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The IMF Strikes Back
By Kenneth Rogoff
Economic Counsellor and Director of the Research Department
International Monetary Fund
Reproduced with permission from FOREIGN POLICY 134
(January/February 2003) www.foreignpolicy.com
Copyright 2003,by the Carnegie Endowment for International Peace
Vitriol against the IMF,including personal attacks on the competence
and integrity of its staff,has transcended into an art form in recent
years,One bestselling author labels all new fund recruits as "third-
rate," implies that management is on the take,and discusses the IMF's
role in the Asian financial crisis of the late 1990s in the same breath
as Nazi Germany and the Holocaust,Even more sober and balanced
critics of the institution—such as Washington Post writer Paul
Blustein,whose excellent inside account of the Asian financial crisis,
The Chastening,should be required reading for prospective fund
economists (and their spouses)—find themselves choosing titles that
invoke the devil,Really,doesn't The Chastening sound like a sequel
to 1970s horror flicks such as The Exorcist or The Omen? Perhaps
this race to the bottom is a natural outcome of market forces,After
all,in a world of 24-hour business news,there is a huge return to
being introduced as "the leading critic of the IMF."
Regrettably,many of the charges frequently leveled against the fund
reveal deep confusion regarding its policies and intentions,Other
criticisms,however,do hit at potentially fundamental weak spots in
current IMF practices,Unfortunately,all the recrimination and finger
pointing make it difficult to separate spurious critiques from
legitimate concerns,Worse yet,some of the deeper questions that
ought to be at the heart of these debates—issues such as poverty,
appropriate exchange-rate systems,and whether the global financial
system encourages developing countries to take on excessive debt—
are too easily ignored,
Consider the four most common criticisms against the fund,First,
Espa?ol Fran?ais
Slammed by antiglobalist protesters,developing-country politicians,and
Nobel Prize–winning economists,the International Monetary Fund (IMF)
has become Global Scapegoat Number One,But IMF economists are not
evil,nor are they invariably wrong,It’s time to set the record straight and
focus on more pressing economic debates,such as how best to promote
global growth and financial stability,
IMF loan programs impose harsh fiscal austerity on cash-strapped
countries,Second,IMF loans encourage financiers to invest
recklessly,confident the fund will bail them out (the so-called moral
hazard problem),Third,IMF advice to countries suffering debt or
currency crises only aggravates economic conditions,And fourth,the
fund has irresponsibly pushed countries to open themselves up to
volatile and destabilizing flows of foreign capital,
Some of these charges have important merits,even if critics
(including myself in my former life as an academic economist) tend
to overstate them for emphasis,Others,however,are both polemic
and deeply misguided,In addressing them,I hope to clear the air for a
more focused and cogent discussion on how the IMF and others can
work to improve conditions in the global economy,Surely that should
be our common goal,
The Austerity Myth
Over the years,no critique of the fund has carried more emotion than
the "austerity" charge,Anti-fund diatribes contend that,everywhere
the IMF goes,the tight macroeconomic policies it imposes on
governments invariably crush the hopes and aspirations of people,(I
hesitate to single out individual quotes,but they could easily fill an
entire edition of Bartlett's Quotations.) Yet,at the risk of seeming
heretical,I submit that the reality is nearly the opposite,As a rule,
fund programs lighten austerity rather than create it,Yes,really,
Critics must understand that governments from developing countries
don't seek IMF financial assistance when the sun is shining; they
come when they have already run into deep financial difficulties,
generally through some combination of bad management and bad
luck,Virtually every country with an IMF program over the past 50
years,from Peru in 1954 to South Korea in 1997 to Argentina today,
could be described in this fashion,
Policymakers in distressed economies know the fund will intervene
