Kenneth Rogoff: Policy Paralysis

Kenneth Rogoff says problems associated with financial market liberalization during the 1990s brought about an irrational fear of relaxing capital market controls in developing countries, and this fear of liberalization is preventing developing countries from realizing their growth potential. Though he acknowledges it will be controversial, he believes developing countries should be encouraged to pursue greater capital market liberalization because "Weak financial systems in emerging markets are a major obstacle to balanced development. They are also a big factor behind the global trade imbalances":

As the IMF meets, policy paralysis is continuing, by Kenneth Rogoff, Project Syndicate: Financial globalization is exploding. Yet, as the world's leading finance ministers and central bankers convene in Washington this month for the semi-annual International Monetary Fund (IMF) board meetings, policy paralysis continues. There is simply no agreement on how to address glaring problems such as America's increasingly fragile trade deficit, or financial dysfunction in a number of emerging markets.

This paralysis has three layers. First, rich countries are deeply reluctant to embrace any collective plan that might impinge on their own domestic policy maneuvers. The United States is the worst offender. US Treasury secretaries ... lecture their foreign colleagues on America's economic perfection, and why every country should seek to emulate it. Never mind that this logic is now in danger of unraveling along with the US housing market; Treasury Secretary Hank Paulson will stick to it. But the fact that the US looks set to borrow almost $900 billion this year from the rest of the world is hardly a sign of US strength and foreign weakness.

It is difficult to summarize the cacophony of European voices so succinctly. ... Europeans generally agree that their societies produce the best lifestyles, even if their economies are less efficient than America's in a Darwinian sense. Thus, European finance ministers, too, will not be keen to admit any need for major policy changes to deal with risks from financial globalization.

The Japanese typically try to keep quiet. As huge winners from globalization, they want to avoid criticism of their ... policies, which arguably remain considerably more protectionist than those of their rich-country counterparts. And they certainly don't want to be pressed to apologize for holding hostage over $800 billion in foreign currency reserves, acquired to resist yen appreciation.

Developing countries are also at fault. Too many policymakers still believe that externally imposed opening to international capital flows was the main culprit behind the financial crises of the 1990s - a view that unfortunately is lent some intellectual respectability by a small number of left-leaning academics.

Never mind that most of the crises could have been avoided, or  at least substantially mitigated, if governments had let their currencies float against the dollar, rather than adopting rigid exchange-rate pegs. Instead, the bogeyman of financial globalization is used as an excuse for continuing to coddle inefficient and monopolistic domestic financial systems. The inability of backward domestic financial systems to allocate investment efficiently is a big factor pushing funds out of poor countries and into the US.

Last but not least, the IMF ... ought to be providing more leadership. ... Unfortunately, the IMF is paralyzed by ... internal governance problems, the biggest of which is the lack of a sensible way to recalculate the voting shares of countries as their relative influence in the global economy evolves. In particular, a radical increase in the weight of Asia's vote is urgently needed.

What, then, should ministers do when they gather in Washington? First, there is the long-standing litany of policy responses needed to deal with the global trade imbalances. These include greater fiscal discipline in the US, greater reliance on domestic demand in both Europe and Asia, and more flexible exchange rates in Asia.

But it is time to go further and begin to lobby aggressively for faster financial liberalization in the developing world. ... [B]ad memories of the IMF's first, premature attempt to promote long-term capital market liberalization remain an obstacle today..., coming as it did in the middle of the 1990s Asian financial crisis... But it is now time to revisit the idea... Weak financial systems in emerging markets are a major obstacle to balanced development. They are also a big factor behind the global trade imbalances.

Pushing for greater capital market liberalization after the debacle of the 1990's will be controversial. But the core of the idea ... is right... In the absence of better mechanisms for capital allocation, global growth in this century will slow down a lot sooner than it should. ...

Comments

[Farrar Richardson]

"...he believes developing countries should be encouraged to pursue greater capital market liberalization because 'Weak financial systems in emerging markets are a major obstacle to balanced development. They are also a big factor behind the global trade imbalances'"

Fine! For example, the Hanoi govt should round up all the speculators and other shady capitalist types whom they have recently released from reeducation camps, place them in an impressive many-columned building full of computers and high speed internet connections, and tell them "Go to it boys (and girls) - here's your new liberalized capital market."

But I must have missed something - after all this guy is a Harvard prof and former IMF honcho; and we shouldn't hold it against him just because of his feud with our alternative economy hero Joe Stiglitz.

[gordon]

Two points; first, the "institutional weakness" of many developing countries is a fact of life. It has been documented over and over again, but very few analysts have ever come up with a response other than "strengthen weak institutions". I seem to remember Gunnar Myrdal making this point way back in the 1970s or even 1960s, but very few people ever paid attention. Myrdal noted (I don't have any of Myrdal's works handy, so this is from pretty hazy memories) that the power structures of developing countries revolve around networks of relationship, obligation and debt which make them fundamentally prone to "coddle inefficient and monopolistic domestic financial systems" in the way Rogoff rails against. A moment's reflection indicates how silly the standard response of "strengthen institutions" is; it is about as silly as saying "poverty would be cured if there were no poor people", or "the trouble with blacks is that they are black".

