International Monetary Fund VOLUME 32 NUMBER 1 January 20, 2003

In this issue

www.imf.org/imfsurvey 1 Financing for IMF strikes deal with Argentina Argentina 1 MF Managing Director Horst Köhler has recommended for Executive Board AEA in Washington approval a transitional program for Argentina. The IMF said that while I 2 providing no net new financing, the arrangement would provide financial sup- Design of SDRM port and an extension of payment expectations to the IMF through August 2003. discussed The Executive Board is expected to review the transitional program in the 6 coming days. Fischer calls for “fairer” The policy commitments developed by the government under the new agree- globalization ment with the IMF could, if implemented consistently, nurture the macro- 9 economic stability seen during the second half of 2002 and build a bridge to a De Vries honored comprehensive program to be negotiated with a successor government after the 10 April elections. The new agreement with the IMF would also unlock funding Latin America still from multilateral development for social programs, which are key to pro- crisis prone? tect the vulnerable groups from the adverse effects of the crisis. 11 In a statement released after the completion of the IMF’s annual assessment African leaders of Argentina’s economy, the IMF said on January 8 that the country should tackle challenges focus on achieving a clear political consensus in favor of reforms, with a view to 15 building a sound fiscal framework, restoring confidence in the banking sector, Demekas on postconflict aid increasing trade openness, rebuilding legal certainty, (Please turn to the following page) and…

3 Annual AEA meeting Use of IMF credit probe past, current crises for insights 12 Recent publications n early January, thousands of economists tradition- gram to Argentina’s recovery? The depth and length 13 Ially descend on a U.S. city for the annual American of the crisis—and the need to look to the future— New on the web Economic Association (AEA) conference. This year, the provided the impetus for Guillermo Calvo (Inter- 14 venue was Washington, D.C., which no doubt prompted American Development ), Michael Dooley IMF arrangements the unusually large number of policy-oriented panels (Deutschebank), Kristin Forbes (previously with the on top of the customary wide array of research-oriented U.S. Treasury and now at the Massachusetts Institute 16 IMF rates panels. Maureen Burke, Asimina Caminis, Jeremy Clift, of Technology), Nouriel Roubini (IMF and New York Elisa Diehl, Sheila Meehan, and Patricia Reynolds University), and Randall Kroszner (U.S. Council of highlight several sessions on financial Economic Advisers) to examine what crises and on the outlook for the U.S. went wrong and what it would take to economy. Coverage of additional panels sustain a recovery. will appear in the IMF Survey’s next Calvo, Roubini, and Dooley essen- issue. tially agreed that the severity of Argentina’s crisis was due to a combina- What has Argentina taught us? Why has tion of fiscal woes, a weak banking sys- Argentina been so hard hit? Was this cri- tem, and political problems. Calvo sis avoidable? Could the international emphasized that the drying up of finan- community have done anything differ- cial flows to emerging markets that 1 ent? And how important is an IMF pro- Guillermo Calvo resulted from (Please turn to page 4)

©International Monetary Fund. Not for Redistribution Argentina secures breathing space

(Continued from front page) and restructuring debt with financial system. Looking forward, the IMF noted private external creditors. that it was important that the authorities garner the Elsewhere in the region, the IMF on January 15 necessary political consensus to carry out their policy approved a two-year, $2.1 billion Stand-By Arrange- agenda. Peru has a $340 million loan program with ment for Colombia in support of its economic pro- the IMF, which was approved in February 2002. The gram through 2004. The approval makes $264 mil- first review of the program, which was completed at lion available immediately. The authorities have the same time as the annual assessment, provides indicated that they intend to treat the arrangement Peru with $154 million in fresh funds. The country as precautionary. In announcing the loan, Köhler has not made any drawings under the loan so far. praised Colombia’s “strong reform program.” He The IMF completed on December 19 the first noted that “the Executive Board commends the gov- review of Brazil’s performance under the $30.7 billion ernment for its rapid and determined action to loan approved last September. Completion of the address the fiscal pressures, which emerged in 2002, review provides Brazil with $3.1 billion in additional and develop a comprehensive strategy for stability, funds, in addition to the $3.1 billion provided when growth, and improved social equity.” the program was approved in September. The As for Ecuador, an IMF mission is currently in Quito remaining amount—about $24 billion—will become to hold discussions with the new economic team on a available in 2003. In a statement released shortly after possible Stand-By Arrangement, as well as to complete the conclusion of the review, Köhler said that Brazil’s a long delayed overall assessment of the state of performance under the program had so far been Ecuador’s economy. President Lucio Gutierrez took “exemplary,” and he called on the new administration office on January 15, and his government is proposing to continue working to restore confidence in its econ- a comprehensive economic program to deal with omy. On January 1, Luiz Inácio Lula da Silva became Ecuador’s immediate fiscal pressures and to restart Brazil’s new president. structural reforms aimed at sustaining growth in the dollarized economy. For further information on these developments, please see In a statement following the IMF’s annual assess- the following items on Colombia (Press Release No. 03/04), ment of Peru’s policies, the IMF said on December 23 Argentina (Press Release No. 03/01), Brazil (News Brief No. 02/128), and Peru (News Brief No. 02/126 and Public that it was pleased with the country’s overall policy Information Notice No. 02/139). All are available on the IMF’s framework, which aims at maintaining macro- website (www.imf.org). economic stability and reinforcing an already solid

