Usually, the International Monetary Fund takes a low profile except when there are riots in the major cities 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 and the resulting bailout packages there totaling about $117 billion should not serve as an excuse to approve urgent requests for a massive increase in the IMF’s resources. The IMF has made matters worse in Asia by establishing moral hazard, hindering rapid and widespread reforms, and undercutting superior, less expensive market solutions. These are serious charges that require public debate rather than the unquestioning financial support of U.S. taxpayers that the IMF has cavalierly come to expect.
I am encouraged, therefore, that the Congress is interested in examining the IMF’s performance and the ability of that organization to comply with the congressional intent of promoting a more stable and prosperous global economy. Evaluations of the IMF, however, should not concentrate on reform efforts if those efforts do little or nothing to address the fundamental flaws of the IMF. For the most part, current proposals to reform the IMF and its relationship with the United States seem to fall under that category.
The IMF suffers from a set of internal tensions in its functions and operations that additional funding from the United States and other donor nations will not resolve and that will be difficult, if not impossible to resolve even without new funding. Those strains include the IMF’s demands that countries be more open versus its resistance at efforts to increase its own transparency; the IMF’s dual role as an international surveillance body versus its role as an agency to prevent the outbreak of crises; the IMF’s bailout function versus its claims to minimize or eliminate moral hazard; and the Fund’s insistence on conditionality to recipient nations versus its reluctance to accept any conditions on its own performance when asking for more money from donor countries.
Those are relatively new concerns that build on the criticisms that free‐market economists have long had about the IMF. Indeed, 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. 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.
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.
Transparency and Reliable Information
The International Monetary Fund is now demanding transparency on the part of Asian governments, whose concealment of financial data and outright deception helped cause the region’s economic crisis. But even as the IMF insists on full and accurate information, it remains one of the world’s most secretive bureaucracies. The agency’s opacity undermines its credibility and allows the fund to dodge accountability.
Openness would surely help to answer the most basic question about the fund’s performance: How successful is the IMF in helping countries reform their economies and achieve self‐sustaining growth? Numerous independent studies have found that the IMF creates long‐term aid dependency, that its credit slows the process of reform and that it has a bureaucratic incentive to lend. Of course, IMF officials claim otherwise, but they continue to keep many of the agency’s documents, economic evaluations and policy prescriptions confidential.
The fund, for example, has never publicly produced a thorough assessment of its own effectiveness as has the World Bank. Harvard’s Jeffrey Sachs has derided the agency for making it “extremely difficult for outside observers to prepare a serious quantitative appraisal of IMF policies.” Even after the IMF grudgingly began to publish the stipulations of some of its loan packages, the head of the Institute of International Finance, Charles Dallara, complained that the information the fund provides is woefully inadequate for the needs of market participants.
But what if countries began providing the fund with the data it demands? Could the IMF at least be expected to detect ominous financial developments and offer timely warnings? Treasury secretary Robert Rubin and others suggest that the world badly needs better economic surveillance. The fund, says IMF chief Michel Camdessus, should fill that role. It is useful to recall that the agency was already charged with that mission and utterly failed to alert the world to problems in Thailand, South Korea, Indonesia or the PhilippinesCa task at which it had promised to do a better job after failing in Mexico in 1994. Instead, the IMF praised all of those economies right up to the outbreak of crisis. Rather than acknowledge negligence or inattentiveness to the impending Asian financial crisis, the IMF has refused to accept responsibility. When asked if the fund’s performance in Asia and Mexico was not evidence of failure, Camdessus responded: “This is a joke. It is true that Mexico revealed the importance of transparency.… But the fact is that we are not suppliers or producers of statistics. These are produced by each individual country.” William Keegan of the London Observer put it aptly: “By calling for >transparency,’ [the World Bank and the IMF] admit they did not know what was going on.”
Not only has the fund shifted blame for its obvious lack of vigilance; it is asking for $18 billion in U.S. funding and making the superficially appealing recommendation that the IMF strengthen its role as a watchdog agency that provides an “early warning” system in case of potential financial troubles. Congress should of course deny support to any bureaucracy that responds to requests for transparency with smugness. Yet even if the IMF somehow transformed itself, it is unclear how a warning mechanism would work. As economist Raymond Mikesell asks, “Who would be warned and when? As soon as the financial community receives a warning that a country is facing financial difficulty, a massive capital outflow is likely to occur, in which case crisis prevention would be out of the question.”
On the other hand, if the IMF perceives serious financial difficulties in a country and does not disclose that information, then it undermines its credibility as a credit‐rating agency for countries. That appears to have been the case in Thailand, where the IMF now claims it issued warnings about the economy before the crisis erupted but kept those concerns confidential. The fund’s credibility is further undercut by inherent conflicts of interest: in many cases, it would be evaluating countries in which it has its own money at stake; in all cases, it would be evaluating countries that, as member‐owners of the IMF, have contributed to the fund’s pool of resources. Only by ceasing to lend could the agency increase its integrity. At that point, however, its evaluations would merely replicate a service already available.
Moral Hazard
Another problem with IMF intervention is that it establishes moral hazard, a problem U.S. Treasury Secretary Robert Rubin has recognized as significant, but, like other advocates of increased funding for that institution, has failed to resolve.(1)
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.(2)
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 todayCat 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.(3)
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.”(4)
As long as the IMF provides bailouts, the moral hazard problem will be prevalent. The only way to eliminate moral hazard is for private sector institutions to feel the full consequence of their investment decisions; that will only happen, however, if the IMF ends its bailout function.
