There are sharp differences over the sort of system needed to make markets work, says Sudhir Mulji
If there is anything that is significant by its absence in Washington, it is consensus. The most conspicuous of all dissensions is that between Joe Stiglitz, and his bosses John Wolfensohn and Michel Camdessus. Stiglitz has been publicly attacking the application of the Washington Consensus formula to countries whose institutions are not sufficiently developed to carry out the reforms. He has been particularly critical of financial institutions in Russia as also Southeast Asia.
The Fund and the Bank have taken umbrage to his criticisms. Camdessus in a press conference endorsed Wolfensohn's rebuke of Stiglitz by using the French adage Ne tirer jamais l'ambulance (Never shoot at the ambulance). The Fund had been the ambulance that assisted countries. He did not feel any need to defend the Fund's actions in lending money to troubled nations.
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Camdessus is, of course, a brilliant international civil servant fluent in many languages, and is able to reply to his critics in their own language whether it is French, English or Spanish. However, the issue is not of language but of economic concepts. Stiglitz is an outstanding professional economist and a potential Nobel Prize winner. He has been a star at Oxford and Princeton. His arguments should always be heeded. He understands the limitations of his subject and knows the flaws in the orthodoxy preached.
His criticism is often valid. Certain types of assistance may be inappropriate to countries that do not have the necessary institutional arrangements in place to use them. It has always seemed to me difficult to introduce market reforms in the erstwhile Soviet Union where the very notion of prices has been lost in distortions for 70 years.
In my STC days, I listened to the peculiar gobbledegook that planners from the Gosplan expounded. They were clearly attempting to replicate a co-ordination mechanism, which markets manage to do so elegantly. Their plans did not seem to work and it was unlikely that they ever could.
Interjecting market-type reforms in such a system looks a non-starter and Stiglitz is right to criticise optimistic expectations. Yet the formidable problem is what other solution is better? Neither Stiglitz nor anyone else has been able to produce a blueprint for the sort of financial regulations that need to be in place to successfully prosecute reforms that can avoid crises. Until Stiglitz can find a better formula he must expect to be snubbed by his colleagues.
The Fed chairman, Alan Greenspan, offered some indications for the sort of system you need to make markets work. Without being self-congratulatory he claimed that the US authorities were surprised at the smoothness with which a crisis was averted last year at the time of the collapse of Long Term Capital Management. The Fed eased liquidity through sharp interest rate cuts. In turn this brought about confidence in the markets and within a short period of four weeks markets stabilised.
But Greenspan warned that injecting liquidity does not always succeed. In particular he cited the Japanese example where liquidity has not improved matters one whit. Greenspan attributed this failure to the fact that the Japanese relied exclusively on the banking system. Japan, he claimed, has an undeveloped capital market; so even when the liquidity of banks improved they were unwilling lenders. The will to borrow had equally vanished so all that was left was unutilised liquidity.
It was a pity that Greenspan did not use familiar terminology. Japan had fallen into a classic liquidity trap, a concept well known to economists ever since Keynes wrote about it. The solution, perhaps the only solution, for Japan is to initiate large-scale public works.
The workings of the liquidity trap were brilliantly if inadvertently illustrated by Abby Cohen, undoubtedly the most outstanding speaker at the Annual Meetings. She is the chief investment strategist for Goldman Sachs. Ms Cohen graphically illustrated that although the cost of capital in Japan was 5 per cent lower than in the US, the return on capital was 10 per cent less than the US. Thus whereas the spread on capital employed in US has shown a positive return of 4 per cent, the spread in Japan has shown a negative return of 2 per cent.
Abby Cohen's answered a point that has puzzled me about the behaviour of economies in recent years. It is surely surprising that economic growth has been so strong in the US when real interest rates have been strikingly high. Yet throughout this decade the American economy has created as many as 16 million new jobs. In contrast, Japan, in spite of its low interest rates, has lost a million jobs. To my question Ms Cohen replied that the reason for this perverse outcome was that because of high real rates American corporate decision-makers were forced to choose their investments with greater care than the Japanese. The Americans have actively sought profitable investments because the cost of capital has been high; while in an environment of easy capital the Japanese have thrown away resources in poor and untimely investments.
This answer, if correct, should be very disturbing to economists. For it is bedrock of economic science that agents will seek the highest return on capital. If the profit-maximising businessman does not exist, that is, if a low cost of capital attracts or satisfies businessmen with seeking low returns on investment, that must be regarded as a significant attitudinal change in economic behaviour. For the time being at least one should look upon Ms Cohen's arguments as speculative at best.
Finally there was the ongoing dissension between those who believe that the Fund and the Bank have served their purpose and the time to wind them up is nigh. In a well-attended seminar under the auspices of Deutsche Bank, Dornbusch and Stanley Fischer expressed opposing views.
Dornbusch, who was described by Paul Volker as the enfant terrible of the economic profession, dismissed the Fund and the Bank in one sentence by stating that the world would be better off without these Bretton Woods institutions.
Fischer, on the other hand, who surely is the epitome of central banking orthodoxy, said that the two institutions had now acquired a role, which made them indispensable to the management of the world economy. In their role as lenders they could perhaps be replaced by the private sector. But in the authority they had acquired in surveillance of economies, in their role as the first port of refuge for economies in crisis, their role had been considerably enhanced. The two institutions had acquired both prestige and enjoyed the confidence of many harassed and distressed finance ministers.
In a masterly demonstration of their new found importance, Fischer gave an admirable summary review of world economies. Between the trouble spots of Southeast Asia and Eastern Europe, he had a word of praise for India, which seemed to have stabilised at a high growth rate. He thought that we could do much better if we completed the reforms; indeed he expressed the view that India could be the next tiger economy of emerging markets. That was a matter of satisfaction indeed for Indians in the audience.