where no private creditor dares tread and will make loans at rates
their countries could only dream of even in the best of times,They
understand that,in the short term,IMF loans allow a distressed debtor
nation to tighten its belt less than it would have to otherwise,The
economic policy conditions that the fund attaches to its loans are in
lieu of the stricter discipline that market forces would impose in the
IMF's absence,Both South Korea and Thailand,for example,were
facing either outright default or a prolonged free fall in the value of
their currencies in 1997—a far more damaging outcome than what
actually took place,
Nevertheless,the institution provides a convenient whipping boy
when politicians confront their populations with a less profligate
budget,"The IMF forced us to do it!" is the familiar refrain when
governments cut spending and subsidies,Never mind that the
country's government—whose macroeconomic mismanagement often
had more than a little to do with the crisis in the first place—generally
retains considerable discretion over its range of policy options,not
least in determining where budget cuts must take place,
At its heart,the austerity critique confuses correlation with causation,
Blaming the IMF for the reality that every country must confront its
budget constraints is like blaming the fund for gravity,
Admittedly,the IMF does insist on being repaid,so eventually
borrowing countries must part with foreign exchange resources that
otherwise might have gone into domestic programs,Yet repayments
to the fund normally spike only after the crisis has passed,making
payments more manageable for borrowing governments,The IMF's
shareholders—its 184 member countries—could collectively decide
to convert all the fund's loans to grants,and then recipient countries
would face no costs at all,However,if IMF loans are never repaid,
industrialized countries must be willing to replenish continually the
organization's lending resources,or eventually no funds would be
available to help deal with the next debt crisis in the developing
world,
A Hazardous Critique
Of course,in so many IMF programs,borrowing countries must pay
back their private creditors in addition to repaying the fund,Yet
wouldn't fiscal austerity be a bit more palatable if troubled debtor
nations could compel foreign private lenders to bear part of the
burden? Why should taxpayers in developing countries absorb the
entire blow?
That is a completely legitimate question,but let's start by getting a
few facts straight,First,private investors can hardly breathe a sigh of
relief when the fund becomes involved in an emerging-market
financial crisis,According to the Institute of International Finance,
private investors lost some $225 billion during the Asian financial
crisis of the late 1990s and some $100 billion as a result of the 1998
Russian debt default,And what of the Latin American debt crisis of
the 1980s,during which the IMF helped jawbone foreign banks into
rolling over a substantial fraction of Latin American debts for almost
five years and ultimately forced banks to accept large write-downs of
30 percent or more? Certainly,if foreign private lenders consistently
lose money on loans to developing countries,flows of new money
will cease,Indeed,flows into much of Latin America—again the
current locus of debt problems—have been sharply down during the
past couple of years,
Private creditors ought to be willing to take large write-downs of their
debts in some instances,particularly when a country is so deeply in
hock that it is effectively insolvent,In such circumstances,trying to
force the debtor to repay in full can often be counterproductive,Not
only do citizens of the debtor country suffer,but creditors often
receive less than they might have if they had lessened the country's
debt burden and thus given the nation the will and means to increase
investment and growth,Sometimes debt restructuring does happen,as
in Ecuador (1999),Pakistan (1999),and Ukraine (2000),However,
such cases are the exception rather than the rule,as current
international law makes bankruptcies by sovereign states
extraordinarily messy and chaotic,As a result,the official lending
community,typically led by the IMF,is often unwilling to force the
issue and sometimes finds itself trying to keep a country afloat far
beyond the point of no return,In Russia in 1998,for example,the
