A Keynesian critique of the IMF:

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Support for aggregate demand social spending is like foreign aid. It is government to government assistance through an international agency - delivered into the hands of political leaders frequently of proven incompetence and who are frequently substantially corrupt.

  However, it is not even a critique of IMF objectives or most of its policies. Although there is some criticism of policy, the book primarily criticizes the process by which policies are implemented, the timing with which they are executed, and - most important - the policy concerns that are omitted. Much of this criticism is clearly well taken.
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  Also, the author's point of view is that of a committed Keynesian. A Keynesian response to a nation's financial panic would be designed to support aggregate demand and social spending rather than merely assist in regaining monetary stability. Support for aggregate demand and social spending is like foreign aid. It is government to government assistance through an international agency - delivered into the hands of political leaders frequently of proven incompetence and who are frequently substantially corrupt. Such assistance will have the same rates of success and failure as foreign aid.
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  However, since these are loans rather than grants, they will have to be repaid or they will incur donor nation disgust and drain the IMF of funds.
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Private sector imbalances such as speculative bubbles do have to be addressed - overextended financial and business entities do need to be restructured - and government corruption and incompetence cannot be ignored.

  Where Stiglitz goes wrong is where you would expect a Keynesian to go wrong.

• He blames the policies of the IMF and other international agencies for the financial panics of recent years while giving only minimal recognition to the roles played by incompetence and corruption and excessive reliance on debt capital in the nations that were primarily afflicted.

• He believes that international agencies can minimize the bureaucratic and political influences that afflict all large bureaucracies - and that they can do this sufficiently to competently execute development policies far more complicated than the financial stabilization and lending policies that they so frequently screw up at present.

• While recognizing that developing nations do not have attractive equity markets and lack the policies and institutions that encourage the expansion of ownership capital, he is apparently oblivious to the impossibility of maintaining stability in economic systems overly dependent on debt capital.

• And, of course, he has utmost faith in deficit spending and monetary expansion as a cure for the business cycle and financial panics, despite the blatant failures of such policies even in the U.S. in the 1970s and in Japan today - failures that are reasonably kept beyond the scope of this book.

Problems with globalization:

  "Why has globalization - a force that has brought so much good - become so controversial?" Recognizing the widespread benefits of globalization from the outset, Stiglitz nevertheless emphasizes the very real defects - and why these defects hurt  vast numbers of people, and generate protests and opposition that could threaten to end globalization and all its benefits - something that occurred during the previous globalization period a century ago.
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"The Western countries have pushed poor countries to eliminate trade barriers, but kept up their own barriers, preventing developing countries from exporting their agricultural products and so depriving them of desperately needed export income."

"The loosening of capital market controls in Latin America and Asia" benefited Western banks but caused great harm in those regions when "hot money" flows flooded in and then out, leaving behind "collapsed currencies and weakened banking systems."

World Bank and other Western loans remain to be repaid even when the projects they financed fail.

  Despite globalization, poverty remains widespread and deeply entrenched. Much of Africa plunges deeper into misery. Russia and other nations transitioning from communism to capitalism, and nations in Asia and Latin America, continue to suffer widespread disappointments.
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  There are many reasons for these failures. Stiglitz enumerates many that are the result of the policies of Western nations.

• "The Western countries have pushed poor countries to eliminate trade barriers, but kept up their own barriers, preventing developing countries from exporting their agricultural products and so depriving them of desperately needed export income." (FUTURECASTS has repeatedly stressed that protectionist practices against poor nation exports are unconscionable.)

• "The more advanced industrial countries continued to subsidize agriculture, making it difficult for the developing countries to compete, while  insisting that the developing countries eliminate their subsidies on industrial goods." Government supported cartels such as in steel and aluminum demonstrate Western hypocrisy and raise costs of necessary imports for poor nations. (Subsidy programs and administered pricing schemes are bad policy - and FUTURECASTS will continue to criticize them.)

• "Looking at the 'terms of trade' -- the prices which developed and less developed countries get for the products they produce -- after the last trade agreement in 1995 - the eighth - the net effect was to lower the prices some of the poorest countries in the world receive relative to what they paid for their imports.

  Beyond doubt, many of these nations were in serious decline even before 1995 - and their terms of trade would naturally be a part of the decline process. But the ones most seriously afflicted were the ones that had least opened their markets to globalization.
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  Of course, economists can't have it both ways. They can't advise currency devaluation as a means of increasing exports and employment and working their way out of financial crises, and then claim indignation that it adversely affects the terms of trade so that more exports have to be produced to pay for a given amount of imports. Adverse shifts in the terms of trade are an inherent part of the downside of currency devaluation.

• "The loosening of capital market controls in Latin America and Asia" benefited Western banks but caused great harm in those regions when "hot money" flows flooded in and then out, leaving behind "collapsed currencies and weakened banking systems."

  While there is considerable truth in this, it is also a case of blaming the messenger for the message. Only nations with major financial weaknesses and unhealthy degrees of debt leverage suffered from the Asian Contagion. Even little Singapore - in the eye of the storm - was able to navigate the crisis successfully.

• The strengthening of "intellectual property rights" benefited Western drug companies but deprived third world peoples of affordable life-saving medicines.

  Of course, it is only the much maligned profit driven drug companies that produce such medicines - and only intellectual property rights that  offer them sufficient scope for profits to justify the massive risks and costs of drug development. The certainty of theft of intellectual property is one reason why there is so little research being done on tropical diseases.

• World Bank and other Western loans remain to be repaid even when the projects they financed fail.

  It is estimated that only one third of World Bank loans result in satisfactory results. However, Keynesians persist in believing that extending loans to governments is an effective route to economic development.

  Stiglitz then provides a remarkable paragraph - attributing most of the problems of the modern world to the failures of globalization.

  "If, in too many instances, the benefits of globalization have been less than its advocates claim, the price paid has been greater, as the environment has been destroyed, as political processes have been corrupted, and as the rapid pace of change has not allowed countries time for cultural adaptation. The crises that have brought in their wake massive unemployment have, in turn, been followed by longer term problems of social dissolution -- from urban violence in Latin America to ethnic conflicts in other parts of the world, such as Indonesia."

  Ah, for the good old days - during the inflationary 1970s or the depressed 1930s - before globalization. Is this the first time Latin America has experienced systemic financial problems? Isn't reliance on wood for fuel by far a bigger cause of deforestation in poor countries than international trade in lumber? Is this the first time there has been widespread ethnic violence in Indonesia? Full employment was the norm and there was no government corruption before 1980? The benefits of rapid technological change and economic development can be divorced from  cultural impacts?
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  Revealingly, all nations that care at all about the welfare of their people strive as quickly as possible to get back on the globalization bandwagon whenever they are forced off - hopefully having learned some lessons about economic policy from the experience. Revealingly, China and even India continue to seek more of the benefits of access to world markets as - despite recent growth - they continue to struggle with massive levels of unemployment and many other economic  ills. Revealingly, studies show that the developing nations that are most successful at economic development are the ones most open to world trade.
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  Without in the least excusing Western protectionist policies, it must be constantly emphasized that nations not only export for their own benefit - they also import for their own benefit. Free trade is a win-win proposition. Regardless of the mercantilist policies that impoverish the citizens of other nations and benefit only the politically influential, a nation's citizens benefit from both its exports and imports.

  Stiglitz himself admits that "these problems are hardly new." It is only now - with globalization - that hopelessness has been replaced with aspirations that - in all too many cases - are not being met. 

  But they are not being met because of failures of political governance - not because of failures of globalization. The process of globalization is incredibly complex. Unintended consequences attend every action - and innumerable special interests constantly maneuver for advantage. Dealing with problems of governance is a never ending task.

Under globalization, there is no international government with democratic institutions capable of regulating international finance, providing mechanisms for compromise and accommodation of conflicting interests, and providing social safety nets for the unfortunate and those temporarily discomfited by change - and labor mobility is limited.

