Struggling with Success

Challenges Facing the International Economy

Anne O Krueger

• Publisher: WSPC
• Year: 2012
• ISBN:
  9789814401975
• Topic: Politics & International Relations
• Subtopic: Globalisation
• Index: Politics & International Relations

Globalization, by which is meant the increasing economic interdependence among nations, has been a critical ingredient in enabling enormous improvement in mankind's condition. While progress has not always been smooth, and has not come without dislocation for some, the economic policy challenge has been, and is, to enable the realization of the large potential benefits of globalization while simultaneously reducing the negative side effects and providing safety nets for those whose lives are disrupted in the process.

This volume focuses on the successes of globalization, and some of the main economic policy challenges and solutions that arise to enhance the benefits and lower the costs. It covers different aspects of globalization, sovereign debt restructuring, development of the financial sector and financial crises in Asia, Turkey, Brazil, etc. The final part of the book covers multilateral international organizations, namely the World Trade Organization, the IMF and the World Bank.

Contents:

• Overview
• Successes of Globalization:
  • Be Careful What you Wish For
  • Trade Policy and Economic Development: How We Learn
  • Increased Understanding of Supply Side Economics
• Economic Policy Reform:
  • DeToqueville's ‘Dangerous Moment’ The Importance of Getting Reforms Right
  • The Crucial Role of Financial Intermediation for Rapid Growth
  • Lessons from the Asian Financial Experience
  • Economic Policy Reforms in Brazil and Turkey
• Sovereign Debt Restructuring:
  • A New Approach to Sovereign Debt Restructuring
  • Sovereign Workouts: An IMF Perspective
• Multilateralism for the Twenty-First Century:
  • The Founding of the Bretton Woods Institutions: A View from the 1990s
  • The Clash between Economics and Politics in the World Trade Organization
  • At the Service of Nations: The Role of the IMF in the Modern Global Economy
  • An Enduring Need: The Importance of Multilateralism in the Twenty-First Century
• Looking Forward:
  • Postscript

Readership: Economists, political scientists, policy makers, finance professionals, professors, students, and others interested in financial crises and globalization.

Chapter 1

OVERVIEW

To anyone with knowledge of economic history, attacks on globalization and politicians’ expressed desires to reverse it are astonishing. Globalization has been going on for centuries. Its consequences have greatly increased life expectancies, the quality of life, and standards of living. As seen in Chapter 2, even in 1900 in the United States, only about 6 percent of Americans lived above what is now the poverty line! Until the 1950s, per capita incomes were low throughout the developing world, malnutrition and hunger were widespread, and life expectancies and literacy rates were very low. As documented later in this volume, progress in the past half century has been enormous.

Globalization, by which is meant the increasing economic inter-dependence among nations, has been a critical ingredient in enabling this enormous improvement in mankind‘s condition. While progress has not always been smooth, and has not come without dislocation for some, the economic policy challenge has been, and is, to enable the realization of the large potential benefits of globalization while simultaneously reducing the negative side effects and providing safety nets for those whose lives are disrupted in the process.

This volume focuses on the successes of globalization, and some of the main economic policy challenges and solutions that arise to enhance the benefits and lower the costs. It contains reprints of several articles published earlier on various aspects of globalization, as well as revised versions of papers previously not published and an essay written for this volume.

A first Part contains three chapters centering on different aspects of the status of globalization and its achievements at the beginning of the twenty first century. The following four chapters center on the crucial role that economic policies play in enabling the benefits of globalization and the reasons why policy reform is important when the existing economic structure and policy framework constrains positive outcomes.

In the third Part, there are two chapters on sovereign debt and sovereign debt restructuring, one of the issues about which the international community

has had great difficulty in agreeing a process for instances when sovereign debt is truly unsustainable. In Part IV, focus is on the multilateral economic institutions, the International Monetary Fund, the World Bank and the World Trade Organization. As interdependence has increased, the need for international economic understandings and agreements to provide an appropriate framework for global economic activity has intensified. Three chapters examine various aspects of the governance of the international economy.

A final chapter, in Part V, addresses the future, outlining some of the challenges that the international community can address to improve the performance of the international economy.

The chapters in Part I are intended to set the stage for what comes later, focusing on the benefits of globalization. But as the benefits have increased, and more and more countries have adopted economic policies conducive to attaining those benefits, the critics of globalization have centered their attention on some of the side effects. While policies need to be adopted to buffer some of the consequences, it is important not to lose sight of the tremendous progress mankind has made in the past several centuries. Chapter 2, “Be Careful What You Wish For”, documents some of these benefits and the role that the international economy has played in achieving them. It also refutes some of the criticisms of globalization that have been made, showing how life expectancies and other indicators of the quality of life have improved dramatically. Finally, it addresses the link between those improvements and the increasing integration of the international economy, especially the expanding role of international trade.