official community threw money behind a fixed exchange-rate regime
that was patently doomed,Eventually,the fund cut the cord and
allowed a default,proving wrong those many private investors who
thought Russia was "too nuclear to fail." But if the fund had allowed
the default to take place at an earlier stage,Russia might well have
come out of its subsequent downturn at least as quickly and with less
official debt,
Since restructuring of debt to private creditors is relatively rare,many
critics reasonably worry that IMF financing often serves as a blanket
insurance policy for private lenders,Moreover,when private creditors
believe they will be bailed out by the IMF,they have reason to lend
more—and at lower interest rates—than is appropriate,The debtor
country,in turn,is seduced into borrowing too much,resulting in
more frequent and severe crises,of exactly the sort the IMF was
designed to alleviate,I will be the first to admit the "moral hazard"
theory of IMF lending is clever (having introduced the theory in the
1980s),and I think it is surely important in some instances,But the
empirical evidence is mixed,One strike against the moral hazard
argument is that most countries generally do repay the IMF,if not on
time,then late but with full interest,If the IMF is consistently paid,
then private lenders receive no subsidy,so there is no bailout in any
simplistic sense,Of course,despite the IMF's strong repayment
record in major emerging-market loan packages,there is no guarantee
about the future,and it would certainly be wrong to dismiss moral
hazard as unimportant,
Fiscal Follies
Even if IMF policies are not to blame for budget cutbacks in poor
economies,might the fund's programs still be so poorly designed that
their ill-advised conditions more than cancel out any good the
international lender's resources could bring? In particular,critics
charge that the IMF pushes countries to increase domestic interest
rates when cuts would better serve to stimulate the economy,The
IMF also stands accused of forcing crisis economies to tighten their
budgets in the midst of recessions,Like the austerity argument,these
critiques of basic IMF policy advice appear rather damning,
especially when wrapped in rhetoric about how all economists at the
IMF are third-rate thinkers so immune from outside advice that they
wouldn't listen if John Maynard Keynes himself dialed them up from
heaven,
Of course,it would be wonderful if governments in emerging markets
could follow Keynesian "countercyclical policies"—that is,if they
could stimulate their economies with lower interest rates,new public
spending,or tax cuts during a recession,In its September 2002
"World Economic Outlook" report,the IMF encourages exactly such
policies where feasible,(For example,the IMF has strongly urged
Germany to be flexible in observing the budget constraints of the
European Stability and Growth Pact,lest the government aggravate
Germany's already severe economic slowdown.) Unfortunately,most
emerging markets have an extremely difficult time borrowing during
a downturn,and they often must tighten their belts precisely when a
looser fiscal policy might otherwise be desirable,And the IMF,or
anyone else for that matter,can only do so much for countries that
don't pay attention to the commonsense advice of building up
surpluses during boom times—such as Argentina in the 1990s—to
leave room for deficits during downturns,
According to some critics,though,a simple solution is staring the
IMF in the face,If those stubborn fund economists would only
appreciate how successful expansionary fiscal policy can be in
boosting output,they would realize countries can simply wave off a
debt crisis by borrowing even more,Remember former U.S,President
Ronald Reagan's economic guru,Arthur Laffer,who theorized that by
cutting tax rates,the United States would enjoy so much extra growth
that tax revenues would actually rise? In much the same way,some
IMF critics—ranging from Nobel Prize—winning economist Joseph
Stiglitz to the relief agency Oxfam—claim that by running a fiscal
deficit into a debt storm,a country can grow so much that it will be
able to sustain those higher debt levels,Creditors would understand
this logic and happily fork over the requisite extra funds,Problem
solved,case closed,Indeed,why should austerity ever be necessary?
