Globalization and its Discontents | Study Guide

Joseph Stiglitz

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Globalization and its Discontents | Chapter 4 : The East Asia Crisis: How IMF Policies Brought the World to the Verge of a Global Meltdown | Summary



The Thai currency, the baht, collapsed in July 1997. Liberalization of Thailand's capital markets had led to enormous speculative investment (largely foreign) in the value of the baht. When the speculators feared, baselessly, that the baht was going to lose value, they sold the currency, which led to its loss of value, which ultimately led to Thailand's financial crisis. Seemingly overnight, the value of the baht fell by 25 percent. The Thai government tried to support its currency by buying more baht, but its reserves could not cover the extent of the losses. As more speculators pulled their money out of Thailand, the baht went into freefall. For many years, Thailand's government had maintained sound control over the nation's economy. This led to such excellent economic growth that Thailand was considered part of the "East Asian Miracle" of stable nations with sound and growing economies. Yet, after Thailand succumbed to pressure from the IMF to quickly liberalize its financial sector and especially its capital market, massive amounts of "hot money" poured in—and then fled. Since Thailand is a key trading partner with other East Asian nations, such as Malaysia, Hong Kong, and Singapore, the "contagion" from the collapse of the baht spread throughout the region and eventually to other parts of the world.

Later that year, an unsubstantiated rumor raced around Wall Street that South Korean businesses would be unable to repay their loans. This baseless rumor caused Western banks to call in outstanding Korean loans and refuse to extend further credit to Korean companies. The withdrawal of credit resulted in a severe contraction of the well-run Korean economy. Without access to credit, many already highly leveraged (indebted) Korean companies faced bankruptcy. Many companies went out of business and unemployment increased dramatically. Korea's problem added to the already dire crisis in East Asia, whose nations experienced negative economic growth, a huge rise in poverty, and skyrocketing unemployment as businesses and banks failed.

What East Asian nations needed was to jumpstart their flailing economies. They desperately needed an influx of money to get businesses up and running again and policies to boost employment and revive economic growth. When these nations turned to the world's primary crisis lender, the IMF, what they got were prescriptions for market fundamentalism—raising interest rates to limit inflation, cutting back government spending on programs encouraging employment, further liberalization of trade and the financial sector, and other policies in line with the Washington Consensus. These policies, part of the one-size-fits-all core belief of the IMF, only made matters worse. When businesses are failing because of a lack of available credit, raising the cost of borrowing by raising interest rates does not improve matters. Market fundamentalism, the belief that the market is always right and government action is always wrong, deepened the East Asian crisis.

How IMF/U.S. Treasury Policies Led to the Crisis

Nations that were part of the East Asian miracle were viewed as havens for investment because of their rapid economic growth and stability. Heads of the IMF and the U.S. Treasury decided that liberalizing these nations' financial and capital market sectors would make Western investments even more profitable. They pushed for "capital account liberalization [which] was the single most important factor leading to the crisis." But without a regulatory framework, capital market liberalization made these nations extremely vulnerable to the whims of foreign investors. When investor sentiment turned negative and money flew out of Thailand and later its neighbors, gross domestic product (GDP), the market value of goods and services produced by a country, fell across the board with annual declines of 7 to 12 percent.

The First Round Of Mistakes

The IMF had required a pace of market liberalization that was too rapid. It didn't give East Asian nations time to put in place the legal and regulatory framework that would moderate the impending crisis. When the crisis hit, the IMF imposed its one-size-fits-all anti-inflationary policies even though these nations were not experiencing inflation. Anti-inflationary policies had worked well in Latin America, where inflation had been a problem, so the IMF assumed they would work in all economic crises. However, anti-inflationary policies cause economies to contract and East Asian countries needed policies that would get their economies growing again.

Hooverite Contractionary Policies: An Anomaly in the Modern World

Another IMF policy that made matters worse was its insistence that East Asian governments reduce expenditures until they had balanced budgets. What was really needed, however, was government spending to boost the economy. A balanced budget was exactly what these nations did not need, and those that acceded to the IMF's directive fell further into recession.

