Globalization and Its Discontents

Chapter 4 is divided into two parts: The first explores IMF policies that have led to the 1997 economic depression, and the second underlines the ineffectiveness of the IMF’s response to alleviate the depression.

Stiglitz first advances the idea that the IMF’s push for rapid financial and capital market liberalization was at the core of the Thai baht collapse and subsequent global economic depression in 1997. The crisis is the result of a too quick and too little regulated financial market liberalization policy, encouraged by the IMF and the US Treasury. Both pushed for full capital account liberalization in East Asia, arguing it would help the region grow even faster, despite knowing that the region did not need additional capital due to its high savings rate.

Stiglitz cites Korea as a perfect example of this: The US Treasury presented Korea’s potential capital market liberalization as an event of national significance for the US, despite the National Economic Council’s disagreement. In the end, the deal was concluded behind closed doors and Korea was forced to deregulate its financial market. On top of being highly undemocratic, this decision was imposed on Korea, which was afraid that refusal would make it look unreliable to foreign investment. Despite the US Treasury and the IMF’s insistence, these deregulatory policies have little evidence of actually promoting growth.

Subsequently, however, the IMF also did not help mitigate the effects of the crisis in Thailand. It instead imposed stringent conditions on providing funds, including forcing countries to maintain high interest rates, which failed to curtail the recession in Asia and precipitated a fall in exchange rates that would end up affecting the entire region.

Stiglitz holds the IMF accountable for misdiagnosing the causes of the crisis. Based on this faulty analysis, it proposed inadequate solutions to the problem. First, it attempted to curb demand during a recession, when there is already insufficient demand, under the guise of balancing budgets. However, Keynesian economics argues that to help mitigate a recession, governments or regulatory infrastructures must find ways to stimulate demand. This can be done through expanding fiscal policy, but the IMF instead pursued austere budget balancing that discourages investment and spending. Second, it raised interest rates when firms had high levels of indebtedness, which forced many into bankruptcy and increased unemployment rates.

Additionally, the IMF failed to recognize that imposing austere fiscal policies onto one country affects neighboring countries as well. To bolster their own economy, countries reduce exports to keep their resources for domestic consumption. To do this, they impose tariffs on foreign products and devalue their own currency, reducing the cost of their own goods compared to imports. However, these protectionist policies also affect neighboring countries, which see a reduction in their exports, thereby causing the spread of the economic depression. The IMF exacerbated this process by asking countries to cut back on imports in order to balance their budgets. As a result, the IMF’s policies have had the opposite effect of its original mission.

Although the IMF was later criticized for its East Asian policies, this only served to further lower confidence in foreign investment in the region. Stiglitz notably describes the IMF as having become part of the problem.

The rest of this chapter is dedicated to analyzing why IMF policies could not curtail the spread nor alleviate the depth of the 1997 financial crisis. Stiglitz first advances the argument that the IMF pushed for a “restructuring” of the financial market in East Asia instead of providing funds to assist necessary expenditure in the region. In Keynesian terms, its policies encouraged a shrinking rather than an expansion of aggregate demand. Its reasoning is simple: It was more concerned with paying back investors than sustaining growth in Asia.

The IMF exacerbated the economic recession by separating healthy from sick banks and shutting down the latter, therefore forcing the rest to quickly meet the capital adequacy ratio—determined by balancing their available capital to their outstanding loans and assets. This policy works when one single bank operates poorly due to mismanagement. It is disastrous in situations where most banks are in trouble due to greater macroeconomic forces.

Businesses lose access to credit and are forced to shut down if they do not find an alternative bank from which to borrow. Unemployment rates increase and production decreases. When industries are forced to shut down, the process cannot easily be reversed. Stiglitz underlines this truth by contrasting South Korea with Indonesia. The former recovered quicker because it recapitalized its banks and ignored the IMF’s advice. In contrast, Indonesia was plunged into a longer-term recession.

The IMF pushed for real restructuring rather than financial restructuring: It asked governments to force firms to reorganize their assets and production when it should have instead asked governments to settle the issue of ownership first, which would have given firms a better chance of reentering credit markets. When a large number of firms are unsure of whether shareholders or current CEOs own the company, management tends to sell assets, forcing companies further into bankruptcy and preventing any chance of recovery.

Most egregiously, the IMF paid $23 billion to bail out creditors while shrinking aid to help the poor, despite Stiglitz warning that this would invite political upheaval. Even beyond the humanitarian argument, Stiglitz believes this decision to be simply bad economics, as poor political stability drives capital out and frays confidence. After riots broke out in Indonesia, the IMF reversed its policies and resumed food subsidies. However, the damage was already done, as people began to question why the funds were contracted when they were perfectly affordable. Workers who saw their wages cut by a quarter knew the economy was stalled from where it could have been, had the crisis been mitigated.

Malaysia and China did not follow IMF programs and grew rapidly compared to other East Asian countries who did. They practiced capital control to prevent having to increase interest rates, thus stalling a large economic recession and allowing firms to stay afloat. This expansionary fiscal and monetary policy brought a certain degree of economic stability, which in turn reinstated confidence in the eye of foreign investors. In contrast to these two countries, Thailand followed the IMF’s orders and still remained in recession three years later.

The IMF now admits its response and policies were too austere, but it still does not recognize that it has made mistakes in its monetary policy. It imposed “astronomically” high interest rates that stunted spending (130). It forced increases of more than 25% at the same time as the Clinton administration worried about the negative effects of a 0.5% increase in domestic interest. It did so under the pretext that high interest rates would incentivize payback and therefore help restore market confidence. However, in a region where firms are leveraged and indebted, an increase in interest rate could spell bankruptcy, which in turn affects banks, contracting both aggregate demand and supply.

When Stiglitz asked the IMF to change its policies, it adopted a wait-and-see attitude. When Japan proposed to create an Asian Monetary Fund to redress the economic situation in the region, it was harshly turned down by the IMF and the US Treasury, who wanted to maintain a monopoly in their own domain.

In sum, Stiglitz demonstrates in this chapter that hubris and the Western financial community’s dogged pursuit of a liberal market ideology caused the IMF to misdiagnose and mistreat the 1997 crisis. Additionally, he provides deeper economic analysis of the IMF’s actions. Chapter 4, along with Chapter 5, most clearly touches upon the first of the three themes of this guide: The Failures of Market Fundamentalism and IMF Policy. Stiglitz’s discontent with market fundamentalism and with its ineffectiveness is not only because it is an ideological rather than practical pursuit but also because it is a flawed and disproven economic model. Although not all of its premises are wrong—Stiglitz does believe in privatization and liberalization—its conclusion, that markets are self-regulatory, has had devastating effects when put into practice by the IMF.

This dogged pursuit of ideology has disincentivized the IMF from developing alternate policies, even after the 1997 crisis. It blinded the Fund to economic indices that affect growth, including employment rates, but that are not valued by the model. In other words, had the Fund paid attention to its mistakes, it would have realized that economic downturns are best resolved by pursuing expansionary monetary and fiscal policies.