Needless to say,Reagan's tax cuts during the 1980s did not lead to
higher tax revenues but instead resulted in massive deficits,By the
same token,there is no magic potion for troubled debtor countries,
Lenders simply will not buy into this story,
The notion that countries should reduce interest rates—rather than
raise them—to fend off debt and exchange-rate crises is even more
absurd,When investors fear a country is increasingly likely to default
on its debts,they will demand higher interest rates to compensate for
that risk,not lower ones,And when a nation's citizens lose confidence
in their own currency,they will require a large premium to accept
debt denominated in that currency or to keep their deposits in
domestic banks,No surprise that interest rates in virtually all
countries that experienced debt crises during the last decade—from
Mexico to Turkey—skyrocketed even though their currencies were
allowed to float against the dollar,
The debate over how far interest rates should be allowed to rise in
defending against a speculative currency attack is a legitimate one,
The higher interest rates go,the more stress on the economy and the
more bankruptcies and bank failures; classic cases include Mexico in
1995 and South Korea in 1998,On the other hand,since most crisis
countries have substantial "liability dollarization"—that is,a lot of
borrowing goes on in dollars—an excessively sharp fall in the
exchange rate will also cause bankruptcies,with Indonesia in 1998
being but one example among many,Governments must strike a
delicate balance in the short and medium term,as they decide how
quickly to reduce interest rates from crisis levels,At the very least,
critics of IMF tactics must acknowledge these difficult trade-offs,The
simplistic view that all can be solved by just adopting softer
"employment friendly" policies,such as low interest rates and fiscal
expansions,is dangerous as well as naive in the face of financial
maelstrom,
Capital Control Freaks
Although currency crises and financial bailouts dominate media
coverage of the IMF,much of the agency's routine work entails
ongoing dialogue with the fund's 184 member countries,As part of
the fund's surveillance efforts,IMF staffers regularly visit member
states and meet with policymakers to discuss how best to achieve
sustained economic growth and stable inflation rates,So,rather than
judge the fund solely on how it copes with financial crises,critics
should consider its ongoing advice in trying to help countries stay out
of trouble,In this area,perhaps the most controversial issue is the
fund's advice on liberalizing international capital movements—that is,
on how fast emerging markets should pry open their often highly
protected domestic financial markets,
Critics such as Columbia University economist Jagdish Bhagwati
have suggested that the IMF's zeal in promoting free capital flows
around the world inadvertently planted the seeds of the Asian
financial crisis,In principle,had banks and companies in Asia's
emerging markets not been allowed to borrow freely in foreign
currency,they would not have built up huge foreign currency debts,
and international creditors could not have demanded repayment just
as liquidity was drying up and foreign currency was becoming very
expensive,Although I was not at the IMF during the Asian crisis,my
sense from reading archives and speaking with fund old-timers is that
although this charge has some currency,the fund was more eclectic in
its advice on this matter than most critics acknowledge,For example,
in the months leading to Thailand's currency collapse in 1997,IMF
reports on the Thai economy portrayed in stark terms the risks of
liberalizing capital flows while keeping the domestic currency (the
baht) at a fixed level against the U.S,dollar,As Blustein vividly
portrays in The Chastening,Thai authorities didn't listen,still hoping
instead that Bangkok would become a financial center like Singapore,
Ultimately,the Thai baht succumbed to a massive speculative attack,
Of course,in some cases—most famously South Korea and Mexico—
the fund didn't warn countries forcefully enough about the dangers of
opening up to international capital markets before domestic financial
markets and regulators were prepared to handle the resulting
volatility,
However one apportions blame for the financial crises of the past two
decades,misconceptions regarding the merits and drawbacks of
capital-market liberalization abound,First,it is simply wrong to
conclude that countries with closed capital markets are better
equipped to weather stormy financial markets,Yes,the relatively
closed Chinese and Indian economies did not catch the Asian flu,or
at least not a particularly bad case,But neither did Australia nor New
Zealand,two countries that boast extremely open capital markets,
Why? Because the latter countries' highly developed domestic
financial markets were extremely well regulated,The biggest danger
lurks in the middle,namely for those economies—many of which are
in East Asia and Latin America—that combine weak and
underdeveloped financial markets with poor regulation,
Moreover,a country needs export earnings to support foreign debt
payments,and export industries do not spring up overnight,That's
why the risks of running into external financing problems are higher
for countries that fully liberalize their capital markets before
significantly opening up to trade flows,Indeed,economies with small
trading sectors can run into problems even with seemingly modest
debt levels,This problem has repeatedly plagued countries in Latin
America,where trade is relatively restricted by a combination of
inward-looking policies and remote location,
Perhaps the best evidence in favor of open capital markets is that,
despite the international financial turmoil of the last decade,most
developing countries still aim to liberalize their capital markets as a
long-term goal,Surprisingly few nations have turned back the clock
on financial and capital-account liberalization,As domestic
economies grow increasingly sophisticated,particularly regarding the
depth and breadth of their financial instruments,policymakers are
relentlessly seeking ways to live with open capital markets,The
lessons from Europe's failed,heavy-handed attempts to regulate
international capital flows in the 1970s and 1980s seem to have been
increasingly absorbed in the developing world today,
Even China,long the high-growth poster child for capital-control
enthusiasts,now views increased openness to capital markets as a
central long-term goal,Its economic leaders understand that it's one
thing to become a $1,000 per capita economy,as China is today,But
to continue such stellar growth performance—and one day to reach
the $20,000 to $40,000 per capita incomes of the industrialized
countries—China will eventually require a world-class capital market.
