Proceedings
MR. MALLOCH-BROWN: Good morning. Thank you all for being here. I
notice immediately two differences which I am sure are connected. One, my colleagues tell
me I've been heard to grumble that we got much too much coverage from the wire services
and those print guys; where was television? Well, clearly, thank you all for joining us in
the back row, and I should have known this was happening, because I found Joe Stiglitz in
a new suit.
[Laughter.]
MR. MALLOCH-BROWN: So, I should have realized that this was sort of--that Joe sort of
lifted us clearly to new levels, superstar levels.
Well, welcome. This is the ninth GEP. It's the World Bank's authoritative survey of the
world economy, and it has got a particular emphasis, obviously, on our clients, the
developing countries. Let me just remind you that the embargo is for 3:00 p.m. tomorrow
afternoon--today, today, today.
[Laughter.]
MR. MALLOCH-BROWN: I'm reading my notes here; today; just that the entire report and
all of the supporting briefing materials are available at the online address at the bottom
of the press release.
Let me then introduce my colleagues who are going to speak about this. Joe Stiglitz
needs little introduction. You all, I think, know him very well at this point, and he will
lead off, followed by Mick Riordan, one of the two authors of the GEP whom we have with us
today. Some of the other authors are on the road in Europe, I think, this week and Milan
Brahmbhatt, who also has been involved in writing the report. Joe?
MR. STIGLITZ: Welcome to this discussion of our Global Economic
Prospects for 1998-99. There is a single set of events which predominates the world
economic scene today, as it has for more than a year: the global economic crisis that
began in Thailand on July 2, 1997; spread from there to Indonesia and Korea and then to
Russia; then to Latin America. Few countries have not been touched by the global forces
which this crisis--by some accounts, the worst that the world has experienced since the
Great Depression--has unleashed.
Some countries have gone, in the space of a few short months, from robust growth into
deep recession or even depression. The social consequences of this economic downturn are
already manifest in interrupted education, increased poverty and poorer health.
The global capital flows, the expansion of which so many wrote so proudly just a short
time around, have not only shriveled but are now recognized to be at the center of the
crisis. As this version of the Global Economic Prospects goes to press, we cannot tell for
sure either how long the crisis will last or how deep it will be. In the midst of this
great uncertainty, it is important for us to have a sense of where the economy is going;
what has brought us to this juncture; and what can be done both to enhance our current
prospects and to make another such global calamity less likely.
Global Economic Prospects and the Developing Countries 1998-99--as was mentioned, the
ninth in an annual series--lays out the anatomy of the crisis in a clear and concise
fashion and assesses both the short and long-term outlooks for the world economy in the
aftermath of the crisis. A current snapshot of the world economic shows an economic
situation dramatically different from just a year ago. What started as a regional economic
slowdown blossomed into a global crisis.
According to the report, 36 countries that account for more than 40 percent of the
developing world's GDP and more than a quarter of its population will see negative per
capita growth in 1998 as compared to only 21 countries in 1997. Some other numbers that
the report highlights show the other aspects of this dramatic slowdown. Global output
growth will go from 3.2 percent in 1997 to 1.8 percent in 1998, and we're forecasting a
slight increase to 1.9 percent in 1999.
For the developing countries, the downturn is more dramatic, from 4.8 percent in 1997
to 2 percent in 1998. Per capita growth, of course, is down even more. We are expecting
per capita growth to be only 0.4 percent in 1998.
It is easier to describe where the world's economy is today than to forecast where it
will be in the coming year. The art and science of economic forecasting is always risky.
It is on particularly shaky grounds when it comes to trying to forecast turning points.
But while forecasting is inevitably highly risky, the task of putting together the
forecast, including exploring the links among the various parts of our integrated world
economy, both among countries and markets, helps draw attention to sources of weaknesses
and strength. By focusing on the downside risks and upside opportunities, it helps focus
attention of policy makers on not only the actions which they should take today but on the
kinds of contingencies for which they should be prepared.
As a development institution, the World Bank is especially concerned with the long-term
prospects. Though we cannot predict with any accuracy when the world economy will fully
recover from the current downturn, we do know this: there have been crises before, and the
world has always recovered from them, and after recovery, the determinants of long-term
growth are underlying forces, such as savings, demography, the pace of technological
change. Crises can have long-lasting effects. European unemployment rates have yet to
return to the levels of 20 years ago. Many analysts attribute this to the attrition of
skills that accompanies prolonged unemployment. Similarly, undoing the effects of the
massive corporate failures that have plagued several of the affected countries will not be
easy.
This report argues, however, that while 1998-1999 will be very difficult years for the
developing countries, in the long-term, growth could still reach the record-setting paces
of the early 1990s, but this will happen only if policies to prevent a deeper global slump
are implemented quickly. In recent weeks, the G-7 countries have taken a number of
important policy steps in this direction to foster world economic recovery and prevent a
global recession.
Understanding the nature of the East Asian crisis and the response of the international
community is vital to shaping how well we rise to the challenge of crises in the future.
Last year, when it became clear that there would not be a magic bullet to fix Asia's
financial crisis quickly, we were encouraged to launch a research project to provide an
in-depth examination of the causes of the crisis and an impartial analysis of the world's
response and some guidance on how we could make crises such as this less frequent and less
painful.
Chapters two and three present our interim report on these research findings. There are
inevitably a multiplicity of factors which contribute to any complex phenomenon such as
the crises that have beset East Asia. This is especially the case because the situation in
each of the countries differed, in some respects markedly. But our research concludes that
the origins of the crisis lay fundamentally in the interaction between institutional
weaknesses in managing domestic financial liberalization and problems of international
capital markets.
