by Kanes
The IMF's stock prescription of liberalization, deregulation and privatization is normally combined with clear instructions to reduce budget deficits, raise interest rates and restructure banks. It is argued that deficit financing and cheap money expands demand and aggravates the balance of payments thereby weakening the currency. On the other, budget surpluses and high interest reduce demand; higher interest rate has the additional advantage of drawing in foreign capital investment and making local currency more attractive to hold thereby strengthening the currency. Control of government expenditure, however, involves a reduction in capital expenditure while a rise in interest rates discourages private investment and creates high debt burdens causing company bankruptcies. Thus, exchange stability appears to be achieved at the expense of economic growth. Therefore, the IMF prescription is proving irksome to some Asian economies which are in a recession with low growth and unemployment. Although they desire to get out of it, the IMF remedies are deflating their economies and depressing their growth further.

The developing countries had to swallow this bitter medicine against their will in order to obtain external assistance. Thailand, South Korea and Indonesia were not at all anxious to go to the IMF for help but they had to. Only Malaysia was strong enough to stand on its own feet and scoff at the IMF. As Premier Mahathir Mohamed stated: 'We try to follow not because we think the IMF is right, but because if we don't then there will be a loss of confidence'. The IMF prescription has now been challenged by the Senior Vice President and Chief Economist of the World Bank — Joseph Stiglitz — who argues that as the financial crisis tends to produce a deep and prolonged depression, what should be done is not to deflate the economy and reinforce contractionary forces but to implement expansionary policies to arrest contraction and revive the economy.

Restoring Growth: Stiglitz's Views
Stiglitz recommends four measures to activate the Asian economies. First is to have an expansionary macroeconomic programme with external financial assistance to reduce the contractionary effects on the economy. Second is to strengthen the financial system and restore confidence by selective credit control to channel adequate credit to exporting firms, agriculture and small and medium enterprises to jump-start the economy. 'Third, reforms need to be cognizant of capital asset values, which have been battered by large unanticipated changes in exchange rate, land and real estate prices, etc., increasing uncertainty and dampening economic activity. One implication: some structural reforms that might be good in the long run can have disastrous consequences in the short run. If the US, for instance, has tried to eliminate distortions in agriculture and energy prices in the mid-1980s, the process would have worsened the savings and loan crisis'. Fourth is the need for corporate restructuring, but Stiglitz warns: 'But this should consider that even a well managed firm can go bankrupt as a result of large devaluations, increases in interest rates, and falls in demand. We must take great care in identifying firms to survive and in assessing their financial needs. Systematic bankruptcies, with creditors of bankrupt firms also going bankrupt, will make corporate restructuring all the more difficult'.

Further, the link between interest rates and the exchange rate, as believed by the IMF, has been questioned by economists and currency dealers who point out that 'Asian interest rates are still a fraction of what speculators stand to gain if they move a currency even just half a per cent in a day — the equivalent of more than 70 per cent annuated'. It is clear that interest rates cannot be raised high enough to discourage big currency speculators like George Soros. As to the question of high interest rates attracting foreign capital, Joseph Stiglitz argues that investors and lenders weigh offered returns against risks. The high risk in lending or investing in troubled Asia at present are likely to offset the attraction of higher interest rates. Further, if a further rise of interest rates results in more defaults and bankruptcies, that may erode confidence further, lead to a flight of capital and depreciate the currency more.

Joseph Stiglitz argument is as follows:
'What matters for private-to-private capital flows, which were at the heart of the East Asian crisis, is not the promised interest rate but the return that investors expect to get, adjusted for the risk they face. Measures that weaken the economy and promote uncertainty rather than confidence can lead to capital flight — and falling exchange rates. Since increasing interest rates might actually lower the risk adjusted expected return thus worsening the exchange rate, the usual trade-off between interest rates and exchange rates may disappear'.

Further there has been little inflow of capital despite high interest rates during the last 12 months in Thailand, Indonesia and South Korea. And their currency remains still under pressure despite IMF's reforms. Stiglitz is rather pessimistic about the prospects of capital inflows which the IMF envisages:

'The continuing uncertainties in the region will stymie the return on capital flows, and there are reasons to believe that capital may continue to leave the region, even if confidence were to be restored. Asian investors had invested heavily in their own and neighbouring countries: their portfolios were less diversified. Now, they may seek more balanced portfolios, and that may mean more capital from certain countries heading to the US and Europe'.

