By Mark Weisbrot
With the stock market plummeting, an economic and political crisis in Russia, and a regional depression in Asia, a lot of people are wondering if we are staring into the abyss. It's no longer just the left, which has predicted six out of the last three world economic crises, that is nervous. "We are in a situation which is indeed a dangerous one, not fully rational," said IMF managing director Michel Camdessus. And Federal Reserve Board chair Alan Greenspan also warned that "it is just not credible that the United States can remain an oasis of prosperity unaffected by a world that is experiencing greatly increased stress."
The latter statement could be contested. The United States still consumes 88 percent of what it produces, and could, with the right policies, protect its population from adverse economic events in the rest of the world. As much as our political leaders would prefer to let the tail wag the dog--subordinate the domestic economy to the needs of international commerce--they are still a long way from transforming the U.S. economy where our fiscal or monetary policies are externally constrained. The dollar lost a third of its international value between 1985 and 1988, and this had no adverse effect on the U.S. economy. In other words, the Fed could lower interest rates as far as it wanted to, in order to keep the U.S. out of recession. Unlike most other nations, we would not have to worry about the inflationary impact of any currency depreciation that might result. We could also run federal budget deficits, if necessary, for the purpose of maintaining economic growth and employment.
It is important to keep this in mind, not because we are close to having a government that would put the needs of its people ahead of the big bondholders or transnational capital. But they should be held accountable, and not be able to shift the blame to nebulous unseen forces of "the global economy." Greenspan's announcement last week that he would consider lowering interest rates is a positive sign, but it remains to be seen whether the Fed's action will, as has happened in the past, end up being too little and too late.
The events that have dominated the headlines of the economic news are not as interrelated as they appear to be. To get a handle on what is happening, it is worth trying to sort them out a bit.
The Stock Market's Decline
The Dow is down about 16 percent since July 17, and this is commonly attributed to events in Russia and Asia. But this is very misleading. The fact is that stocks were, and still are, grossly overvalued relative to the earnings of the underlying assets they represent. When this happens, decline is inevitable, and the external event that triggers the decline does not "cause" it in any meaningful sense of the word.
It is not that difficult to show that stock prices have been inflated into a speculative bubble. Dean Baker of the Economic Policy Institute has done the necessary arithmetic, in the course of refuting the exaggerated claims--regarding potential stock market returns--made by those who seek to privatize Social Security.
Stock prices can bounce all over the place in the short run, as the market is driven by psychology. But ultimately stocks only have value because the companies they represent earn profits. People forget this sometimes, and then remember it when the market plunges--much as drivers in Washington DC seem to re-learn how to drive in the snow and ice each winter.
There are two sources of income from holding stocks: first, a dividend payout, which represents the shareholder's portion of the companies profits (earnings). The average dividend payout is currently about 2 percent. The other source of income is from an increase in the price of stocks or capital gains. The question is, how much can stock prices increase?
The average price to earnings ratio is still at a record high, even after the recent plunge. So it is safe to assume that prices will not increase faster than earnings. Earnings, however, cannot increase much faster than the growth of the economy--unless we think that there is going to be a continuous redistribution of income from labor to capital. Some of that has happened--the share of national income going to corporate profits has increased by 3.2 percentage points since the last business cycle peak (1989). The typical worker would be earning about $1,100 more annually today if not for that shift. But no one is projecting this trend to continue, and real wages for the majority of the work force have begun to rise significantly during the last two years.
So if stock prices cannot grow faster than earnings, and earnings cannot grow faster than the economy, then we would expect stock prices to grow at about the same rate as the economy. Over the next decade, economic growth is projected to be about 2 percent annually. If we add that to the dividend payout, we get a rate of return on stocks of 4 percent a year, maybe 4.5 percent if the economy grows a little faster.
