RICHARDT. ELYLE CTURE

Globalizationand Its Challenges

By STANLEY FISCHER*

Istandhere with deeply con icting emotions. policyeconomists of our time. In his policy Iamhonored to be delivering this prestigious workhe displayedthe same rare talentas he had lecture.I amprofoundly sad that Rudi Dorn- inhis theoretical work, of being able to extract busch,who should have delivered the Ely Lec- theessence of a complicatedproblem and ex- ture,died in Julylast year and that I amhere in plainit in terms that made it seem simple. hisplace. So I wouldlike to start by talking Amonghis policy papers, the most famous is about Rudi. the1994 Brookings paper with Alejandro Rudiwas bornand grew upin Krefeld, Ger- Werner thatpredicted the Mexican peso crisis, many.He was anundergraduate at the Univer- butthat is only one of manyapplied papers that sityof Geneva and completed his Ph.D. at the repaysrereading. Universityof Chicago in 1971, which is where As hispolicy interests grew, Rudi’ s fame we met.He was astudentof Robert Mundell, spread.He was anindefatigableglobal traveler, andboth the subject matter (the development of speaker,and writer, and a frequentcolumnist. In theMundell-Fleming model) and the elegance hismorepopular articles, in hiscolumns, and on andinsights of his early work re ected Mun- thepodium, his wit and the speed of his mind dell’s inuence. He taughtat the University of madehim an exciting and formidable presence. Rochesterand at the University of Chicagobe- He was oneof the Ž nestdebaters and polemi- fore acceptingan offer from MITin1975. cistsin the profession. He was toughand did not In1976, soon after coming to MIT, Rudi shyaway from statinghis views, often in ways wrotehis most famous and in uential theoreti- thatre ected the advice of Keynes: “ Words calarticle, “ Expectationsand Exchange Rate oughtto be a littlewild for theyare the assault Dynamics.”As KenRogoff (2002 p. 1) saidin ofthoughtson theunthinking.”At varioustimes hiscelebratory lecture on the 25th anniversary hewas personanon grata to theauthorities in a ofits publication, “ The‘ overshooting’paper... numberof countries; it did not help that more marksthebirthofmoderni nternational oftenthan not he was right. macroeconomics.” Despitehis public persona, Rudi was an From thelate 1970’ s, Rudi became increas- excellentconŽ dential policy adviser. When I inglyinterested in policy issues. Within a de- was atthe IMF, I oftencalled him to discuss cade,he had become one of the outstanding adifŽcult situation. His advicewas always thoughtful,typically nuanced, and frequently providedinsights that no one else had seen— *Citigroup,399 Park Avenue, New York,NY 10022- andhe was willingto talk as long as it took. 4614(e-mail: Ž[email protected]).This is arevised Rudiplayed a centralrole in the MIT Eco- versionof the Ely Lecture presentedat theAmerican Eco- nomicsDepartment. He was aspectacularly nomicAssociation meetings in Washington, DC, on 3 January successfulteacher, in the classroom, in super- 2003.The Ely Lecture was originallyto have been presented byRudi Dornbusch, who died on 25 July 2002. I am grateful visingtheses, and through his textbooks. But he toAndrew Balls, Olivier Blanchard, Vittorio Corbo, Angus didnot spoonfeed the students, sometimes po- Deaton,Peter Diamond,Jaewoo Lee, PrachiMishra, Chi sitioninghimself in frontof anunfortunate stu- Nguyen,Maurice Obstfeld,Ratna Sahay,Lyn Squire, Larry dent,asking a seriesof questions until he Summers, andJohn Williamson, and to my Citigroup col- leagues,Lewis Alexander,Eric Darwell, andDana Peterson, extractedan answer.Nonetheless he wonmany fortheir assistance andadvice. Views expressedare thoseof prizesfor teaching.Every outstanding Ameri- theauthor and not necessarily ofCitigroup. caninternational macroeconomist who has been

1 2 AEAPAPERSAND PROCEEDINGS MAY 2003 toMIT, among them Jeffrey Frankel,Paul Thedebate is untidy and ill-deŽ ned, and one Krugman,Maurice Obstfeld, and Ken Rogoff, couldreact by saying that it has no place in a was aRudistudent. And there are outstanding professionalsetting like this one. But we cannot Rudistudents all over the globe, many of them affordto ignore it, for theviews and attitudes heretonight, many of them professional econ- expressedin itwill inevitably affect public pol- omists,some who became Rudi’ s co-authoron icy—and the issues are critically important for apaper,many who became policymakers. In the thefuture economic growth and well-being of richlydeserved devotion of this legion of stu- allthe people of theglobe. 2 dentsto theirteacher and friend lies the greatest Here isthe message: Globalization, the complimentto his teaching and mentoring. ongoingprocess of greater interdependence Ihadthe good fortune and pleasure of amongcountries and their citizens, is complex collaboratingwith Rudi in the writing of two andmultifaceted. Many of theproblems that the textbooksand several articles. Our textbook criticsof globalization point to arereal. Some of Macroeconomics ,whichhas sold well over a themrelate to economics. Others relate to non- millioncopies worldwide, has given me as economic,but no lessimportant, aspects of life. muchsatisfaction as anything else I havedone Andwhile some of theproblems do stem from inmy professional life. And I knowRudi felt theprocess of globalintegration, others do not. thesame way. As far aseconomics is concerned, the big Rudiwas avitaland positive personality, challengeis poverty, and the surest route to wholit up any group in which he participated. sustainedpoverty reduction is economic growth. He was amongthe most talented of men, and Growthrequires good economic policies. The amongthe warmest, the most generous, with his evidencestrongly supports the conclusion that timeand himself, available for hisstudents and growthrequires a policyframework thatprom- hisfriends whenever they needed him. When inentlyincludes an orientation toward integra- theycalled or visited, Rudi would say “ Tell tioninto the global economy. This places meeverything” and then give them his sympa- obligationson threegroups: those who are most thy,his understanding, and his unsentimental responsiblefor theoperation of theinternational advice. economy,primarily the governments of thede- We willmiss Rudi deeply, including tonight, velopedcountries; those who determine the in- for hisincisive mind, the brilliance of his in- tellectualclimate, which includes this audience sights,the exuberance of his writing, and his butalso government and nongovernment orga- challengesto conventional thinking— but most nizationsand individuals; and the governments ofall,for hisfriendship and the pleasure of his ofthedeveloping countries who bear the major company. responsibilityfor economicpolicy in their countries. I.The GlobalizationDebate Letme startby discussingthe historical back- ground,the protagonists, their views, and the Thedebate over globalization is lively, often passionate,and has sometimes been violent. At 1 leastuntil recently, it has been intensifying. throughthe use ofthe Google search engine,and typing in“ anti-globalization”brings up 80,000 links. Type in globalizationand inequality, and there are almost 500,000 1 Duringthe 1970’ s theword “ globalization”was never references; 700,000references toglobalization and environ- mentionedin the pages of TheNew YorkTimes. Inthe 1980’ s ment;almost 200,000links to globalization and labor theword cropped up less thanonce a week; intheŽ rst half standards;50,000 references toglobalization and multina- ofthe1990’ s, less thantwice aweek; andin the latter half tionals;and 70,000 references toglobalizationand cultural ofthe decade, nomore thanthree times aweek. In2000 diversity.A search ofglobalization and the IMF yields there were 514stories in the paper that made reference to 180,000suggestions. “globalization”; there were 364stories in 2001, and 393 2 Fora comprehensivereview ofthe economic issues, references in2002. Based onstoriesin TheNew YorkTimes, see theextremely usefulpaper by Franc¸oisBourguignon et theidea ofbeing “ anti-globalization”was notone that al.(2002), which covers many of theissues inthis lecture existedbefore about 1999. Turning from the newspaper to (see alsoInternational Monetary Fund, 1997; World Bank, theinternet, “ globalization”brings up 1.6 million links 2002a). VOL. 93 NO. 2 RICHARDT. ELYLECTURE 3 issues.Economic globalization, the ongoing tries(the more developed and larger developing processof greater economic interdependence countries)increased, the impossible trinity once amongcountries, is re ected in the increasing againasserted itself, and in a seriesof crises, amountof cross-bordertrade in goods and ser- countryafter country was forcedto give up its vices,the increasing volume of international peggedexchange rate and allow the currency to Žnancial ows,and increasing  owsof labor.  oat. As iswell known to our profession, economic Bynow, the gross volume of international globalizationthrived in the period before 1914, capital owsrelative to globalGDP far exceeds butwas setback by thetwo World Wars andthe thelevels reached in the period just before GreatDepression. 3 Theinternational Ž nancial 1913,though net  owsof foreigndirect invest- orderthat was establishedat the end of World menthave not yet attained the extraordinary War IIsoughtto restore the volume of world levelsof the decade before World War I. 5 trade,and by 1973,world trade as a percentage Itis generally believed that, with respect to ofworldGDP was backto its 1913 level, and it migrationand labor  ows,the modern system is hascontinued to grow almost every year since. 4 lessglobalized than it was acenturyago. 6 In Whilethe founders of the Bretton Woods 1911,nearly 15 percent of the United States systemsaw therestoration of tradein goodsand populationwas foreign-born;today that number servicesas essential to the recovery of the isprobably a bitabove 10 percent. Emigration globaleconomy, they did not have the same ratesfrom Europe,especially Ireland and Italy, benignview of capital ows.Nonetheless, cap- were amazing:14 percent of the Irish popula- ital ows amongthe industrialized countries did tionemigrated in the 1880’ s, and over 10 per- recoverduring the 1950’ s, and intensiŽ ed inthe centof the Italian population emigrated in the 1960’s. Rapidly they became too powerful for Žrst decadeof the 20th century. Jeffrey Wil- thepegged exchange-rate system to survive, liamson(2002) attributes a signiŽcant part of andby 1973, as aresultof theimpossible trinity theconvergence of incomelevels in the Atlantic (of apeggedexchange rate, capital mobility, economyin the late 19th and early 20th centu- anda monetarypolicy directed at domestic ob- riesto mass migration. 7 Whetheror not migra- jectives),the Bretton Woods adjustable-peg tionand labor  ows aregreater now than they systemhad to give way to  exibleexchange ratesamong the major countries. Capital owsto developing countries grew 5 Somesuggest that capital markets remain less inte- moreslowly. In the late 1970’ s andearly 1980’ s gratedtoday than in 1913 (e.g., Maurice Obstfeldand Alan theyconsisted mainly of bank loans; by the Taylor,2003). 1990’s theytook the form mainlyof foreign 6 Thenote of caution is enteredbecause itis notclear directinvestment and purchases of marketable howmuch labor  owsbetween developingcountries (South–South labor  ows)have changed. These tookplace securities.As thevolume of internationalcapi- ona large scale before1913, but they are alsovery large tal owsto andfrom theemerging market coun- today.Timothy J. Hattonand Williamson (2002 p. 25) comment “South–South migration is not new. It is just ignoredby economists.” What is clear is thatimmigration 3 Jeffrey Williamson(2002) classiŽ es theperiod 1820 – owsto and from industrialized countries are lowernow 1914as theŽ rst great globalizationera, andthe period since thanin the decade beforeWorld War I(see Williamson, WorldWar IIas thesecond. 2002).For example, the annual immigration rate tothe 4 Trade as apercentage ofworld GDP isestimated to UnitedStates fell fromabout 11.6 per 1,000 in 1910 to 0.4 haverisen from less than5 percentin 1800 to a peakof just in1940 and rose to4 inthe 1990’ s. The volume of remit- over20 percent at thestart ofWorld War I,andthen tances providessome evidenceon labor-marketintegration. collapsedto 5 percentat theend of WorldWar II.Between Remittances fromoverseas workersmake laborservices a 1947and the Ž rst oilshock in 1973, world exports grew at major exportfor many poor countries. The volume of re- anaverage annualrate of8.8 percent per year. Between mittances increased froman annual average of$22billion in 1973and 1990 they grew at anannual rate of4.4percent; the1970’ s (measured in1995dollars) to $81billion in the thegrowth rate inthe1990’ s was 7percent.As aresult,the 1990’s, which is more thanthe annual volume of aid(Clau- world’s markets forgoods and services are more integrated diaBusch et al.,2002). thanever before,though the pattern is different, with a rise 7 Inhis work, Jeffrey Williamsonfrequently uses the inintra-industrytrade, compared with the predominance of convergenceof prices, rather thanthe volume of trade,as an inter-industrytrade inthe earlier periodof globalization. indicatorof theextent of globalization. 4 AEAPAPERSAND PROCEEDINGS MAY 2003 were acenturyago, we arebecoming more improvementsin communications and the spread globalizedin this regard too, for migrationrates ofinformation were criticalto the collapse of havebeen rising— and in a potentiallyimpor- theIron Curtain. People learned what was hap- tantway, for moremigration than in the past peningin other countries and understood that isfrom less-developedto more-developed theydid not have to live the way they were countries.8 living,and the Iron Curtain fell. Allthis is at an abstract level. In terms of Whilewe needto recognize the importance, people’s dailylives, globalization means that andpossibly the predominance, of thenoneco- theresidents of onecountry are more likely now nomicelements, I shallfocus on the economic thanthey were 50years ago to consume the debate.One set of views on economic global- productsof anothercountry, to investin another izationis summedup byacharacteristicpassage country,to earn income from othercountries, to from RudiDornbusch (2000 p. 91): talkon the telephone to people in other coun- tries,to visit other countries, to know that they Onthe verge of world de ation, Japan arebeing affected by economic developments bankruptand Europe moving at near- inother countries, and to know about develop- stallingspeed only, the emerging markets mentsin other countries. batteredand the United States beholding a Globalizationis much more than an eco- gloriousbubble— how can this mark the nomicphenomenon. The technological and endof a greatcentury of prosperity?And yet,this has been the best century ever, politicalchanges that drive the process of nevermind the great depression, a mo- economicglobalization have massive noneco- 9 mentarysetback from communismand nomicconsequences. Inthe words of Anthony socialism,and two great wars. Mankind Giddens(2002 p. 10), a leadingsociologist: todayis far andfurther ahead of whereit “Iwouldhave no hesitation ... insaying that hasever been and there are the seeds of globalisation,as we areexperiencing it, is in innovationfrom biologyto the Internet manyrespects not only new, but also revolu- for betterand richer lives even beyond tionary....Globalisation is political, technologi- ourwildest dreams. caland cultural, as well as economic.” Thenoneconomic aspects are at least as im- Thiscentury, and in particular the last portantin shaping the international debate as are threedecades, have witnessed just that as theeconomic aspects. Many of those who ob- thenation state has been dismantled in jectto globalizationresent the political and mil- favorof a globaleconomy, state enter- itarydominance of the United States, and they priseand economic repression give way resentalso the in uence of foreign (predomi- tofree enterprise,and breathtaking inno- vationand greedy capitalism break down nantlyAmerican) culture, as they see it at the governmentand corporate bureaucracies. expenseof national and local cultures. Anyonewho says impossible Ž nds him- Thetechnological elements matter in practice selfinterrupted by someone who just did aswellas in thedebate. For instance,the events it.The process is far from complete;in- of11 September 2001 could not have taken novationand free enterprisespread the placebefore the current global era. The com- mindset,the success and the acceptance municationsand transport systems that have ofthis model to the horror of status quo acceleratedthe pace of globalizationare also at politiciansand the sheer exuberance of all thedisposal of terrorists,money-launderers, and thosewho are willing to embrace a can-do internationalcriminals. On the positive side, attitude.If thiscentury taught anything it issurelythis: even daunting setbacks like depressionand war areonly momentary tragedies—buying opportunities, if you 8 Thefact thatmigration often has abrain-drainaspect raises importantissues. like—in a relentlessadvance of the stan- 9 Therapid increases inglobal integration in the second dardof livingand the scope for enjoying halfof the19th century and early 20thcentury were driven betterlives. One of the great economists bytheoutbreak of peace inEuropeand the invention of the ofthis century, Joseph Schumpeter— telegraph,the steamship, and the railroad. AustrianŽ nanceminister of the 1920s VOL. 93 NO. 2 RICHARDT. ELYLECTURE 5

