Themes > Current Issues
07.04.2000
Global Development Finance
Jayati Ghosh
It is no secret that intellectual fashions in developing
countries, as indeed many other kinds of fashion, are often lagged versions
of what was earlier popular in the west. The mystery, then, is not that
such a tendency should exist in India as well. Rather, the questions
are why, even after the communications technology revolution, the time
lags in their adoption persist, and how such imported ideas can continue
to hold sway here well after they have been discredited elsewhere.
This is of course evident in all sorts of ways, whether in trends in cinema and literature, or even in terms of choosing objects of adulation. Thus, quite recently, much of the English language media in India expressed a near-hysterical degree of obsequiousness in covering the visit of Bill Clinton, a man who is already dismissed in his own country as a somewhat embarrassing lame-duck President. Quite apart from the servility reflected in a response which did not take into account the effects for our own citizens of the policies symbolised by this man, it was also an outdated reaction showing a retarded appreciation of current reality.
But nowhere is this slowness in adapting modes of thought more sharply illustrated than in terms of ideas about economic policy. The 1990s was the decade of the explosion of free market ideology in economic policy in the West, the period when dirigisme ran for cover and government intervention of any variety was seen as anathema. Even by the middle of the period, the flaws of simple-mindedness on this question were obvious. And by the close of the decade, extreme marketism was possibly even more exposed than the strategies it had defeated, especially with respect to financial markets.
In India, however, at least in the corridors of power, all this is yet to become news. The Finance Ministry apparently persists in the belief that financial markets can function efficiently to increase savings and allocate them to the most socially desirable investments with minimal government regulation, and that liberalising the rules for capital entry and exit in the country is the best way of stabilising and benefiting from such flows. Such axioms must have underwritten the latest financial liberalisation measures as outlined in the Budget, and recent official expositions on the subject have left no doubt of the firmness of these beliefs.
Elsewhere, of course, that optimistic vision has been greatly tempered, not only by the sobering experience of many emerging markets over the decade, but also by theoretical developments in economics which have highlighted the possibility of many kinds of market failure specific to financial markets. What is now widely accepted is that some kinds of regulation may be necessary, not just to prevent or mitigate the effects of capital flight, but even to control periodic rushes of capital entry which can have destabilising effects.
This perception has now come home even to the multilateral institutions that have been seen as the high priests of market-driven economic philosophy. Thus, the World Bank, in its most recent edition of the annual publication Global Development Finance, makes arguments which - if made in India by less hallowed sources - would be immediately dismissed by market apologists as typical leftist ranting.
To emphasise this point, some of the discussion in this recent World Bank report deserves fuller quotation at some length : "All past episodes of surges in capital flows to emerging markets have ended in severe international financial crises. Hard landings rather than soft landings have been the rule... Booms in private capital flows to emerging markets have been punctuated by frequent banking and exchange rate crises in the capital-receiving countries, and have usually ended in severe economic dislocation or political conflict. By contrast, financial crises and debt overhangs were relatively rare during the Bretton Woods era, when capital controls and stringent financial sector regulation limited capital flows to emerging markets (although several exchange rate crises did occur).
" It remains extremely difficult to determine to what extent these periodic reversals of capital flows have been themselves the cause of crises or a response to fundamental economic problems in the borrowing economies. Certainly such reversals have responded to excessive levels of debt, terms-of-trade shocks, or other events that reduce the prospects for economic growth in the borrowing countries. However, actions by creditor countries or lending institutions also have contributed. Crises have been sparked by monetary tightening in creditor countries and sudden changes in tolerance for risk on the part of lenders. Creditors have also contributed to crises by continuing to lend even in the face of evidence that funds were being directed to activities that could not generate sufficient returns with which to repay the debts created." (World Bank, Global Development Finance 2000, Washington, D. C., page 120).
On a similar note, the World Bank report is cautious about reacting to the possibility of a renewed spurt in capital flows to developing countries such as India, the prospect of which currently causes so much excitement among our own policy makers. Thus, while it recognises that the current pause in capital flows could last for some years, it also suggests that factors such as continued technological progress, rapid economic growth, a favourable political climate, and the ageing of industrial country populations (compared to the much younger age structure of most emerging markets) may well lead to a renewed boom in capital flows to emerging markets over the next decade.