Beggar-Thyself Policies

Beggar-thy-neighbor policies involve one nation in economic trouble devaluing its currency and cutting back on imports so its citizens buy products made in their home country. In this case a nation's trade partners suffer from a lack of revenue because they can't sell their exports. This leads to the contagion that spreads one nation's economic woes to its neighbors. The IMF told each East Asian nation to create a trade surplus—that is, to export more than it imports. But if all East Asian countries were told to cut back on imports, there was no one to sell exports to. Unsold exports and diminishing imports was a contractionary policy that led to a devaluation of citizens' income. This "beggar-thyself" policy worsens a recession because it shrinks a country's economy and impoverishes its people.

Strangling an Economy with High Interest Rates

The IMF's anti-inflationary policy forced East Asian nations to raise interest rates, sometimes to 25 percent or higher. Businesses in need of loans but suffering from lack of credit could not afford to borrow at such high rates, so many went under. One rationale behind the rate hike was that it would attract foreign investment, but international lenders were loath to invest in countries whose economies were in a recession. Lenders need to have confidence that borrowers will repay loans. High interest rates did nothing to restore confidence in the health of East Asian economies, they just "amplified the downturn" to such an extent that the policy "actually drove capital out of the country" in trouble. As a result of high interest rates, 75 percent of all of Indonesia's businesses were in trouble. In Thailand, nearly 50 percent of highly leveraged companies defaulted on their loans because they could not refinance.

The Second Round of Mistakes: Bumbling Restructuring

For the IMF, restructuring meant "banks that had bad loans on their books should be shut down" and "companies that owed money should be closed or taken over by their creditors."

Financial Systems

A financial system is "the brain of the economy," run by high-powered government, banking, and corporate leaders, directing capital where it's needed for economic growth. When the financial system no longer functions correctly, banks cut back on loans and businesses are shuttered for lack of credit. Financial institutions also retain important information about the creditworthiness of their borrowers. When banks collapse, this information disappears along with them. Without its credit information, a business finds it very difficult to obtain a loan from another bank.

Inducing a Bank Run

IMF policies focused on shutting down distressed banks, but this action impeded the overall flow of credit from banks to businesses. As businesses faltered they defaulted on their outstanding loans, and the banks they borrow from suffered a shortfall in income and thus in their required reserves. To replenish their reserves, banks were encouraged to reduce their lending to businesses and to call in outstanding loans. This led to more business failures, as companies had nowhere else to go to get credit. The "downward spiral" deepened the economic crisis. To make matters worse, the IMF's insistence that troubled banks be shut down led to a run on banks by citizens and small businesses alike, leaving the banks further depleted and weakened.

Corporate Restructuring

In restructuring the companies that were "effectively in bankruptcy," the IMF imposed rules on "the nuts-and-bolts decisions [about] what a firm should produce ... and how it should be organized" rather than addressing its financial structure, such as ownership. Instead of letting the government determine financial restructuring based on local conditions, the IMF limited the government to selling off companies' assets while the IMF brought in foreign management.

The Most Grievous Mistakes: Risking Social and Political Turmoil

Required cutbacks in government spending on social services—the austerity policy—led to "social and political unrest" in some parts of East Asia. Riots erupted in Indonesia when subsidies for food and fuel were drastically cut back. Although the IMF intended for government austerity to revive confidence in East Asian nations, their draconian policies had the opposite effect. No investor would put a significant amount of money into a nation roiled by riots.

Recovery: Vindication of the IMF Policies?

After the East Asia crisis, the IMF admitted "that serious mistakes were made." Yet, the effects of its misguided policies had long-term negative effects. As of 2002, East Asian economies had still not recovered to pre-1997 levels. Unemployment, lower GDP growth, and lower productivity still plagued these countries (as of the publication of this book in 2002). It takes a long time to recover from an economic crisis, but the recovery period is even longer when it is exacerbated by misguided policies.

Malaysia and China

Malaysia and China were caught up in the East Asia economic crisis. However, both weathered the crisis better than other nations because they rejected many of the actions prescribed by the IMF. Instead, their governments maintained social welfare policies and ignored advice to raise interest rates to cure nonexistent inflation. Because they maintained their independence and enacted stimulus policies, these two nations did not suffer the same financial and banking failures, the same business collapse, the same currency volatility, and other economic disasters that befell their more compliant neighbors. They enacted expansionary, not contractionary, economic policies that reduced the effects of the crisis on their economies.

Korea, Thailand, and Indonesia

Because Thailand followed IMF prescriptions for recovery it suffered the steepest economic decline and slowest economic recovery. In contrast, Korea largely ignored IMF strictures, and its government was more engaged in the country's recovery. Its consistently robust exports helped South Korea recover quickly from the crisis. Indonesia suffered from political and social turmoil largely because of IMF's restrictive policies.