Whereas international merchandise trade is estimated to have accounted for only 2 percent of world GDP in 1800 and 5 percent in 1950, it accounted for more than 20 percent in 2000, having grown at about 8 times the rate of world GDP. Moreover, services trade has been growing even more rapidly than trade in goods, and is estimated to have risen to more than 30 percent of all trade in goods and services. Trade has grown more rapidly than world GDP in all but a few years since the Second World War, providing an “engine of growth”.

Until the 1970s, most of the developing countries (which were in many cases newly independent) did not avail themselves of opportunities to grow through expansion of trade, and rather chose to encourage new developments of industry by extending high walls of protection for domestic production. That was a major reason why those countries did not grow as rapidly as might have been hoped, but even they, as seen in Chapter 2, grew at rates higher than those that had earlier prevailed. But by the l970s, a few developing countries had shifted away from “import-substitution” development

strategies toward an “outer-oriented” one (in which incentives for producing import-competing goods were generally no greater than incentives for exportable production). The acceleration in their growth rates was spectacular. Other developing countries, including especially China and India, followed their lead later on.

The experience of those countries, and much other evidence, shows the importance of an open and growing international economy for the prospects of those countries whose policies still insulate them from the world economy. It is also one manifestation of the importance of economic policy for enabling the growth rates that can result in rapid growth and poverty reduction.

Hence, Chapter 3 describes and analyzes the shift in thinking about trade policy, and how it came about, in the decades after 1970. After the adoption of import substitution policies in so many countries, experience mounted demonstrating the limitations of these policies. As is seen in Chapter 3, research analyzing those policies and their effects interacted with experience in the countries themselves. Moreover, the success of the countries that changed their policies to integrate with the international economy was remarkable. Chapter 3 shows how, in a social science, learning comes about. That learning takes place and interacts with research to show the drawbacks of old ways and the potential of new ones is an especially important lesson as the academic and policy communities struggle to understand the factors leading up to the Great Recession of 2007-09 and to use the lessons learned to find policies that can prevent a repetition of the mistakes leading up to 2008-09, or at least reduce the magnitude of any future financial crisis.

Part II then proceeds to focus on economic policy reform itself. One of the lessons of the past sixty years for all economies is the importance of economic policies that promote a stable macroeconomic framework, an open economy, and appropriate domestic incentives. Chapter 4 expands on this theme. In “Increased Understanding of Supply Side Economics”, the increased appreciation of the role of economic policies over the past sixty years (including but not limited to trade policy) is shown. One of the ways in which an open trade policy is supportive of economic growth is that policy makers are constrained in the extent to which they can intervene counter- productively in economic activity.

Understanding of the overall role of economic policy (governing macro- economic and microeconomic issues, as well as trade) has been greatly improved. Evaluation and comparison of the experience of different countries with their different policy regimes and outcomes, analysis of the ways in which policy changes have worked, and other research tools have all contributed to better understanding. This same combination is now at work with

regard to the lessons that may be learned from the Great Recession, a subject to which attention returns in the final chapter.

As is elaborated in Chapter 4, appreciation of the importance of incentives (in both the public and the private sector) has increased markedly, while there is significantly greater awareness of the political economy of economic policy formulation and implementation.

The papers in Part I are designed to demonstrate the huge contribution globalization has made to human welfare. They also indicate the role of appropriate economic policies in bringing about increased prosperity. While no country has ever had “perfect” policies, sufficiently ill-chosen policies can greatly retard growth potential and, on occasion, even result in falling per capita incomes.¹

In Part II, the difficult questions associated with economic policy reform are addressed. For it is one thing to know what appropriate and realistic economic policies are, and it is quite another for policy makers to formulate and implement economic policy reforms. Yet those countries that have succeeded in sufficient economic reforms have usually been able to achieve much higher rates of economic growth. All the successful countries have reformed in ways that have opened their economies and increased their integration with the international economy.

The perils in the reform process are many: there are always some who are benefitting from existing policies, no matter how costly they are; there are always some who believe they will be harmed by change; and there are some who will be harmed, at least in the short run. Moreover, there may be doubt or even disbelief that things could ever improve significantly, and some may therefore question whether the effort at reform is worth it.