IMF Board debates SDRM design

n December 19 and 20, the IMF’s Executive tioners and other workout specialists, academics, and OBoard—chaired by First Deputy Managing members of the official community. Director Anne Krueger—continued discussions of In her summary of the Board’s discussions, Krueger the possible features of a new sovereign debt restruc- noted that “most Directors reaffirmed their belief that turing mechanism (SDRM). The discussion was a a carefully designed debt restructuring mechanism step toward fulfilling the International Monetary and can make an important contribution to improving the Financial Committee’s request for a concrete SDRM comprehensive framework for crisis resolution and proposal that could be considered at its next meeting the international financial architecture more generally. in April. The Board’s debate revolved around a staff The objective of the SDRM is to provide a framework paper that reflected extensive staff contacts with pri- that strengthens incentives for a sovereign and its vate market participants, debt restructuring practi- creditors to reach a rapid and collaborative agreement on a restructuring of unsustainable debt in a manner that preserves the economic value of assets and facili- Photo credits: Denio Zara, Padraic Hughes, Pedro tates a return to medium-term viability, and thereby Márquez, and Michael Spilotro for the IMF, pages 1, reduces the cost of the restructuring process. 4–10, and 15; Christophe Simon for AFP, page 16. January 20, 2003 “To achieve this objective, the SDRM must not 2 only address collective action problems among

©International Monetary Fund. Not for Redistribution creditors, but also catalyze an early and effective justified. They noted that several proposed features of the dialogue and exchange of information between mechanism would discourage abuse of the SDRM. the debtor and its creditors. By creating greater Furthermore, the IMF would be able to influence a predictability in the restructuring process, the SDRM member’s decision to activate the mechanism through its should also be expected to improve the functioning policy dialogue and the exercise of its financial powers. of international capital markets—an objective that • Consequences of activation. A central issue is should remain a primary concern going forward.” whether the mechanism should provide a stay on cred- While Executive Directors found much common itor enforcement. Many Directors favored keeping ground for moving the discussion forward, a wealth open the option of an automatic stay on litigation that of views were expressed on many aspects of a possible would remain in place for a brief period until creditors SDRM. For some important features of the mecha- were sufficiently organized to vote on an extension. nism, Directors insisted that all options under consid- However, many other Directors noted that an eration remain on the table at this stage. Although a automatic stay would constitute a significant, and brief summary cannot do justice to the breadth of the possibly unnecessary, erosion of contractual rights. debate, issues generating the most discussion They viewed the use of a more limited approach— included the following: which lawyers refer to as the hotchpot provision— • Scope of claims to be covered. Directors generally possibly supplemented by injunctive relief as a work- agreed that, in cases where a sovereign’s debt burden able alternative that would discourage litigation with- was unsustainable, a broad range of claims might out imposing a limitation on enforcement rights. need to be restructured—both to help ensure a Some Directors urged that this rule be supplemented return to debt sustainability and to achieve sufficient by a feature that would enable the Sovereign Debt intercreditor equity to garner broad support for the Dispute Resolution Forum, upon the request of the restructuring. At the same time, Directors observed debtor and the approval of a qualified majority of that the debtor could decide to exclude certain types creditors, to issue a stay under specific circumstances. of claims from a restructuring, in particular to limit Directors encouraged management and the staff to the extent of economic and financial dislocation. continue work on the design features of the SDRM. Most Directors therefore thought that the mecha- The conference on the SDRM—hosted by the IMF on nism should identify the range of claims that could January 22—will be an important opportunity to make potentially be restructured under the provisions of further progress in clarifying outstanding issues and in the SDRM while leaving it to the debtor—in negotia- building consensus on the mechanism’s design. tions with its creditors—to determine which of these eligible claims would need to be restructured in a particular case. Much of the discussion then focused The full text of the Public Information Notice on the Board discussion and the staff paper are available on the IMF’s web- on which types of claims should be excluded from site (www.imf.org). the SDRM and how to define more precisely those claims that should be included. In particular, Directors supported the exclusion of Members’ use of IMF credit claims that were already governed by domestic law (million SDRs) and subject to the exclusive jurisdiction of domestic During January– January– courts. However, they stressed that the mechanism’s December December December transparency requirements would need to help ensure 2002 2002 2001 General Resources Account 2,569.35 25,236.95 23,761.62 that the restructuring of these claims would be ade- Stand-By 2,294.11 23,948.13 23,019.62 quately coordinated with the restructuring of claims SRF 1,141.06 9,044.73 13,240.71 under the SDRM. EFF 275.24 1,261.85 742.00 CFF 0.00 0.00 0.00 Directors did not reach a definitive view on how to EMER 0.00 26.98 0.00 treat the claims of official bilateral creditors. While PRGF 120.98 1,344.49 872.64 many thought that such debts had been efficiently Total 2,690.33 26,581.44 24,634.26 restructured in the past (as needed) through the Paris SRF = Supplemental Reserve Facility EFF = Extended Fund Facility Club, a number of other Directors thought that includ- CFF = Compensatory Financing Facility ing official bilateral creditors under the SDRM would EMER = Emergency assistance programs for countries following conflicts and natural disasters be important for achieving greater inter-creditor equity. PRGF = Poverty Reduction and Growth Facility • Activation. Most Directors thought that the debtor Figures may not add to totals shown owing to rounding. should be allowed to activate the mechanism unilaterally, Data: IMF Treasurer’s Department January 20, 2003 without third-party confirmation that the activation was 3