So why would anyone hold stocks if they can get almost the same return on a short-term bond, with virtually no risk? Well, they might not have seen this arithmetic. If we look at who has done what in the last few market downturns, it has been overwhelmingly the small investors buying and the big players selling. But even for those who know they are sitting on a bubble, there is an enormous temptation to stay in as long you expect others to buy enough to keep driving prices up, so long as you can jump before everyone else does. But that's easier said than done, and of course most people won't be able to pull it off; such is the nature of bubbles, manias, and other excesses of markets generally.
All this analysis shows us is that the stock market's decline is not the result of events in faraway places. It is, however, a truly significant event that might well herald the end of an era in U.S. politics.
Here is the silver lining in the clouds looming over Wall Street: some of the regressive social engineering that took place over the last decade is about to come undone. Certainly the extension of these counter-reforms, in the form of privatizing Social Security, has been dealt a serious blow. The more class-conscious among the privatizers, such as Washington Post columnist James Glassman, have been fully cognizant of the political implications of replacing social insurance--which is not only many times more efficient than any private alternative, but also a solidaristic system with a different ethic--with millions of individual stock holders. They want people to identify with corporate profits, and to have policy makers increasingly constrained from doing anything that might upset the stock market.
The spread of stock ownership to 43 percent of households, many through 401 (k) and other retirement accounts, has coincided with a record run-up in stock prices. To be sure, this ownership is still highly concentrated, with the median household holding only about $14,000 in stocks. In fact, 86 percent of the stock market gains since 1989 have accrued to the top 10 percent of households.
But the idea has been popularized that stocks are the means by which the majority of people partake in the gains from economic growth. That idea will soon be as good as dead. A more sensible alternative can be found in the not-too-distant past, when the majority of Americans shared in the fruits of technological progress through rising wages and an expanding social safety net: e.g. Social Security (which was indexed to inflation in the 1970s), and expanded access to health care (Medicare and Medicaid, long overdue to be extended to the rest of the population). If progressives are able to frame the issue this way, they will likely find a receptive audience, now that the alternative of gambling one's life savings in the stock market has been exposed for what it is--gambling.
Globalization in Crisis
Neoliberalism at the global level has also been dealt some serious blows--although one of the hardest punches has not received the attention it deserves: Russia's default on $200 billion worth of debt, some $40 billion of which is owed to foreigners. Like the proverbial sewer smell arising in the midst of a dinner party, the guests--the international creditors--do not want to mention it. This is a first for the international system of debt peonage, and the idea could easily spread. Mozambique, one of the poorest countries in the world, is paying about a quarter of its export earnings for debt service, more than it spends on education and health care. Other desperately poor countries are similarly squeezed, and the threat of Russia's example is being taken very seriously.
The collapse of the ruble also has implications far beyond Russia's borders. The stabilization of the ruble had been the IMF's only accomplishment over the past six years. The ruble's collapse just weeks after the IMF had put up nearly $5 billion dollars to support it, which went right into the outstretched hands of speculators, has given the Fund another high profile black eye. The IMF's credibility crisis is internationally the most important aspect of neoliberalism's troubles right now, since the IMF is by far the most powerful instrument of transnational capital. Since the Fund inflicts more damage, in economic and human terms, than any other national or international institution, it is worth looking at the current fight over expanding the IMF in the context of the current international economic situation.
The spread of financial and economic turmoil has reminded people that unregulated markets are prone to crises, panics, overshooting, recessions and even depressions. At the level of the nation-state, a number of institutions have evolved which regulate, and sometimes prevent the worst excesses and irrationalities of a market system: even in the United States we have the Federal Reserve as a lender of last resort, Federal deposit insurance, and the automatic stabilizers of government spending, to name just a few examples. At the same time, and sometimes within the same institutions, the welfare state has softened the impact of these irrationalities and also mitigated the injustices that result from market outcomes.
The global economy has no analogous institutions, and transnational capital and its political allies have deliberately expanded its importance (through agreements like NAFTA, the GATT, and the MAI) for the purpose of avoiding the civilizing influences of the last century and a half of struggle. The process has been one of continually removing economic decision making from Parliaments, Congresses, and elected officials, and placing it in the hands of unaccountable institutions such as the IMF, WTO, G-7, etc.
