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martin felstein 1 of 2
This is a very interesting article by Martin Feldstein, the conservative
economist who was Reagan's chief economic adviser, on the Asian financial
crisis and the IMF. Particularly notable, in the second half, is a
principled argument that the IMF should not intervene in national economic
decisions (or only very rarely), irrespective of the merits of the
proposals it may be proposing.
Robert Weissman
Essential Information | Internet: rob@essential.org
FOREIGN AFFAIRS - March/April 1998 Issue
REFOCUSING THE IMF
By Martin Feldstein
[Image]
OVERDOING IT IN EAST ASIA
In the Asian currency crisis, the International Monetary Fund is
risking its effectiveness by the way it now defines its role as
well as by its handling of the problems of the affected
countries.
The IMF's recent emphasis on imposing major structural and
institutional reforms as opposed to focusing on
balance-of-payments adjustments will have adverse consequences in
both the short term and the more distant future. The IMF should
stick to its traditional task of helping countries cope with
temporary shortages of foreign exchange and with more sustained
trade deficits.
Today's emphasis on structural and institutional reforms has not
always been part of IMF programs. The IMF was founded in 1945 to
help operate a system of fixed exchange rates, in which all
currencies were pegged to the dollar, in turn fixed with respect
to gold, that experts then considered necessary to encourage
international trade. Although that system succeeded temporarily,
differences in inflation between countries forced many to alter
their currency values. When the fixed-rate system collapsed
completely in 1971, the IMF was forced to find a new raison
d'etre.
The fund found a new and important role, which is still
appropriate for the current crisis, in the 1980s. Changes in
economic conditions led Mexico and other Latin American countries
to announce they could not meet the interest and principal
payments on their large borrowings from overseas commercial
banks.
A default on those obligations would have wiped out the capital
of
many leading banks in the United States, Europe, and Japan, so
the
U.S. government provided a temporary bridge loan that allowed
Mexico to meet its imminent payments. Negotiations then began
between the Mexican government and representatives of the lending
banks, who agreed to restructure the debts, lengthening
maturities
and lending additional money with which the borrowers could meet
part of their interest obligations. Similar negotiations were
later conducted with the other Latin American debtors.
To meet their interest obligations and reduce their outstanding
debt, Latin American countries had to earn more foreign exchange
by increasing their exports or decreasing their imports. So Latin
American governments raised taxes, cut government outlays, and
tightened credit to reduce domestic uses of national output. The
IMF monitored these adjustments and provided moderate amounts of
credit to indicate that it was satisfied with the policy progress
that the debtors were making. But the primary provision of credit
was left to negotiations between the foreign banks and each of
the
debtor countries.
Over time the process was successful. The region's economic
growth
eventually resumed, and the countries were generally able to
service their rescheduled debts. The commercial banks wrote off
some loans of small, heavily indebted countries. In the end the
banks swapped their remaining loan balances for so-called Brady
Bonds that had government guarantees but paid less interest or
had
a reduced principal. This approach succeeded because of a general
recognition that the problem of the major Latin American
countries
was one of liquidity rather than insolvency-that is, they were
temporarily unable to pay current foreign obligations but were
not
permanently unable to earn enough foreign currency by exporting
to
service and repay their debts.
The next major chapter in the IMF's history began with the
collapse of the Soviet Union and the liberation of its former
European satellites. These countries needed to shift from
communism to a market economy and to integrate themselves into
international financial markets. Their officials, bankers, and
economists had little or no experience with market economics. The
IMF could therefore provide useful advice on a much wider range
of
economic issues than it had previously done in Latin America or
elsewhere in the world. Much of this advice-about the strategy of
privatization, banking systems, and tax structures-was useful.
Much of it was also controversial. But while economists outside
the fund had a variety of views about the right way for Russia
and
the other countries of Eastern Europe and the former Soviet Union
to proceed, the IMF was generally able to get its way because it
brought substantial financial rewards to countries that accepted
its advice.
The IMF is now acting in Southeast Asia and Korea in much the
same
way that it did in Eastern Europe and the former Soviet Union:
insisting on fundamental changes in economic and institutional
structures as a condition for receiving IMF funds. It is doing so
even though the situations of the Asian countries are very
different from that of the former Soviet Union and Eastern
Europe.
In addition, the IMF is applying its traditional mix of fiscal
policies (higher taxes, less government spending) and credit
tightening (implying higher interest rates) that were successful
in Latin America. To assess the appropriateness of these
policies,
it is necessary to understand what is happening in Asia.
THE ASIAN MELTDOWN
The Southeast Asian currency collapse that began in Thailand was
an inevitable consequence of persistent large current account
deficits and of the misguided attempt of Thailand, Indonesia,
Malaysia, and the Philippines to maintain fixed exchange rates
relative to the dollar. Thailand's current account deficit-the
sum
of its trade deficit and the interest on its foreign
obligations-had exceeded four percent of Thailand's GDP since
1990, implying that Thailand had to attract that much foreign
capital each year. Such large current account deficits have
inevitably ended in a sharp decline in the local currency's value
when foreign creditors and domestic investors became concerned
that the borrower would be unable to service its debts.