andHarvard professor at the end— wrote othereconomic issues that feature in the debate ofcreative destruction as the dramatic overglobalization and its consequences, among mechanismof economic progress. That them:whether globalization results in unfair processis at work. laborpractices in developing countries— an ar- gumentwhich is not compelling; whether glob- Abroadrange of critics is arrayed on the other alizationdamages the environment; whether side.Among them are academics, opinion lead- multinationalcorporations have become too pow- ers,individuals and groups who see their inter- erfulto the detriment of developing-country citi- estsbeing affected by globalization,politicians, zensand governments; whether globalization NGO’s, and demonstrators— and these categories givesrise to tax competition that undermines arenot mutually exclusive. 10 Tolisten to the thecapacity of governments to raise revenues debatein the terms each side paints the other, andthus to provide necessary services to their onemight think that it is a discussionbetween citizens;whether intellectual-propert yprotec- Dr. Pangloss,who believes that all is for the tionis damaging the health of developing- bestin thebest of allpossible worlds, and those countrycitizens; and the roles of the World whobelieve that the world is going to hellin a Bankand the World Trade Organization. These handbasket.That is doubly misleading. In the Ž rst areimportant issues, some of themcritical, and place,many of those who regard themselves as somedo not have simple answers. But these pro-globalization,myself among them, know problemsare being seriously analyzed by econ- thatthere is far toomuch misery in the world, omists,for instanceby Bourguignon et al. thatthere are many wrongs to berightedin the (2002)for theEuropean Commission, by the globaleconomy, and that it could be made to WorldBank (2002a), and others. 12 operatemuch better. And on the other side, Onequestion before turning to the evidence: many(but not all) of thecritics are not against Almosteveryone recognizes that the world globalization.Rather, from NGO’s demonstrat- couldbe a betterplace, and that there is much ingfor furtherdebt relief and campaigning for workto be done to improve it. Why then is so greateraccess of developing-countryexports to muchof thedebate about whether the world is industrialized-countrymarkets, to academic critics gettingbetter or worse, rather than about what questioningcurrent policy views, many are seek- canbe done to make it a betterplace? It is inga betterand fairer globalization. becausethe debate is ultimately about policies. Iwilldiscuss Ž veofthekey economic issues Theimplicit premise is that if theworld is going inthe debate: 11 tohell,then the policies that have been followed for thepast 50 yearsare likely to be wrong.And (i) whetherpoverty and inequality are in- ifthe world has been getting better, then the creasingor decreasing; policiesare more likely to be right. 13 It is a (ii)whether integration into the global econ- separatequestion whether it is globalization that omyis good for growth; isresponsible for whathas happened. (iii)whether the international Ž nancialsystem Thepolicies in dispute are generally those istoo crisis prone, and capital  owsneed thathave been recommended by the international tobe banned or regulated; Žnancialinstitutions and most industrialized- (iv)the unfairness of the global trading system, countrygovernments. 14 At thebroadest level, andthe inadequacy of aid ows; (v) therole of theIMF. 12 Forreferences tothe literature, see Bourguignonet al. For wantof time, but also for lackof com- (2002);on the trade-related issues,see alsoJagdish Bhag- parativeadvantage, I willnot cover a hostof wati (2000). 13 Whilepersuasive, the implicit proposition is not logicallycompelling, for policies could be wrong even if 10 Fora discussionof the anti-globalization groups and theworld is improving,and right even if the world is theirconcerns, see KimberlyAnn Elliott et al.(2003). deteriorating. 11 See thediscussion of the 12 charges againstglobal- 14 Inthat regard, the present discussion is merely the izationin the Ž nalchapter of Bourguignon et al.(2002). latest manifestationof a long-runningeconomic policy 6 AEAPAPERSAND PROCEEDINGS MAY 2003 thepolicy consensus consists of fourelements: worldsituation confronting policymakers, I still policiesto ensure macroeconomic stability; regardthese ten elements as a usefulshorthand market-orientedmicroeconomic policies; inte- descriptionof a majorpart of adesirablebasic grationinto the global economy, particularly on policyorientation. 17 Andfor thatreason I shallat thetrade side; and a positiverole for govern- leastfor awhilecontinue to use the term “ Wash- mentin establishing, monitoring, and develop- ingtonconsensus.” ingthe institutional framework oftheeconomy, providingpublic goods including especially so- II.The Evidenceon Poverty cialexpenditures, and conducting stabilization and GlobalInequality policies. Beyondthese broad headings, detailed policy A. Poverty recommendationshave been spelled out in manyWorld Bank and IMF publications,for For sometime it was acceptedthat the pro- instancethe WorldDevelopment Reports of the portionof peopleliving in povertyin the world World Bank.15 Oneformulation that has re- hasbeen declining, but their absolute number ceivedmuch attention and a largeshare of cal- hasbeen increasing. This refers tothe World umnyis theso-called Washington consensus set Bank’s measureof absolutepoverty, deŽ ned as outby John Williamson (1990). 16 The ten ele- livingon a realincome of less than one dollar mentsof the 1990 consensus were (i) Žscal a day.18 Thereis noconsistentfully reliable set discipline,(ii) public-expenditu re prioritiesin ofdata re ecting longer-term developments in educationand health, (iii) tax reform (thetax poverty.19 Ausefulestimate of post-WorldWar baseshould be broad, and marginal tax rates IIdevelopmentsis shown in Figure1: theglobal shouldbe moderate), (iv) positive but moder- povertyrate is estimated to have declined im- atemarket-determined interest rates, (v) acom- pressivelyfrom about55 percent in 1950 to petitiveexchange rate as the “ Žrst essential 23.7percent in 1992. 20 Ithas continued falling elementof an‘outward-oriented’economic pol- since. icy”(p. 14), (vi) import liberalization, (vii) Thedata most often used in discussing recent opennessto foreigndirect investment (but “ lib- povertydevelopments come from theWorld eralizationof foreign Ž nancial ows isnot re- Bankand are based on national estimates of gardedas a highpriority” [p. 15]), (viii) povertyrates. These estimates are likely to be privatization(based on “ thebelief that private subjectto signiŽcant error, astherecent debate industryis managed more efŽ ciently than state overthe Indian poverty data illustrates. Indian enterprises”[p. 16]), (ix) deregulation, and (x) growthin the1990’ s averagednearly 6 percent, protectionof property rights. morethan 3 percentper capita. Aggregate con- TheWashington consensus is a brandname sumptionin the national income accounts rose thathas been so abused as probably to have by3.2percent per capita. But household survey outlivedits usefulness. While no short descrip- data,on which India’ s povertyestimates are tionof theeconomic policy choices that face a countryand of the principles that it should follow 17 Iwas oneof thediscussants of theWilliamson (1990) canbe adequateto the complexities of thereal- paperat thetime (mycomments are onpp. 25– 28) and mentionedamong the missing elements theresponsibility of thegovernment to create anenabling environment for eco- debatethat has at times pittedprotectionists against free- nomicactivity, the need for directed anti-poverty policies, traders andthose who believe in a greater rolefor the state andenvironmental concerns. againstthose who believe more inmarkets. 18 Strictlyspeaking, the $1 per day Ž gurecorresponds to 15 See DavidLindauer and Lant Pritchett (2002) for an aPennWorld Tables PurchasingPower Parity income of accountof changing views ofdevelopment policy during about$1.08 in 1993 prices (ShaohuaChen and Martin thepost-World War IIperiod. Ravallion,2001). 16 These were notnecessarily JohnWilliamson’ s views, 19 Iam particularlygrateful to Angus Deaton for guiding butrather hisattempt tocapture the consensus of thetime. me throughthe debate on the poverty data. He bears no Inthearticle, heexpandson the range of views (including responsibilityfor the views set outin thissection. hisown, which generally include several qualiŽcations) 20 These data are fromBourguinon and Christian Mor- undereach heading. risson(2002). VOL. 93 NO. 2 RICHARDT. ELYLECTURE 7