©International Monetary Fund. Not for Redistribution Panelists discuss Argentina, sovereign debt crises

(Continued from front page) East Asia’s crisis of or less stabilized following a 70 percent depreciation 1997–98 caused a sharp depreciation of the equilib- last year; unemployment has declined by 4 percent rium real exchange rate. The warranted depreciation since May 2002; bank deposits have stabilized and was larger in relatively closed economies like are starting to increase; and although inflation is Argentina that are less able to respond by increasing high, there is no hyperinflation. Still, Kroszner their exports. Argentina was also more vulnerable pointed out, growth needs to be reignited. For that to because of the level of its debt denominated in U.S. happen, there must be political stability and less dollars. uncertainty about future economic policies. In Roubini’s view, the severity of Argentina’s fiscal Forbes and Kroszner agreed that if Argentina Nouriel Roubini problems distinguished it from other emerging mar- wanted a vigorous recovery, IMF support for the eco- kets. The country was basically insolvent, and this, nomic program would be important. It would together with currency, banking, and corporate crises, improve the chances of a stable environment and sig- capital controls, a bank run, a freeze on deposits, and a nal to foreign direct investors that recovery was start- default on domestic and external debt, made Argentina ing. In Forbes’s view, if the IMF made more money more vulnerable to financial turmoil and political strife. available to Argentina than the country needed to Dooley blamed the severity of Argentina’s crisis on repay debt, the government would have the incentive the government’s unwillingness to take any corrective to undertake difficult reforms. But Roubini had reser- steps. Its choices were to default or devalue, and it did vations about Argentina’s receiving net new financing. neither, he said, until it was too late. Instead, it raided He noted that the IMF already had a large exposure to the banks, introduced capital controls, and redistrib- the country, the current Argentine administration had uted wealth arbitrarily, which led to a complete no credibility for reform, and the huge current breakdown of financial intermediation and uncer- account turnaround, of 10 percent of GDP, suggested Michael Dooley tainty about how the problems would be resolved. that Argentina needed money only to roll over its cur- Dooley’s prognosis was that recovery in Argentina rent debt. would be delayed as much as 10 years because of the How should sovereign debt crises be addressed? difficulty of restructuring private sector debt. “Until Given gaps in the current international financial all losses are allocated,” he said, “there will be no eco- architecture, sovereign states with unsustainable nomic recovery.” debt burdens often delay restructuring efforts, with Was the crisis avoidable? Could the international painful results for debtor and creditors alike. IMF community have done something else? As Forbes First Deputy Managing Director Anne Krueger, noted, none of the panelists suggested that a large whose proposal in November 2001 for a “statutory” bailout could have prevented the crisis. Roubini agreed solution reenergized the debate on this issue, out- in part with Dooley that a government could not be lined the current state of play with regard to the forced to default, but he argued that if official financ- sovereign debt restructuring mechanism (SDRM) Kristin Forbes ing had been cut off in November or December 2000, proposal (see also page 2). She highlighted, in par- even as late as the summer of 2001, Argentina, lacking ticular, work that was proceeding on a framework another source of finance, would have experienced a that would strengthen the incentives for both par- rollover crisis. It would then have been forced to ties to reach a rapid and collaborative restructuring default and accept the consequences. of unsustainable debts. By mid- or late 2001, Roubini said, Argentina had Randall Kroszner then reviewed U.S. administra- reached the point of no return. It was too late for fiscal tion proposals for a “contractual” approach that adjustment, and dollarization, which had been sug- could expand the use of collective action and other gested, was a bad idea. Early on, he maintained, if clauses in individual bond issues and encourage the Argentina had resolved its own problems through the formation of voluntary dispute resolution forums. private sector, debt restructuring would have been How should the respective merits of these propos- more orderly. But the country did not go that route, als be evaluated? Barry Eichengreen (University of and, as a result, the debt restructuring occurred much California, Berkeley) acknowledged that the statutory Randall Kroszner later and was far more disorderly. approach would be more comprehensive because it But, Forbes and Kroszner noted, Argentina’s situa- could restructure multiple debt issues simultaneously. tion has begun to stabilize and a recovery—albeit In practice, however, its relative usefulness would January 20, 2003 slow—is under way. According to Forbes, output hinge, in part, on whether restructurings involving 4 growth in 2003 should be positive; the peso has more many debt issues were significantly more costly than

