The International Monetary Fund was created in 1945, after the 2nd World War, to help promote the health of the world economy. Its primary responsibilities include the promotion of international monetary cooperation, the promotion of exchange and economic stability and the control of a balanced growth of international trade. The IMF is also responsible, through its policies, to provide any resources available to countries facing economic difficulties in order to help them recover.
Unfortunately in the case of countries in East Asia the IMF policies did not manage to be successful and they were a very important factor causing one of the greatest economic crises ever. The collapse of the Thai baht, on 2 July 1997, marked the beginning of the crisis. The baht lost its value by almost 25% overnight and speculators spread and hit Malaysia, Korea, the Philippines and Indonesia and by the end of 1997 banks, stock markets and entire economies were threatened. The policies that the IMF imposed during that period were not of any help and they worsened the situation.
These failures of the IMF lead many people to call for reforms in its policies, since it was founded primarily to prevent such crises from taking place. It is true that in the case of East Asia the IMF policies did not only made things worse, but were responsible for the crisis. The excessively rapid financial, as well as capital market liberalization was probably the most important cause of this economic disaster.
Ironically, a few months before the crisis, the IMF had forecast strong growth in the area based on the fact that during the last 30 years East Asia was growing faster, doing better and was more stable than any other region. In fact, because of its excellent performance it was called the “East Asia Miracle”. After the crisis broke out, the IMF in an attempt to cover its mistakes, accused the Asian nation’s institutions and governments of being corrupted and rotten, and argued that the cause of the crisis was the fact that these institutions and governments did not follow as they should the policies of the IMF. As Joseph Stiglitz very correctly states, it wouldn’t be possible for these countries to perform so well during the past years if their governments were truly corrupted.
What the IMF and World Bank did, was to avoid studying the region just because of its success. After pressure from the Japanese, the World Bank studied the East Asian countries and concluded that the miracle, as it was called, was based on the important roles that the governments of these countries had played. The truth is that the countries managed to save at very high rates and at the same time to invest well the funds. In order to achieve something like this, the East Asian nations had a great help from their governments, who actually played the most important part.
During the era of the “East Asian Miracle”, there were exceptional reductions in poverty in the region, as well as, large raises in incomes. The high saving rates in combination with the government investment in education, helped make those countries an economic power. Growth rates were phenomenal and the standard of living rose enormously for millions of people. According to the Washington Consensus, the removal of trade constraints was a major reform to take place, and a great emphasis was given on the promotion of exports.
However, East Asian countries decided to liberalize their trade but only gradually. In addition, in contrast with what the Consensus was stating, governments both at national and local level, helped creating efficient industries and decided to shape and direct their markets, even though the Washington Consensus was emphasizing the reduction of any government intervention.
When the crisis begun the West did not realise its importance and at the annual meeting of IMF and World Bank officials in 1997 they decided to put more pressure on the developing countries to liberalize their markets. Even though the Asian leaders were not in favour of such policies they feared to go against the IMF decisions, because that would have result in the withdrawal of international capital from their countries. The only country that was brave enough to do so was Malaysia, and the result was that Malaysia’s downturn was shorter and less severe than any of the other countries. The policies of the IMF lead to the spread of the crisis, that begun from Indonesia and moved to South Korea.
There are two main patterns to these crises. The first one is illustrated in the case of Korea. It managed to grow fast after the Korean War and become one of the largest manufacturers of technological products. Under pressures from the US, it allowed its firms to borrow from abroad. In the late 1997, however, there were rumours spread in Wall Street that Korea was in trouble ant that it would not be able to repay its loans from the Western banks. Quickly the banks decided not to roll over their loans and the prophecies became true. Korea was, indeed, in trouble. The second pattern is illustrated by Thailand. Speculators believed that the currency would devalue against the dollar and tried to convert their baht into dollars. As a result because of the higher supply of baht into the market and the low demand for it, its price fell tremendously down and again the prophecies were true.
