The Washington Post, November 16, 1998
It is said that doctors bury their mistakes, but so can economists, when they have the power to implement them. And sometimes they bury them in mass graves. Such is the case with the brain trust of the International Monetary Fund, which is now set to operate on its latest unlucky patient: Brazil.
After racking up disasters in Asia and then Russia, the Fund and its allies in the Clinton Administration have concluded that their only mistake was that they did not intervene early enough. So they have put together a 42 billion "rescue" package for Brazil.
But there is little reason to believe that the IMF’s bitter medicine will help Brazil any more than it helped Indonesia or Russia. In fact, economists are already predicting a recession there for next year, on the assumption that Brazil takes the IMF money and the advice that goes with it.
That advice mandates big cutbacks in government spending, tax increases, and enormously high interest rates-- a deadly mix practically guaranteed to send any economy into a tailspin. It is difficult to see how the prospect of recession-- not to mention the potentially explosive political conflict that such policies will provoke-- will accomplish the stated goal of calming nervous financial markets.
Brazil has the most unequal distribution of income in the world, with the upper 10% taking about half the nation’s income, while 43% of the people survive on less than two dollars a day. The IMF-engineered economic contraction will therefore have terrible consequences even if it "succeeds" on its own terms: people who are already malnourished will get less food, and some will die. Spending on health care and education will also be cut, and millions of people will lose their jobs, homes, and livelihoods.
Are these drastic measures necessary? Let’s start with the federal budget deficit. It is currently running at 7% of the economy (or GDP). To put this in perspective, the United States government ran a budget deficit of 6.1% of GDP in 1983, with no harm done. One might argue that either of these deficits is too high over the long run, but there is no urgency about cutting them.
It is sometimes feared that budget deficits in this range will cause accelerating inflation, but this is clearly not the case in Brazil, where inflation is currently at 3%.
What about the exorbitant interest rates, now running at 42%, which cripple economic activity even more than the budget cuts? The Fund argues that these are necessary to prevent the Brazilian currency from collapsing. This is because lenders, due to the risk of currency devaluation, are unwilling to keep their money in the country at lower rates.
But there are other possible solutions. Some economists argue that the country would be better off with a flexible exchange rate, and they are probably correct. Defenders of the status quo counter that the Brazilian real is by now highly overvalued, and so if it were allowed to float immediately it would first sink like a stone. This would increase inflation (by raising the price of imported goods). But Brazil’s imports are only about 7% of its economy, which means that the inflationary effects of a devaluation would be relatively small.
There are other measures that could help Brazil avoid plunging its economy into recession. For example, the government could place controls on the buying and selling of its currency, so as to prevent a currency collapse without having sky-high interest rates. But the IMF does not allow these, or almost any other kind of "capital controls."
In the wake of the Asian economic crisis, which was clearly brought on by the liberalization of international capital flows, a number of leading economists have changed their views and are willing to consider various forms of capital controls. But the IMF and its allies in the Clinton administration remain committed to maximizing the freedom of international investors, while protecting them from the risks of bad loans and currency depreciations. Hence their insistence that Brazil maintain its fixed exchange rate, without capital controls, no matter what the cost to Brazilians-- or to US taxpayers financing the bailout.
The Brazilian financial crisis, like the Asian "contagion" that set it off, is a product of these misplaced priorities that are decided in Washington. And that raises the most important question: shouldn’t Brazilians have the right to choose their own economic policy? Washington clearly says no: it announced just before the Brazilian Presidential election last month that the funds to prevent a currency collapse would only be made available if President Cardoso were re-elected.
So much for democracy. But the battle is far from over, and the Brazilians will make their voices heard: in their Congress, state legislatures, and most likely, the streets.