Unlike the Latin American debt crisis of the 1980s, the East Asian crisis is not
characterized by excessive sovereign borrowing or severe macroeconomic imbalances.
The report concludes that the heart of this current crisis, as I have said, is the
surge of capital flows: the surge in followed by a precipitous flow out. Few countries, no
matter how strong their financial institutions, could have withstood such a turnaround,
but clearly, the fact that the financial institutions were weak and their firms highly
levered made these countries particularly vulnerable.
The fact that one has to confront is that the frequency and cost of financial crises,
always significant, have risen in recent decades. When there is an isolated accident on a
road, one tends to blame the driver; but when accidents occur repeatedly at the same bend
in the curve, one begins to suspect something is wrong with the road. This report is
devoted to understanding precisely what is wrong with the road and how we can make it
safer both for the countries and especially for the poorest within them and how best to
respond to the accidents which inevitably will occur.
The report suggests that one of the lessons to be learned from the past year is that in
responding to crises, we need to focus even more on the individual circumstances of each
country; for instance, the appropriate policy responses need to be tailored to the degree
of leverage of the firms within the country and to its initial state of macro balance or
imbalance. We need, too, to focus both on the aggregate demand and aggregate supply.
On the demand side, not only is it difficult to restore confidence in an economy as it
plunges into a deep recession or even depression, but the bankruptcy which such economic
downturns give rise to has long-run disruptive effects. Aggregate demand and aggregate
supply thus become intertwined.
On the aggregate supply side, we need to focus on recapitalization of banks and
restructuring of corporations, but this restructuring is made all the more difficult in
any country by a precipitous economic downturn.
We have also learned about the central importance of social safety nets, the provision
of which has become one of the central foci of the Bank's programs. We need to remember
first that less-developed countries typically have weaker social safety nets--if they have
them at all--than more developed countries. This needs to be taken into account both in
the design of the responses as well as in the design of policy more broadly. The
willingness to expose oneself to risk should be tailored to how well one can handle those
risks.
Finally, we have also been reminded of the importance of strong feedback effects. The
downturn in one country has contributed to the weaknesses in others. These negative
feedbacks, combined with the supply-side effects that I referred to earlier, help explain
the failure of exports to grow anywhere near to the extent that one might have hoped,
especially in the light of the large devaluation.
The final chapter of the report explores how to avoid future crises. In an age of
large-scale private capital flows, developing countries face very complex problems
managing these flows but have little experience with the institutional and regulatory
safeguards necessary to prevent crises. But even developed countries have, in recent
years, faced financial crises of increasing frequency and severity. Some of the most
recent crises have occurred in countries with advanced institutional structures and high
levels of transparency. We know, too, that establishing the strong institutional
infrastructure required to make markets work effectively to enable the economy to
experience stable and sustained growth are tasks that will not be accomplished overnight,
even in countries with a high level of commitment to make the necessary reforms.
In order to deal with the risks posed by large capital flows, especially significant
when financial systems are weak, the report suggests that reforms must be comprehensive
and include a combination of more flexible macro policies, tighter financial regulation
and, where necessary, restrictions on capital inflows. In some cases, it may be necessary
to reverse the excesses of financial sector deregulation, especially in situations where
countries lack the capacity for the required regulatory oversight.
In each case, we need to ask what are the benefits and costs of the proposed reforms?
We need to look at the impacts on growth, stability and poverty. The balance of benefits
and costs of different policy reforms may differ in different countries. We need to
recognize that in many of the poorest countries, we are not likely to have in the
immediate future robust safety nets. We have seen the devastation to the lives and
livelihoods of millions of people that financial crises can have on innocent bystanders.
We are seeing poverty increase overnight, undoing the slow progress that has been taking
place year by year. For the poor people in these many less-developed countries without an
adequate safety net, the risks are indeed high, perhaps unacceptably so.
While the consequences of the crisis have been severe, the report ends on a positive
note. Events over the past year may well herald a new, more realistic and stable
environment for developing countries. We now have a better understanding of the
institutional infrastructure that is required to make market economies work. The
international community is giving serious attention to necessary improvements in the
international financial architecture, from better bankruptcy laws; a greater willingness
to accept standstills and arrangements entailing more equitable burden sharing to a
greater receptivity to interventions designed to stabilize capital flows, to a greater
recognition of the need for responses to crises that are better adapted to the
circumstances of the country and to protecting the most vulnerable within them.
The two together: improvements in domestic institutions and in the international
financial architecture, will enable greater numbers of countries to be able to enjoy more
of the benefits and minimize the peril of the global economy.
Now, I would like to turn the microphone over to Mr. Riordan, who will present a more
detailed look at the prospects for developing countries.
MR. RIORDAN: Thank you, Joe.
I would like to take a few minutes and just walk through some of the numbers and some
of the issues in the global outlook. There is little doubt that a period of sluggish
global growth is ahead. Although we are not looking for an outright recession in 1999,
there are a number of important risks that tend to concentrate on the down side. In 1998,
developing countries, as Joe had mentioned, in and outside of East Asia are being hit
hard, with 36 countries experiencing negative per capita GDP growth.
I would like to make four brief points relating to the global outlook, and as we can
see--we have these messages on the chart over here. The first is that the deflationary
impulse coming from East Asia was about twice what we had expected at the turn of this
year. Because of this and other developments, including the much worse than expected
situation in Japan, the world economy is in the midst of a slowdown, as Joe noted, from
growth of 3.2 percent in 1997 to what we estimate to be 1.8 percent this year, and
sluggish growth is likely to continue into 1999 at 1.9 percent as economies in East Asia
stabilize but as growth slows in the United States, in the European Union and especially
in Latin America.
