Well, there has been this enormous global financial crisis. It has had an
enormous effect ... on the lives of millions of people throughout the world.
Millions have become unemployed, millions are suffering in a whole variety of
ways. Education has been interrupted. It has been an event of cataclysmic
proportions. In some countries, the downturn is greater than the Great
Depression in the United States, and we know how much that affected thinking in
the United States for a long time. So for those affected countries, this has
been a very major event.|
The question is: What caused it? What can we do to prevent or make less likely
another occurrence? What can we do to make sure that if another event occurs
... it will have less devastating effects?
How do we prevent less devastating effects?
Well, we can't prevent the crises. What we can hope to do is to make their
effects less severe. Now part of that has to do with the fact that in advanced
countries like the United States, we have what we call good safety nets. We
have things like welfare programs. We have things like unemployment insurance.
For most of the developing world, they don't have those kinds of safety
We're working to try to strengthen those safety nets at the World Bank, but we
have to remember that even in the United States the kinds of protections that
we have ... for the rural sector, are not really adequate. So those are areas
that predominate in many of the less developed countries. We should recognize
that, while we can do better than we have done in the past, these countries are
going to remain vulnerable to the shocks. That really puts a greater burden in
asking the question: What causes the shocks? What can we do to make it less
likely that those shocks happen?
What causes the shocks?
Well, that is one of the areas of great debate in the international community.
My own feeling is that a critical factor in that is the short-term capital
flows. Capital flows into a country in a boom, and then when market
expectations change almost overnight, the funds can flow out in an enormous
To give you an order of magnitude, in June 1997, right before the Thai crisis,
which began this whole process, bonds for Thailand were selling at a very
little premium over bonds from more advanced, developed economies. The market
was treating these as if they were very safe. Two months later, the risk
premium had grown enormously. After the Russian crisis in August of '98, many
less developed countries couldn't even get access to credit. So even good risks
found it almost impossible to obtain credit.
In the context of the Thai crisis, the amount of capital flowing out of the
country, the turnaround, represented about 10% of the GDP. That would be like
overnight in the United States, $700 billion deciding to leave the country. We
have very good financial institutions, but I dare say we would have had a hard
time withstanding $700 billion deciding to walk from the country.
Why did the Russian devaluation and default have such repercussions
worldwide, even in our own stock market?
That is a very interesting question because if you look at the Russian market
as a fraction of the total world capitalization, it is a small event. Russia,
regrettably, over the last decade has become an economy that has been
shrinking. As a result, the role that it plays in the global economy is much
smaller than it was a decade ago. So the question is: Why would a shock in this
relatively small economy have such global effects?
Well, part of the reason is that there were many firms that were investing
heavily in Russian bonds, you might say speculating, gambling, hoping for a
bailout when a crisis occurred. They clearly were anticipating a crisis. If you
looked at the interest rates they were charging--the interest rates reflected a
high likelihood of a problem.
These same firms that were lending to Russia were also firms that were lending
to, say, Brazil. When it turned out that the Russian part of their portfolio
went bad with the default, they had to pull in their reins, and they had to
take in their capital. The consequences for Brazil and for other countries were
It was not as if we learned anything about the Brazilian economy from the
default in Russia. The problems in Russia were completely different than the
problems in Brazil. So it wasn't as if the market suddenly woke up and said,
"Oh, we think the Brazilian economy has a social security problem that we
didn't know about before." It was nothing of that kind. There was no new news
with respect to the Brazilian economy that was conveyed by that event.
You mentioned that many of the lenders in Russia were expecting a bailout.
Talk about ... the effect of the expectations of bailouts on this rolling
Well, economists refer to this as the problem of moral hazard. When you lend
money, you have a responsibility as the lender to do what you call due
diligence--to look and see if the borrower is likely to repay. If he is not
likely to repay, you either don't lend to him or you lend to him but charge an
interest rate that reflects that risk.
Well, there is a real concern that with the repeated international bailouts ...
the lender feels that if a debtor has a problem either somebody else will come
in and bail it out, the government will come in and provide funds, or the
government will put pressure on the debtor to make sure that he repays or
assumes those liabilities. In any of those kinds of circumstances, the lender
doesn't have to exercise as much caution, so he is more willing to make a loan
even when the circumstances don't deserve it or lend at lower interest rates to
make a deal that is too good for the borrower to pass up. So, as I said, it is
called the moral hazard problem, and many people think it is responsible in
part for the high level of foreign indebtedness, particularly short-term
foreign indebtedness, that many of these countries experienced.
There is an impression that the U.S. taxpayer is footing this bill, is
bailing this out, but that is not the case at all.
That is a very important point. The fact is that while the international
financial institutions lend money to these countries, the countries repay that
money. The recovery rate for the international financial institutions is almost
100%. So that means that it is not the U.S. taxpayers that are left holding the
bag. It is the taxpayers in Brazil and in Russia that pay the bill that have to
Basically what happens is, in many of these instances, the international
financial institutions provide money for the poor governments of these
developing countries, to assume the liabilities from their private companies to
pay back the banks. Then the taxpayers in these countries bear the burden of
paying back the international financial institutions.