These sources of resistance have sometimes resulted in reforms being reversed before they have had a chance to take effect. In some cases, the “reforms” are sufficiently watered down before being introduced that they could not be expected to accomplish much. And in some instances, policies not being considered for reforms prevent realization of the gains that might otherwise have been had from reforms that are enacted. Moreover, when reformers promise large benefits from reform and then reforms “fail” (or are reversed before they have a chance to succeed or are sufficiently weak so as to change little), skepticism about the potential for great gains from reforms

increases, resistance to reforms mounts, and the next set of efforts to achieve reforms is even more difficult to inaugurate and implement.

The challenges confronting would-be reformers are the subject of Chapter 5. Very often, change is resisted until there is a crisis, at which time decision-makers must act quickly. Moreover, there is always considerable uncertainty about the outcome, both because it is difficult to predict how quickly economic units will believe that the altered economic policy framework will be sustained and because it is not possible to know how the external environment will evolve and how large responses will be.

Any given reform has more impact when other economic policies are appropriate. If, for example, there are domestic price controls on agricultural products, moving toward a more realistic exchange rate will have less impact than if price controls are relaxed at the same time as the exchange rate is permitted to move to an appropriate level. But the more reforms are undertaken simultaneously, the more thinly policy makers and those implementing reforms are stretched, and the more difficult it is to communicate clearly what the objectives are. Moreover, some reforms may need to be phased in more quickly (as, for example, the exchange rate), while for others it may be desirable to move more gradually to allow time for firms and individuals to adjust (as with lowering and removal of high tariffs). When gradual changes are contemplated, it is of course essential that they be preannounced and credible. An important task of the reformer is to evaluate which reforms are critical at early stages, how much can be undertaken at once, and what the timing of additional reforms should be. These, and other, considerations are set forth in Chapter 5, with examples of some major reform efforts, including Argentina, New Zealand, South Korea, and Turkey.

Chapter 6 then addresses the crucial role of the financial sector and the importance of its liberalization in the process of economic growth. It was written in 2007, prior to the financial crisis.² It focused, as the title suggests, on the importance of financial sector development for economic growth, starting with the need for financial intermediation and then proceeding to focus on the lessons from the Asian financial crises in the 1990s.

Despite the questions that have arisen about the financial system in light of the events of the Great Recession of 2007-09, there is ample evidence that financial development (both the broadening and the deepening of financial markets) has been an important component in all countries that have developed

successfully. Rudimentary banking can suffice in a poor, mostly rural subsistence, economy, but bankers must develop capabilities to evaluate risk-reward trade-offs to lend to new and expanding activities; equity markets become important, especially to finance large-scale undertakings; and bond markets, venture capitalists, and other forms of finance become increasingly needed as development progresses.

This does not negate the need for financial regulation, as incentives can be perverse if financial institutions lose their equity: “gambling for resurrection” may result as the firms' managers take on high yield-high risk portfolios: if their bets are wrong, they are wiped out anyway, and if their bets pay off, they are rescued. Regulation, however, must balance the need to align financial incentives and the need for innovation and risk assessment capabilities within the system.

Whereas Chapter 6 focuses on the financial system and its importance, Chapter 7 contains an analysis of the Asian crises of the late 1990s. Attention is paid primarily to the circumstances surrounding Japan, for whom a protracted period of stagnation started in the early l990s, and South Korea in the Asian crisis of 1997, which also impacted many other Asian countries. Japan’s floating exchange rate, strong international reserve position, and current account surpluses meant that the authorities did not seek support from the IMF or the international financial community. But the failure to address the difficulties of the banking system, and especially to remove the bad loans from banks’ portfolios to enable them to resume normal lending, led to extremely low growth and even deflation for part of the period.

The South Korean crisis, already touched upon in Chapter 6, demonstrated the importance of addressing issues in the banking system rapidly, as the South Koreans removed nonperforming loans (NPLs) from the banks into a “bad bank”, and rapidly undertook other needed reforms, including allowing the Korean won to float freely, imposing restrictions on connected lending, and improvements in corporate governance. The IMF played a key role in South Korea (and Thailand and Indonesia) in providing funding to enable economic activity to return gradually to normalcy and in supporting much needed economic policy forms in economic governance and the financial sector. South Korean authorities moved very rapidly to implement the needed reforms, and were the first of the crisis- afflicted Asian countries to reattain their pre-crisis levels of real GDP and to resume growth.