Effects on the Future

In some ways the East Asia crisis was beneficial because it taught developing nations how important it is to institute solid regulatory reforms in the financial sector. Businesses in other nations, such as Korea, will no doubt also streamline their operations to be more globally competitive. Despite these bright spots, however, the high interest rates imposed on East Asian countries are likely to have long-term negative effects on their economies that stifle economic growth. As East Asian nations develop legal and regulatory frameworks to guide their economies and industries, and as they emerge from the burden of debt they incurred from the IMF, their economies should slowly but surely begin to strengthen and grow.

Explaining the Mistakes

The IMF admits it pushed capital market liberalization prematurely and too quickly in East Asia but it has not admitted that its monetary advice—its insistence on high interest rates—was misguided. Stiglitz believes that the IMF's policies simply "reflect[ed] the interests and ideology of the Western financial community," and not the needs of the nations in crisis.

An Alternative Strategy

Stiglitz stresses that "maintain[ing] the economy ... as close to full employment as possible" should be the main objective in reversing an economic downturn. Debts would be restructured to forestall business failures, and governments would implement comprehensive bankruptcy laws that would allow companies to get out of debt, as American firms do under U.S. law. Governments would be encouraged to engage closely in rebuilding their economies, including their financial sectors.

The author states unequivocally that the performance of the IMF during the East Asia crisis is what "brought globalization under attack" among citizens around the world. "The East Asia crisis made vivid ... the dissatisfaction ... those in the developing world had long felt."


Several of the IMF's Washington Consensus policies not only led to the East Asian crisis, but they also made it worse. The author writes, "The IMF policies not only exacerbated the downturns but were partially responsible for the onset."

The IMF had pressured the developing nations of East Asia to liberalize their markets, especially their capital markets, which involved global trade in stocks, bonds and, crucially, currency. Market liberalization occurred before these nations had the structures in place to control any adverse effects of liberalization. So the IMF-imposed timing of liberalization had inherent vulnerabilities. When a developing nation follows the IMF directive to liberalize its capital market, it must strip "the regulations intended to control the flow of hot money in and out of the country." In many East Asian nations there was scant regulation to begin with, so hot money could flow freely without oversight or control. Prior to 1997 investors poured vast amounts of money into buying Thai currency, the baht, certain its value would increase. When Wall Street and other financial centers began to feel jittery about the baht, they sold the currency at the electronic speed of a computer keystroke. The value of the baht fell so quickly that Thailand was unable to stabilize and its economy crashed. Capital market liberalization imposed before a nation has established a regulatory and oversight infrastructure (such as the Federal Reserve, the U.S. Treasury, the Commodity Futures Trading Commission, and other oversight agencies in the United States) is a recipe for economic disaster, as the IMF has admitted. But once the East Asia crisis was in full force and had spread to Thailand's trading partners, the IMF's prescriptions for recovery deepened the downturn.

Meanwhile, the United States has substantial government-run agencies in place to maintain economic security and stability. The Federal Reserve, the U.S. Treasury, the Commodity Futures Trading Commission, and the United States International Trading Commission, among other agencies, safeguard the United States's economic interests in various ways:

  • The central bank of the United States, the Federal Reserve (also called the Fed), monitors the economy and implements policies to maximize employment and keep prices stable. It also regulates the banks and provides financial services for the federal government.
  • The Department of the Treasury promotes economic growth and stability domestically and abroad. The U.S. Treasury is an executive agency that reports to and counsels the president in financial matters. It produces currency and works with other foreign agencies and foreign governments.
  • The Commodity Futures Trading Commission oversees commodities such as heating, crude oil, gasoline, energy and metals, and resources such as copper, gold, and silver. It also handles, in more recent years, financial products, such as interest rates, stock indexes, foreign currency, and the swaps market, the contractual exchanges between businesses and financial institutions—a $400 trillion industry. The Futures Trading Commission enables business persons, such as farmers, ranchers, producers, commercial companies, and municipalities to lock in prices or rates.
  • The United States International Trading Commission provides global safeguards and conducts the international trading system.

