Surely Not the IMF Again? Jayati Ghosh

It has been some time now since the IMF lost its intellectual credibility, especially in the developing world. Its policy prescriptions were widely perceived to be rigid and unimaginative, applying a uniform approach to very different economies and contexts. They were also completely outdated even in theoretical terms, based on economic models and principles that have been refuted not only by more sophisticated heterodox analyses but also by further developments within neoclassical theory.

What may have been more damning was how out of sync the policies proposed by the IMF have also been with the reality of economic processes in developing countries. The 1990s and early 2000s were particularly bad for the organisation in that respect: their economists and policy advisers got practically everything wrong in all the emerging market crises they were called upon to deal with, from Thailand and South Korea to Turkey to Argentina. In situations in which the crisis has been caused by private profligacy they called for larger fiscal surpluses; faced with crisis-induced asset deflation they emphasised high interest rates and tight money policies; to address downward economic spirals they demanded fiscal contraction through reductions in public spending.

The countries that recovered clearly did so despite their advice, or in several cases because they actively pursued different policies. And the recognition became widespread among governments in the developing world that IMF loans were too expensive because of the terrible policy conditions that came with them. So returning IMF loans early became something of a fashion, led by some Latin American countries.

And of course, for the past few years an even more terrible fate had befallen the IMF: that of increasing irrelevance. From 2002 onwards, the IMF, along with the World Bank, became a net recipient of funds from developing countries, as repayments far exceeded fresh loans. The developing world turned its attention to dealing with private debt and bond markets, which is where the action was. Less developed countries found new sources of aid finance and private investment from other sources, as China, Southeast Asia and even India to a limited extent, began investing in other developing countries.

So the IMF has not really been a significant player in the international economic scene in the recent past, and the reasons for its very existence were often called into question. Embarrassingly, in this period the IMF in turn was called to book by its own auditors, for apparently poor management of its financial resources!

But what is interesting about IMF economists is how thick-skinned and impervious they appear to be. Not only do they simply ignore the devastating criticisms from outside that completely undermine their own arguments, they even ignore their own internal research when it comes up with conclusions that do not fit with their world view. And they appear to be unconcerned with the growing evidence that they are both unconnected to reality and unable to influence it in any productive way.

Such intellectual autism is certainly deplorable, but for a while we did not really need to be too bothered by it any more, since it seemed to matter so little to the rest of the world what the IMF said or did. But every crisis is also an opportunity, and the IMF has been quick to seize on the current global financial crisis as an opportunity to increase its own influence.

Given its poor record of past incompetence and current irrelevance, one might imagine that there would be some justified hesitation on its part, in making grandiose and generalised policy proposals. But that is too far from what the IMF is used to doing, and so its recent pronouncements continue in the same hortatory fashion, albeit in a slightly more subdued and even confused manner.

The most recent World Economic Outlook was released in mid-October this year, to be presented at a meeting of the IMF that discussed the financial crisis. What is chiefly remarkable about this report is not just the continued confidence in its own capacities, but also the very blatant double standards that the IMF is now openly using for industrial and developing countries.

In the industrial countries, threatened by economic depression, the talk has now turned to going beyond monetary measures that do not address the liquidity trap, to fiscal expansion to revive the flagging economies. This talk is likely to get louder in the run-up to the Obama administration in the US, since the New President-Elect has made his own preferences clear in that respect.

But the record of the IMF in this matter is equally clear: countries in the midst of financial crisis are supposed to do fiscal contraction, whether they like it or not. When the government account is in deficit, it must be reduced or converted into a surplus: when it is already in surplus, that surplus must be increased. If this is pro-cyclical and causes the crisis to spread to the real economy and create a sharp downswing, that is just too bad; this is after all, the “right” medicine and the necessary pain must be gone through to recover eventually.

In this context, what does the IMF now say about fiscal policy? “Macroeconomic policies in the advanced economies should aim at supporting activity, thus helping to break the negative feedback loop between real and financial conditions, while not losing sight of inflation risks…Discretionary fiscal stimulus can provide support to growth in the event that downside risks materialize, provided the stimulus is delivered in a timely manner, is well targeted, and does not undermine fiscal sustainability.” (IMF, World Economic Outlook October 2008, page 34, emphasis added.)

So, the IMF completely breaks from all its past practice to recommend that in this situation the developed countries should engage in countercyclical fiscal and monetary policies to get out of the crisis. All right, then what about the developing countries, who have this time been caught in a crisis that is not of their own making? Oh dear, for them the same advice is not tenable at all.

Consider the following: “While emerging economies have greater scope than in the past to use countercyclical fiscal policy should their economic outlook deteriorate …this is unlikely to be effective unless confidence in sustainability has been firmly established and measures are timely and well targeted. More broadly, general food and fuel subsidies have become increasingly costly and are inherently inefficient.” In fact, there is room or tightening on all fronts, both fiscal and monetary! “Greater restraint on spending growth, including public sector wage increases, would complement tighter monetary policy, in the face of rising inflation, which is particularly important in economies with inflexible exchange regimes.” (page 38, emphasis added)

So, the cards are now all out on the table, and it is clear that they have been dealt unevenly. And even the rules of the game seem to differ for the IMF. There is one rule for industrial countries in crisis, no matter how irresponsible the run-up to the crisis; and another rule for developing countries, even the most prudent and fiscally “disciplined” of them.

In fact, this partiality of the IMF even extends to its analysis of the current crisis, where, bizarrely, the developing countries are held responsible for some of this mess. “While there is indeed some evidence that monetary policy may have been too easy at the global level and that the global economy may have exceeded its collective speed limit, excessive demand pressures seem to be concentrated in emerging economies and do not appear egregious at the global level by the standards of other recent cycles. It is hard to explain the intensity of the recent stress in financial, housing, and commodity markets purely through these macroeconomic factors, although they have played some role.” (page 23, emphasis added.)

Once again, all this would not matter too much if the IMF were to  remain as irrelevant as it has been recently. But now, as the crisis spreads and engulfs developing countries, and as global credit markets seize up and create credit crunches, more and more developing and transition countries are going to need access to liquidity. Already several countries have lined up for this: Pakistan, Ukraine, Hungary and Iceland. And once again the IMF is pushing the same disastrous conditions that caused economic and financial collapse in other emerging markets.

In this context, it is terrifying to hear that European Union governments are calling for a strengthening of the IMF and even imploring some surplus countries like China to put more money into the IMF’s coffers. With its current personnel and ideological framework, such strengthening of the IMF will only mean that conditions get much worse for the developing world. The need to examine alternative and less destructive sources of emergency finance for crisis-affected developing countries is therefore urgent.