What is really even more disturbing, perhaps, is that it is, in effect, the
workers in these countries ... Because capital flies out of the country, they
see the tax rates are going to rise in order to pay back the international
financial institutions, and they say, "This is not a good place to keep my
money, because the high tax rates that are going to have to pay back these huge
debts makes it a less attractive place." So quite often a marked characteristic
of the problem is that domestic capital and foreign capital leave to escape the
taxation, leaving the burden of the taxation on those who can't leave, which
are typically the poor workers.
So in a case like Russia or Brazil, the taxpayers there are now tens of
billions of dollars poorer?
Exactly. It will affect their standard of living and history. After the '80s
crisis ... there was a lost decade of growth. Part of that had to do with the
debt overhang. Eventually, that debt overhang got reduced and got dealt with,
but the cost was enormous.
Let's go back to the international debate over the nature of reform. You
have said that there are two sides to that debate ...
Well, as I said before, there is a growing consensus that something is wrong
with the system, a system that can impose such high costs on so many people,
many of whom were not speculating in international markets, were not gambling
by borrowing abroad in foreign-denominated currencies ... Given that there were
such costs, a system that imposes that cost on so many people, something needs
to be done about it.
Well, there are two schools of thought on that. One you might call the
minimalist view that says, "Well, the burden is mainly on the developing world,
they ought to do something," and it focuses on two issues. One, increased
transparency, better surveillance, examining the books, making sure you have
better information. [Two], improving the financial structure, the banking
systems in these countries. My own view is those are very important things to
do, but I don't think they are enough ...[because] most of the key information
that was relevant to the crisis was readily available. Everybody knew that the
Korean firms had very high debt-equity ratios. Everybody knew that the level of
transparency in these countries was not as high as elsewhere. Moreover, we know
that the last set of major crises in the world had occurred in Scandinavia ...
which probably have the highest level of transparency. So it was clear that
that in itself is not going to inoculate you against another crisis.
So the debate has shifted with the other school saying that we need to do more.
We need, for instance, to take actions to stabilize short-term capital flows.
We want to get the advantages of long-term capital, foreign direct investment
that brings with it know-how, technology, access to markets. We want to promote
that, encourage that. But it is the short-term flows of capital that comes in
and out that seem to be at the root of the problem, and we want to think of
ways that we can stabilize that without having adverse effects on the long-term
foreign direct investment.
So which side is in the ascendancy in this debate?
There has been a major sea change in views on this issue in the last few
months. The magnitude of the devastation and the, you might say, irrationality
of the market, the nature of the magnitude of the response to the Russian
crisis on Brazil and on much of the rest of the world, has led people to
recognize that [some] kinds of measures that countries undertake to stabilize
their short-term flows are going to be absolutely vital. So, for instance,
Chile has a system of trying to stabilize short-term flows. Right now, a lot of
people are saying that is the kind of thing that ought to be looked at, at
least given serious consideration, thought about. It is not an undermining of a
market system and, in fact, is part of making a market system more stable.
In your opinion, is this crisis that we have been witnessing, come to an
Well, there is an important observation. The fact is that there are some
aspects of these economies that are stabilized. Exchange rates no longer are
falling, but that typically happens. Exchange rates never continue to fall,
because eventually the goods would be free, so the fact that they have
stabilized is an important fact, but what we really need to focus on is what I
call the real economy--output, unemployment, the things that affect people's
lives. People don't eat exchange rates. They eat food. They need jobs. What is
happening on that score is what we need to look at.
... Unemployment in Korea, for instance, is three to four times as high as it
was before the crisis. It is not getting worse, but it is not getting better
very fast. In some countries, like Brazil, stabilization of the exchange rate
but unemployment looks like it is even increasing. These are numbers that we
have to monitor very carefully. But it is very clear that the underlying
economic recovery has not yet taken place. Again, every economic downturn
eventually comes to an end. The Great Depression came to an end. The question
that you asked is the relevant question: How soon, how fast, will it come to an
end? And the forecast that many of us are talking about is that it will take a
while before things really turn up--2000, 2001.
In the case of some countries, like Indonesia, where the disruption has been
far more fundamental, the recovery is going to take a long while. In some of
the economies in transition, Russia, where today incomes are much lower than
they were at the beginning of the transition, we are still waiting for a real
process of growth to start occurring.
And the devastation in Eastern Europe that has occurred over the last decade
needs to be really understood. At the beginning of the decade, there were
roughly something, like, 14, 15 million people living at the poverty level,
that is, under $4 a day. By the mid-'90s, that number had been multiplied
basically by tenfold to almost 150 million people in that region, in the East
bloc. So we are in that area, talking about not only a crisis of 1998, but we
are talking of a decade-long process, a decade-long problem.
So when we read in the newspapers that these places are recovering, it is
mostly referring to the financial indicators and not to the real economies that
you are describing?
That's right. The fact that it isn't getting deeper in most of the countries,
and, in the case of Korea, there are signs of an upturn. But at this juncture
unemployment has not yet come down. So it is a varied picture across different
What happens if there is a downturn in the U.S. or the stock market bubble
bursts before these countries have recovered?