FIGURE 1. GLOBAL POVERTY RATES: PERCENTAGEOF PEOPLE LIVING ON LESS THAN $1 PER DAY Source: Bourguignonand Morrisson (2002). based,showed very little increase in per capita Applyingthe Bhalla procedure to all coun- consumption. 21 triesalso produces rapid declines in global pov- Basedon the sample surveys, poverty de- erty.23 Morecautiously, recent World Bank data clinedrelatively little in India in the 1990’ s. showthe global poverty rate declining sharply Basedon the national income accounts, it from 29.6percent in 1990 to 23.2 percent in shouldhave declined signiŽ cantly. One way of 1999(Table 1). 24 Accordingto these estimates combiningthe data, chosen by Surjit Bhalla (andthey are only estimates), the absolute num- (2002),is to assume that the distribution of berof thepoor declined by 123million people, consumptionin the sample surveys is correct, or10percent,during this period. The number of butto adjust the mean increase in consumption poorin China alone fell by 150 million. Table inthe sample surveys to equal that in the na- 1showsthat the major decline in the global tionalincome accounts. This produces spectac- povertyrate is accounted for byAsia, with the ulardeclines in poverty in India during the absolutenumber of poor in sub-Saharan Africa 1990’s. TheofŽ cial data also show signiŽ cant, but smaller,declines in the Indian poverty rate, neitheris there anyevidence that the pro-market reforms led from about40 percent in 1987– 1988 to 26per- toincreases inpoverty or slowed poverty reduction. centin 1999 –2000.In checking these data, 23 Bhalla’s (2002)estimates are thatpoverty was 30 Deaton(2002a) reports, “ Muchto my surprise, percentin 1987, and only 13 percent in 2000. This would mostof the ofŽ cially claimed reduction in pov- implythat the last decade ofthe last centurywas themost 22 successful inall ofhistory in reducing poverty. Xavier ertyappears to be real.” Sala-i-Martin(2002b) shows even larger declinesin global povertycounts over the period 1970 – 1998,using a similar methodology.He estimates the$1 perday poverty rate tobe only5 percentin 1998. 21 AngusDeaton (2002a) provides a briefdescription of 24 Surprisingly,the heading on a tablevery similar to theproblem. Table1 (table1.2, p. 18) in the United Nations Develop- 22 Deaton,whose work is regardedas authoritative,es- ment Program’s (2002) HumanDevelopment Report is: timates thepoverty rate for2000 to be28percent;he Žnds “Worldwide,the number of peopleliving on less than$1 a thatthe poverty rate inIndia declined fairly steadily over the daybarely changed in the1990s.” The table shows that even past20 –30years, withno evidence of a pickupfollowing theabsolute number of those living on less than$1 a day thereforms in1991. But he notes (Deaton, 2002a) that declinedby 10 percentin the1990’ s. 8 AEAPAPERSAND PROCEEDINGS MAY 2003

TABLE 1—REGIONAL BREAKDOWN OF POVERTY IN DEVELOPING COUNTRIES

Numberof peopleliving on $1 per day less than$1 perday headcountindex (millions) (percent) Region 19871990 1999 1987 1990 1999 East Asia andPaciŽ c, 418 486 27926.6 30.5 15.6 excludingChina 114 110 5723.9 24.2 10.6 Europeand Central 1 6 24 0.2 1.4 5.1 Asia LatinAmerican and 64 48 5715.3 11.0 11.1 theCaribbean MiddleEast and 9 5 6 4.3 2.1 2.2 NorthAfrica South Asia 474 506 48844.9 45.0 36.6 Sub-SaharanAfrica 217 241 31546.6 47.4 49.0 Total: 1,1831,292 1,169 28.3 29.6 23.2 ExcludingChina: 880 917 94528.5 28.5 25.0

Source: WorldBank staff estimates ( GlobalEconomic Prospects 2003 ).

(andalso in the transition economies) rising risenin all regions in the last 25 years, and signiŽcantly. infantmortality has declined signiŽ cantly. Life Betweenthem, China and India account for expectancyhas risen in most regions. However, 38percent of the world’ s population.In 1990 underthe impact of theHIV/ AIDSpandemic, theyaccounted for 60percent of the world’ s ithasbegun to declinein sub-SaharanAfrica, poor.It is therefore hardly surprising that the withparticul arlylarge and tragic impact in globalpoverty rate fell sharply in a decadein Botswana,Zimbabwe,South Africa, and whichChina grew atmore than 9 percentand Kenya.27 Indiaat 6 percent.It may be argued that what The HumanDevelopment Report presents a happenedin Chinaand India is atypical.That is HumanDevelopment Index (HDI), whichis trueif theunit is the country, but not if the unit basedon three equally weighted factors, life isthe individual. 25 Further,there can be little expectancy,education, and (the logarithm of) a doubtthat, in both India and China, the growth purchasing-power-parityestimate of per capita policyduring the period was pro-globalization, GDP.28 Figure3 showschanges in the HDI over pro-entryinto the global economy. Of course, thepast 20 years. Note in particular that the notevery detail of policy in either country fol- HDIisinherently an index of relative perfor- lowedthe Washington consensus, but both mance,so that the improvements in all regions countriesgrew fasterafter opening up. 26 representa convergenceof this more general Beyondthe data on per capita income, most measureof economic and social progress across socialindicators have also shown considerable regions. improvementin the postwar period and more Inaddition, as the 2002 HumanDevelopment recently.As Figure2 (takenfrom theUnited Report shows,democracy has been spreading, NationsDevelopment Program’ s [2002] Human includingin thedeveloping world. By oneclas- DevelopmentReport )shows,adult literacy has

27 Life expectancyis estimated byapplying current age- 25 Thesharp differences inpoverty rates amongIndian speciŽc mortalityrates; itthusis not the life expectancyof states andamong Chinese provinces should also contain anindividual born today, for which it wouldbe necessary to policy-relevantinformation. forecast mortality. 26 However,Deaton (2002b) Ž ndsno acceleration inthe 28 Allmeasures are takenrelative tothe highest level rate ofpoverty reduction following India’ s policyreforms in attainedwithin the sample, sothe index is boundedabove 1991. by 1. VOL. 93 NO. 2 RICHARDT. ELYLECTURE 9

FIGURE 2. ALTERNATIVE INDICATORSOF HUMAN DEVELOPMENT Notes: Regionsare abbreviatedas follows:LHD, low human development; SSA, sub-Saharan Africa; AS,Arab states; SA, southAsia; EA,east Asia andthe PaciŽ c; LA,LatinAmerica andthe Caribbean; CEE, central andeastern Europeand CIS; OECD,high-income OECD. Source: UnitedNations Development Program’ s (2002) HumanDevelopment Report .

siŽcation, the number of authoritarian regimes Thediscussion of trendsin global poverty is declinedfrom 67to26between1985 and 2000 asigniŽcant part of the globalization debate. (hardlysurprising given the transition in the Butit doesnot directly address the globalization former Sovietbloc and the changes in Latin issue,of whetherwhatever has been happening America) whilethe number of nations catego- iscaused by increasing integration into the global rizedas “ mostdemocratic” rose from 44to 82 economy.That question will be addressed when I (UnitedNations Development Program, 2002 discussthe impact of openness on growth. [Ž g. 1.1]). Thusthere is considerable evidence that on B. Inequality averageconditions have been improving in the developingcountries. That is to say, the worldis Whilea globalRawlsian perspective would notgoing to hell in a handbasket.But that is leadto afocuson povertyreduction, we needto emphaticallynot to say that everyone in the focusalso on inequality, not only because for developingcountries is doing better. In partic- manygreat inequality is undesirable per se, but ular,conditions in most of sub-SaharanAfrica, alsobecause growing inequality may have pow- whereper capita growth has been negative in erfulpolitical consequences. For instance,in the nearlyhalf the countries in thelast quarter cen- Žrst eraof globalization,changes in theincome tury,have been deteriorating, and Latin Amer- distributionthat affected real wages and the icahas not done well in the last decade. returnsto land and capital led to pressure to 10 AEAPAPERSAND PROCEEDINGS MAY 2003

inequalityamong country average incomes wouldeventually decline— but that could take a verylong time. The weight of the evidence appearsnow to have moved away from the initialconclusion of conditional convergence towardthe twin-peaks view, that there is a con- vergenceclub among the high-income OECD countries,while lower-income countries are convergingto a lowerincome level (Danny T. Quah,1996). Developmentsin inequality within countries maybe politicallymore important than changes ininequalityamong countries. There was arise FIGURE 3. RECENT TRENDS IN THE HUMAN DEVELOPMENT ininequalityin the United States and the United INDEX (HDI), SHOWING GLOBAL DISPARITIES Kingdomfrom thestart of the1980’ s untilwell Notes: Regionsare abbreviatedas follows:SA, South Asia; intothe last decade. Inequality during that pe- SSA,sub-SaharanAfrica; AS,Arab States; DC,all devel- rioddid not increase markedly in continental opingcountries; EA, east Asia andthe PaciŽ c; LA,Latin Europe,probably due to labor-market regula- America andthe Caribbean; CEE, central andeastern Eu- tions,social welfare programs,and tax sys- ropeand CIS; OECD, high-income OECD. 30 Source: UnitedNations Development Program’ s Human tems. Reviewingthe literature, Lawrence F. DevelopmentReport ofŽce calculationsbased on indicator Katzand David H. Autor(1999) concluded that table 2. tradeexplains at most 20 percent of therise in inequalityin the United States and that skill- limiteconomic integration (Jeffrey Williamson, biasedtechnological change explains 80 percent 2002).That could happen again, as globaliza- of the rise.31 Thereare also instances of increas- tioncreates losers as well as winnersin theshort inginequality within some poor countries, in- run.29 cludingChina and India, even though incomes Inequalityamong national average incomes haveincreased at both the top and the bottom of appearsto havebeen increasing for atleast 400 thescale. In the transition economies of the years,since before the rapid increases in eco- former Sovietbloc, inequality increased sharply nomicintegration that took place in the 19th inthe 1990’ s. century(Jeffrey Williamson,2002). However, Beyondthe inequalities among national av- thislong-term rise in inequalityamong national erageincomes, and within countries, stands the averageincomes seems to have slowed during conceptof the distribution of global income thepast 20 years(see Bourguignonand Morris- amongall the world’ s people,of which there son,2002; Sala-i-Martin, 2002a, b). arenow several estimates (e.g., Bhalla, 2002; Theconvergence debate in macroeconomics Bourguignonand Morrisson, 2002; Milanovic, was basedon purchasing-power-parity esti- 2002a;Sala-i-Martin, 2002). These are all based matesof national average incomes. As iswell ondata on the distribution of income within known,and as Figure 4 illustrates,the raw data nations,and some method (typically using pur- oncountry average incomes show divergence, chasingpower estimates) for comparingincome notconvergence. The early results, for instance levelsacross countries. Figure 5 showswhy thoseof RobertJ. Barro(1997), supported con- suchan estimatemight Ž ndinequalitydeclining ditional convergence.Provided the conditioning variablesdo not change in an offsetting direc- tion,conditional convergence implies that the 30 Theymay well insteadhave produc edhigher unemployment. 31 KennethScheve and Matthew Slaughter (2001) em- phasize whatthey call the“ skills-preferences cleavage”on 29 See BrankoMilanovic (2002b) for a forcefulstate- globalizationamong the American public,in which views ment oftheview that current trends are likelyto producea onglobalizationare signiŽcantly affected bythe skill level backlashunless globalization as we knowit is tamed. ofpollrespondents. VOL. 93 NO. 2 RICHARDT. ELYLECTURE 11