  Current globalization is similar to the geographic expansion of the U.S. economy in the 19th and early 20th century. The author properly notes such similarities as declining transportation and communication costs, market expansion, capital flows free to go where they could best be used, and goods and services free to be sold anywhere in an expanding market.
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  However, the differences are also important. Under globalization, there is much less labor mobility even with modern rates of immigration. There is no international government with democratic institutions capable of regulating international finance, providing mechanisms for compromise and accommodation of conflicting interests, and providing social safety nets for the unfortunate and those temporarily discomfited by change. There is no international government concerned with assuring that economic benefits are widely shared.
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  That there are many good aspects of globalization is something that is widely recognized. These include the spread of medical care, modern communications, travel, and international governance institutions. It is only certain narrow economic aspects that are challenged - where narrow economic interests force harmful policy changes on third world nations. Stiglitz points to the removal of controls on flows of short term "hot" capital that can flood into and out of a third world nation on short notice, leaving havoc in its wake. (See, "The International Monetary Fund," below.)
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The International Monetary Fund:

The author prefers the policies emphasized by the World Bank during the long tenure of Robert McNamara.

The need to deal with corrupt and inept governing practices and policies is recognized by Stiglitz. But he concentrates on the need to throw in more money - more "liquidity" - to shield economic systems from the consequences.

  The IMF - established in 1944 - was intended by John Maynard Keynes and his followers - who were influential in its development - as a means of pressuring nations to use Keynesian remedies to combat recessions that might negatively impact trade partners - and to provide loans to assist them to pump up aggregate demand and maintain full employment. (As is clear from economic history, this role was never even remotely fulfilled.)
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  In the 1980s, the IMF became more market oriented. It now began to use the promise of loans to pressure financially troubled nations to reform the policies causing their problems.

  "The Keynesian orientation of the IMF, which emphasized market failures and the role for government in job creation, was replaced by the free market mantra of the 1980s, part of a new 'Washington Consensus' -- a consensus between the IMF, the World Bank, and the U.S. Treasury about the 'right' policies for developing countries -- that signaled a radically different approach to economic development and stabilization."

  The change was induced by Ronald Reagan and Margaret Thatcher who "preached free market ideology." Stiglitz is sharply critical of this new approach. (If third world reversals were less noticeable before 1980, that was solely because there were so few advances.)
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  The author prefers the policies emphasized by the World Bank during the long tenure of Robert McNamara, its president from 1968 to 1980. He praises McNamara's policies - which saw the Bank lending vast sums to governments that were socialistic, despotic and/or corrupt - often thus encouraging private financial institutions to also extend loans - the vast majority of which were wasted - leaving the beneficiaries essentially bankrupt.
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  Efforts to clean up this mess continue to this day - with only very spotty success. Stiglitz blames this failure on current World Bank and IMF leadership rather than on the continuing failures of economic policy and governance in the bankrupt nations. He blames the Bank for lending money to corrupt despots who have since departed with the money, and asserts that these nations should not now be still liable for such debts.

  However, he doesn't explain how credit can be extended to the mass of today's undeveloped nations - most of which are still being run by corrupt and incompetent despots. Nor will debt relief help undeveloped nations that maintain smothering command economy systems or that make little effort to facilitate profit driven, market directed commerce.
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  By the end of the 1970s, Keynesian policies had been thoroughly tried and had widely failed in the U.S. and much of the rest of the developed world - as well as in the third world - something the author neglects to mention. The need to deal with corrupt and inept governing practices and policies is recognized by Stiglitz. But he concentrates on the need to throw in more money - more "liquidity" - to shield economic systems from the consequences.
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  If governments don't have it, they should borrow it. If they can't borrow it, they should print it.
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  These are the standard Keynesian nostrums which - even before Keynes - were universally resorted to as palliatives to temporarily put off politically difficult reforms - invariably with dire longer term consequences. Keynesian theory is just an invalid intellectual justification.
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  Japan - rather than confronting its fundamental "command economy" economic policy blunders - has been deficit spending for a decade. Its basic interest rates are near zero, and its basic money supply has expanded 40% in the last two years, without noticeable impact on its sluggish economy. Keynesian nostrums are failing even in wealthy, advanced, productive Japan. Even the U.S. economy remains sluggish despite massive deficit spending, historically low interest rates, and rapid monetary expansion.
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  The Keynesian response is: "It's not enough." It never is!

Stiglitz does not ignore the importance of getting the governance policies right and dealing with the excesses in the private sector.

Stiglitz criticizes IMF and World Bank efforts to force market reforms on frequently unwilling and otherwise unready third world nations.

Stiglitz is particularly and correctly critical of the removal of restraints on short term "hot" capital flows in undeveloped nations that still lack any semblance of proper government oversight for such capital markets.

  The IMF should function as intended by Keynes, the author asserts. It should provide "liquidity" (it should lend money) to nations in financial crisis even before needed reforms are negotiated. However, to his credit, Stiglitz does not ignore the importance of getting the governance policies right and dealing with the excesses in the private sector.

  This, of course, assumes that, if the ship is temporarily stabilized, political leaders will accept discipline that many were incapable of before. This is a prescription for throwing money down financial black holes - as occurred in Russia and is occurring - albeit with domestic funds - in Japan.

  Since 1980, the Reagan-Thatcher free market policies have failed to achieve hoped for results in many nations. Rather than examining the particular policy causes for those failures, Stiglitz criticizes IMF and World Bank efforts to force market reforms on frequently unwilling and otherwise unready third world nations. He is particularly and correctly critical of the removal of restraints on short term "hot" capital flows in undeveloped nations that still lack any semblance of proper government oversight for such capital markets.

  "Capital market liberalization has been pushed despite the fact that there is no evidence showing it spurs economic growth."

  However, developing nations continue to liberalize their capital markets - hopefully now with more competent regulation. They must be aware of some benefits that somehow have escaped the author's attention.
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  Economic liberalization is not an all or nothing proposition, and fortunately, perfection is not required - nor has it been achieved even in the developed nations. China makes impressive progress by a series of cautious but persistently continuous market liberalization reforms while maintaining many command economy and socialist practices. However, as Japan is finding out, major governance defects will eventually have noxious impacts if left in place.

The changes forced by sudden liberalization of trade can easily destabilize third world nations.

  But stabilization, privatization, and market liberalization are not enough for economic success. Stiglitz is undoubtedly correct when he states:

 "In other cases, the economic policies that evolved into the Washington Consensus and were introduced into developing countries were not appropriate for countries in the early stages of development or early stages of transition."

  The periodic financial crises in U.S. economic history are proof that the proper functioning of financial markets and credit institutions - as part of the nation's monetary system - must be prime concerns of government oversight - something few third world nations have the sophistication to provide.

  All advanced nations applied protectionist policies for some of their domestic industries during their development stages, Stiglitz correctly points out. Perfectly open trading systems have never proven themselves in a development context.

  Here, the author avails himself of the "perfect virtue" propaganda ploy. The real question is whether  development efforts have been successful when accompanied by substantial degrees of trade liberalization - as occurred widely in Europe at the end of the 19th century. Then, one can proceed with economic analysis of the contribution of trade liberalization policies. Fortunately, for mere mortals, perfection in economic virtues is not required to generate a cornucopia of benefits.

  The author also correctly points out that the changes forced by sudden liberalization of trade can easily destabilize third world nations. (These nations typically  lack the credit and other market facilities and entrepreneurial talent needed to flexibly respond to rapid changes.)
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  The author adopts a most appropriate analogy about developing nations.

  "Small developing countries are like small boats. Rapid capital market liberalization, in the manner pushed by the IMF, amounted to setting them off on a voyage on a rough sea, before the holes in their hulls have been repaired, before the captain has received training, before life vests have been put on board. Even in the best of circumstances, there was a high likelihood that they would be overturned when they were hit broadside by a big wave."

  The IMF wields immense influence over a poor nation's access to credit - not just  from governments, but from private sources as well. Donors, too, will not provide funds to a nation that is out of compliance with IMF requirements. Even debt relief - a recent welcome policy reform - will be withheld from nations that are not in compliance.
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  Today, small nations seek improved access to international capital markets. For this, they need the "seal of approval" of the IMF and World Bank. This gives these institutions great power to influence economic policy even before the advent of some crisis. Thus, the author blames the IMF for just about all the economic problems of the third world - emphasizing that all but a few of these nations have failed to achieve prosperity even after adopting IMF reforms.
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The author views the current crisis in Argentina as an IMF failure - but doesn't explain how that crisis could have been avoided under that nation's dysfunctional budget processes.

Stiglitz perceptively does not attack the reforms themselves, but the pace and sequence with which they are imposed.

  The experience in Argentina is presented as a prime example. The author views the current crisis in Argentina as an IMF failure.