The second point is that for developing countries, the outlook for export earnings and
for external finance is now very weak. Exports are being affected by slowing of world
trade volumes and the sharp declines in oil and non-oil commodity prices that we've seen
in recent months. Private capital flows to developing countries have come to a virtual
halt in recent months, and spreads in secondary markets for emerging market bonds
skyrocketed in the wake of the Russian devaluation of mid-August.
The third point is that due to these external factors as well as circumstances in the
countries themselves, growth across all developing regions will be slowing in 1998 and
1999 compared to 1997.
Finally, in terms of the main points, the short-term projections of the base case or
the most likely outlook remain cautiously optimistic that a world recession can be
averted, and an important reason, as Joe alluded to, was the recent series of policy
initiatives, of which the most significant are the interest rate reductions in the United
States, the United Kingdom, Canada and smaller European countries in preparation for EMU;
the passage of a financial restructuring program amounting to some 12 percent of GDP in
Japan and additional stimulus measures amounting to 24 trillion yen; also, increased
availability of official finance to emerging markets, including funding for the IMF and a
new Japanese and multilateral funding package for the Asian crisis countries.
Given the importance of Brazil, the world's eighth largest economy, the agreement on
the broad outlines of a package of fiscal consolidation and international assistance for
that country was another major development.
These policy steps have caused confidence to improve. They will prove vital in
supporting world economic activity over the next year or so. They also significantly
reduce the likelihood that recession, which affects a large part of the developing world,
will spread to industrial countries. Unfortunately, however, policies take time to work,
and the momentum of world economic activity is still on a deceleration path at present.
The next slide, which shows the evolution of forecasts for 1998 GDP and current
balances for the most affected East Asian countries and highlights the slow but inexorable
deterioration in view, and on East Asia recently, there have been some more encouraging
macro signs, largely for external and financial indicators, suggesting that the potential
for slowing of output contraction in several countries exists. And among these, briefly,
are the massive current account swing of some US$120 billion, which represents 2 percent
of world trade from 1996 to 1998, which, though quite painful, has built a general
framework of improving confidence.
And building on this, we have seen stabilization and subsequent appreciation of
exchange rates, which is serving to restore a degree of purchasing power to these
economies. We have seen large declines in interest rates to precrisis levels in some
countries and, more recently, pronounced recovery in equity markets. Export volumes
continue to grow in the region, although they are starting to slow, and that has been a
major source of stimulus for these countries, but importantly, among recent developments,
more stimulative fiscal policies are now underway.
This indirect evidence lends some support to the view that after declining by 8
percent, GDP for the four most affected middle-income countries and Korea in 1999 may come
to stabilize. Projections range, for individual countries, range from a continued decline
of 2.5 percent in Indonesia to a gain of similar magnitude in the Philippines. While signs
of increasing stability are emerging, it is still too early to be sure that we will not
suffer another setback, since the external environment remains quite murky at present, and
the recovery, in any event, is likely to be slow and drawn out.
Briefly, in this regard, at the micro level in these countries, the financial viability
of banks and firms will need to be restored, while international debt workouts proceed.
And given the difficulties inherent in many of these processes, recovery in the
crisis-affected countries is expected to be relatively protracted, and the potential
growth rates, long-term growth rates, to which they return, may be more tempered.
We currently anticipate growth for these economies of 3 percent in 2000 and averaging
about 5 percent in the long-term, but this compares with a 7 percent track record for the
last 20 years.
The next slide shows that for developing countries, as a group, in 1998, GDP will slow
from almost 5 percent in 1997 to about 2 percent in 1998. As illustrated in the chart for
this group, excluding the transition economies, this is the worst growth out-turn since
the early 1980s, the start of the debt crisis.
In looking at the major industrial countries briefly, growth is likely to slow in the
United States and Europe moving into 1999, while in Japan, stimulus measures are hoped to
limit the recession, which yielded a 2.5 percent decline in GDP this year. We currently
anticipate a modest output contraction for Japan in 1999.
In the United States, slowing of growth from the rapid pace of 1998 is likely to be
driven, in part, by the crisis in Asia and elsewhere, as exports continue on a declining
trend that they started this year but also as consumers retrench, given their current
overextension, and some slowing of investment spending as well. Recent Federal Reserve
measures are likely to achieve a soft rather than a hard landing next year.
All Western European countries are also likely to show some modest slackening of growth
in 1999 as export growth has diminished and business confidence has softened. Next slide.
Returning to the second point, that developing countries face difficult conditions in
the external environment, the anticipated slowing of industrial country growth into 1999
may accentuate the adverse trends that we have already seen dominate in world trade and
the commodity markets. In recent months, there appears to be a further slowdown in world
trade volumes. Trade probably grew at 3 percent year-on-year rates in the 3 months to
August of this year as opposed to double-digit gains in 1997 and early 1998.
Oil and non-oil commodity prices, some of the effects of which we see in this chart,
have, for the most part, remained near their historic lows, and several have continued on
a further downward trend. Abrupt shifts in commodity prices carry large differential
effects across developing regions, and changes in the terms of trade--here, we picture
them as--the income effects as a proportion to GDP in 1998--show that oil exporters in the
Middle East and North Africa, Russia and several in the CIS are hard-hit, as are some of
the countries that suffered large devaluations in East Asia.
Some countries benefit from these terms of trade changes. Industrial and developing
countries that are importers of oil and foods.
The next slide also highlights the fact that external finance from private sources has
also become more expensive and more scarce. Just in the last month or so, following the
Russian devaluation, we began to see a large decline in spreads pictured in the chart, the
Brady bond spreads and also U.S. high yield spreads, and there have also been some signs
of a life-end (phonetic) bond issuance. However, bond issues have been a fraction of its
earlier levels this year. It's only been by the best borrowers and at very high spreads;
furthermore, commercial bank lending, which had only declined moderately in August and
September, appears to have staged a retreat in October, as banks prepare their balance
sheets for the end of the financial year.
