The perfect storm

Shadow Finance Minister Leo Brincat traces the storm which World Bank economist Joseph E. Stiglitz created in IMF circles about globalisation, financial regulation and a redefinition of the role of the state

This has nothing to do with the recent cinema blockbuster. The confrontations that ensued relied more on intellect than on muscle.

No CGI or state-of-the-art special effects were employed in the process.

Joseph Stiglitz is a remarkably productive economist and is internationally recognised as one of the world's leading thinkers.

He made a name for himself both for his voluminous writings in academic journals, conference proceedings and edited volumes as well as for his teaching and the conduct of research at many of the world's most prestigious universities.

From 1993-97 Stiglitz was a member of the US President's Council of Economic Advisors, having gone on to chair the CEA in June 1995.

In a book he has recently written not only did he outline the aberrations of the globalisation process but also pointed out various flaws in the politics and running of the International Monetary Fund (IMF) to the extent that he even attributed certain financial crisis mishandling to the IMF itself.

His findings created such an uproar that for a few weeks the polemic and controversy found itself extended to the IMF Website, where there were rather uncomplimentary exchanges with the author.

Understandably, this was more than a clash of personalities. It was a full frontal attack that put the whole integrity of the Fund into question, particularly when Stiglitz insinuated that key IMF officials had acted the way they did because undue influence had been exerted on them by certain financial institutions which they eventually ended up joining. I would rather not name names for prudence's sake.

Before engaging himself in this acidic exchange with the IMF, Stiglitz had already resigned in controversial circumstances from the prestigious post of senior vice-president and chief economist at the World Bank.

Market failure was always something that caught his imagination. By developing and extending the theory of market failure to take into account the impact of imperfect information and incomplete markets, Stiglitz advanced economists' understanding of how to improve the efficiency and effectiveness of state intervention designed to improve the functioning of market-based economics.

He did not believe that Governments should revert to their former role of replacing the markets, but on the other hand he provided an intellectual thrust for those who see an important role for government as a strategic complement to markets.

One did not have to wait for his recent bestseller for him to launch his critical attacks on major US-based institutions.

His outspoken views challenging the so-called Washington consensus have frequently involved extensive criticism of the IMF and the US Treasury Department, institutions that continue to play a pivotal role in influencing and managing the global economy.

When referring specifically to the East Asian crisis, Stiglitz attributed policy failure in large part to a culture of secrecy and lack of dialogue, which surrounds international economic policy-making.

In 2000 he wrote a particular paragraph which should prove to be an eye-opener for all of us politicians - leftists, rightists or centrists:

"Smart people are more likely to do stupid things when they close themselves off from outside criticism and advice. If there's one thing I've learned in Government, it's that openness is most essential in those realms where expertise seems to matter most."

On Russia's transition to a market economy, he felt that the US Treasury Department and the IMF were more influenced in their policy recommendations by the shock therapists than those economists like him who emphasised a piecemeal, incremental and adaptive approach to transition.

I can see his point. Gradualism as an approach need not be interpreted as indecisiveness. It could also serve to emphasise the importance of carefully establishing the necessary institutional infrastructure as a key prerequisite if the launch of a market economy is to have lasting success.

It was for this reason that Stiglitz had stated in 1994 that transforming to a market economy does not entail a withering away of the state but a redefinition of its role.

He felt that in order to work effectively, in addition to private property a market economy requires legal and financial institutions, regulatory frameworks, an independent judicial system capable of enforcing laws which establish a secure economic environment, a capable, effective system of government, and political stability.

Stiglitz has often argued strongly in favour of changing the process of development dialogue away from one reflecting the paternalistic attitude of the North. For him the role of the economist is not to tell governments what to do but to lay out the consequences of various courses of action and allow the country to make the decision.

One of his major regrets is that the old IMF-World Bank mantra was very much focused on primary education but paid little attention to the role that education could play as part of the whole social transformation and the closure of the knowledge gap.

Another point, which Stiglitz regularly makes, is that students of economics should also study economic history. He said so with Russia particularly in mind, as he was of the opinion - rightly or wrongly - that the legacy of Russia's past has had an important influence on the course of events there.

On the financial crisis in South East Asia, he opined that premature capital market liberalisation associated with inadequate financial sector regulation leading to heavy short-term indebtedness was the main source of the crisis. He said so because he was of the opinion that financial sector liberalisation without the necessary regulations and supporting institutions was the fundamental cause.

The speed with which capital market liberalisation was forced on these countries meant that important institutions, such as risk management structures, were not put into place. Therefore, there were no effective systems in place in these countries to cope with the risk and that is undoubtedly the core of the problem.

What is most intriguing is not only that a respected Western economist wrote this but that he had it published in an official World Bank publication.

Stiglitz has that unique quality of writing that makes one sit back and take note, whether one agrees with it or not.

What I found most compelling was his view on globalisation. On one hand he considered it to be a very powerful force for the good, citing the East Asian miracle and the recent performance of China to see what can be achieved by adopting a more outward-oriented strategy, but on the other hand he emphasised that globalisation done the 'Washington consensus' way, imposed on countries around the world, has been a very negative force.

On the role of the state this will ultimately change with a country's stage of economic development as well as changes in the external environment. Citing as an example of the would-be partnership between government and markets, Stiglitz said that the financial system plays a key role in promoting development, but if it is not functioning well it can also be a major source of instability.

e-mail: leo.brincat@magnet.mt

References

Redefining the Role of the State - Joseph Stiglitz interviewed by Brian Snowdown

"Joseph E. Stiglitz on Principles of Financial Regulation", The World Bank Research Observer, Spring 2001, Volume 16 - No. 1.