Global Policy Forum

by Mark Weisbrot

Everyone knows that the past 20 years have been an era of rapid overall economic progress for the vast majority of countries, especially in the developing world. Tariffs have collapsed and countries have flung open their borders to international trade and investment. Technology has progressed as never before, we are told, with revolutions in such cutting-edge industries as communications, computers, and the Internet spawning and spreading productivity miracles around the globe. Of course, there are problems: a widening gap between rich and poor nations; environmental destruction; and, in some countries and regions, the poor being left behind. But the engine of growth has roared ahead. So if we can fix some of the problems, then growth--and the policies that produced it--will allow future generations to enjoy a better life. Right?

Actually, it's quite clear that the opposite is true. The past 20 years have been an abject economic failure for most countries, with growth plummeting. The World Bank publishes data on the growth of income per person, as do other official sources. But few economists and almost no journalists have seen fit to make an issue out of what history will undoubtedly record as the most remarkable economic failure of the twentieth century aside from the Great Depression.

Consider this: In Latin America and the Caribbean, where gross domestic product grew by 75 percent per person from 1960 to 1980, it grew by only 7 percent per person from 1980 to 2000. The collapse of the African economies is more well known, although still ignored: GDP in sub-Saharan Africa grew by about 34 percent per person from 1960 to 1980; in the past two decades, per capita income actually fell by about 15 percent. Even if we include the fast-growing economies of East Asia and South Asia, the past two decades fare miserably. For the entire set of low- and middle-income countries, per capita GDP growth was less than half of its average for the previous 20 years. Also, as might be expected in a time of bad economic performance, the past two decades have brought significantly reduced progress according to such major social indicators as life expectancy, infant and child mortality, literacy, and education--again, for the vast majority of low- and middle-income countries.

There is no disputing this data; nor can anyone take issue with the time periods chosen for comparison. This is not a cyclical phenomenon: Both of these periods contain a world recession, and the 1970s had major oil shocks. In fact, if full data were available for the 1950s, the past 20 years would look even worse.

Yes, growth isn't everything, but it's all that the authorities who have directed policy for most of the developing world--the International Monetary Fund, the World Bank, the U.S. Treasury Department--have promised to deliver. If the basic facts were better known, one big economic question would occupy center stage with regard to the developing world: What are the structural and policy changes that have led to this terrible economic failure?

What Went Wrong?

It is, of course, difficult to isolate the causes of a long-term, worldwide economic decline that involves so many economies in very different stages of development. But there is a pattern to the policies that have emanated from Washington, D.C., during the past 20 years; and a few examples can illustrate a big part of the story.

The Asian financial crisis of 1997 was brought on by an opening of capital markets that led to a rapid inflow of foreign funds. This was forcefully promoted by the U.S. Treasury Department, despite the fact that the affected countries had high domestic savings rates and did not necessarily need to increase their foreign borrowing. As Nobel laureate Joseph Stiglitz--the World Bank's chief economist at the time--has pointed out, the architects of this policy did not have a single study showing that opening up capital markets led to higher growth. In this case, the policy had the opposite effect: In 1996 and 1997, there was a reversal of capital flow that amounted to about 11 percent of the GDP of South Korea, Indonesia, Malaysia, the Philippines, and Thailand. The outflow of funds crashed the local currencies and set off a financial panic.

Washington intervened in several ways that helped transform the crisis into a serious regional economic downturn. First, Treasury convinced Japan to abandon a proposed Asian monetary fund, that would have provided at least $100 billion to stabilize the currencies before they went into free fall. Second, the IMF imposed unnecessary fiscal and monetary austerity on the crisis-ridden economies, with interest rates as high as 80 percent in Indonesia. There were other major blunders as well, and the result was disastrous: In 1998 Indonesia's economy shrank by 13.7 percent and Thailand's by 10 percent.

The Asian crisis spread first to Russia and then to Brazil. This illustrates another debilitating effect of the period's reckless liberalization of investment: "Contagion" could now spread panic among countries that had only the slightest of commercial relationships with one another. The herd behavior of investors who sought to avoid the next emerging-market meltdown was the only connection needed.

Once again, the IMF's intervention exacerbated the damage. In both Russia and Brazil, the organization insisted on maintaining overvalued exchange rates, propping them up with enormous loans ($42 billion in Brazil) and high interest rates (up to 170 percent in Russia). In both cases, the currencies collapsed anyway; the countries had suffered lost output and high-debt burdens in exchange for no economic gain. The IMF's only proffered argument for maintaining the overvalued exchange rates was that a collapse would trigger hyperinflation. But the hyperinflation never occurred; and both economies responded very positively to the currency devaluations, with Russia recording its highest growth in two decades (8.3 percent) in 2000.

This scenario has been repeated most recently in Argentina, where the government is currently defaulting on the mountain of debt it has accumulated in maintaining its fixed exchange rate through four years of recession, a tripling of interest rates, and a phenomenal $40-billion loan package from the IMF last December. To grasp the absurdity of the situation that Argentina was drawn into, imagine the U.S. government borrowing $1.4 trillion--70 percent of the federal budget--to keep the overvalued dollar from falling.