For a sample of large emerging markets, private capital flows, excluding foreign direct
investment, during August and September stood at 40 percent of their monthly average
levels in January to July of this year, which were already quite low, so the situation is
quite serious at the moment.
The third point, again, is that this combination of developments is likely to result in
a significant slowing of GDP growth across all developing regions in 1998 and continued
sluggish or falling growth in 1999. Briefly, looking at the chart in East Asia, what
appears to be a very sharp rebound is simply the fact that the rate of decline in the most
affected countries is slowing in 1999, and China continues to grow at a very rapid pace.
But looking at the Europe and Central Asia region, the uncertainties surrounding the
outlook in Russia and the likelihood for continued declines there are bringing growth
lower in 1999 than they were in 1998.
And finally, in Latin America, the implementation of fiscal measures in Brazil and the
slowing of growth in the U.S. is likely to result in some additional slowing of growth in
that region.
Finally, there still exists a risk of world recession in 1999, although, following on
some important policy steps in the last 2 months that we touched on briefly, the
probability of recession has receded somewhat. It still remains a possibility, and it
especially concerns developing countries, which would, again, be the worst-affected. The
possibility of a world recession, defined as world growth less than 1 percent, exists, in
part, because there are three distinct sources of risk that, in this case, tend to be
strongly mutually reinforcing.
They are: an even deeper recession in Japan; a large correction in the stock markets of
the United States and some European countries and the possibility of prolonged withdrawal
of capital flows from emerging markets. Right now, we remain cautiously optimistic that
the worst will be avoided, provided we do not have another setback in a large emerging
market; providing that the conditions, economic conditions, in Japan don't deteriorate
further, we should see a gradual resumption of capital flows after the turn of the year.
But even against the background of this scenario, capital flows are likely to be much
lower in 1999 than they were in 1998.
Growth in developing countries may take some time--maybe by 2001--to return to the
rapid pace that they enjoyed during the first half of the 1990s. But this period of
renewed growth may be a more sustainable one, with improved institutional capabilities to
reap the benefits of globalization while mitigating some of its risks.
At this point, I would like to turn to my co-author, Milan Brahmbhatt, to address some
issues on East Asia.
MR. BRAHMBHATT: Thanks, Mick.
I'm just going to talk very briefly about some of the conclusions that the report draws
about the evolution of the crisis in East Asia and about the policy responses that were
adopted in response to this crisis.
One of the central messages we derived from this study is the large extent to which
these crises were different from the debt crisis of the 1980s, which originated in
excessive government fiscal deficits and borrowing and for which a well-rehearsed, even
though painful, response already existed.
The East Asian crisis was new in many respects, occurring in the private sector and in
the context of this new, 1990s world of private capital flows; that is, from international
private lenders to emerging market private borrowers. As Joe noted, it was really the
interaction of home-grown institutional weaknesses with imperfections in international
capital markets, which are prone to large swings between euphoria, on the one hand, and
panic on the other, which laid the groundwork for the crisis, as well as ensuring that
their macroeconomic consequences would be very severe.
One of the most critical manifestations of vulnerability was the excessive buildup of
unhedged, short-term foreign currency borrowing by recently liberalized but poorly
supervised financial institutions and also corporations in the crisis countries during the
boom of the 1990s. This buildup made countries very vulnerable to the kind of sudden swing
or reversal in its international capital market sentiment that actually occurred in the
second half of 1997. In several countries, these surging capital inflows and these
weaknesses in financial sector regulation and supervision contributed to huge lending
booms by domestic financial institutions.
These credit booms augmented already high levels of corporate leveraging. They fostered
speculative investments; they fueled bubbles in asset prices, and they weighed down banks'
portfolios with doubtful quality loans. Banks and corporations, therefore, became highly
vulnerable to shocks affecting their cash flow and net worth, such as the bursting of
asset price bubbles or the slowdown in export growth that took place in 1996.
When the reversal in capital flows and in exchange rates occurred then, it was activity
and demand in the private sector, in particular, private investment and consumption that
suffered a collapse and is that which is at the core of the current recessions.
Now, the initial policy responses to the crises, which might have worked in the very
different context of the 1980s government debt crises, proved much less effective in
restoring confidence than anyone initially expected. Indeed, much or most of the
depreciation in currencies occurred after the initial policy measures were taken. The much
larger than expected deterioration in financial and real economic conditions then required
several quick changes in these initial policy packages. Initial fiscal policies turned out
to be more restrictive than was originally the intention, in part, because of the
underestimation of the severity of the downturn in the private sector.
As this became clear, fiscal policies were relaxed in favor of a much more stimulative
stance. Tight monetary policies designed to stem currency devaluation also generates some
very tough policy dilemmas, having an adverse impact on ailing banks and highly leveraged
firms and increasing the risk perceptions attached to financial instruments issued by
these bodies.
The report stresses the critical role of fiscal and monetary policies now in
alleviating the collapse in aggregate demand, as well as in providing resources for
expanding the social safety net and in recapitalizing the financial system. As is too
often the case, the collapse in economic activities is having its most dramatic impacts on
the poor. Unemployment in Indonesia, Korea and Thailand is expected to more than triple,
while the numbers falling below poverty could reach 25 million in Indonesia and Thailand
alone.
Priority actions to protect the poor, including ensuring food supplies to the poor
through direct transfers or subsidies; generating income through cash transfers or public
works; preserving the human capital of the poor through maintaining basic health care and
education services and increasing training and job search assistance for the unemployed
are all important actions.
