The “Washington Consensus”, the IMF dogma of the 90′s reigns supreme in Israel

Stanley Fischer, the Consensus Man

At the concluding remarks of the last G20 meeting in London, Gordon Brown Britain’s PM declared: “The old Washington Consensus is over”.

What came to be known among financial circles as “the Washington Consensus” was a set of ‘ten commandments’ which over the years reflected the thinking of the US Treasury, the IMF and the World Bank as to what constitutes a “right “economic policy for developing countries. Critics of the  Consensus, had always seen  it as a tool  of   the financial elite of Wall Street and Washington to dictate to countries seeking its assistance an economic policy that serves its interests through its power and control over the IMF and the World Bank.

In the aftermath of the Asian crisis of 1997 which was followed by a Latin American crisis, the criticism of the Consensus reached Washington. According to opponents of the Consensus, on top of the fact  that some of the dictates caused the crises, the remedies imposed by the IMF further aggravated them.

The responsibility for the current economic crisis that was placed on the US’s doorstep   enabled the other G20 members to shake-off    American leadership and its position as a standards setter in managing and regulating the global financial system. When president Obama  asked the EU, China and India, to participate in enhancing the capital of the IMF, they made their contributions conditional on termination of US dominance in the running of the  IMF and the  World Bank.

The most controversial ‘commandment’ of the Consensus was the full liberalization of the capital account.

The dispute was not about whether or not governments should  control all movements of capital.  Rather, it was about how to protect an economy from the potential risk represented by short term capital movements that full liberalization brings about.

In a speech given in 2004 by John Williamson, the man credited with coining the phrase “Washington Consensus”, he admitted that full liberalization was the main cause behind the Asian and Latin American crises of the late 1990’s.

Stanley Fischer, who was  then  Deputy Managing Director of the IMF as a nominee of  the US Treasury and considered by many as someone representing its interest, was at the focus of many of those critiques.

In Israel, Fischer distinguished himself as an authoritative envoy of the US administration as early as 1985. As an academic he was dispatched that year by George Schultz, the  Secretary of State in the Reagan administration, to oversee  Israel’s  implementation  of its  Economic Stabilization Plan. In a recent interview given to an Israeli newspaper, Fischer described his role in 1985 and detailed the modalities of coordination of economic policy between the two governments which exists since then.

It is therefore not surprising that in Israel the Consensus has never been questioned. Although mindful of the risks involved, Israel adopted full liberalization. The process was completed  in the years  2003-2005 during the tenure of Benjamin Netanyahu as Finance Minister and Stanley Fischer as Governor of the BOI . The various stages of the process and the risks they posed had been detailed in a 2005 paper by  Mr. Balfour Ozer of  the Bank of Israel (BOI).. However, it is not clear from the paper what were the objectives that justified taking the risky steps . According to the paper, even without adopting the “risky” parts of full cialis versus levitra liberalization, foreign investors and individuals could operate in the Israeli market and Israeli companies could operate overseas.  One possible explanation is  the ambition of the Ministry of Finance (MOF)  and BOI to prove that Israel could become an OECD country in spite of the political challenges facing it.

What was clear however, were the consequences of full liberalization.

A policy which combines high interest rates, over valued local currency   and a leadership whose political prestige is tied to its commitment to such policy, provides all the familiar ingredients which preceded previous currency crises.

During the same period, Israeli investors who were backed by a strong Shekel and by a cheap and generous credit provided by domestic institutional investors, expanded their investments overseas to levels never before imaginable.

A  measure of    the high risk of  that exists for a currency crisis in Israel are   the changes in the International Investment Position of Israel in the period 2003-2008, which are published by the BOI.

On the Liabilities side, Nonresident Investments in tradable financial securities increased by $ 55 billion(160%). This is the category where speculative capital is usually included.

On the Assets side, Residents Direct Investment abroad increased by $40 billion (400%).

With regard to the latter it is already known that a significant portion of it has been wiped out, since they financed the equity portion of real estate investments by Israeli companies in Central and Eastern Europe, India, Canada and the US.

Bearing in mind that the total foreign currency reserve of Israel is $43 billion, then it is clear that any slight change in the sentiment of Nonresident investors, may gravely destabilize the Shekel.

The massive new inflows of capital stimulated economic activity and created a sense of prosperity in the country. The flattering reviews of the Israeli economy by the leading international investment houses, hedge funds, and wealth management organizations, the same organizations that channeled those short term investments to Israel, reinforced in Israelis a false sense of immunity from the global crisis. Testimony to it is the absence of any political criticism of the do- nothing attitude of the MOF and the BOI.

That prosperity however, came at a price: high interest rates depleted the wealth of businesses and households, and a strong Shekel hampered the competitiveness of Israeli exports.

Therefore there can be no consensus behind Stanley Fischer’s statement: “we entered the global crisis readier than most other countries”

By: Dr. Ehud Kaufman*

* The writer was Chairman of Israel Electric, deputy director general of the MOF and vice president of Israel Discount Bank.

2010-12-07  »  ehud