Testimony
of Mark Weisbrot
Research
Director at the Preamble Center1
Before the General Oversight
and Investigations Subcommittee,
House of Representatives
Committee
on Banking and Financial Services
September
10, 1998
On the International Monetary Fund and its Operations in Russia
Mr. Chairman and Members of the House Banking Oversight Committee, I would like to thank
you
for this opportunity to testify regarding the IMFs intervention in the Russian
economy. This hearing
comes at a time of severe economic and political crisis in Russia, as well as a regional
depression in Asia, and mounting economic stress in Latin America and elsewhere.
At the same time, the United States Congress is being asked to appropriate $18 billion in
additional
funds to expand the IMFs capacity to intervene not only in Russia, but in other
countries that may
find themselves in economic crisis in the near future. It is therefore appropriate to ask
whether this
institution is capable of contributing to the resolution of such crises, or whether it is
likely to make
them worse.
In Russia, attention has been focused on the events that triggered the current crisis: the
collapse of
the ruble and the governments partial default on its debt.
But there is much more here than meets the eye. While the current crisis is serious, the
Russian
economy has already collapsed over the last seven years of "reforms." These
"reforms" were
designed by the IMF and supported by successive administrations of the United States
government,
none of whom have acknowledged complete failure of their policies.
The IMF has presided over one of the worst economic declines in modern history. Russian
output
has declined by more than 40% since 1992-- a catastrophe worse than our own Great
Depression.
Millions of workers are denied wages owed to them, a total of more than $12 billion.
Pensions are
delayed by at least three to six months.
Most economic transactions now take place through barter. The majority of the population
has fallen
into poverty. Death rates have risen sharply, and the decline in male life expectancy--
from a
pre-reform 65.5 years to 57 years today-- is unprecedented in peacetime, in the absence of
a
natural disaster. And all of this had occurred before the current meltdown.
These are the results of "shock therapy," a program introduced by the
International Monetary Fund
in 1992. Things were supposed to get worse for about six months, and then get better. Six
years
later, Russians have undergone many shocks, but still no therapy.
In retrospect, it's hard to see what could have been done wrong that wasn't. First there
was an
immediate de-control of prices. Given the monopoly structure of the economy, as well as
the large
amount of cash savings accumulated by Russian households, inflation soared 520% in the
first three
months. Millions of people saw their savings and pensions reduced to crumbs.
In order to push inflation down, the authorities slammed on the monetary and fiscal
brakes, bringing
about a depression. Privatization was carried out in a way that enriched a small class of
people,
while the average person's income fell by about half within four years.
"Shock therapy" has also created a large and powerful criminal class: Russian
police have to wear
masks to conceal their identity when arresting organized crime figures. The head of the
Russian
Interior Ministrys organized crime division estimated that 20 percent of Russian
bank loans were
actually payments to organized crime. This is often treated as if it were always a part of
Russian life,
but in fact there has been an explosion of organized crime in the "reform" era.
This is a result not only
of the destruction of the economy, but also the rapid privatization, which left organized
criminals as
one of the few groups of people that could position themselves to buy up formerly
publicly-owned
assets.
Democracy, too, has been compromised. The unpopularity of these destructive economic
policies
has fostered increasingly authoritarian practices on the part of Russian President Boris
Yeltsin. The
Clinton Administration, wedded to these policies, has supported a number of
anti-democratic
measures, including President Yeltsin's dissolution of the democratically elected
Parliament in 1993.
The IMFs defenders have yet to admit failure of any kind. On the contrary, the
Clinton
Administration is insisting that more "disciplined, hard things," need to be
done, such as closing down
more enterprises, and balancing the central government budget. Never mind that we would
not
expect to balance our own federal budget during a recession, much less during a
depression.
They argue that Russias problem is that they did not take enough of their
"reform" medicine. But the
historical record shows that Russia actually followed their prescription fairly closely,
and the direct
result is the catastrophe they are facing today.