©International Monetary Fund. Not for Redistribution those involving fewer issues. His empirical evidence borrowing terms. Factors (undertaken jointly with the IMF’s Ashoka Mody) like public debt levels and suggested that investors did indeed perceive this to be membership in the British the case. In particular, countries with the lowest credit Empire also began to play a rating (those most likely to restructure) faced higher role in determining spreads. risk premiums on new debt issues if many issues were “Plus ça change, plus c’est already outstanding. la même chose” was Michael Panelists, as well as discussants Guillermo Calvo, Bordo’s (Rutgers University) Ann Harrison (University of California, Berkeley), and conclusion after he and Marc Morris Goldstein and Michael Mussa (both with the Flandreau (University of Institute for International and previously Paris and the Centre for the IMF), broadly agreed that the key test would be Economic Policy Research) Barry Eichengreen (left) how well a proposed solution could minimize the compared the financial crises of the 1990s with crises with Ashoka Mody number of financial crises and how quickly it could between 1880 and 1914. Little has changed over the return crisis countries to a sustainable growth path. past century except that the “core” (advanced) coun- Most saw merit in the two-track approach: promoting tries in the earlier period chose to peg their currencies the use of collective action clauses and voluntary to gold, whereas today, except for the euro area, they forums while working toward agreement on an float their currencies, and paper has replaced gold and SDRM. They saw the two tracks—one that could be silver. Then, as now, the “peripheral” (emerging mar- pursued relatively quickly and the other that would ket) countries were burdened with “original sin”— take some time—as complementary. that is, they could not issue long-term domestic debt But several discussants also cautioned against over- or borrow abroad in their own currency. They were selling either option. Goldstein noted that neither also hindered in their choice of exchange regime approach addressed a critical obstacle to restructur- because of their lack of financial maturity, which ing—the large overhang of sovereign bonds in the Bordo and Flandreau defined as open and deep finan- domestic economy. Mussa observed that, even if an cial markets, stable money, and fiscal probity. SDRM had been in existence, it would have been Examining the past experiences of the United applicable in only a small number of past crises. And States, Australia, Canada, and New Zealand, Bordo very little of the enormous costs associated with characterized the notion of original sin as an explana- financial crises has been attributable to litigation tion for emerging market crises as “overblown.” These (although he conceded that the ultimate resolution of countries had original sin in that they could not issue Argentina’s crisis may teach us a lot about such costs). abroad bonds denominated in domestic currency, yet The SDRM might be useful, but Mussa cautioned they were financially mature and fiscally sound. They against proposing it as a solution to emerging market were also less exposed to currency and maturity mis- financial crises. That, he said, was like “giving an matches than emerging market economies today aspirin to someone who has cancer.” because their debt was small and mostly long term. Learning from history? Earlier eras of global finan- Such mismatches are thus a recent phenomenon. cial integration may hold lessons for today’s emerging What the core countries had that many peripheral market economies. Delving into the question of how countries lacked was a good track record that made lenders in the prewar and interwar periods assessed their adherence to the gold peg credible, allowing sovereign risk, Maurice Obstfeld (University of them to deviate from it temporarily during a war or California, Berkeley) and Alan M. Taylor (University financial crisis and giving them the short-term flexi- of California, Davis) studied the London bond mar- bility they needed to implement stabilization pro- ket from the 1870s to the 1930s. They found that grams. Thus, policy played a critical role then, as it adherence to the gold standard gave sovereign bor- does today, in preventing, or allowing a swift resolu- Michael Bordo rowers credibility before World War I, shaving 40 to tion of, a crisis. 60 basis points from country borrowing spreads. The Corporation of Foreign Bondholders (CFB)— In the 1920s, however, as workers and previously an association of British investors that was effective, disenfranchised groups gained political power, and much of the time, in coordinating orderly debt work- access to global markets became more democratic, outs during the “heyday of international bond markets began looking more closely at the “books.” finance” (1870–1913)—may have had an easier time The markets no longer considered a hard peg to be than any comparable body would have today, accord- a substitute for good policies, and adherence to the ing to Paolo Mauro (IMF) and Yishay Yafeh (Hebrew January 20, 2003 gold standard ceased to be a guarantee of attractive University). For one thing, in the past, individuals 5

