The Politics of IMF Lending

M. Breen

• Publisher: Palgrave Macmillan
• Year: 2013
• Print ISBN: 9781137263803
• eBook ISBN: 9781137263810
• Topic: Politics & International Relations
• Subtopic: International Business
• Index: Politics & International Relations

As national governments continue to disagree over how to respond to the aftermath of the global financial crisis, two of the few areas of consensus were the decisions to increase the IMF's capacity to respond and remove the policies designed to limit the use of its resources. Why was this massive increase in the size of the IMF, accompanied by the removal of policies designed to limit moral hazard, such an easy point of consensus? Michael Breen looks at the hidden politics behind IMF lending and proposes a new theory based on shareholder control. To test this theory, he combines statistical analysis with a sweeping account of IMF lending and conditionality during two global crises; the European sovereign debt crisis and the Asian financial crisis.

1

Introduction

International organizations have come to play a prominent role in an increasingly interdependent world. The International Monetary Fund (IMF), in particular, is one of the most important international organizations in modern times. Every year for the last decade, more than one billion people have lived in countries under IMF supervision. Only a handful of developing countries have not participated in an IMF program, and this list grows smaller every year. As a result, the extent of its involvement in the societies of developing countries is remarkable. When taken together with the depth of its involvement in national policy-making, via conditionality, its role is unique in contemporary international relations (IR). Few international organizations can claim to have such a broad reach while still retaining the ability to make and enforce decisions that affect the core functions of sovereign states.

In return for an IMF loan a country must agree to implement a list of policy conditions. The Fund’s ability to set and enforce conditions has been a source of great controversy, with criticism coming from across the political spectrum over whether it, or any other international organization, should have the power to dictate economic policy to sovereign states. On the one hand, critics argue that it has used its powers recklessly, contributing to a series of financial crises all over Asia and Latin America in the late 1990s. Supporters on the other hand argue that while there is always room to improve the IMF, financial crises like those which occurred in Latin America and Asia were really nothing new.

Despite being the subject of considerable research, scholars of IR disagree over how politics matters when it comes to IMF behavior. The consensus is that the United States has considerable influence over IMF decision-making. However, some argue that US influence is not unique and that a larger group of powerful states also matter. The European sovereign debt crisis is a reminder that the United States does not exercise a monopoly on political control, as it has ceded this region as a sphere of German and French influence.

In this book, I develop and test a theory that explains variation in IMF policies, based upon the domestic interests of its largest shareholders – the United States, the United Kingdom, France, Germany, and Japan. I contend that some of the IMF’s most important policies vary because of the economic exposure of powerful domestic interests in the large shareholders, including (a) the decision on whether to approve an IMF program for a troubled country, (b) the decision on how much to lend, and (c) the terms and conditions attached to the loan.

Apart from helping to fill a gap in IR, analyzing IMF decisions is important for a number of reasons. First, the IMF is the custodian of a large pool of financial assets. One of its primary tasks is to redistribute these according to the needs of its membership. As of late 2012, it has committed $243 billion to help both rich and poor countries on five continents. With so much at stake, it is important to scrutinize how the IMF makes decisions about loans and conditionality.

Second, the IMF’s far-reaching and deep involvement in the societies of its member-states affects the lives of millions of people. As a consequence, scholars from across the social sciences have been engaged in explaining the effect of IMF programs on a diverse range of outcomes, including human rights (Abouharb and Cingranelli 2009), human health (Stuckler et al. 2008), government spending (Nooruddin and Simmons 2006), the global spread of financial liberalization (Mukherjee and Singer 2010) and privatization (Brune et al. 2004; Doyle 2011; Breen and Doyle 2013), foreign direct investment (Jensen 2004; Jensen 2006; Biglaiser and DeRouen 2010; Bauer et al. 2012), poverty (Joyce and Hajro 2003), civil war onset (Hartzell et al. 2010), inflation (Stone 2002), income inequality (Vreeland 2003a), debt crises (Jorra 2012), government crises (Dreher and Gassebner 2012), economic reform (Biglaiser and DeRouen 2006), and economic growth.¹ Anyone seeking to understand the Fund’s effect on social outcomes must understand also, by necessity, how the organization functions and reaches decisions. By elucidating the determinants of IMF behavior, the argument and findings presented in this book can help to illustrate the logic underlying IMF policies.

Third, the consequences of the global financial crisis have sparked a debate on the appropriate international architecture required to ensure global financial stability. Recently, the G20 group of industrialized and emerging economies agreed to treble the IMF’s lending capacity to $750 billion at their summit in 2009. Since the onset of the global crisis, there has also been a record-breaking surge in IMF lending activity. Loans far exceeding normal limits were recently agreed with Greece (23 billion and 26 billion Special Drawing Rights; SDRs), Portugal (23 billion SDRs), Ireland (19 billion SDRs), Poland (19 billion SDRs), and Romania (11 billion SDRs). As the future of global financial stability rests on political choices, understanding how states reach collective decisions through international financial institutions can help us to understand how states cooperate to address financial crises. While previous research has analyzed national policy responses to international economic crises (Gourevitch 1986), this book seeks to explain how states and societies generate international policy responses through international institutions.