The IMF’s Credibility Problem and the Failure of Conditionality
IMF bailouts of Asian countries are expensive, bureaucratic, and fundamentally unjust solutions to currency crises. The Fund’s approach helps explain why the Fund’s conditionality lacks credibility and why reform efforts are unlikely to improve its performance. 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,” Jeffrey Sachs observes, “didn’t help anybody but the banks.”(5)
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 countryCespecially 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.(6)
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.
The IMF Versus the Market
It is worth noting that IMF bailouts undermine superior, less expensive market solutions. No amount of IMF reform in that area, short of an end to its bailout function, can change that reality. 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.”(7)
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.
Reform Proposals
Because the Fund suffers from an array of inherent tensions in the way it operates, causes more harm than good once a crisis erupts, and undermines superior market solutions, we should not allow superficial reform proposals to serve as a distraction from the Fund’s fundamental flaws and to lead us into believing that its severe shortcomings will somehow be overcome. If Congress wishes to continue supporting the IMF, the most important reform it can pursue — but one which may only make a marginal difference in Fund’s effectiveness — is that of increased transparency at the lending agency. The U.S. government and the U.S. public are entitled to know what advice the IMF is giving countries, when it is giving that advice, under what financial and policy conditions is the Fund providing support, and what exact criteria the IMF will use to measure whether a country is successfully reforming or merely delaying comprehensive market reforms. The Fund should also publicly identify those institutions, public and private, in recipient nations that are receiving its subsidized finance. In practice, that means that IMF documents including economic evaluations, policy prescriptions, letters of intent, and other memoranda be made public. The Fund should also allow outside auditors to assess the quality of IMF loans and to conduct full evaluations of the IMF’s lending record.
At the very least, more transparency would provide for a more informed public debate and, in theory, would make the IMF more accountable. There is, however, no reason to believe that the IMF would noticeably improve its performance or significantly change its behavior even if much damning evidence came to light. After all, Washington’s other major multilateral lending agency, the World Bank, already conforms with many of the stipulations some are suggesting for the IMF. The Bank’s Operations Evaluations Department and other internal reviews have for years consistently turned up self‐admitted dismal performance. These have resulted in reforms and promises of reform, but no noticeable improvement in performance. Congress should expect the same experience from the IMF bureaucracy if it attaches demands for transparency in exchange for continued or increased financial support.
Congress, moreover, may ask the U.S. Treasury Department to report whether the IMF is complying with Congressional stipulations; but Congress should not rely on the Treasury Department to provide adequate assessments. Because the Treasury Department, through the U.S. executive director at the IMF, has influence over the use of IMF funds, it is in its bureaucratic interest to maintain and even increase those resources under its influence. Treasury has long supported the prerogatives of the IMF, regardless of whether U.S. administrations have been conservative or liberal. Treasury’s recent and disingenuous claims that funding the IMF does not cost U.S. taxpayers a dime is only the most recent example of its virtually uncritical endorsement of IMF lending activities.
Another proposal which has been made — to explore alternative sources of IMF funding such as the issuance of bonds — is also unlikely to change the Fund’s performance and may even make the agency even less accountable than it is today. As long as the United States maintains its membership in the IMF, and by so doing guarantees the agency’s financial soundness, the Fund should not move to such a system. In case the Fund experiences any financial difficulties, its bondholders would be repaid using additional U.S. taxpayer money. Again, such a system already exists at the World Bank; while it has increased U.S. taxpayer liability there, it has not improved the Bank’s performance.
Finally, it is worth noting that the global financial system could improve in a number of ways. Countries do need to increase the transparency of their financial institutions and disclose economic data. Financial deregulation and openness to foreign investment in that and other sectors would also reduce instability and promote prosperity in developing nations. That would imply an end to policies of directed credit and the crony capitalism that such policies often engender. The establishment of bankruptcy procedures and the rule of law are requisite to encourage sustained investment, both foreign and domestic. Free exchange rates and disciplined monetary and fiscal policy are also necessary to help avoid crises. Currency boards as an alternative to floating exchange rates have also been consistent with stability and economic growth in the countries that have adopted that exchange rate mechanism. In general, economic liberalization will help promote prosperity and stability in the global economy. But all of those reforms can be unilaterally introduced by developing nations. Such policy change does not require IMF intervention. Reforms at the IMF, which promise little, are thus a distraction to the important tasks developing countries are more likely to undertake without IMF money and advice. The conditionality that Congress attaches to increased funding of the IMF is in any event likely to be about as effective as IMF conditionality itself.
Notes
1. See David Wessel, “Rubin Says Global Investors Don’t Suffer Enough,” Wall Street Journal, September 19, 1997.
2. 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 Ais a set of perverse incentives for Mexican officials and foreign investors that ensures the >crisis’ will reappear on an even larger scale.
3. 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.
4. Michael Prowse, “The Rescuers,” New Republic, February 27, 1995.
5. Quoted in Peter Passell, “Economic Scene,” New York Times, February 12, 1998.
6. 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).
7. Lawrence B. Lindsey, “The Bad News About Bailouts,” New York Times, January 6, 1998.