The Asian crises were called by some “the first crises of the twenty-first century”, by which was meant that the role of an open capital account was

much greater than in earlier, “balance-of-payments” crises, where capital controls had meant that difficulties were primarily in the current account.

But two other crises after the Asian crises demonstrated exhibited another set of ways in which economies could get into difficulty, and also showed another facet of the IMF’s role in crisis resolution. In Chapter 8, the histories of the Brazilian and Turkish crises and their aftermaths are recounted. Both countries’ economies were in severe economic difficulties in the late 1990s, and both entered into IMF programs that were designed to curb inflation and correct fundamental imbalances.

In Turkey’s case, the authorities were unable to implement the program, and there were in any case doubts as to whether the contemplated changes were sufficient to enable a return to normalcy. Turkey had very high inflation rates for a number of years, with high volatility in rates of growth and inflation. In Brazil’s case, the l999 program had seemed to be taking hold, but a forthcoming election in 2002 raised questions as to whether the policies would be maintained. In both cases, IMF programs were adopted which addressed key issues. In Turkey’s case, these issues included the control of inflation, the restructuring of the banking system, and sustainability of fiscal policy. In Brazil’s case, emphasis was on sustaining a reasonable fiscal balance, controlling inflation, and enabling growth.

These programs were both eminently successful. Turkish inflation fell to single digits within a few years, and the banking system was sufficiently healthy to withstand the challenges of the 2007-09 Great Recession. Turkish growth rates were above even those envisioned in the IMF programs, and Turkish foreign debt was brought down to manageable levels. Brazil’s inflation rate was also low, and economic growth picked up after the program began. At the time of writing (early 2011), the Brazilian economy is seen, if anything, to be overheating as growth has accelerated, and foreign capital has flowed in. As in Turkey, Brazil’s public indebtedness has dropped markedly. Interestingly, these countries represent two cases in which moves toward tighter fiscal policies enabled an acceleration of growth. The usual association of fiscal cutbacks with austerity did not hold in these cases.

One of the issues that has plagued the international economic system has been how to judge countries’ levels of indebtedness, and how to deal with debt, especially sovereign. Until the 1990s, most indebtedness of developing countries was to official lenders, and various measures were adopted through the “Paris Club” to reduce the debt and debt-servicing obligations. This was done in a number of ways: reducing the face value of official debt, postponing payments coming due and providing for several years’ grace before debt servicing obligations resumed, lowering the interest rate, and, ultimately, debt

forgiveness. At the same time, an unofficial “London Club” of creditors met to decide upon relief for low-income countries.

But as private capital flows to emerging sovereigns and markets increased, difficulties with debt service to private creditors inevitably arose. In some cases, policy changes (especially including adjusting fiscal balances) were sufficient to enable countries to maintain voluntary debt servicing. This was usually in the context of IMF programs in which official money from the IMF enabled sufficient liquidity for debt servicing until reforms took hold. That was certainly the case in the Asian crises, Brazil, and Turkey.

But in some other countries, the situation differed. The most publicized was that of Argentina, where abandonment of the quasi-currency board (which linked the peso to the U.S. dollar at a one to one ratio) and devaluation to three pesos to the dollar ...

Table of contents

• Cover
• Title
• Halftitle
• Copyright
• Preface
• Acknowledgement
• ListOfAbbrevations
• Contents
• Chapter 1: Overview
• Part I: Successes of Globalization
• Chapter 2: Be Careful What you Wish For
• Chapter 3: Trade Policy and Economic Development: How We Learn
• Chapter 4: Increased Understanding of Supply Side Economics
• Part II: Economic Policy Reform
• Chapter 5: DeToqueville’s ‘Dangerous Moment’: The Importance of Getting Reforms Right
• Chapter 6: The Crucial Role of Financial Intermediation for Rapid Growth
• Chapter 7: Lessons from the Asian Financial Experience
• Chapter 8: Economic Policy Reforms in Brazil and Turkey
• Part III: Sovereign Debt Restructuring
• Chapter 9: A New Approach to Sovereign Debt Restructuring
• Chapter 10: Sovereign Workouts: An IMF Perspective
• Part IV: Multilateralism for the Twenty-First Century
• Chapter 11: The Founding of the Bretton Woods Institutions: A View from the 1990s
• Chapter 12: The Clash between Economics and Politics in the World Trade Organization
• Chapter 13: At the Service of Nations: The Role of the IMF in the Modern Global Economy
• Chapter 14: An Enduring Need: The Importance of Multilateralism in the Twenty-First Century
• Part V: Looking Forward
• Chapter 15: Postscript
• Author Index
• Subject Index