Finally, it is clear that the IMF is a unique international organization because of the depth and breadth of its involvement in the societies of its members. According to Randall Stone (2002) it has been, since the end of the Cold War, the most powerful international institution in history. As such, it provides us with one of the most important laboratories for investigating the use of power in international organizations, allowing this book to contribute to a broader literature on the nature of that power (Bachrach and Baratz 1962; Abbott and Snidal 1998; Barnett and Finnemore 1999; Keohane and Nye 2003; Barnett and Duvall 2005).

The IMF’s role in the world economy

Since the collapse of the Bretton Woods system of fixed exchange rates, the Fund’s primary role has been to prevent and manage the consequences of financial crises in developing and emerging markets.² By doing so it is fulfilling the mission set out in its “Articles of Agreement,” which charge it with maintaining an open and stable world economy by helping governments to resolve international monetary problems. While much of its work to achieve this outcome involves macroeconomic surveillance and technical assistance, it is also unique in several respects. First, the IMF’s Articles of Agreement stipulate that it should be a permanent venue from which member-states can cooperate to resolve international monetary problems. As such, it is one of the most important sites of international cooperation and global governance.

Second, it holds the unique position of de facto lender of last resort for scores of middle- and low-income countries (Fischer 1999). Over the last few decades it has exercised this function through short- and long-term conditional lending arrangements. Transitional and emerging markets generally enter short-term arrangements such as the Stand-By Arrangement or Extended Fund Facility. Such arrangements are intended to provide a country with breathing room to address its balance of payments problems. While many countries have entered short-term programs, the IMF also introduced long-term programs in the 1980s with the Structural Adjustment Facility (SAF).³ Under this facility it offers loans with lower interest rates and longer repayment periods. In 2009, 78 low-income countries were eligible for concessional assistance based on a cutoff point of $1095 (per capita income, 2007) (IMF 2009a). As well as providing bridging loans of this nature, the Fund is also deeply involved in the economic policies of its member governments through its application of binding conditions to every loan. These conditions stipulate the precise way in which the Fund expects a government to adjust its economic policies in order to be able to continue to receive assistance.

Although the Fund’s policies on loans and conditionality are the subject of intense scrutiny and debt, important questions remain as to how the Fund actually makes decisions on how to treat its borrowers. A look back at some recent cases reveals considerable variation. For example, Ireland (19 billion SDRs in 2010) and Greece (23 billion in 2010 and 26 billion SDRs in 2012) received generous loans with relatively few conditions, while others like Thailand (2.9 billion SDRs in 1997) received smaller loans with many conditions. The difference in treatment has serious consequences for the countries involved. A lot hinges on the Fund’s decision over how to treat a borrower. For one, a larger loan can provide a government with much more breathing room to implement an adjustment program, sheltering it from some of the immediate pressures of domestic politics in hard times. Furthermore, a loan with too many binding conditions can create panic among creditors; if a country fails to implement even one of these conditions it cannot continue to draw on IMF resources. Indeed, both Mauritania in 2000 and Gabon in 2001 were given so many binding conditions in their IMF agreements that both failed to meet several, and were subsequently granted waivers so that they could continue with their IMF programs.

What explains the difference in treatment? The conventional explanation is that IMF decisions are responsive to both political and economic pressures. More specifically, many scholars stress that IMF policies consistently reflect US interests and are not merely technocratic decisions (Kahler 1990; Thacker 1999; Stone 2002; Oatley and Yackee 2004; Andersen et al. 2006; Woods 2006; Dreher and Jensen 2007; Stone 2008). By contrast, other scholars emphasize the independent role of the IMF’s bureaucracy (Vaubel 1996; Dreher and Vaubel 2004; Willett 2000; Barnett and Finnemore 2004; Chwieroth 2008). While most studies have converged on one of these two positions, there is still an ongoing debate over whether the other large shareholders matter. According to Stone (2011), US influence at the IMF far exceeds G5 influence, with the exception of French and British influence over the application of conditionality in Africa. Kang (2007) and Copelovitch (2010a), on the other hand, argue that a larger group – the G5 shareholders – affect the IMF’s lending and conditionality.

The big shareholders and IMF decision-making

In this book, I reconsider the role of the large shareholders in IMF decision-making. While there is no shortage of anecdotes about the effect of powerful states on IMF policies, the European sovereign debt crisis is a reminder that France, Germany, and the United Kingdom also have substantial influence. One of the reasons why the “others” matter is that IMF programs can have significant distributive consequences in all of the Fund’s shareholders – not only the United States and the countries that use IMF resources. From this, it is my contention that the IMF will tend to offer governments bigger loans with fewer conditions when interest groups in the G5 (the United States, the United Kingdom, France, Germany, and Japan) pressure their governments into achieving this outcome. But why do domestic actors want these sorts of policies? What do they do to get their desired policies enacted? Why are G5 governments in a position to deliver favorable policies? And how do G5 governments share the gains from international cooperation over IMF policies?