As noted above, the de-control of prices was immediate, and the IMF did not anticipate the
terribleinflation that would result. The resulting inflationary spiral discouraged any long-term
investment inproductive activity. The IMFs insistence on tight monetary policy to bring down
inflation accelerated the economys collapse. The Funds defenders complain of
deficit spending by the Russian government, but for the first four years of "shock
therapy," the government mostly stayed within the Funds target range. As the
economic collapsed continued, tax collection became increasingly difficult. A recent
survey found 73% of the transactions of major enterprises were carried out through barter,
debt swaps, or other non-monetary exchanges. In such situtations it is not that easy to
increase cash tax receipts.
Privatization, too, was accomplished very rapidly. By 1994 more than three-quarters of
industrial
production was taking place in non-state enterprises. The idea was to create efficiently
run firms that
could compete on world markets, but this did not happen. The Russian economy was highly
integrated. It was not that easy to just "weed out" some enterprises so that
others might prosper,
since they were interdependent. In addition, the necessary capital was not made available
for the
potentially "efficient" firms to modernize.
The IMFs idea of "efficiency" is also problematic: from their point of
view, if existing production
cannot compete in world markets, it is not efficient and should be scrapped. But this does
not take
into account the enormous waste of resources in allowing tens of billions of dollars of
plant and
equipment to lay idle and rust-- not to mention the resulting unemployment.
Foreign direct investment was supposed to play a key role in providing capital, but this
never
materialized, given the instability of the economy. During the first two years of
"shock therapy," the
outflow of capital exceeded inflow by two to four times. But the whole idea that Russian
industry had to be destroyed, so that they could start from scratch on the basis of
foreign investment, was wrong from the beginning.
The IMFs most recent failure in its attempt to support the ruble has been
overwhelming. The ruble
lost two-thirds of its value against the dollar within days, setting off panic buying and
a new round of
inflation that may exceed the worst of the "reform" era. Nearly $5 billion, the
IMFs latest installment
on a $23 billion package, was squandered-- delivered right into the outstretched hands of
speculators-- in a futile attempt to maintain the exchange rate at 6 rubles to the dollar.
Before it
collapsed, the Russian government was forced to pay 170% interest rates on its short-term
debt,
while millions of workers went without wages.
In such circumstances, what is the point of maintaining the convertibility of the domestic
currency into
dollars? The IMF argues that it is essential to creating a climate in which foreign direct
investment
can be attracted, but that is clearly not worth the price in Russia, where the capital
flows that were
attracted were overwhelmingly speculative. This is another example of the IMFs
skewed priorities,
which have now brought Russia to a state of economic and political chaos.
As the irrationality of subordinating the domestic economies of "emerging
market" countries to the
whims of international financial markets becomes more apparent, a debate over the current
"IMF
consensus" has arisen within the economics profession. A number of prominent,
pro-globalization,
economists have come out in favor of increased capital controls. Joseph Stiglitz, chief
economist of
the World Bank and former chair of President Clintons Council of Economic Advisors,
has openly
accused the IMF of exacerbating the Asian financial crisis. Columbia Universitys
Jagdish
Bhagwhati, one of the worlds most prominent international economists and the
Economic Policy
Adviser to the Director-General of the GATT (1991-93) has noted that "the Asian
crisis cannot be
separated from the excessive borrowings of foreign short-term capital as Asian economies
loosened
up their capital account controls and enabled their banks and firms to borrow abroad. . .
it has
become apparent that crises attendant on capital mobility cannot be ignored." Jeffrey
Sachs and
Steve Radelet of the Harvard Institute of International Development have reached similar
conclusions in their extensive research on the Asian financial crisis, and Sachs has had
some harsh words for the IMF, calling it "the Typhoid Mary of emerging markets,
spreading recessions in country after country." Paul Krugman has proposed a return to
restrictions on the convertibility of currencies, a policy that was promptly adopted by
Malaysia last week.
Krugmans policy of foreign exchange controls makes more sense than the enormously
high interest
rates that countries like Mexico and Brazil are now adopting to stem the capital flight,
currency
collapse, resultant inflation, and possible economic disaster that has threatened them in
the wake of
Russias meltdown. The irrationality of international financial markets has reached
new extremes, as
one poor country after another is trampled by the herd behavior of investors who may know
nothing
more than the fact that other investors might be averse to "emerging markets"
after the last disaster.