The point, however, is that even such a renewed boom is not seen as necessarily a cause for celebration among the host emerging economies. Thus, the report argues that "if these inflows continue to be as volatile as they have been in the past, their benefits to the developing world may be reduced. Also, the spread of capital flows to countries with weak institutional capacity may increase the likelihood of crises in those economies. The great differences in incomes, legal and institutional frameworks, and cultural backgrounds between creditors and borrowers will tend to heighten the effects of asymmetric information and encourage herding among lenders. The growing role of banking systems in emerging markets in intermediating volatile capital flows could lead to greater risk to financial systems and could intensify the devastating effects of crises on economic output, particularly given the weakness of banking systems in many countries. Finally, continued financial innovation is likely to facilitate speculation and the rapid shifting of flows in and out of emerging markets." (page 120)
To counter these possible adverse consequences (note, of the boom in inflows as well, not just of the slump), the World Bank appears to have made a giant leap in its thinking in terms of recognising the relevance and viability of some capital controls. (Or could it just be the public swan song of the institution's departing Chief Economist, Joseph Stiglitz ?) Thus the report seriously considers a variety of capital control measures, ranging from taxation of short-term capital inflows to prudential controls on capital inflows, and also controls on capital outflows during crisis episodes along with liquidity-enhancing measures such as higher foreign currency reserves and contingent access to international credit. It allows that both the "market-friendly" prudential measures regulating inflows in Chile and the mid-crisis measures to control capital flight in Malaysia could have played important roles. But what is most important is that the report accepts that such controls need to be developed within countries according to specific requirements of particular economies.
Certainly the report recognises that such safeguards would impose costs on the domestic economy either by restricting the quantity of foreign borrowing or by raising its price. However, it quite sensibly points out that such costs are clearly likely to be less than the cost of a full-fledged financial crisis. What is even more significant is that finally the Bank also recognises the distributive element in such policy choices, since financial crises typically make the poor pay for the subsequent adjustment by bringing about fairly deep recessions which increase both unemployment and poverty. Regulations on capital flow, by contrast, tend to put a greater part of the adjustment on to those who actually benefit more directly from foreign borrowing.
All this is no more than a rather belated recognition (by an institution that is known for belated and partial responses) of the hard reality broadcast by the succession of financial crises that have hit emerging markets over the 1990s. But in the context of the currently ruling economic ideology in India, it appears not just heretical but impossible in terms of gaining official acceptance, if only because this echoes belatedly much of what Indian critics have written about the policies being followed in our country at the behest of the Bretton Woods institutions.
Obviously, the time will eventually come when these ideas are accepted generally by Indian policy makers and their economists as well. It remains to be seen whether this will simply follow the usual intellectual time-lag, or will be the result of bitter experience.
This is of course evident in all sorts of ways, whether in trends in cinema and literature, or even in terms of choosing objects of adulation. Thus, quite recently, much of the English language media in India expressed a near-hysterical degree of obsequiousness in covering the visit of Bill Clinton, a man who is already dismissed in his own country as a somewhat embarrassing lame-duck President. Quite apart from the servility reflected in a response which did not take into account the effects for our own citizens of the policies symbolised by this man, it was also an outdated reaction showing a retarded appreciation of current reality.
But nowhere is this slowness in adapting modes of thought more sharply illustrated than in terms of ideas about economic policy. The 1990s was the decade of the explosion of free market ideology in economic policy in the West, the period when dirigisme ran for cover and government intervention of any variety was seen as anathema. Even by the middle of the period, the flaws of simple-mindedness on this question were obvious. And by the close of the decade, extreme marketism was possibly even more exposed than the strategies it had defeated, especially with respect to financial markets.
In India, however, at least in the corridors of power, all this is yet to become news. The Finance Ministry apparently persists in the belief that financial markets can function efficiently to increase savings and allocate them to the most socially desirable investments with minimal government regulation, and that liberalising the rules for capital entry and exit in the country is the best way of stabilising and benefiting from such flows. Such axioms must have underwritten the latest financial liberalisation measures as outlined in the Budget, and recent official expositions on the subject have left no doubt of the firmness of these beliefs.
Elsewhere, of course, that optimistic vision has been greatly tempered, not only by the sobering experience of many emerging markets over the decade, but also by theoretical developments in economics which have highlighted the possibility of many kinds of market failure specific to financial markets. What is now widely accepted is that some kinds of regulation may be necessary, not just to prevent or mitigate the effects of capital flight, but even to control periodic rushes of capital entry which can have destabilising effects.
This perception has now come home even to the multilateral institutions that have been seen as the high priests of market-driven economic philosophy. Thus, the World Bank, in its most recent edition of the annual publication Global Development Finance, makes arguments which - if made in India by less hallowed sources - would be immediately dismissed by market apologists as typical leftist ranting.