©International Monetary Fund. Not for Redistribution almost never sued sovereign states in the event of a ishing defaulting debtors failed. For today’s creditors, default. For another, bonds were often collateralized the appeal of defection is stronger, and the appeal of or implicitly backed by tangible assets or tax rev- coordination weaker, than in the past. The challenges enues: creditors were therefore motivated to act faced by a modern version of a creditor association together to seize the collateral (trading their debt, for would thus be commensurately greater today than example, for equity in such valuable entities as rail- they were for its predecessors. roads) or even to administer and collect some of the defaulting government’s tax revenues. Eyes on the U.S. economy Individual bondholders numbered in the hundreds Fiscal stimulus? The panel “Fiscal Stimulus 2003” was rather than in the tens of thousands, although mutual convened hurriedly when former U.S. Treasury funds were less prominent than they are today. Secretary Paul O’Neill canceled his scheduled address. Paolo Mauro Moreover, the CFB had close ties with the British In his place, economists Alan Auerbach (University of government, and, in a few extreme cases, it persuaded California, Berkeley), Eric Engkin (American the British government to resort to diplomatic or Enterprise Institute), Robert Hall (Stanford even military intervention when other means of pun- University), Matthew Shapiro (University of

Toward “better and fairer globalization”

Citigroup Vice Chair and former IMF First Deputy increased among the average income levels of different Managing Director Stanley Fischer delivered the 2003 countries while possibly decreasing among all individuals in Richard T. Ely Lecture, “Globalization and Its Challenges,” the world. On average, social indicators including literacy during the American Economic Association meetings. In it, and health have improved significantly in the developing he recounted the benefits of globalization—including countries. It thus appears that, on average, conditions in the improved growth—but also acknowledged that many of the developing world have improved. But, Fischer emphasized, problems critics point to are real. He highlighted a number of this is not the same as saying that everyone in the developing policies that are necessary to achieve a “better and fairer glob- countries is doing better. alization.” In his opening remarks, he also paid tribute to his Trends in global poverty figure prominently in the global- friend and colleague Rudiger Dornbusch, who passed away ization debate. But the facts alone do not, Fischer noted, in July 2002 and was to have delivered the Ely Lecture. directly address the issue of whether the trends are caused by For the full text of the lecture, see www.iie.com/fischer. developing countries’ increasing integration with the global economy. To address this question, we must assess the Almost everyone agrees that the world could be a better Fischer: “The pro- impact of openness on growth. market, pro- place and recognizes that much work will be required to Trade policy is a central aspect of economic policy. Many globalization improve it. Why, then, is so much of the globalization studies have shown that greater openness to trade is associ- approach is the debate about whether the world is getting better or worse? ated either with higher levels of income or with more rapid worst economic The reason, Fischer said, is that this debate is ultimately growth. And countries that have adopted export promotion policy, except for about policies. “The implicit premise is that if the world is strategies have achieved greater economic success than those all the others that going to hell, then the policies of the past 50 years are likely that have sought to keep imports out. The evidence and the have been tried.” to be wrong and if the world has been getting better, then studies, he observed, should persuade many that openness to the policies are more likely to be right.” It is a separate ques- the global economy is a necessary, though not sufficient, tion, he argued, whether all recent developments in global condition for sustained growth. conditions can be attributed to globalization. A set of policy recommendations for reform-minded Regional challenges countries that has received much attention and a large Clearly, the major challenge facing the world today, Fischer share of negative press is the so-called Washington consen- said, is poverty. And the surest route out of poverty is eco- sus set out by John Williamson in 1990. Fischer nomic growth. Growth requires good economic policies set regarded its 10 elements—which included fiscal discipline, in a policy framework that prominently includes an orien- tax reform, financial and trade liberalization, deregulation, tation toward integration with the global economy. A way and privatization—as a useful shorthand description of must be found to make the global system deliver economic part of a desirable policy orientation. growth more consistently and more equitably. Global growth is determined mainly by the performance What do the data show? of the industrial countries, and attitudes toward globaliza- Globally, poverty rates have been declining, especially in Asia, tion in these countries are key to the future of the global Fischer noted. Developments in income distribution are economy. Governments in these countries should stand up January 20, 2003 more mixed, with the evidence showing that inequality has and support the right policies; help their own people deal 6

