The leading contender to replace Strauss‐Kahn, who resigned while proclaiming his innocence, is French Finance Minister Christine Lagarde. The board plans to make its selection by June 30, but instead should shutter the organization.
The Fund was one of the “Bretton Woods” institutions created in 1945. Its purpose was to stabilize exchange rates. When the system of fixed exchange rates collapsed in 1971, the IMF effortlessly found a new job, promoting development. The Fund created a generous dole for Third World governments.
After Communism fell, such east European nations as Romania, Ukraine, and Hungary became major borrowers. The IMF now is a leading lender to Greece, Ireland, and Portugal. In fact, before his arrest Strauss‐Kahn was heading back to Europe for talks on expanding the Greek bailout arranged last year.
The IMF is funded by its member governments, which also back its large‐scale borrowing. The organization has steadily increased lending over time. In 1989 the IMF pressed to double its capital which, explained Managing Director Michel Camdessus, would be “the cheapest way for taxpayers in the richer countries to come to the aid of the poor.” In 2009 the heavily indebted industrial states agreed to an immediate $100 billion increase in Fund resources in response to the financial crisis and approved the objective of trebling the Fund’s $250 billion in resources. (The organization has a multitude of “credit facilities,” credit “arrangements,” and “credit lines.”)
The IMF famously imposes policy changes as part of its lending programs. Unfortunately, there is no evidence that the organization has effectively promoted economic growth. Even its advocates can point to few successes.
Two decades ago Richard Feinberg and Catherine Gwin concluded that “the record of IMF‐assisted adjustment efforts in Sub‐Saharan Africa is discouraging.” Back before he thought foreign aid could end poverty, economist Jeffrey Sachs warned that most agreements “are now honored in the breach.”
The Fund spent decades subsidizing the world’s economic basket cases, including Egypt, pre‐reform India, Sudan, pre‐reform Turkey, communist Yugoslavia, Bangladesh, Guinea‐Bissau, Pakistan, Zaire (now Congo), and Zambia. None advanced because of Fund programs. In contrast, expanding private investment and trade offered development opportunities for countries that adopted sensible economic policies.
Now the IMF has become the bailout king. There always were better alternatives to throwing cash at countries suffering economic and financial crashes: bankruptcies, debt reschedulings, and forced work‐outs. The common panic fomented by the Fund was rarely justified. Former Treasury Secretary and Secretary of State George Shultz opposed an earlier proposal to increase IMF resources: “typically crises are overrated in prospect and used to justify things that have big, big downsides, and in which the downsides are not quite seen at the time the intervention is being proposed.”
However, the organization gloried in finding another purpose. Mexico became the Fund’s biggest borrower. Then there was Asia.
But the financial disasters stopped. Noted the Economist magazine in 2006: “What is a firefighter to do when there aren’t any fires? The IMF spent 1994–2002 dashing from one financial conflagration to the next. But the sirens have been silent for some time. As a result, the fund’s budget is shrinking and the moral of its staff is sinking.”
No longer. Europe is in crisis, with Greece now Borrower No. 2 — and likely headed to No. 1 with another bailout in the offing.
Alas, the IMF continues to record few hits. There are several reasons for the organization’s lack of success.
In setting loan conditions, the Fund often focused on narrow accounting data, causing its advice to have perverse consequences — such as raising taxes rather than cutting bloated spending. Moreover, reform is a process. Without political support, which is less likely when the policies appear to be imposed from outside, governments are unlikely to move forward and undertake even more politically painful reforms. As a result, IMF programs often occur in policy environments that remain terribly distorted in other ways.
Even when the organization pushes for sensible reform, it has rarely proved to be a tough taskmaster. Only a minority of borrowers reduced their need for aid; many nations were addicted to Fund programs for decades. New programs routinely followed old, failed ones. For example, Peru negotiated seventeen different programs between 1971 and 1977. Economist John Williamson pointed to the problem of the Fund feeling pressure “to lend money in order to justify having it.”
Indeed, the IMF seemingly measured success by making loans. The assumption is that financial input into poor countries automatically translates into growth output. In good year and bad the Fund pressed for increased resources.