Thailand's
large current account deficit persisted for a surprisingly long
time because creditors believed that Thailand might be
"different"
since much of the capital inflow came as direct investment by
Japanese manufacturing firms and lending by their affiliated
banks. Creditors also derived confidence from Thailand's high
savings rate and its government budget surplus, noting that the
current account deficit reflected enormously high business
investment rather than government or consumer profligacy. But the
primary thing that kept foreign funds coming to Thailand and
local
funds staying there was the combination of relatively high
interest rates on Thai baht deposits and a promise that the
baht's
value would remain fixed at 25 baht per dollar. It looked like
too
good a deal to pass up.
But the baht's fixed value relative to the dollar could not be
sustained. The pressure for a devaluation of the baht increased
in
1996 and 1997 when the Japanese yen declined by 35 percent
relative to the dollar. Since Japan is Thailand's major trading
partner, the sharp rise in the value of the dollar (and therefore
of the baht) relative to the yen made Thai products more
expensive
and therefore less competitive and pointed to even larger trade
deficits in the future. Foreign speculators as well as local
investors began to sell bahts. The Thai government secretly
bought
the baht to support its value but eventually had to give up. At
that point the IMF stepped in with a multibillion dollar rescue
plan.
The Thai currency collapse spread to Indonesia, Malaysia, and the
Philippines as financial investors became worried about their
large current account deficits, high ratios of foreign debt to
local GDP, and deteriorating trade competitiveness. Each country
was forced to abandon its fixed exchange-rate policy and let the
market determine the currency's value. Indonesia lacked the
reserves to meet its short-term obligations and called in the
IMF.
Malaysia has not yet done so, while the Philippines was already
in
an IMF program when the crisis began.
All of these countries clearly need to shrink their current
account deficits by increasing exports and reducing imports. That
in turn requires reductions in public and private consumption and
investment. The proper remedy is a variant of the traditional IMF
medicine tailored specifically to each country-some combination
of
reduced government spending, higher taxes, and tighter credit.
Even in those countries where government budgets are already in
surplus, an increase in taxes or a reduction in government
spending will shrink the current account deficit. The experience
in Latin America provides a useful model of what can be done.
But the IMF's role in Thailand and Indonesia went far beyond the
role that it played in Latin America. Instead of relying on
private banks and serving primarily as a monitor of performance,
the IMF took the lead in providing credit. In exchange, it has
imposed programs requiring governments to reform their financial
institutions and to make substantial changes in their economic
structures and political behavior. The conditions imposed on
Thailand and Indonesia were more like the comprehensive reforms
imposed on Russia, including the recent emphasis on reducing
Russian corruption, than like the macroeconomic changes that were
required in Latin America. In Indonesia, for example, in exchange
for a $40 billion package (more than 25 percent of Indonesia's
GDP), the IMF has insisted on a long list of reforms, specifying
in minute detail such things as the price of gasoline and the
manner of selling plywood. The government has also been told to
end the country's widespread corruption and curtail the special
business privileges used to enrich President Suharto's family and
the political allies that maintain his regime. Although such
changes may be desirable in many ways, past experience suggests
that they are not needed to maintain a flow of foreign funds.
The Korean situation is different from that of the four countries
of the Association of Southeast Asian Nations and is more
important because its economy is the 11th-largest in the world.
Korea's problem did not stem from an overvalued exchange rate and
an excessive current account deficit. The value of the Korean won
had not been fixed in recent years but had gradually adjusted to
maintain Korea's competitiveness. A collapse of the market for
semiconductors, a major Korean export, had caused Korea's current
account deficit to jump from 1.7 percent of GDP in 1995 to 4.7
percent of GDP in 1996. But by mid-1997 it was already back to a
2.5 percent annual rate and heading lower.
The Korean economy was performing well: real GDP grew at eight
percent per year in the 1990s, as it had in the 1980s, inflation
was below five percent, and the unemployment rate was less than
three percent. Although there were recent bankruptcies among the
smaller business conglomerates and merchant banks, this was
clearly an economy to envy. Korea got in trouble in mid-1997
because its business and financial institutions had incurred
short-term foreign debts that far exceeded Korea's foreign
exchange assets. By October, U.S. commercial banks estimated that
Korea's short-term debts were $110 billion-more than three times
Korea's foreign exchange reserves. With investors nervous about
emerging markets in general and Asia in particular, it is not
surprising that the Korean won came under attack.
Since Korea's total foreign debt was only about 30 percent of GDP
(among the lowest of all developing nations), this was clearly a
case of temporary illiquidity rather than fundamental insolvency.
Moreover, since the current account deficit was very small and
rapidly shrinking, there was no need for the traditional IMF
policy of reduced government spending, higher taxes, and tight
credit. Yet something needed to be done to stop the loss of
foreign exchange and to maintain bank lending to the country and
its healthy businesses. Because of the overhang of excess
short-term foreign liabilities, each foreign bank acting
independently had a strong incentive not to roll over its loans.
Investors, fearing a drain on Korea's reserves and a depressed
won, were induced to anticipate the process by selling the won
immediately.