  However, just throwing money at the problem won't work. Until Argentina gets a grip on its governmental budgets, nothing will work.
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  The IMF doesn't have unlimited resources - is actually quite limited in the policy reforms it can require - and is frequently dependent on local officials and political leaders of proven incompetence to implement corrective measures. It is inevitably subject to political and bureaucratic imperatives from all its major contributing nations as well as from within its own ranks.
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  It is thus hardly an agency that can guarantee world prosperity. That remains dependent on national governments working within their own boundaries and joining various international initiatives to facilitate particular aspects of world commerce.
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  IMF influence is actually very limited. Stiglitz himself notes some of the many instances where developing nations - like China, India, Malaysia, and South Korea - have rejected IMF advice. He also recognizes that many other nations simply fudge on implementation of reforms, or maintain them only until an economic crisis passes. IMF influence is only powerful in direct proportion to the trouble nations get into.
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  "Laissez faire" capitalism is a myth that has never remotely existed. Government not only has many economic roles that it shouldn't play - it has many roles that it must play. It is considerably more arguable that IMF reforms don't go far enough - or are not adequately implemented - than that they go too far and are imposed too rigorously.

  However, Stiglitz perceptively does not attack the reforms themselves, but the pace and sequence with which they are imposed.
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Policy reform conditions for financial assistance:

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  When nations require assistance because of some financial crisis, the IMF enforces its requirements of "conditionality" by paying out its loans in installments - each one dependent on the achievement of scheduled policy reforms.

  "The IMF staff monitored progress, not just on the relevant indicators for sound macromanagement - inflation, growth and unemployment - but on intermediate variables, such as money supply, often only loosely connected to the variables of ultimate concern. Countries were put on strict targets - what would be accomplished in thirty days, in sixty days, in ninety days. In some cases the agreements stipulated what laws the country's Parliament would have to pass to meet IMF requirements or 'targets' - and by when."

The IMF forces nations in financial crisis to surrender a variety of subsidies and welfare expenditures to qualify for assistance.

Financial market liberalization and eliminating trade barriers, monopolies, and tax distortions - "may enhance long-run growth, but the disturbances to the economy as it strives to adjust, may only deepen its downturn" in the short run.

"Good policies cannot be bought."

  The IMF forces nations in financial crisis to surrender a variety of subsidies and welfare expenditures to qualify for assistance. This Stiglitz blames on IMF policies rather than on the financial mismanagement that undermined the financial strength needed to maintain these programs. He correctly accuses the IMF of mission creep beyond its intellectual and political capabilities.

  "The IMF is like so many bureaucracies; it has repeatedly sought to extend what it does, beyond the bounds of the objectives originally assigned to it. As IMF's mission creep gradually brought it outside its core area of competency in macroeconomics, into structural issues, such as privatization, labor markets, pension reforms, and so forth, and into broader areas of development strategies, the intellectual balance of power [between IMF and client nation experts] became even more tilted."

  Other conditions typically imposed - such as financial market liberalization and eliminating trade barriers, monopolies, and tax distortions - "may enhance long-run growth, but the disturbances to the economy as it strives to adjust may only deepen its downturn" in the short run. Changing the charter of the nation's central bank to make it more independent of political pressure is another condition frequently imposed.

  A Keynesians would naturally be unhappy with this, since it is an attempt to take the decision to print money out of political hands. Of course, the actual independence of independent central banks varies widely.

  Stiglitz is certainly correct in stating: "Good policies cannot be bought." If other economic policies are bad - or if the conditional policies are poorly implemented - or if corruption or other weaknesses remain too prevalent - the IMF cannot succeed. (That's one reason why debt relief has been withheld in some otherwise appropriate instances.)

Keynesian assistance to support social programs during the crisis period might have provided needed political stability and support.

  Some of the specific reasons why IMF efforts fail are provided by the author:

• Money is fungible. Even if outside assistance is properly used to build a road facilitating the bringing of farm produce to market, that may just free up other moneys to be used in building a road to the summer villas of the political leaders. (The same can be said for foreign economic aid "for schools and clinics.")

• Financial market liberalization in places like Kenya may fail because the sophisticated conditions for the success of such markets may not be in place.

• Fiscal austerity will always make matters worse - as it did in Southeast Asia.

  It wasn't the austerity policies that were wrong - it was the vain effort at currency stabilization at untenable levels. Austerity policies need not be so severe - and can have rapid beneficial impacts - if imposed to stabilize a currency and economic system after the currency has been allowed to decline to sustainable levels and pertinent policy blunders have been reformed.

• Conditions were imposed on nations too politically unstable to carry them to a successful conclusion. "The policies could not withstand the vicissitudes of the political process." Keynesian assistance to support social programs during the crisis period might have provided needed political stability and support. Stiglitz asserts that such support would be considerably less than the billions of dollars generally required for monetary stabilization.

  But Keynesian money is provided in order to be spent. If successful - which is far from the norm - just the existence of stabilization funds will restore confidence so it doesn't have to be spent. This generally requires adequate reforms adequately implemented - and most important - a devaluation of the currency to a level that is sustainable - a requirement that is all too often not initially acknowledged. See, "Bail outs and moral hazard," below.

• The IMF did throw vast sums at Russia and Indonesia for political reasons, but refused similar support for nations like Kenya which are not strategically placed. (That international agencies are political agencies that will inevitably be used for political purposes is acknowledged by Stiglitz.)

• IMF imposition of conditions caused resentments sufficient to destabilize the political situation and cause riots in many nations - forcing capital to flee and causing further injury to those nations rather than assisting them.

  It is actually quite encouraging how often relatively new and  shaky democratic systems were able to absorb these political pressures by means of reasonably fair electoral processes. Such precarious democracies as those in Russia, Indonesia, S. Korea, Brazil, and many of the East European states all functioned as intended with reasonably fair elections even under crisis circumstances.
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  Often, the IMF is simply used as a scapegoat, to deflect anger away from the domestic political leaders whose incompetence and corruption caused the economic mess and whose efforts at reform are inept.

• The IMF can make serious mistakes in its evaluation of a nation's economic policies. For example, it persistently believed that the U.S. was heading for increased inflation in the 1990s and should be fighting inflationary pressures even as inflation kept declining and prosperity reached new high levels. The U.S. could ignore the IMF recommendations - but smaller nations frequently cannot because of the impact on their access to financial markets.

  Stiglitz is here only partially correct. In fact, inflation in the U.S. did not decline all by itself. It was driven down by the persistent maintenance of somewhat higher than normal real interest rates - and substantial reductions in Cold War levels of military spending. These anti-inflationary policies resulted in sluggish economic growth until they ultimately paid rich dividends in the last half of the decade.

• The IMF imposes "one-size-fits-all" conditions - only modestly fine tuned for specific requirements in different nations. (Again - hardly surprising in a government agency.)

For the programs to be implemented in an effective and sustainable manner, there must be a commitment of the country behind the program, based on a broad consensus.

Conditionality can prevent governments from just taking the money and then not making the needed policy changes. Rigid timetables help force the pace of needed change.

  But at other times, the IMF has failed - because the policies were not well suited to the country - or because they created hostility - leaving the country just as impoverished and even more deeply in debt.

  The IMF should consult more widely within countries and bring local authorities on board for any required policy initiatives, the author advises. Consultation and consensus building is essential. Lack of citizen participation and lack of transparency are basic causes for resentment. The IMF negotiates in secret. (Almost all international negotiations of contentious issues are in secret - and the need to make decisions rapidly in the face of a rapidly progressing crisis would inevitably limit the scope of any discussions.)

  "Those within the country are likely to know more about the economy than the IMF staffers - - -. And for the programs to be implemented in an effective and sustainable manner, there must be a commitment of the country behind the program, based on a broad consensus. Such a consensus can only be arrived at through discussion -- the kind of open discussion that, in the past, the IMF has shunned."

  The World Bank has been following this model - using the carrot of additional funds for those nations that use funds well - rather than the stick of imposed conditions. Nevertheless, the Bank remains in actual control because it controls the funds. There are those who resent even this retention of the power of the purse.

  This retention of the power of the purse makes this policy difference with the IMF almost a distinction without a difference. One of the major differences is that the World Bank is not necessarily working under the time pressure of crisis conditions.

  The IMF has in fact had some successes, the author readily acknowledges. These occur when it is dealing with nations with good economic policies already in place - or with nations capable of implementing required reforms - or when involved with nations where the debate could be shifted in ways favorable toward good economic policies. He recognizes that conditionality can prevent governments from just taking the money and then not making the needed policy changes. Rigid timetables help force the pace of needed change.
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  But at other times, the IMF has failed - because the policies were not well suited to the country - or because they created hostility - leaving the country just as impoverished and even more deeply in debt.

