FINANCIAL HYPOCRISY

By Joseph Stiglitz

[This article published in the Spanish daily El Pais, 11/30/2007 is translated from the German on the World Wide Web, http://www.nachdenkseiten.de/wp-print.php?p=2828. Joseph Stiglitz is a Nobel Prize winning economist and professor at Columbia University. His latest book is titled “Making Globalization Work,” Project Syndicate, 2007]




2007 is the 10th anniversary of the East Asian crisis that began in Thailand on July 2, 1997 and spread over Indonesia in October to Korea in December. Finally, it turned into a worldwide financial crisis that reached Russia and several Latin American countries like Brazil and triggered a series of de-stabilizing forces in the following years. Argentina in 2001 was one of its victims.

After the crisis of 1997, not one important financial reform was carried out in the world. There were many other innocent victims including countries not involved in the international capital flows that caused the crisis. One of the most afflicted was Laos. Although all the crises ended, no one knew then the breadth, depth or duration of the recessions and depressions. It was the worst crisis since the great world economic crisis.

In my capacity as chief economist and first vice-president of the World Bank, I was in the middle of the fire and the debates about the causes and politically viable responses. In the summer and fall of 2007, I revisited many afflicted countries including Malaysia, Laos, Thailand and Indonesia. It is encouraging to see their recovery. These countries today have a growth of 5 or 6% and more, not as high as in the times of the East Asian miracle but more than many observers predicted after the crisis.

Many countries changed their policy but in a different direction than the IMF recommended. The poor suffered most under the consequences since wages sank in a nosedive and unemployment soared. After the countries came out of the hole, many redefined “harmony” as repairing the breach between rich and poor, city and countryside. Investments in people are now more important. Creative initiatives give health care and access to money to more persons. Social funds are created to help the development of local communities.

If we analyze the crisis 10 years later, we can see with more clarity where the IMF and the US Treasury Department erred in their diagnoses, prescriptions and predictions.

The fundamental problem was the premature liberalization of the capital markets. Ironically the US Secretary of the Treasury recommended the liberalization of the capital markets in India, one of the two mammoth countries on the path of development (together with China) who emerged uninjured from the 1997 crisis.

It is no accident that the countries that did not completely liberalize their capital market did well. Investigations of the IMF have confirmed all those serious studies that said: liberalization of capital markets causes instability and not necessarily growth (India and China were also the economies that grew fastest).

The liberalization of capital markets obviously favors Wall Street (whose interests are represented by the US Treasury Department). Wall Street earns money with capital receipts with the outgoing stocks and with the restructuring that occurs through the ensuing chaos. In South Korea, the IMF recommended the sale of the state banks to US investors despite the fact that the Koreans organized their economy in a remarkable way for 40 years with higher growth and greater stability than the US and without the systemic scandals of the North American financial markets.

In some cases, US firms bought banks. They held them until Korea recovered and then sold them with billions of dollars in profits. In the haste to facilitate the West’s purchase of the banks, the IMF forgot one detail, the guarantee that South Korea retains at least part of the profits through taxes. We could argue whether North American investors have more experience in the world of banking. But they undoubtedly have more experience in tax evasion.

The contradictions between the recommendations of the IMF and the US Treasury Department in relation to East Asia and what happens in the current disaster of mortgages with high risk cannot be denied. East Asian countries were told they should raise their interest rates, in some cases up to 25% or even 40% or more provoking a wave of payment cessations. In the current crisis, the Federal Reserve Bank of the United States and the European Central Bank have lowered their interest rates.

The countries stricken by the East Asian crisis also received the piece of advice that more transparency and less regulation were necessary. However the lack of transparency was a fundamental factor in the credit crisis of the summer of 2007. The rotten mortgages were changed, distributed all over the world and packaged in better products. These products pretended to be guarantees although no one could say with certainty who had what from whom. A choir of voices of caution is now heard regarding the new norms that obviously could be an obstacle for the finance markets (the exploitation of poorly informed borrowers is the root of the problem). At the end despite the references to the moral risks, the western banks were partly rescued from their bad investments.

After the 1997 crisis, the consensus arose that a fundamental reform of the world financial architecture was necessary. However the current system is useful for certain interests although unnecessary instability and terrible costs are forced on threshold countries. So it is not surprising that not a single reform of significance has occurred 10 years later. The world again faces a period of financial instability with an uncertain outcome for the world economy.