©International Monetary Fund. Not for Redistribution Michigan), and Janet Yellen (University of California, cause this recession (U.S. recessions typically occur Berkeley, and former chair of the U.S. Council of after the Fed tightens monetary policy), the country Economic Advisers, 1997–99) debated whether stim- had price stability, and there was no liquidity trap. ulus was warranted at this juncture and what form it But, in her view, the call on whether the U.S. econ- should and would take. omy had emerged from recession was “too close for Auerbach and Engkin argued that the recession, a comfort,” and the Fed had few tools left in its arse- historically mild one, was effectively over; Hall, nal—most of them virtually untried. Shapiro, and Yellen were not so confident. Hall and A discussion of what to do quickly turned to what Yellen expressed concern about unemployment, and not to do. There was universal unease with the coun- Shapiro cited intangibles—the impact of a war with try’s fiscal position, which had deteriorated rapidly in Iraq and a possible asset market meltdown. For Hall, recent years and was looking grim going into the fiscal policy also lent a welcome added dimension to longer term. Auerbach admitted to being “totally puz- Robert Hall a U.S. economic policy framework heavily reliant on zled” by a stimulus package fashioned around a per- monetary policy. Yellen termed the U.S. economy manent cut in dividend taxation (it would, he said, “abnormally fragile.” She noted that the Fed did not “stimulate private wealth—nothing else”). He pre-

with the adverse consequences of economic change; and economy, Fischer said. But, national economic, social, and deliver on their promises on trade, aid, and the strengthening cultural preferences are bound to take a front seat in this of the international economic system. area. Moreover, greater clarity is needed on the economic Although most of the world’s poor are moving toward effects of alternative policies—an area in which more pub- sustainable growth (notable exceptions are some countries lic policy attention will eventually be focused. in Asia and Latin America), Fischer said that the most pro- Improving governance. Ordinary people everywhere want found problems of poverty were increasingly concentrated to improve their lives. But corrupt governments do not nec- in sub-Saharan Africa. It already has the world’s highest essarily respond to those desires. That is why, Fischer poverty rate, and the number of poor has been rising argued, the trend to democracy is so important. rapidly. In addition, HIV/AIDS is taking a tragic toll. While countries are primarily responsible for their own fates, he said, outsiders—from both the public and the pri- National and global policy challenges vate sector—can influence outcomes by promoting democ- All countries have challenges to surmount if globalization racy, investing in economic activity, and supporting good is to benefit more of the world’s citizens. projects in social sectors. Through their actions, they can Implementing the right policies. The outward-oriented poli- also help fight corruption in developing countries. With a cies described in the 1990 Washington consensus, Fischer nod to Winston Churchill’s famous observation about said, remain an important component of the right approach democracy, Fischer concluded that “the pro-market, pro- to economic policy, but also needed are a greater emphasis globalization approach is the worst economic policy, except on social justice, more effective economic governance, crisis- for all the others that have been tried.” proofing economies, and labor market reforms that allow more of the workforce to enter the formal labor market. Tribute to Rudi Dornbusch Delivering on trade and aid. The industrial countries need “Collaborating with Rudi,” Fischer said of his coauthor on to do their part to facilitate developing countries’ integra- the textbook Macroeconomics,“has given me as much satis- tion with the global economy. That means liberalizing agri- faction as anything else I have done in my professional life.” cultural trade and ending the massive subsidies to agricul- In opening remarks at the Richard T. Ely Lecture, Fischer ture that impede the exports of so many developing coun- paid tribute to Dornbusch’s many contributions to the theo- tries. At the same time, the developing countries can retical and policy fields, from his influential “overshooting” achieve major gains by opening up trade to each other. paper to the equally famous 1994 Brookings Institution Making the international financial system less crisis prone. paper that predicted the Mexican peso crisis. Dornbusch The shift to flexible exchange rates 30 years ago and the was, Fischer said,“one of the outstanding policy economists strengthening of macroeconomic policy frameworks have of our time.” Fischer indicated that he often called helped prevent foreign exchange crises among the industrial Dornbusch to discuss difficult situations at the IMF.“His countries, Fischer noted. But emerging market countries are advice was always thoughtful, typically nuanced, and fre- still disturbingly prone to crises. Although their shift to more quently provided insights that no one else had seen—and he flexible exchange rates will make their financial systems more was willing to talk as long as it took,” Fischer said.“We will stable, crises can erupt for other reasons, particularly market miss Rudi deeply for his incisive mind, the brilliance of his fears that these countries’ debts are unsustainable. insights, the exuberance of his writing, and his challenges to Dealing with migration. Flows of labor, either temporary conventional thinking—but most of all, for his friendship January 20, 2003 or permanent, are a potentially powerful force in the global and the pleasure of his company.” 7