  That the IMF or any similar agency will occasionally fail is hardly surprising. Stiglitz apparently believes that international governance agencies can be highly competent and devoid of political or special interest influences. Unfortunately, economic history is everywhere dominated by incompetent policies and special interest influences on economic governance at all levels.

IMF and World Bank management is chosen by the major developed nations without regard to experience in the third world.

International government institutions - just like national ones - are influenced by narrow vested interests.

  The way the IMF and World Bank are governed is a focus of the author's criticism. Their management is chosen by the major developed nations without regard to experience in the third world. "The institutions are not representative of the nations they serve." He wants greater "openness and transparency." He expresses chagrin that international government institutions - just like national ones - are influenced by narrow vested interests.

  After all, if Libya can chair the U.N. Human Rights Commission, why can't Myanmar (Burma) or Cuba lead the World Bank?
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  Lack of experience with third world nations is a more than reasonable criticism. However, complaining that the nations that write the checks control policy rather than those who receive the checks is hopelessly naïve. The power of the purse is not something political entities lightly surrender. The staffing of international agencies on the basis of patronage rather than expertise is notorious.
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  There is a good reason why most economic institutions are not democratic and broadly open to public influence. Democracy and open processes are not about efficiency or effectiveness. They are about curbing abuses of power. More democratic and open procedures will curb some abuses of power or change the nature of those abuses, but they will certainly not improve effectiveness.

   Because of the narrow experience and concerns of the IMF, a country like Argentina "can get an 'A' grade even if it has double-digit unemployment for years, so long as its budget seems in balance and its inflation seems in control." (Argentina's complex of government budgets has not been even remotely in balance.) 

  The author accurately blasts the IMF for errors of policy - something hardly unexpected in a government agency - or in any agency working under crisis pressures. It is doubly to be expected in an international agency of governments - which labors under a compound dose of political and bureaucratic imperatives. 
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  However, it must be remembered that, by the time the IMF arrives on the scene, the situation is frequently already critical. Only a fool would expect such crises to be resolved quickly and without considerable pain. These situations frequently have already proceeded so far that a substantial devaluation of the currency is unavoidable - something that all by itself will cause much pain. It is not for no reason that the first official instinct is to avoid a devaluation. That there will be a certain number of outright failures is hardly surprising.

Bail outs and moral hazard:

The only beneficiaries of these wasteful IMF rescue efforts were those who were thus given time to bail out - frequently from recklessly created positions.

  An IMF rescue package provides time for banks to call in their loans. Money expended to support the currency exchange rate "temporarily at an unsustainable level" was largely wasted, leaving the stricken nations with an economy shocked by high interest rates, devalued currencies and a large obligation to repay to the IMF. The only beneficiaries of these wasteful IMF rescue efforts were those who were thus given time to bail out - frequently from recklessly created positions.

  The problem of "moral hazard" is all too real - but these bail outs do reduce perceived risks and reduce the interest costs of third world nations. Private financial institutions need to be forced to take a substantial hit when lending reaches reckless proportions. However, like so many of these questions, this is not amenable to simplistic answers - since any increase in perceived risks will raise the cost of capital to these nations.
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  Nations adopt fixed currency exchange rates in an effort to remove the risk of currency weakness and thus reduce the interest rates at which they borrow. This can also help attract equity capital. Unfortunately - all too often - these governments lack the budgetary discipline needed for stability, and their private businesses lack the broad base of equity capital needed for stability. That many ultimately fail to maintain their fixed exchange rates should come as no surprise.
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  Floating exchange rates will prevent monetary crises - and will concentrate the minds of lenders concerning the risks of lending to these nations - hopefully forcing these nations to maintain some semblance of budgetary discipline and to adopt policies that facilitate the functioning of equity capital (stock) markets.
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  Devaluation without austerity leads to repeated devaluations or to a chronically declining floating exchange rate. This quickly results in ruinous levels of inflation. But austerity designed to maintain an overvalued currency causes economic collapse, and is rightly criticized by Stiglitz.
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  To work, the two must go together - and suitable reforms must be instituted to deal with the fundamental problems that caused the panic in the first place. Both the "market fundamentalists" and the Keynesians generally omit important parts of the policies needed to address panic conditions. Moreover, the fundamental problems almost always include major weaknesses in government and institutional policies that may be politically difficult to address.

Ethiopia:

Aid flows to Ethiopia were actually more reliable than tax flows - which after all varied with economic conditions.

  Money is fungible - as Stiglitz acknowledges in other contexts. With some exceptions for such things as toll roads and bridges that directly  pay for themselves, the segmentation of national budgets is a fiction. Like abuse of "pro forma" earnings reports, such segmentation is designed to remove deficits and liabilities from view and obscure unpalatable operations. Aid "for schools and clinics" frees tax funds for other purposes.

  The IMF also insisted on examining for approval individual financial transactions - like the sensible decision to prepay a high interest loan on an airplane.

  "But the IMF felt countries receiving money from it had an obligation to report everything that might be germane; not to do so was grounds for suspension of the program, regardless of the reasonableness of the action. To Ethiopia, such intrusiveness smacked of a new form of colonialism; to the IMF, it was just standard operating procedure."

  The IMF also wanted to force Ethiopia to open up its tiny financial markets to Western competition, divide its largest bank into several pieces - that would then be too small to have any chance to compete - and stop administering interest rates so that they could be determined by market forces. This latter requirement would have ended the government policy of allocating cheap credit to its vast impoverished agricultural sector.

  Stiglitz does not reveal whether there were other favored interests benefiting from allocation of cheap credit - or what the impact was on the access to credit of small business and others not politically favored.

  It was only with considerable effort that Stiglitz got the World Bank to triple its lending to Ethiopia, and ultimately convinced IMF officials of the error of their views with respect to poor countries that are dependent on substantial flows of foreign aid.
 &

Botswana:

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IMF advice is essentially correct - it is just often terribly wrong with respect to sequence and pacing.

Conditions imposed as shock therapy in the midst of a crisis can tear a nation apart.

  However, this array of policies included most of the things the IMF insists upon, the author points out. IMF advice is essentially correct - it is just often terribly wrong with respect to sequence and pacing. When a drought resulted in a financial crisis, there was little more the IMF could ask for. Here, certainly, was a place for Keynesian policies - to help a well governed nation get through a tough spot.
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  Because Botswana had prudently put aside reserves for such events, it was able to draw on them to limit the amount of austerity needed to get through the crisis. It thus limited the suffering and avoided the social and political disruption that frequently attend austerity policies. Stiglitz reasons that the IMF should provide reserves for such purposes when domestic funds are not sufficient.

  As Stiglitz points out: "Governments that fail to manage their overall economy generally typically do a poor job managing foreign aid." There are generally reasons why nations lack reserves when crises occur.

  It's not that the basic IMF requirements are wrong, Stiglitz notes. It's just that imposing them as shock therapy in the midst of a crisis can tear a nation apart. (But, when can the IMF impose budgetary and monetary discipline and good governance practices if not during a crisis when national political leaders can no longer ignore their responsibilities?)
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The Washington consensus:

Privatization:

How government productive entities are privatized - and the economic environment existing for privatized entities - are vital factors often disregarded by the IMF and the World Bank.

"Once a vested interest has been created, it has an incentive, and the money, to maintain its monopoly position, squelching regulation and competition, and distorting the political process along the way."

Economic growth involves governance practices far beyond mere privatization and budgetary and monetary discipline.

Privatization may not be a solution to government corruption - since a corrupt government will inevitably award its assets in a corrupt manner.

  Governments often have to do what is needed but what the private market won't do. Social welfare programs and environmental programs are prominent examples.
 &
  Even if the private market will eventually be able to perform some needed function, government may have to fill in until it is established. Stiglitz points to New Deal programs such as Social Security and the Federal National Mortgage Association as examples even in developed nations. In undeveloped nations, where the economy has become dependent on a variety of government supplies and services, their withdrawal can be traumatic.
 &
  The debate is not really whether government has a role, but what is "the appropriate balance between governments and markets."
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  The author correctly criticizes the tendency to replace government monopolies with unregulated private monopolies - which then proceed to charge monopoly prices. He rejects the IMF argument that privatization should be done quickly - that matters of competition and regulation can be dealt with latter.