State Intervention
East and South-East Asian countries achieved such high growth rates not under a free market but within the framework of a State guided capitalism or a mixed economy where the State not only actively intervened to guide, protect and support indigenous private enterprises but also engaged in economic activity side by side with the private sector — not so much to compete but to complement the private sector. It is doubtful whether these countries would resume their high growth in a free market economy as prescribed by the IMF. The extent to which the governments intervened in the economy and protected private enterprise can be gauged by the following facts. State investment was about 26 per cent of gross domestic investment in Malaysia in 1990-1995 — only lower than India's 32 per cent in Asia — about 15 per cent in South Korea and Indonesia and 10 per cent in Thailand. The weighted mean tariff on all imported products in Thailand for instance was 41.5 per cent in 1993 or more than double that of Sri Lanka — 20.7 per cent in 1997.

Further, as mentioned earlier, the depressed Asian economies need to be revived by an expansion of investment. As the private sector is too weak — with debts, bankruptcies, etc. — the necessary stimulus to recovery can be given only by public investment. The Asian Development Bank underlined this by stating: 'Unless public investment levels are maintained, overall investment and growth will be severely affected'. Thus, emasculation of the public sector as recommended by the IMF will only tend to prolong the depression. The IMF also prefers restructuring and recapitalising of banks to revive domestic lending to lowering interest, but this brings in State intervention through the back door. Restructuring programmes to bail out banks, take over bad loans and protect deposits and recapitalising financial institutions involve vast capital outlay by the State and the establishment of a number of State institutions to implement and oversee the programme.

The Japanese government for instance, has set up a $214 billion fund to recapitalise banks and protect bank deposits and proposes to set up a bridge bank to take over failing financial institutions. The South Korean government has established the Financial Supervisory Commission to reorganize the banking system by closure, merger or better management. It proposes to mobilize $35 billion to support domestic banks to dispose of their bad loans. One effective method of reorganizing and reviving crisis-stricken banks is for the State to nationalize them. The bad debts of the banks are so high, no private investor would be prepared to invest in them or buy them. Thus, there is no alternative but for the State to step in. In fact, a panel of economists and financial consultants from leading private consultancies in Asia have recommended bank nationalization as a remedial measure (see Far Eastern Economic Review of June 18, 1998). The Thai govenrment nationalized four large banks and the Bank of Thailand took over seven ailing financial companies.

Stiglitz supports State intervention as follows:
'It is inconsistent to rule out government 'interference' with the market while still supporting bail-outs which are after all, massive government interventions. Whether justified or not, the existence of repeated bail-outs nationally and internationally means that individuals and firms do not bear the full costs of the risks they create. As a result, we cannot count on the free market to lead to the best outcome and thus some government action may be required to 'correct' private incentives. When firms impose costs on society, for instance through pollution, we tax or regulate them. Similarly, when they impose risks on the entire society by incurring short-term debt the question should not be whether government action is desirable, but whether we can find actions whose benefits exceed the ancillary costs. There is every reason to believe that we can'.

The Asian developing countries faced with deepening depression, rising unemployment and growing foreign ownership of national assets may get disillusioned with the IMF's reforms and revert to their customary paradigm of development with protection, regulation and active State intervention. These countries are witnessing the transfer of economic sovereignty to the IMF and their own central banks and ministries becoming its mere appendages. The IMF has even interfered in areas outside its domain like labour markets, banking rules, competition policy, corruption, cronyism and collusion with no supervision by any authority but with the backing of the USA. The developing countries are seeing the transformation of their economies to free markets but have yet to see the alleged benefits of the free market such as inflow of private capital, stable exchange rate, rapid growth and full employment. But the IMF's objective is to ensure that they remain free markets to allow free access to foreign goods and investment — that they open the doors to transnational corporations. The United States is even more anxious than the IMF that the economies remain fully open to US goods and investment, that it has set up its own system to monitor the progress of liberalization in these countries and maintains close liaison with the IMF and WTO.

The US, however, has not forgotten the terrible results of rapid deregulation of the financial sector in Indonesia. Consequently, it is reluctant to press Japan to deregulate its financial markets fast fearing a rash of bank failures and a global catastrophe.