Even though a continued move toward greater capital mobility is
emerging as a global norm,absolute unfettered global capital mobility
is not necessarily the best long-term outcome,Temporary controls on
capital outflows may be important in dealing with some modern-day
financial crises,while various kinds of light-handed taxes on capital
inflows may be useful for countries faced with sudden surges of
inflows,Chile is the classic example of a country that appears to have
successfully used market-friendly taxes on capital inflows,though a
debate continues to rage over their effectiveness,One way or another,
the international community must find ways to temper debt flows and
at the same time encourage equity investment and foreign direct
investment,such as physical investment in plants and equipment,In
industrialized countries,the pain of a 20 percent stock market fall is
shared automatically and fairly broadly throughout the economy,But
in nations that rely on foreign debt,a sudden change in investor
sentiment can breed disaster,
Nevertheless,financial authorities in developing economies should
remain wary of capital controls as an easy solution,"Temporary"
controls can easily become ensconced,as political forces and budget
pressures make them hard to remove,Invite capital controls for lunch,
and they will try to stay for dinner,
Striking a Global Bargain
Should the international community just give up on global capital
mobility and encourage countries to shut their doors? Looking further
ahead in the 21st century,does the world really want to adopt greater
financial isolationism?
Perhaps the greatest challenge facing industrialized countries in this
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century is how to deal with the aging bulge in their populations,With
that in mind,wouldn't it be more helpful if rich countries could find
effective ways to invest in much younger developing nations,and
later use the proceeds to support their own increasing number of
retirees? And let's face it,the world's developing countries need funds
for investment and education now,so such a trade would prove
mutually beneficial—a win-win,Yes,recurring debt crises in the
developing world have been sobering,but the potential benefits to
financial integration are enormous,Full-scale retreat is hardly the
answer,
Can the IMF help? Certainly,The fund provides a key forum for
exchange of ideas and best practices,Yes,one could go ahead and
eliminate the IMF,as some of the more extreme detractors wish,but
that is not going to solve any fundamental problems,This
increasingly globalized world will still need a global economic forum,
Even today,the IMF is providing such a forum for discussion and
debate over a new international bankruptcy procedure that could
lessen the chaos that results when debtor countries become insolvent,
And there are many other issues where the IMF,or some similar
multilateral organization,seems essential to any solution,For
example,the current patchwork system of exchange rates seems too
unstable to survive into the 22nd century,How will the world make
the transition toward a more stable,coherent system? That is a global
problem,and dealing with it requires a global perspective the IMF
can help provide,
And what of poverty? Here,the IMF's sister organization,the World
Bank,with its microeconomic and social focus and commensurately
much larger staff,is appropriately charged with the lead role,But
poor countries in the developing world still face important
macroeconomic challenges,For example,if enhanced aid flows ever
materialize,policymakers in emerging markets will still need to find
ways to ensure that domestic production grows and thrives,Perhaps
poor nations won't need the IMF's specific macroeconomic
expertise—but they will need something awfully similar,
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