The IMF response to these situations was to provide huge amounts of money, up to $95 billion, so that the countries could keep up their exchange rates. However, this money was intended to serve another function. It made those countries financially able to repay their loans from the Western countries. Therefore, in reality, the money were coming from the West to go back to the same pocket, the West. Also, the IMF was giving the money after certain conditions were agreed to be put into practice. The conditions included high interest rates, higher taxation, reduced government spending and structural reforms. In the case of East Asia, these conditions also included political and economic changes.
The IMF’s officials were claiming that imposing such conditions was their responsibility, since they were providing such large amounts of money. In reality, if countries accepted the Fund aid they automatically had to give up a great part of their country’s autonomy. When the programs failed, the IMF accused the countries saying that they failed to undertake the reforms necessary. IMF, therefore, became part of the problem instead of a part of the solution as it was supposed to.
During the years of the crisis, unemployment reached soaring levels, GDP fell enormously and banks closed down. The unemployment rate was up to 4 times as much in Korea, £ times in Thailand and 10 times in Indonesia! At the same time poverty in Indonesia doubled and in South Korea it almost tripled. In 1998 the GDP in Indonesia fell by 13.2%, in Korea by 6.7% and in Thailand by 10.8%. In 2000, Indonesia’s GDP was still 7.5% lower and Thailand’s 2.3% lower than that before the crisis.
Even though in some cases, the communities tried hard to survive by ensuring education to their children and by making sure that everyone had enough food to live, still the crisis was so big that had also global effects as well. The global economic growth slowed down and that caused average prices to fall. The emerging countries depending on natural resources were all in trouble. Eventually, almost every emerging market was affected by the crisis in the East Asia.
How IMF/US treasury policies led to the crisis
Due to the fact that East Asia was a newly emerging market a lot of investors were attracted to the area because of the high returns and the relatively low risk. The private capital investments from developed to developing countries became seven times greater within the short period of seven years. The IMF and the US treasury believed that a fully liberalized capital account would facilitate the fast growth of the region. Unfortunately this was the single most important factor causing the crisis.
In the case of East Asian countries there was a huge reversal from capital inflows to huge capital outflows because their banks and stock markets were not strong enough to support such huge investments and a completely liberalized capital market. In Thailand for example this reversal amounted to an average of 9% within the period 1997-1999. These countries, not only didn’t have the power to control such situations, but also they did not have the abilities to cope with the results of a major crisis. Because of their previous excellent economic performance, East Asian countries did not thought of developing any unemployment schemes.
Ironically, in October 1997, the IMF was promoting the imposition liberalization policies arguing that this would enhance the countries’ economic stability. In order to achieve that it was spending a lot on money aids to the countries. However, when these policies finally failed and the East Asian countries really need the help of outside funds, the western banks were asking for their money back.
Another interesting example of IMF’s wrong policies is the case of Thailand. Before liberalization, Thailand had high constraints on the extent to which banks could lend for speculative real estate. It believed that by doing so it would help its economy to grow and jobs would be created. The IMF together with the US Treasury, however, believed that this kind of limitations did not allow the market to allocate resources efficiently. Liberalization finally took place and when Thailand needed large amounts of money to strengthen its infrastructure and education, billions were invested in real estate.
Korea is also one of the countries that suffered the most. For more than 30 years Korea was enjoying an amazing economic growth without any significant amounts of foreign investment. It managed to create its own strong enterprises like Samsung, Daewoo and Hyundai and become almost equally competitive as any other developed country. The government of the country planned for careful and slow liberalization, but that did not serve the interests of the Wall Street that demanded for a fast process. After many negotiations together with the National Economic Council, and after the arguments of the US treasury that liberalization of the market would not create any instabilities, liberalization was enforced. As a result Korea, the global economy and even the US lost.
In conclusion, in the region of East Asia the IMF policies proved to be a failure. The countries in the area were advancing economically during the last years and they achieved that by imposing restrictions on capital flows from abroad. The IMF decided to push liberalization of the markets and the result was a big crisis with not only domestic but also global effects.