The benefits of neoliberalism could have been exaggerated for decades, according to the IMF

Neoliberal reforms have predominated in the world since 1980. The IMF and the World Bank have been two of the institutions that have advised various countries for years to carry out such reforms. The success of the Chilean economy seemed to guarantee the good functioning of the neoliberal reforms, which, however, after being implemented in dozens of developing countries, do not seem to have been as positive as expected.

As Jonathan D. Ostry, Prakash Loungani and Davide Furceri, economists at the International Monetary Fund (IMF), describe in the official magazine of the Finance & Development organization, “this neoliberal agenda does not offer good results for all countries.”

“The neoliberal agenda is characterized by the deregulation and opening of domestic markets, including financial markets, and the entry of foreign competition. In addition to reducing the role of the state through privatization and the fiscal limitation of incurring deficits and accumulating debt”. The expansion of international trade and direct investment is also encouraged to encourage knowledge transfer.

However, despite the theory that these changes are positive for economic development, “there are aspects of the neoliberal agenda that have not worked as expected.” According to these economists, not all countries have achieved sustained economic growth, while there have been significant increases in inequality, which in turn has eroded the development of these countries.

The theory

Although the liberalization of the capital account is usually seen as something positive for the adaptation of countries to globalization, it does not always have the desired effects. Theoretically, capital account liberalization should allow for a more efficient allocation of capital on a global scale, from capital-rich industrial countries to capital-poor developing countries. The benefits should be widespread: a higher rate of return on private savings in developed countries and improved growth, employment and living standards in developing countries.

It is true that this step allows the entry of direct investment flows that serve to transfer technological knowledge, human capital and stimulate long-term growth. But the opening also allows the entry of ‘portfolio investments’, through which the investor seeks a financial return that does not usually have positive effects on the real economy, in addition to eliminating the borders so that foreign banks lend money to agents from developing countries.

“These portfolio investments and debt flows do not seem to stimulate growth or allow the country to share risks with its trading partners. This suggests that the growth and shared risk resulting from capital flows depend on the type of flow that is “, sentence the IMF economists.

While the benefits are somewhat uncertain for some countries, the costs may be represented by increased economic volatility and a greater frequency of financial crises. Since 1980, there have been around 150 episodes of net capital inflows in more than 50 emerging markets; 20% of the time, these episodes have ended in financial crises, many of these crises are associated with sharp declines in production, as shown in Finance & Development magazine.

economist and president of the Center for Economic Policy Research, explained in 2004 that “the rapid liberalization of financial systems and capital flows in many developing countries, in some cases voluntary, in others recommended by the IMF and the Bank World, and in a few, forced by a certain program of said institutions, has helped trigger the recent financial crises in some of these countries”.

And there is no return without risk, nor reward without danger: “The freedom of movement of capital has, like all freedom, its dangers, since it gives greater opportunities to individuals, companies and financial institutions to take greater risks, sometimes reckless, which can produce crises and even systemic risks”.

The most suitable solution

As De la Dehesa explained, “rapid liberalization of the capital account of the balance of payments can bring with it more problems than benefits. The OECD countries took more than three decades to liberalize their capital accounts and it was thought that the countries in development, less prepared for it, could carry it out in less than a decade”.

The dangers associated with a too rapid liberalization of capital movements can be reduced by granting a prolonged space of time to the countries that initiate the process and “through a combination of sound and stabilizing macroeconomic policies, so as not to incur in aggregate financial and policy imbalances. of regulation, supervision and control of financial institutions that develop adequate incentives to ensure efficient risk management”.

The tax adjustment

On the other hand, this current also advocates fiscal control to avoid high burdens of public debt. A public debt that is too high in relation to GDP can weigh down growth and confidence in the country. But trying to reduce the debt can have counterproductive effects that lead the country to a worse situation than before.

“To get to a lower level of debt, you need to distort economic behavior by temporarily raising taxes or reducing government spending, or doing both. The costs of raising taxes or cutting spending to reduce debt can be much worse.” … By this we also do not mean to say that a high level of debt is good for growth and well-being,” the IMF economists point out.

In short, the benefits of some policies of the neoliberal agenda “could have been exaggerated”, especially in the case of financial openness, which not only do not seem to have led to the expected benefits but could also have increased economic inequality and growth eroded. In the case of fiscal consolidation, secondary effects such as “lower growth in production and the Welfare State, and higher unemployment” have been underestimated, the IMF economists point out.

To conclude, these experts assure that the income inequality generated by these policies ends up undermining economic growth, which in the end is the ultimate goal of the neoliberal agenda. Financial openness and austerity can intensify economic cycles creating bubbles that swell and burst, jeopardizing the long-term economic growth of these nations.