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The mirage of an oasis of prosperity

Author: Caroline Atkinson, Adjunct Senior Fellow for International Economics
March 28, 2001
Financial Times

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Crises "are great media fodder but they are not real hot for anybody else", Paul O'Neill, US Treasury secretary, said in the Financial Times soon after he took office. His suggestion for dealing with inter- national financial crises is more full-blooded capitalism, with less intervention by the International Monetary Fund and others.

Events since then - from Turkey to Argentina - show that capitalism without crisis is not here yet. Countries and investors make mistakes. These can trigger a loss of confidence that endangers financial stability and growth.

The Bush administration has signalled a preference for a "hands-off" policy in dealing with international economic problems. But that sits uneasily with the reality of the global economy and with George W. Bush's own rhetoric about the need to shore up the US economy. The outlook for emerging markets has deteriorated recently. Whether now or later, the odds are that the administration will have to handle a full-blown financial crisis. Will pragmatism win over conservative rhetoric?

There are good reasons to argue that it should. We saw in Asia in 1997 and more broadly after Russia's default in 1998 that financial markets do not always quickly "self-correct" when confidence is lost. In the US, even with its overall trust in the virtues of capitalism and the ability of a market system to deliver the best economic outcome for the country as a whole, voters would be furious if the government did not respond to a domestic crisis. Why should it be any different if the crisis arises from outside?

One argument is that it simply does not matter. But as Alan Greenspan, the chairman of the Federal Reserve, famously remarked in 1998 - and many farmers and manufacturing workers could testify at the time - the US cannot be an oasis of prosperity. The fear gripping US equity markets makes it more obvious that it is in the national interest to fight a crisis that could endanger global growth and stability.

More generally, the interdependence of the financial world is an argument for more, not less, engagement in how other countries conduct economic policies. It turned out to matter for the global financial system that Thailand kept its exchange rate pegged for too long in 1997 and that Russia could not pay its debts in 1998.

It is also important that more countries "emerge" and join the international system of trade and finance, boosting investment, jobs and growth. If countries facing crisis are cold-shouldered, they will be less likely to embrace globalisation.

Surprisingly few countries have turned inward as a result of recent crises. This is partly because they want to catch up with the rich countries. But it also reflects the efforts of the IMF and its member governments to support reform and provide conditional financing when trouble hits. Political and security relationships cannot be divorced from economics - and vice versa. A collapse in Turkey's economy is serious even if it is not a direct threat to the global economy.

The Bush administration's diplomats recognise this. Concerned by how much power accrued to the US Treasury under secretaries Robert Rubin and Lawrence Summers, they have made much of taking back part of that responsibility. It would be ironic if a misplaced desire for purity in letting markets work led the traditional guardians of global economic policy in the US Treasury to cede influence to others more focused on politics and diplomacy and less able or concerned to promote sensible economics.

What about the argument that intervention just causes more crises? There is scant evidence that such "moral hazard" has so far been a significant force behind swings in international capital flows. International investors in Asia before 1997 were not there in search of an IMF bail-out; governments running up dangerously large debts do not typically have an eye on the comforts of an IMF programme if all goes awry.

This is not to dismiss the concerns. With private flows increasingly dominating international finance, the private sector has to be involved in crisis management. In particular, when countries have excessive debt and are unlikely to make a quick return to capital markets, creditor governments should be unwilling to put in money just to let the private sector get out.

This is now broadly recognised. It is still a messy and uncertain process but the world is not simple enough - nor is capitalism perfect enough - to manage crises with a few clear rules and an IMF on autopilot. Alongside prevention measures - strengthening emerging market finances; resisting pressure to support unsustainable exchange rate pegs; and pushing for a better informed and more discriminating international capital market - a capacity for crisis response is vital. The US will step aside at its peril.


Caroline Atkinson is senior fellow at the Council on Foreign Relations and former senior deputy assistant secretary at the US Treasury Caroline Lucas on a green reform of European agriculture: www.ft.com/personalview

Copyright: The Financial Times Limited

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