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The Social and Political Impacts on Emerging Markets of Recent Economic Events

AS THE moderator argued in her introduction, the backlash against globalisation in many developing countries has been from some perspectives surprisingly muted. All the same the panellists argued that it was impossible to understand either the cause or the cures of the Asian contagion without taking into account non-financial factors, such as the quality of the government, the integrity of the legal system and the prevalence of corruption. Some participants thought that the West needed to put more effort into tackling these things before lending money. Others thought the International Financial Institutions should stick to what they know about rather that engage in broad-ranging social engineering.


There are plenty of important non-financial things that have contributed to the spread of the Asian crisis, and also must be part of any cure. These begin with the quality of government: a $57 billion aid package is unlikely to be successful if the government is incompetent and corrupt. Another challenge is the legal system. Countries with property rights and good bankruptcy systems have a much better chance of surviving the storm than those that do not. Many countries sell jobs as judges to the highest bidder: in the Caucuses, for example, many of the wealthiest people are all judges. Then there is the regulatory framework, and finally, the social safety net.

The people who suffer most from economic dislocation are almost always the poor. In Russia as many as 50 million people live on less than $4 a day. Two hundred thousand people have been thrown out of work in the coal mines, threatening social

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unrest. In South Korea, the poor are still suffering, and the biggest need there is for more structural reform. South Korea was enormously lucky that it elected a reforming president just before the financial system collapsed. Kim used his opportunities to push through structural reform and even set up a social safety net in Korea. Kim now faces an even more intractable problem: the fact that the economy has bounced back without the reform program being completed.

No reform program will be complete without the active participation of business. Seven years ago $30 billion a year flowed into emerging markets. Last year the figure was $300 billion. Engaging business is not just a matter for theoretical debate. It is crucial.


The International Monetary Fund is controlled by 24 executive directors, eight from single countries, the rest from groups of countries. Countries vote in proportion to the number of shares they control in the organisation: the United States has 18% of the votes, the G7 has half, meaning that a united West cannot really lose a vote. Everything the IMF does is voted on. But contested votes are rare: decisions are by consensus, with the consensus usually put together outside the boardroom. The IMF's legitimacy results from the fact that it was established by international treaty with more or less universal membership. It sticks very close to its original articles of agreement.

Corruption is a huge problem in the Fund's work. In Kenya, for example, hundreds of millions of dollars worth of reserves have been paid out to businessmen and politicians. The IMF clearly cannot lend developing countries money if is likely to be stolen; but without IMF loans their economies are likely to decline still further. Before giving a large loan to Indonesia the Fund had to deal with corruption, particularly the forestation fund, which represented 2% of GDP but had never been properly accounted for in the budget and provided the president's family with monopolies. Was the Fund's decision to fight corruption

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destabilising? Perhaps. But the real cause of instability was the system itself.

The International Financial Institutions are facing increasing pressure to use their might to democratise countries. They should not just consult with the government, they are being told, but with interest groups of all descriptions. They are increasingly responding to this pressure. But is it really their job to get countries to accept values and standards that are not rooted in economics? Pushing for the implementation of the International Declaration of Human Rights, for example, is very far from the traditional role of financial institutions.


The best way to solve the economic and social problems associated with crises maybe to prevent boom-bust cycles from happening. In America, where these cycles have successfully been resisted, high school dropouts are extraordinary successful at getting new jobs. Boom-bust cycles are particularly bad for emerging markets. The poor are hardest hit. There is no safety net to catch them when they fall. And the middle class is devastated. We were very lucky that a highly capable, democratic leader came to power in South Korea when he did.

The countries that went under in the financial crisis all have one thing in common: very weak banking systems. As Schumpeter pointed out, the only institution that is really essential to a capitalist economy is a bank: banks act as shock absorbers and workout specialists during recessions. But in Asia's command economy the government simply told bankers what to do. In a meeting of bankers in South Korea in April, 1998, it rapidly became clear that none of the bankers in the room had any idea what a "workout loan" was: they had never made a credit judgement and had no idea how to work with a troubled customer.

