<nettime> IMF: Neoliberalism:,Oversold?

[nettime's apostate <nettime@kein.org>]

[This is part of a growing number of statements coming from the
IMF expressing alarm over unsustainable inequality and the kind of
political instability this is causing even in the most developed
countries. In many ways, it's rather disingenious. Still, it's a clear
sign that the neo-liberal agenda is exhausted. But what to replace it?
Some mild form of Keynesianism, as they suggest? As long as there is
no alternative, it will stagger on like a zombie, not the least since
its still profitable to the powerful groups.]


http://www.imf.org/external/pubs/ft/fandd/2016/06/ostry.htm
Finance & Development, June 2016, Vol. 53, No. 2

Summar: Instead of delivering growth, some neoliberal policies have
increased inequality, in turn jeopardizing durable expansion.


Milton Friedman in 1982 hailed Chile an “economic in earlier,
1982 miracle.” Nearly a decade earlier, Chile had turned to
policies that have since widely been emulated across the globe.
The neoliberal agenda—a label used more by critics than by the
architects of the policies— rests on two main planks. The first is
increased competition—achieved through deregulation and the opening
up of domestic markets, including financial markets, to foreign
competition. The second is a smaller role for the state, achieved
through privatization and limits on the ability of governments to
run fiscal deficits and accumulate debt. There has been a strong
and widespread global trend toward neoliberalism since the 1980s,
according to a composite index that measures the extent to which
countries introduced competition in various spheres of economic
activity to foster economic growth. As shown in the left panel of
Chart 1, Chile’s push with started a decade or so earlier than 1982
with subsequent policy changes bringing it ever closer to the United
States. Other countries have also steadily implemented neoliberal
policies.

There is much to cheer in the neoliberal agenda. The expansion of
global trade has rescued millions from abject poverty. Foreign direct
investment has often been a way to transfer technology and know-how to
developing economies. Privatization of state-owned enterprises has in
many instances led to more efficient provision of services and lowered
the fiscal burden on governments. However, there are aspects of the
neoliberal agenda that have not delivered as expected. Our assessment
of the agenda is confined to the effects of two policies: removing
restrictions on the movement of capital across a country’s borders
(so-called capital account liberalization); and fiscal consolidation,
sometimes called “austerity,” which is shorthand for policies
to reduce fiscal deficits and debt levels. An assessment of these
specific policies (rather than the broad neoliberal agenda) reaches
three disquieting conclusions:

• The benefits in terms of increased growth seem fairly difficult to
establish when looking at a broad group of countries.­

• The costs in terms of increased inequality are prominent. Such
costs epitomize the trade-off between the growth and equity effects of
some aspects of the neoliberal agenda.

• Increased inequality in turn hurts the level and sustainability of
growth. Even if growth is the sole or main purpose of the neoliberal
agenda, advocates of that agenda still need to pay attention to the
distributional effects.

Open and shut?

As Maurice Obstfeld (1998) has noted, “economic theory leaves
no doubt about the potential advantages” of capital account
liberalization, which is also sometimes called financial openness. It
can allow the international capital market to channel world savings to
their most productive uses across the globe. Developing economies with
little capital can borrow to finance investment, thereby promoting
their economic growth without requiring sharp increases in their own
saving. But Obstfeld also pointed to the “genuine hazards” of
openness to foreign financial flows and concluded that “this duality
of benefits and risks is inescapable in the real world.” This indeed
turns out to be the case. The link between financial openness and
economic growth is complex. Some capital inflows, such as foreign
direct investment—which may include a transfer of technology or
human capital—do seem to boost long-term growth. But the impact of
other flows—such as portfolio investment and banking and especially
hot, or speculative, debt inflows—seem neither to boost growth nor
allow the country to better share risks with its trading partners
(Dell’Ariccia and others, 2008; Ostry, Prati, and Spilimbergo,
2009). This suggests that the growth and risk-sharing benefits of
capital flows depend on which type of flow is being considered; it may
also depend on the nature of supporting institutions and policies.­
Although growth benefits are uncertain, costs in terms of increased
economic volatility and crisis frequency seem more evident. Since
1980, there have been about 150 episodes of surges in capital inflows
in more than 50 emerging market economies; as shown in the left panel
of Chart 2, about 20 percent of the time, these episodes end in a
financial crisis, and many of these crises are associated with large
output declines (Ghosh, Ostry, and Qureshi, 2016).­ The pervasiveness
of booms and busts gives credence to the claim by Harvard economist
Dani Rodrik that these “are hardly a sideshow or a minor blemish in
international capital flows; they are the main story.” While there
aremany drivers, increased capital account openness consistently
figures as a risk factor in these cycles. In addition to raising
the odds of a crash, financial openness has distributional effects,
appreciably raising inequality (see Furceri and Loungani, 2015, for
a discussion of the channels through which this operates). Moreover,
the effects of openness on inequality are much higher when a crash
ensues (Chart 2, right panel).­ The mounting evidence on the high
cost-to-benefit ratio of capital account openness, particularly with
respect to shortterm flows, led the IMF’s former First Deputy
Managing Director, Stanley Fischer, now the vice chair of the U.S.
Federal Reserve Board, to exclaim recently: “What useful purpose is
served by short-term international capital flows?”