©International Monetary Fund. Not for Redistribution ferred temporary measures, notably steps to encour- boards of directors to rein in excesses in executive age business investment and extend unemployment compensation. “There is little doubt that some execu- benefits (money likely to be spent quickly). tives have been paid more than they would if it Engkin favored seizing the opportunity to enact weren’t for boards of directors stacked with their policies that would boost long-term growth and move cronies; if it weren’t for quirks in our tax laws that the country toward fundamental tax reform. Removing favor certain types of stock options over other types the tax on dividends would, he said, improve competi- of pay; and if it weren’t for the fact that options don’t tiveness and increase the incentives corporations have have to be expensed,” he argued. “In the 1990s, top to pay dividends. He opposed raising exemptions for executives extracted $3.3 billion from companies that child care, extending unemployment benefits, or pro- they led into bankruptcy. That’s unconscionable. We viding a temporary “holiday” on payroll (social secu- need standards of corporate governance that ensure rity) tax payments. Hall, too, proclaimed the moment that executive compensation does more than just line ripe for incremental, opportunistic tax reform. He saw the pockets of executives.” the country moving rapidly toward a consumption tax A key change would be to require the expensing and welcomed the removal of personal taxation on div- of stock options, meaning that companies would idends as a step in the right direction. account for the cost of options in their balance sheets. It was just this type of piecemeal tax reform, how- At present, such options are listed in a footnote of the ever, that worried Shapiro, given looming increases in corporate accounts. “Options have a real value to the expenditures to meet pension and security concerns. executive receiving them and a real cost to the share- Much as he did not favor accelerating scheduled 2004 holders who grant them,” Levitt said. “Like any other tax cuts into 2003, he would do this if the scheduled form of compensation, they should be expensed. 2006 tax cuts could be scrapped. He also hoped that Investors deserve, and the integrity of our markets politicians would not forget that spending was the demands, an accurate and full picture of a company’s other half of fiscal policy. He urged relief for states financial outlook, and expensing stock options will (many of which face severe revenue shortfalls) and a help us paint that picture.” He added that “new rules Janet Yellen boost in federal spending on security. regarding auditor independence and expensing of In Yellen’s view, stimulus should be temporary, stock options will go a long way to improve the work- increase demand, and provide maximum “bang for ings of our markets.” the buck” and quick results. Like Auerbach, she In a separate session, Kevin Murphy (University of favored an extension of unemployment benefits to Southern California) also highlighted the expensing address skyrocketing long-term unemployment rates of options as a key element in reform. Options now (such an extension did indeed pass shortly after the account for 51 percent of the pay of senior executives, AEA conference concluded) and relief for state gov- he said, and part of the problem is that managers and ernments that were having to make nearly unprece- boards of directors do not understand the true cost of dented cuts in public investment. stock options. “They think they are free,” he said. It was interesting, Hall observed, that the panel’s dis- Wayne Guay (University of Pennsylvania) indicated cussion of short-term stimulus turned so quickly to that it was clear that options should be treated like long-term concerns. The panel expressed much less business expenses; otherwise, the balance sheet pre- certainty that long-term issues would shape the debate sented a distorted picture. But one consequence of that was just beginning on Capitol Hill. expensing the options, Murphy said, would be the Lessons from Enron. Following a string of corporate granting of fewer options. scandals in the , policymakers, regulators, The bottom line, Levitt explained, was that it was and economists are examining how to improve corpo- important to retain investor confidence in the markets. rate governance and revive confidence in the equities “Just as quickly as we have brought millions of new markets. At a luncheon speech organized jointly by the investors into our markets, we may have lost that con- AEA and the American Finance Association, Arthur fidence in those markets.” He urged companies to Arthur Levitt Levitt, chair of the U.S. Securities and Exchange appoint independent directors willing to ask awkward Commission during 1993–2001, called the scandals a questions.“All the regulations in the world can’t collective failure of all the gatekeepers—the accoun- replace a board willing to ask tough questions,” he said. tants, the lawyers, the boards of directors, the standard Social security reform on the back burner? Unlike setters, the rating agencies, and the regulators.“The fiscal stimulus and corporate governance, reform of whole system was asleep at the switch,” he said. the U.S. social security system is not prominent in January 20, 2003 Levitt, now a senior advisor to the Carlyle Group, U.S. newspaper headlines. But, with a huge group of 8 a private global investment firm, said that it was up to postwar “baby boomers” nearing retirement and

