The Mirage of Progress

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?

growth to support an overvalued exchange rate, budget tightening during a
recession--all of these are described as "sound macroeconomic policies," so long
as they are prescribed by the IMF. As world economic growth now plummets, the
media's main worry is that reform and progress toward free trade might stall.

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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