  "But the danger here is that once a vested interest has been created, it has an incentive, and the money, to maintain its monopoly position, squelching regulation and competition, and distorting the political process along the way."

  He also criticizes the initial loss of jobs, as private owners cut bloated labor forces to increase efficiency - often before the economy is functioning well enough to absorb these workers - causing widespread turmoil. "Privatization often destroys jobs rather than creating them."

  Without the good governance practices that facilitate profit driven, market directed commerce, private enterprises cannot flourish. Privatization under such circumstances will reduce government waste, but it will not create new jobs.
 &
  However, the effort in China to go slowly with privatization has not prevented the spread of unemployment problems. It has just extended the period of high unemployment indefinitely as the inefficient state owned enterprises hog financial resources without which they can't survive. Among other things, this prevents rapid development of the small businesses that, with access to financing,  would expand and absorb the unemployed.

  The author dwells on the hardships of the resulting unemployment - never venturing a comparison with the hardships of the nonfunctional economic systems that would  continue indefinitely without privatization. He correctly emphasizes that economic growth involves governance practices far beyond mere privatization and budgetary and monetary discipline.

  "Privatization needs to be part of a more comprehensive program, which entails creating jobs in tandem with the inevitable job destruction that privatization often entails. Macroeconomic policies, including low interest rates, that help create jobs, have to be put in place. Timing - and sequencing - is everything. These are not just issues of pragmatics, of 'implementation:' these are issues of principle."

  If governments had the ability to manage such things, they wouldn't be getting into so much trouble in the first place. The persistence of high rates of unemployment even in some advanced nations with commitments to full employment provides ample proof of government inability to "create" jobs.
 &
  To a Keynesian, of course, money is never in short supply and interest rate markets are tame servants of a government's desires. Credit allocation - assuring low interest financing to favored sectors at the expense of the rest of the economy - is a favorite technique - the ultimate results of which can be seen in a host of dysfunctional Asian financial systems.

  The author correctly points out that privatization may not be a solution to government corruption - since a corrupt government will inevitably award its assets in a corrupt manner. "If government is corrupt, there is little evidence that privatization will solve the problem."
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Trade:

The "hypocrisy" of Western insistence on trade liberalization for Western exports while Western nations still impose restraints on the exports of undeveloped nations is properly blasted by Stiglitz.

  The "hypocrisy" of Western insistence on trade liberalization for Western exports while Western nations still impose restraints on the exports of undeveloped nations is properly blasted by Stiglitz. Subsidies and tariff protection for agricultural products and textiles remain in place. (Some welcome progress has been made in reducing textile restraints for some third world producers, but the agricultural lobbies in the U.S. and Europe and Japan are too powerful to be confronted.)
 &
  Maritime and construction services are also subject to trade restraints and subsidies. U.S. "unfair trade" remedies are notoriously anything but fair. (See "United States industrial policy practices," below.)
 &

Financial markets:

Capital market liberalization subjects immature financial systems to the temptations and risks of short term "hot money" borrowing - with disastrous results.

  Financial market liberalization "undertaken prematurely before strong financial institutions are in place," increases instability, Stiglitz correctly points out. Capital market liberalization subjects immature financial systems to the temptations and risks of short term "hot money" borrowing - with disastrous results. He notes that China was spared during the Asian contagion because of its "wise policies" in maintaining a controlled financial system.

  The vast unemployment and underemployment problems in China - and in India, too - persist precisely because of - among many other things - a lack of private sector access to financing that would be available under a liberalized financial system. Where credit is allocated, only the influential have access, and small businesses generally remain small.

Financial markets without proper regulation and policing will become subject to widespread abuses that market mechanisms by themselves cannot control,

  Financial markets without proper regulation and policing will become subject to widespread abuses that market mechanisms by themselves cannot control, Stiglitz properly emphasizes. A laissez faire approach to financial markets is doomed to failure. 

   In modern politically correct style, Stiglitz emphasizes that periods of instability in market systems disproportionately hurt the poor. Of course, every societal problem hurts the poor disproportionately - especially the manifold problems of government administered systems - which unlike market instability, are interminable - for the duration of the administered systems - notwithstanding that the poor are made dependent on those administered systems for a few rudimentary benefits.
 &
  For that matter, resort to Keynesian palliatives in lieu of confronting politically sensitive dysfunctional policies also disproportionately hurts the poor. The inflation and stagflation that inevitably flow from persistent reliance on Keynesian policies also disproportionately hurt the poor.

Foreign investment:

"Temporary" protections designed to give local interests a chance to catch up and compete all too often become permanent, with permanent unnecessary costs for local consumers.

  The many advantages of foreign investment are recognized by Stiglitz, but he grieves for the local businesses, large and small, that crumble away in the face of foreign competition. Local ice cream manufacturers can't compete with Unilever's ice cream products. Local soft drink providers can't compete with Coca Cola and Pepsi. (Not always true!)  However, he properly notes that "temporary" protections designed to give local interests a chance to catch up and compete all too often become permanent, with permanent unnecessary costs for local consumers.

  Foreign competition raises business standards. In many third world nations, if you want to find a clean restroom, look for one of those much maligned McDonalds restaurants.

Foreign investment in corruptly governed nations just benefits the corrupt ruling groups - and drives up the value of the currency - undermining the competitiveness of traditional exports. 

  Some Asian nations that enjoy high savings rates - such as China and Japan - have been able to develop rapidly without foreign investment or with tightly controlled foreign investment. (This is not the general rule among undeveloped nations, however.)
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  Foreign investment in corruptly governed nations just benefits the corrupt ruling groups - and drives up the value of the currency. This is especially dangerous with respect to exploitation of significant natural resources, since the benefits of such development need not flow through to the general economy.
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Industrial policy:

Proper sequencing and pacing:

Private property will not automatically generate the institutions and legal structures needed for realizing the full advantages of private property.

  However,  laissez faire policies do not work in the real world of market imperfections and information limitations. And, private property will not automatically generate the institutions and legal structures needed for realizing the full advantages of private property.

  Economic policy in successful capitalist nations has never been that of  laissez faire neutrality. It has always been characterized by extensive efforts - admittedly not always wise or successful - to facilitate profit driven, market directed commerce. Such policies have reached significant levels of complexity, which undeveloped nations are hard pressed at best to implement.

  Sequencing and pacing of reforms has been ignored by the IMF. Also ignored is the need to be "sensitive to the broader social context" of their programs. 

  "[Stiglitz criticizes the IMF for] forcing liberalization before safety nets are put in place, before there was an adequate regulatory framework, before countries could withstand the adverse consequences of the sudden changes in market sentiment that are part and parcel of modern capitalism; forcing policies that led to job destruction before the essentials for job creation were in place; forcing privatization before there were adequate competition and regulatory frameworks." (However, as stated above, the IMF must act when crisis situations give it leverage.)

Privatization must include policies that protect competition. Replacing government monopolies with private monopolies offers little or no benefits.

Replacing corrupt government administered systems with markets dominated by corrupt political influences or local Mafiosi achieves little.

Inattention to the pacing and sequencing of reforms "has resulted in job destruction outmatching job creation," and the exposure to market risks "outmatched the ability to create institutions for coping with risk, including effective safety nets."

  The IMF is charged with an array of errors of commission and omission.
 &
  The author acknowledges that sustained reductions in poverty requires "robust economic growth," and correctly points out that economic growth may not benefit all. Government plays a major role in enabling widespread benefits from economic growth - and in turn facilitates that growth.

  It properly does this through such policies as universal education, the support and regulation of securities markets and a financial system that provide widespread access to credit and promotes equity capital, and policies that facilitate small businesses as well as larger businesses.

  The author summarizes his criticism:

• Privatization must include policies that protect competition. Replacing government monopolies with private monopolies offers little or no benefits.

• Similarly unproductive is replacing corrupt government administered systems with markets dominated by corrupt political influences or local Mafiosi. (The IMF is hardly equipped to tackle organized crime or indulge in "regime change.")

• Lack of financial sector regulation is another weakness ignored or even promoted by the IMF. Faulty financial regulation played a major role in the Asian Contagion crisis.

• The "social contracts" of established popular benefits must be maintained through the stressful period of economic transformation.

• There is always a need for free elementary education - for girls as well as for boys - something the IMF ignores.