FIGURE 4. AVERAGE ANNUAL GROWTH (1980– 2000) ON INITIAL LEVEL OF REAL GDP PER CAPITA Note: Thedata are valuesfor real GDP inU.S.dollars per equivalent adult. Source: PennWorld Tables, version 6.1 (available online: http://pwt.econ.upenn.edu/ ). amongnations: it is the graphic representation ectedin theHDI, presentsa moreencouraging ofapopulation-weightedconvergencediagram, pictureof thechanging fortunes of thepoorest, inwhich the dominance of China and India butthe HIV-AIDS epidemicis taking a sadtoll drivesthe relationship. Bourguignon and Mor- onlongevity in Africa. risson(2002) conclude that the inequality of Income-distributiondevelopments are more globalincome worsened from thestart of the mixed.There has been a growingdivergence 19thcentury until the end of WorldWar II “and amongnational average incomes. Inequality has afterthat seems to have stabilized or to have risenwithin many countries; but it is likely that grownmore slowly.” 32 inequalityamong the world’ s citizensdeclined Wheredoes that leave us onbothpoverty and duringthe last decades of the 20th century. theglobal distribution of income?Poverty rates However,we shouldnot take too much comfort havebeen declining, especially in Asia. So very from that,for asSala-i-Martin (2002a) points likelyhas the absolute number of those living at out,“ UnlessAfrica startsgrowing in the near belowone dollar a day.Increasingly, global future,... incomeinequalities will start rising povertyis being concentrated in Africa. At the again.” sametime, poverty rates have not declined muchin Latin America in recentdecades. Tak- III.The PolicyIssues ingaccount of other social indicators, as re- A. Tradeand Growth

Tradepolicy has long been central to eco- 32 However,Milanovic (2002a) Ž ndsthat global income inequalityincreased between 1988and 1993, in part be- nomicpolicy choices. In the early post-World cause ofgrowing gaps between ruraland urban incomes in War IIperiod,the theory of import-substituting China.By contrast, Bhalla (2002) shows world inequality in industrialization(ISI) dominatedamong devel- 2002at itslowest level in the post-World War IIperiod,a opingcountries, and its implementation for resultof themuch greater reductionsin global poverty in the 1990’s thathis methodology produces. Similarly, Sala-i- sometime seemed to produce positive results. Martin(2002a) Ž ndsmassive decreases inglobal inequality Then,as timewent by, it was observedboth that at theindividual level between 1980and 1998. countriesthat had pursued export promotion 12 AEAPAPERSAND PROCEEDINGS MAY 2003

FIGURE 5. AVERAGE ANNUAL GROWTH (1980– 2000) ON INITIAL LEVEL OF REAL GDP PER CAPITA (AS IN FIG. 4, BUT WITH AREA PROPORTIONALTO POPULATIONIN 1980) Note: Thedata are valuesfor real GDP inU.S.dollars per equivalent adult. Source: PennWorld Tables, version 6.1 (available online: http://pwt.econ.upenn.edu/ ). strategieswere moresuccessful than those that (1995)which concludes that, ceteris paribus, hadfocused on keepingimports out and that the opencountries grow 2 percentper annum more returnsto ISI seemedto be diminishing. rapidlythan closed countries, has received par- Earlycase studies of tradeliberalization were ticularattention. A closelyrelated literature ex- conductedin the 1970’ s and1980’ s underthe aminesthe mechanisms through which openness auspicesof the OECD, theNational Bureau of contributesto growth, particularly through its EconomicResearch (NBER), andlater the impacton productivity,where the availability of World Bank.33 Theseby andlarge supported the importedinputs plays a role. 36 casefor exportpromotion policies, that is, for Theregression studies have been comprehen- integrationinto the global economy. Subse- sivelyreexamined and criticized by Francisco quentlya hostof cross-sectional regression Rodriguezand Dani Rodrik (2001), who argue studieswere undertaken, 34 mostof themshow- thatthe results are not robust, the measures of ingthat greater openness is associated either with opennessused in thestudies neither clearly ex- higherlevels of incomeor morerapid growth. 35 ogenousnor consistent across studies, and the Thestudy by Jeffrey Sachsand Andrew Warner econometrics awed. 37 Nonetheless,the case studiesthat show trade liberalization as an es- sentialelement in policy reforms thatled to 33 TheNBER studiesare summarized inBhagwati growth,the bulk of theempirical evidence, and (1978)and Anne Krueger (1978); the World Bank studies thefact that the most spectacular growth stories are summarized inMichael Michaely et al.(1991). 34 T.N.Srinivasanand Bhagwati (1999) criticize the allinvolve rapid increases in both exports and regressionapproach in arguing for the superiority of the imports(frequently after speciŽ c policydeci- case-studymethod. I haveused both methods on different occasionsand regard each as havingimportant weaknesses (see alsoKrueger, 1983). 36 Theliterature on openness and growth is well sum- 35 Examplesinclude David Dollar (1992), Dan Ben- marized byBourguignon et al.(2002 pp. 37– 39) and by David(1993), Jeffrey Sachs andAndrew Warner (1995), AndrewBerg and Krueger (2003). SebastianEdwards (1998), Jeffrey Frankeland David Ro- 37 Warner’s (2001)draft response to the Rodriguez- mer (1999),and Dollar and Aart Kraay (2001a,b). Robert Rodrikcritique strongly disputes several ofthese criticisms, E.Hall andCharles Jones(1999) include both openness (the includingthe suggestion that the black-market premium is Sachs-Warner index)and a measure ofgood governance, nota usefulindicator of trade distortions,and reafŽ rms the whichis highlycorrelated withthe openness indicator. Sachs-Warner conclusions. VOL. 93 NO. 2 RICHARDT. ELYLECTURE 13 sionshave been made to open up) should per- hasbeen fastest where economic growth has suadeus that openness to the global economy beenfastest (in developing Asia) andslowest isa necessary,though not sufŽ cient, condition wheregrowth performance has been worst (in for sustainedgrowth. 38 Toquote Dani Rodrik Africa). (2001p. 23), “ Nocountry has developed suc- Nor, despitethe early results of Simon cessfullyby turning its back on international Kuznets,does there appear to beanyinevitable tradeand long-term capital  ows.” associationbetween growth and inequality; Tosay that is not to say that immediate full rather,it depends on the details of thepolicies, tradeliberalization is necessarilythe best policy includingdistributional policies, that accompany for acountry,nor that opening to trade is suf- thegrowth strategy. 41 Intwo related studies, Žcientfor growth,nor that the accompanying Dollarand Kraay (2001a, b) conclude,based on policyframework isirrelevant. 39 Indeed the datafrom 92countries, that on average the accompanyingframework isessential. It is to say, incomeof thelowest Ž fthof theincome distri- however,that countries that want to grow should butionrises one-for-one with aggregate income, asa keypart of their policy framework orient andthat this same relationship holds for growth themselvestoward integration into the global thatis induced by trade liberalization. tradingsystem, to take advantage of the avail- Tosaythat, on average,growth or openingto abilityboth of much larger global than domes- tradedoes not adversely affect the incomes ticmarkets, and of more sophisticated capital-, ofthe poor is not to say that the impact of intermediate-,and consumer- goodimports. 40 policychanges on income distribution should beignoredwhen any particular policy change is B. Growth,Poverty, and Inequality beingconsidered. The opening of trade is de- signedto affect domestic relative prices and Here Icanbe brief. Logic dictates that there mostlikely will affect the distribution of income isno way of lifting the populations of poor ineach case. 42 If theseeffects are judged to be countriesout of poverty (say, on the scale that adverse,transitional compensatory measures hasbeen achieved in East Asia) withoutsus- andgradual liberalization may help mitigate tainedgrowth. Globally, the decline in poverty them(see Scheveand Slaughter, 2001 pp. 94 – 96).It is also the case that a smalleconomy tendsto be more vulnerable to  uctuationsin 38 Rodrik(2001 p. 23) does not disagree withthis con- clusion,emphasizing rather thespeed of adjustmentand the theterms of tradewhen it is openthan when it needfor accompanying policies: “ Thetrick in the successful isclosed, and that the poor may be the most cases has beento combine the opportunities offered by vulnerablein this regard. 43 worldmarkets witha domesticinvestment and institution- buildingstrategy to stimulate theanimal spiritsof domestic C. Capital-AccountLiberalization entrepreneurs.Almost all ofthe outstanding cases— East Asia, China,India since theearly 1980s—involve partial andgradual opening up toimports and foreign investment.” Thereis far morecontroversy about capital- 39 Bergand Krueger (2003 p. 39) state, “Opennesshas accountliberalization as part of a growth importantpositive spillovers on otheraspects ofreform,so strategythan there is aboutcurrent-account lib- thecorrelation of trade withother pro-reform policies speaks tothe advantages of makingopenness a primarypart eralization.That is not surprising, for asthe ofthereform package.”This relates toanemerging litera- ture(e.g., Dollar and Kraay, 2002;William Easterly and RossLevine, 2002) that argues either that the growth effects 41 Barro(1999) states thatthe Kuznets curve does ofopenness and the institutional structure of the economy emerge as aclear empirical regularitybut does not explain are difŽcult to distinguish, or that institutions are more mostof thevariations of inequalityacross countriesor over important.I Žndthe Berg-Krueger argument on this point time. persuasive. 42 MattiasLundberg and Lyn Squire (1999) Ž ndthat growth 40 NancyBirdsall (2002) argues that openness does not ismore sensitivethan inequality to policy interventions. workwell forthe poorest countries, because oftheir greater 43 There isnogeneralprescription for what these policies dependenceon primary exports and because oftheirgreater shouldbe; they need to be designed taking the circum- vulnerabilityto external shocks. It is nonethelessdifŽ cult to stances ofthe country into account; for instance, in the see howa small economycould hope to reach ahighlevel Indonesiancrisis of1997–1998, subsidizing the price ofrice ofincomewithout integrating into the global economy. was akeypro-poor policy. 14 AEAPAPERSAND PROCEEDINGS MAY 2003