Finally, restructuring and recapitalizing the banking systems and fostering corporate
restructuring are also essential for revitalizing investment and growth. Large parts of
the financial and corporate sectors in the most affected crisis countries in East Asia are
insolvent or suffering severe financial distress. In several countries, the cost of
recapitalizing banking systems is expected to rise to at least 20 to 30 percent of GDP.
Cross-country experience suggests that restructuring on this scale will require government
intervention within a comprehensive plan for the financial sector, including the injection
of substantial public funds.
At the same time, countries have undertaken the long process of putting into place or
strengthening the laws and institutions needed to provide high-quality prudential
supervision and regulation of their domestic financial systems. Over time, this is likely
to improve the likelihood that countries can enjoy the benefits of greater global
financial integration while reducing some of the risks of crises that come with these
benefits.
Thank you.
MR. MALLOCH-BROWN: Well, we will now--thank you all very much.
We'll take questions. Can I just ask you, one, to wait for the microphone, and two,
although we know who you all are, to identify yourselves by name and organization for the
transcript of this? Just--yes, there.
MR. WOOD: Barry Wood, Voice of America.
Mr. Stiglitz, you say that capital flows in and out caused the crisis. I wonder if you
would elaborate on that. On page 168, you mention Chile, but you don't really say much
about it. But implicit in your remark would be that some kind of Chile tax on short-term
flows must be useful, and I wonder, also, if you would elaborate where you speak about
capital controls having no apparent effect on growth.
MR. STIGLITZ: Well, the point that I made in my introductory remarks was the fact that
these countries have experienced a huge change in flow in and then flow out, and that kind
of change in investor sentiment obviously is very disruptive to an economy and would be
disruptive even if it had strong financial institutions. Obviously, if it has weaker
financial institutions, the adverse effects are all the greater in destabilizing the
economy.
The changing sentiment, of course, is partly a response to weaknesses within the
economy itself. So, one can't separate those, but I think the general sense is that most
of the information relevant to, say, Thailand that led to the crisis in July was available
in May and June. There were a few pieces of information that were not available, but most
of the information was available. Yet, in the month before the crisis, the spreads over
LIBOR rates for borrowing in Thailand were very small; and then, immediately after the
crisis, they increased enormously.
This just illustrates the large shifts in investor sentiment that can occur in very
short spans of time without the release of news of commensurate magnitude that would fully
justify that kind of shift, and that has led--that, combined with one other observation,
the fact that the social risks associated with these disturbances are far greater than the
risks borne by the individuals who engage in these activities; that there is a discrepancy
between social and private returns or social and private risk-bearing that, in general, is
the kind of discrepancy that motivates government intervention to try to bring the two
into balance.
The analogy that I sometimes give is that constructing a dam that stops--that you're
going to have water flow from the top of the mountain down to the ocean, and if you
construct--without the dam, you can have floods and destruction and death. The dam doesn't
stop the flow. It eventually goes from the top of the mountain down to the ocean. But by
putting the dams that stabilize it, you convert this water, which is such a source of
destruction, into actually a very productive source, a source of productivity.
So, the bottom line is that our objective here is to try to look for interventions that
can help stabilize these flows and, therefore, impose less risk on them. There are a
number of examples under discussion. One that is of most interest is the Chilean tax on
inflows, which is designed to stabilize, and it is very much designed to stabilize. Let me
emphasize that; as in the current situation, where the problem is they need more inflows,
they've dropped the tax rate down to zero. So, the tax is there when there is a surge to
try to stop the surge, but now that they need the flow, they have dropped the tax rate
down to zero. So, it really is an intervention designed for stabilizing short-term flows.
MR. MALLOCH-BROWN: Take down here in the bottom right.
MR. ESQUIVEL: Jesus Esquivel from the Mexican News Agency. I have a couple of
questions, Mr. Stiglitz.
First of all, in Latin America, the report says that the forecast for 1999 is 0.6
percent of growth. That means Latin America is going to be in a recession. And can you
please be more specific about the perspectives of growth in Mexico, Venezuela, Brazil and
Argentina, and also, do you fear that this kind of crisis could motivate another social
unrest in the developing countries?
MR. RIORDAN: I'll take a first crack.
The slowdown in Latin America that we have projected for 1999 is largely based on a
number of factors. The first is the likely effects, the short-term effects of the fiscal
austerity measures undertaken in Brazil, which will be somewhat contractionary. The second
case is that we do have continued weak oil prices, in particular, and other commodity
prices that are affecting countries such as Venezuela and other oil exporters.
The third is that the U.S. economy is likely to slow next year, and as a source of
exports for Latin America, this will have some moderating influence on exports from the
region.
We can't comment directly on individual countries. It's a matter of World Bank policy
in terms of projections, in terms of forecasts, but we could speak later for some more
information.
MR. STIGLITZ: Let me address the second part of your question.
You know, in general, there really are systematic relationships between severe economic
downturns and political and social unrest, and we have already seen one manifestation of
that in one of the countries in East Asia. So, it is obviously a source of concern, and
it's one of the backdrops to the World Bank's commitment to trying to develop social
safety nets so that the poorest at least have some degree of protection against the severe
economic circumstances.
The other broad issue is that--a concern to me--is that there not be a swing of the
pendulum on the policy side if part of the problems that we are confronting today are a
result of excessive zeal in deregulation in countries that were not at the stage where
they had the adequate financial and regulatory capacity, institutional capacity; the real
danger now is that there will be a withdrawal from international markets from the
advantages of globalization, and what we would very much hope is that we can get a balance
here where we can go forward in ways that will enable countries to take advantage of
globalization but reduce the risks that are imposed by it on them.