For those who care about the human consequences of these developments, there is a strategic question that is becoming increasingly important: should we accede to the process of increasing global economic integration, and try to create the requisite quasi-state institutions at the international level? Or should we oppose it, with the hope that individual nation states will thus be able, to varying degrees, find their own regulatory mechanisms--whether they be national-developmentalist, social democratic, or even socialist?
In some cases it might be possible to do both--e.g., oppose the process and simultaneously fight for labor rights clauses in new international agreements. But in other cases our choices are much more limited, and it is crucial that we understand this limited range of choice.
The IMF is one such case, and the lack of clarity among the progressive community is hurting us. The recent troubles have amplified the voices of those among our elite who would support some greater international regulatory mechanisms--the U.S. Treasury Department calls it a "new architecture of the global economy." While not all of the measures they would consider are harmful, the expansion of the IMF's power that they propose would be an enormous step backward.
Many people who would ordinarily oppose economic colonialism are willing to acquiesce to, or even support the expansion of the IMF in the hope that it may someday be transformed into its opposite. This is a terrible mistake. The IMF is a brutal, colonial institution, controlled by Washington, an organizer of creditors that squeezes the world's poorest countries for debt service on loans they cannot ever hope to repay. It is also a de-regulatory institution, whose adopted mission is to open up the world's economies to transnational capital on the latter's terms. It has consistently wielded its enormous power against any industrial or even agricultural strategy that has been centered around national economic development. With the exception of the Mexican peso crisis, it has never functioned as a lender of last resort, as its recent failures in Indonesia and Russia have amply demonstrated.
This is not a question of reform versus abolition, as it is often posed. The IMF will indeed change its policies in response to criticism--as even dictators like Suharto did. In fact, it already has, allowing Indonesia to increase its budget deficit target from 1 percent to 8.5 percent of GDP. But it will not be reformed into anything that can have a net positive impact, if for no other reason than it is unaccountable to any population anywhere. And it will not be abolished any time soon.
The idea that we can create international institutions, controlled by the governments of the world's richest countries, that would somehow reverse the policies that these governments are pursuing, has always seemed far-fetched to me. It would make more sense to first change the foreign economic policy of the United States, where at least we can vote, before expanding its power over the poorer countries of the world.
The need for clarity on these questions is important, as the Clinton administration is asking for $18.5 billion to expand the IMF's capital base by 45 percent (with the contributions of other members, who will likely follow the U.S. lead). With every tremor in the international economy, as well as the stock market, the Administration has exhorted Congress to approve the money or risk being blamed for the next disaster. Most Democrats have gone along from the beginning, with only a handful--along with the large majority of Republicans--holding it up. After the latest IMF-sponsored fiasco in Russia, House Appropriations chair Bob Livingston, the Administration's key Republican ally, announced he was reconsidering his support, and Newt Gingrich made similar noises.
Neoliberalism will of course survive with a much weakened and discredited IMF, but its backers are aware how much more difficult it is to force countries like South Korea to accept mass layoffs or remove its remaining controls on foreign capital and ownership, as the IMF has recently arranged, if the orders were coming directly from Washington or a handful of private foreign banks. The neoliberals understand the importance of this battle; unfortunately, many on our side do not.
Cracks in the Wall
It is understandable that many people could be carried away by the prospect of global economic reform. There has been a significant shift in the public debate over the last year, and even the last few months. A number of prominent, pro-globalization, mainstream economists have come out in favor of increased capital controls. Joseph Stiglitz, chief economist of the World Bank and former chair of President Clinton's Council of Economic Advisors, breached protocol by openly accusing the IMF of exacerbating the Asian financial crisis. Columbia University's Jagdish Bhagwhati, one of the world's most prominent international economists and the Economic Policy Adviser to the Director-General of 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 some well-researched papers 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." The most radical break with neoclassical orthodoxy has come from no less a champion of globalization than Paul Krugman, who, writing in a recent article for Fortune magazine, proposed a return to restrictions on the convertibility of currencies. The latter policy was promptly adopted by Malaysia last week.