The second point is more worrying. What does Rogoff want when he says "But it is time to go further and begin to lobby aggressively for faster financial liberalization in the developing world"? "Lobby aggessively"? Invade somebody else? Are we going to revisit the MAI? Is colonialism respectable again?

[Winslow R.]

" What does Rogoff want when he says "But it is time to go further and begin to lobby aggressively for faster financial liberalization in the developing world"? "

I think its clear what Paulson et. al. want.

Restrictions on financial institutions has eliminated the profits from the spoils of bankruptcy. Look at China, Goldman Sachs is drooling over the load of supposedly nonperforming state loans. Now if they can only convince the Chinese to allow some instability into their system.....

Rogoff has been bought off. Things are just too stable for those in our financial system to continue making profits. Now that the profits from the carry trade are ending too, what to do?

China with its absolute need for stability has inadvertently created a stable financial system for the whole world, who'd of thunk! They must be stopped before New York/London goes bankrupt and globalization bites its own tail!

[spencer]

After the Asian financial crises of the 1990s many Asian governments were forced by the IMF, IBRD and Washington to implement restrictive financial policies that severely damaged their economies, at least on a cyclical basis.

They looked around and saw the one exception of Taiwan that had not been forced to tighten. Why was Taiwan the exception? Because they had huge foreign exchange reserves and did not have to go hat-in-hand to the IMF for emergency financing. So they learned their lesson and implemented a policy of building large foreign exchange reserves to make them independent of the IMF, IBRD and the Washington consensus.

It looks like they have resolved the problem. So why does Rogoff want to return to the old system?

[DRR]

I want global financial markets to be liberalized too. And they will eventually. But capital liberalization should be one of the last if not the thee last step in a developing countries' checklist. But developing countries can't handle the capital policies of nations like the U.S., Canada or Sweden yet.

[david]

Nuts.

"the power structures of developing countries revolve around networks of relationship, obligation and debt which make them fundamentally prone to "coddle inefficient and monopolistic domestic financial systems""

I don't see why the above comment needs the word "developing" in it. How does the US work again? Rogoff to Paulson to Rubin and back, relationship, obligation and debt, supported by and supporting trade liberalization as an answer to all those people's woes.

[Winslow R.]

Thought this graph was interesting show of how private lenders 'interests' are misaligned with the public interest. Financial liberalization is not all its cracked up to be.

http://www.responsiblelending.org/pdfs/Net-Losership-3-26.pdf

"Regulators and Congress have hesitated to curb abusive and reckless lending practices, citing a
concern that stronger consumer protections might reverse the gains in homeownership. The poor
record of subprime loans shows that this fear is misplaced. In fact, states that have passed
stronger laws in recent years have reduced targeted practices without reducing access to home
loans.13"

[Cassandra]

Winslow said:
Rogoff has been bought off. Things are just too stable for those in our financial system to continue making profits. Now that the profits from the carry trade are ending too, what to do?

If there is one thing Economic History reveals, it is that one writes the epithet for volatility and instability at their peril. At best Economists betting upon volatility's permanent demise will - with hindsight - see it as windowing illusion, for investors have seemingly learned that he best forecast is to extrapolate the latest observations.....until it's [often spectacularly] not.

[Winslow R.]

"If there is one thing Economic History reveals, it is that one writes the epithet for volatility and instability at their peril"

I have no doubt that in the end Goldman Sachs etc. will get their desired volatility even if assassinations, revolutions, etc are required.

It seems an integral portion (financial) of the system has a vested interest in destabilizing the other (government).

Now that moving financial wealth from one jurisdiction to another is easier than ever (though still highly restricted in some critical areas) one has to wonder how 'needed' instability will be brought about?

How 'needed' is instability by the general population?

[Cassandra]

Winslow
Now that moving financial wealth from one jurisdiction to another is easier than ever (though still highly restricted in some critical areas) one has to wonder how 'needed' instability will be brought about?

It is the very fact that (for the moment) "wealth" can - or at least is deemed to be transportable across boundaries that causes, or will cause, instability. For there is a fallacy of composition here. Recall the lovely scene in MAry Poppins when the young boy demands his tuppence....and multiply it by trillions....

[gordon]

David, thank you, excellent point. If all we are left with in the globalisation debate is difficuties of accommodation between local and foreign elites, each as corrupt as the other, then I suppose we can formally bury Development Economics and reduce that whole field to a branch of "Realpolitik". That will create some room in a whole lot of bookshelves. I wonder, what will fill the space? Game Theory? Or maybe just Jane's Fighter Aircraft?