It is a pleasure to leave Washington to contribute to the discussion about the International Monetary Fund and its role in Asia. I take it as indication that people are genuinely interested in debating the merits of various perspectives as opposed to discussing it because they can derive immediate and direct benefit from advocating one point of view-nobody ever comes to Washington asking not to be bailed out. Usually, the IMF takes a low profile except when there are riots in the capitals of client countries, national currency crises, or when the IMF is asking for more money. Unfortunately, all three factors explain the currently high profile of the Fund.
The emergency atmosphere of the ongoing Asian financial crisis has resulted in bailout packages there totaling about US$117 billion and urgent requests for a massive increase in the IMF’s resources. For the United States, the added contribution would be $18 billion, which U.S. Treasury officials insist doesn’t cost U.S. taxpayers a dime. Only in Washington can one simultaneously plead for more money and insist, with a straight face, that the contribution is cost-free. Cato Institute chairman William Niskanen, the former head of Reagan’s Council of Economic Advisors, put it more accurately when he described the U.S. relationship with the IMF thusly: “U.S. government membership in the IMF is like being a limited partner in a financial firm that makes high-risk loans, pays dividends at a rate lower than that on Treasury bills, and makes large periodic cash calls for additional funds.”
But the monetary costs of supporting the IMF are not the most important reasons to oppose more funding. The people who are most directly affected by IMF interventions-the world’s poor—are those who can least afford it. If the goal is to help developing countries progress economically and to promote a liberal global economy, then the least rich countries can do is deny further funding for the IMF.
Free-market economists have long been critical of the IMF. Mexico-style crises may have brought much attention to the Fund in recent years, but the lending agency’s record over the past 50 years has been dismal, as numerous books and studies have documented. The IMF does not appear to have helped countries either achieve self-sustaining growth or to promote market reforms. Despite its poor performance, the IMF has proven to be a remarkably resilient institution. When the system of fixed exchange rates ended in the early 1970s, so did the agency’s original mission of maintaining exchange-rate stability by lending to countries experiencing balance-of-payments problems. Instead of closing down, however, the Fund has created new missions for itself with each new crisis, each time expanding its economic influence or resources or both. Those episodes included the oil crises of the 1970s, the Third World debt crisis, the collapse of communism, and now, Mexico-style crises.
Keep in mind that the IMF in theory makes short-term loans in exchange for policy changes in recipient countries. This has not, however, helped countries move to the free market. Instead the Fund has created loan addicts as review of its lending reveals. Eleven nations have been relying on IMF aid for at least 30 years; 32 countries had been borrowers for between 20 and 29 years; and 41 countries had been using IMF credit for between 10 and 19 years. That is not evidence of either the success of the Fund’s so-called conditionality or the temporary nature of the Fund’s short-term loans.
But the reason we are discussing the IMF today is because of the turmoil in Asia and because of calls for increased funding. Specifically, the money would finance a new fund at the IMF, known as the New Arrangements to Borrow, which would function as a special bailout fund for countries in crisis; and for a general increase in resources, known as a quota increase, which of course would also be used for bailouts. Using the IMF to bail out a country experiencing a currency or debt crisis is a bad idea for three reasons.
The first reason is that it creates moral hazard. This is not a minor point, as U.S. Treasury Secretary Robert Rubin has himself recognized. The more the IMF bails out countries, the more we can expect countries to slip into crises in the future because it encourages risky behavior on the part of governments and investors who fully expect that if anything goes wrong, the IMF will come to their rescue.
We’ve seen the moral hazard problem in the past and we are seeing it today. With every election cycle in the past 20 years, for example, Mexico has experienced a currency crisis caused by irresponsible monetary and fiscal policy. Each episode has been accompanied by U.S. Treasury and IMF bailouts, each time in increasing amounts. In Mexico, everybody has come to expect a financial rescue at the end of each presidential term. And although IMF and U.S. officials had since 1995 claimed the last Mexican bailout a success, its legacy has been the Asian crisis of today-at least in its degree and severity. Indeed, the bailout of Mexico was a signal to the world that if anything went wrong in emerging economies, the IMF would come to investors’ rescue. How else can we explain the near doubling of capital flows to East Asia in 1995 alone?