Among policymakers today, there is increased acceptance of controls
to limit short-term debt flows that are viewed as likely to
lead to—or compound—a financial crisis. While not the only
tool available—exchange rate and financial policies can also
help—capital controls are a viable, and sometimes the only, option
when the source of an unsustainable credit boom is direct borrowing
from abroad (Ostry and others, 2012).


Size of the state

Curbing the size of the state is another aspect of the neoliberal
agenda. Privatization of some government functions is one way
to achieve this. Another is to constrain government spending
through limits on the size of fiscal deficits and on the ability of
governments to accumulate debt. The economic history of recent decades
offers many examples of such curbs, such as the limit of 60 percent
of GDP set for countries to join the euro area (one of the so-called
Maastricht criteria).­

Economic theory provides little guidance on the optimal public debt
target. Some theories justify higher levels of debt (since taxation is
distortionary) and others point to lower—or even negative—levels
(since adverse shocks call for precautionary saving). In some of its
fiscal policy advice, the IMF has been concerned mainly with the
pace at which governments reduce deficits and debt levels following
the buildup of debt in advanced economies induced by the global
financial crisis: too slow would unnerve markets; too fast would
derail recovery. But the IMF has also argued for paying down debt
ratios in the medium term in a broad mix of advanced and emerging
market countries, mainly as insurance against future shocks.­

But is there really a defensible case for countries like Germany, the
United Kingdom, or the United States to pay down the public debt?
Two arguments are usually made in support of paying down the debt
in countries with ample fiscal space—that is, in countries where
there is little real prospect of a fiscal crisis. The first is that,
although large adverse shocks such as the Great Depression of the
1930s or the global financial crisis of the past decade occur rarely,
when they do, it is helpful to have used the quiet times to pay down
the debt. The second argument rests on the notion that high debt is
bad for growth—and, therefore, to lay a firm foundation for growth,
paying down the debt is essential.­

It is surely the case that many countries (such as those in southern
Europe) have little choice but to engage in fiscal consolidation,
because markets will not allow them to continue borrowing. But
the need for consolidation in some countries does not mean all
countries—at least in this case, caution about “one size fits
all” seems completely warranted. Markets generally attach very
low probabilities of a debt crisis to countries that have a strong
record of being fiscally responsible (Mendoza and Ostry, 2007). Such a
track record gives them latitude to decide not to raise taxes or cut
productive spending when the debt level is high (Ostry and others,
2010; Ghosh and others, 2013). And for countries with a strong track
record, the benefit of debt reduction, in terms of insurance against a
future fiscal crisis, turns out to be remarkably small, even at very
high levels of debt to GDP. For example, moving from a debt ratio of
120 percent of GDP to 100 percent of GDP over a few years buys the
country very little in terms of reduced crisis risk (Baldacci and
others, 2011).­

