Global Policy Forum

By Abid Aslam

Washington - The past week has seen remarkable confessions from officials at the World Bank and International Monetary Fund (IMF) about policy positions that have affected millions of people in borrowing countries.

First, Joseph Stiglitz, outgoing chief economist and senior vice president of the World Bank, faulted not only the results but also the very intent of the agencies' response to the "Asian financial crisis." This, he said, had been designed to coddle investors at the expense of workers. "A standard message was to increase labour market flexibility, and the not-so-subtle subtext was to lower wages and lay off workers," Stiglitz declared. The results included spiraling unemployment and severe deflation - falling prices as a result of declining economic activity - a combination that consigned 40 percent of the global economy to recession. This, even as IMF-led emergency financing poured more than 100 billion dollars on the financial wildfire that engulfed Asia and spread to Latin America.

Also this week, a team of IMF staffers admitted - albeit implicitly - that their agency had been driven by ideology rather than empirical observation in doggedly opposing capital controls. These are measures to regulate the speed and volatility with which short-term and speculative investment - so-called "hot money" - is allowed to cross borders. Investors would shun countries using controls, the IMF has long argued, setting back long-term hopes of tapping relatively cheap financing for national development.

This week, the agency's Monetary and Exchange Affairs Department admitted in a report that controlling both the inflows and outflows of capital has, to varying degrees, helped countries to protect themselves from crisis. Indeed, overwhelming capital inflows precipitated Asia's woes by encouraging investment in projects of questionable financial pedigree and economic merit. The experience of countries that have sought to control short-term capital inflows showed that "to be effective, the coverage of the controls needs to be comprehensive, and the controls need to be forcefully implemented." Case studies included Brazil in 1993-97, Chile in 1991-98, and Malaysia in 1994.

What's more, the IMF team conceded, Malaysian moves to control outflows since 1998 - first by preventing, then by regulating foreigners seeking to repatriate their investments - appear to have paid off. "Since the introduction of the controls, there have been no signs of speculative pressures on the exchange rate, despite the marked relaxation of fiscal and monetary policies to support weak economic activity," the IMF admitted. "Nor have there been signs that a parallel or nondeliverable forward market is emerging; and no significant circumvention of efforts have been reported."

Technical jargon notwithstanding, "it's so nice to see this arrogant and disdainful agency have to eat crow," or admit it was wrong in slamming Malaysia for introducing controls against IMF advice, said Doug Hellinger, executive director of the Development Group for Alternative Policies (DGAP), a Washington think tank. That pleasure, Hellinger told IPS, was tempered by the knowledge that vulnerable countries have been denied what the Fund now admits is a legitimate policy tool. What's more, the confession was not without considerable qualification.

"This review of...capital controls in 14 countries cannot be considered exhaustive and it again illustrates the difficulty of precisely assessing the effect of capital controls, which may have benefits as well as costs," the IMF report said.

As far as Malaysia was concerned, "the jury is still out," insisted Stefan Ingves, a former Swedish central banker who now heads the department that produced the IMF report. Malaysia was well on its way to recovery, but time would reveal whether the country would be punished with higher costs of access to international capital markets. Nor could the IMF tell how much of Malaysia's improvement was due to the capital controls and how much was because of other domestic and international factors.

In any event, according to the report, "capital controls cannot substitute for sound macroeconomic policies. Countries with serious macroeconomic imbalances, and no credible prospect for improvement in the short run, were regularly unable to address large-scale capital flows or their adverse economic effects by using capital controls." Thus, the Fund appeared to balance its retreat on capital controls with a renewed push for economic restructuring in borrowing countries.

"Now that they're wrong, they raise other factors," Hellinger said. "They never raised them before when their position was simple and outright rejection of controls."

For years, the Fund has been urging countries to open their capital markets to overseas investors and, until last year, had actively sought to amend its charter so it could require member states to do so. Enthusiasm for this idea has waned amid the financial crises of the past three years. Successive meetings of IMF and World Bank member states have seen a growing number of delegates from borrowing countries question the merits of removing all restraints on what they see as herds of roaming speculators.

By late 1998, the IMF had begun to shift its emphasis, urging a gradual and properly-sequenced process of liberalisation to help countries mitigate unsettling side-effects. By last September's annual meetings of the Bretton Woods siblings, there was no formal talk of the need to liberalise - much less make this part of the IMF's central mission. This does not mean the agenda has been abandoned, however. Fund and outside analysts alike said this week that the agency was updating its hymnal but its underlying religion remained unchanged. "In the long run," Ingves argued, "capital controls are bad."

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