  Without disputing the worthiness of such efforts, here it is Stiglitz who is guilty of "mission creep." Here it is Stiglitz who would use a crisis to force desired social policies.

• High interest rates must not be "pursued blindly" in ways that greatly increase unemployment and reduce public benefits. While inflation must be kept from getting out of hand or must be checked when it does, the author repeatedly emphasizes that modest rates of inflation are better than the high interest rates and high exchange rates needed to totally eliminate it. Such austerity causes widespread economic dislocation.

  As stated in "Bail outs and moral hazard," above, repeated efforts to defend currency exchange rates that are clearly no longer tenable is clearly one of the IMF's greatest sins. However, the Keynesian belief that governments can manage interest rates ignores the fact - repeatedly proven by economic history - that efforts to force interest rates down must ultimately result in higher interest rates - and that the only way to get interest rates down is to let them rise to reflect market conditions.
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  Unless nations have substantial monetary reserves - as the U.S. had in the 1950s and 1960s - Keynesian efforts to force interest rates down can break down fairly quickly. Inadequate monetary reserves is generally the rule by the time a nation is embroiled in a monetary crisis - as occurred in the U.S. early in the 1970s. It is thus the crisis not the IMF that causes the high interest rates - and the more they are held down, the higher they will go. This is what ultimately occurred in the U.S. in the 1970s and early 1980s.

• Inattention to the pacing and sequencing of reforms "has resulted in job destruction outmatching job creation," and the exposure to market risks "outmatched the ability to create institutions for coping with risk, including effective safety nets."

• By concentrating on stabilization policy, the IMF ignores the need for job creation. (As stated above, there is no proof of government competence at "job creation.")

• While tax reform is always on the agenda, land reform is not. The inability of those who work the land to own their own land is a particular systemic weakness ignored by the IMF. Land reform was an important part of the success of economic transformation in both Korea and Taiwan (and China, too). (But land reform in favor of people who know little about the business of farming can be an economic disaster.)

• Promoting labor market flexibility as a means of increasing employment and commerce does too little to justify the increase in insecurity. (As we see in Japan and Europe, it is the young who are the primary victims of inflexible labor markets, and the unions that are the primary beneficiaries - until commerce declines sufficiently to threaten even union interests.)

Transformation economies and the Russian crisis:

Capitalism requires an environment that facilitates profit driven, market directed commerce - and that environment includes numerous factors of political governance and civic attitudes.

  IMF insistence on wasting billions of dollars in vain efforts to defend Russia's overvalued currency here again caused considerable damage for no benefit, facilitated capital flight, and played a major role in further undermining the Russian economy. Ultimate devaluation in 1998 finally released the economy from this burden and - with help from higher oil prices - facilitated recovery.
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   Privatization and entrepreneurship are complex matters. We now know - if we didn't know it before - that capitalism requires an environment that facilitates profit driven, market directed commerce - and that that environment includes numerous factors of political governance and civic attitudes. Stiglitz perceptively points out:

  "The transition from communism to a market economy was more than just an economic experiment: it was a transformation of societies and of social and political structures. Part of the reason for the dismal results of the economic transition was the failure to recognize the centrality of these other components."

  Even after transformation nations abandon communism, they lack nearly all the attributes of the good governance needed to facilitate profit driven market directed commerce - and they are at least a whole generation away from developing a politically and legally empowered civil society that can responsibly support political and economic freedoms, individual liberty, property rights and the rule of law. Indeed, many of these nations are still despotic and/or still in many ways socialistic or subject to smothering command economy policies.

  Poland is presented as a transformation nation with better sequencing and pace. Privatization was slower in Poland, which first concentrated on getting the supporting institutions right. These included "banks that actually lend, and a legal system that could enforce contracts and process bankruptcies fairly." While hyperinflation was rapidly addressed, eliminating the last modest levels of inflation took second place to concerns "such as the importance of democratic support for reforms, which entailed trying to keep unemployment low, providing benefits for those who were unemployed and adjusting pensions for inflation, and creating the institutional infrastructure required to make a market economy function."

  "The gradual process of privatization allowed restructuring to take place prior to privatization, and the large firms could be reorganized into smaller units. A new, vibrant  small enterprise sector was thus created, headed by young managers willing to invest for their future."

  Taiwan and China are examples of transition economies that took a deliberate approach - not only redeploying resources from command and control systems to market systems, but also steadily establishing more of the institutions that underlie a market economy. (See, Chow, "China's Economic Transformation.") They have thus had remarkable success. "Rather than prolonged transition recession, they had close to double-digit growth."
 &
  In China, privatization was secondary to creating the institutional infrastructure for a market economy - and assuring competition - so that privatization does not just substitute private monopolies for government monopolies. Infrastructure such as a securities and exchange commission, bank regulations, and safety net provisions were provided for.
 &
  While this has been far from perfect or even sufficient, China's experience has been far superior to that of Russia. Privatization of state-owned enterprises is a task still to be undertaken. And, while certain types of foreign direct investment have been welcomed, full capital market liberalization has yet to be attempted.

  Stiglitz is here generally correct, but is far from candid  about the difficulties China still faces, and the ongoing weaknesses of its current economic system.
 &
  China's growth has been truly remarkable - but it must be remembered that it is being measured from the extraordinarily low base of the Cultural Revolution. Growth rates have benefited from successive steps at economic liberalization - exactly as one would expect. However, the pace of growth - as fast as it undeniably is - has not come close to being sufficient to avoid vast levels of unemployment and underemployment, and has left China with a dysfunctional banking system, burdensome state owned enterprises, and growing budgetary problems - and a vibrant but stunted small business sector starved for capital.
 &
  China has to continue its economic liberalization - which it seems laudably determined to do - or it too will run into a financial brick wall similar to that of the Asian Tigers.
 &
  Also, one tremendous disadvantage that afflicts Russia is not fully applicable to China and most of the Eastern European transformation economies. Russia experienced seven decades of socialist economics that was sufficiently long to destroy all entrepreneurial, managerial, legal and societal capital. In these other transformation nations, there were still people who knew how to run a farm or a business or a bank - or were familiar with the government institutions needed to facilitate commerce.

Above all, throughout all levels of government, Russia lacked the essential pervasive desire to facilitate the success of the transformation effort. Instead, corruption and incompetence undermined all efforts.

  The experience in China and Taiwan was ignored by the "radical reformer" advisers - who thought that market direction by itself would propel the economic system in the most positive direction. However, Russia lacked an appropriate legal and regulatory framework, private property rights, contracts and commercial law and bankruptcy procedures, functional markets for equity and debt capital, competition policies, modern banking institutions, and much more that is needed to create an investment friendly environment. It lacked effective mechanisms for creditors to collect debts and governments to collect taxes. Also lacking was stability in the political environment - which is impossible unless the vast mass of the population can see that they can achieve real improvements in their lives under the new market system.
 &
  Above all, throughout all levels of government, Russia lacked the essential pervasive desire to facilitate the success of the transformation effort. Instead, corruption and incompetence undermined all efforts.
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  Stiglitz tries to take this perceptive argument further - to support egalitarian views - asserting that the growth of inequality is the primary force for political instability. (Even in Russia - with its widespread residual socialist sensibilities - it is a lack of personal opportunity that creates instability - not the superior achievements of others.)
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Under these conditions, managers, controlling owners, and regional and municipal governments had no incentives for good governance. Instead, they got what they could by stripping assets and demanding the "rents" of corrupt practices.

The social institutions and empowered civil society that are needed to support the system didn't exist.

  Since legitimate enterprise was impossible under these conditions, managers, controlling owners, and regional and municipal governments had no incentives for good governance. Instead, they got what they could by stripping assets and demanding the "rents" of corrupt practices.

  "They tried to take a short cut to capitalism, creating a market economy without the underlying institutions, and institutions without the underlying institutional infrastructure. Before you set up a stock market, you have to make sure there are real regulations in place. New firms need to be able to raise new capital, and this requires banks that are real banks, not the kind of banks that characterized the old regime, or banks that simply lend money to government. A real and effective banking system requires strong banking regulations. New firms need to be able to acquire land, and this requires a land market and land registration."

  Markets for both inputs and outputs didn't exist. The social institutions and empowered civil society that are needed to support the system didn't exist. There was no safety net for the unemployed, no ability to obtain housing where the jobs existed.

