Raising Keynes: Stiglitz’s Discontent with the IMF

Twisted Child

In Globalization and Its Discontents, Joseph Stiglitz uses the terms “market fundamentalism” and “free market ideology” interchangeably. In Fragmented World, Chris Edwards analyzes the three main schools of economic theory of value: subjective preference, cost-of-production, and abstract labor. Stiglitz, on the other hand, denounces the deleterious effects of what he sees as an economic religion that has malappropriated some of the “scientific” postulates of subjective preference theory. One might say that, in Stiglitz’s view, market fundamentalism is a blind faith in Adam Smith’s “invisible hand.” To use a Jeffersonian phrasing, market fundamentalism might be summed up as, “That economy functions best that is governed least.” While Thomas Jefferson’s original aphorism—and this economic corollary—might have been true in the pre-industrial America of more than two centuries ago, neither can be assumed to be true in today’s vastly more complex society and economy. As Stiglitz says repeatedly throughout his book, there is a legitimate role for government in managing the economy and compensating for market imperfections and distortions. When markets fail, government must intervene to put the economy back on track.

Adam Smith, David Ricardo, Karl Marx, and other classical economic thinkers were more than simply economists in the sense that the word is now used. Their work studied more than purely economic issues, but rather studied the relationships between money and power in society. As such, they were political economists. However, in the course of more than a century, the most prestigious economic schools have drifted away from the study of political economy and have retreated into an insular world of theoretical models, where the real world of power politics and market imperfections is not allowed to intrude. Market fundamentalists misapply the principles of this ideal model to the real world, a world that includes not only economic relationships and transactions, but power relationships and transactions as well. The one influences the other. The proposition that politics and power don’t matter, that economics is the only thing that matters, is itself a political statement that is intended to enhance the power of a particular class in society and to cut off debate by those who presume to dissent. Thus neoliberal globalism’s (Manfred Steger’s term for market fundamentalists’ vision for globalization) inherent contradiction: it espouses a political agenda in the name of an economic theory that assumes the absence of politics.

The International Monetary Fund’s (IMF) role in furthering the neoliberal agenda is a tragic irony in view of the institution’s origins 60 years ago. According to John Maynard Keynes, lowering taxes on the lower and middle classes put more money in their pockets, which they would readily spend on deferred necessities. Increased spending, especially on infrastructure and education, an also on the military, created jobs, which again put money in the pockets of those most likely to spend it. The government could employ armies of people to dig holes and fill them in again. It was not necessary that the government spent the money productively (although this was obviously preferred, especially in sectors that would facilitate the private economy, yet which private financing was ill-positioned to provide, such as infrastructure), the important point was that the government ran a deficit, spending more money that it was receiving through taxation, thereby pumping money into the economy. As people spent this money, private investment was stimulated to produce to meet rising demand, creating new jobs. As the upward spiral reinforced itself, the economy recovered. Adolf Hitler, for all his other faults, was a Keynesian wunderkind in pulling Germany out of the Great Depression. Franklin Roosevelt used similar strategies to a lesser degree and less successfully, constrained as he was by the political opposition of a democratic process.

It was agreed at the Bretton Woods conference in 1944 that there must be an international institution in place to discourage a country from taking external measures, such as competitive currency devaluations, to protect its economy during a slump. Instead, this international financial institution would lend money to a country to finance Keynesian deficit spending in order to stimulate an economic recovery. The purpose of the IMF is to ensure global financial stability. Keynesian economics seemed to be in an unassailable position in the post-war global economic order, embraced in the USA by Democrats and Republicans alike. “We are all Keynesians now,” declared Richard Nixon in 1969.

However, in the late 1970s in Britain under Margaret Thatcher, and in the early 1980s under Ronald Reagan, market fundamentalists gained ascendancy in the halls of power, and in due course the Keynesian IMF was hijacked by Thatcherism and Reaganomics. Under this ideological onslaught, the IMF reversed its lending policies. Instead of lending money to finance Keynesian deficit spending and stimulate economic recoveries, IMF loans now come with draconian strings attached called “structural adjustments.” To receive IMF loans, governments must agree to austerity measures, to live within their means rather than run up debts. Government workers are laid off, creating unemployment. Government services are reduced, adversely affecting the poorest members of society. Government subsidy of vital staples such as grain and dairy products are reduced, driving up prices. Government assets are sold off at fire sale prices to raise money to pay off debts. Often the private investors who take advantage of these opportunities cut services and raise prices in order to operate these formerly government-owned assets at a profit. Interest rates are driven up in order to attract foreign investment; however, doing so drives domestic companies out of business, creating even more unemployment.

Certainly Stiglitz would concur with Peter Dicken’s exhaustive description of the historical and technological evolution of the global financial system, its interpenetration in terms of geography (doing business in each other’s countries) and services (diversification of traditionally distinct lines of business into “one-stop shops”), as well as his references to what Susan Strange has called “casino capitalism” and its volatility. However, whereas Dicken’s purpose in Global Shift is to catalogue the evidence and he does not concern himself with the various schools of economic thought, Stiglitz seeks to bring an indictment, not just against footloose capital, but against the totality of market fundamentalist, anti-Keynesian policies.

