The global economic crisis began in Thailand, on July 2, 1997. The
countries of East Asia were coming off a miraculous three decades: incomes
had soared, health had improved, poverty had fallen dramatically. Not
only was literacy now universal, but, on international science and math
tests, many of these countries outperformed the United States. Some
had not suffered a single year of recession in 30 years.
But the seeds of calamity had already been planted. In the early '90s,
East Asian countries had liberalized their financial and capital markets--not
because they needed to attract more funds (savings rates were already
30 percent or more) but because of international pressure, including
some from the U.S. Treasury Department. These changes provoked a flood
of short-term capital--that is, the kind of capital that looks for the
highest return in the next day, week, or month, as opposed to long-term
investment in things like factories. In Thailand, this short-term capital
helped fuel an unsustainable real estate boom. And, as people around
the world (including Americans) have painfully learned, every real estate
bubble eventually bursts, often with disastrous consequences. Just as
suddenly as capital flowed in, it flowed out. And, when everybody tries
to pull their money out at the same time, it causes an economic problem.
A big economic problem.
The last set of financial crises had occurred in Latin America in the
1980s, when bloated public deficits and loose monetary policies led
to runaway inflation. There, the IMF had correctly imposed fiscal austerity
(balanced budgets) and tighter monetary policies, demanding that governments
pursue those policies as a precondition for receiving aid. So, in 1997
the IMF imposed the same demands on Thailand. Austerity, the fund's
leaders said, would restore confidence in the Thai economy. As the crisis
spread to other East Asian nations--and even as evidence of the policy's
failure mounted--the IMF barely blinked, delivering the same medicine
to each ailing nation that showed up on its doorstep.
I thought this was a mistake. For one thing, unlike the Latin American
nations, the East Asian countries were already running budget surpluses.
In Thailand, the government was running such large surpluses that it
was actually starving the economy of much-needed investments in education
and infrastructure, both essential to economic growth. And the East
Asian nations already had tight monetary policies, as well: inflation
was low and falling. (In South Korea, for example, inflation stood at
a very respectable four percent.) The problem was not imprudent government,
as in Latin America; the problem was an imprudent private sector--all
those bankers and borrowers, for instance, who'd gambled on the real
Under such circumstances, I feared, austerity measures would not revive
the economies of East Asia--it would plunge them into recession or even
depression. High interest rates might devastate highly indebted East
Asian firms, causing more bankruptcies and defaults. Reduced government
expenditures would only shrink the economy further.
So I began lobbying to change the policy. I talked to Stanley Fischer,
a distinguished former Massachusetts Institute of Technology economics
professor and former chief economist of the World Bank, who had become
the IMF's first deputy managing director. I met with fellow economists
at the World Bank who might have contacts or influence within the IMF,
encouraging them to do everything they could to move the IMF bureaucracy.
Convincing people at the World Bank of my analysis proved easy; changing
minds at the IMF was virtually impossible ... It was maddening, not
just because the IMF's inertia was so hard to stop but because, with
everything going on behind closed doors, it was impossible to know who
was the real obstacle to change ... I shouldn't have been surprised.
The IMF likes to go about its business without outsiders asking too
many questions. In theory, the fund supports democratic institutions
in the nations it assists. In practice, it undermines the democratic
process by imposing policies. Officially, of course, the IMF doesn't
"impose" anything. It "negotiates" the conditions for receiving aid.
But all the power in the negotiations is on one side--the IMF's--and
the fund rarely allows sufficient time for broad consensus-building
or even widespread consultations with either parliaments or civil society.
Sometimes the IMF dispenses with the pretense of openness altogether
and negotiates secret covenants.
When the IMF decides to assist a country, it dispatches a "mission"
of economists. These economists frequently lack extensive experience
in the country; they are more likely to have firsthand knowledge of
its five-star hotels than of the villages that dot its countryside.
They work hard, poring over numbers deep into the night. But their task
is impossible. In a period of days or, at most, weeks, they are charged
with developing a coherent program sensitive to the needs of the country.
Needless to say, a little number-crunching rarely provides adequate
insights into the development strategy for an entire nation. Even worse,
the number-crunching isn't always that good. The mathematical models
the IMF uses are frequently flawed or out-of-date. Critics accuse the
institution of taking a cookie-cutter approach to economics, and they're
right. Country teams have been known to compose draft reports before
visiting. I heard stories of one unfortunate incident when team members
copied large parts of the text for one country's report and transferred
them wholesale to another. They might have gotten away with it, except
the "search and replace" function on the word processor didn't work
properly, leaving the original country's name in a few places. Oops.
It's not fair to say that IMF economists don't care about the citizens
of developing nations. But the older men who staff the fund--and they
are overwhelmingly older men--act as if they are shouldering Rudyard
Kipling's white man's burden. IMF experts believe they are brighter,
more educated, and less politically motivated than the economists in
the countries they visit. In fact, the economic leaders from those countries
are pretty good--in many cases brighter or better-educated than the
IMF staff, which frequently consists of third-rank students from first-rate
universities. (Trust me: I've taught at Oxford University, MIT, Stanford
University, Yale University, and Princeton University, and the IMF almost
never succeeded in recruiting any of the best students.)
The IMF pressed ahead, demanding reductions in government spending.
And so subsidies for basic necessities like food and fuel were eliminated
at the very time when contractionary policies made those subsidies more
desperately needed than ever ... Not only was the IMF not restoring
economic confidence in East Asia, it was undermining the region's social
fabric. And then, in the spring and summer of 1998, the crisis spread
beyond East Asia to the most explosive country of all--Russia.
Today, Russia remains in desperate shape. High oil prices and the
long-resisted ruble devaluation have helped it regain some footing.
But standards of living remain far below where they were at the start
of the transition. The nation is beset by enormous inequality, and most
Russians, embittered by experience, have lost confidence in the free
market. A significant fall in oil prices would almost certainly reverse
what modest progress has been made.
East Asia is better off, though it still struggles, too. Close to
40 percent of Thailand's loans are still not performing; Indonesia remains
deeply mired in recession. Unemployment rates remain far higher than
they were before the crisis, even in East Asia's best-performing country,
Korea. IMF boosters suggest that the recession's end is a testament
to the effectiveness of the agency's policies. Nonsense. Every recession
eventually ends. All the IMF did was make East Asia's recessions deeper,
longer, and harder. Indeed, Thailand, which followed the IMF's prescriptions
the most closely, has performed worse than Malaysia and South Korea,
which followed more independent courses.
I was often asked how smart--even brilliant--people could have created
such bad policies. One reason is that these smart people were not using
smart economics. Time and again, I was dismayed at how out-of-date--and
how out-of-tune with reality--the models Washington economists employed
were. For example, microeconomic phenomena such as bankruptcy and the
fear of default were at the center of the East Asian crisis. But the
macroeconomic models used to analyze these crises were not typically
rooted in microfoundations, so they took no account of bankruptcy.
But bad economics was only a symptom of the real problem: secrecy.
Smart people are more likely to do stupid things when they close themselves
off from outside criticism and advice. If there's one thing I've learned
in government, it's that openness is most essential in those realms
where expertise seems to matter most.
Joseph E. Stiglitz served on the U.S. Council of Economic Advisers
from 1993 to 1997 under President Clinton. He was Chief Economist
the World Bank from 1996 to 1999 when he resigned in protest. He
is the author of the book Globalization and its Discontents, a critique
of the major international financial institutions.