"The most contentious [debates] centered on the speed of reform: some experts worried that if they did not privatize quickly, creating a large group of people with a vested interest in capitalism, there would be a reversion to communism. But others worried that if they moved too quickly, the reforms would be a disaster -- economic failures compounded by political corruption -- opening up the way to a backlash, whether from the extreme left or right. The former school was called 'shock therapy,' the latter 'gradualist.'"

The wealthy - including those made wealthy by political influence - care not for rule of law, property rights, a free press, and protection from monopolies. They have other ways of taking care of themselves - and do nothing to support either democracy or market economic systems.

  The IMF and the U.S. Treasury favored shock therapy. However, actual events proved the superiority of the gradualist approach. Stiglitz provides a blow-by-blow account of how the transformation effort unraveled, and how the 1990s became a lost decade for Russia. 
  The ultimate crisis in 1998 was also badly mishandled by the IMF - wasting many billions of dollars. Similar results - sometimes milder, sometimes worse - were experienced in other East European transformation economies. The author points to Moldova and Ukraine as suffering the worst results. (These two are hardly paragons of virtue under any transformation plan.)

  "Russia has gotten the worst of all possible worlds -- an enormous decline in output and an enormous increase in inequality. And the prognosis for the future is bleak: extremes of inequality impede growth, particularly when they lead to social and political instability." (The ever-suffering Russian people remain remarkably stoic in the face of their disappointments.)

  The author perceptively notes one of the most important casualties of this failure. The "social capital" that provides an environment of trust within which markets can most effectively function has been destroyed by widespread looting of Russia's assets. He offers several other insightful conclusions.

• Transformation is terribly complex and cannot be pushed in haste.

• "Incentives matter." There must be incentives in place that encourage enterprise rather than looting.

• Sequence matters. Privatization can't achieve anything without competition and the establishment of antimonopoly policies and procedures.

• Modern democracy is built on middle class demands for rule of law, protection from monopolies, property rights, a free press, and all the other necessary attributes of an empowered civil society. The wealthy - including those made wealthy by political influence - care not for such things - have other ways of taking care of themselves - and do nothing to support either democracy or market economic systems.

  The GDP figures for communist states have to be evaluated with a good deal of skepticism. Without disputing the very real suffering experienced during the transformation process, the economic decline was actually considerably less than indicated by the figures.
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  Aside from the inordinate share dedicated to military production - something the author acknowledges - much of the GDP of these communist states constituted shoddy and less than desirable types of goods and services, and a bloated government sector. Production figures were often grossly overstated and hid much waste. The improvement in the clothing of average citizens visible on the streets of Eastern European and Russian cities is no mirage.

The Asian contagion:

  The author barely mentions the problems of corruption so evident to other commentators. He chastises the IMF for ham handed handling of bank and corporate restructuring and failure to prevent sharp increases in interest rates during the Asian Contagion.

A dysfunctional banking system and lack of reliable stock markets and suitable protections for creditors and minority ownership interests are large parts of the answer as to why the region's high savings rates did not provide adequately for its capital needs.

  The area's high savings rates are noted, but Stiglitz does not explain why all those savings could not be adequately marshaled so that the region's capital needs could be met without heavy borrowing from abroad. A dysfunctional banking system and lack of reliable stock markets and suitable protections for creditors and minority ownership interests are large parts of the answer.
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  In the event, as Stiglitz notes, the Asian Contagion was sharp but short. What he doesn't discuss is the direct relationship between implementation of IMF reforms - which was far from total in any of these nations - and the pace of recovery. Korea was in the lead in both respects and Indonesia was the laggard in both respects. Malaysia - which the author acknowledges started from a stronger position that most of the others - was actually quite good at implementing IMF-type reforms under cover of its anti-IMF rhetoric.

  However, the "moral hazard" problem and other systemic weaknesses in IMF operations are usefully reemphasized by the author in relation to the Asian Contagion.
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  On the other hand, IMF requirements for "increased openness and transparency and improved financial market regulation," as well as abolition of certain government supported monopolies hardly look like unreasonable requirements. (Political leaders should not need a panic to force them to make such reforms - but unfortunately - even in Western nations -where pension problems loom, among other things - they frequently do.)
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  True to his Keynesian beliefs, the author would have liked the IMF to provide funds for sustaining social programs and keeping interest rates down throughout the crisis. The IMF should provide liquidity "to finance needed expenditures" and maintain aggregate demand. Stabilization involved billions in loans - welfare for ordinary citizens would have cost mere hundreds of millions.

  Cost estimates for welfare programs are - like cost estimates for major defense contracts - grossly understated. And, as stated in "Proper sequencing and pacing," above, the ability of governments to force interest rates down is grossly exaggerated by Keynesians.

  He deplores the fact that the short crisis was so sharp (but does not address the question of whether avoiding the sharpness would have lengthened its duration).
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  High interest rates strangle an economy - especially a heavily indebted economy. Thus, instead of restoring stability by attracting capital into an economy, high interest rates further chase capital out - fleeing rapidly deteriorating economic conditions. (This is just one more reason why the Keynesian tolerance for heavy reliance on debt capital is so stupid.)
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Malaysia:

The capital controls - carefully limited - did not frighten away foreign investors as feared. Investors are more interested in tomorrow's prospects than in yesterdays problems.

  Malaysia, too, restructured weak banks and corporations, but did this with modest temporary capital controls - replaced by temporary exit taxes on transfers of capital abroad but applied only to residents and foreign portfolio investors. It also maintained low interest rates and did not put itself through an austerity wringer.
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  The Malaysian program was assisted by a fairly rigorous preexisting system of bank regulation (which didn't exist in some of the other stricken nations) and the fact that the panic in Malaysia was due to private sector financial problems rather than a lack of discipline in governmental monetary policy or budgets. In Latin America, financial problems frequently involve lack of monetary and/or budgetary discipline, making an austerity response unavoidable, the author acknowledges.
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  Stiglitz convincingly points out that IMF and other Western officials failed to understand these differences, predicted long term trouble for Malaysia, and in the event were duly proven wrong. The capital controls - carefully limited - did not frighten away foreign investors as feared. Investors are more interested in tomorrow's prospects than in yesterdays problems.
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India and China:

India grew at 5% and China at 8% despite the economic downturn all around them

  India has clearly suffered from very slow growth for decades due to its smothering regulatory systems - in which capital controls have played a significant part. India's recent improvement in economic growth rates corresponds with various liberalization efforts. Like China, its current rates of growth are from a very low base.

  China responded in a Keynesian way with substantially increased spending on infrastructure - something that was clearly needed and beneficial in its own right. (In Japan, spending on infrastructure of dubious benefit has failed to restore economic growth.) Stiglitz concludes:

  "Though the differences in individual circumstances make the reasons either for the occurrence of a crisis or for quick recovery hard to ascertain, I think it is no accident that the only major East Asian country, China, to avert the crisis took a course directly opposite that advocated by the IMF, and that the country with the shortest downturn, Malaysia, also explicitly rejected an IMF strategy."

Korea and Thailand:

The relative success of Korea is attributed to its rejection of certain IMF prescriptions and its active role in shaping corporate restructuring and banking reform.

  Korea's robust recovery is contrasted with the sluggish recovery of Thailand. The author attributes the relative success of the former to its rejection of certain IMF prescriptions and its active role in shaping corporate restructuring and banking reform.
 &
  Thailand, on the other hand, "followed IMF prescriptions almost perfectly" - but was still burdened with massive levels of non performing loans and had achieved little corporate restructuring. (Thailand's lack of effective commercial law - especially a lack of effective bankruptcy procedures - has played a major role in its continuing difficulties.)
 &
  Indonesia is a complex and special case - but clearly no triumph for IMF policies.
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Asian Contagion outcomes:

  The Asian Contagion panic and economic contraction did what would be expected under standard economic theory, Stiglitz acknowledges.
 &

  Financial regulatory systems and financial institutions have been improved and economic competitiveness has improved. "Some of the worst aspects of corruption, the so-called crony capitalism, will have been checked." (None of this would have occurred without the lash of market discipline in hard times.)
 &
  However, because the region still lacks properly functioning markets for equity capital, it remains overly dependent on dept capital - the raising of which will be far more difficult and expensive. Interest rates are being set higher to reflect the greater risks revealed by the crisis and IMF refusal to employ Keynesian policies to restrain panic-level interest rates.
 &

  The IMF now admits that it made serious mistakes in its policy mix with respect to the Asian Contagion. These include premature liberalization of capital markets, fiscal policy mistakes, and the manner of bank restructuring in Indonesia. However, it has not signed on to Keynesian views of appropriate monetary policy in panic situations, and it offers no explanation why its econometric models performed so badly. (But NO macroeconomic econometric models have ever worked in volatile periods - because they are all inherently invalid.)
 &
  The growth records of Asian businesses prior to the panic are viewed with approval by Stiglitz.

