Below is the third part of my exchange with Joe Studwell, author of How Asia Works. Here's part 1 and part 2.

SR: In your previous answer you took a swipe at the IMF for its behaviour towards Indonesia during the currency crisis, so I wonder if you could say some more about the role of international institutions.

I notice that Michael Pettis, in his Amazon review of your book, says the merits of industry policy are so obvious as to be not worth debating. The fact it is debated 'suggests to me how unreal academic economics has become and how divorced from historical understanding.'

But it's not just academic economics, clearly. It's also the policy advisers in the IMF and World Bank (and perhaps even the NGOs?) who push a pure free market line. How do you account for the fact that these institutions seemingly continue to ignore the evidence of successful industry policy? And how have Asian governments dealt with advice from the IMF, World Bank and others? Do they just ignore it?

JS: The story of the international institutions is a complex one, so I'd like to try to reflect that complexity. I would also like to say that I am not an expert in the history of these institutions and mostly know them from the work I have seen them doing in east Asia.

The first point is to consider the origins of the IMF, the institution that is best known for going in to countries after financial crises occur and agreeing (forcing?) and overseeing reform 'programs'. The IMF was created at the end of the Second World War and gained its early crisis experience in the 1970s in already quite mature western European countries after the Bretton Woods fixed exchange rate regime broke down. The IMF played an important role cajoling countries that had employed what I earlier called the 'economics of development' or 'economics of learning' in order to get back on their feet after the Second World War towards what I called the 'economics of efficiency'.

In other words, the institution moved countries along from one kind of economics to the next (at least in my conceptualisation). For the most part this involved deregulation, the imposition of freer markets and the gradual removal of currency controls (the latter not in the UK, for instance, until the advent of Margaret Thatcher as prime minister in 1979).

In the 1980s the IMF then took its medicine to Latin America with the onset of the Latin American debt crisis. As far as I can see (again, I am not an expert), Latin America had messed up its development policy in two main ways. First, land reforms were absent or ineffective (because of lousy execution). This left a very skewed income distribution in place, failed to give landless farmers any capital (in the form of land) with which to play the capitalist game, and did not maximise yields.

During the post-war industrialisation drives in countries like Brazil, agricultural exports either flatlined or fell, or imports increased, exacerbating the balance of payments stresses that occur in the early stages of industrialisation when countries always run trade deficits (because of the need to import producers' goods -- typically, machines to make stuff with). The second policy cock-up was the shortfall of 'export discipline' to ensure adequate returns on subsidy and protection to manufacturers.

The wrong agriculture policy and the failure to export enough manufactures created balance of payments pressures and a capital shortfall that were filled with foreign loans. When dollar interest rates rose under the Reagan Administration, the loans could not be serviced, and governments resorted to printing money (just like in the Philippines under Marcos, which was east Asia's Latin American state).

In this respect, the deflationary macro policies the IMF brought in were necessary and stabilised the situation. However, the IMF also dismantled industrial policy and has never, as far as I can see, understood anything about agriculture. The upshot was that the IMF undermined Latin America's ability to develop quickly and sustainably. But then one can say that the Latin Americans had already done that for themselves by borrowing lots of money and investing it unwisely.

I make the point in How Asia Works that, scaled for GDP, the Koreans borrowed more money overseas than any Latin American country, but it didn't matter because they had export discipline which meant they were creating lots of globally competitive manufacturing firms. Latin America seems to have produced one: Embraer.

Anyhow, we can say the IMF did well in western Europe, and then did well-ish (at best) in Latin America. Next it came to east Asia after the Asian financial crisis. Here, for me, it really made a terrible mess of southeast Asia by imposing Anglo-Saxon financial systems in Thailand and Indonesia after the crisis, having already done the same thing in the Philippines following the fall of Marcos in 1986. Industrial policy has been almost completely undermined and the banking systems now focus loans on consumers (making very tidy profits, just like in post-crisis Latin America). But the banks do not support sensible developmental policies that make national economies more value-adding. It should be no surprise that southeast Asia has had east Asia's best performing stock markets since the Asian crisis while, in terms of the real economy, a country like the Philippines is on the brink of a return to the Third World. The only positive thing the IMF has done in southeast Asia is to make the place work for hedge fund managers. In fact I often think the IMF should become a hedge fund.

In defence of the IMF, I would point out two things. In southeast Asia, Malaysia did much of what the other major economies did, but without an IMF intervention; it just copied them anyway. With that kind of lack of political leadership, a country is in a lot of trouble anyway. And second, the IMF intervention in South Korea, which got caught up in the crisis, was much better timed, at least in my view.

South Korea was already a US$10,000 GDP per capita country when the crisis hit and the IMF forced sales of equity in the financial system to foreigners, required major changes to company law, and oversaw other adjustments in favour of consumers and minority shareholders. Contrary to Ha Joon Chang (whom I admire enormously), I think these interventions were well-timed. Of course the good timing was totally by chance because the IMF does not believe in timing, if you get what I mean! South Korea, in short, was ready for the economics of efficiency.

So that's the IMF. The World Bank, by contrast, was set up specifically to support economic development at the micro level, and should be judged on this basis. Its real name is the International Bank for Reconstruction and Development.

My own observation over the years has been that the World Bank has some fantastic people, but that the institution is only as good as the use governments make of it. This means knowing what you want and getting World Bank specialists to work within some kind of brief that is defined by the developing state. If you just ask the World Bank (or the IMF) what to do, the ideologues in these institutions will their list of currently fashionable options, almost all of which have been between useless and disastrous for the past 40 or more years.

Classic examples include 'privatise your banks', 'develop your stock markets', and 'concentrate financial intervention on micro-finance'. Note that each one is a financial liberalisation policy, reflecting exactly what has been fashionable (often rightly so) in rich countries and is deemed to be good for poor ones too. We may be about to get a new fashion menu based more around 'institutions'. Again my expectation is that in timing terms the advice will be out of kilter. The institutional stuff becomes critical after the basic structural stuff that I talk about in How Asia Works. However now we are getting on to the subject of my next book again...

Successful developing countries have ignored the fashion menu(s) and instead have asked the World Bank's technical people to support a proper development strategy. This is what China did in the 1980s when it had the World Bank, for instance, bring over Korean government people to explain what they had done and produce a bunch of comparative historical development studies. The process is described from different perspectives in Ezra Vogel's biography of Deng Xiaoping, and in Harold Jacobson and Michael Oksenberg's China's Participation in the IMF, the World Bank, and the GATT, and, in Chinese, in Wu Jinglian et al (eds), Chinese Economists 50 Forum Looking at Thirty Years: Retrospective and Analysis (????50???????????).

Other developing countries would do well to study the manner in which China, the ROK and Japan have handled the IMF and the World Bank and gotten value from them. It is basically about avoiding the ideologues and making use of the technical people. You don't want people like the World Bank guy in Jakarta who, shortly before the fall of Suharto, held a press conference lauding a successful telecoms 'privatisation' that had actually just been handed to one of Suharto's daughters. You do want the ones like Edwin Lim, the Filipino Chinese who led the early World Bank mission in China.

Your last question is the one about why the bad advice continues to flow. I think it mainly comes down to ignorance, although just the other day someone was saying that they once asked a USTR guy in a bar to name one instance in which policies of free trade from the get-go had led to a positive developmental outcome, and the person just got up and left.

So maybe there is some pre-meditated desire to screw poor countries. Friedrich List claimed that one British prime minister used to keep a copy of The Wealth of Nations in his pocket and quote it to French leaders at every meeting in a cynical attempt to have them accept their (then very backward) division of labour in grain and wine production and leave manufacturing and services up to Britain.