Bad Samaritans: The Myth of Free Trade and the Secret History of Capitalism

assassinate undesirables, but it is much feared by developing countries all the same, for it plays the role of gatekeeper vis-a-vis the these countries, controlling their access to international finance.

When developing countries get into a balance of payments crisis, as they often do, signing an agreement with the IMF is crucial. The money that the IMF itself lends is only a minor part of the story, for the IMF does not have much money of its own. More important is the agreement itself. It is seen as a guarantee that the country will mend its ‘profligate’ ways and adopt a set of ‘good’ policies that will ensure its future ability to repay its debts. Only when such agreement is made do other potential lenders – the World Bank, rich country governments and private- sector lenders – agree to continue their supplies of finance to the country concerned. The agreement with the IMF involves accepting conditions on a wide (and, indeed, ever-widening, as I discussed in chapter 1) range of economic policies, from trade liberalization to the adoption of new company law. But the most important and feared of IMF conditions concern macroeconomic policies.

Macroeconomic policies – monetary policy and fiscal policy – are intended to change the behaviour of the whole economy (as distinct from the sum total of the behaviours of the individual economic actors that make it up).[1] The counter-intuitive idea that the whole economy may behave differently from the sum total of its parts comes from the famous Cambridge economist John Maynard Keynes. Keynes argued that what is rational for individual actors may not be rational for the entire economy. For example, during an economic downturn, firms see the demand for their products fall, while workers face increased chances of redundancy and wage cuts. In this situation, it is prudent for individual firms and workers to reduce their spending. But if all economic actors reduced their expenditure, they will all be worse off, for the combined effect of such actions is a lower aggregate demand, which, in turn, further increases everyone’s chances of bankruptcy and redundancy. Therefore, Keynes argued, the government, whose job it is to manage the whole economy, cannot simply use scaled-up versions of action plans that are rational for individual economic agents. It should always deliberately do the opposite of what other economic actors do. In an economic downturn, therefore, it should increase its spending to counter the tendency of the private sector firms and workers to reduce their spending. In an economic upturn, it should reduce its expenditure and increase taxes, so that it can prevent demand from outstripping supply.

Reflecting this intellectual origin, until the 1970s, the main aim of macroeconomic policies was reducing the magnitude of the swings in the level of economic activity – known as the business cycle. But since the rise of neo- liberalism, and its ‘monetarist’ approach to macroeconomics, in the 1980s, the focus of macroeconomic policies has radically changed. The ‘monetarists’ are called as such because they believe that prices rise when too much money is chasing after a given quantity of goods and services. They also argue that price stability (i.e., keeping inflation low) is the foundation of prosperity and, therefore, that monetary discipline (which is required for price stability) should be the paramount goal of macroeconomic policy.

When it comes to developing countries, the need for monetary discipline is even more emphasized by the Bad Samaritans. They believe that most developing countries do not have the self-discipline to ‘live within their means’; it is alleged that they print money and borrow as if there were no tomorrow. Domingo Cavallo, a famous (or infamous, after the financial collapse in 2002) former finance minister of Argentina, once described his own country as a ‘rebel teenager’ who could not control his behaviour and needed to ‘grow up’.[2] Therefore, the firm guiding hand of the IMF is seen as crucial by the Bad Samaritans in securing macroeconomic stability and hence growth in these countries. Unfortunately, the macroeconomic policies promoted by the IMF have produced almost the exact opposite effect.

‘Mugger, armed robber and hit man’

Neo-liberals see inflation as public enemy number one.Ronald Reagan once put it most graphically: ‘inflation is as violent as a mugger, as frightening as an armed robber and as deadly as a hit man’.[3] They believe that the lower the rate of inflation is, the better it is. Ideally, they want zero inflation. At most, they would accept a very low single-digit rate of inflation. Stanley Fischer, the Northern- Rhodesia-born American economist, who was the chief economist of the IMF between 1994 and 2001, explicitly recommended 1–3% as the target inflation rate.[4] But why is inflation considered so harmful?

