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World: IMF Economic Model Comes Under Growing Scrutiny

  • Tony Wesolowsky

Prague, 3 February 1999 (RFE/RL) -- The economic crisis in Brazil and continuing problems in Asia and Russia formed an uncomfortable backdrop for many policy-makers attending the World Economic Forum this week in Davos, Switzerland.

It wasn't long ago that Asia, Latin America and Russia were held up as success stories to prove that strict monetarist policy, modest government intervention and the free movement of capital across borders was the best formula for economic development. That was the recipe most often chosen by the International Monetary Fund and its main member countries.

That model has come under increasing scrutiny, however, as one country after another is forced to stifle its domestic investment with high interest rates and weaken its domestic exporters with high currency valuations -- all to satisfy the needs of increasingly remote foreign investors.

If the Davos conference is any judge, the number of voices calling for corrective measures, if not a complete overhaul of this development model, is clearly growing.

In theory, markets serve to match investment capital with prospective ventures in the hopes those ventures will eventually add trade and investment to the real economy. In the 1980s and 90s, world markets were pried open with the theory that free roaming capital would guarantee maximum efficiency. But, as events in Asia and Brazil show us, the freedom also brings instability and collapse.

That's because the amount of capital employed for speculative purposes far exceeds the amount invested in the real economy. The amount spent every day on currency markets, for example, amounts to 1.3. By comparison, the turnover on the U.S. stocks markets, by far the world's largest, amounts to just 10,000 million a day. Only five percent of the world's capital is employed in real economy, the rest is speculative.

Nobel prize-winning economist James Tobin wrote in the Washington Post in 1997 that it's too easy these days for banks, governments, businesses and speculators to buy and sell huge blocks of a country's currency. Such capital flows, he said, can throw a country literally overnight into a crisis.

This is painfully evident now to people in Thailand, South Korea, Indonesia, Malaysia, Russia and now Brazil, all of which were regarded only 18 months ago as models of new development.

The best example of the problems of this capital-led development can be seen in Mexico in the earlier '90s. Mexico had become a magnet for financial speculators. Under U.S. pressure, the country opened up its markets to foreigners, reduced its deficit, privatized key branches of industry and raised interest rates to reduce inflation. The reforms were praised by foreign investors, who poured some $30 billion into Mexican financial markets in 1993 alone.

But the flood of money caused problems, artificially inflating the value of the currency and consequently making exports unattractive. Fearing a devaluation, investors started pulling their money out. As panic grew, the drain of funds quickly turned to a hemorrhage, sparking the peso crisis of 1994.

The current volatility would not have surprised the architects of the post-war Bretton Woods financial system, which contributed greatly to growth in the 1950s and '60s. These planners feared that floating currency rates were unstable, undermining trade through uncertainty and market overreactions.

The system collapsed in the 1970s after the U.S. could not maintain its currency peg to gold and floating currencies were instituted. In the 1980s and 90s, under U.S. direction, the focus turned to deregulating national economies and opening up financial and capital markets. This later led to today's range of speculative and hedging instruments like options, swaps and futures.

Joseph Stiglitz, a senior vice-president and chief economist at the World Bank, is now leading the turn away from free market development models.

Stiglitz, a former chairman of the U.S. Council of Economic Advisors, explains that the economies of South Asia were built up with a guiding hand played by the state in promoting economic growth, including controls on capital flows. Stiglitz also notes that every developed country, from Britain to the United States, followed a similar path.

The nations affected by the current economic crisis are increasingly questioning and then rejecting the prescriptions of the IMF and other world bodies in favor of more state-led measures. Last September, Malaysian imposed capital controls after declaring "the free market has failed disastrously." Russia has imposed a moratorium on some debt payments and has threatened to go back to a regime of fixed prices and capital controls.

While the IMF is clearly suffering from a tarnished reputation, the people paying the most are those living in the affected countries. The International Labor Organization estimates that 15-20 million people will lose their jobs in Asia this year alone. Then there are the taxpayers who are asked to fund organizations like the IMF.

Tobin says that speculators and investors, the ones who should pick up the pieces when their investment plans don't work out, often don't lose much. Tobin says the main beneficiaries of bailout funds and loans � which make good these nations' debts � are big banks, investment houses and speculators.