Asiancrisis drove home, a countrywith an open aticin this case, for asHali Edison et al. (2002b) capitalaccount is more vulnerable to external note,successful economies are generally open shocksthan one that is closedto external capital economies.  ows. Therelationship between capital-account lib- Inconsidering capital-account liberalization, eralizationand growth is likely to beinherently Iassumethat countries will and should at some weakerthan that between current account liber- stagein thecourse of theirdevelopment want to alizationand growth, since it is more dependent liberalizethe capital account and integrate into onthe sequencing of reforms, andthe presence globalcapital markets. This view is based in ofpreconditions(e.g., a strongmacroeconomic parton the fact that the most advanced econo- framework) thanis the current-account liberal- miesall have open capital accounts; it is also izationrelationship. An interesting Ž ndingin basedon the conclusion that the potential ben- thisregard is thatof CarlosArteta et al.(2001), eŽ ts of well-phasedand well-sequenced inte- whoconclude that capital-account openness has grationinto the global capital markets (and this apositiveimpact on growth contingent on the includesthe beneŽ ts obtained by allowing for- absenceof a largeblack-market premium— eigncompetition in the Ž nancialsector) out- whichis agoodidicator of theabsence of mac- weighthe costs. 44,45 roeconomicimbalances. Withregard to empirical evidence on the At presentmost developing countries main- beneŽts of capital-account liberalization, I taincapital controls. Experience suggests they believewe areroughly now where we were shouldonly be removed gradually, at a time inthe 1980’ s oncurrent-account liberaliza- whenthe exchange rate is not under pressure, 47 tion—that some evidence is coming in, but andas thenecessary infrastructure (in the form thatit is at thisstage weak and disputed. 46 The ofstrong domestic Ž nancialinstitutions, a directionof causation is particularly problem- soundmacroeconomic framework, a market- basedmonetary policy, the underpinnings of an effectiveforeign-exchange market, and the in- 44 Theargument is developedat greater lengthin Fischer formationbase necessary for themarkets to 48 (1998).The point has beenmuch disputed, including by operateefŽ ciently) is put in place. For most Bhagwati(1998). countries,it wouldbe desirableto begin allow- 45 Itis alsobased on the views thatin practice capital ingsome  exibilityof exchange rates as the controlsare oftendiscriminatory, a standinginvitation to corruption,and grow progressively less effective overtime. controlsare eased, unless the country intends to 46 Rodrik(1998) presents a critical viewof capital- moveto a hardpeg— and after Argentina, that accountliberalization. A set ofpapers presented at aMay doesnot look advisable, unless there is aclearly 2002World Bank conference “FinancialGlobalization: deŽned terminal condition. 49 Prudentialcontrols ABlessingor a Curse?”(available online: http://www. worldbank.org/research/conferences/Žnancial_globalization. htm )onbalance pointedto small positiveimpacts ofŽnan- cial liberalizationon growth (see e.g.,Geert Bekaert et al. 47 Theremoval of controls on out ows sometimes re- (2002),Anusha Chari and Peter B.Henry(2002), Arturo sultsin a capital in ow, aresultof foreigners or domestic Galindoet al.(2002), Pierre Gourinchasand Olivier Jeanne residentsbringing capital intothe country in light of the (2002),and Carmen Reinhartand Ioannis Tokatlidis (2002). greater assurance itcan beremoved when desired. Hali Edisonet al.(2002a) review theliterature on the 48 Somecountries have attempted to impose controls on relationshipbetween growthand capital-account liberaliza- outows once a foreign-exchangecrisis is alreadyunder tion.They Ž ndthat capital-account liberalization spurs way.This use ofcontrolshas generallybeen ineffective (see growthsigniŽ cantly in amiddle-incomerange of countries, AkiraAriyoshi et al.,2000 pp. 18 – 29;Edwards, 1999 pp. butnotforrich or poor countries. However, in a studyof 57 68–71).It has alsoto be considered that the imposition of countries,using a widearray ofmeasures ofinternational controlsfor this purpose in a crisis islikely to have a Žnancialintegration and an assortment ofstatistical meth- longer-termeffect onthe country’ s access tointernational ods,Edison et al.(2002b) are unableto establish a relation- capital.For the record, I shouldnote here thatthere isvery shipbetween greater internationalŽ nancialintegration and littleinformation about such use ofcontrolsin the Malay- faster economicgrowth. They do identify indirect effects, siancase of1998, for the controls were imposedwhen byŽ ndinga signiŽcant impact fromcapital-account liber- exchangerates inthe region were at theirmost depreciated, alizationon investment and Ž nancialdevelopment; these andas capital owsin all thecrisis countrieswere reversing. twochannels are estimated toincrease growthby 0.5 per- 49 Forinstance, that the country plans to join the Euro- cent peryear ormore. peanMonetary Union and give up its currency. VOL. 93 NO. 2 RICHARDT. ELYLECTURE 15 thathave a similareffect to some capital con- countryis tryingto reduce in ation using an trols,for instance,limits on the open foreign- exchange-rateanchor and, for anti-inationary exchangepositions that domestic institutions purposes,needsinterest rates higher than cantake, should also be put in place as direct thoseimplied by the sum of theforeign inter- controlsare removed. 50 estrate and the expected rate of currency Anycountry using capital controls builds up depreciation.A taxon capital in ows can aninformation system on capital  ows.It may helpmaintain a wedgebetween the two inter- beuseful to maintain an information base for estrates. In additio n,by taxing short-term sometime even after the removal of controls,as capitalin ows more than longer-t erm in- inthe Brazilian case, for suchinformation can ows,capital-i now controlscan also in prin- beuseful in managing a crisis. ciplein uence the composit ionof inows. Severalcountries, among them Singapore, Evidencefrom theChilean experien ce thethree Asian crisis countries, and Malaysia impliesthat controls were for sometime havetaken steps to limit the offshore use of successfulinallowing some monetary -policy theircurrencies. In principle this makes it pos- independence,and also in shifting the sibleto break the link between onshore and compositionof capital in ows towardthe offshoreinterest rates, particularly by restrict- longend. Empirical evidence presente dby ingthe convertibility of the currency for non- Jose´De Gregorioet al. (2000) suggests residents—who need access to the domestic thatthe Chilean controls lost their effective - bankingsystem to complete their transactions nessafter 1998. They have recently been (see ShogoIshii et al., 2001). 51 Ishii et al. removed. (2001)conclude that such restrictions have been Thus,controls can be usedto help limit cap- moresuccessful the more comprehensive they italout ows and maintain a peggedexchange havebeen, and that they could provide the au- rate,given domestic policies consistent with thoritieswith a breathingspace in which to maintenanceof the exchange rate. However, implementpolicy changes. 52 Butas with other suchcontrols tend to losetheir effectiveness and capitalcontrols, their effectiveness tends to efŽciency over time. Capital-in ow controls erodeover time. Further, the longer the mea- mayfor atimebe useful in enabling a country suresare implemented, and the stronger they torunan independentmonetary policy when the are,the higher the associated costs in terms of exchangerate is softly pegged and may in u- theefŽ ciency of the Ž nancialsystem are likely encethe composition of capital in ows, but to be. theirlong-term effectiveness to those ends is Excessiveindebtednessof domestic Ž nan- doubtful. cialand nonŽ nancial institut ionsarises not from capitalout ows, but from inows, es- D. Instabilityin the Global Financial System peciallyshort-ter minows. Market-b ased capital-inow controls ,Chileanstyle, could Theseries of emerging-market Ž nancialcri- behelpful for acountryseeking to avoid the sesfrom Mexicoin 1994 to Asia to Russia, difŽculties posed for domesticpolicy by cap- Brazil,Turkey, Argentina, and Brazil again, has italin ows. This typical lyoccurs when a beenat the center of the globalization debate. Thecrises hit some countries that had at times beendescribed as model reformers, andothers 50 MorrisGoldstein (2002) recommends a“managed (inAsia) thathad been growing very fast. The oatingplus” regime, where theplus consists of measures to crisestook a heavytoll on almost all of the discouragecurrency mismatching by domesticinstitutions. 51 Thispaper describes three differentmechanisms that crisiscountries, as well as on other countries 53 are usedto limitoffshore currency trading. affectedby thecontagion. Figure6 showsthe 52 Singaporehas beengradually dismantling these con- behaviorof output in the crises. trols.Jaewoo Lee (2001)concludes that the Singapore con- trolswere successful inlarge partbecause theunderlying macroeconomic imbalances were verysmall andtherefore didnot provide signiŽ cant incentivesto circumvent the controls. 53 Inthissection I draw heavilyon Fischer (2001, 2002). 16 AEAPAPERSAND PROCEEDINGS MAY 2003

FIGURE 6. REAL GDP GROWTH Source: InternationalMonetary Fund ( WorldEconomic Outlook ).

Theproximate cause of most of the crises theonly country that kept growing through its was thereversal of large-scaleshort-term capi- externalcrises. tal ows.In every case except Brazil in 2001– Althoughhedge funds received a largeshare 2002,the crisis affected a countrywith a more oftheblame for thereversals, and were proba- orless formally pegged exchange rate, which blypredominant in determining the timing of gaveway, usually at the beginning of thecrisis. someof the crises, 54 thereversals were more Inevery case except in Brazil, the crisis hit a generaland not conŽ ned to short-term funding. countrywith a weakŽ nancialsystem— though Neitherwere theyconŽ ned to the actions of theRussian Ž nancialsystem was verysmall at foreigners;not surprisingly, in most of the cri- thetime of thecrisis, and the Argentinian bank- sesdomestic residents and corporations played ingsystem had been strong a yearbefore the aprominentpart in the capital- ow reversals. crisisbut was severelyweakened by measures Whatcan be done to reduce the volatility of imposedon it in attempts to preserve the cur- capital owsto emerging-market countries? rency peg. TheŽ rst responsewould be for countriesto shut Capital-ow volatility during the crises was themselvesoff from internationalcapital  ows. massive.For theextreme cases, between 1996 Itbears emphasis that despitethe crises, and and1998, private capital in ows to Indonesia thearguments of many critics of globalization, declinedby 16.5 percent of GDP, whilethe almostno country has taken this route; the turnaroundfor Turkeybetween 2000 and 2001 was 13.6percent of GDP. Amongthe crisis countriesshown in Figure 6, thesmallest rever- 54 Followingthe Asian crisis, anIMF studyconcluded salin privatecapital  owswas inBrazil, where thata widerange of Ž nancialinstitutions, including banks, thedecline was by3.1percent of GDP between hadengaged in thesame behavioras thehedge funds (see 2001and 2002. This helps explain why Brazil is BarryEichengreen and Don Mathieson, 1998). VOL. 93 NO. 2 RICHARDT. ELYLECTURE 17 revealedpreference of the emerging-market Duringthe 1980’ s LatinAmerican debt cri- countriesis to stay involved with the interna- sis,the Federal Reserve System and the IMF tionalŽ nancialsystem. 55 workedclosely with the principal creditors, the However,as previously noted, some coun- banks,and the debtor countries to put together trieshave taken measures to limit the offshore Žnancingpackages. As the1990’ s crisesun- useof their currencies, thus securing more folded,there were manywho argued that the monetary-policy exibility.In addition, I should authoritiesshould act similarly and seek to co- notethat capital- ow reversals would not have ordinatethe creditors. In effect, the argument is beenso large had the in ows beensmaller thatthere is a badequilibrium in which all the tobegin with. The introduction of a exible lendersseek to withdrawfunds and only worsen exchange-ratesystem has generally sharply re- thecrisis in doingso, and a goodequilibrium in ducedshort-term capital in ows and is thus a whichthe creditors stay in and thereby help majorpart of the solution to the problem of mitigatethe crisis. In such situations, in coor- excessivecapital- ow volatility. For transi- dinatingthe creditors the authorities can be seen tionalperiods, the use of Chilean-stylecapital- asresolvinga collective-actionproblem that the inow controls and more detailed reporting creditorsacting individually cannot solve. requirementscan also help moderate in ows. Thisapproach was successfulin the South Thequestion also arises of whetherpolicy Koreancrisis at the end of 1997 and in early measuresto mitigate the volatili tyof capital 1998.Nonetheless, great care needs to be taken ows toemerging -marketcountrie scanbe inseeking to coordinate the creditors. It would takenby the authorit iesin the major capital bedestabilizing if the creditors were coordi- marketsfrom whichthe funds  ow.Many, natedin every crisis, for theywould have a includingtheauthorit iesin some Asian coun- greaterincentive to rush for theexits at themere tries,have argued for moretranspare ncyby hintof a crisis. 58 Inaddition, it is much more thehedge funds and other market partici- difŽcult for theauthorities to justify coordinat- pants.56 Howeverit has not been possible to ingthe creditors when there is a signiŽcant risk reacha consensusongreater disclosu re of thatthose who have been persuaded to stay position-takingby Ž nancialinstitut ionspar- inwill nonetheless suffer losses.That is why ticipatingin emergingmarkets. Although it is industrial-countryregulators have been less doubtfulthata differentconsensu swill enthusiasticabout creditor coordination in re- emergeany time soon, this issue should re- centyears than they were inthe 1980s: there is mainon the agenda— and in the meantime ,it aconict between their regulatory role and their remainsopen to emerging -marketauthorit ies pressuringthe banks to maintain portfolio posi- tobuildbetter informati onsystemsabout cap- tionsagainst their will. ital owsin their countrie s. Therecent experience suggests a differenti- Alsoprominent on the agenda is private- atedapproach to creditor coordination. Some- sectorinvolvement in the resolution of crises. timesa formalapproach may be necessary,as in Letme brie y takeup two issues: the extent to Koreaat Christmasin 1997; at other times, as in whichthe ofŽ cial sector should seek to coordi- thecase of Brazil in March 1999, when the natethe actions of the private sector when a commercialbanks voluntarily agreed to main- crisisappears imminent, and the recent IMF taintheir lines of credit,less formal discussions proposalfor asovereigndebt-restructuring couldserve better; when Ž nancingneeds are mechanism.57 small,or whenan IMFpackageseems adequate

