A quarterly magazine of the IMF

March 2001, Volume 38, Number 1

Money on the Move: The Revolution in International Finance Since 1980

Princeton University Press, Princeton, New Jersey, 1999, xiii + 210 pp., $29.95 (cloth).

As a Director of the Federal Reserve Board's International Finance Division, a staff economist on the U.S. Council of Economic Advisers, and then a Brookings Institution Scholar, Robert Solomon has been at the center of the debate on, and the implementation of, international monetary policies for four decades. Money on the Move is his lucid and highly engaging sequel to The International Monetary System, 1945-81 (New York: Harper & Row, 1977, rev. 1982).

Solomon's writing is both eminently accessible to the nontechnical reader and intellectually rigorous, making it fascinating reading for policymakers and economists as well. This volume, which offers perhaps the most readable overview of the international monetary system over the past two decades, avoids the flamboyance of other economics books aimed at a general audience, such as Paul Krugman's The Age of Diminished Expectations. Incorporating frequent references to the personalities involved in policymaking, illuminating anecdotes, the political background, and a rich bibliography of both technical and nontechnical references, Solomon brings international policy issues vividly to life without displaying any personal biases or sacrificing insights from economic theory. Indeed, he acknowledges that some predictions he had made in previous writings were incorrect.

The opening chapter, which discusses the strengthening of the U.S. dollar before the Plaza accord of 1985 and its subsequent decline, describes the economic background of the major industrial economies and changes in government and economic doctrine, focusing on the United States and the United Kingdom. Solomon's explanation of the rise of the dollar against the background of a widening current account deficit in the United States in the first half of the 1980s, in which he draws parallels to the recent depreciation of the euro, reminds the reader that understanding large exchange rate movements continues to be a challenge for both academic and policy economists.

Solomon next leads the reader carefully through the developing country debt crisis of the 1980s as it unfolded, providing a front-row seat to the various initiatives undertaken to deal with it. The chapter serves as a reminder of the long history of both perceived moral hazard (the encouragement of risky behavior by investors, who see measures such as insurance or government subsidies as guarantees that they can reap the benefits of their risky investments while being protected against any losses) and private sector involvement in dealing with developing country debt crises, and the longer-term impact policy initiatives had on the pattern of financial flows in the 1990s.

The perspective on European Economic and Monetary Union (EMU) is painstakingly constructed from the Marshall Plan up to the creation of the single European currency. Solomon reflects on the economic debate surrounding convergence as well as on the operations of central banks and the makeup of financial markets, which illustrate practical issues about policy implementation even in advanced economies. He also reflects on the long-term pressures on the euro and likely IMF relations with EMU members. This chapter is essential reading for those looking for a complete yet brief European monetary history.

The chapter on capital mobility in the 1990s examines the increase in capital flows across both industrial and developing country borders, as well as the proliferation of financial instruments and derivatives that have accompanied these flows. In a refreshing departure from some academic economists who treat the increasing complexity of financial markets and their interactions with macroeconomics with some degree of discomfort, Solomon embraces the two and weaves a cogent story about the implications of these developments on flows, exchange rates, and the emerging market crises of the 1990s.

Finally, Solomon muses on the future of the international monetary system and the IMF's role within it. By tying together the major developments of the past two decades and important policy conundrums that remain unresolved, he evaluates proposals that have been the subject of active debate, ranging from exchange rate arrangements to the Tobin tax (a proposed uniform tax that all countries would levy on all foreign exchange transactions with the aim of making short-term movements of "hot money" unprofitable). He concludes by considering the future of a monetary system that revolves around the three major currency areas of the dollar, the euro, and the yen. The book, engaging to the very end, is a highly recommended reference for all policy economists interested in international monetary and economic relations.

Subir Lall

Distributive Justice and Economic Development: The Case of Chile and Developing Countries

University of Michigan Press, Ann Arbor, Michigan, 2000, x + 206 pp., $49.50 (cloth).

It is said that "timing is everything." In view of the considerable attention being devoted to the problem of poverty, this book is well timed to influence the debate on the policies that are most likely to reduce poverty and income inequality. It focuses on the Chilean experience during the 1990s for two important reasons. First, Chile is widely seen as a pioneer for its efforts to combine market-oriented reforms with a socially progressive policy framework. A retrospective look at whether it has been able to reduce poverty rates and bring about socially acceptable patterns of income distribution and wealth is thus welcome. Second, although, like much of Latin America, Chile is a middle-income country, it is nonetheless characterized by high poverty rates and unequal income distribution. The book also brings an unusual perspective—contributors include respected academic scholars of economic development as well as key Chilean ministers and researchers who were involved in formulating and implementing social policy in the 1990s.