But the IMF has shown little interest in allowing countries the flexibility to implement
capital controls,
and is still insisting that Russia restore the full convertibility of the ruble.
Before appropriating more money so that the IMF can provide further "help" for
Russia, it is worth
considering the Funds role in the Asian crisis. In this case the IMF not only
precipitated the financial
crisis, it also prescribed policies that sent the regional economy into a tailspin. The
short-term debt
build-up that preceded the financial crisis clearly created the instability that turned
the fall of the Thai baht in July of 1997 into a regional financial meltdown. With a high level of short-term
international debt, a depreciation of the domestic currency increases the cost of debt service. Everyone
needs more domestic currency to get the same amount of dollars for debt service, and the selling
of domestic currency to get those dollars (or other "hard" currencies) drives the
domestic currency down further. It does not take much to set off a panic, especially if the central bank
does not have a high level of foreign currency reserves relative to the short term debt. These reserves
shrink further as more and more investors convert their domestic currency and domestic assets into
dollars. Foreign lenders refuse to renew the short-term loans, and the downward spiral continues.
The rapid accumulation of short-term debt in Asia was a direct result of the removal of
capital controls-- at the insistence of the IMF. For example, South Korean, Thai, and Indonesian
banks (as well as non-financial corporations) were allowed, in the last six years, to borrow from
international markets with fewer restrictions then ever before.
What was needed at the onset of the crisis was a supply of foreign exchange reserves, to
assure investors that they did not have to flee the country today in order to avoid further
foreign exchange losses tomorrow. The government of Japan actually proposed, at a meeting of regional
finance ministers in September 1997, that an "Asian Monetary Fund" be created in order
to provide liquidity to the faltering economies, and with fewer of the conditions imposed by the IMF. This fund
was to have been endowed with as much as $100 billion in emergency resources, which would come
not only from Japan, but from China, Taiwan, Hong Kong, Singapore, and other countries, all of
whom supported the proposal.
After strenuous opposition from the U.S. Treasury Department, which insisted that the IMF
must determine the conditions of any bailout before any other funds were committed, the plan
was dropped by November. It is impossible to tell how things might have turned out
differently, but it is certainly conceivable that not only the depression, but even the worst of the currency
collapses could have been avoided if the fund had been assembled and deployed quickly at that time.
The IMF then failed to provide the necessary reserves-- Indonesia had received only $3
billion by March of 1998. Even worse, the IMFs insistence on very high interest rates, as well
as fiscal austerity, worsened the contraction of the injured economies. The result was that a
liquidity crisis, which could have been managed and limited to the financial sphere of the economy, became a
major regional depression.
The human cost of this depression has been staggering. Years of economic and social
progress are being negated, as the unemployed vie for jobs in sweatshops that they would have
previously rejected, and the rural poor subsist on leaves, bark, and insects. In Indonesia, the
majority of families now have a monthly income less than the amount that they would need
to buy a subsistence quantity of rice, and nearly 100 million people-- half the
population-- are being pushed below the poverty line. Women have been particularly hard
hit: they are first to be laid off, have taken sharper cuts in access to food and other
necessities, and girls are being pulled from school to help with their
families survival.
It is especially disheartening to read that the IMFs managing director, Michel
Camdessus, has referred to the Asian crisis as "a blessing in disguise."
The IMFs favorite reformer, Anatoly Chubais, has now admitted that he
"conned" the IMF out of $20 billion. But the IMF economists are not the only ones who have been fooled. All the
people who thought they would be bailed out by the Fund, but were then thrown overboard, are
among the victims. American taxpayers, whose taxes make up the largest contribution to the Fund,
have also been deceived as to the nature of this operation.
The IMF has never served as a lender of last resort, as the world had been reminded in the
cases of Russia and Indonesia. It is not a rescue mission. Its policies over the last year have
failed as spectacularly as can be imagined, and the last seven years of "reform" have left
the Russian economy in ruins. Yet there is no sign that the Funds managers are aware of their mistakes.
Is there any reason to think that they will do better in the future?
1. Mark Weisbrot served as Research Director of the Preamble Center until 1999. He is currently co-director of the Center for Economic and Policy Research (http://www.cepr.net).