Dissatisfaction with the way the International Monetary Fund has handled financial crises in Asia and Russia led Congress to attach conditions to the increased funding it rewarded the IMF last fall. Those conditions are intended to address legitimate concerns about transparency, accountability, IMF conditions and advice, and the overall effectiveness of IMF bailouts. In assessing the extent to which IMF programs in crisis countries have been consistent with congressional intent, it is important to also identify the extent to which we can expect Congress’s measures to address the fundamental problems of the lending agency. There is unfortunately little reason to believe that the IMF today does not still suffer from the flaws that plagued it before Congress attempted to make the Fund more effective. The IMF continues to make matters worse in Asia and elsewhere by perpetuating moral hazard, hindering rapid and widespread reforms, and undercutting superior, less expensive market solutions.
Moral Hazard Is Still A Problem
A major and widely recognized problem with IMF intervention — that it establishes moral hazard — has not been resolved or adequately addressed by the new legislation. As long as the IMF bails out countries, nations will continue to slip into crises in the future because the bailouts encourage risky behavior on the part of governments and investors who fully expect that if anything goes wrong, the IMF will come to their rescue.
The Fund has played a large role in creating the financial turmoil of recent years. With every election cycle since 1976, 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.i 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.ii The financial crisis in Asia was created in Asia, but the aggravating effect of moral hazard was extensive.
Efforts to “promote policies that aim at appropriate burden‐sharing by the private sector so that investors and creditors bear more fully the consequences of their decisions“iii may help chasten investors and promote greater prudence. However, there is no reason creditors should not bear the full consequence of their decisions or why the IMF should be in the position to determine what those consequences should be. If the IMF continues its bailout function, moral hazard will still exist and the Fund’s efforts to make lenders pay for their bad judgement will merely amount to a sloppy approximation of a penalty that the market would have imposed in the absence of IMF intervention.
Moral hazard — which is difficult, if not impossible to measure before a crisis erupts — has likely been reduced somewhat by Russia’s debt default. However, that outcome has resulted from the failure of IMF lending there, not from an IMF policy of burden sharing. In the Russian episode, the IMF unwittingly showed investors that it could be an unreliable bailout agency, thus creating a greater incentive for market participants to play by market rules. Evidence for this was provided by the devaluation of the Brazilian real, which also occurred after an IMF bailout but had no dramatic effect on international financial markets. International investors may be more cautious today, but they are still insulated from full exposure to market forces.
The IMF’s Credibility Problem Continues To Plague Economies In Crisis
The second major problem with IMF bailouts is that they 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.“iv 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 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.
That has certainly been the experience of Mexico since becoming a recipient of IMF aid in 1995,v and appears to be the case as well in Korea, another country in which the Fund is claiming success. Although progress has been made there, backtracking in important areas such as bankruptcies and privatization has occurred. After having promised to quickly privatize state‐owned monopolies, the Korean government has put off such moves for the energy, telecommunications and tobacco industries until 2003.vi As the Economist Intelligence Unit reported in February 1999, banks are more tightly controlled by the government today than when the crisis began and the chaebol, or Korean conglomerates, dominate the economy even more.