58 Thispossibility was verymuch in the minds of those 55 EvenMalaysia, which imposed capital controlsin contemplatingcoordinated action during the crises ofthe 1998,removed most of them within1– 2 years. 1990’s: we believedthat the more oftenwe soughtto 56 Formore detailedproposals, see WendyDobson and coordinatethe creditors, the more likelyit was thatthe crisis Gary Hufbauer(2001). wouldspread even further than it did, and that in the limit 57 Fora more comprehensiveanalysis, see Fischer theentire system couldseize up,and we wouldhave been (2002). backin the1930’ s. 18 AEAPAPERSAND PROCEEDINGS MAY 2003 toreverse out ows, there may be no need to marketdebtors will too easily use legal provi- approachthe creditors; and in extreme and in- sionsto restructuredebts, spreads will rise, and frequentcases, an involuntary restructuring of capital owsto those countries will decline. thedebt may be necessary. Thatis why policymakers from emerging- Itis striking that, when governments face the marketcountries generally oppose proposals decisionon whether to seek to impose a stand- tomake it easier for themto restructure their stilland/ orrestructure their debts in a nonvol- payments,be it throu ghco llective-action untaryway, they are generally willing to go clausesor the creation of a sovereignbank- veryfar toavoid a default.Why? The reasons ruptcyprocedure . are:(i) thata debtrestructuring will almost Basedon their behavior during the last de- certainlyinvolve a restructuringof thedomestic cade,I believeit unlikelythat emerging-market Žnancialsystem, where Ž nancialinstitutions economicofŽ cials will be encouragedto default (includingbanks and pension funds) hold gov- bythe presence of an SDRM, though some of ernmentbonds as important parts of their themfear thatit would change the balance of portfolios;(ii) that there may be serious inter- forceswithin the country, encouraging populist ruptionsto the payments mechanism and to forcesthat often favor repudiating debts. tradecredit; 59 and(iii) that it is impossible to Rather,an SDRM would be more likely to knowwhen domestic and foreign conŽ dence in affectthe behavior of the IMF andthe ofŽ cial thegovernment’ s abilityto meet its promises sector,which could become too quick to urge willbe restored, and for howlong the country restructuringsas an alternative to IMF lending. willbe punished by the markets for having Thereis a balanceto bestruck,and it is impor- defaulted.Rightly or wrongly,probably rightly, tantfor theeffective operation of the interna- debtorgovernments see the costs of a debtde- tionalsystem that the IMF notstep back from faultas extremelylarge— and much larger than providingŽ nancingto countries facing a liquid- thecritics of IMFloanstypically imply. 60 ity crisis. Akeyproblem is that we haveno accepted TheSDRM proposal has already achieved framework inwhich a countryin extremis can successin leading the private sector to sup- imposea paymentssuspension or standstill portthe inclusion of collective active clauses pendingagreement with its creditors to support (CAC’s) inbondcontracts. It is certainlydesir- therestoration of viability— which takes us to ablethat the IMF continueits important work AnneKrueger’ s proposalfor aSovereignDebt onthe mechanism. But we shouldrecognize RestructuringMechanism (SDRM), alegal thatat bestit willtake years to changethe legal mechanismto approve payments standstills by framework,and that it is quite possible that it sovereignnations, and for therestructuring and, willnot in the end be possible to persuade the ifnecessary,writing down of sovereigndebts. 61 U.S. Congresson this issue. In any case, I Thecosts of resortingto such measures have believethe Executive Board of theIMF should tobehighif theinternational Ž nancialsystem is continueseeking to spell out more precisely a toworkwell. If creditorsbelieve that emerging- setof proceduresfor howit willact in the event itconcludesthat a countryhas an unsustainable levelof debt. This would help formalize the 59 Theexperience ofArgentinaso far inits current crisis approachthat has already been developed on an suggeststhat creditor legal action following a defaultmay adhoc basis in response to some of the recent beless disruptivethan many, including me, hadanticipated. 60 crises.At thevery least, it wouldprovide more Itis thejudgment of howfar togo to help a country clarityon thequestion for debtorsand creditors thatseeks toavoid a default,and of what probability of success torequire, that lies behindthe controversies over alike,which would be a goodin itself. recent IMFsupportfor Turkey, its decision to support Letme turn next to what the emerging- Argentinain August 2001, and not to provide further sup- marketcountries can do to reduce their vulner- portin December 2001. ability.The crises of thelast decade can be seen 61 Nationalbankruptcy laws shouldapply to private- sector debtorswho cannot make payments;if debtors can asthemanifestation of theimpossible trinity in payin local currency, the stay could permit a delayin theemerging markets, 25 yearsafter the Bretton convertingthese paymentsinto foreign currency. Woodssystem succumbed to the same forces. VOL. 93 NO. 2 RICHARDT. ELYLECTURE 19

Theadoption of  exibleexchange-rate systems policieswhen in recessionbut that the IMF does bymost emerging-market countries is by far notrecommend a similarcourse for emerging- themost important emerging-market crisis- marketcountries in crisis. If acountryin crisis preventionmeasure taken in response. 62 In hasa strongŽ scalposition and has no problem choosinga newnominal anchor to replace the borrowing,then it can indeed run a moreex- exchangerate, most countries have (wisely, I pansionaryŽ scalpolicy. 64 Butmany emerging- believe)opted for ination-targeting. marketcountries that enter IMF programsare in However,exchange-rate  exibilityis notsuf- adebtcrisis, in which they cannot borrow from Žcientto prevent crises, for acountrymay themarket, and high interest rates are adding nonethelessget into trouble because of market toadverse debt dynamics. The country cannot doubtsabout its ability to service its debt. This increasemarket borrowing in these circum- isthe main cause of the 2002 crisis in Brazil. stances,65 andthe international Ž nancialinstitu- Evenwith a exibleexchange rate, excessive tions(IFI’ s) donot usually have enough indebtednessof either the public or the private resourcesto more than offset the contractions sector,and weaknesses in the Ž nancialsector, imposedby themarkets. Thus, Ž scalpolicy has makea countrymore vulnerable to bothinternal tobe tightened if the country is to avoid a andexternal shocks. default—as virtuallyevery country in crisis des- Hence,countries wishing to operate in the peratelywants to do. internationalcapital markets need both to As tomonetarypolicy, if the country has few strengthentheir Ž nancialsystems and to ensure debtsdenominated in foreign currency, and in- thattheir Ž scalpolicies are sustainable. Fiscal ationis low, then it can cut interest rates and sustainabilityrequires not only that the debt to allowthe currency to depreciate. If, however,its GDPratiowill stabilize if things go well, but currencyis plunging, then a risein interest rates alsothat the debt will be sustainable (possibly ismorelikely than an interest-ratecut to slow or withthe assistance of policy adjustments and stopthe collapse. 66 theIMF) ifthe economy is hit by shocks. As alreadydiscussed, in adaptingthemselves Fiscal-sustainabilitycriteria for emerging-market toliving in the international Ž nancialsystem, countrieshave not yet been deŽ ned. However, it countriesneed also to be cautious about when islikelythat the Maastricht 60-percent debt-to- andhow they liberalize capital-account transac- GDPthresholdratio is too high for countries tions.Other measures include greater transpar- subjectto much larger interest-rate and other encyabout both data and the intentions of the externalshocks than are the industrialized government,and the adoption of international countries.63 Incriticizing IMF-supported programs, it is 64 oftenremarked that industrialized countries can As notedin Jack Boormanet al.(2000), the initial programssupported by theIMF in Asia, where government cutinterest rates and run expansionary Ž scal indebtednesswas generallylow, tightened Ž scal policy excessively,though policy was relaxedwithin a short time. Policywas tightenedbecause itwas believedthis 62 Bya exibleexchange-rate system Idonot mean a wouldstrengthen market conŽdence, and would serve as a purely oatingrate, butrather asystem inwhich the au- down-paymenton the expected costs ofŽ nancial-sector thoritiesmay interveneto affect therate butare notper- restructuring. ceivedas tryingto defend a particularrate ornarrowrange 65 Mindfulof thedifŽ culties caused bytighteningŽ scal of rates. policyin a recession,the IMF inlate 2000agreed with 63 Several economistshave pointed to what they call the Argentinaon asmall Žscal expansion,as acontributionto originalsin of emerging-market borrowers, that they are recovery.Political economy is complicated: we were toldby unableto borrow internationally in their own currencies. As some Argentinesat thetime thatthis was amistake, not Eichengreenand Ricardo Hausmann (2002) explain, had because Keynes was wrong,but because thegovernment Brazil beenborrowing in itsown currency, investor uncer- woulduse theextra roomgiven by the IMF supportto taintythat caused the real toplummet would mainly have increase thedeŽ cit bymore thanthe agreed amount.They ledto more competitiveBrazilian exports,rather thana turnedout to beright. large increase indebt-servicingcosts. I see nosimple solu- 66 However,at some point,further increases inthe in- tionto the original-sin problem, beyond establishing a terest rate become counterproductive,because theymake recordthat encourages creditors to accept therisks of lend- debtdynamics worse andweaken theŽ nancialconditions of ingin emerging-market currencies. bothŽ nancialand nonŽ nancial corporations. 20 AEAPAPERSAND PROCEEDINGS MAY 2003

