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Challenges to policy-making
THE Asian economic crisis, sparked by
a flight of capital from Thailand and snowballing effects on other
economies, will be exactly a decade-old this July.
Despite the wide-ranging analysis of what happened, we are really
none the wiser about the root causes of events that brought
economic disarray to Thailand, Indonesia, Malaysia and South
Korea.
In the weeks and months before the crisis, there had been fulsome
praise of the economic performance of these countries, even though
there had been problematic areas such as the respective banking
sectors and the level of non-performing loans and rising fiscal
deficits.
We are arguably somewhat wiser about what should be done in the
wake of such a crisis, partly because enough time has passed to
assess policy responses and because Malaysia took a contrarian
view to International Monetary Fund (IMF) solutions by pegging its
currency, conducting a managed sale of non-performing assets and
easing its monetary policy.
Indonesia is probably one of the more distinctive examples of what
went wrong. Not long after full endorsement of its macroeconomic
policies by the IMF and World Bank, Indonesia was sucked into the
vortex of the financial crisis. Strictly speaking, it has not
fully recovered.
Most economists now agreed that the policy prescriptions of these
two institutions were poorly conceived and steeped in the IMF
tradition of “one policy suits all”. The resulting policy
framework has been a recipe for disaster.
The unexpected plunge into ethnic and religious conflicts, and the
continuing attraction of Islamic fundamentalism for a small number
of adherents in the world’s most populous Islamic nation, is
partly an outcome of these policies and the millions of people
suddenly finding themselves below the poverty line.
Now that the IMF and World Bank have successfully put away former
president Suharto as a bad and corrupt leader and democracy is
taking root, it seems ironic to point out that unprecedented
wealth and prosperity had come the way of Indonesia during
Suharto’s term in office.
Between 1967 and 1997, Indonesia enjoyed a 20-fold increase in its
per capita incomes, one of only a handful of nations that managed
to propel itself from the ranks of low income countries to middle
income developing countries as categorised by the World Bank.
These gains were made in spite of high and pervasive levels of
corruption – most observers would probably argue corruption
steadily worsened in this three-decade period – and mainly
occurred because windfall revenues from the two 1970s oil shocks
had been well used in the country’s agricultural sector.
Even though there are the makings of a new resources boom – it has
in recent years become the world’s biggest exporter of steaming
coal – it is unlikely these benefits will ever again have the same
national impacts on development.
Indeed, I would go so far as to suggest that the 20-fold increase
in incomes enjoyed in the Suharto era will never again be repeated
in Indonesia. (If improvements of this scale had occurred in Papua
New Guinea, income levels today would possibly be close to
Australia, and ahead of virtually all developing countries in
Asia.)
Hopefully, some of the policy mistakes are beginning to be better
understood.
Recent articles published by the IMF is beginning to pay heed to
the possibility that the “one policy fits all” concept borders on
stupidity.
The events of the late 1990s nevertheless continues to underline
the importance of good fiscal and monetary policies under any
circumstances.
Unfortunately, because of the way the IMF and World Bank operate,
and their adherence to primacy of open markets in all
circumstances, it is unlikely that much policy variation can be
anticipated in IMF responses to future financial crises.
Lessons from 1990s crisis
One of the clearest examples is provided by an article last year
titled Rethinking Growth by Roberto Zagha, Gobind Nankani and
Indermit Gill, three economists who were closely involved with the
World Bank’s 2005 report, Economic Growth in the 1990s: Learning
from a Decade of Reform.
“The 1990s yielded many lessons,” they wrote in IMF’s quarterly
magazine.
“The most important perhaps is that our knowledge of economic
growth is extremely incomplete.
“This calls for more humility in the manner in which economic
policy advise is given, more recognition that an economic system
may not always respond as predicted, and more economic rigour in
the formulation of economic policy advice.”
The central result of their World Bank study was the rediscovery
of “the complexity of economic growth, recognising that it is not
amenable to simple formulas”.
“Even though the practitioners, senior bank operational staff, and
economists started from different perspectives, they all came up
with similarly remarkable lessons.”
Another article on strategy, Getting the Diagnosis Right – A new
approach to economic reform, indirectly pointed to why the IMF got
it so badly wrong through its demands for wholesale reforms in
Indonesia.
The authors said the path of wholesale reforms, though technically
correct, was practically impossible to implement in real life; to
reform as much as possible was likely to fall prey to secondary
impacts, while reform that target the biggest distortions has
uncertain benefits especially in the short run.
“It is best to focus on the reforms, whose direct effects are
expected to produce the biggest bang for the reform buck.”
The article is by three distinguished economists – Ricardo
Hausmann, director for Harvard University’s Centre for
International Development, Dani Rodrik, Professor of International
Political Economy, and Andres Velasco, Sumitomo Professor of
International Finance and Development at Harvard’s John F Kennedy
School of Government.
I would like to suggest that the short-term impacts of the IMF
policies in Indonesia post-1997, whether intended or otherwise,
included a run on many banks and increased financial instability.
The sudden withdrawal of oil and other subsidies plunged millions
into poverty.
Another article published by the IMF, Levers for Growth looked at
43 countries that had significant growth episodes despite weak
institutions such as central banks and the judicial system.
These countries, they said, were able to “ignite and sustain
growth” and to improve “the quality of their broad institutions
during their growth episode”.
“For this group, there is a kind of virtuous cycle of policy
levers (for example, fiscal, exchange rate and trade policies, as
well as policies relating to education and the costs of doing
business) that ignite growth despite the weak institutions.
“Growth is then sustained and institutions are improved, possibly
laying the foundation for an improvement in long-term growth
prospects,” noted Simon Johnson, a professor at the Sloan School
of Management at the Massachusetts Institute of Technology. His
co-authors were Jonathan D Ostry, a senior adviser, and Arvind
Subramanian, division chief in the IMF’s research department.
It was such a “virtuous cycle” that accounts for the 20-fold
income growth in the Suharto era, during which the Consultative
Group on Indonesia, which met annually, had helped underwrite the
nation’s development.
President Susilo Bambang Yudhoyono last month announced that he
was dismantling CGI, whose membership over the past four decades
has included the World Bank, Asian Development Bank, Japan,
Australia, its former colonial ruler, the Netherlands, and some
other countries.
Aid via the CGI process provides access to cheap loans that are
generally not available via capital markets placements the
Indonesians will now pursue. This unfortunate outcome is also
possibly a hangover from the IMF policy medicine meted out in the
late 1990s which had been seen as blatant interference but also as
a global showcase for incompetence.
Indonesian finance minister Mulyani Indrawati explained the ending
of the CGI linkage quite candidly, when she said it had a
“political cost” since some people saw it as interference in
domestic affairs.
Unfortunately for Indonesia, capital markets will probably take a
more harsh view of the country’s development financing
requirements, particularly when compared with donors such as Japan
and Australia, even though she may be right there will be less
“politicising of issues” in these private sector forums.
 
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