Banking is a very difficult business to learn. The best way to learn it is to let foreign banks come into you country. Argentina was perhaps the first country to do this. Argentine banking fami-

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lies now send their children to foreign banks so that they can learn the latest banking methodologies before they return to the local bank. The other thing that is crucial is the rule of law: you need to be able to collect on your loans. In the United States you can take ownership of collateral property in three months; in Mexico it can take a minimum of three-and-half years -- and in that time your investment has probably deteriorated hopelessly.


An early theme to the discussion was the fate of globalisation as an ideology. A Swiss participant pointed out that the Uruguay Round had ended up in a very different -- and very much more pro-market -- climate than it had begun; now, he warned, the climate seemed to be changing again, with right-wing governments losing power around the world. He wondered what could be done to co-opt emerging countries into the system. A panellist replied that the reason why countries find the transition to the market economy difficult is not usually ideological -- anti-market ideology is dying out in much of the world, and has almost completely disappeared in Latin America -- but lack of competence, particularly in putting together a financial and legal system that works.

For one Swedish participant, confidence was the key. In most countries, there is plenty of private capital available. But no one will invest their capital unless they have confidence in the institutional framework of the countries in which they are investing. Indeed, lack of confidence promotes capital flight: there is thirty times more Russian capital outside the country than inside the country.

Several other participants emphasised the importance of fighting corruption. An Italian pointed out that Europeans are often too shy about fighting corruption in their own backyards: in some European countries bribes are tax deductible. A Canadian thought it a little odd to make the International Financial Institutions the main vehicle for fighting corruption and imposing the rights of labour, when non-governmental organisations already have an

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impressive track record in fighting for these causes.

The problem of Russia aroused a good deal of comment. A French participant argued that the West bore a good deal of responsibility for Russia's situation. It had encouraged Russia to jump into a free-market system that it had taken forty years for Western Europe to embrace. Perhaps we should recognise that we do not need a perfect world in order to do business, he argued. But most participants were less sympathetic. A Swede pointed out that much of the money sent to Russia has been squandered. The state of the coal industry, for instance, is not primarily a social problem, he argued, but a problem of organised crime. An American asked whether there would ever come a point at which the West would decide to stop lending money to Russia. Yes, replied one of the panellists, the West has said enough is enough in August 1998; but the West has a continuing interest in tying Russia into the international financial system.

However, the main focus of the discussion was the degree to which outsiders -- particularly the international financial institutions -- could intervene in the non-financial affairs of borrowers. A Finnish banker pointed out that it has been standard practice in the academic community for years to take into account social and political factors. A Portuguese participant emphasised the importance of having a "social argument" with all the major partners in economic life.

But others were more sceptical. A Swedish banker pointed out that for his profession, the state of the legal system was simply part of credit risk. An American argued that it could be a huge mistake to interfere in political issues: the IMF should meddle only in areas where it has the expertise, such as banking. In South Korea, for instance, the struggle between the chaebol and the politicians has been a long-standing political issue, and the IMF interfered at its peril. A Canadian saw even more limitations in taking a "holistic" approach. Should the private sector really be involved with labour organisations and religious organisations? And should businesspeople try to double up as social missionar-

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ies? He worried that this policy would make the West enormously vulnerable to demagogues. It might even create a "matrix of colonialism".

In their conclusions, some of the panellists defended the idea that the West had the right to demand higher standards. The first panellist pointed out that in places like Azerbaijan, Armenia and Georgia the discussion has not been about the West imposing something: it had been asked to provide help and give the benefit of its experience. Fighting corruption had got huge domestic support in these countries: in Georgia, for example, the government had put the exams for judgeships on television to prove that the system was being cleaned up. The battle against corruption is not an overnight thing. And it needs to be built around the traditions of the countries concerned. But, in his view, it was certainly not a matter of imposing foreign values.