These epiphanies by prominent economists are long overdue, and recent events have provided an opportunity to blurt out the obvious. China has notably been the least affected by the Asian crisis, and certain reasons for its relative immunity seem clear: their currency is not convertible, they have little foreign ownership in financial markets, and their banking system is government-owned. Being free from IMF orthodoxy has its advantages: in response to the crisis, China announced last March a three year, $1 trillion public works program (the equivalent in the U.S., if you can imagine it, would be more than $8.5 trillion). How much and how it is actually implemented remains to be seen, but any expansionary policy makes a lot more sense than the beggar-thy-neighbor process of trying to export your unemployment by means of an undervalued currency--the latter is a zero-sum game.
Krugman's policy of foreign exchange controls makes sense, too, and Russia appears to be the next candidate for adopting it, unless the IMF can stop them. Look at the alternative: Mexico is jacking up interest rates to 38 percent in order to stem the capital flight, currency collapse, resultant inflation, and possible economic disaster that has threatened them because of…Russia--country that has nothing to do with them. 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.
The human cost of this irrationality has been staggering, especially in Asia. 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.
How much of this misery is directly due to neoliberal policies and their supporting institutions? It appears to be quite a bit. The short-term debt build-up that preceded the Asian financial crisis clearly created the instability that turned the fall of the Thai baht in July 1997 into a regional financial meltdown. This rapid accumulation of short-term debt, in turn, was a direct result of the removal of capital controls--at the insistence of the United States. 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. Since the burden of foreign debt service increases when the domestic currency falls, this left these economies extremely vulnerable to a panic, and the ensuing vicious spiral of currency depreciation.
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 1998. Even worse, the IMF's 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.
Less noticed has been Washington's contribution to Russia's economic disaster. Most Americans are unaware of it, but the Russian economy had already collapsed long before the recent unhinging of the ruble and default on government debt. Over the last six years, American economists--together with the International Monetary Fund--have presided over one of the worst economic declines in modern history.
Russian output has declined by more than 40 percent since 1992--a catastrophe worse than our own Great Depression. Millions of workers are not being paid and 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. All of this happened before the current meltdown.
The failures of neoliberalism are getting harder to ignore, even for its defenders. Its global component had already suffered a significant defeat last year, as the president's quest for fast-track authority--to negotiate new trade and commercial agreements without amendments from Congress--was blocked. Opposition to IMF expansion has also thrown a wrench in their machinery. The Multilateral Agreement on Investment, a treaty that would extend the investment provisions of NAFTA to the 29 mostly high-income countries of the OECD (Organization for Economic Co-operation and Development), and then to the rest of the world, has also been slowed down by worldwide opposition.
Nonetheless we are only beginning to crack the structure of neoliberal ideology in the United States. Although the debate within the economics profession has received a bit of coverage in the Wall Street Journal and the New York Times, most reporting--whether through print or electronic media--remains unaffected by it. The airwaves are saturated with blather about "crony capitalism" as the cause of Asia's troubles, and we are daily reminded that Russia needs to be forced to follow the West's "reform" program more diligently. Unlike the stock market, which directly affects some millions of people's lives and forces them to think about their future, foreign economic policy remains in the mystified realm of the experts and officials. The foreign policy establishment has made no concessions, and is not planning to make any. The Clinton administration is forging ahead with plans to complete the MAI negotiations this fall.
Washington is a still a long way from changing its course, but its ability to impose its neoliberal dogma on the rest of the world is waning. And that, by itself, is cause for hope.
Mark Weisbrot is Research Director at the Preamble Center, in Washington, DC (www.preamble.org).
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