Mr. Chairman and members of the Joint Economic Committee: Mythanks for this opportunity to testify on “The IMF and U.S.Economic Policy.”
The case for the massive IMF/World Bank response to the recentAsian crisis reminds me of an all‐too‐frequent proposal tojump‐start economic growth: the combination of massive demandstimulus and a solemn promise never to do it again. The problem ofthis type of policy, of course, is that the initial responseundermines the credibility of the promise. Secretary Rubin seems tounderstand the moral hazard problem caused by socializing thelosses on international loans, but he claims not to know what to doabout it. The young St. Augustine was rather more honest withhimself; when faced by a similar problem, he prayed: Lord, make mechaste, but not quite yet.
For there should be no doubt about the nature of the choice thatwas made by the response to the recent Asian crisis: theinternational financial establishment committed over $100 billionto reduce the near‐term contagion effect of the recent Asian crisiswithout apparent regard for a longer‐term contagion effect thatthis bailout will probably increase the number of similar futurecrises in these and other countries. The historical record isclear: Most of the less‐developed nations funded by the IMF havelater returned for more funds. Mexico, for example, has had afinancial crisis in each of the past four presidential‐electionyears. A total of 84 nations have been in debt to the IMF for 10years or more, 43 nations for 20 years or more. And there is littledoubt that the massive IMF and U.S. bailout of Mexico in l995contributed to the near‐doubling of capital flows to East Asia thatsame year.
Finance ministers and central bankers will commit almost anyamount of our wealth to avoid a major financial crisis on theirwatch, even when they recognize that the socialization of lossesincreases the probability of a crisis on some later watch. Ratherthan resolving the conditions that lead to financial crises, theIMF treats each successive crisis as a new event, indirectlyassuring that there will always be a queue of new crises toaddress. U.S. government membership in the IMF is like being alimited partner in a financial firm that makes high‐risk loans,pays dividends at a rate lower than that on Treasury bills, andmakes large periodic cash calls for additional funds. The currentadministration campaign to convince Congress to approve more fundsfor the IMF is also quite deceptive. To some groups, the officialssuggest that more funds are necessary to help the poor starvingchildren of Nameyourland. In fact, the IMF bailouts are a form ofinsurance for the foreign and domestic individuals, firms, andbanks that had made high‐risk investments in the country subject tothe crisis du jour. The 1995 Mexican bailout, for example, insuredthose who had purchased the 28 day government bills, providinglittle help for the general Mexican population for whom the realper capita income is now less than before the bailout. Similarly,the administration seems to have gained the support of thecongressional Democratic leadership for new IMF funds on thepremise that such funds would reduce the exchange rate effects andresulting trade effects of future crises. In fact, the exchangerate of an IMF client generally stays weak for some time after abailout. The dollar value of the Mexican peso, for example, is nowless than half that before the l994 crisis, with the effect thatMexico has since had a trade surplus with the United States.Finally, the administration has gone around the world making aseries of promises and then asserts that congressional support ofthese promises is necessary to maintain U.S. leadership. TheClinton administration did not invent this gambit but it has beenespecially consistent in using this argument to support itsposition on trade negotiations, global warming, NATO expansion,Iraq, and now the IMF.
For now, it looks like the bailout of Thailand, Indonesia, andSouth Korea is history, a done deal for which the IMF does not needany more funds. So the current issue is whether the IMF should berefunded to prepare for the next round of financial crises. Fornow, I suggest, Congress should defer a decision to refundthe IMF until it has a better understanding of the conditions thatlead to a financial crisis, the moral hazard effects of socializingthe losses on international investment, the long‐term record of theIMF, and the feasible alternatives — including the implications ofno multilateral governmental response to a financialcrisis in any country.
It is especially important, for example, to understand thereasons why the recent Asian crisis was limited to Thailand,Indonesia, and South Korea but with much less effect, at least sofar, in Singapore, Hong Kong, Taiwan, and China. My initialjudgement is that two patterns are common to the problem countriesin Asia and also in Mexico:
1. A record of state‐directed credit allocation, either by aformal industrial policy or by crony capitalism, and
2. A futile attempt to maintain both a fixed exchange rate and amonetary policy responsive to political pressure.
It is also important to understand why the frequency andmagnitude of financial crises are increasing. Studies by the IMFand the World Bank have documented some 90 episodes of severebanking crisis over the past 15 years, a period of relativelystable economic growth. For this condition, I suggest, the IMF andthe World Bank bear substantial responsibility. When a borrower isilliquid or insolvent, the only way to avoid the moral hazardproblem is a financial workout in which both the borrowerand the lender take a major hit:
1. The borrower, by giving up some or all control of theremaining firm or assets, and
2. The lender, by a lengthening of the maturity of the loans(when the problem is illiquidity) or by trading the outstandingdebt claims for lower‐ranked debt or for equity (when the problemis insolvency.)
Private bankers have handled such problems for generations, longbefore the IMF and the World Bank muscled their way into this rolewith our taxes. I ask you to at least entertain the possibilitythat private bankers, committing the assets of their own firms, arelikely to handle such problems better than do public officials whoplay this game with other people’s money.
As a rule, however, as documented in an important recent articleby Prof. Charles Calomiris of Columbia University, recent IMFassistance has been “designed to absorb the losses of insolventbanks and their borrowers in developing economies, and to insulateinternational lenders from the losses that they would otherwisesuffer.” Calomiris goes on to document three major consequences ofthis developing policy:
1. “The main influences of the IMF and U.S. government in thel990s have been …to lend legitimacy to …domestic bailouts byproviding conditions that call for taxation of the domestic middleclass to repay the bridge loans from the IMF and the U.S.government and …to insulate foreign creditors (especially banks)from losses during these crises.”
2. After the crisis has passed, “The big winners are thewealthy, politically influential risk takers, and the biggestlosers are the taxpayers in countries like Mexico andIndonesia.”
3. This effect, thus, delays the necessary reforms. “Ifoligarchs can avoid true liberalization but still maintain accessto foreign capital,” Calomiris asks, “where is the incentive forthem to relinquish the rule of man in favor of the rule of law, orto allow competition and democracy to flourish?”
Calomiris concludes that “The principal lesson of the recentbailout programs managed by the IMF and the U.S. government…isfor all parties…to find a credible way to commit not tosponsor such counterproductive bailouts.”
The characteristic IMF response to this type of criticism, ofcourse, is that the conditions for receiving IMF credit induce thetype of reforms that are necessary to avoid a future crisis. In afew cases, this has been successful. The larger record, however,does not provide a basis for optimism. Most developing countrygovernments, once the recipient of IMF’s subsidized credit, havebecome loan addicts. As noted earlier, most of these governmentshave relied on IMF loans for more than two decades, despite theconditions for receiving these loans and the usual two‐to‐five yearmaturity of these loans.
Maybe we don’t need the IMF — that is now the judgement offormer Treasury secretaries George Shultz and William Simon and theformer chairman of Citicorp Walt Wriston. I am willing to deferjudgement on this issue. In the meantime, Congress should notapprove any additional funds for the IMF, at least untilsome of the broader questions are addressed.
Thank you for your attention.