The papers concentrate on two principal themes. The first is the relationship between growth and macroeconomic stability and that between poverty and income distribution. These topics have been well plumbed, but the passage of time has made them more amenable to further refinement and more insightful empirical analyses. The second theme is the impact that specific sectoral policies—in education and other social spheres and in the labor market—can have on improving the equality of access to wealth-producing assets (for example, land and education) and their associated effects on poverty rates and income distribution.

The principal conclusions can be presented briefly. First, the papers by Michael Bruno (the last paper he wrote before his death), Martin Ravallion, Lyn Squire, and Lance Taylor suggest that there is no trade-off between policies that foster economic growth and poverty reduction: growth is poverty reducing, and there is no evidence that it worsens income distribution. These authors describe the reasons for questioning, and even displacing, the traditional view that an unequal distribution of income is necessary for growth. Indeed, one important conclusion of one of the papers in the volume is that the higher the level of asset inequality, the lower the gains of growth to the poor. Second, the papers underscore the importance of fiscal and financial stability for both growth and poverty reduction.

Third, ambitious social policies that are intended to give poor people from rural and urban areas equal access to education, credit, land, health care, and other productive assets are a key element in the desirable mix of poverty-reduction measures. Chile's educational reform is seen as an important experiment in seeking efficiency and distributive justice through an improved educational system. Social safety nets, targeted subsidies, and an adequate food supply are considered equally important, not only to protect the poor and provide a context within which they can take advantage of opportunities for asset creation, but also because these mechanisms help ensure political and social stability during economic downturns. A paper by Vito Tanzi emphasizes that in fostering progressive social policies, the state must grapple with how to prevent the middle- and upper-income classes from capturing the benefits, an outcome that is all too common in many developing countries.

Finally, several papers underscore the importance of maintaining a balance between meeting social objectives and respecting macroeconomic and political realities. This position supports two tenets of the current emphasis of the poverty-reduction strategies in the IMF and World Bank's enhanced Heavily Indebted Poor Countries Initiative—namely, that a sound fiscal position is central to achieving macroeconomic stability and that social policies need to be "owned" by their key beneficiaries and supported through their social organizations and political representatives.

Chile has made good progress, particularly in reducing poverty rates. Reducing inequalities in the distribution of wealth has proved to be a more substantial challenge, one that this thought-provoking book suggests is a "pending objective for the twenty-first century."

Peter S. Heller

Collapse: The Venezuelan Banking Crisis of '94

Group of Thirty, Washington, 2000, [xv] + 281 pp., $40 (paper).

Although many authors have studied the causes, consequences, and early indicators of banking crises, this book is unique for several reasons. It presents a detailed account by one of the major players in the drama of the events that took place before and during one of the worst banking crises to hit Latin America. An interesting and provocative case study in political economy, it aims at a broad audience and provides important evidence about the factors that contribute to banking crises in general and those that led to the one in Venezuela in particular. It describes the consequences of inappropriate macroeconomic policies, weak institutions, and ineffective regulatory frameworks, combined with bad luck and lack of political will to take the necessary measures at the right time.

Ruth de Krivoy was president of the central bank of Venezuela during the height of the crisis that erupted in early 1994. During the early 1970s, she had been vice president of research at the central bank, where she played an active role in strengthening economic research as a major instrument of support for monetary policy. After she left the central bank, she continued to be involved in financial sector issues as an independent consultant. In 1992, two months after an attempted coup d'état, she became president of the central bank. Her appointment seemed a natural choice, given both her extensive experience and her firm belief in central bank independence. Ruth de Krivoy resigned the central bank presidency in April 1994, but continued to be actively involved in financial sector issues, participating in the Toronto International Leadership Center for Financial Sector Supervision and several international seminars and events.

This book provides an excellent background for the main macroeconomic developments in Venezuela before the crisis as well as for the structural problems associated with the country's dependency on oil, the distortions created by price and interest rate controls, and the pervasive subsidies supported by oil revenues. The asymmetric response of fiscal policy to oil price shocks created a government that was too large and overly involved in the private sector. The book also describes the weaknesses and ineffectiveness of the financial and banking regulatory system. Excessive controls discouraged transparent, easily monitored institutions, while too many supervisory agencies were responsible for maintaining a sound financial system, all in the absence of appropriate prudential regulations and effective enforcement. In this context, structure and ownership in the banking sector became highly concentrated, with little foreign competition, poor corporate governance, and an overreliance on oil revenues.

The reader is exposed to all possible factors that contributed to the Venezuelan crisis, many of which have been found to underlie other banking crises: moral hazard, inadequate accounting rules and prudential norms, an undercapitalized banking system, a weak regulatory framework, and large undisclosed contingent liabilities. One of the book's most interesting aspects is the combination of technical and political economy analysis. As de Krivoy explains, the rapid transformation of the economic system resulting from the liberalization of Venezuela's economy in the late 1980s and early 1990s did not take place as expected, because reforms were not appropriately sequenced and they adversely affected too many interests, which conspired against the political support required for the success of the program.