changes,the world trading system will remain unfairlytilted against the developing countries. Figure8 showsthe results of a WorldBank modelsimulation, which examines the long- termimpact of full trade liberalization. 67 The dynamicgains calculation assumes that open- nessaffects productivity. With or without this effect,the gains are impressive and are greater relativelyand even absolutely for thedevelop- ingcountries than for theindustrialized coun- tries.Nearly half the beneŽ ts for thedeveloping countriescome from theliberalization of agri- culturaltrade. Oneother result bears emphasis. A consistent FIGURE 7. TRADE PROTECTIONIN INDUSTRIAL COUNTRIES Žndingof such studies is that at least half the Note: TheŽ gureshows tariffs onmerchandise importedby gainsfor thedeveloping countries derive from high-incomecountries (as percentages) in1995. greaterintra-developing-co untrytrade, that is, Source:Global Economic Prospects 2003 (Ch. 6). South–South trade. In other words, the devel- opingcountries would beneŽ t notonly from the industrializedcountries opening up to their ex- codesand standards with regard to the Ž nancial ports,but also from openingup theirmarkets to system,Ž scal-and monetary-policy transpar- each other. ency,accounting standards, corporate gover- Of themany measures that could be taken nance,and so forth. tomake the international system work better andmore fairly, removing the bias against E. TheInternational Trading System developing-countryexports and further South– Southtrade liberalization would be among the Reductionsin tariffs andthe growth in trade mosteffective. inthepast half century have been greater among theOECD countriesthan between industrial- F. Aid izedand developing countries. In particular, as iswell known, agricultural protection in the Over theperiod 1990 – 2000,the percentage EuropeanUnion, the United States, and Japan oftheir GDP givenas aid by industrialized discriminatesagainst those goods in which countrygovernments fell from 0.33percent to manydeveloping countries are relatively most 0.22percent. 68 Thetotal amount of aid is about efŽcient, and limitations on textiles exports $60billion, and donor governments are com- (whichare due to be removed in 2005) have a mittedto seeking to raise aid’ s shareof their similareffect. Figure 7 illustratesthis trade pro- GDPby2015. The share of 0.7 percent is a tectionof manufacturing and agriculture in norm,but only Scandinavian countries and the high-incomecountries. Netherlandscome close to meeting this ratio Theinternational trading system is biased (andthey all exceed it). 69 For thedeveloping againstdeveloping countries. In the wake of countriesas a whole,net private capital  ows September11, the Doha Round of trade nego- far exceedaid. But for thegroup of the 44 tiationswas inauguratedand named “ thedevel- least-developedcountries (32 of them in Af- opmentround.” It remains to be seen whether agriculturalsubsidization and protection in the industrializedcountries will be lifted, and 67 These resultsare presentedin GlobalEconomic Pros- whetherantidumping regulations and other non- pects 2003 (Ch. 6). 68 Net grantsby NGOs addedanother 0.03 percent of tariff barrierswill be eased. To be sure, reduc- donorGDP tothe total in each year. ingagricultural protection is politicallydifŽ cult 69 In2002,Luxembourg gave 0.71 percent of itsGDP in inthe industrialized countries, but absent such aid. VOL. 93 NO. 2 RICHARDT. ELYLECTURE 21

FIGURE 8. LONG-TERM IMPACT OF FULL TRADE LIBERALIZATION Notes: TheŽ gureshows that developing countries could reap incomegains of more than$500 billion from full trade liberalization,which implies up to a 5-percentboost in incomes. The left-hand panel shows additional income in 2015, in terms of1997 dollars, compared with the baseline. The right-hand panel shows the income boost as apercentage ofbaseline incomein 2015.Static gains refer tothe results holding productivity constant. Dynamic gainsallow productivity to respond tosector-speciŽc export-to-outputratios. Source: WorldBank model simulations. rica),foreign aid (at 7.6 percent of GDP) is withina country. 72 Themillennium challenge threetimes larger than private  ows. 70 approachset out by theUnited States, in which The0.7-percent norm has been in existence countrieswill have to compete for extraaid, is for decades,while aid has continued to fall. aninteresting and potentially important experi- Underlyingthe rationale for thedecline has ment.In terms of focuswithin countries, there is beengrowing skepticism about the effective- anincreased emphasis on health and education nessof aid,abetted by thecontinuing emphasis spending.Greater relianceon NGOs todeliver bythose in the development business on re- aidis another— but the proliferation of NGOs mainingproblems rather than achievements. hasalso fostered aid dependence. Corruptionin some of the recipient govern- Thenew (as of2000) approach of the IMF mentshas also severely reduced public support andthe World Bank, in which countries are for aid.In addition, the way the aid process has supposedto takethe lead in preparing poverty- workedhas created an aid dependence in some reductionstrategy plans, in cooperation with ofthe poorest countries that has inhibited their theiraid partners, could help deal with the prob- takingaction to solve their own problems. 71 lemof aiddependence, but the evidence on the Amongthe new approaches now being im- successof the new approach is notyet in. This plementedis greater selectivity, both among approachre ects the evidence that economic countriesand in the focus of the aid effort programsare more likely to succeed when they areowned by thoseimplementing them— which isto say that the government regards the pro- gramas its own rather than an impositionof the 70 There are several small andvery poor countries that receive more than20 percent of GDP inaid. Data are aid-givers,and the government has public sup- availablein the HumanDevelopment Report, based on portfor theprogram. DevelopmentAssistance Committee reports(United Na- tionsDevelopment Program, 2002). 71 There isalsoa selectionbias in theevaluation of aid. Thecountries that used aid most successfully at earlier stages, including,for example, Korea andTaiwan nolonger 72 See WorldBank (2002b) for recommendations (in- countin the evaluation of aid. cludinggreater selectivity)for making aid more effective. 22 AEAPAPERSAND PROCEEDINGS MAY 2003

Oneproblem inherent in approaches that pe- secretiveorganization, with no realaccountabil- nalizegovernments for badbehavior, and that ity.In the past the Fund may well have been too makesaid such a difŽcult area, is thatwhen aid secretivefor thegood of its member countries toa countrywith a badgovernment is cut off, oritsowngood. But there has beena seachange mostof those who suffer areprivate citizens, inthe Fund’ s transparency,and the charge of whoare already suffering from poorgovern- secrecyis no longer valid. ment.Hence humanitarian aid generally does As toaccountability, Fundmanagement is andshould continue even in cases, like Zimba- accountableto the shareholders, the member bwe,where the humanitarian crisis is caused by governments, whoare represented in the Exec- theactions of the government. Jeffrey Sachs utiveBoard. The Board discusses and votes on andothers (see World Health Organization, allloans and all Fund policies. The largest 2001)have also made a powerfulcase that the shareholdershave individual representatives; verypoorest countries should receive large othercountries are grouped into constituencies, amountsof aid, to enable them to improve withone Executive Director representing all the health,education, and infrastructure, as part of countriesin the group. Voting is weighted by aneffort to jump-start development. thenumber of sharesof thecountry or countries As countriesdevelop, private capital  ows theExecutive Director represents. augmentand then replace aid. But private cap- Theseshares, the quotas, are proportional to italbarely  owsto the poorest countries, and theamount the country has to contribute to the solutionsto theplight of thoseliving in the very Fund.Thus the largest contributors have the larg- poorestcountries, which have a populationof estshare of the vote, which means the United about650 million, will require major external States,with over 17 percent of the contribu- assistance.It is hard to believethat a successful tions,has far andaway the biggest share of the attackcan be madeon globalpoverty with con- vote.The quotas not only determine the coun- tinuallydeclining  owsof aid—though some of try’s shareof thetotal vote, but they are also a thenew approaches should make that aid more normfor theamount a countrycan borrow from effectivethan it has been in the past. the Fund.75 Themember governments, through their Ex- G. Reformof the IMF ecutiveDirectors (and sometimes directly, in discussionswith the management) play an ac- As aresultof the crises of the last decade, tiverole in Fund decision-making. 76 Because the andits own internal dynamics, the IMF haslaid managementneeds Board support for itspro- outan agenda of reform. 73 Theagenda includes posals,it consults with Board members well morefocused conditionality, with an emphasis beforean issue reaches them for formaldiscus- onmacroeconomicpolicies and those structural sion.Although the management rarely loses measuresessential to macroeconomic stability, votesin the Board, this is mainly because it andgreater efforts toensure country ownership doesits homework and does not take issues on ofprograms. The Fund is also seeking to im- whichit expects to lose to the Board. proveits surveillance, as part of an overall Iregardthe accountability of theFund’ s man- effortto help prevent crises. agementto its member governments, and the Ratherthan discuss Fund reform indetail, 74 I weightedvoting, as both fundamental and ap- wantto concentrate on one issue that has re- propriate.It has been suggested that the Fund ceiveda greatdeal of attentionin recentdiscus- managementshould be more independent, sionsabout the IMF, that of its accountability. alongcentral-bank lines. But this misunder- Thecharge is often made that the Fund is a standsthe nature of Fund lending activities,