©International Monetary Fund. Not for Redistribution financial storm clouds on the horizon, the issue is not cluded, is ensuring that investment risk is shared by going away. future generations and current savers. In a forum on public policy, John Campbell Peter Diamond (Massachusetts Institute of () addressed the risk aspects of Technology) took up three different issues relating to social security reform, noting that a major problem social security reform: the indexing of benefits and is that people often compare the historical average of taxes for life expectancy, the use of earmarked funds, returns available in the U.S. stock market with the and the idea of dedicating the estate tax to social implied returns of the current social security system. security. Indexing, Diamond noted, is already done This comparison, of course, ignores some serious for wages and prices and could work well for life issues: past performance does not guarantee future expectancy if handled through a rule, making it auto- results, stock returns are risky, and returns on the matic and thus politically less contentious. current system are low because most contributions The United States, he explained, finances its social are devoted to paying the benefits of current retirees, security system through an “earmarked” payroll tax. and these benefits represent a huge unfunded liability. Earmarking—dedicating revenue to a particular The existing pay-as-you-go (PAYG) system of social expenditure—has limited pressure for higher benefits security reduces the national saving rate, making a and permitted increases in the tax because the rev- funded component necessary. The current challenge, enues are for an extremely popular purpose. Thus, Campbell said, is to address how the government earmarking has played an important role in the polit- Peter Diamond should use its taxation authority to operate the system’s ical process and has made the public think about the PAYG component, how big the federally funded compo- tax much more sensibly. (In general, the public favors nent should be, and how the funds should be invested. expenditures and opposes taxes, which does not add He described two different reform proposals, both up.) In Diamond’s opinion, the estate tax with a large of which have advantages and disadvantages. One is exemption is an excellent tax. It is currently under based on individual retirement accounts (favored by siege, but linking it to social security, he said, may Republicans) and the other (favored by Democrats) offer a good way to defend it. consists of a centralized system with an independent Diamond concluded with a broader warning about board to oversee the investment of the social security the upcoming debate over social security reform. trust fund. He suggested that a compromise system Beware politicians who promise to fix social security could be devised that addressed the disadvantages of without cutting benefits or raising taxes. It can’t be each. One important consideration, Campbell con- done, he said.

Margaret de Vries receives few in number, and her early mentors, Carolyn Shaw Bell award notably Edward Bernstein and Irving Friedman, were men. She represented the IMF On January 3, retired IMF economist and historian on negotiating missions to such countries as Margaret Garritsen de Vries received the 2002 Carolyn Burma (now Myanmar), Costa Rica, India, Shaw Bell award from the American Economic Israel, Mexico, Nicaragua, the Philippines, Association’s Committee on the Status of Women in the Thailand, Turkey, and Yugoslavia and helped Economics Profession (CSWEP). The award honors an develop and implement IMF policy on multi- individual who has advanced the status of women in eco- ple exchange rates. De Vries rose to the rank nomics through example, achievement, or mentoring. of Division Chief—the first woman to do As a child in Detroit, Michigan, during the Great so—in 1957. Depression, de Vries personally witnessed the devastating In 1952, she married her colleague Barend A. effects of unemployment, which sparked her interest in eco- de Vries, an eminent economist who later nomics. The first member of her family to finish high school, worked at the World Bank. After a brief hiatus de Vries won a full scholarship to the University of Michigan, from the IMF when her children were young, where she obtained a B.A. with honors in economics and was de Vries returned as the institution’s first full- Honoree Margaret elected to Phi Beta Kappa. In 1946, she received a Ph.D. in time historian and served in this capacity until Garritsen de Vries economics from the Massachusetts Institute of Technology, her retirement in 1987. had a long, shortly after Nobel prize winner Paul A. Samuelson founded In presenting the award, Barbara Fraumeni of distinguished the economics department there. CSWEP paid tribute to de Vries’s distinguished career at career at the IMF. Joining the IMF in July 1946, de Vries was one of the the IMF and made special note of her pioneering role institution’s first staff members. Her female colleagues were and lifelong commitment to mentoring women. January 20, 2003 9

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