The attempted coup in 1992 ignited a series of events that weakened the very core of the democratic regime. Reforms were reversed, credibility was lost, and the economy was destabilized by large capital outflows. In this context, before and throughout the crisis, a political struggle between the central bank and the institutions directly responsible for taking corrective actions undermined the central bank's recently established independence.

Perhaps the most valuable contribution of the book is contained in the last chapter, "A Call for Action." After a careful analysis of the events, and based on first-hand experience, de Krivoy expounds on how to avoid a banking crisis, and, if a crisis emerges, how to minimize and control its impact. It is useful and pragmatic advice, with recommendations directed at bank owners and managers, institutions involved in the regulation and supervision of banks, central bankers, lawmakers, economic policymakers, and the world community of bankers and supervisors. The author also presents important reflections on special problems faced by Latin America and Venezuela.

Mercedes Da Costa

Pensions, Savings and Capital Flows: From Ageing to Emerging Markets

Edward Elgar, Cheltenham, United Kingdom/Northampton, Massachusetts, 2000, x + 277 pp., £55/$90 (cloth).

In this book, Helmut Reisen, Head of the Research Division at the OECD Development Center, addresses some of the major policy challenges of the day: aging populations, the promotion of savings, and volatile capital markets. By clarifying how these challenges relate to each other, this book will usefully inform policy and academic debates on financial globalization.

In the first part, Reisen essentially argues that by diversifying their assets globally, countries can increase the returns on pensions. Reisen maintains that industrial countries with aging populations, such as the member countries of the Organization for Economic Cooperation and Development, can escape part of their demographic problem by investing in emerging markets, which will continue to benefit from the net pension contributions of their younger populations. Likewise, the author reasons that developing countries can invest a part of their pension assets in developed countries, thereby spreading around some of the risks that stem from their higher exposure to, say, weather shocks. These recommendations are reinforced with evidence of the demographic impact on stock market valuation in the United States. The increase in asset prices owing to investment by the large baby-boomer generation is likely to be reversed by the end of this decade as funded pension plans cease to be a net buyer of stock market shares.

While Reisen's argument is forceful and well documented, it is not entirely convincing. The emerging markets have repeatedly suffered from currency crises, which, in turn, have triggered strong contagion effects. Financial crisis makes the stock market returns of the emerging markets more highly correlated (that is, uniform), eliminating the potential benefits of diversification. Moreover, although the emerging markets have grown more quickly than the industrial countries, this growth has not translated into higher earnings per share. Corporate profitability has grown too slowly, because listed companies have too often chased higher market share rather than concern themselves with shareholder returns. And if, indeed, the emerging markets succeeded in attracting a considerable share of global pension assets, the correlation between aging and emerging markets would increase and the diversification benefits would be lower than Reisen suggests.

In the second part of the book, an important empirical paper investigates whether funded pensions contribute to higher aggregate savings—a far too common assumption that should be challenged. Examining pension and life insurance assets for 11 countries during 1982-93, Reisen finds that the development of funded pensions does contribute to higher aggregate savings if individuals who earn low incomes can be encouraged to save more and if the resulting savings are not offset by increased access to consumer credits (that is, if a certain degree of liquidity constraint is maintained in the economy). This would require, however, mandatory rather than voluntary saving schemes, comprehensive coverage of the working-age population, and limits on borrowing against accumulated pension assets.

Most of the other papers, and the entire third part of the book, deal with the management of capital inflows by developing country authorities, a subject on which Reisen has written authoritatively for many years. He recommends resisting capital inflows that augment debt when they are seen to coincide with unsustainable currency appreciation, excessive risk taking in the banking system, and a sharp drop in private savings. Reisen sees the recent emerging market currency crises, which are often rooted in the weak portfolio discipline of local financial systems, as a result of "disorderly" financial opening and heavy short-term inflows. Hence the need to raise the quality of inflows, with a preference for equity rather than debt. On the supply side, the author believes that progress toward a less crisis-prone global financial system hinges on correcting regulatory distortions that intensify inherent herd effects, as exemplified by the Basel Accord on capital requirements, and on curbing excessive risk taking by banks. The author also criticizes the impact of sovereign ratings, which have reinforced booms and busts in emerging market lending.

While all these subjects may have been analyzed elsewhere in more detail and rigor, Pensions, Savings and Capital Flows is original in highlighting the links between pension pressures, saving, and global capital flows. The essays are highly readable and well argued. Not least, they are documented with rich empirical evidence and a superb bibliography, providing the reader with confidence in the author's nonpartisan perspective.

Robert Holzmann