But even if the insurance benefit is small, it may still be worth
incurring if the cost is sufficiently low. It turns out, however, that
the cost could be large—much larger than the benefit. The reason
is that, to get to a lower debt level, taxes that distort economic
behavior need to be raised temporarily or productive spending needs
to be cut—or both. The costs of the tax increases or expenditure
cuts required to bring down the debt may be much larger than the
reduced crisis risk engendered by the lower debt (Ostry, Ghosh, and
Espinoza, 2015). This is not to deny that high debt is bad for growth
and welfare. It is. But the key point is that the welfare cost from
the higher debt (the so-called burden of the debt) is one that has
already been incurred and cannot be recovered; it is a sunk cost.
Faced with a choice between living with the higher debt—allowing the
debt ratio to decline organically through growth—or deliberately
running budgetary surpluses to reduce the debt, governments with ample
fiscal space will do better by living with the debt.­

Austerity policies not only generate substantial welfare costs due
to supply-side channels, they also hurt demand—and thus worsen
employment and unemployment. The notion that fiscal consolidations can
be expansionary (that is, raise output and employment), in part by
raising private sector confidence and investment, has been championed
by, among others, Harvard economist Alberto Alesina in the academic
world and by former European Central Bank President Jean-Claude
Trichet in the policy arena. However, in practice, episodes of fiscal
consolidation have been followed, on average, by drops rather than by
expansions in output. On average, a consolidation of 1 percent of GDP
increases the long-term unemployment rate by 0.6 percentage point and
raises by 1.5 percent within five years the Gini measure of income
inequality (Ball and others, 2013).­ In sum, the benefits of some
policies that are an important part of the neoliberal agenda appear to
have been somewhat overplayed. In the case of financial openness, some
capital flows, such as foreign direct investment, do appear to confer
the benefits claimed for them. But for others, particularly short-term
capital flows, the benefits to growth are difficult to reap, whereas
the risks, in terms of greater volatility and increased risk of
crisis, loom large.­

In the case of fiscal consolidation, the short-run costs in terms
of lower output and welfare and higher unemployment have been
underplayed, and the desirability for countries with ample fiscal
space of simply living with high debt and allowing debt ratios to
decline organically through growth is underappreciated.

An adverse loop­

Moreover, since both openness and austerity are associated with
increasing income inequality, this distributional effect sets up
an adverse feedback loop. The increase in inequality engendered by
financial openness and austerity might itself undercut growth, the
very thing that the neoliberal agenda is intent on boosting. There
is now strong evidence that inequality can significantly lower both
the level and the durability of growth (Ostry, Berg, and Tsangarides,
2014).­

The evidence of the economic damage from inequality suggests that
policymakers should be more open to redistribution than they are.
Of course, apart from redistribution, policies could be designed
to mitigate some of the impacts in advance—for instance, through
increased spending on education and training, which expands equality
of opportunity (so-called predistribution policies). And fiscal
consolidation strategies—when they are needed—could be designed
to minimize the adverse impact on low-income groups. But in some
cases, the untoward distributional consequences will have to be
remedied after they occur by using taxes and government spending to
redistribute income. Fortunately, the fear that such policies will
themselves necessarily hurt growth is unfounded (Ostry, 2014).­

Finding the balance

These findings suggest a need for a more nuanced view of what the
neoliberal agenda is likely to be able to achieve. The IMF, which
oversees the international monetary system, has been at the forefront
of this reconsideration.­

For example, its former chief economist, Olivier Blanchard, said in
2010 that “what is needed in many advanced economies is a credible
medium-term fiscal consolidation, not a fiscal noose today.”
Three years later, IMF Managing Director Christine Lagarde said the
institution believed that the U.S. Congress was right to raise the
country’s debt ceiling “because the point is not to contract the
economy by slashing spending brutally now as recovery is picking
up.” And in 2015 the IMF advised that countries in the euro area
“with fiscal space should use it to support investment.”

On capital account liberalization, the IMF’s view has also
changed—from one that considered capital controls as almost always
counterproductive to greater acceptance of controls to deal with the
volatility of capital flows. The IMF also recognizes that full capital
flow liberalization is not always an appropriate end-goal, and that
further liberalization is more beneficial and less risky if countries
have reached certain thresholds of financial and institutional
development.­ Chile’s pioneering experience with neoliberalism
received high praise from Nobel laureate Friedman, but many economists
have now come around to the more nuanced view expressed by Columbia
University professor Joseph Stiglitz (himself a Nobel laureate)
that Chile “is an example of a success of combining markets with
appropriate regulation” (2002). Stiglitz noted that in the early
years of its move to neoliberalism, Chile imposed “controls on
the inflows of capital, so they wouldn’t be inundated,” as, for
example, the first Asian-crisis country, Thailand, was a decade and
a half later. Chile’s experience (the country now eschews capital
controls), and that of other countries, suggests that no fixed agenda
delivers good outcomes for all countries for all times. Policymakers,
and institutions like the IMF that advise what has them, must be
guided not by faith, but by evidence of what has worked.