73 See forinstance the speech ofthethen new Managing 75 Forexample, borrowing in excess of300 percent of Director at theAnnual Meeting in Prague in September quotais regardedas “exceptionalaccess.” 2000,available online: http://www.imf.org/external/am/ 76 TheBoard of the Fund is generallyviewed as more 2000/speeches/PR03E.pdf . involvedin Fund decision-making than the Board of the 74 Thatis done in Fischer (2001). WorldBank in Bank decisions. VOL. 93 NO. 2 RICHARDT. ELYLECTURE 23 whichinevitably have a politicalelement to tothe formalization of the role of NGOs and them—and on which, the governments who are civilsociety in the Poverty Reduction Strategy fundingthe loans should ultimately decide. In Papers,arguing that as democratically elected negotiatingprograms, I tookgreat comfort from governments,it is for themto represent their themanagement’ s accountabilityto the Board, countryand the views of its citizens. for withoutthe legitimacy provided by theneed Inbrief, the Fund is and should be account- for backingby member governments, it was ableto thegovernments that are its members. It notclear what authority a bureaucratlike my- shouldbe asopen and as transparentas possible selfwould have had for undertakingsuch aboutits activities, and it has moved a longway negotiations. inthatdirection in thelast decade. It should be As tothe weighted voting, the Fund is com- asopenas possibleto discussionswith members mittingthe resources of its member govern- ofcivil society constructively interested in the mentswhen it lendsmoney, and I believethose issuesit deals with. But its decision-making whoprovide more of theresources should have processesshould remain inter-governmental, abiggersay. The one-country, one-vote alter- withthe primary responsibility for reecting the nativewould put the borrowers in charge of viewsof civilsociety on eachissue and in each lendingdecisions, which is not a goodprinciple programbeing taken by member governments. onwhichto runa Žnancialinstitution. However, thepresent quotas are not optimal, for thereare IV.The Challenges countrieswhose actual quota is far from repre- sentativeof their role in the global economy. Theoverall challenge to economic globaliza- Ithas also been suggested that the Fund staff tionis to make the global system deliver eco- andmanagement should be moreaccountable to nomicgrowth more consistently and more thecitizens of the countries receiving loans. equitably,as the best way to further reduce Increasingly,Fund staff hastried to ensure that globalpoverty and inequality. The speciŽ c chal- thecitizens of the recipient country are well lengesto globalization are both region- and informedabout the details of loans, and it en- subject-speciŽc. couragesthe borrowing government to publish Globalgrowth is determined mainly by the therelevant documents. Many of them do so, performanceof theindustrial countries. 77 After andall should do so. Ultimately though, Fund thecurrent adjustments are done, the United loansare to member governments, and it is the Statesand, less certainly, Europe should be able governmentsthat make the decisions and that toresume growth at rates in the range of 2– 4 shouldbe accountable to their citizens. percent.The prospects for Japanare more dif- Ithas also been suggested that the Fund Žcult:with decisive action to deal with its weak shouldconsult more with outside academics bankingsector and associated corporate-sector andexperts. In the normal course of business, problems,Japan can return to modest but posi- theFund does from timeto time hold organized tivegrowth; without such action Japan is likely meetingswith outside experts on speciŽc issues, tocontinueits present dismal performance, with regions,and countries. There is less time for achanceof a crisisever present. The choice is formalconsultative meetings when a programis Japan’s, for thenature of the problem and the beingnegotiated. But as negotiations proceed, choiceare well understood. thestaff andmanagement do consultinformally Attitudesto globalization in the industrial- withacademic and other experts whose judg- izedcountries will be key to the future of the mentand discretion they trust. globaleconomy. Hence, governments in those Manyothers would like to beheardand take countriesneed to stand up andsupport the right partin the discussion as the Fundthinks through andnegotiates its programs. To the extent time 77 allows,the Fund should be open to those dis- TheIMF calculates globalgrowth by weightingcoun- trygrowth rates bypurchasing-power-parity estimates of cussions.But not everyone who wants to be GDP,which leads toa highergrowth number by enhancing heardhas a legitimaterole in the process. Some of therole of the developing countries (including China and theborrowing countries have objected strongly India)in the estimate. 24 AEAPAPERSAND PROCEEDINGS MAY 2003 policies,help their own people deal with the ofpoorhas been rising rapidly. There have been adverseconsequences of economicchange, and successstories in Africa, includingfor along deliveron their promises on trade, aid, and the timeBotswana and Uganda, but success has strengtheningof the international economic beenfragile. The economic future of southern system. Africa willbe determined by developments in InAsia, where South Korea has already led SouthAfrica, whoseeconomic policies during the theway, China and India are well launched on pasteight years have been very good, but where thepath to sustainablegrowth, and it is reason- theHIV/ AIDS problemand events in Zimbabwe ableto expect growth to continue to spread havecast multi-dimensional shadows. throughthe region— though we shouldnot for- Somecountries in Africa arebeset by prob- getthat some countries in Asia are among the lemsof governance, which are exacerbated by world’s poorest.Nor shouldwe forgetthat In- poverty,wars for controlover mineral wealth, dia’s growthcould accelerate if itintensiŽ es its andin some cases ethnic fragmentation. The macroeconomicstabilization and reform efforts. problemsof Africa canonly yield to a combi- Mostof theformer Soviet-bloctransition econ- nationof domestic political and economic re- omies,most importantly Russia, have turned the form andoutside assistance. The creation of the cornerfrom declineto growth,which is likely to NEPAD, theNew Partnershipfor AfricanDe- continueif policies stay on track. velopment,is an encouraging sign of African LatinAmerica made a promisingstart toward determinationto take the lead in solving their sustainedgrowth in the Ž rst halfof the last ownproblems. But a greatdeal of furtherwork decade.But then there were majorcrises in the needsto be done to make NEPAD succeed. threebiggest economies in the region: Mexico, Inturning next to the national and global Brazil,and Argentina. South America’ s eco- policychallenges, I shallbe summarizingmuch nomicprospects are tied to the fortunes of Bra- ofthe material presented to this point. zil,which faces a difŽcult but manageable economicsituation. If thenew government suc- A. Implementingthe Right Policies ceedswhile maintaining both macroeconomic stability(and this is an issue on which it has Theoutward-oriented policies described in insisted)and deepening its links with the rest of the1990 Washington consensus remain an im- theworld, while at the same time increasing portantcomponent of theright approach to eco- socialspending, that would help solidify the nomicpolicy. 78 Thatpolicy approach needs to ongoingtransformation of theeconomic policy beenhanced by: Ž rst,a greateremphasis on approachin Latin America. The stakes are very socialjustice, to be implemented through health high,but the answers interms of the right andeducation spending, social safety nets generalorientation of policy seem clear. Suc- adaptedto the economic structure of the coun- cessfulnegotiation of a free-tradearea of the try,and infrastructure spending; second, greater Americaswould help secure the economic gains attentionto developing the institutions of effec- thatthe region is close to achieving. tiveeconomic governance, including efŽ cient Thereis relativelylittle poverty in theMiddle judicialsystems, civil service, the tax system, East.But the countries of the region, the oil- andother elements in the enabling environment producersincluded, face formidable economic for private-sectoractivity; third, more attention developmentchallenges, many of thema result tocrisis-prooŽ ng the economy, especially by ofthe pressure of rapid population growth. strengtheningthe Ž nancialsystem, and macro- Whethergovernments can meet those chal- economicpolicies; and fourth, labor-market re- lenges,and the associated challenge of democ- form toallow a greaterproportion of the ratization,will affect not only the economies of workforceto enter the formal labor market. theMiddle East, but also peace in the Middle Eastand the rest of theworld. Thechallenge of development is most pro- 78 Iam gratefulto John Williamson for discussion and foundin sub-Saharan Africa, whichhas by far forallowing me todraw ona draftpaper on the policy thehighest poverty rate, and where the number lessonsof the last decade (Williamson,2002). VOL. 93 NO. 2 RICHARDT. ELYLECTURE 25

B. Deliveringon Trade and Aid inthe global economy, for good(in helping produceconvergence of income levels among Theindustrialized countries need to deliver countriesif it istheunskilled who migrate) or ill ontheirpart of thebargain that tells developing (becauseof possiblebrain-drain effects). This is countriesthat they should integrate into the anarea where national economic, social, and globaleconomy. In particular, that means liber- culturalpreferences are bound to take a front alizingagricultural trade and ending the mas- seat.But it isalsoan areawhere greater clarity sivesubsidies to agriculture that impair the isneededon theeconomic effects of alternative exportsof so many developing countries. It policies,and where, eventually, more public meansalso making a successof the Doha de- policyattention will be focused (see e.g., velopmentround. At thesame time, the devel- GeorgeBorjas et al., 1997; Barry Chiswick and opingcountries can achieve major gains by TimothyHatton, 2003). 80 openingup trade to each other. Theaid process needs to be made more ef- E. ImprovingGovernance fectivethrough greater selectivity among coun- triesand sectors within countries and through Itwas oftensaid during the mid-1990’ s that countriestaking greater ownership of the pro- “we cannotwant reform morethan the Russians cess.But at the same time it is hard to see the do.”The same applies everywhere. Ordinary problemsof the poorest countries being solved peopleeverywhere want to improvetheir lives. withoutsigniŽ cant increases in aid. Butcorrupt governments do not necessarily re- spondto thosedesires. That is whythe trend to C. Makingthe International Financial System democracyis so important. It is alsowhy global Less Crisis-Prone termlimits are a goodidea, even though I have noidea of how to enforce them— but I have Theshift to  exibleexchange rates 30 years seenno government improve after ten years in ago,and the strengthening of macroeconomic ofŽ ce. policyframeworks since,which has removed Whilecountries are primarily responsible for thein ation problem, have helped prevent for- theirown fates, outsiders from boththe public eignexchange crises among the industrialized andprivate sectors can help in uence the countries.79 Butthe system is still disturbingly outcome,by promoting democracy, by eco- crisis-pronefor theemerging-market countries. nomicinvesting, and by supporting good Measuresare being implemented to make the projectsin social sectors. Through their actions systemmore stable for theemerging-market theycan also help Ž ghtcorruption in develop- countries.The most important of these is the ingcountries. shiftto exchange-rate  exibility—but crises canerupt for otherreasons, particularly market V.Concluding Comments fears ofan unstable debt dynamics, and the strengtheningof domestic policies and institu- Inthinking about the globalization debate, tionsis essential. andconsidering that the proponents of global- izationrecognize the need to dealwith most of D. Dealingwith Migration theproblems to which the critics point, I am sometimestempted to conclude that the debate Migrationof laborand temporary labor  ows ismainly a matterof temperament— between areplaying an increasing role in the global thosewho see the glass as half full versus those economy.They are a potentiallypowerful force whosee it as half empty; those who see the doughnutand those who see the hole; or those

79 Infact, exchangerates amongthe industrialized coun- tries movedin bipolar fashion, with members ofEMU peggingin the hardest possible way byeliminating their 80 Bhagwati(2003) points to the importance of migration owncurrencies, andall otherexchange rates becoming andsuggests the establishment of a WorldMigration Orga-  exible. nizationto coordinate international policy on these issues. 26 AEAPAPERSAND PROCEEDINGS MAY 2003 onthe inside who are in apositionto in uence internationalisationof whichwas nearly policydirectly and those who, for whatever completein practice . reason,are outside critics. But then I reect that thedebate will affect economic policies in both Someargue that globalization is driven by industrializedand developing countries, and I technology,and that it represents an unstoppa- realizeagain its critical importance for theeco- bleforce. Perhaps— in the long run. But we nomicfuture. economistsknow that the forces of globaliza- Indeveloping that argument, I willquote two tionwere stoppedand reversed for nearlya third ofthe greatest Englishmen of the last century. (theworst third) of the last century. As the TheŽ rst isJohn Maynard Keynes, the young wordsof Keynes remind us, we cannottake it Keyneswho in 1919 (pp. 9 –10)said: for grantedthat the world will continue down theroad of globalization, greater prosperity, Whatan extraordinaryepisode in theeco- andgreater democracy. That may be an aston- nomicprogress of man that age was ishingthing to say at the end of a centurythat whichcame to an end in August witnessedthe Ž rst sustainedcompetition be- 1914!... Theinhabitant of London could tweentwo clearly deŽ ned economic and politi- orderby telephone, sipping his morning calsystems, and in which the pro-democracy, teain bed, the various products of the pro-market,pro-globalization system won that wholeearth, in suchquantity as hemight contestdecisively. Nonetheless that system is seeŽ t,and reasonably expect their early underattack. deliveryupon his doorstep; he could at thesame moment and by the same means Theattack is about much more than econom- adventurehis wealth in the natural re- ics,and it could well be thatthe issues we have sourcesand new enterprises of any quar- discussedtonight are not the decisive ones. terof the world, and share, without Rather,political, cultural and religious forces exertionor even trouble, in theirprospec- couldplay the dominant role in shaping the tivefruits and advantages; or he could futureof globalization.As concernedand well- decideto couple the security of his for- informedcitizens we canparticipate in and try tuneswith the good faith of thetownspeo- toshape the broader debate. pleof anysubstantial municipality in any Butwe havespecial obligations as profes- continentthat fancy or informationmight recommend.He couldsecure forthwith, if sionaleconomists participating in the debate hewished it, cheap and comfortable overeconomic globalization: meansof transitto anycountry or climate withoutpassport or other formality ... . (i) tomaintain our professional standards; (ii)not to be afraid to take on big untidy is- Thispaean of praisewould place Keynes safely sues,but to do so objectively, element by amongthe extreme globalizers. But then comes element; hiswarning: (iii)to keep trying to Ž ndsolutions to real worldproblems; and But,most important of all, he regarded (iv)from timeto time— to stand up and be thisstate of affairs asnormal,certain, and countedon the issues. permanent,except in the direction of fur- therimprovement, and any deviation from Theworld and the economic system we live itas aberrant, scandalous, and avoidable. inare highly imperfect. There is much that Theprojects and politics of militarism needsto be doneto makethem work better. But andimperialism, of racial and cultural aswe dothat,we shouldmaintain a perspective rivalries,of monopolies, restrictions, and thatre ects what Winston Churchill said of exclusion,which were toplay the ser- 81 pentto this paradise, were littlemore democracy: Thepro-market pro-globalization thanthe amusemen tsofhisdaily news- paper,and appeared to exercise almost noin uence at all on the ordinary 81 “Democracy isthe worst form of government,except courseof social and economic life, the forall theothers that have been tried.” VOL. 93 NO. 2 RICHARDT. ELYLECTURE 27 approachis the worst economic policy, except Birdsall,Nancy. “AStormyDay on an Open for allthe others that have been tried. Field:Asymmetry and Convergence in the GlobalEconomy,” in David Gruen, Terry REFERENCES O’Brien,and Jeremy Lawson, eds., Glo- balisation,living standards and inequality . 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