MS. SCOTT: Heather Scott with Market News Service.
Mr. Stiglitz, back to the short-term capital flows issue: could you elaborate a little
on which countries are most likely to need that kind of control? The larger economies,
smaller economies and any in particular that you would care to mention.
Also, you mentioned that some countries might be required to reverse the process of
liberalization somewhat. Can you elaborate on that, what you mean exactly? And don't you
think that might erode confidence further rather than improve it?
MR. STIGLITZ: Let me answer the second question first and answer by way of analogy. I
think there is a general sense that in the United States in the 1980s, financial market
deregulation was carried to an excess, and that excess led to the S&L crisis and that
beginning in 1989, with a new law that was passed and strengthened financial market
supervision, there was a step back from the lax regulatory policies and excesses of
deregulation that had led to the very severe S&L crisis, which did lead, I think, in a
very important way, to the economic downturn in the United States in 1990, 1991, 1992.
So, that is exactly what I have in mind. In less-developed countries, these problems
are more severe, because their regulatory capacities are more restricted, and the risks
that they face are greater. So, the difficulties are greater, and their institutional
capacities are weaker, and the regulatory structure that one designs, the overall system,
the financial system, has to take into account both the risks the countries faced and
their regulatory capacity.
On the first question, I'm very careful in using the word interventions rather than the
word controls. Controls has the overtone of heavy-handed interventions. The kinds of
actions that I have in mind are actions like that of Chile, where they are trying to
stabilize through a tax measure, effectively, a tax measure, and the tax measure is
correcting for a discrepancy between social and private costs and benefits. Just like we
recognize in the area of environment that private incentives are distorted; firms do not
have an incentive to control air pollution, and as a result, we have to take actions to
try to control air pollution; here, we have an example of where private markets may have
an incentive to undertake excessive risks, which puts a real burden on the economy, and we
have to take actions to try to mitigate that kind of excessive risktaking.
A major vehicle for doing that is through adequate, appropriate financial sector
regulation. If the financial sector is doing its job well, it is limiting the extent of
leverage of the private firms, so you don't have huge leverage that makes a country more
vulnerable; you don't have firms that are borrowing very heavily abroad that don't have
balanced earnings to offset that foreign exposure. So, many forms of intervention are
through appropriately-designed financial sector regulation.
MR. MALLOCH-BROWN: Down here.
MR. SITOV: Andre Sitov from TASS.
Chapter two of the report is entitled Responding to the East Asian crisis. The
question, sir, is are the policy responses relevant to other countries such as Russia, for
instance?
MR. STIGLITZ: Well, I tried in my introductory remark to extract some of what I view as
the general lessons that are applicable to all countries, and Mr. Riordan, in his
introductory remarks, also pointed out the fact, for instance, that the circumstances in
East Asia were different from those in Latin America meant that whereas, in Latin America,
you began with a situation of very large macro imbalance, heavy debt, heavy deficits on
the part of governments; inflationary policies on the part of monetary authorities. So,
you had a macro imbalance.
An appropriate response to the crisis was to try to restore that balance. In the case
of East Asia, you began in a situation of rough macro balance. Inflation in Korea had been
brought down from 5.5 to 4 percent, you know, not a bad picture. In that context, you have
to be very careful, in the face of a crisis, of excessive contractionary policies, because
inevitably, in a crisis, you are going to have large falls in aggregate domestic demand;
falls in investment and, quite often, falls in consumption, and that means that if you
begin with a situation of balance, you decrease aggregate demand; you are going to put
yourself into a deep recession.
The consequences of that depend on the circumstances of the country. If you are in a
highly-levered country, which Korea was, for instance, you know that if you go into a
recession in a highly-levered country, you are going to have high levels of bankruptcy.
High levels of bankruptcy, then, are going to contract the potential supply of the
economy.
So, the other lesson that we've learned is you focus not only on aggregate demand but
also on the micro foundations of the economy, the supply side of the economy, and you have
to keep that picture in mind as well. So, I think those are examples of general lessons
that apply rather universally.
MR. MALLOCH-BROWN: Number three here.
MR. MILVERTON: Damien Milverton from Dow Jones.
Just in the report, you mention along the same sort of lines that a substantial share
of losses of restructuring, in particular, the banking sector, should be allocated to
those who benefitted the most from past risk taking, such as bank shareholders and
managers. How would you actually allocate the share of that sort of loss? What are you
actually thinking of there when you mention that?
MR. STIGLITZ: This is just a general proposition. We are not talking here about precise
numbers of this is the percentage of benefit; therefore, this is the percentage of cost
you have to bear. Rather, the point that one is trying to emphasize is that we know that
in these crises, a very large part of the burden is being paid by workers and small
businesses that did not have any share in or a limited share in the benefits. What we are
saying is that the process of restructuring has to be such that some of the old
shareholders, some of the people who lent; some of those parties have to bear some of the
significant costs.
MR. MILVERTON: How do you allocate them?
MR. BRAHMBHATT: Yes; part of the motivation there also is that when you are undertaking
a financial rescue package or recapitalizing the banks, you want to make sure that you
don't end up simply bailing out the risk takers who are responsible in large part for the
problems that have arisen, because that is really going to increase the moral hazard of
the financial rescue package. So, this is really quite a standard prescription that is put
forward when financial restructuring is taking place that those who benefitted in the past
should bear some of the burdens, in order to minimize future moral hazard arising from the
financial rescue operation.
MR. MALLOCH-BROWN: Way back, back row.
MR. CHAPMAN: Irv Chapman from Bloomburg Television.