Governments in Asia were not discouraged from maintaining flawed policies as long as lenders kept the capital flowing. Lenders, for their part, behaved imprudently with the knowledge that government money would be used in case of financial troubles. That knowledge by no means meant that investors did not care if a crisis erupted; but it led to the mispricing of risk and a change in the investment calculations of lenders. Thailand, Indonesia, and South Korea, after all, shared some common factors that should have led to more investor caution, but didn’t. Those factors included borrowing in foreign currencies and lending in domestic currency under pegged exchange rates; extensively borrowing in the short term while lending in the long term; lack of supervision of borrowers’ balance sheets by foreign lenders; government-directed credit; and shaky financial systems. The financial crisis in Asia was created in Asia, but the aggravating effect of moral hazard was extensive. As Michael Prowse of the Financial Times commented after the Mexican bailout, “Rubin and Co. wanted to make global capitalism safe for the mutual fund investor. They actually made it far riskier.”
An Expensive, Unjust Solution
IMF bailouts of Asian countries are expensive, bureaucratic, and fundamentally unjust solutions to currency crises. In the first place, the financial aid cuts investors’ losses rather than allowing them to bear the full responsibility for their decisions. Just as profits should not be socialized when times are good, neither should losses be socialized during difficult times. “The $57 billion committed to Korea,” Harvard economist Jeffrey Sachs observes, “didn’t help anybody but the banks.” Unfortunately for the ordinary Asian citizens who had nothing to do with creating the crisis, they will be forced to pay for the added debt burden imposed by IMF loans.
IMF bailouts pose another burden on ordinary citizens because they don’t work very well. The Fund’s money goes to governments that have created the crisis to begin with and that have shown themselves to be unwilling or reluctant to introduce necessary reforms. Giving money to such governments does not tend to promote market reforms, it tends to delay them because it takes the pressure off of governments to change their policies. Rather, a suspension of loans will tend to concentrate the minds of policymakers in the various troubled countries. The reason, after all, that there is any talk today of market-reform is not because the IMF has shown up and suggested it is a good and necessary thing. That is fairly obvious. Economic reality is forcing the long-needed change. To the extent that the IMF steps in and provides money, those reforms will not be as forthcoming. Thus, the citizens of recipient Asian nations suffer the added burden of IMF intervention. Not only do they have to pay a greater debt; but they also have to suffer prolonged economic agony that is produced by the Fund’s bailouts.
But what about the Fund’s “strong conditionality”? Don’t the strict conditions of IMF lending ensure that important policy changes will be made? Again, the record of long-term dependency of countries shows that conditionality has not worked well in the past. But besides the Fund’s poor record, there is good reason why the IMF has little credibility in imposing its conditions. As we have seen with Russia over the past several years, a country-especially a highly visible one—that does not stick to IMF conditions risks having its loans suspended. When loans are cut off, recipient governments tend to become more serious about reform. Note that the IMF encourages misbehaving governments to introduce reforms by cutting loans off; it is the cut off of credit that induces policy change.
Unfortunately, when policy changes are forthcoming, the IMF resumes lending. Indeed, the IMF has a bureaucratic incentive to lend. It simply cannot afford to watch countries reform on their own because it would risk making the IMF appear irrelevant. The resumption of financial aid starts the process over again and prolongs the period of reform. The Fund’s pressure to lend money in order to keep borrowers current on previous loans and to be able to ask for more money is well documented. The IMF’s bureaucratic incentive to lend is also well known by both recipient governments and the IMF itself, making the Fund’s conditionality that much less credible.
Undermining Superior, Market Solutions
The third reason I oppose IMF bailouts is that they undermine superior, less expensive market solutions. In the absence of an IMF, creditors and debtors would do what creditors and debtors always do in cases of illiquidity or insolvency: they renegotiate debt or enter into bankruptcy procedures. In a world without the IMF, both parties would have an incentive to do so because the alternative, to do nothing, would mean a complete loss. Direct negotiations between private parties and bankruptcy procedures are essential if capitalism is to work. As James Glassman has stated, capitalism without bankruptcy is like Christianity without Hell. IMF bailouts, unfortunately, undermine one of the most important underpinnings of a free economy by overriding the market mechanism. There is simply no reason why international creditors and borrowers should be treated any differently than are lenders and debtors in the domestic market.