The transition economies are a special case, but they illustrate the monumental damage that can be done when America's best and brightest are given free rein to design a new society. Russia lost about half of its national income in just a few years after adopting the recommended "shock therapy" program in 1992. Although the IMF has tried to deny it, Russia really did follow its program, including immediate decontrol of prices (which resulted in 520 percent inflation within three months) and rapid privatization of industry. The government even met most of the IMF's fiscal and monetary targets, at least until the economy had collapsed to the point where barter became the preferred medium of exchange. The result was a newly underdeveloped country with a per capita income that was less than Mexico's; outside of wars or natural disasters, it was the worst economic collapse in history.

Other structural and policy changes also slowed growth in low- and middle-income countries during this period. Tight monetary policies (high interest rates) were part of a general trend in IMF lending requirements throughout the developing world. This trend was evident in high-income areas as well, including the United States and Europe (where it prevails today), and the resulting slower growth also hurt developing countries through reduced demand for their exports. In addition, monetary reserves held by developing countries grew markedly, probably as a result of more financial instability and globalization. In terms of forgone investment, the cost of holding these reserves is significant--probably between 0.4 and 2 percentage points of annual growth, depending on the country's accumulation.

The West's Double Standards

The failed policies of the past two decades are often described as a product of extreme free-market or free-trade ideology. But this is not accurate. For example, in the countries that sacrificed the economy in order to maintain a fixed exchange rate--Russia, Brazil, and Argentina--the free-market solution would have been to abandon the peg and let the currency fall. In the Asian crisis, one of the few things that Washington actually did accomplish was to get the governments of the region to guarantee the privately held debt of foreign lenders, rather than letting the banks be subjected to the discipline of the market.

The more consistent pattern is that the national interests of the developing and transition countries have been increasingly sacrificed for the sake of more-powerful foreign interests. This is perhaps most obvious in the case of intellectual-property rights. The global South already loses some tens of billions of dollars annually to these foreign monopolies--a drain of resources that will multiply if the rich countries succeed in implementing the World Trade Organization's TRIPS (Trade-Related Aspects of Intellectual Property Rights) agreement. (To put this in perspective: Total Official Development Assistance from high-income countries to developing ones was $40.7 billion in 1999.)

Patent monopolies are the most costly, inefficient, and--in the case of essential medicines--life-threatening form of protectionism that exists today. From an economic point of view, they create the same kinds of distortions as tariffs, only many times greater. Yet the attempt to extend U.S. patent and copyright law to developing countries has become one of the primary objectives of America's foreign commercial policy.

The expansion of foreign intellectual-property claims not only drains scarce resources from developing countries but also makes it difficult for them to follow the more successful examples of late industrialization, such as South Korea or Taiwan, where diffusion of foreign technology played an important role. This is part of a more general problem that is reflected in the economic failure of the past 20 years. There have historically been many paths to development, but none resembles the collection of policies that Washington foists upon developing countries today.

The late-industrializing countries used various combinations of industrial policy and planning, state-owned industries, extensive controls on subsidies and exchange rates, tariffs, and import restrictions to reach the point at which their industries and firms could become internationally competitive. In many respects, these strategies were similar to those of the high-income countries that came before them. The United States had a hefty average tariff of 44 percent on manufactured goods as late as 1913.

But the rich countries are now "kicking away the ladder," as economist Ha-Joon Chang describes it in his forthcoming book by that title. It is difficult to say how much of the growth slowdown has resulted from the prohibition of potentially successful development strategies and their replacement by a rigid adherence to the theory of comparative advantage. Trade liberalization has historically followed development, as national economies became competitive on world markets. It would not be surprising if attempts to reverse this pattern proved to be counterproductive.

In response to such criticisms, the World Bank has produced a series of papers and arguments purporting to show that the countries that "globalized" the most during the past two decades were the most successful. Yet this research proves nothing of the sort, as Harvard University's Dani Rodrik has demonstrated. It takes the trade share of GDP as its measure of globalization. But trade share is an outcome, not a policy variable; it tends to increase with growth. So all that the World Bank has really shown is that faster-growing countries tend to increase the proportion of their economy devoted to trade.

Indeed, the World Bank's favorite "globalizers" seem to be three countries whose growth has accelerated over the past 20 years: China, India, and Vietnam. But China and India have two of the most protected domestic markets in the world. China does not even have a convertible currency, and India retains strict capital controls. So does Vietnam, where the majority of investment in recent years has been undertaken by the state.

The successful globalizers, then, are the exceptions that prove the rule. And if there is any rule that can be gleaned from successful development experiences, it is that the conditions under which international trade and investment can contribute to growth and development are country-specific. Even some of the most basic questions of international finance, such as whether to have a fixed or flexible exchange rate, depend on specific national institutions. All the more reason to let national governments make their own economic policies.

But that is exactly the point that Washington's army of economists and bureaucrats will not concede. And they have a powerful creditors' cartel, headed by the IMF, that is able to determine policy for dozens of borrowing countries. A government that does not comply with the IMF's conditions will often not be eligible for private credit or, in most cases, for credit from the World Bank, other multilateral lenders such as the Inter-American Development Bank, or Group of Seven nations.

Until this cartel is broken--or its policies drastically changed--only countries whose governments are strong enough to stand up to it will have a reasonable chance of reversing the economic failure of the twentieth century's last two decades.

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