  Again typically Keynesian - he never even considers the weaknesses of the major instances where growth was pushed for the sake of growth, regardless of lack of profitability. The importance of profits in capitalist systems is ignored to a remarkable degree in Keynesian theory - a serious defect that is a carryover from its Marxist roots.
 &
  While Asian enterprises demonstrated remarkable ability to expand - when favored by allocated credit and other command economy favors - many had deplorably low levels of profitability - and a likely inability to survive without continued political favors. Dependent on debt financing - and lacking a cushion of profitability - these Asian success stories were ripe for a fall at the first significant economic storm.

Summing up the Keynesian alternative:

  These suggestions provide a useful summation of the author's most pertinent views on this complex subject.

• A functioning bankruptcy procedure is essential. It should offer a rapid reorganization remedy and give "greater presumption for the continuation of existing management" rather than liquidation whenever possible. Stiglitz - with considerable optimism - advocates an accelerated procedure that could get salvageable corporations up and running again under experienced management with appropriately restructured capitalization considerably more rapidly than is even possible in the U.S. However, he also reasonably opposes IMF influence over national bankruptcy proceedings - since the IMF is inevitably a primary creditor. He offers no other international agency that might influence the establishment and functioning of such bankruptcy procedures.

 Of course, the author is an economist, not an attorney. Disputed property rights are seldom so easily disposed of. However, an economist should appreciate the difficulty of assuring adequate creditors rights with the suggested system. Also, unfortunately, bankruptcy procedures remain weak to nonexistent in many Asian and other third world nations, and changing laws to establish appropriate procedures cannot be done quickly.

• He advises debt restructuring on the successful Korean model, with a standstill on existing debt repayments. Creditors must bear more of the risks of default - to force due diligence in lending. 

  Making institutions that extended loans to an imprudent extent stick around to help clean up the mess would have salutary effects on the "moral hazard" problem, but - as stated in "Bail outs and moral hazard," above - it would raise risks, interest rates and the difficulties of raising debt capital in all nations still heavily dependent on dept capital. However, if that forced more care in the extension and use of debt capital - and reforms to facilitate the raising of equity capital - that would undoubtedly be a significant improvement.
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  The author deplores how these panics increase the difficulty and cost of obtaining debt capital. Instead, he should be deploring the continued weakness of equity markets. Keynesians prefer not to have to worry about the inherent instabilities of extensive reliance on debt capital.

• Monetary exchange rates should be permitted to fall to avoid wasting billions in vain attempts to prevent the inevitable. If there could be rapid reorganization of financially weak businesses, they would be in position to take advantage of the expanding export opportunities provided by a cheaper currency, and the reduced competitiveness of imports. The economy could more rapidly export its way out of difficulties 

  This is exactly as standard economic theory explains - but will not work as the author suggests if effective bankruptcy procedures are not already in place.

• Keynesian budgetary deficits and monetary expansion should be used to maintain the stricken economy "at as close to full employment as possible." Stiglitz recognizes the need under these circumstance for "greater efforts at restructuring existing institutions."

  However, he does not address how this is to be done once pressure is reduced by IMF assumption of a nation's social welfare budget - nor under what circumstances humanitarian relief - once extended - can be cut off if there is less than adequate political cooperation.
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  The author's approach would clearly require immediate action - before economic contraction could accelerate. Substantial IMF assistance would have to be initiated BEFORE negotiation and implementation of reform conditions. Since, as the author advises, appropriate reforms would have to be individually studied and tailored for each nation, negotiations will inevitably drag on for some considerable time. By the time inadequate implementation of conditions could become evident - and such inadequacies will exist in a significant proportion of the cases - IMF assistance may have flowed for some time and amount to appreciable sums.

• Budgetary support for "safety net" relief efforts should be provided during crisis periods. (See previous comment.)

• Budgetary support for deficit spending to maintain aggregate demand should be provided in amounts sufficient to avoid recession and maintain employment at as nearly full levels as possible. If the U.S. uses Keynesian policies to combat recession, why shouldn't undeveloped nations use them? (But the U.S. doesn't call on the IMF to finance those policies - and in the 1970s it had to bear the burdens of its own failure.)

  Keynesian policies WITH such policy reforms as Stiglitz advises can facilitate recovery. But even that ignores the private sector problems that can contribute to these panic situations. Only the forces of competition in a market under the pressures of recession can broadly force out the excesses that can accumulate in the private sector. In market systems, the right to fail is as important as the right to succeed.
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  Fortunately, in market systems like that of the U.S. that remain fairly competitive and flexible, it only takes a whiff of recession to drive private sector rationalization.

• Some international method for managing the risks of floating exchange rates should be established. 

  As explained in "Bail outs and moral hazard," above, currency problems don't arise because rates are fixed or floating - but because monetary discipline is lacking. There is no way the international community can protect national governments from their own irresponsible monetary policies.

World Bank reforms:

  Aid should be expanded, financed by the creation of "Special Drawing Rights" or systems of international taxation for exploitation of global resources - like fisheries. Debt relief is also important - especially for debts incurred by corrupt despotisms that have since been overturned.

  This, of course, involves all the attributes of world government - complete with the vital power of the purse - and a need for its own police force. It can be expected to have problems similar to those of U.N. agencies - and much more.
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  There will be massive politicization of decisions as to which developing nations are worthy, and how much they should be provided. The tax system will require a vast police force to collect taxes and patrol the broad expanses of the world's commons, a judiciary to resolve disputes, a legislature to set tax levels and determine whether fishermen from poor nations serving poor markets should pay as much as fishermen from wealthy nations selling into wealthy markets. Inevitably, there will be problems with nations that refuse to join the system.
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  Staffing and compensation levels will become matters of patronage. The bureaucracy will inevitably eat up most of the proceeds.
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  Since there is no productive capacity behind them, Special Drawing Rights have to be kept scarce or they will lose value, undermining their value as reserve instruments. The creation of Special Drawing Rights - like the printing of national currencies - is just a method of taxing an economy - the world economy - through the processes of monetary inflation.

  Systems of global governance are essential for problems that exceed national boundaries, the author correctly notes. This applies not only to the political issues that are addressed in the U.N. - or economic issues addressed by the IMF, World Bank and WTO - but global environmental and health issues. (The need for particular international agencies limited to particular purposes  is widely acknowledged.)
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United States industrial policy practices:

U.S. "unfair trade" remedies have been intentionally designed in a way that facilitates abuse by special interests in the U.S.

  The shameful role of the Clinton administration - principally its State Department and Treasury Department - in setting up a world wide aluminum cartel to protect U.S. producers from competition - is set forth by the author at some length as an example. (The Bush administration, with its steel tariffs and agricultural subsidies, is rapidly accumulating its own list of horrid policies.)
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  In blasting U.S. Unfair Trade Laws that have absolutely nothing to do with any concept of "fairness," Stiglitz joins a long list of economists (and FUTURECASTS online magazine). Not only does the U.S. act as prosecutor, judge and jury - but the procedure has been intentionally designed in a way that facilitates abuse by special interests in the U.S.

  "[They are] not written on the basis of economic principles. They exist solely to protect American industry adversely affected by imports."

The stench of "crony capitalism" emanates also from Washington, D.C.

  These laws were even used to block a program for procuring uranium from Soviet era nuclear weapons. The uranium was to be bought so that the nation could be protected from possible loss of control over this dangerous material. The follies of the privatized U.S. Enrichment Corporation, which was supposed to implement this program, are also set forth. As the author points out, the stench of "crony capitalism" emanates also from Washington, D.C.
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  In his commentary on the U.S., the author accepts the common error of statistical analysis that has led so many uncritical critics to claim that the economic growth during the 1980s did not benefit the working poor.

  This ignores the fact that the vast majority of the working poor at the beginning of the decade were not there at the end. The ladder of upwards mobility is still clearly in operation. It also ignores the census data that shows widespread advances during this period in all creature comforts such as living space, air conditioning, color televisions, microwave ovens, etc., even among the working poor.