A quarterly magazine of the IMF

September 2006, Volume 43, Number 3

Book Reviews

Globalization's losers

Jeffry A. Frieden

Global Capitalism
Its Fall and Rise in the Twentieth Century

W.W. Norton, New York, 2006, 448 pp., $29.95 (cloth).

Jeffry Frieden has written a lucid and fast-flowing account of what is now almost the standard orthodoxy about globalization over the past hundred years. He describes a movement, resembling the letter U, in which substantial integration in labor, goods, and capital markets occurred in the late 19th century and was subsequently reversed as a result of the Great War and the Great Depression. After the Second World War, globalization slowly began to revive but has picked up more quickly since the 1970s, bringing a rapid diffusion of technological innovation and substantial improvement in well-being.

As a political scientist, Frieden is also profoundly interested in the politics of globalization. In any process of change, there are winners and losers, and the sustainability of the system depends—in his eyes—on how the losers are handled. Before the First World War, the losers were the old landed elites of Europe and perhaps workers, who had to bear the costs of adjustment under the monetary regime of the gold standard.

Frieden, like Karl Polanyi, sees gold standard adjustment as difficult or even impossible in an environment of political responsibility or democratization. The interwar years thus saw both a collapse of democracy and an attempt to restore the gold standard. In the years immediately after 1945, however, Frieden said that democracy was rescued in many states (primarily in Western Europe, he means) by their adoption of Keynesian-inspired welfare policies. Such policies were viable in a national setting but became less so as the costs of adjustment rose with the real wave of globalization that occurred after the 1970s.

Frieden ends with a survey not only of the failures of globalization—especially for very poor states that remain outside the framework of open goods, labor, and capital markets—but also of the increasing challenges to the world posed by globalization that emanate from rich countries whose citizens believe that trade and immigration have adversely affected their income. Frieden's story of the political response to globalization is a tour de force. His surveys of the explanations offered by such theorists as Eli Heckscher, Bertil Ohlin, Wolfgang Stolper, and Paul Samuelson for the effects of trade on incomes are easy to understand.

But Frieden's account raises puzzles that are never really solved. At some points, he seems to adopt a quite rigid form of economic determinism, although the effects of economic structures on political outcomes sometimes run in different directions: he insists on page 196 that, in the 1920s and 1930s, "every debtor country went the way of fascist or nationalist autarky; every creditor country remained democratic and committed to international economic integration." It is easier to see this mechanism, in which populist hostility to an externally imposed debt burden turned voters and politicians away from internationalism, than it is to follow the logic of the claim that, in other circumstances, debt crises promoted democracy (for example, in the Latin American crunches of the 1980s). In that case, the logic that links debt to democratization is not fully spelled out. But in each case, economics pushes politics.

At other moments, however, Frieden gives a great deal of autonomy to policy choices: countries are poor above all because their elites have made the wrong political choices; or (perhaps more astonishing in the light of the debt and dictatorship thesis for the 1930s) he tells us that in Germany—the most important and destructive collapse of interwar democracy—"even modest measures to stimulate the economy, subsequent analysis has shown, would have been enough to stop the Nazis' electoral advances" (p. 177). He does not really address the central question, at least of the 20th century, of what room politicians had for maneuver. Consequently, it is hard to see how the general worry about the uncertainties and discontents of globalization should be mapped into concrete policy proposals.

In addition, the reader should be warned that this book is much more a history of globalization than it is of global capitalism. Little time is spent discussing national differences in capitalism or debating whether there are separate regional models. The book assumes rather than demonstrates that one form of capitalism is in accordance with the logic of history—namely, the form that is dominated by large, management-run, and diversely owned multinational corporations that operate on much the same principles of corporate governance in any country. At a time when the chief executive of IBM has proclaimed that the age of the multinational corporation is over, it might be worth questioning the usual narrative of the existence of only one form of capitalism.

Harold James
Princeton University

No time for sleep

Guillermo A. Calvo

Emerging Capital Markets in Turmoil
Bad Luck or Bad Policy?

MIT Press, Cambridge, Massachusetts, 2006, 547 pp., $45.00 (cloth).