To begin with, it is argued that inflation is a form of stealth tax that unjustly robs people of their hard- earned income. The late Milton Friedman, the guru of monetarism, argued that ‘inflation is the one form of taxation that can be imposed without legislation’.[5] But the illegitimacy of ‘inflation tax’, and the ‘distributive injustice’ arising out of it, is only the beginning of the problem.

Neo-liberals argue that inflation is bad for economic growth as well.[6] Most of them would hold that the lower a country’s rate of inflation, the higher its economic growth is likely to be. The thinking behind this is as follows: investment is essential for growth; investors do not like uncertainty; so we must keep the economy stable, which means keeping prices flat; thus low inflation is a prerequisite of investment and growth. This argument has had a particularly strong appeal in those Latin American countries, where memories of disastrous hyperinflation in the 1980s combined with collapse in economic growth were strong (especially Argentina, Bolivia, Brazil, Nicaragua and Peru).

Neo-liberal economists argue that two things are essential in achieving low inflation. First, there should be monetary discipline – the central bank should not increase the money supply over and above what is absolutely necessary to support real growth in the economy. Second, there should be financial prudence – no government should live beyond its means (more on this later).

In order to achieve monetary discipline, the central bank, which controls the money supply, should be made to pursue price stability single-mindedly. Fully embracing this argument, for example, New Zealand in the 1980s indexed the central bank governor’s salary to the rate of inflation in inverse proportion, so that he/she would have a very personal interest in controlling inflation. Once we ask the central bank to consider other things, like growth and employment, the argument goes, the political pressure on it would be unbearable. Stanley Fischer argues: ‘A central bank given multiple and general goals may choose among them and will certainly be subject to political pressures to shift among its goals depending on the state of the electoral cycle’.[7] The best way to prevent this from happening is to ‘protect’ the central bank from politicians (who do not understand economics very well and, more importantly, have short time-horizons) by making it ‘politically independent’. This orthodox belief in the virtues of central bank independence is so strong that the IMF often makes it a condition for its loans, as, for example, it did in the agreement with Korea following the country’s currency crisis in 1997.

In addition to monetary discipline, neo-liberals have traditionally emphasized the importance of government prudence – unless the government lives within its means, the resulting budget deficits would cause inflation by creating more demands than the economy can meet.[8] More recently, following the wave of developing country financial crises in the late 1990s and the early 2000s, it was recognized that governments do not have a monopoly in living beyond their means. In those crises, much of the over-borrowing was by private-sector firms and consumers, rather than by governments. As a result, an increasing emphasis has been put on the ‘prudential regulations’ of the banks and other financial-sector firms. The most important among these is the so-called capital adequacy ratio for banks, recommended by the BIS (Bank for International Settlements), the club of central banks based in the Swiss city of Basel (more on this later).*

There is inflation and there is inflation

Inflation is bad for growth – this has become one of the most widely accepted economic nostrums of our age. But see how you feel about it after digesting the following piece of information.

During the 1960s and the 1970s, Brazil’s average inflation rate was 42% a year.[9] Despite this, Brazil was one of the fastest growing economies in the world for those two decades – its per capita income grew at 4.5% a year during this period. In contrast, between 1996 and 2005, during which time Brazil embraced the neo-liberal orthodoxy, especially in relation to macroeconomic policy, its inflation rate averaged a much lower 7.1% a year. But during this period, per capita income in Brazil grew at only 1.3% a year.

If you are not entirely persuaded by the Brazilian case – understandable, given that hyperinflation went side by side with low growth in the 1980s and the early 1990s – how about this? During its ‘miracle’ years, when its economy was growing at 7% a year in per capita terms, Korea had inflation rates close to 20%–17.4% in the 1960s and 19. 8% in the 1970s. These were rates higher than those found in several Latin