To emphasise this point, some of the discussion in this recent World Bank report deserves fuller quotation at some length : "All past episodes of surges in capital flows to emerging markets have ended in severe international financial crises. Hard landings rather than soft landings have been the rule... Booms in private capital flows to emerging markets have been punctuated by frequent banking and exchange rate crises in the capital-receiving countries, and have usually ended in severe economic dislocation or political conflict. By contrast, financial crises and debt overhangs were relatively rare during the Bretton Woods era, when capital controls and stringent financial sector regulation limited capital flows to emerging markets (although several exchange rate crises did occur).
" It remains extremely difficult to determine to what extent these periodic reversals of capital flows have been themselves the cause of crises or a response to fundamental economic problems in the borrowing economies. Certainly such reversals have responded to excessive levels of debt, terms-of-trade shocks, or other events that reduce the prospects for economic growth in the borrowing countries. However, actions by creditor countries or lending institutions also have contributed. Crises have been sparked by monetary tightening in creditor countries and sudden changes in tolerance for risk on the part of lenders. Creditors have also contributed to crises by continuing to lend even in the face of evidence that funds were being directed to activities that could not generate sufficient returns with which to repay the debts created." (World Bank, Global Development Finance 2000, Washington, D. C., page 120).
On a similar note, the World Bank report is cautious about reacting to the possibility of a renewed spurt in capital flows to developing countries such as India, the prospect of which currently causes so much excitement among our own policy makers. Thus, while it recognises that the current pause in capital flows could last for some years, it also suggests that factors such as continued technological progress, rapid economic growth, a favourable political climate, and the ageing of industrial country populations (compared to the much younger age structure of most emerging markets) may well lead to a renewed boom in capital flows to emerging markets over the next decade.
The point, however, is that even such a renewed boom is not seen as necessarily a cause for celebration among the host emerging economies. Thus, the report argues that "if these inflows continue to be as volatile as they have been in the past, their benefits to the developing world may be reduced. Also, the spread of capital flows to countries with weak institutional capacity may increase the likelihood of crises in those economies. The great differences in incomes, legal and institutional frameworks, and cultural backgrounds between creditors and borrowers will tend to heighten the effects of asymmetric information and encourage herding among lenders. The growing role of banking systems in emerging markets in intermediating volatile capital flows could lead to greater risk to financial systems and could intensify the devastating effects of crises on economic output, particularly given the weakness of banking systems in many countries. Finally, continued financial innovation is likely to facilitate speculation and the rapid shifting of flows in and out of emerging markets." (page 120)
To counter these possible adverse consequences (note, of the boom in inflows as well, not just of the slump), the World Bank appears to have made a giant leap in its thinking in terms of recognising the relevance and viability of some capital controls. (Or could it just be the public swan song of the institution's departing Chief Economist, Joseph Stiglitz ?) Thus the report seriously considers a variety of capital control measures, ranging from taxation of short-term capital inflows to prudential controls on capital inflows, and also controls on capital outflows during crisis episodes along with liquidity-enhancing measures such as higher foreign currency reserves and contingent access to international credit. It allows that both the "market-friendly" prudential measures regulating inflows in Chile and the mid-crisis measures to control capital flight in Malaysia could have played important roles. But what is most important is that the report accepts that such controls need to be developed within countries according to specific requirements of particular economies.
Certainly the report recognises that such safeguards would impose costs on the domestic economy either by restricting the quantity of foreign borrowing or by raising its price. However, it quite sensibly points out that such costs are clearly likely to be less than the cost of a full-fledged financial crisis. What is even more significant is that finally the Bank also recognises the distributive element in such policy choices, since financial crises typically make the poor pay for the subsequent adjustment by bringing about fairly deep recessions which increase both unemployment and poverty. Regulations on capital flow, by contrast, tend to put a greater part of the adjustment on to those who actually benefit more directly from foreign borrowing.
All this is no more than a rather belated recognition (by an institution that is known for belated and partial responses) of the hard reality broadcast by the succession of financial crises that have hit emerging markets over the 1990s. But in the context of the currently ruling economic ideology in India, it appears not just heretical but impossible in terms of gaining official acceptance, if only because this echoes belatedly much of what Indian critics have written about the policies being followed in our country at the behest of the Bretton Woods institutions.
Obviously, the time will eventually come when these ideas are accepted generally by Indian policy makers and their economists as well. It remains to be seen whether this will simply follow the usual intellectual time-lag, or will be the result of bitter experience.
© MACROSCAN 2000