While “malfeasance” might be too strong a word to apply to the neoliberal reorientation of the IMF in that Stiglitz shies from accusing the IMF of deliberate misconduct, he does find culpable negligence in its conduct that might be said to constitute “misfeasance.” He accuses it of both narrow vision and intellectual laziness in its degeneration into “one size fits all” solutions. The IMF is certainly a far cry from what Keynes originally had in mind for it, and Stiglitz thinks that Keynes must be spinning in his grave over what his brainchild has grown up to become.

Tyger, Tyger, Burning Bright

The East Asian economic crisis of 1997-98 was exactly the sort of situation that the IMF had been established to deal with, yet according to Stiglitz, the IMF took a manageable economic downturn and turned it into an unmitigated disaster. Anti-Keynesian, structural adjustment may have been a credible policy in the cases of governments (many of them in Latin America) that had indulged in profligate spending for years and had run out of money to pay the bills. These countries were bleeding money. But this was not true of the East Asian “tiger” economies. Their government budgets were running surpluses, and their private sectors had high savings rates. The scolding that the IMF had fallen into the habit of administering to undisciplined Latin Americans was inappropriate to East Asia.

According to Stiglitz, the IMF fumbled the ball from the very beginning. Its capital market liberalization policies made economies more vulnerable to currency speculators. When East Asian currencies began to be attacked, the IMF demanded that the capital markets be kept open. Only Malaysia defied the IMF, and as a result it weathered the financial firestorm far better than its neighbors. Secondly, the loans that the IMF provided were targeted at propping up these currencies, rather than allocated to deficit government spending to stimulate the flagging regional economy. This allowed foreign creditors to get much of their loans repaid before the currencies crashed, but did nothing to put out the smoldering fire that threatened to spread throughout the region. And of course, the IMF loans came with structural adjustment conditions, despite the fact that government budgets had been in balance before the crisis hit, and there was every reason to believe that they would return to surpluses after it passed. However, given that the underlying problem was overleveraged firms, driving up interest rates pushed these companies into bankruptcy, and the banking system was put in distress as the number of nonperforming loans skyrocketed. When, to the IMF’s astonishment, structural adjustment failed to produce the anticipated results, it attributed the failure to fundamental problems in these economies. As Stiglitz says, this was like crying “Fire!” in a crowded theater. Investors fled, and economies collapsed one by one, each dragging down its neighbors. High interest rates, rather than attracting foreign capital, actually drove capital out of the countries. What had started as a little smoke in the form of a weak Thai baht due to commercial real estate overcapacity became a conflagration engulfing much of East Asia, including the “tigers.”

A Tale of Two Transitions

Stiglitz observes that in the main, command economies transitioning to market economies have been better served by gradualism than shock therapy. The extreme ends of the spectrum are typified by China and Russia.

China has privatized slowly. The Party that remains communist in name only has managed the transition to the free market so as to ensure minimal social disruption. Having abandoned its foundation in Marxist and Maoist ideology, its legitimacy now rests almost solely on its ability to deliver prosperity to a vast population in a reasonably equitable manner. The problem of inefficient, money-losing, government-owned industries remain, yet so long as the Chinese economy continues to grow at a about 10% per annum, it would seem to be a manageable one. Certainly, despite its reluctance to liberalize its capital markets, it has had little trouble attracting the foreign investment it needs to sustain this healthy growth rate, despite (and Stiglitz says, because of) its failure to follow the IMF’s prescriptions.

Stiglitz stresses the need to get the sequencing of reforms right. Before government assets are conveyed into private hands, the rule of law must gain ascendance over the rule of the Party (especially where the one-party system remains in place, as in China), and the new legal system must include clearly defined property rights as well their effective and impartial enforcement. The rules of the marketplace must be established before the wheeling and dealing begin. The fidelity of the market model depends on “perfect information,” but this in turn depends on the development of robust financial institutions, transparent corporate practices, and a free press to provide such information. Also, the sudden dismantling of government institutions does not necessarily mean that the private sector will rush into the vacuum to provide these services; rather, gaping holes may be left in the structure of the economy that may take years to be filled by a competitive private sector. Worse still, those best positioned to fill the sudden vacuum may be corrupt alliances of racketeers and government officials that form monopolies and erect barriers to the future development of competitive markets.

In Russia, it seems that everything that could go wrong with transition did. Public assets were sold to the cronies of government officials at “kopeks on the ruble.” IMF loans to prop up the currency allowed oligarchs time to strip these assets and convert the cash into hard currency before the ruble crashed. Even an effective system of taxation was lacking, thus the government was unable to collect the revenue to service its debt and eventually defaulted. Property rights remain so ill-defined and poorly enforced that few private foreign investors dare enter. Shock therapy has reduced the patient to a persistent vegetative state, dependent on IMF life support. As with the East Asian crisis, Stiglitz sees in Russia a clear case of IMF malpractice.

