Responding to my post from last week, James Gordon, the Assistant Director of the Asia and Pacific Department at the International Monetary Fund, wrote to complain that I was being unfair in my criticism of the international bureaucracy. The full letter is reprinted below, and he makes two points. First, he argues that I was unfair to criticize the IMF for being quick to recommend higher taxes and currency devaluations. He certainly is correct that the IMF does occasionally propose good policies, but I am quite comfortable with my claim that bad policies generally are “high on the list” of recommendations. For those who want more information, the Policy Handbook chapter by Ian Vasquez of Cato, the Meltzer Report, and various studies by the Joint Economic Committee (here, here, here, and here) make the case that the IMF is too statist in its orientation.

Second, he argues that Japan has been frugal. Looking at the same OECD data (specifically, Annex Table 25), he uses 2005 as the base year to make his point, while I was using 2006 since I wanted to capture the most recent developments. But we both can be accused of cherry-picking the data, which is why I made the point in my original post that the long-run trend clearly shows an expansion in the burden of government spending. The more relevant point, however, is that Japan has a public sector - consuming more than 36 percent of GDP - that is far too large. According to IMF data, government spending consumes only about 16 percent of economic output in Hong Kong. If the bureaucrats really want to give Japan some much-needed advice, they should recommend sweeping and radical expenditure reductions rather than trimming-around-the-edges proposals that merely reduce the size of previously-scheduled spending increases. Mr. Gordon explains that there are “limits” to this approach given the “social objectives” of Japanese politicians. But why should the IMF let Japanese political constraints be a factor? Most important, recommending higher taxes turns the IMF into an enabler for Japan’s irresponsible politicians.

Here’s the full letter from the IMF:

Dear Dr. Mitchell:

I was glad to see in your recent blog (“Typical Bad Advice from the IMF”) that you sometimes wonder whether you are being unfair in characterizing the IMF as peddling snake oil economic advice such as higher taxes and currency devaluation. I encourage you to do more research into whether your prior is justified. On currency devaluation, you will be aware that over the last few years the IMF has been pushing China to do the opposite, namely to allow the exchange rate to appreciate more rapidly because it is undervalued. Certainly, in the past, we have recommended that countries devalue, but this has tended to be in cases where exchange rates were overvalued. On taxes, the IMF does not only recommend increases. Again it depends on the circumstances. For example, we have been supporting tax cuts in Australia and New Zealand of late because strong economic growth was leading to large fiscal surpluses.

In Japan, public debt is already very high and the population is aging rapidly. If left unchecked, social security spending (primarily pensions and medical spending) threatens to balloon over the next twenty years. Contrary to your assertion, the authorities have been making efforts to reform entitlement programs to limit this spending (the 2004 Pension Reform being a case in point). The authorities have also been cutting expenditure elsewhere (notably in public works). In fact, using the OECD figures you cite, general government spending declined (not increased as you say) to 35.8 percent of GDP in 2007 from 38.4 percent of GDP in 2005. There are, however, limits to expenditure cuts, particularly given the Japanese government’s social objectives, hence our view that a consumption tax increase is also likely to be necessary.

Yours sincerely,

James Gordon
Assistant Director
Asia & Pacific Department
International Monetary Fund