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Emerging Markets: Institutional Deficiencies or Inappropriate Policies?

English Pages, 27. 11. 1998

We have been witnessing, in the last years of the 20th century, a visible increase in instability (both economic and political) in transition countries of Asia, Latin America and Europe. When discussing it, we should not forget that the costs of it are very high and that they are paid by the affected countries themselves, not by anyone else. The countries in question are, therefore, highly motivated to look for the explanation of this phenomenon much more than anybody else. The countries which recently went through such a period have many similarities, but at the same time important differences. We have to pay a special attention to them.

The first task in our attempt to find out what happened and why it happened should be to answer a simple question why it did not happen in all transition economies. We have to search for the presence or absence of some characteristics existing in the affected countries and non-existing in non-affected countries.

I mentioned countries of three continents, and did not mention the fourth continent, Africa. This is important. It seems to me that Africa is not affected because in recent years this continent did not have huge capital inflows, inflows which can - practically overnight - change sign and become capital outflows. The same differences can be found inside continents among individual countries. The more the country was considered to be a success (realized or promised), the more open and more deregulated it was, the more vulnerable to crisis it was and the more often the crisis really happened. Saying that, I do not want to suggest, however, that there is a direct casuality between capital inflows and financial crises. I prefer to consider huge capital inflows a precondition for a future crisis. And I would like to stress that this argument should not be used as a basis for the now-fashionable idea that the flow of capital between countries should be limited or restricted.

Recently, the affected countries themselves have been blamed for their political and economic immaturity, for the imperfections of their financial and banking systems, for the lack of their capital market supervision, for their incompleteness of property rights, etc. but this is an explanation, based on misunderstanding of the transition process (and its peculiarities) and an explanation based more on anecdotical evidence than on hard data.

I cannot accept it for a very simple reason. The whole decade of the nineties was in all these countries devoted to the institutional (sometimes called – in the IMF jargon – structural) transformation, and even if the relative success of it was very uneven, there is no doubt that the degree of immaturity or imperfection of those countries is much lower in 1997 – 98 than it was in 1990 – 91. Therefore, something else had to happen. (Somebody might argue that inefficient, but coherent system of a communist command economy was replaced by imperfect and incoherent market system, but it is not true. The command economy collapsed totally, its institutions melted down and there was no chance to prolong their existence.)

I would like to mention another dimension of this problem. The countries (or perhaps individual economic agents in those countries) exporting capital misinterpreted the economic preparedness (and health) of countries eager to import capital and sent there more capital than was appropriate. In addition to it, they (together with the IMF and World Bank) convinced the importing countries that the outflows of capital must have the same easiness as the inflows. There has been created an atmosphere where anyone who dared to raise questions about the rationality of such arrangement was caricatured as an anti-liberal advocate of mercantilism or of inward-looking economic policies.

Such an arrangement, where some were more equal than some others (in a true Orwellian sense), arrangement which was supplemented by quasi-patronage of IMF and by moral hazard connected with it, put good cards into the hands of capital-exporting countries and placed all the risks on capital importing countries. It was not accepted that investors seeking higher returns there than in developed countries must accept higher risks as well. On the contrary, the lenders could rely on being rescued – at least since the Mexico crisis in 1980. It was partly because capital investment was hypocritically interpreted as a help, as foreign assistance. I remember how often I warned foreign investors who wanted to help us and asked them to make a good business, not charity. The problem was reinforced by IMF´s intervention based on a bureaucratic incentive to be involved. The IMF simply did not want to let countries reform on their own. It would undermine its significance.

The problem was aggravated by handling the emerging-markets crisis when it developed. I agree with Jeffrey Sachs, Rudiger Dornbusch, John Makin, Martin Feldstein and many others who speak about mishandling the crisis. The IMF and its influence - respecting central banks in the affected countries did not distinguish the fatal difference between inflationary and deflationary world, did not shift their policies in due time from fighting inflation (and external imbalance) to averting recession, did not understand that the scarce commodity maybe demand, not supply, and that restrictive policy in such case may become an economic suicide.

The IMF wanted to keep capital in the affected country by all means, especially by extremely high interest rates. Waiting for the return of confidence with high interest rates and no new credits to domestic firms, however, did not work. It caused severe recessions and a financial distress. As a result of it, even healthy banks and companies collapsed, even the best-managed companies were driven into bankruptcy, even good loans were rapidly turned into bad ones. Nevertheless, the affected countries were constantly blamed for their weak banks, for their bad loans, for the lack of financial supervision, for imperfect capital markets and it was forgotten that even the best economies would have similar problems in a deflationary situation.

At the end, I would like to stress that my views are based both on looking around and on following relevant economic literature, as well as on the recent experience of the Czech Republic which forces me not to be an uninvolved observer but a passionate insider.

Václav Klaus, Notes for the British Aerospace Innovation Forum, Warsaw, November 27, 1998.