As a result, loans often acted as a general subsidy for collectivist development strategies. Years ago Williamson defended the organization against the criticism that it was too market‐oriented by pointing to its support for the communist states of Cambodia, China, Laos, Romania, Vietnam, and Yugoslavia. The IMF formally disclaimed any bias against collectivist systems, pointing to “programs in all types of economies” which had “accommodated such nonmarket devices as production controls, administered prices, and subsidies.”
At times it would appear that the more perverse the policies the more generous the IMF. Many Third World borrowers followed statist economic policies for decades. For instance, India collected more money than any other developing state from the IMF, which acted more as a lender of first rather than last resort, during its first 40 years. Yet India then was pursuing a Soviet‐style industrialization program.
How, one wonders, were countries with such policies going to achieve self‐sustaining economic growth? Between 1965 and 1995, 48 of 89 developing nations were no better off after borrowing from the IMF; 32 actually were poorer.
Even the Fund eventually had to recognize the free market revolution, but it remains a profoundly statist organization. Strauss‐Kahn was considered an advocate of the free market, but that says more about Europe’s political spectrum. After all, he was expected to seek the Socialist Party’s presidential nomination in France. He also advocated more relaxed bailout terms for profligate Greece (the Fund provided $43 billion of last year’s $157 billion aid package).
Christine Lagarde appears to be a standard French statist and has been deeply involved in organizing the succession of European bailouts. Agustin Carstens, the Mexican central banker also seeking to head the IMF, observed: “I dare say that it might be more appropriate to have a non‐European because a new set of eyes can look at Europe’s problems more objectively.”
There is an even more insidious problem with IMF lending. Many countries have moved unsteadily towards more market‐oriented policies because they have suffered the consequences of disastrous economic failure. The day of reckoning finally came.
Naturally, the IMF claims credit for today’s reforms. But the organization likely has retarded the process.
The Fund’s financial assistance alone is unlikely to persuade governments otherwise lacking the will to reform. Loans can, however, undermine that commitment by reducing the financial pain caused by politically popular but economically harmful policies.
Indeed, argued economist Roland Vaubel, “the prospect of cheap IMF lending is likely to generate a moral hazard by reducing the incentive to stay solvent. It would pay a potential borrower to pass the international means test.” While governments rarely desire to wreck their economies, they do choose to take greater risks. In 1998 a report by the Joint Economic Committee noted: “Recent IMF lending and prospects for future lending not only reinforce existing risk‐promoting incentives in emerging economies but also create incentives for additional risky lending by international financial institutions.”
The prospect of an IMF bailout leaves private lenders less reason to assess risks and exercise restraint. Columbia’s Charles Calomiris argued that “instead of repaying the domestic oligarchs and the foreign banks, we should penalize them.” Precedent matters. Observed economist Allan Meltzer, “Had it not been for the Mexican bailout, banks would have been much more cautious in Asia.” The IMF helped create what George Shultz called a “bailout mentality.”
That appears to be what is happening in Greece. The Fund has been encouraging more lending and another, bigger bailout, to the consternation of Germany, which is picking up much of the European bill. Although the condition for more aid is supposed to be additional reform, the program is seen in Athens as a foreign imposition. Default and lack of access to international credit would be a more effective disciplining mechanism.
If the IMF was only spending other people’s money, then the U.S. might remain an amused bystander. But as the largest single contributor (16.67 percent, to be exact) to the Fund, American taxpayers are on the hook for a share of that organization’s lending, which ran more than $90 billion last year.
Another Greek bailout will add to the cost. And if Spain and Italy tumble economically, the stakes will rise astronomically. Youssef Boutros‐Ghali, the chairman of the Fund’s policy committee, said: “If we are going to start including funds made available to Europe [more bailouts], then the IMF is not properly resourced.”
It is an extraordinary spectacle. The U.S. and other improvident, irresponsible debt‐laden countries provide money that they do not have to an international organization that produces nothing to lend to even more improvident, irresponsible debt‐laden countries. The U.S. borrows money from China to lend to Greece to pay off German banks which financed the generous Greek welfare state.
The outcome of this process cannot be good.
Mr. Strauss-Kahn’s travails have provided at least one important public service: focusing attention on the IMF. With America drowning in red ink, Washington must stop throwing good money after bad. The Fund would be a good place to start.