At the beginning of the 1990s, the Brady Plan, under which nonperforming commercial bank loans were restructured into tradable bonds, inaugurated the most recent wave of capital flows to emerging markets. This year, as one Latin American country after another retires its Brady bonds, there is a sense that an era is drawing to a close. Throughout this period, Guillermo Calvo has been at the center of the debate over the character and efficacy of those capital flows, at the IMF, at the Inter-American Development Bank, and in academia. Timing is everything in comedy and scholarship. One cannot imagine better timing for this book's publication.

Collected in this book are all of Calvo's important articles on capital flows and crises, starting with his prescient work with Leiderman and Reinhart that, as early as 1993, questioned the sustainability of the new wave of capital flows. These articles observed that capital tended to flow equally to emerging markets that had traveled far down the road of structural reform and to others whose journeys had barely begun. This pointed to the role of conditions in global financial markets—ample liquidity, the carry trade, and investors' growing tolerance for risk—in influencing the pattern of capital flows. And, if global conditions were so important for the direction of capital flows, Calvo warned, it was possible that as interest rates rose in the United States and global financial conditions tightened, the direction of flows might reverse, bringing the entire house of cards tumbling down. Parallels anyone?

Many of us tend to forget, perhaps because of Calvo's soft-spoken nature, the number of intellectual and policy debates over the last 15 years to which he has made fundamental contributions. He was one of the first to question the applicability of familiar first-generation models of the monetary and fiscal roots of crises to the wave of 21st-century financial crises that began in Mexico in 1994. He was one of the first to highlight the role of financial factors such as high levels of short-term debt and currency mismatches. Similarly, he was among the first to link so-called second-generation models with multiple equilibriums. He saw how a bridge could be built from these models to popular discussions of contagion and how this last concept could be given analytical rigor. And he drove home his points by showing their applicability to the Mexican crisis, the Russian crisis (1998), and the Argentine crisis (2001–02).

His impact on policy was slower in coming. In a series of new commentaries, Calvo describes how his pioneering papers, written while he was an Advisor at the IMF, were greeted with skepticism. Officials did not like to be told that investors' new willingness to lend to developing countries was not testimony to the miracles of Fund-supported structural reform programs. They were less than sympathetic to the idea that even countries with low inflation and balanced budgets were still vulnerable to crises. Having done a stint at the IMF myself, I can attest that not a few high-level staff members saw this attention to contagion and self-fulfilling crises as merely the fashion of the day and thought that the institution's preoccupation with financial fragilities represented a dangerous diversion from more fundamental monetary and fiscal matters. It is thus all the more striking how many of Calvo's core ideas are now conventional wisdom in the IMF and integral to its day-to-day operations.

The one point in the analysis that is less than fully convincing is when Calvo considers the implications of these ideas for reform of the international financial architecture. He argues that the vulnerability of emerging markets, even those with strong monetary and fiscal fundamentals, to sudden stops and reversals in the direction of capital flows creates an argument for a global rescue fund administered by an international lender of last resort. One suspects that this idea will be more warmly received than some of Calvo's earlier brainstorms in the upper echelons of the IMF. In practice, however, it raises serious issues of moral hazard for both emerging market governments and international investors.

Collections, even of papers as significant as these, often elicit a mixed reaction. Rereading them is not unlike watching a favorite old movie: the element of surprise is missing, but the viewer is better able to appreciate the director's craft. And Calvo is, indeed, attempting to teach us something about the economist's craft. He explains that most economists occupy extreme points on the methodological spectrum: they work either on discovery or on applications. The profession includes skilled theorists capable of building elegant abstract models formalizing new ideas and applied economists fundamentally concerned about understanding economic data, but few economists with the intellectual breadth and the capacity to function without sleep, which are the prerequisites for working in both areas.

Calvo has made fundamental contributions to both theory and policy. More impressive still, he made them not serially—theory when young, policy work when not so young—but in tandem over the course of a long career. The most powerful message of Calvo's book is that the rest of us should sleep less and, like him, work closer to the center of the methodological spectrum.