Dr. Stiglitz, you mentioned some 30 countries in addition to the ones that we have been
focusing on for a year and a half, the Brazils and Russias and Indonesias and the East
Asian tigers. Is there anything that these other countries, these developing countries,
can do for themselves that would mitigate this effect of what's gone wrong in East Asia
and Russia, or are they stuck until the East Asian tigers roar again?
MR. STIGLITZ: That's a very good question. I think in the initial stages of the crisis,
the focus was very much on the fact that these particular countries had misguided economic
policies in one way or another. As the crisis has unfolded and become a global crisis,
many countries that have, I don't want to say faultless economic policies, because there
are no countries that have faultless economic policies, but as reasonable as you will
find, have been very adversely affected, and the recognition that the contagion that
occurs affects countries whether or not they have undertaken undue risks, is a reality
that has to be confronted.
They are affected in a number of different ways that have been talked about. One of
them is this huge terms of trade effect, so a country like Chile that may be pursuing very
good economic policy, its price of copper falls; it's going to be adversely affected. The
oil exporting countries, regardless of whether they were pursuing good or bad economic
policies, and some of them were pursuing bad economic policies, and some of them were
pursuing good economic policies, have been very badly affected. So, that is one channel.
The other channel is the fall in exports at a global level that was depicted, and that
means, you know, countries that are export-dependent, which are very many of the small,
open economies, and we have encouraged that openness, are going to be adversely affected.
And finally, the drying up of international capital markets means that the source of funds
for investment in many countries is going to--is drying up, imposing enormous negative
impact on these countries. The data for the last few months have been, quite honestly,
very dismal.
And these have affected countries, no matter, again, whether they have good or bad
economic policies. The ones with bad economic policies: weak institutions, weak financial
systems, have had bigger effects and are more vulnerable, and the risks, therefore, are
greater. So, to come back to your bottom line, what do they do? Well, the fact that you
have good institutions; that you put into place a good safety net, these are things, these
are policies--good financial regulation--that minimizes the down side. You cannot isolate
yourself from these impacts, but you at least can make sure that the magnitude of the
impact and the down side impact is minimized or less than it otherwise would be.
Secondly, on the capital market exposure, that is really what the third chapter of the
report is about, and raising the question that perhaps they should think about imposing
policies like the Chilean tax to stabilize the flow, so you are less vulnerable to this
sloshing of money in and then money out. Foreign direct investment has been far more
stable than the short-term capital flows. Foreign direct investment brings with it not
only the capital but also access to markets; access to new technology and human capital.
And so, it brings with it far greater benefits that can be identified.
The short-term flows, it's much harder to identify the benefits that are associated
with those flows. The challenge is to find ways of stabilizing the flows that, at the same
time, do not have adverse effects on long-term capital flows. The Chilean experience
suggests that there are those kinds of actions.
MR. SANGER: David Sanger from the New York Times.
In the first two chapters of the report, there isn't much discussion of the role of the
IMF and other major governments that were pressing some of the higher interest rate
policies on Thailand and Indonesia and then, later, Korea, although there is some
suggestion that those high interest rate policies contributed to the recessionary effect.
Did you come to any conclusions about what might have happened to these economies and what
kind of shape they would be in today had they ignored the advice; not increased the
interest rates in order to defend the currencies?
MR. STIGLITZ: Well, let me--okay, issues of counterfactual history are always
difficult, what would have happened if. We know what happened with the policies that were
pursued, but some of our research has cast--not all of which is reflected in this
report--has cast some light on that kind of issue. And let me illustrate what I have in
mind. The debate at the time was centered around the following issue or sets of issues.
Everybody recognized that one of the factors that was important in restoring strength was
restoring confidence. One issue was could you restore confidence in an economy that was
going into a deep recession, and particularly following up on one of the earlier
questions, if that deep recession or depression is going to give rise to social and
political unrest, is that an environment that is going to give rise to restoration of
confidence, and confidence here is not only confidence of investors in the major money
centers like New York and London and Frankfurt but also confidence of investors within the
country that may have to make a decision to keep their money in the country or to engage
in capital flight, and we know from some of the earlier experiences, like in Mexico,
capital flight can be as or more important; so, domestic investors can be as or more
important than investors in foreign countries.
The related set of issues is that in economies with high degrees of leverage,
highly-levered firms, increases in interest rates, if sustained over a very long period of
time, inevitably lead to high levels of bankruptcy, and interest rates have been high for
long periods of time. The good news that was reported is that those interest rates have
now come down, and contractionary policies--and fiscal policies are less contractionary;
so, those policies are now quite changed from the way they were initially.
But high interest rates would inevitably, if sustained, lead to high levels of
bankruptcy, and the levels of bankruptcy--some estimates are that levels of bankruptcy in
Indonesia now are 75 percent, and, you know, you cannot have a country perform with 75
percent of its firms in bankruptcy.
The debate in some sense focused around the difficult issue, very difficult issue, of
the adverse effects of further devaluation versus the adverse effects of higher interest
rates, and there was, as I say, a real concern that further devaluation would have this
very negative effect.
Now, as was commented, most of the devaluation occurred after the policies were
initially put into place, and that raises the point that there may not have been a
tradeoff, because the high interest rates, if they did not succeed in restoring
confidence, would, in fact, lead to further--or be associated with a further devaluation
and would, in any case, not stop the devaluation. They would only work in stopping the
devaluation if they restored confidence. So, it was only if there was a tradeoff that you
had a policy dilemma of whether you should have high interest rates or allow a
devaluation. In fact, what one wound up with was both.