Two policies form the cornerstone of the Washington Consensus's prescription for reversing an economic recession: imposing anti-inflationary measures, and removing government from interfering in the economy. In the latter case, the tenet is that the free market, if left alone, is always perfectly self-correcting. This is wishful thinking and clearly not the case in the real world. Further, anti-inflationary policies are destructive in recessionary economies without inflation. The high interest rates imposed by these policies make expansionary, pro-growth measures—such as government spending to increase employment and making low-interest loans more available and affordable to struggling businesses—impossible. But this is the policy regime the IMF imposed and that Thailand followed. As the contagion spread, the same policies were forced upon other nations in the region. Only those nations that resisted these demands, such as Malaysia, Indonesia, and South Korea, had economies that recovered quickly compared to IMF-influenced economies.

Anti-inflationary policies worsened the debt crisis in East Asian countries, especially in South Korea. When the high interest rates the banks were forced to pay weakened them and drew down their monetary reserves, the banks no longer had enough capital to lend to struggling Korean businesses. Western banks lost confidence in Korean banks and called in outstanding loans. To stay afloat, Korean banks called in their outstanding business loans. Many businesses teetered on the edge of bankruptcy but could find no source of new capital. Even among Korean banks that were solvent enough to offer loans, the anti-inflationary interest rates they were compelled to charge were too high for companies to pay. High interest rates thus decimated industries in these countries, and lack of bank reserves made securing a loan almost impossible. Korean firms were most severely affected by the strain placed on banks. Many Korean companies were already highly leveraged, or burdened with debt, but as the contagion of the crisis spread to Korea, its indebted firms could not get loans anywhere. Although the IMF had insisted that high interest rates would attract investment and increase lending to these troubled economies, their economic condition was so dire investors no longer had confidence in them and kept their money out. IMF policy failed to promote investment to bolster these nations' currencies, banks, or businesses.

The IMF's insistence that East Asian governments adopt austerity plans, composed of conditionalities, to balance their budgets and increase their capital reserves made it impossible for them to take any meaningful action to ameliorate the economic crisis and the human suffering it caused. In addition to having to hike interest rates, governments were compelled to increase taxes and cut spending on social programs that provided food and fuel for its poorest citizens. Austerity measures undermined the sovereignty, and the democratic form of government, of the nations whose policies were thus dictated by the IMF. The government was prohibited from carrying out policies it had been elected to enact. While fiscal austerity was intended to boost confidence in the afflicted governments, it had the opposite effect. As the economic crisis worsened, foreign investors avoided putting money into these countries. The problem of "capital flight," citizens withdrawing money out of domestic banks and stashing it in safer Western banks, exacerbated the crisis. As the restoration of the economy and the likelihood of providing desperately needed economic stimulus rapidly faded, the gross domestic product of East Asian nations declined significantly as they fell deeper and deeper into recession.

IMF bias was evident in its demand that East Asian banks, and particularly Korean banks, use what capital they had to repay their outstanding loans from Western banks. Thus, the banks of the industrialized world lost little if any money from the loans they had made to East Asian nations and their banks. There was little capital left in East Asian banks to stimulate the depressed and struggling East Asian businesses. The focus on repaying Western banks while ignoring the need for domestic stimulus—which would have kept businesses alive and generated employment—severely tarnished the IMF's reputation and magnified the inequity of its policies.

Stiglitz stresses, as an alternative to IMF austerity, providing for debt relief and allowing for bankruptcy as the United States does. Bankruptcy laws are rooted in the U.S. Constitution (Article 1, Section 8) even though they were not enacted until 1898 and have gone through many changes up until the late 1970s. Today, businesses and individuals, when facing financial ruin, can declare bankruptcy. The most common types of bankruptcy are known as Chapter 11 or Chapter 7. A business that files for Chapter 11 bankruptcy can still maintain its operations while a judicial body provides oversight, and the floundering business has a chance to come back from bankruptcy. In the case of Chapter 7 bankruptcies, the company's assets are liquidated (sold off). Bankruptcy is highly regulated, and government infrastructures are in place for deciding how best to protect investors, pay back debts, and minimize losses for public shareholders. Allowing businesses to file for bankruptcy, providing debt relief, and legally protecting creditors and investors if businesses should fail encourages entrepreneurial innovation, free-flowing credit from banks and investors, and bolsters confidence in the market, helping to stabilize the United States's economy at large. However, the IMF often does not allow the countries it loans money to provide the same regulations and laws.

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