Barry Eichengreen
University of California, Berkeley

Planners versus searchers

William Easterly

The White Man's Burden
Why the West's Efforts to Aid the Rest Have Done So Much Ill and So Little Good

Penguin Group, New York, 2006, 400 pp., $27.95 (cloth).

William Easterly divides the world of aid into "planners" and "searchers." The lead planner is Jeffrey Sachs, who argues that The End of Poverty (his recent book) requires only directing a lot of money and applying the latest technologies to the problem. Sachs's underlying premise is that countries are caught in a "poverty trap," with poverty begetting poverty. His solution is for the United Nations to coordinate a massive effort, with the assistance of donors and international financial institutions (including the IMF), to help countries formulate comprehensive plans to meet the Millennium Development Goals by 2015.

Easterly argues engagingly that this approach is hopelessly flawed. In his review of aid and development, with a section on colonization and foreign military intervention thrown in for good measure, he combines sometimes moving on-the-ground anecdotes with well-chosen country examples and authoritative reviews of the economic and development literature.

Among his key points are that, although today's poor countries have received substantial aid over the decades, it doesn't seem to have done them much good; aid agencies are generally unaccountable, especially to the intended beneficiaries; there is little actual evidence of the poverty-trap view of the world—today's poor countries are not those of previous decades; and the impulse required to generate sustained development must come from within, not from foreigners.

The book is longer on criticisms than on solutions. In fact, Easterly takes pains to emphasize that he has no alternative grand solution to the development problem. But he argues for a dramatic scaling down of expectations about what aid, and foreign involvement more generally, can achieve: foreigners cannot bring growth and development, but they can, if they avoid grandiose illusions, help some very poor people. In this spirit, he proposes another way of thinking about aid: donors should be "searchers," who experiment with ideas, get lots of feedback from the proposed beneficiaries, and keep an open mind about what works. Of course, being a planner is more exciting—just talking about ending poverty makes people feel good, even if nothing good comes of it.

In the end, the book is more powerful in its condemnation of outside solutions than of planning. Easterly does not seriously engage in the debate about the role of major state-led initiatives or other manifestations of planning in, say, the success of many East Asian miracle economies. Nor does he entirely squeeze out the thought that, in some countries and in some circumstances, there may be scope for big, coordinated investments to help ignite development. But he is more convincing in showing the ease with which donors (and military interveners and colonizers) have been able to fool themselves about the prospects for radical outside solutions. For this reason alone, Easterly's voice belongs inside the head of anyone practicing development, not only as a counterweight to Sachs's voice, but also to remind us, when we do something Easterly might ridicule, to think twice.

There is one common thread to the Easterly and Sachs views: aid institutions, including the IMF, behave almost mysteriously badly. For Sachs, these institutions are insufficiently ambitious, while to Easterly they are too caught up with planning top-down solutions. That these two could disagree so spectacularly about the reasons for the failures of these institutions suggests that they may both be missing something. The planning that Easterly denigrates dominates the discourse of Sachs, Bono, and other top stars of the development universe. Most development practice, however, recognizes the need to find locally owned solutions and to test them on the ground. But that is hard to achieve. Faced with a huge and desperate problem, a desire to help, and the occasional partial success, people understandably keep trying. Sebastian Mallaby's The World's Banker, published last year, describes with more understanding how we have arrived where we are, and The Macroeconomic Management of Foreign Aid: Opportunities and Pitfalls, published by the IMF last year, provides in one volume a balanced, if more technical, overview of current aid debates.

The urge to synthesize Sachs's and Easterly's ideas or to find some common ground between them is dubious—their perspectives are so different—but impossible to resist. For our own work at the IMF, we might consider two Easterly-esque points. First, economists do not know much about how to get growth going, and, second, solutions imposed from the outside rarely work. Thus, we must carefully weigh our reaction when a recipient country wants, say, to massively scale up public investment. We should be cautious about saying that this will not work; as searchers, our job is to help design a plan to make the best of this approach. On the other hand, when a country chooses a strategy of export-led growth and reduced aid dependency, we need to support that as well, even if it means taking some hits from planners like Sachs.

Andrew Berg
IMF Policy Development and Review Department