The IMF and World Bank have long quarrelled about what policies would have helped most when the Asian financial crisis struck in 1997. On the eve of the spring meeting of the two organisations, the quarrel has been resuscitated by Joseph Stiglitz, former chief economist of the World Bank. Having criticised the IMF throughout the crisis, he has aimed one more salvo at it in an article in The New Republic. He says IMF economists are third-raters, arrogant and ignorant. This has drawn a sharp response from Rudi Dornbusch of MIT, an old IMF supporter. He says “Stiglitz is a distinguished economist, on the short list for a Nobel prize on his theoretical contributions on how markets fail. But nobody ever thought of him as a policy economist and still less as someone who has the remotest clue of macroeconomics and stabilisation”.

I am amused by the rival claims of the two sides to superior wisdom. In fact both have been exposed as having severe shortcomings. Did either the World Bank or IMF predict the coming of the Asian financial crisis? No. Did either produce a formula to stem the rot? No. Did either have the prescience to see the crisis-hit countries would stage a miraculous recovery in 1999? No. The real issue is not which of the two was smarter, but which was dumber.

Stiglitz says disaster was inevitable when the Asian countries opened up their capital accounts under pressure from the US Treasury and IMF. Really? If this was so obvious to him, why did he not scream warnings about it at the top of his voice? Besides, Indonesia had an open capital account from the early 1970s. How come it suffered no disaster till 1997?

When the financial avalanche hit Asia in 1997, the IMF responded with its standard formula of fiscal austerity plus high interest rates. Stiglitz says this medicine might have made sense in earlier crises in Latin America brought on by excessive fiscal deficits, but made no sense in Asian countries running a fiscal surplus. Austerity in such conditions, says Stiglitz, simply shrank demand further and deepened the recession, while high interest rates would drive ever more companies into bankruptcy.

The need of the hour was really a fiscal deficit and low interest rates. I find it amazing that Stiglitz talks as though Asia was suffering from a textbook recession. It was not. The crisis was brought on by a mixture of large trade deficits financed by unsustainable short-term debt, which culminated in capital flight and currency crashes. Yet he simply ignores these issues. Dornbusch says so trenchantly. “What is he saying? In the face of the government taking a 50 per cent of GDP (or more) hit in public finances from bank failure and pervasive bankruptcy, fiscal largesse should be the rule? And in the face of a collapse of currencies under pressure of capital flight, interest rates should be cut to make it cheaper to take money out and crash the exchange rate?”

Many IMF supporters (including Dornbusch) point to the strength of the Asian recovery in 1999 as proof that IMF policies work. Stiglitz disagrees, saying that Thailand, which followed the IMF line, has fared better than Malaysia, which did not. He also disputes the claims that Korea followed the IMF line closely. And so what if the Asian recession has ended? He thinks the IMF made it deeper, longer and harder than it need have been.

The facts suggest that neither side has much to boast about. GDP forecasts are made by the IMF in its publication World Economic Outlook, and by the World Bank in annual publication called Global Development Finance. Both publications last year forecast a grim year for the crisis-hit Asian countries in 1999, with indifferent prospects in the next year.

The Bank forecast was prepared under Stiglitz’s supervision. After being proved wrong comprehensively, he still has the gall to repeat his tired old claim that the recession was made much longer by IMF policies. Indeed, he even declares that Indonesia remains mired in recession, whereas the country registered 5.8 per cent growth in the most recent quarter.

The Asian recession lasted a modest one and a half years, so the IMF cannot be accused of making it over-long. But can it take credit for ending the recession quickly? No, since it too had forecast a long and continuing recession.

Most Asian countries looked to the IMF for guidance and financial assistance. Mahathir Mohamad of Malaysia was the exception: he acidly attacked the IMF, and imposed capital controls on foreign investors.

Western pundits declared almost unanimously that this was a formula for disaster. By contrast, some Asian pundits hailed him as a hero. Both the abuse and praise were overdone: Mahathir imposed capital controls so late that most of the capital that was going to flee had already fled.

Stiglitz lauds Mahathir, while Dornbusch calls him a quack. This is much ado about rather little. Malaysia suffered neither more nor less than other Asian countries, so Mahathir’s defiance was neither a triumph nor disaster. And when the Asian recovery came, Malaysia recovered just about as quickly as others who had toed the IMF line. The lesson: defying the IMF does not make you either a hero or zero. It simply shows how little the IMF matters.

For too long, the IMF and World Bank have suffered from the illusion that they have the leverage to induce good policies and outcomes across the world. That is simply untrue. The Bank and IMF have dispensed the same advice to Asia, Latin America and Africa. Yet for five decades Asia has performed very well, Latin America’s performance has been mixed, and Africa’s performance has been plain bad. The difference is explained by the quality of policymakers in each region, not by whether the IMF has better quality staff than the Bank.

Neither Stiglitz nor Dornbusch find it convenient to emphasise this.

What do you think?