Finally, in assessing the--if there were a tradeoff, one has to look carefully at the
consequences of the two alternative policies, and here is where some recent data for
Thailand is somewhat insightful. In the case of Thailand, we have looked at which were the
firms that were highly in debt--had a high level of foreign indebtedness, and when you ask
that question, you ask, you know, who would be affected by the devaluation versus who is
affected by the high interest rates? We know that high interest rates have adverse effects
on all firms in the economy that are in debt, and financial depth, which includes
borrowing, is one of the central pieces of modernization of a capitalist economy. So, all
firms in the economy were affected by high interest rates: small firms, medium-sized
firms, firms that engaged in international trade; firms that did not. So, it was broadly
across all sectors of the economy.
The foreign indebtedness in Thailand was highly concentrated in two groups. There was a
lot of real estate borrowing and financial sector borrowing to finance real estate. Well,
with the bursting of the real estate bubble in Thailand, those firms were dead, and there
is a general proposition that you can only die once. I guess cats have nine lives, but
they were already dead. So, no matter what happened, those firms were dead, and further
devaluation would not have really made them deader, because there is this huge excess. We
estimate the excess at the time of the crisis; throughout, the vacancy rate was already
approaching 20 percent in Thailand.
The other group are the large exporters. These firms would lose on their exposure in
foreign indebtedness, but they would gain from the devaluation in terms of export
earnings. So, they were, to a large extent, protected.
So, when you do that kind of detailed microanalysis, you come up very clearly with the
conclusion that the risk posed by the economy, the marginal risks, were greater with the
interest rate policy than with the devaluation.
Finally, let me say that there is a lot of discussion about the moral hazard issue. I
think the moral hazard issue is deeper and more profound than has often been recognized.
The moral hazard has focused on the moral hazard associated with the bailouts, but there
is also a moral hazard issue associated with trying to maintain exchange rates at higher
levels than market-determined levels.
You asked the question who are you protecting when you try to maintain that exchange
rate by having high interest rates? Who are you protecting? You're protecting firms that
have gambled on the exchange rate. They have borrowed in an uncovered way. Those are the
firms that you're protecting. And who is paying the price? The small businesses that did
not gamble; the workers who are going to be put out of jobs. And so, this is the real
moral hazard, that you say, if you gamble and expose, we will impose macroeconomic
policies that will minimize your loss. That is the real moral hazard, and that is the one
that has had an enormous--going forward, imposes enormous risks in setting examples in the
future.
MR. MALLOCH-BROWN: We can only take one last question. A lot of you caught my eye. I'm
going to--you caught it first. Let's just wait for the microphone.
[Pause.]
QUESTION: Yes, I have, actually, two quick questions, one for Mr. Riordan. You created
two scenarios, one baseline scenario and one low-case scenario, in which one, you have a
recession in one, and maybe there is a recession in one and no recession in the other. I
would like for you to give some probability to each of those scenarios.
And the second question, for Mr. Stiglitz: if this analysis that you just made
regarding the tradeoff between exchange rate and interest rate could be applied nowadays
in the Brazilian situation.
Thank you.
MR. RIORDAN: Regarding the low-case scenario, as we noted, the number of policy
measures that have been enacted over the last 2 months have, we believe, decreased the
probability of that happening. Japan--the measures implemented in Japan are hoped to
provide some cushion to growth next year. The reductions in interest rates in the U.S. and
in some European countries are likely to help engineer a soft landing in this country and
potentially set the stage for smoother growth in Europe.
So, the industrial countries, the slow down in industrial country growth could have
been much worse had these policies not been taken; we feel pretty strongly about that.
The other aspects in this low-case scenario were related to corrections in equity
markets and the possibility that capital flows do not return to emerging markets, as we
expect them to do in our most likely scenario after the turn of the year. We can't really
assign probabilities to these. These are exercises that help us gauge what level of risks
exist in the global economy, but we still believe that our baseline scenario continues to
be most likely, although we still have to be aware, as the East Asian financial crisis has
taught us, of the possible down side risks.
MR. STIGLITZ: Let me answer the second.
The general propositions that I described earlier, the general factors that one takes
into account, apply in every country. The way that they are interpreted depends very much
on the circumstances of the country, and I emphasized this in my introductory remarks, and
let me just mention four circumstances that differ markedly from one country to another.
The degree of leverage makes the country far more vulnerable, firms in the country--a high
degree of leverage can make firms much more vulnerable.
Korea probably had the highest degree of leverage of its firms of any country in the
world, and that made it particularly vulnerable. The maturity structure of the debt has a
very big impact. If you have short-term debt relative to long-term debt, then, changes in
the interest rate have a much more immediate effect and make it more difficult for firms
to withstand periods of high interest rates.
The existence of special windows for access to capital make the economy less vulnerable
to interest rate changes. Many economies have available, for instance, special windows for
small and medium-sized enterprises or for agriculture that mean that when interest rates
go up, the interest rates that you see, the interest rates that borrowers have to pay, may
not go up in tandem. So, the fragmentation of the capital market in some senses can be a
good thing in the face of this kind of a crisis.
One of the problems of East Asia was that it had actually less degree of fragmentation
in the capital markets than many other countries less--fewer special windows to insulate
the impact. And finally, on the side of the impact of exchange rate changes, the extent of
exposure, the kinds of analysis that I gave in the case of Thailand needs to be done for
each particular country: which are the firms that have borrowed? What is their exposure?
Are they dead once already or not? That kind of detailed analysis has to be done to assess
the appropriateness of the nature, the tradeoffs, in facing each country.
So, what I'm arguing for is a general framework for thinking about this but not a set
of answers that is automatically applicable to any particular situation.
MR. MALLOCH-BROWN: Thank you all very much.
[Whereupon, at 11:13 a.m., the briefing was concluded.]