Jonathan D. Ostry is a Deputy Director, Prakash Loungani is a Division
Chief, and Davide Furceri is an Economist, all in the IMF’s Research
Department. References

Baldacci, Emanuele, Iva Petrova, Nazim Belhocine, Gabriela Dobrescu,
and Samah Mazraani, 2011, “Assessing Fiscal Stress,” IMF Working
Paper 11/100 (Washington: International Monetary Fund).­

Ball, Laurence, Davide Furceri, Daniel Leigh, and Prakash Loungani,
2013, “The Distributional Effects of Fiscal Austerity,” UN-DESA
Working Paper 129 (New York: United Nations).­

Dell’Ariccia, Giovanni, Julian di Giovanni, André Faria, M. Ayhan
Kose, Paolo Mauro, Jonathan D. Ostry, Martin Schindler, and Marco
Terrones, 2008, Reaping the Benefits of Financial Globalization, IMF
Occasional Paper 264 (Washington: International Monetary Fund).­

Furceri, Davide, and Prakash Loungani, 2015, “Capital Account
Liberalization and Inequality,” IMF Working Paper 15/243
(Washington: International Monetary Fund).­

Ghosh, Atish R., Jun I. Kim, Enrique G. Mendoza, Jonathan D. Ostry,
and Mahvash S. Qureshi, 2013, “Fiscal Fatigue, Fiscal Space and Debt
Sustainability in Advanced Economies,” Economic Journal, Vol. 123,
No. 566, pp. F4–F30.­

Ghosh, Atish R., Jonathan D. Ostry, and Mahvash S. Qureshi, 2016,
“When Do Capital Inflow Surges End in Tears?” American Economic
Review, Vol. 106, No. 5.­

Mendoza, Enrique G., and Jonathan D. Ostry, 2007, “International
Evidence on Fiscal Solvency: Is Fiscal Policy ‘Responsible’?”
Journal of Monetary Economics, Vol. 55, No. 6, pp. 1081–93.­

Obstfeld, Maurice, 1998, “The Global Capital Market: Benefactor
or Menace?” Journal of Economic Perspectives, Vol. 12, No. 4, pp.
9–30.­

Ostry, Jonathan D., 2014, “We Do Not Have to Live with the Scourge
of Inequality,” Financial Times, March 3.­

———, Andrew Berg, and Charalambos Tsangarides, 2014,
“Redistribution, Inequality, and Growth,” IMF Staff Discussion
Note 14/02 (Washington: International Monetary Fund).­

Ostry, Jonathan D., Atish R. Ghosh, Marcos Chamon, and Mahvash S.
Qureshi, 2012, “Tools for Managing Financial-Stability Risks from
Capital Inflows,” Journal of International Economics, Vol. 88, No.
2, pp. 407–21.­

Ostry, Jonathan D., Atish R. Ghosh, Jun I. Kim, and Mahvash Qureshi,
2010, “Fiscal Space,” IMF Staff Position Note 10/11 (Washington:
International Monetary Fund).­

Ostry, Jonathan D., Atish R. Ghosh, and Raphael Espinoza, 2015,
“When Should Public Debt Be Reduced?” IMF Staff Discussion Note
15/10 (Washington: International Monetary Fund).­

Ostry, Jonathan D., Alessandro Prati, and Antonio Spilimbergo, 2009,
Structural Reforms and Economic Performance in Advanced and Developing
Countries, IMF Occasional Paper 268 (Washington: International
Monetary Fund).­

Rodrik, Dani, 1998, “Who Needs Capital-Account Convertibility?”
in Should the IMF Pursue Capital-Account Convertibility? Essays
in International Finance 207 (Princeton, New Jersey: Princeton
University).­

Stiglitz, Joseph, 2002, “The Chilean Miracle: Combining Markets with
Appropriate Reform,” Commanding Heights interview.­





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