To answer the first question, bigger IMF loans benefit domestic actors when some of the loan is diverted back to them in the form of debt service or other payment. As well as benefitting from bigger loans, some domestic actors also benefit from less stringent conditionality, reducing the risk that a borrowing country will be cut off from IMF assistance. Interest groups should be aware that failure to comply with even one binding condition can lead to a situation where a borrowing country is forced to exit its program, possibly triggering losses among creditors. Apart from this motivation, reducing conditionality frees up the capacity of the borrowing country to service its creditors, providing another incentive for them to seek less conditionality.

To answer the second question one must realize that while many domestic actors in the G5 stand to benefit from generous IMF loans to developing countries, few are actually in a strong position to pressure their governments into achieving this outcome. Indeed, governments will not always slavishly capitulate to pressure from societal groups. Governments must strike a balance between protecting their investment in the Fund and supporting special interests at home. In this book, I argue that due to collective action problems concentrated interests in the G5 – banks and exporters with significant levels of exposure in developing and emerging markets – are capable of shaping government preferences over IMF lending and conditionality.

While domestic political processes drive G5 governments’ policies in relation to the IMF, these governments must also bargain and cooperate with one another on the international stage to secure gains for domestic actors. Their success or failure in influencing IMF policy depends on the strength of their position in the organization. Without being correctly positioned to affect the IMF’s decision-making process, a government will not be able to deliver any benefits to special interest groups.

This brings me to the third and fourth questions posed in this section: why only G5 governments? And how do these governments share the gains from international cooperation over IMF policies? In this book, I advance the argument that the G5 are in a commanding position to influence IMF policies. Their position is reflected in the institution’s rules and design, which give them extensive control over Fund policy. First, unlike the other 19 members of the Executive Board, their representatives are automatically appointed without having to stand for election.⁴ This advantage means they do not need to cater to the interests of other countries in advance of elections, allowing their representatives to advance their country’s national interests more effectively. Second, apart from this advantage, the G5 possess around 40 per cent of the Fund’s votes, giving them the ability to easily form a coalition of 50 per cent to pass any decision over lending or conditionality. Third, without the need to form a coalition, the G5 have enough votes to veto any major “program decision” that would change the way in which the organization is governed by its membership, thus preserving the status quo. As such, the group’s power is enshrined in the organization’s rules and design. However, it is rarely invoked or formally exercised. Instead, it prefers informal decision-making procedures, leading to the appearance of consensus. That the organization proceeds by consensus gives the other member-states an incentive to participate, as long as they do not form coalitions to block programs that are favorable to G5 interests.

Finally, how does the G5 actually cooperate as a group? Does it act as a single unit in all lending cases, or are there one or more dominant countries, like the United States? Copelovitch (2010a) is particularly interesting in the context of this question. He argues that the variance of G5 exposure determines whether they will cooperate. When some members of the group have a weak interest in a bailout and others have a strong interest, we should expect them to disagree strongly over the generosity of the bailout. Stone (2011), on the other hand, argues that the United States clearly dominates the other shareholders. I argue that neither perspective captures fully the political pressures on IMF lending. Rather, I contend that the G5 has significant incentives to cooperate, even in cases where it appears that some have a very weak interest and others have a strong interest. If one shareholder is highly exposed, the threat of contagion should push the group to cooperate. A former US Secretary of the Treasury, Robert E. Rubin, put this in simple terms:

Say, for instance, that Japanese banks were heavily exposed to South Korea. And say that U.S. commercial and investment banks had heavy exposure to Japanese banks. South Korea’s troubles could feed back in unexpected ways to U.S. banks that had not considered themselves unduly exposed to South Korea. (Rubin and Weisberg 2003: 231)

As a consequence, I argue that the G5 should cooperate through simple favor-trading where each member of the group supports the most exposed shareholder in the knowledge that the others will reciprocate when their turn comes. This is the most plausible way in which these countries could cooperate, given the rules and design of the IMF. Moreover, too much conflict over lending cases among the group’s members would eventually undermine the informal consensus-based decision-making system at the IMF, which allows the G5 to continue to benefit while also pacifying the other members of the Fund’s 24-member Executive Board.

To summarize, my theory supposes the following steps: First, an economic shock leads interest groups in the G5 to seek favorable IMF treatment for the affected country. Second, G5 governments decide whether to capitulate to the demands of the relevant interest group depending on the degree to which it is exposed. Third, G5 governments engage in international bargaining over IMF treatment for the affected country. And finally, their position at the IMF influences staff behavior, leading to more favorable treatment for a country affected by an economic shock.

The structure of the book

This book proceeds as follows. In Chapter 2, I outline the existing approaches to the study of IMF behavior, finding two very broad approaches to explaining variation in its behavior. The first focuses on the internal drivers of policy change, specifically the IMF’s bureaucracy, and the second stresses the importance of the external drivers of change, most notably powerful states and private actors. Building on this blueprint to explain IMF behavior, Chapter 3 ...

Table of contents

• Cover
• Title
• Copyright
• Contents
• List of Figures and Tables
• Acknowledgments
• List of Abbreviations
• 1 Introduction
• Part I Theory
• Part II Evidence
• Part III Implications
• Appendix
• Notes
• Bibliography
• Index