Governments would also react differently if no IMF interventions were forthcoming. There would be little alternative to widespread and rapid reforms if policymakers were not shielded from economic reality. Lawrence Lindsey, a former governor of the U.S. Federal Reserve opposed to bailouts, has noted, for example, that, “All of the ‘conditions’ supposedly negotiated by the IMF will be forced on South Korea by the market.” Of course, there is always the possibility that a government would be reluctant to change its ways under any set of circumstances; but that is a possibility that is larger, and indeed has become a reality, under IMF programs.
The U.S. Congress plays a large role in determining the scale of the IMF’s influence on the world economy. An increasing number of prominent economists are now calling for an end to IMF bailouts and even its abolition-something to which U.S. congressmen are paying attention. Because the Fund creates moral hazard, causes more harm than good once a crisis does erupt, and undermines superior market solutions, the United States and other major donors should reject further funding for the IMF and in that way vote for a more stable and free global economy. That would send a signal to the world that the Fund’s resources are not, in fact, unlimited. Beyond that, wealthy nations should further help the world’s poor by dismantling the IMF altogether.
- See, for example, Robert Rubin, “Address on the Asian Financial Situation,” Georgetown University, Department of the Treasury News, January 21, 1998; and Lawrence Summers, “Emerging From Crisis: The Beginnings of a New Asia,” Economic Strategy Institute, Department of the Treasury News, February 12, 1998.
- William Niskanen, “Comments at a discussion of The Role of the World Bank and the IMF in Economic Development and Crisis,” Dartmouth College, February 9, 1998.
- See David Wessel, “Rubin Says Global Investors Don’t Suffer Enough,” The Wall Street Journal, September 19, 1997.
- W. Lee Hoskins and James W. Coons, “Mexico: Policy Failure, Moral Hazard, and Market Solutions,” Cato Policy Analysis no. 243, October 10, 1995. The authors claim that the result of the Mexican bailout “is a set of perverse incentives for Mexican officials and foreign investors that ensures the ‘crisis’ will reappear on an even larger scale.”
- Some of these points were made by Allan H. Meltzer at a Cato Policy Forum, “Why We Should Say No To the IMF,” Washington, D.C., February 12, 1998. See also Allan H. Meltzer, “Danger of Moral Hazard,” Financial Times, October 27, 1997.
- Michael Prowse, “The Rescuers,” New Republic, February 27, 1995.
- Quoted in Peter Passell, “Economic Scene,” New York Times, February 12, 1998.
- See, for example, John Williamson, The Lending Policies of the International Monetary Fund (Washington: Institute for International Economics, 1982); Roland Vaubel, “Bureaucracy at the IMF and the World Bank: A Comparison of the Evidence,” The World Economy, March 1996; and Peter B. Kenen, Ways to Reform Exchange Rate Arrangements (Princeton, N.J.: Princeton University Press, 1994).
- Lawrence B. Lindsey, “The Bad News About Bailouts,” New
York Times, January 6, 1998.
- See, for example, Ibid; George Shultz, William Simon, and Walter Wriston, “Who Needs the IMF?” The Wall Street Journal, February 3, 1998; Lauch Faircloth, “Unwise Bailouts,” Washington Post, December 12, 1997; Rudi Dornbusch, “A Bailout Won’t Do the Trick In Korea,” Business Week, December 8, 1997; Gary Becker, “Asia May Be Shaken But It’s No House of Cards,” Business Week, February 2, 1998; James Glassman, “Who Needs the IMF?” Washington Post, December 9, 1997; William Simon, “Abolish the IMF,” The Wall Street Journal, October 23, 1997; Lorraine Woellert, “Armey Declares His Doubts About New Funding For IMF,” Washington Times, January 22, 1998.