Good government will bring financial markets to heel
ON lessons learnt at the IMf jamboree
Thursday 25 September 1997
Some of them were less obviously exciting than others. For instance, the IMF got the go-ahead for a quota increase and redistribution and a special allocation of Special Drawing Rights (SDR). Dry as it sounds, this subject caused a massive row between the developed and developing nations three years ago, and delicate negotiations have been going on ever since. What it means is that member governments have agreed to increase the IMF's capital by 45 per cent, and tilt the balance of shareholding in the fund to better reflect the growing economic strength of newly industrialised countries.
In addition, the new allocation of the IMF's Special Drawing Rights, its basket currency, will also give member countries a fair share. These apparently technical housekeeping agreements are part of the process of giving fast-growing countries a greater voice in the international financial institutions.
Of more obvious interest was the unexpected focus of the meetings on what the IMF and World Bank should be doing in the modern world, and the consensus that the answer is reducing poverty, furthering social goals, making government more open and transparent, and cracking down on corruption. In short, the delegates talked about how to make the world a better place, and agreed on the steps needed even though in some cases this was inevitably only a matter of paying lip service.
However, this surprise agreement on the ends produced a fissure between the developed and developing countries over the means. The new split showed up in several ways, most dramatically in the war of words between Mahathir Mohamed, the Prime Minister of Malaysia, and the financier George Soros. But it was also revealed by the developing countries' resistance to plans for the IMF to enhance the free flow of capital around the world, and by surprise Japanese proposals for an Asian Monetary Fund whereby Asian neighbours would give each other financial support.
The disagreement boils down to one group of countries having second thoughts about capital liberalisation after this summer's currency and stock market crisis in South-east Asia. There was a fear amongst developing country finance ministers and bankers that if global capital could do this to the Tiger economies then nobody would be safe from the risk of a sudden crisis. They put out a statement saying that while they would support "orderly" capital liberalisation, it must not be allowed to put too much stress on countries already struggling to adjust to globalisation. They gave only tentative backing to the IMF's wish to amend its articles to make freedom of capital movements as well as free movement of goods and services fundamental to its operations.
These hesitations were reflected in support for the idea of an Asian Monetary Fund, a $100bn (pounds 62bn) fund that would stand ready to support any country in the region that got into the kind of crisis they have seen this summer. The fund would therefore be a kind of barrier that could be raised when the tides of free capital became too disruptive.
There are some good arguments against putting this kind of defence system in place, the main one being the question of "moral hazard". This means simply that investors would take bigger risks knowing that a large pot of money was ultimately available to bail them out than they would if there was no safety net.
With investors in Mexico rescued in 1995, and investors in Thailand in 1997, how long would it be before another country facing a run on its currency decided the time had come to activate the new fund?
However, the point is that the battered Asian economies are keen to sign up to such a fund because they feel they need protecting from the odd hurricane in the financial markets. After this summer, free capital flows look pretty destructive.
The debate was of course at its starkest in Hong Kong in the high drama - or was it farce? - of the Mahathir/Soros debate. Mr Mahathir complained: "Quite a few people who are in the media and in control of the big money seem to want to see these South-east Asian countries and in particular Malaysia stop trying to catch up with their superiors and know their place." He touched - rightly - on the fear of many in the developed world that countries like Malaysia are "stealing" jobs and business. As he put it: "To the yellow peril of yesteryear will be added the brown peril. The Europeans will be overwhelmed."
Mr Mahathir is quite right to condemn this for both its racism and its falsehood. As he said in the speech, world-wide trade and investment do not add up to a zero-sum game where one country's gain is another's loss. He also reflected a widespread feeling that trading in the international capital markets is divorced from anything real that is going on in the world. "No real money is involved, only figures," he said.
Although the outspoken Prime Minister went well beyond logic in concluding that currency trading must therefore be banned, his speech did reflect in extreme form some of the new concerns in South-east Asia. His opponent in the debate also conceded that there were problems with global capitalism. George Soros said: "Financial markets are inherently unstable and international financial markets even more so. International capital flows are notorious for their boom-bust pattern."
However, he concluded, not that governments should try to ban the markets, Malaysian style, but rather that the existence of the global markets demands a different kind of government. Broadly speaking, an open and democratic government will be less vulnerable to the deficiencies of financial markets - and he criticised Asian governments for clinging to an autocratic and corrupt politics.
The world's most famous financier therefore ended up reaching the same conclusion as the finance ministers and central bank governors: the next big issue in economic progress is better government. But until that lesson is put into practice, the IMF will find it heavy-going on its plans for capital liberalisation. The experience of the 1930s, when the international financial system broke down, suggests that financial crises do nothing to improve the prospects of open government.
Nor is there anything to suggest that this summer's crisis has prodded South-east Asia on to a higher political plane. The Thai government is in turmoil, while Mr Mahathir's autocratic tendencies seem to have been reinforced. Free markets police bad governments very effectively, but freer markets do not necessarily improve bad governments. These have to want to improve themselves to reap the benefits of economic liberalisation.
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