Doctor Stiglitz’s Home Remedies

Stiglitz concurs with the broad consensus that has developed outside of the IMF that it “should limit itself to its core area, managing crises; that it should no longer be involved (outside crises) in development or the economies of transition.” Not only would it perform better by focusing on its traditional area of expertise, this would also enable greater accountability.

Additionally, Stiglitz emphasizes that developing economies and those transitioning from communism are better served by crafting country-specific, “home-grown” solutions in partnership with, rather than under the imperious supervision of, international financial institutions. Countries do not feel invested in reforms imposed from the outside. This inhibits societal change and undermines democratic processes. The dicta of the IMF and the tyranny of the capital markets undermine national sovereignty, with ominous implications for democratic institutions in the developed world where such institutions are well-established as well as in the developing world where democracy is more fragile. A physician may perform surgery and prescribe drugs, but ultimately depends on the body’s ability to heal. As Macbeth’s physician advised, “Therein the patient must minister to himself.” Thus the economic healer’s wisdom must take into account the unique mix of endowments—whether natural, cultural, or institutional—of the individual nation to be treated.

However, systemic reforms are required in order to provide an environment in which such home remedies are encouraged and can flourish. Key reforms recommended by Stiglitz are:

1. Acknowledgement of the dangers of capital market liberalization. Hot money imposes huge costs on those not directly party to the transactions. Interventions through the banking and tax systems are desirable. Mentioned in his notes rather than in the main text is the Tobin tax, suggested by economist James Tobin, on international portfolio investment transactions to slow capital flows and lessen their volatility.

2. Bankruptcy reforms and standstills. A “super-Chapter 11” is needed to address bankruptcies that occur due to macroeconomic disturbances, to expedite restructuring, giving greater presumption for the continuation of existing management rather than imposing more creditor-friendly “reforms.”

3. Less reliance on bailouts. Via the “moral hazard” mechanism, they encourage rather than discourage the continuation of risky investment. With increased use of bankruptcies and standstills, there will be less need for big bailouts. This will discourage the kind of reckless lending that has been so common in the past.

4. Improved banking regulation in both developed and less developed countries. Although not mentioned by Stiglitz specifically, this must include reining in the poorly regulated “off-shore” bank and tax havens.

5. Improved risk management. The problem posed by exchange rate volatility is clear, but the solution is not. US monetary policy also can expose debtor countries to higher risk, as when tight money policies during the 1980s drove up interest rates and created the Latin American debt crisis. Today, countries can only buy insurance against short-run fluctuations; developing countries and financial institutions should structure loans in ways that mitigate the risks of large fluctuations.

6. Improved safety nets. These are inadequate in developing countries overall, and in specific sectors of developed economies such as agriculture and small business. An international program would benefit all.

7. Improved response to crises. The interests of workers and small businesses have to be balanced against the concerns of creditors. Responses to future crises will have to be placed within a social and political context. Capital will not be attracted to countries facing turmoil incited by policies perceived to have been imposed from the outside.

The Once and Future Keynes

Most importantly, there needs to be a return to Keynesian economic principles. The IMF must return to its original mandate of providing funds to restore aggregate demand in countries facing economic recession. Anti-Keynesian “structural adjustment” conditionalities have wreaked havoc time and again.

Yet Stiglitz admits that so far reform has been more rhetorical than real. He points to the need for a change in mind-sets in the IMF and the other Bretton Woods institutions, but offers no real roadmap regarding how this might occur. The problem remains that representation in the IMF and the World Bank is based on the size of the monetary contribution of each member, which in general reflects the size of each nation’s economy. Structurally, these are institutions of the developed nations and by the developed nations, therefore it is questionable whether they can ever be truly for the developing nations. And although the World Trade Organization has a “one nation, one vote” structure, some are more equal than others. Agendas are set in side meetings of the developed nations, meetings to which few developing nations are invited.

This lack of responsiveness is cause for concern, for on the present course the discontent over globalization can only grow. Marx believed that the creative destruction of capitalism would breed successively deeper and prolonged crises, leading to its ultimate collapse. The laissez faire policies of the late 19th and early 20th centuries very nearly made him a prophet. The Great Depression of the 1930s might have been the penultimate—or even the ultimate—crisis of capitalism that Marx foresaw, had it not been for Keynes, who was widely credited with rescuing capitalism from the extremes that distorted its virtues into excesses. Today only the Great Depression of the 1930s is remembered, not the many depressions that preceded it, and since then we have dared not use the “D” word for fear of inciting panic, and the word “recession” is a palliative substitution. In the modern hype of globalization, it is often overlooked that the laissez faire era was an earlier age of globalization. We may have invented the word in our own era, but it is a process that has occurred repeatedly throughout history, never the same way each time, to be sure, but reflecting the capabilities and limitations peculiar to its age. The preceding age of globalization had its own discontents who rose to power and became among the most infamous figures of history. Laissez faire capitalism bred these discontents; Keynesian reforms eventually deprived them of their hold on the dispossessed masses. One wonders whether market fundamentalism will take the world over the edge of the abyss again, or whether voices of moderation will prevail in time to avert a global disaster.