"Inequality will grow if all you do is unleash market forces"

Mr Azis, why was structural adjustment so painful in Indonesia? Indiaʹs process of structural adjustment seem to go a lot more smoothly.

Iwan J. Azis: I disagree with you. The experience in Indonesia was essentially similar as in India. In both countries, the macro-economic data improved fast and that was what you would expect. There are always positive effects at the beginning, especially when you are making it easier to do business in markets that, to date, have been highly restricted. The problems arise later, because the benefits of the reforms are not shared evenly. So even if the macro-economic figures remain good, underlying inequality is likely to increase and many people will feel left behind. Initially, however, there is a healthy dynamism, which was the case when structural adjustment first started in Indonesia in 1984. And it was the case again in India in 1991.

I was actually thinking of Indonesia during the Asian crisis of 1997/98, when the terms imposed by IFIs and the International Monetary Fund (IMF) in particular deepened the crisis.

Azis: Indeed, that is a totally different story. It was a disaster.

What went wrong?

Azis: The IMF misunderstood what was going on. IMF experts had stated as late as January 1997 that things were going well in Indonesia. Growth was said to be good, the budget situation was deemed satisfactory. Social issues, including disparities among different groups, were not considered. And when the crisis hit, the same people from the IMF blamed the government, complaining about corruption, institutional weaknesses et cetera. Ultimately, the crisis put an end to the Suharto regime. The irony was that the same people, the same IFIs that had previously praised Indonesia’s economic policies suddenly blamed the country and "crony capitalism" for every problem.

And that was wrong?

Azis: Definitely. Indonesiaʹs economic misery was a direct result of the Asian crisis. In reaction to Thailand’s financial crisis, which is where the 1997 Asian crisis began, international investors started withdrawing capital from all South-East Asian emerging markets. That kind of thing was not supposed to happen, according to the dominant IFI doctrine at the time. The IMF believed that the free flow of capital was always good. However, if capital suddenly flows out of a country, the impact is always devastating. The demands the IFIs made actually worsened things in Indonesia. In retrospect, we can see that Indonesia was worst affected by the crisis, despite the fact that it had not originated there.

So based on a faulty diagnosis, the IFIs insisted on the wrong therapy in the late 1990s?

Azis: They insisted that the government had to cut spending, even though they had previously approved its budgets. If austerity is applied in a downturn, it can turn a recession into a depression. The way the IFIs handled the Asian crisis actually compounded the problems, not only in Indonesia. The IMF has since modified its stance. In 2012, a few years after the 2008 global financial crisis, its economists began emphasising what they call "macro-prudential" policies. That is really only soft phrasing for accepting that capital controls are sometimes useful, because sudden in- or out-flows of capital cause problems. I think the IFIs have learnt a few lessons. Today, their stance tends to be far more nuanced and less orthodox.Let me return to the basics of structural adjustment as understood in the 1980s and 1990s. It was typically a mix of de-regulation, privatisation and austerity. My impression is that de-regulation is often useful, privatisation may cause trouble and austerity often proves counterproductive.

Azis: As a rule of thumb, thatʹs a bit too simplistic. The essential thing is to consider what adjustment policies are supposed to achieve. Since they are supposed to improve a nation’s general welfare, it is sensible to make it easier to do business. So yes, if you have an over-regulated economy, as Indonesia was until the 1980s and India was until the 1990s, de-regulation will prove helpful and accelerate economic activity. In the same sense, privatisation can be a means to that end. Private-sector companies can indeed be more efficient than state-owned behemoths, but if privatisation is not done well, it will cause new problems.

Please give an example.

Azis: Consider Russia, where privatisation resulted in a small group of oligarchs controlling vast business empires, without facing the kind of competition that drives market efficiency. In that instance, privatisation did not lead to free markets; it created crony capitalism. Of course, we should promote market dynamism, but we must consider carefully what the appropriate steps are.

What about austerity?

Azis: Cutting wasteful government spending can be useful too, but it isn’t always. It is counter-productive to reduce social protection precisely at a time when it is most needed. That kind of austerity will not only result in political resentment; it can even slow down the economy because it further reduces aggregate demand when demand is weak already.

Government-sponsored social protection is, by definition, re-distribution. The state takes money from those who are better off in order to support those in need. Part of the old structural-adjustment doctrine, however, was that governments must not distort markets.

Azis: Yes and that has caused long-term problems. As I indicated earlier, inequality is likely to grow if all you do is to "unleash" market forces. In theory, playing fields are level, but in real life, they generally arenʹt. Weak institutions are another serious constraint. Worsening inequality, however, means that the public will stop supporting economic policies. And that is so even if the dynamism helps to reduce poverty, as it did in Indonesia in the 1980s and India in the 1990s. People do not think in terms of absolute poverty; they compare themselves with others. People who feel left behind become angry; that is evident in the USA and Europe too. What you need in the long run is not only the facilitation of market-driven growth, but also some kind of compensation for those who do not get a fair share of that growth. The lesson is that one must not neglect distributional aspects. The most effective interventions in this regard are not investments in physical infrastructure, but in human capital. Indeed, the health and education sectors enable a wider segment of the society, not just a selected few people, to take advantage of market opportunities.

Is there another long-term lesson?

Azis: In the past, the general idea was that all that was needed to improve a nation’s welfare was growth. Nothing else seemed to matter. Today, however, we know that we have to pay attention to multiple objectives, especially the institutional factors including distribution, but also the condition of the natural environment and other things. We must pay attention to qualitative dimensions of economic development.

Are you expecting more turmoil on the financial markets in the not too distant future?

Azis: Something will undoubtedly happen. Instability is evident, especially in emerging markets. They have become used to cheap money. The price of debt has been very low for a decade, ever since the global financial crisis of 2008. If I have counted correctly, five central banks have actually introduced negative interest rates at some point or another. In search of higher returns, international investors have used cheap capital from the rich world to hand out loans with comparatively higher interest rates abroad, especially in emerging markets. Accordingly, debt levels have been rising, especially in the private sector. Because interest rates are rising in the USA and the dollar is appreciating internationally, there is going to be trouble. My impression is that too many analysts are still looking at the wrong indicators – such as growth and financial markets – and overlooking important ones, including financial instability and social and distributional issues.

Interview conducted by Hans Dembowski

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