That would be a real calamity. I mean, we have to understand that the U.S.
economy has been a real engine of growth, a source of strength of the whole
world economy in the last year ... We talked about how commodity prices have
fallen, and that has actually helped the United States so that some of the bad
news elsewhere has been a benefit to the United States.
In fact, many people think another reason for the strength of the United States
has been as the stock markets and financial markets collapsed elsewhere, there
was a flight to quality. That flight to quality buoyed up our stock market and
contributed to the overall sense of prosperity in the United States.
So some of this is our gaining at the expense of other countries. The good news
out of all of that is that the American consumer has been spending at a level
that has been unprecedented. That has helped feed demand in the rest of the
world and stopped the economic downturn from being as severe as it otherwise
would have been.
But if we slow down you said there could be real problems. Explain what
Well, the underlying problem is where is there a real source of demand that
will provide the basis of expansion in the rest of the world? The Japanese
economy is beginning to show a little bit of signs of recovery but is still
very weak. So in Europe there is a little bit of uncertainty in the economic
situation. Much of the developing world, as I mentioned, where our forecast is
that even with a strong U.S. economy buying blocks of their goods growth in the
developing world and economies in transition is only going to be a meager 1.5%,
down from 4.8% just two years ago. So the real source of demand for goods is
from the United States. We are a very important player on the global economy.
Then the concern is if that important player slows down, the ramifications for
the rest of the world would be quite severe.
Meaning that even more people would be in recession?
Or it would surely mean that the recovery of the countries that have faced
severe problems would be delayed, be stretched out. They would face much harder
times. Whether the upturn in the natural path of recovery, which happens after
every recession, would be strong enough to outweigh the downpull of the U.S.
economy would be a delicate balance. I think it would depend on the country. In
the countries where the upturn appears to be a little bit more vibrant, as in
Korea, they might be able to withstand that. But in other countries, where the
upturn has not yet shown or where it is more fragile, there will be real
Are you worried that the wrong lessons are being drawn in some quarters by
Well, the good news is that one of the lessons that I mentioned before is that
short-term capital flows represent a real problem and need to be dealt with,
need to be thought of differently from long-term foreign direct investment.
That lesson, I think, has been really learned or is being learned quite
The recognition that crises can have such devastating effects on the poor and
that the economic downturn can be quite so severe has had a positive lesson in
making us think more about the consequences of the policies that are put into
place and the regimes that we impose, the risks that we expose countries to.
And there is a broader sense of thinking about what I call risk management. The
world is a risky place, and you have to learn how to manage that risk.
The danger that I see is that as the economies recover that people will say,
"Ah, well, the right policies were pursued; therefore, the recovery occurred."
There is an old Latin saying, post hoc, ergo propter hoc (after this, because
of that.) Now what that means in this context is yes, certain policies were
undertaken and recovery did occur, but, of course, as I said before, economies
recover from every economic downturn. Never have exchange rates, or almost
never have, fallen continuously. They stabilize at some point. The real
question is--what is the connection between the policies and the recovery?
Were the policies the appropriate polices? Could the level of unemployment been
lessened? Those are key lessons ...
Step outside this policy debate. Why should people in the U. S. worry if
there aren't changes in the system, if these reforms that you are talking about
There are several reasons why it is important. At one level it is important for
United States economic, national interests. We live in an interdependent world.
For a large part of the recovery of the United States, from '93 to '96, our
recovery was based on the strength of the developing world, particularly, East
Asia. We benefited from their boom. In an interdependent world such as we live,
in weaknesses in any part of the world eventually, if they are deep enough, get
transmitted back to the United States. In the current crisis, we have benefited
a little bit, but in the long run that will not be true.
Secondly, most Americans believe very strongly in the market economy and
democracy. And, quite honestly, I think there is a certain evangelical spirit.
We believe that a market economy provides a framework for more democracy, and
that more democracy is a fundamental right that people have. If the market
economy fails in these countries, if the market economy leaves millions of
these people to be pushed down into poverty, to be without jobs, their faith in
the market economy will be undermined. Their faith in the democratic system to
which they are just in the process of becoming converted to will be undermined.
So in terms of the broader American values, this is absolutely essential, that
there be success around the world. Success means a more stable global economic
Are we seeing a backlash yet against American values and what we have been
Well, as I travel around the world, it is certainly the case that questions are
being raised. My own sense is that if we forcefully address some of these
underlying problems, if we think of more effective ways of responding to crises
that do not cause the magnitude of distress that has occurred, in other words
if we create a better global architecture, much of this kind of criticism will
be undermined because the fact of the matter is that the kind of market
economy, for instance, that East Asia has had has delivered enormous prosperity
over 30 years to that region. The movement to what you might call the market
socialist economy with a Chinese character in China has delivered enormous
fruits in that economy. It is very interesting that as the fruits of prosperity
get shared, there has been in country after country an opening up to greater
democracy as well.
And that is what you are saying could be in danger.
Unless we make the market economy succeed, the conviction on these fundamental
values will be clearly undermined.